Commodity Futures Trading Commission Securities and ... · futures can compete with, and be an...

Thursday,

October 4, 2001

Part III

Commodity FuturesTrading CommissionSecurities andExchangeCommission17 CFR Part 41

17 CFR Part 242Customer Margin Rules Relating toSecurity Futures; Proposed Rules

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50720 Federal Register / Vol. 66, No. 193 / Thursday, October 4, 2001 / Proposed Rules

1 All references to the Exchange Act are to 15U.S.C. 78a et seq.

2 Appendix E of Pub. L. No. 106–554, 114 Stat.2763 (2000).

3 15 U.S.C. 78g(c)(2).4 See 15 U.S.C. 78g(c)(2)(A).

COMMODITY FUTURES TRADINGCOMMISSION

17 CFR Part 41

RIN 3038–AB71

SECURITIES AND EXCHANGECOMMISSION

17 CFR Part 242

[Release No. 34–44853; File No. S7–16–01]

RIN 3235–A122

Customer Margin Rules Relating toSecurity Futures

AGENCIES: Commodity Futures TradingCommission and Securities andExchange Commission.ACTION: Joint proposed rules.

SUMMARY: The Commodity FuturesTrading Commission (‘‘CFTC’’) and theSecurities and Exchange Commission(‘‘SEC’’) (collectively, ‘‘Commissions’’)are proposing rules that would establishmargin requirements for securityfutures. The proposed rules wouldpreserve the financial integrity ofmarkets trading security futures, preventsystemic risk, and require that themargin requirements for security futuresbe consistent with the marginrequirements for comparable exchangetraded option contracts.DATES: Comments must be received onor before November 5, 2001.ADDRESSES: Comments should be sent toboth agencies at the addresses listedbelow.

CFTC: Comments should be sent tothe Commodity Futures TradingCommission, Three Lafayette Centre,1155 21st Street, NW, Washington, DC20581, Attention: Office of theSecretariat. Comments may be sent byfacsimile transmission to (202) 418–5521, or by e-mail to [email protected] should be made to ‘‘CustomerMargin for Security Futures.’’ Allcomment letters will be posted, assubmitted, on the CFTC’s Internet website (http://www.cftc.gov).

SEC: Persons wishing to submitwritten comments should send threecopies to Jonathan G. Katz, Secretary,Securities and Exchange Commission,450 Fifth Street, NW, Washington, DC20549–0609. Comments also may besubmitted electronically at the followinge-mail address: [email protected] comment letters should refer to FileNo. S7–16–01; this file number shouldbe included on the subject line if e-mailis used. Comment letters received willbe available for public inspection andcopying in the SEC’s Public Reference

Room, 450 Fifth Street, NW.,Washington, DC 20549–0102.Electronically submitted commentletters will be posted on the SEC’sInternet web site (http://www.sec.gov).The SEC does not edit personalidentifying information, such as namesor e-mail addresses, from electronicsubmissions. Submit only theinformation you wish to make publiclyavailable.FOR FURTHER INFORMATION CONTACT:

CFTC: Phyllis P. Dietz, SpecialCounsel; or Michael A. Piracci,Attorney, Division of Trading andMarkets, Commodity Futures TradingCommission, Three Lafayette Centre,1155 21st Street, NW, Washington, DC20581. Telephone: (202) 418–5000. E-mail: ([email protected]); or([email protected]).

SEC: Hong-anh Tran, Special Counsel,at (202) 942–0088; Jennifer Colihan,Special Counsel, at (202) 942–0735;Bonnie Gauch, Attorney, at (202) 942–0765; and Lisa Jones, Attorney, at (202)942–0063, Division of MarketRegulation, Securities and ExchangeCommission, 450 Fifth Street, NW,Washington, DC 20549–1001.SUPPLEMENTARY INFORMATION: The CFTCis proposing Rules 41.43 through 41.48,17 CFR 41.43 through 41.48, and theSEC is proposing Rules 400 through404, 17 CFR 242.400 through 242.404,under authority delegated by theFederal Reserve Board pursuant to theExchange Act.1

I. IntroductionII. Description of the Proposed Rules

A. Applicability of Regulation TB. Who is Covered by the Proposed RulesC. Exclusions from Coverage1. Financial Relations between a Customer

and a Creditor under a PortfolioMargining System

2. Financial Relations between a ForeignBranch of a Creditor and a ForeignPerson

3. Margin Requirements Imposed byClearing Agencies

4. Credit Extended, Maintained orArranged by a Creditor to or for aMember of a National SecuritiesExchange or a Registered Broker orDealer

a. Margin Arrangements with an ExemptedBorrower

b. Margin Arrangements with a BorrowerOtherwise Exempt Pursuant to Section 7of the Exchange Act

c. Financial Relations Between a Creditorand Member of a National SecuritiesExchange or Association

D. Customer Margin Levels for SecurityFutures

1. Definition of Current Market Value2. Twenty Percent of the Current Market

Value

3. Margin Offsets4. Higher Margin LevelsE. Time Limits for Collection of MarginF. Forms of Collateral

III. SEC and CFTC Rule Review ProcessesRelating to Margin Requirements forSecurity Futures Products

A. CFTC Rule Review Process andProcedures for Notification of ProposedRule Changes Related to Margin

B. SEC Rule Review ProcessIV. Request for CommentsV. Paperwork Reduction Act

A. CFTCB. SEC

VI. Costs and Benefits of the Proposed RulesA. CFTCB. SEC1. Costsa. Compliance with Regulation Tb. Levels of Marginc. Computation of Margind. Notification Requirements Regarding

Exempted Borrowerse. Time Limits for Collection of Margin2. Benefitsa. Benefits to Brokers, Dealers, and

Members of National SecuritiesExchanges

b. Benefits to Customersc. Regulatory BenefitsC. Request for Comments

VII. Consideration of Burden on Competition,Promotion of Efficiency, and CapitalFormation

VIII. Regulatory Flexibility Act CertificationsA. CFTCB. SEC

IX. Statutory Basis and Text of ProposedRules

I. IntroductionThe Commodity Futures

Modernization Act of 2000 (‘‘CFMA’’),2which became law on December 21,2000, lifted the ban on single stock andnarrow-based stock index futures(‘‘security futures’’). In addition, theCFMA established a framework for thejoint regulation of these newly-permissible products by the CFTC andthe SEC.

To facilitate the issuance of rulesgoverning customer margin fortransactions in security futuresproducts, the CFMA added a newsubsection (2) to Section 7(c) of theExchange Act 3 to provide the FederalReserve Board with authority toprescribe regulations for brokers,dealers, and members of nationalsecurities exchanges extending ormaintaining credit to or for, orcollecting margin from, customers forsecurity futures products.4 Section7(c)(2) of the Exchange Act furtherrequires the Federal Reserve Board toprescribe rules establishing initial and


50721Federal Register / Vol. 66, No. 193 / Thursday, October 4, 2001 / Proposed Rules

5 See 15 U.S.C. 78g(c)(2)(B).6 Id.7 See Letter from Jennifer J. Johnson, Secretary of

the Board, Federal Reserve Board, to Mr. James E.Newsome, Acting Chairman, CFTC, and Ms. LauraS. Unger, Acting Chairman, SEC, March 6, 2001,reprinted as Appendix B to this proposal.

8 Because Section 6(h)(6) of the Exchange Actprovides that options on security futures may notbe traded for at least three years after the enactmentof the CFMA, the Commissions are not currentlyproposing margin requirements for options onsecurity futures. 15 U.S.C. 78f(h)(6).

9 15 U.S.C. 78f(a).10 The proposed rules recognize that security

futures can compete with, and be an economicsubstitute for, equity securities, such as equityoptions. Specifically, a synthetic futures contractmay be created by two option contracts based onthe same underlying instrument. To create asynthetic long (short) futures contract, an investorwould buy (sell) a call option and sell (buy) a putoption on the same underlying security, with thesame expiration date and strike price.

11 12 CFR 220 et seq. Regulation T governs theinitial margin requirements imposed by brokers,dealers, and members of national securitiesexchanges for all securities, other than exemptedsecurities and security futures products. The rules

of self-regulatory organizations (‘‘SROs’’) govern,among other things, maintenance marginrequirements. Regulation T, among other things,establishes the securities that may be purchased onmargin, sets the time frames within which initialmargin requirements must be met, establishes anddefines the types of accounts in which broker-dealers may record securities transactions,including the Margin Account, Cash Account,Special Memorandum Account (‘‘SMA’’), the GoodFaith Account, and the Broker-Dealer CreditAccount, and specifies the maximum loan value(i.e., the maximum amount that may be loaned) ofcertain non-exempted equity securities, notincluding security futures products, that may beextended by brokers, dealers or members of nationalsecurities exchanges.

12 The Commissions propose to define ‘‘currentmarket value’’ in Proposed CFTC Rule 41.44(a)(2)and Proposed SEC Rule 401(a)(2), discussed infranotes 62–67 and accompanying text.

13 The term ‘‘regulatory authority’’ means an SROthat is registered as a national securities exchangeunder Section 6 of the Exchange Act (15 U.S.C. 78f)or as a securities association under Section 15A ofthe Exchange Act (15 U.S.C. 78o-3). See ProposedCFTC Rule 41.44(a)(7) and Proposed SEC Rule401(a)(7).

14 The term ‘‘creditor’’ is used in this release andin the proposed rules to refer to brokers, dealers,and members of a national securities exchange thatwould be subject to the margin requirements forsecurity futures. The use of this term and otherterms, such as ‘‘borrower,’’ is not intended toindicate that there is an extension of credit involvedin the margining of security futures. Rather, suchterms are proposed to be used as a means to fulfillthe statutory requirement that the marginrequirements for security futures are and remainconsistent with Regulation T. Regulation T uses theterm ‘‘creditor’’ to refer to brokers, dealers andmembers of a national securities exchange that aresubject to Regulation T requirements for customers’securities positions, including options positions.Margin requirements for short options positionsrepresent a performance bond, as do the marginrequirements proposed today for security futures.

15 See 15 U.S.C. 78g(c)(2)(B)(iv).16 See Proposed CFTC Rule 41.43(b)(1); Proposed

SEC Rule 400(b)(1).17 12 CFR 220.4.18 12 CFR 220.5.19 12 CFR 220.6.

maintenance customer marginrequirements imposed by brokers,dealers, and members of nationalsecurities exchanges for security futuresproducts.5 Alternatively, the ExchangeAct provides that the Federal ReserveBoard may delegate this rulemakingauthority jointly to the Commissions.6The Federal Reserve Board so delegatedits authority by letter dated March 6,2001.7 Accordingly, the Commissionsare proposing initial and maintenancecustomer margin requirements,including the levels of margin, forsecurity futures.8

The rules proposed by theCommissions under Section 7(c)(2) ofthe Exchange Act must satisfy thefollowing four statutory requirements.First, the rules must preserve thefinancial integrity of markets tradingsecurity futures products. Second, theymust prevent systemic risk. Third, therules must require that: (1) The marginrequirements for a security future beconsistent with the margin requirementsfor comparable option contracts tradedon any exchange registered pursuant toSection 6(a) of the Exchange Act;9 and(2) the initial and maintenance marginlevels for a security future not be lowerthan the lowest level of margin,exclusive of premium, required for anycomparable option contract traded onany exchange registered pursuant toSection 6(a) of the Exchange Act, otherthan an option on a security future.10

Fourth, the rules must ensure that themargin requirements (other than levelsof margin), including the type, form,and use of collateral for security futures,are and remain consistent with therequirements established by the FederalReserve Board under Regulation T.11

As jointly proposed by theCommissions, the rules would:

• Establish the minimum initial andmaintenance margin levels required forcustomers carrying a long or shortsecurity futures position at 20 percent ofthe ‘‘current market value’’ of suchposition.12

• Permit regulatory authority 13 rulesto provide that customers with strategy-based offset positions involving securityfutures and one or more relatedsecurities or futures have minimuminitial and maintenance margin levelslower than the aggregate margins for thecomponents of an offset position,provided that such minimum marginlevels are consistent with the marginrequirements for comparable offsetpositions involving exchange-tradedoption contracts.

• Provide that the requirements ofRegulation T, other than margin levels,apply to financial relations between acreditor 14 and a customer with respectto security futures.

• Establish the time limits for thecollection of initial and maintenancemargin from customers; and

• Set forth the acceptable collateralfor margining a security futuretransaction or position.

II. Description of the Proposed Rules

A. Applicability of Regulation T

Section 7(c)(2)(B)(iv) of the ExchangeAct requires that the marginrequirements (other than levels ofmargin), including the type, form, anduse of collateral for security futuresproducts, are and remain consistentwith the requirements established bythe Federal Reserve Board pursuant tosubparagraphs (A) and (B) of Section7(c)(1) of the Exchange Act, i.e.,Regulation T. 15

In analyzing how to implement thestatutory mandate that marginrequirements for security futuresproducts are and remain consistent withRegulation T, the Commissions havediscussed two possible approaches. Thefirst approach, which is reflected in theproposed rules, would require thatRegulation T apply to financialrelations, including marginarrangements, between a creditor and acustomer with respect to securityfutures and any related securities orfutures contracts that are used to offsetpositions in such security futures, to theextent consistent with the proposedrules. 16

This approach would ensure thatexisting and future Federal ReserveBoard interpretations of Regulation Twould apply. This approach is one wayto ensure that margin requirements forsecurity futures would remainconsistent with Regulation T withoutfurther action by the Commissions.

A second approach would be to issuecomprehensive ‘‘stand-alone’’ marginrules that would parallel Regulation Trequirements for securities to the extentthat such requirements are relevant tosecurity futures. The stand-alone ruleswould apply to security futures and anyrelated securities or futures contractsthat are used to offset positions in suchsecurity futures. The stand-alone ruleswould not, however, apply to any othersecurities or futures transactions.

Regulation T establishes and definesthe various types of accounts wheresecurities subject to Regulation T maybe carried and held. These accountsinclude the Margin Account, 17 SMA, 18

the Good Faith Account, 19 the Broker-



20 12 CFR 220.7.21 12 CFR 220.8.22 See 12 CFR 220.4(a)(1).23 The following entries represent credits to the

SMA balance: (1) Dividend and interest payments;(2) Regulation T excess (the amount by which acustomer’s equity exceeds the initial Regulation Trequirement); (3) deposits not needed to meetRegulation T margin calls; (4) deposits of securities(other than security futures) that carry loan valuein the margin account; and (5) cash made availablewhen a liquidation transaction releases funds forwithdrawal from the margin account. See 12 CFR220.5(b)(1)–(4).

24 12 CFR 220.5(b).25 12 CFR 220.7.26 12 CFR 220.6(e).27 15 U.S.C. 78o(b)(1).

28 See Proposed CFTC Rule 41.43(a); ProposedSEC Rule 400(a).


Dealer Credit Account, 20 and the CashAccount. 21

More specifically, Regulation Trequires all transactions to be recordedin a Margin Account, unless they arespecifically authorized for inclusion inanother account. 22 For example, marginin excess of the required margin underRegulation T and certain other itemsmay be journaled as a credit to theSMA 23 where the credit would remainuntil the customer uses such credit bywithdrawing it from the account or byapplying the credit in the SMA asmargin on a new securitiestransaction. 24 Certain broker-dealersalso may effect or finance certaintransactions for their owners, partners,or shareholders, or for other broker-dealers in a broker-dealer creditaccount. 25 Customers may also tradeinstruments other than securities, suchas futures contracts and foreigncurrencies, in a Good Faith Account. 26

Under the proposed rules, securityfutures transactions would be recordedin a Margin Account because theproposed margin level requirementsrepresent a performance bond toguarantee contract performance by boththe buyer and seller of such contract.Any daily net gain (or loss) on a securityfuture (‘‘settlement variation’’) would becredited to (or debited from) the MarginAccount. Broker-dealers registered withthe SEC under Section 15(b)(1) of theExchange Act 27 may journal any marginexcess in the SMA.

The Commissions request commenton the extent to which Regulation Tshould apply to security futures.

Q 1 The Commissions requestcommenters’ suggestions on alternativeways to satisfy the statutory requirementthat the margin requirements (other thanlevels of margin), including the type,form, and use of collateral for securityfutures, are and remain consistent withthe requirements of Regulation T. Inparticular, commenters are asked todiscuss the advantages anddisadvantages of issuing a rule that

incorporates Regulation T by reference,as compared to issuing a stand-alonerule that would include requirements ofRegulation T insofar as they are relevantto security futures. With respect to thestand-alone alternative, commenters areasked to consider any potential issuesarising from the Federal Reserve Board’son-going authority to amend or interpretRegulation T and how such a stand-alone rule would ensure that the marginrequirements for security futures held ineither a securities account or a futuresaccount would remain, over time,consistent with Regulation T.Commenters are asked to explain themeaning they ascribe to the term‘‘consistent,’’ when discussing meansfor satisfying the statutory requirement.

Q 2 The existing customer accountstructure used by futures commissionmerchants (‘‘FCMs’’) offers one type ofcustomer account into which allcustomer property, including cash andother assets, is deposited. FCMs are notcurrently subject to Regulation T and,therefore, do not delineate accounts inaccordance with Regulation T.

(a) Would the application ofRegulation T account requirements toFCMs, to the extent they hold customerpositions in security futures, necessitatethe restructuring of FCM accountsystems?

(b) In addition to the Regulation Taccount structure, what otherrequirements of Regulation T wouldnecessitate operational or other changesfor FCMs that are notice-registeredbroker-dealers?

(c) What are the estimated costsassociated with such changes?

Q 3 Can a futures account beconsidered a Margin Account underRegulation T? If not, how would anFCM modify its futures accounts tosatisfy Regulation T requirements forMargin Accounts?

Q 4 In order to comply withRegulation T, would FCMs need toestablish Regulation T accounts otherthan margin accounts? If so, what wouldbe the costs and operational feasibilityof establishing such accounts?

Q 5 What benefits to FCM customersor others can be expected if an FCMconverts to the Regulation T accountstructure?

Q 6 What benefits to FCM customersor others can be derived fromapplication of other provisions ofRegulation T?

Q 7 How should the SMA work inthe context of security futures?

Q 8 Are there any otherrequirements under Regulation T thatare inappropriate for security futures?

Q 9 Without applying Regulation Taccount requirements, could the

existing rules applicable to futuresaccounts satisfy the statutoryrequirement that the marginrequirements (other than levels ofmargin) including the type, form, use ofcollateral for security futures are andremain consistent with Regulation T?

Q 10 How would broker-dealers,including FCMs that are notice-registered broker-dealers, and membersof national securities exchangesstructure customer accounts ifRegulation T were not incorporated byreference into the margin rules forsecurity futures?

Q 11 (a) If the Commissions were toissue stand-alone rules that wereparallel to Regulation T, how wouldcommenters recommend that theCommissions incorporate the FederalReserve Board’s existing and futureinterpretations of Regulation T into suchstand-alone rules?

(b) How would stand-alone rulesimpact the way securities firmscalculate margin requirements forsecurities other than security futures?

(c) Is there a risk of inconsistentapplication of the same rules?

(d) What implications would thisapproach have for compliance withsuch rules?

Q 12 Should the proposed rulesincorporate any special requirements forspecific types of transactions or tradingactivity (e.g., day trading) that may beimposed under the margin rules of theSROs?

B. Who Is Covered by the ProposedRules

The principal purpose of theproposed rules is to regulate customermargin collected by brokers, dealers,and members of national securitiesexchanges related to customers’transactions in security futures,including the minimum amount ofinitial and maintenance margin thatmust be collected.28 The proposalwould require a broker, dealer, ormember of a national securitiesexchange that effects transactions for acustomer involving, or carrying anaccount for a customer containing, asecurity future to collect from suchcustomer sufficient collateral to satisfythe margin requirements set forth inProposed CFTC Rules 41.43 through41.48, and Proposed SEC Rules 400through 404.29

FCMs are brokers or dealers under theExchange Act if they effect transactionsin securities, including security future



30 15 U.S.C. 78o(b).31 15 U.s.C. 78o(b)(11).32 See Securities Exchange Act Release No. 44730

(August 21, 2001), 66 FR 45138 (August 27, 2001)(SEC Release adopting amendments to its broker-dealer registration requirements for notice-registered broker-dealers and adopting Form BD–N).

33 15 U.S.C. 78f(g).34 See Proposed CFTC Rule 41.45; Proposed SEC

Rule 402(a).35 See Proposed CFTC Rule 41.43(b)(3); Proposed

SEC rule 400(b)(3). The Commissions note thatthere may be some factual circumstances that willsatisfy the criteria of more than one exclusion.

36 15 U.S.C. 78g(c)(2)(B)(iii).37 12 CFR 220.1(b)(3)(i).

38 12 CFR 220.12(f)(1).39 See Proposed CFTC Rule 41.43(b)(3)(i);

Proposed SEC rule 400(b)(3)(i).40 15 U.S.C. 78s(b)(2); 7 U.S.C. 7a–2(c). Pursuant

to Sections 19(b)(1) and 6(g)(4)(B)(ii) of theExchange Act (15 U.S.C. 78s(b)(1) and 15 U.S.C.78f(g)(4)(B)(ii), respectively), rules implementingportfolio margining for security futures must besubmitted to the SEC for approval in accordancewith Section 19(b)(2) of the Exchange Act.Designated contract markets registered underSection 5 of the CEA and registered derivativestransaction execution facilities (‘‘DTFs’’) also mustseek prior approval from the CFTC or providenotice by written certification to the CFTC,pursuant to Section 5c(c) of the CEA (7 U.S.C. 7a–2(c)). See infra notes 110–140 and accompanyingtext.

41 The CFTC also has approved SPAN marginingfor all options on futures contracts. Developed in1988, the SPAN margining system currently is usedon more than 30 exchanges and clearingorganizations worldwide, including the LondonInternational Financial Futures Exchange, whichtrades single stock futures contracts.

42 See Securities Exchange Act Release No. 23167(April 22, 1986), 51 FR 16127 (April 30, 1986).

43 See Securities Exchange Act Release No. 28928(March 1, 1991), 56 FR 9995 (March 8, 1991).

44 To date, the Commissions have approved cross-margining programs between The OCC and thefollowing futures clearing organizations: TheIntermarket Clearing Corporation (1988); ChicagoMercantile Exchange (‘‘CME’’) (1989); Board ofTrade Clearing Corporation (‘‘BTCC’’) (1991);Kansas City Board of Trade Clearing Corporation(1992); and Comex Clearing Association (1992). TheCommissions also have approved cross-marginingprograms between the Government SecuritiesClearing Corporation and the following futuresclearing organizations: the New York ClearingCorporation (1999); BTCC (2001); and CME (2001).For further discussion of cross-margining programs,see ‘‘Eighth Annual Report to the Board ofGovernors of the Federal Reserve System on theReview of Stock Index Futures and OptionMargining Systems by the Commodity FuturesTrading Commission’’ (June 2001), note 7 andaccompanying text (available from the CFTC Officeof the Secretariat).

45 The pilot program currently being developedby the CBOE, The OCC, the NYSE, AMEX, CBOTand CME is contemplated to be available for (1) anyregistered broker or dealer registered with the SECpursuant to Section 15(b)(1) of the Exchange Act;(2) any affiliate of a self-clearing Exchange ActSection 15(b)(1) registered broker-dealer; (3) anyregistered futures floor trader to the extent thatlisted index options positions hedge the trader’sindex futures and options positions; and (4) anyperson or entity that has or, establishes andmaintains equity of at least five million dollarsacross all securities and futures accounts under his/her/its common ownership.

products, and they would therefore besubject to these proposed rules.Accordingly, such FCMs must registeras broker-dealers under Section 15(b) ofthe Exchange Act. 30 The CFMA addedSection 15(b)(11) to the Exchange Act, 31

which permits FCMs to register asbroker-dealers by filing a written noticewith the SEC for the limited purpose oftrading security futures products, ifcertain conditions are met.32 Inaddition, although certain naturalpersons that are members of designatedcontract markets registered underSection 6(g) of the Exchange Act33 areexempt from the broker-dealerregistration requirements, those personsare members of a national securitiesexchange and, as such, would be subjectto the proposed rules.34

The rules would explicitly excludecertain categories of financialrelations.35 The proposed exclusions aredescribed below.

C. Exclusions From Coverage

1. Financial Relations Between aCustomer and a Creditor under aPortfolio Margining System

Section 7(c)(2)(B)(iii) of the ExchangeAct 36 provides that the marginrequirements for security futures mustbe consistent with the marginrequirements for comparable exchange-traded options, and the initial andmaintenance margin levels for a securityfuture may not be lower than the lowestlevel of margin, exclusive of premium,required for any comparable exchange-traded option. Accordingly, risk-sensitive/portfolio-based margining(‘‘portfolio margining’’) for securityfutures would be permissible to theextent it would be permissible forcomparable exchange-traded options.

Regulation T by its terms does notapply to financial relations between acustomer and a creditor to the extentthat they ‘‘comply with a portfoliomargining system under rules approvedor amended by the SEC.’’37 Moreover,Regulation T provides that the requiredmargin for exchange-traded optionsshall be the amount or other position

specified by the rules of the registerednational securities exchange orregistered national securities associationauthorized to trade the option, that havebeen approved, or amended, by theSEC.38 Accordingly, if a portfoliomargining system were developed by aregistered national securities exchangeor registered securities association, andapproved by the SEC for exchange-traded options, a comparable portfoliomargining system could be developedfor security futures products.

The proposed rules 39 similarly do notapply to financial relations between acustomer and a creditor to the extentthat they comply with a portfoliomargining system under rules that havebecome effective in accordance withSection 19(b)(2) of the Exchange Actand, as applicable, Section 5c(c) of theCEA.40

Portfolio margining sets levels ofmargin by assessing the actual netmarket risk of specific market positionsin specific securities or commodities.Under a portfolio margining system, theamount of required margin isdetermined by analyzing the risk of eachcomponent position in a customeraccount (e.g., a class of option with thesame expiration date) and byrecognizing any risk offsets in an overallportfolio of positions (e.g., acrosscontracts on the same underlyinginstrument). So that adequate margin isdeposited to cover extraordinary marketevents, one or more additionalmultipliers or other adjustments may beapplied in calculating a customer’srequired margin. Depending upon therisks attributable to one or morepositions, the amount of requiredmargin may be greater than or less thanthe margin levels currently required forsecurities positions in a fixed-percentage strategy-based marginingsystem.

The SEC and the CFTC have alreadyapproved exchange rules regarding anumber of different portfolio marginingsystems for various purposes. The CFTChas approved portfolio margining using

the Standard Portfolio Analysis of Risk(‘‘SPAN’’) system for all currentlytraded futures contracts, at both theclearing level and customer level.41 In1986, the SEC first approved TheOptions Clearing Corporation (‘‘TheOCC’’) portfolio margining system, theTheoretical Intermarket Margin System(‘‘TIMS’’), for margin collected by TheOCC for the non-equity option positionsof The OCC clearing members.42 In1991, the SEC approved The OCC’s useof TIMS for equity options.43 Moreover,the SEC and CFTC have approvedexchange rules that permit portfoliomargining for options market makers inthe context of limited cross-marginingprograms involving futures and optionson broad-based stock indexes.44

Currently, the Chicago Board OptionsExchange (‘‘CBOE’’) is working incooperation with The OCC, the NewYork Stock Exchange (‘‘NYSE’’), theAmerican Stock Exchange (‘‘AMEX’’),the Chicago Board of Trade (‘‘CBOT’’),and the CME to develop a pilot programthat would provide an alternativemethod of margining (i.e., a portfoliomargining system) for certaincustomers 45 in broad-based stock index



46 This pilot program would likely take a two-prong approach: (1) It would adopt a portfoliomargining system that sets margin requirements forportfolios in a securities account consisting ofpositions in products based on U.S. domestic broad-based market indexes, including securities indexoptions, securities index warrants, and marginableindex Unit Investment Trusts (‘‘UITs’’) based on thegreatest projected net loss of all positions in a ‘‘classgroup’’ or ‘‘product group’’ as determined by anoptions pricing model covering a specified range ofmarket moves; and (2) it would adopt a cross-margining system that would apply a portfoliomargining system to portfolios consisting ofpositions in products based on U.S. domestic broad-based market indexes, including securities indexoptions and warrants, UITs, and index futures andoptions on index futures. The two prongs of thepilot are severable, and only the approval of thefirst prong—a portfolio margining system—is aprecondition for using portfolio margining, ratherthan strategy-based margining, for security futures.

Before approving the cross-margining system, theCommissions would need to ensure that any suchaccounts are adequately protected againstinsolvency risks; in particular, relief fromapplicable securities and commodities customerprotection regimes is necessary to facilitate cross-margining.

47 In its delegation letter, the Federal ReserveBoard requested that ‘‘the Commissions provide anassessment of progress toward adopting more risk-sensitive, portfolio-based approaches to marginingsecurity futures products.’’ It further stated that‘‘The Board has encouraged the development ofsuch approaches by, for example, amending itsRegulation T so that portfolio margining systemsapproved by the [SEC] can be used in lieu of the

strategy-based system embodied in the Board’sregulation. The Board anticipates that the creationof security future products will provide anotheropportunity to develop more risk-sensitive,portfolio based approaches for all securities,including security options and security futuresproducts.’’ See Appendix B.

48 12 CFR 220.1(b)(3)(iv).49 Regulation T defines the term ‘‘foreign person’’

to mean a person other than a United States personas defiend in Section 7(f) of the Exchange Act. See12 CFR 220.2.

50 15 U.S.C. 78g(c)(2).51 See Appendix B.52 15 U.S.C. 78s(b)(2).53 7 U.S.C. 7a–1; 7 U.S.C. 7a–2.

options and futures positions. The staffsof the Commissions are working withthe participating regulatory authoritiesand their members to identify theregulatory and operational issues thatneed to be resolved to ensure successfulimplementation by the regulatoryauthorities of a portfolio marginingsystem for securities futures products.46

Among other issues, the Commissionswould have to be satisfied that theportfolio margining system used tocalculate customer margin requirementsappropriately takes into account thetrading characteristics and historicalmarket performance of the applicablesecurities products, as well as theobserved correlations among thoseproducts to the extent that offsets acrossvarious products are permitted. TheCommissions would also need to beconfident that the system provides asufficient cushion of margin or capitalagainst extraordinary price movements.

The Commissions strongly encouragethe efforts of market participants todevelop a portfolio margining proposalfor security futures, and are committedto working with these participants toresolve any outstanding issues, asquickly as feasible. Such a portfoliomargining system would also beresponsive to the Federal ReserveBoard’s desire to encourage thedevelopment of more risk-sensitive,portfolio-based approaches to marginingsecurity futures products.47

Q 13 Should there be anyrestrictions on a firm’s eligibility to offera portfolio margining system to itscustomers? If so, what types ofrestrictions are appropriate?

Q 14 Should there be anyrestrictions on a customer’s eligibility touse portfolio margining? If so, whattypes of restrictions are appropriate?

Q 15 (a) Should a firm be permittedto elect to use either SPAN or TIMS tocalculate security futures marginrequirements?

(b) Would the use of SPAN and TIMSresult in significantly different marginrequirements for the same account?

(c) Are there other portfolio marginingsystems that the Commissions shouldconsider?

Q 16 What costs would be incurredin order for firms to set up and operatea portfolio margining system? Howwould the costs of using a portfoliomargining system differ from the costsof using the proposed strategy-basedapproach?

2. Financial Relations Between aForeign Branch of a Creditor and aForeign Person

Financial relations between a foreignbranch of a creditor and a foreign personinvolving foreign securities areexcluded from the scope of RegulationT.48 Similarly, Proposed CFTC Rule41.43(b)(3)(ii) and Proposed SEC Rule400(b)(3)(ii) specify that the proposedrules would not apply to financialrelations between a foreign branch of acreditor and a foreign person involvingforeign security futures.49 Thisexclusion is designed so that financialrelations between a foreign branch of acreditor and a foreign person involvingforeign securities would be treated in amanner consistent with the wayRegulation T treats such financialrelations.

3. Margin Requirements Imposed byClearing Agencies

Section 7(c)(2) of the Exchange Actgives the Federal Reserve Board theauthority to prescribe regulationsregarding the extension or maintenanceof credit to or for, or the collection ofmargin from, any customer on any

security futures product,50 but it doesnot confer authority over marginrequirements for clearing agencies. Forthis reason, in its delegation letter, theFederal Reserve Board stated that ‘‘[t]heauthority delegated by the Board islimited to customer marginrequirements imposed by brokers,dealers, and members of nationalsecurities exchanges. It does not covermargin requirements imposed byclearing agencies on their members.’’ 51

The margin rules of clearing agenciesare approved by the SEC pursuant toSection 19(b)(2) of the Exchange Act.52

The CFTC has authority to ensurecompliance with core principles forclearing organizations under Sections 5band 5c of the CEA.53

Proposed CFTC Rule 41.43(b)(3)(iii)and Proposed SEC Rule 400(b)(3)(iii)would exclude from the proposed rulesmargin requirements that clearingagencies registered with the SEC or theCFTC impose on their members. Thepurpose of the proposed rules would beto clarify that these margin rules wouldnot apply to clearing agencies registeredwith either the SEC or the CFTC.

4. Credit Extended, Maintained orArranged by a Creditor to or for aMember of a National SecuritiesExchange or a Registered Broker orDealer

a. Margin Arrangements With anExempted Borrower

Proposed CFTC Rule41.43(b)(3)(iv)(A) and Proposed SECRule 400(b)(3)(iv)(A) would excludefrom the proposed rules’ requirementsmargin arrangements between a creditorand a borrower with respect to theborrower’s financing of proprietarypositions in security futures, based onthe creditor’s good faith determinationthat the borrower is an ‘‘exemptedborrower.’’ Regulation T defines an‘‘exempted borrower’’ as a member of anational securities exchange or aregistered broker or dealer, a substantialportion of whose business consists oftransactions with persons other thanbrokers or dealers, and includes aborrower who: (1) Maintains at least1,000 active accounts on an annual basisfor persons other than brokers, dealers,and persons associated with a broker ordealer; (2) earns at least $10 million ingross revenues on an annual basis fromtransactions with persons other thanbrokers, dealers, and persons associatedwith a broker or dealer; or (3) earns atleast 10 percent of its gross revenues on



54 12 CFR 220.2.55 See 15 U.S.C. 78g(c)(3)(A); see also 12 CFR

220.2.56 See 15 U.S.C. 78g(c)(3).57 In its March 6, 2001 letter, the Federal Reserve

Board stated that ‘‘[i]n the current open-outcryenvironment, the Board believes that floor tradersact as market makers and therefore would beexempt [under Section 7(c)(3) of the ExchangeAct].’’ See Appendix B.

58 15 U.S.C. 78g(c)(3).

59 15 U.S.C. 78o–3(a).60 15 U.S.C. 78s(b)(2).61 This provision incorporates the definition of

‘‘market maker’’ found in Section 3(a)(38) of theExchange Act (15 U.S.C. 78c(a)(38)), whichprovides that a market maker is ‘‘any specialistpermitted to act as a dealer, any dealer acting in thecapacity of block positioner, and any dealer who,with respect to a security, holds himself out (byentering quotations in an inter-dealercommunications system or otherwise) as beingwilling to buy and sell such security for his ownaccount on a regular or continuous basis.’’

62 The option premium is the net sales proceedsof the option on the day the option is sold. SeeAmex Rule 462; CBOE Rule 12.3; and NYSE Rule431.

63 Id.64 Id.

an annual basis from transactions withpersons other than brokers, dealers, andpersons associated with a broker ordealer.54

The Regulation T criteria for an‘‘exempted borrower’’ establishstandards for the applicability ofSection 7(c)(3)(A) of the Exchange Act,which exempts from federal marginrules ‘‘credit extended, maintained, orarranged by a member of a nationalsecurities exchange or a broker or dealerto or for a member of a nationalsecurities exchange or a registeredbroker or dealer * * * a substantialportion of whose business consists oftransactions with persons other thanbrokers or dealers.’’ 55

The Commissions propose underCFTC Rule 41.45(e) and SEC Rule 402(e)that once a person ceases to qualify asan exempted borrower under RegulationT, it would be required to notify thecreditor of this fact before establishingany new security future positions.Under such circumstances, any newsecurity future positions established bysuch person would be subject to theprovisions of this proposed regulation.

b. Margin Arrangements With aBorrower Otherwise Exempt Pursuant toSection 7 of the Exchange Act

Under Section 7(c)(3) of the ExchangeAct, the financing of the market makingor underwriting activities of a memberof a national securities exchange or aregistered broker or dealer is exemptedfrom the scope of federal marginregulation.56 The Federal Reserve Boardhas expressed the view that certainfutures floor traders, i.e., those tradingin the current open-outcry environment,act as market makers and thereforewould be exempt under Section 7(c)(3)of the Exchange Act.57 For clarity, theCommissions are proposing to specifyunder Proposed CFTC Rule41.43(b)(3)(iv)(B) and Proposed SECRule 400(b)(3)(iv)(B) that creditextended by a broker, dealer or memberof a national securities exchange that isexempt under Section 7(c)(3) of theExchange Act 58 would also be excludedfrom the proposed rules.

c. Financial Relations Between aCreditor and a Member of a NationalSecurities Exchange or Association

In addition, because the Commissionsexpect that certain members of nationalsecurities exchanges that use a screen-based trading system also will act asmarket makers, the Commissions areproposing to exclude from the scope ofthe proposed rules certain floor traders,floor brokers, and securities dealers whoare exchange members and who havemarket maker obligations. Accordingly,the Commissions propose under CFTCRule 41.43(b)(3)(iv)(C) and SEC Rule400(b)(3)(iv)(C) to exclude from thescope of these proposed rules creditextended by a creditor to a member ofa national securities exchange or anational securities association registeredpursuant to Section 15A(a) of theExchange Act 59 that does not directly orindirectly accept or solicit orders fromany customer or provide advice to anycustomer in connection with the tradingof securities futures and that isregistered with such exchange orassociation as a security futures dealer,pursuant to regulatory authority rulesapproved by the SEC pursuant toSection 19(b)(2) of the Exchange Act.60

To take advantage of this exemptionthese regulatory authority rules wouldhave to require such member: (1) To beregistered as a floor trader or floorbroker with the CFTC, or as a dealerwith the SEC; (2) to comply withapplicable SEC or CFTC net capitalrequirements; (3) to maintain recordssufficient to demonstrate compliancewith this proposed exclusion and therules of the exchange or association; and(4) to hold itself out as willing to buyand sell security futures for its ownaccount on a regular or continuousbasis.61 Finally, the regulatoryauthority’s rules would have to providefor disciplinary action against a memberfor its failure to comply with theCommissions’ margin rules or the rulesof the exchange or association.

Q 17 (a) Do the criteria set forth inproposed CFTC Rule41.43(b)(3)(iv)(C)(2) and proposed SECRule 400(b)(3)(iv)(C)(2) encompass all ofthe persons that would perform a

market maker function in an electronicmarket?

(b) Is this provision equitable to bothsecurities exchanges and futuresexchanges trading security futures?

D. Customer Margin Levels for SecurityFutures

This section describes how theCommissions propose that brokers,dealers, and national securitiesexchange members calculate thecustomer margin levels for securityfutures. Specifically, the Commissionspropose to require both the seller andthe buyer of a security future to provideand maintain, on a daily basis, cash orother acceptable assets equal to apercentage of the ‘‘current marketvalue’’ of the security future.

1. Definition of Current Market Value

Currently, the initial and maintenancemargin requirements for the sale of anat-the-money, uncovered put or calloption are 100 percent of the optionpremium,62 plus a fixed percentage ofthe value of the underlying financialinstrument. The reference price used indetermining the value of the underlyingfinancial instrument when calculatingthe initial margin required on the saleof an uncovered option differs from thereference price used in calculating itsmaintenance margin. Specifically, todetermine the initial margin required onthe sale of an uncovered put or calloption, the price used to determine thevalue of the underlying stock is theprice at which the stock closed on thebusiness day preceding the day onwhich the option is sold.63 Todetermine the maintenance marginrequired at the end of a particulartrading day for an uncovered, short putor call option, the price used is the priceat which the underlying stock closed atthe end of such trading day.64

The CFMA requires that the marginrequirements for security futures beconsistent with the margin requirementsfor comparable options contracts. Forthis reason, the Commissions areproposing to use a reference price fordetermining security futures marginconsistent with the reference price usedfor determining margin on uncoveredshort options positions. Specifically, theCommissions are proposing to requirethat the daily settlement price of asecurity future be used to calculate boththe initial and maintenance margin



65 Under Proposed CFTC Rule 41.44(a)(8) andProposed SEC Rule 401(a)(8), the daily settlementprice means, with respect to a security future, thesettlement price of such security future determinedat the close of trading each day, as determined bythe rules of the applicable exchange or clearingorganization. This daily settlement price is used forcalculating daily margin requirements. For physicaldelivery contracts, the settlement price on the lasttrading day may also be used as the invoice pricefor delivery of the security. For cash settledcontracts, the final settlement price of a securityfuture is directly based on the market for theunderlying stock or security and may differ fromthe daily settlement price on the last trading day.See Securities Exchange Act Release No. 44743(August 24, 2001), 66 FR 45904 (August 30, 2001).

66 See Proposed CFTC Rule 41.44(a)(2)(i);Proposed SEC Rule 401(a)(2)(i).

67 See Proposed CFTC Rule 41.44(a)(2)(ii);Proposed SEC Rule 401(a)(2)(ii). Under ProposedCFTC Rule 41.44(a)(1) and Proposed SEC Rule401(a)(1), the term contract multiplier means thenumber of units of a narrow-based security indexexpressed as a dollar amount, in accordance withthe terms of the security future.

68 See Proposed CFTC Rule 41.45(b); ProposedSEC Rule 402(b).

69 15 U.S.C. 78g(c)(2).70 See, e.g., Amex Rule 462; CBOE Rule 12.3;

National Association of Securities Dealers(‘‘NASD’’) Rule 2520; NYSE Rule 431; PCX Rule2.16; and Philadelphia Stock Exchange Rule 722.

71 See Proposed CFTC Rule 41.45(b)(1); ProposedSEC Rule 402(b)(1).

72 See Proposed CFTC Rule 45.45(b)(2); ProposedSEC Rule 402(b)(2).

73 See Appendix B.74 See Proposed CFTC Rule 41.45(d); Proposed

SEC Rule 402(d).75 See Securities Exchange Act Release Nos.

41658 (July 27, 1999), 64 FR 42736 (August 5, 1999)(order approving SR–CBOE–97–67 amending CBOERule 12.3); 42011 (October 14, 1999), 64 FR 57172(October 22, 1999) (order approving SR–NYSE–99–03 amending NYSE Rule 431); 43582 (November 17,2000), 65 FR 70854 (November 28, 2000) (orderapproving SR–Amex–99–27 amending Amex Rule462); and 43581 (November 17, 2000), 65 FR 71151(November 29, 2000) (order approving SR–NASD–00–15 amending NASD Rule 2520).

requirements for such security future.65

The Commissions believe that, forpurposes of calculating marginrequirements for a security future, usingthe daily settlement price for suchfuture as the reference price isconsistent with the use of the closingprice of the underlying security used asthe reference price for determiningmargin for equity options. For thesereasons, the Commissions are proposingto use the daily settlement price of asecurity future as the reference price forcalculating margin for such securityfuture.

In addition, the Commissions believethat using the daily settlement price ofa security future on the day of atransaction—rather than the dailysettlement price on the day precedingthe transaction—to calculate the initialmargin is consistent with using theunderlying stock’s closing price on thepreceding business day. The dailysettlement price of a security future onthe preceding business day, forexample, may not exist if such securityfuture were not available for trading onthe preceding business day.

Finally, the Commissions propose todefine ‘‘current market value’’ of afuture on a single security, on anytrading day, to be the product of thedaily settlement price of such securityfuture as shown by any regularlypublished reporting or quotationservice, and the applicable number ofshares per contract.66 The Commissionspropose to define ‘‘current marketvalue’’ of a narrow-based security indexfuture to be the product of the dailysettlement price of such security future,as shown by any regularly publishedreporting or quotation service, and theapplicable contract multiplier.67 Q 18 Isthe proposed method for calculatingcurrent market value of a security future

appropriate? If not, commenters arerequested to suggest alternatives.

2. Twenty Percent of the Current MarketValue

The Commissions propose that theminimum initial and maintenancemargin levels required of customers foreach security future carried in a long orshort position be 20 percent of thecurrent market value of such securityfuture.68 Under Section 7(c)(2) of theExchange Act, the initial andmaintenance margin levels for a securityfuture must not be lower than the lowestlevel of margin, exclusive of premium,required for any comparable optioncontracts traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act.69

Currently, all listed options have thesame margin requirements. For long,listed option contracts the purchaser isgenerally required to pay the fullamount of such contract. The requiredinitial and maintenance margin forshort, at-the-money listed optioncontracts, where the underlyinginstrument is either an equity security(such as a stock or an instrumentimmediately convertible into a stock), ora narrow-based index, are 100 percent ofthe option proceeds plus 20 percent ofthe underlying security or indexvalue.70

Unlike an options contract, however,a futures contract involves obligations ofboth parties to perform in the future—the buyer (long) to purchase the assetunderlying the future and the seller(short) to deliver the asset. Thus, boththe buyer and the seller of a futurescontract must initially post andmaintain, on a daily basis, margin toassure contract performance and theintegrity of the marketplace. In addition,all market participants pay or receivedaily settlement variation payments as aresult of all open futures positions beingmarked to current market value by theclearing organization.

The Commissions propose that theinitial and maintenance margin levelsrequired of customers for each securityfuture carried in a long or short positionbe 20 percent of the current marketvalue of such security future 71 because20 percent is the uniform margin levelrequired for short, at-the-money equityoptions traded on U.S. options

exchanges. Any national securitiesexchange or national securitiesassociation may, of course, imposehigher margin level requirements on itsmembers, and any broker, dealer, ormember of a national securitiesexchange may impose higher marginlevel requirements on its customers.72

As noted elsewhere in this notice, theFederal Reserve Board has expressed theview that ‘‘more risk-sensitive,portfolio-based approaches to marginingsecurity futures products’’ should beadopted.73 Pending adoption of suchsystems by regulatory authorities,however, the 20 percent level isconsistent with the currentrequirements for comparable equityoptions.

3. Margin Offsets

The Commissions also propose toallow national securities exchanges ornational securities associations to haverules that reduce the marginrequirements for customers with certainsecurity or futures positions that offsettheir security futures positions,provided that the resulting marginlevels are not lower than the lowestcustomer margin levels required forcomparable offset positions involvingoption contracts traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act.74

Currently, regulatory authority rulesapproved by the SEC permit lowermaintenance margin requirements forstock positions that are part of hedgingstrategies with options positions.75 Thefollowing hedging strategies, forexample, currently have lowermaintenance margin requirements forthe overall combined position thanwould be the case if each componentposition in each of the hedgingstrategies described below weremargined separately:

(1) Long put option/long stock;(2) Long call option/short stock;(3) Long stock/long put option/short

call option (where the put and the calloptions have the same expiration dateand exercise price);



76 See, e.g., NYSE Rule 431(f)(2)(G). In addition tothese hedging strategies that affect the maintenancemargin requirement for the underlying stock, thereare strategies involving covered calls (long theunderlying security and a short call option position)and covered puts (short the underlying security anda short put option position) in which there are noinitial or maintenance margin requirements for theoption component. There are also hedging strategiesinvolving option-to-option offsets with lower initialand maintenance margin requirements.

77 Regulation T requires that the initial margin forcertain equity securities, other than exemptedsecurities and security future products, be 50

percent of the current market value of the security.See 12 CFR 220.12(a).

78 See, e.g., NYSE Rule 431(f)(2)(C).79 The maintenance margin for a short stock is

calculated as either: (1) $2.50 per share or 100% ofthe current market value (as defined in RegulationT), whichever amount is greater, of each stock shortin the account selling at less than $5.00 per share;or (2) $5.00 per share or 30% of the current marketvalue (as defined in Regulation T), whicheveramount is greater, of each stock short in the accountselling at $5.00 per share or above. See, e.g., NYSERule 431(c).

80 A customer is required to have equity of at least$2,000, except that cash need not be deposited inexcess of the cost of any security purchased. See,e.g., NYSE Rule 431(b).

81 See, e.g., NYSE Rule 431(f)(2)(G)(v).82 15 U.S.C. 78s(b)(2). Implementation of such

rules by designated contract markets registeredunder Section 5 of the CEA (7 U.S.C. 7) andregistered DTFs also would be subject to the noticerequirements of Section 5c of the CEA (7 U.S.C. 7a–2). See infra notes 110–121 and accompanying text.

83–88See supra note 75.

(4) Short stock/short put option/longcall option (where the put and the calloptions have the same expiration dateand exercise price); and

(5) Long stock/long put option/shortcall option (where the put and the calloptions have the same expiration date,but the exercise price of the long putoption is lower than the exercise priceof the short call option).76

Because, however, the initial marginfor equity securities is governed byRegulation T, the initial margin on thestock components of hedging strategiesremains the same as initial margin forstock that is not part of a hedgingstrategy.77 Thus, to initially purchaseany one of these combined stock/option(s) positions on margin, acustomer must satisfy the marginrequirements individually for each ofthe securities that compose the hedgingstrategy. For example, when enteringinto a combined long call optionposition and a short position in thestock underlying the call option, acustomer must pay for the call option infull 78 and satisfy the initial marginrequirement for the short stock position,which is the greater of: (1) The amountspecified in Regulation T; (2) themaintenance margin requirement underSRO rules for a short stock;79 (3) suchgreater amount as the SRO may from

time to time require for specificsecurities; or (4) the minimum equityrequired to be deposited under theSRO’s rules.80 However, for thecustomer to maintain the same long calloption and short stock position, thecustomer need only maintain margin inits account equal to the lesser of: (1) 10percent of the call option exercise price,plus 100 percent of any amount bywhich the call option is out-of-the-money; and (2) the maintenance marginrequirement on the short stockposition.81

Under this joint proposal, theCommissions propose that customers bepermitted to offset positions involvingsecurity futures with certain relatedsecurities or futures. Such offsets wouldbe available under regulatory authorityrules approved by the SEC pursuant toSection 19(b)(2) of the Exchange Act.82

When the SEC approved strategy-based offsets for options (that arecomparable to the offsets proposed to bepermitted for security futures in thechart below), the SEC found that it wasappropriate for the SROs to recognizethe hedged nature of certain combinedoptions strategies and prescribe marginrequirements that better reflect the riskof those strategies.83–88 Furthermore, theSEC found that the SROs’ proposalsrelating to strategy-based offsets

involving options contracts werecarefully crafted as they were based onthe SROs’ experiences in monitoring thecredit exposures of options strategies. Inparticular, the SEC noted that the SROsregularly examine the coverage ofoptions margin as it relates to pricemovements in the underlying securitiesand index components. Moreover, theSROs’ proposals were thoroughlyreviewed by the NYSE Rule 431 ReviewCommittee, which is comprised ofsecurities industry participants whohave extensive experience in marginand credit matters. As a result of thesefactors, the SEC was confident that theSROs’ proposed margin requirementswere consistent with investor protectionand properly reflected the risks of theunderlying options positions.

The following table includes strategy-based offsets for security futures that theCommissions have preliminarilyidentified as consistent with thosepermitted for comparable offsetpositions involving options, and thatwould qualify for reduced marginlevels. Although the levels are intendedto be consistent with the margin levelsfor comparable offsets involvingoptions, the Commissions recognize thatthe margin levels set forth in the tablemay not fully reflect the reduction inrisk associated with the offsets.

Description of offset Security underlying thesecurity future

Initial marginrequirement

Maintenance margin require-ment

1 ............... Long security future or shortsecurity future.

Individual stock or narrow-based security index.

20% current market value ofthe security future.

20% current market value ofthe security future.

2 ............... Long security future (or basketof security futures rep-resenting each componentof a narrow-based securitiesindex 1) and long put op-tion 2 on the same under-lying security (or index).


20% of the current marketvalue of the long security fu-ture, plus pay for the longput in full.

The lower of: (1) 10% of thethe aggregate exerciseprice 3 of the plus put plusthe aggregate put out-of-the-money 4 amount, if any;or (2) 20% of the currentmarket value of the long se-curity future.

3 ............... Short security future (or bas-ket of security futures rep-resenting each componentof a narrow-based securitiesindex) and short put optionon the same underlying se-curity (or index).


20% of the current marketvalue of the short securityfuture, plus the aggregateput in-the-aggregate moneyamount, if any. Proceedsfrom the put sale may beapplied.

20% of the current marketvalue of the short securityfuture, plus the aggregateput in-the-money amount, ifany.5






4 ............... Long security future and shortposition in the same secu-rity (or securities basket)underlying the security fu-ture.


The initial margin requiredunder Regulation T for theshort stock or stocks.

10% of the current marketvalue as defined in Regula-tion T of the stock or stocksunderlying the security fu-ture.

5 ............... Long security future (or basketof security futures rep-resenting each componentof a narrow-based securitiesindex) and Short call optionon the same underlying se-curity (or index).


20% of the current marketvalue of the long security fu-ture, plus the aggregratecall in-the-money amount, ifany. Proceeds from the callsale may be applied.

20% of the current marketvalue of the long security fu-ture, plus the aggregate callin-the-money amount, ifany.

6 ............... Long a basket of narrow-based security futures thattogether tracks a broadbased index and short abroad-based security indexcall option contract on thesame index.

Narrow-based security index .. 20% of the current marketvalue of the long basket ofnarrow-based security fu-tures, plus the aggregatecall in-the-money amount, ifany. Proceeds from the callmay be applied.

20% of the current marketvalue of the long basket ofnarrow-based security fu-tures, plus the aggregatecall in-the-money amount, ifany.

7 ............... Short a basket of narrow-based security futures thattogether tracks a broad-based security index andshort a broad-based secu-rity index put option contracton the same index.

Narrow-based security index .. 20% of the current marketvalue of the short basket ofnarrow-based security fu-tures, plus the aggregateput in-the-money amount, ifany. Proceeds from the putsale may be applied.

20% of the current marketvalue of the short basket ofnarrow-based security fu-tures, plus the aggregateput in-the-money amount, ifany.

8 ............... Long a basket of narrow-based security futures thattogether tracks a broad-based security index andlong a broad-based securityindex put option contract onthe same index.

Narrow-based security index .. 20% of the current marketvalue of the long basket ofnarrow-based security fu-tures, plus pay for the longput in full.

The lower of: (1) of 10% ofthe aggregate exercise priceof the put, plus the aggre-gate put out-of-the-moneyamount, if any; or (2) 20%of the current market valueof the long basket of secu-rity futures.

9 ............... Short a basket of narrow-based security futures thattogether tracks a broad-based security index andlong a broad-based securityindex call option contract onthe same index.

Narrow-based security index .. 20% of the current marketvalue of the short based ofnarrow-based security fu-tures, plus pay for the longcall in full.

The lower of: (1) 10% of theaggregate exercise price ofthe call, plus the aggregatecall out-of-the-moneyamount, if any; or (2) 20%of the current market valueof the short basket of secu-rity futures.

10 ............... Long security future and shortsecurity future on the sameunderlying security (orindex).


The greater of: 10% of thecurrent market value of thelong security future; or (2)10% of the current marketvalue of the short securityfuture.

The greater of: 10% of thecurrent market value of thelong security future; or (2)10% of the current marketvalue of the short securityfuture.

11 ............... Long security future, long putoption and short call option.The long security future,long put and short call mustbe on the same underlyingsecurity and the put and callmust have the same exer-cise price. (Conversion).


20% of the current marketvalue of the long security fu-ture, plus the aggregate callin-the-money amount, ifany, plus pay for the put infull. Proceeds from the callsale may be applied.

10% of the aggregate exerciseprice, plus the aggregatecall in-the-money amount, ifany.

12 ............... Long security future, long putoption and short call option.The long security future,long put and short call mustbe on the same underlyingsecurity and the put exer-cise price must be belowthe call exercise price.

(Collar) ....................................


20% of the current marketvalue of the long security fu-ture, plus the aggregate callin-the-money amount, ifany, plus pay for the put infull. Proceeds from call salemay be applied.

The lower of: (1) 10% of theaggregate exercise price ofthe put plus the aggregateput out-of-the-moneyamount, any; or (2) 20% ofthe aggregate exercise priceof the call, plus the aggre-gate call in-the-moneyamount, if any.






13 ............... Short security future and longposition in the same secu-rity (or securities basket)underlying the security fu-ture (or long position in asecurity immediately con-vertible into the same secu-rity underlying the securityfuture, without restriction, in-cluding the payment ofmoney).


The initial margin requiredunder Regulation T for thelong stock or stocks.

10% of the current marketvalue, as defined in Regula-tion T, of the long stock orstocks.

14 ............... Short security future (or stockor basket of security futuresrepresenting each compo-nent of a narrow-based se-curities index) and long calloption or warrant on thesame underlying security (orindex).


20% of the current marketvalue of the short securityfuture, plus pay for the callin full.

The lower of: (1) 10% of theaggregate exercise price ofthe call, plus the aggregatecall out-of-the-moneyamount, if any; or (2) 20%of the current market valueof the short security future.

15 ............... Short security future, Short putoption and long call option.The short security future,short put and long call mustbe on the same underlyingsecurity and the put and callmust have the same exer-cise price. (Reverse Con-version)


20% of the current marketvalue of the short securityfuture, plus the aggregateput in-the-money amount, ifany, plus pay for the call infull. Proceeds from put salemay be applied.

10% of the aggregate exerciseprice, plus the aggregateput in-the-money amount, ifany.

16 ............... Long (short) a basket of secu-rity future, each based on anarrow-based security indexthat together tracks thebroad-based index andshort (long) a broad based-index future.

Narrow-based security index .. 20% of the current marketvalue of the long (short)basket of security futures.

10% of the current marketvalue of the long (short)basket of security futures.

17 ............... Long (short) a basket of secu-rity futures that togethertracks a narrow-based indexand short (long) a narrowbased-index future.

Individual stock and narrow-based security index.

The greater of: (1) 20% of thecurrent market value of thelong security future(s); or (2)20% of the current marketvalue of the short securityfuture(s).

The greater of: (1) 10% of thecurrent market value of thelong security future(s); or (2)10% of the current marketvalue of the short securityfuture(s).

1 Baskets of securities or security futures contracts must represent exactly the same securities that comprise the index, and in the same pro-portion.

2 Generally, for the purposes of these rules, unless otherwise specified, stock index warrants shall be treated as if they were index options.3 ‘‘Aggregate exercise price,’’ with respect to an option or warrant based on an underlying security, means the exercise price of an option or

warrant contract multiplied by the numbers of units of the underlying security covered by the option contract or warrant. ‘‘Aggregate exerciseprice’’ with respect to an index option means the exercise price multiplied by the index multiplier. See, e.g., Amex Rules 900 and 900C; CBOERule 12.3; and NASD Rule 2522.

4 ‘‘Out-of-the-money’’ amounts must be determined as follows:(1) For stock call options and warrants, any excess of the aggregate exercise price of the option or warrant over the current market value of

the equivalent number of shares of the underlying security.(2) For stock put options or warrants, any excess of the current market value of the equivalent number of shares of the underlying security

over the aggregate exercise price of the option or warrant.(3) For stock index call options and warrants, any excess of the aggregate exercise price of the option or warrant over the product of the cur-

rent index value and the applicable index multiplier.(4) For stock index put options and warrants, any excess of the product of the current index value and the applicable index multiplier over the

aggregate exercise price of the option or warrant. See e.g., NYSE Rule 431 (Exchange Act Release No. 42011 (October 14, 1999), 64 FR 57172(October 22, 1999) (order approving SR–NYSE–99–03)); Amex Rule 462 (Exchange Act Release No. 43582 (November 17, 2000), 65 FR 71151(November 29, 2000) (order approving SR–Amex–99–27)); CBOE Rule 12.3 (Exchange Act Release No. 41658 (July 27, 1999), 64 FR 42736(August 5, 1999) (order approving SR–CBOE–97–67)); or NASD Rule 2520 (Exchange Act Release No. 43581 (November 17, 2000), 65 FR70854 (November 28, 2000) (order approving SR–NASD–00–15)).

5 ‘‘In the-money’’ amounts must be determined as follows:(1) For stock call options and warrants, any excess of the current market value of the equivalent number of shares of the underlying security

over the aggregate exercise price of the option or warrant.(2) For stock put options or warrants, any excess of the aggregate exercise price of the option or warrant over the current market value of the

equivalent number of shares of the underlying security.(3) For stock index call options and warrants, any excess of the product of the current index value and the applicable index multiplier over the

aggregate exercise price of the option or warrant.(4) For stock index put options and warrants, any excess of the aggregate exercise price of the option or warrant over the product of the cur-

rent index value and the applicable index multiplier.



89 See Proposed CFTC Rule 41.45(b)(2)(i);Proposed SEC Rule 402(b)(2)(i).

90 See Proposed CFTC Rule 41.45(b)(2)(ii);Proposed SEC Rule 402(b)(2)(ii).

91 15 U.S.C. 78s(b).

92 15 U.S.C. 78f(g). New subsection 6(g) of theExchange Act provides an expedited process for anexchange that lists or trades security futuresproducts to register with the SEC as a nationalsecurities exchange if that exchange (1) is a boardof trade that has been designated as a contractmarket or is registered as a DTF; and (2) does notact as a market place for transactions in securitiesother than security futures products. The SEC hasadopted rules prescribing the requirements fordesignated contract markets and DTFs to register asnational securities exchange pursuant to Section6(g) of the Exchange Act. See Securities ExchangeAct Release No. 44692 (August 13, 2001), 66 FR43721 (August 20, 2001).

93 15 U.S.C. 78o–3(k). A futures associationregistered under Section 17 of the CEA (7 U.S.C. 21)will be registered as a national securitiesassociation for the limited purpose of regulating theactivities of brokers or dealers registered pursuantto Section 15(b)(11) of the Exchange Act (15 U.S.C.78o(b)(11)) with respect to their activities insecurity futures products.

94 15 U.S.C. 78s(b)(2). See Proposed CFTC Rule41.45(c); Proposed SEC Rule 402(c).

95 15 U.S.C. 78s(b)(7). See infra note 130 andaccompanying text.


97 See, e.g., CBOE Rule 12.2.


99 15 U.S.C. 78s(b)(2). See Proposed CFTC Rule41.46(b); Proposed SEC Rule 403(b).

100 ‘‘Examining authority’’ with respect to acreditor is proposed to mean: (1) The regulatoryauthority of which such creditor is a member, ifsuch creditor is a member of only one regulatoryauthority; (2) The regulatory authority designatedresponsibility by the SEC pursuant to 17 CFR240.17d–1 for examining such creditor forcompliance with applicable financial responsibilityrules, if a regulatory authority is so designated; or(3) The regulatory authority designated inaccordance with 17 CFR 1.52, if such creditor is amember of more than one regulatory authority andthe SEC, pursuant to 17 CFR 240.17d–1 has notdesignated responsibility for examining suchcreditor for compliance with applicable financialresponsibility rules. See Proposed CFTC Rule41.44(a)(3) and Proposed SEC Rule 401(a)(3).

101 15 U.S.C. 78s(b)(2). The Commission expectsuch regulatory authority rules for security futuresto be consistent with those rules currently in placefor securities. See, e.g., NYSE Rule 434; and NASDRule 2520.

102 15 U.S.C. 78g(c)(2)(B)(iv).103 Regulation T defines ‘‘margin deficiency’’ as

‘‘the amount by which the required margin exceeds

Q 19 (a) Are there offset positions inaddition to those enumerated in theabove chart that are consistent withmargin requirements for comparableoptions, which the Commissions shouldconsider adding to the list ofpermissible offsets?

(b) Are there offset positions includedin the above chart, which theCommissions should consider deletingfrom the list of permissible offsets?

Q 20 Have the Commissionsappropriately taken into account theoverall risk of a position for thespecified offset positions?

Q 21 Are the proposed minimummargin levels prudential and efficient inmeeting the objectives of preserving thefinancial integrity of security futuresmarkets and preventing systemic risk?

Q 22 Are there other ways ofmeeting the comparability standard insetting margin levels for offsettingpositions? For example:

(a) Is it necessary to consider a longor short security futures position to becomparable to a long or short positionin an underlying security for thepurpose of determining margin for offsetpositions that only involve securityfutures and options contracts? If not,commenters are asked for specificrecommendations on alternatives.

(b) Does the comparability standardnecessitate that initial and maintenancemargin requirements for strategy-basedoffsets be set at different levels?

4. Higher Margin Levels

Notwithstanding the proposedminimum initial and maintenancemargin levels specified above, theCommissions further propose that theregulatory authorities may impose ontheir members initial and maintenancemargin levels that are higher than theminimum margin levels specified inProposed CFTC Rule 41.45(b)(1) andProposed SEC Rule 402(b)(1).89 This isto permit regulatory authorities to sethigher margin levels as may, from timeto time, be considered prudent by suchregulatory authorities. In addition,regulatory authorities may permit theirmembers to use a method for calculatingrequired initial and maintenance marginthat may result in margin levels that arehigher than the minimum margin levelsspecified in those proposed rules.90 Anysuch higher margin requirement wouldhave to be filed with the SEC underSection 19(b) of the Exchange Act.91 TheCommissions also propose that a

national securities exchange registeredwith the SEC under Section 6(g) of theExchange Act (‘‘Security FuturesProduct Exchange’’) 92 or a nationalsecurities association registered with theSEC under Section 15A(k) of theExchange Act (‘‘Limited PurposeNational Securities Association’’) 93 mayraise or lower the required margin levelto a level not lower than that specifiedin Proposed CFTC Rule 41.45 andProposed SEC Rule 402,94 in accordancewith Section 19(b)(7) of the ExchangeAct.95

E. Time Limits for Collection of MarginThe Commissions also propose other

margin requirements for securityfutures. Specifically, the Commissionspropose that the amount of initialmargin required by Proposed CFTC Rule41.45 and Proposed SEC Rule 402would be obtained as promptly aspossible and in any event within threebusiness days after the position isestablished, or within such shorter timeperiod as may be imposed by applicableregulatory authority rules approved bythe SEC in accordance with Section19(b)(2) of the Exchange Act.96

Currently, Regulation T requires thecollection of margin calls for certainsecurities covered by Regulation Twithin five business days after theposition is established, and regulatoryauthority rules require the collection ofmaintenance margin as promptly aspossible and in any event within fifteenbusiness days.97 To lower counterpartyrisk in transactions involving securityfutures, the Commissions are proposingshorter time periods than thosepermitted by Regulation T. Specifically,

the Commissions are proposing a threebusiness day time period.98

Further, the Commissions proposethat the amount of maintenance marginrequired by Proposed CFTC Rule 41.45and Proposed SEC Rule 402 would beobtained as promptly as possible and inany event within three business daysafter the margin deficiency is created orincreased, or within such shorter timeperiod as may be imposed by applicableregulatory authority rules approved bythe SEC pursuant to Section 19(b)(2) ofthe Exchange Act.99

Finally, the Commissions proposethat the time limits for collection ofinitial margin may be extended uponapplication by the creditor to itsexamining authority 100 to the extentpermitted by applicable regulatoryauthority rules approved by the SECpursuant to Section 19(b)(2) of theExchange Act.101

Q 23 Are the proposed time limitsfor collection of margin appropriate forsecurity futures?

F. Forms of CollateralSection 7(c)(2)(B)(iv) of the Exchange

Act requires that the marginrequirements for security futuresproducts (other than levels of margin),including the type, form, and use ofcollateral for security future products,are and remain consistent with therequirements established by the FederalReserve Board in Regulation T pursuantto subparagraphs (A) and (B) of Section7(c)(1) of the Exchange Act.102

Regulation T requires a customer todeposit margin with its broker or dealerwhenever securities transactions by thecustomer, on any given day, create orincrease a ‘‘margin deficiency’’ 103 in the



the equity in the margin account.’’ 12 CFR 220.2.The ‘‘required margin’’ for a position in securities(other than security futures) is based on the‘‘current market value’’ of the securities anddetermined in accordance with Section 220.12 ofRegulation T. 12 CFR 220.12.

104 12 CFR 220.4(c).105 Regulation T defines ‘‘payment period’’ as

‘‘the number of business days in the standardsecurities settlement cycle in the United States, asdefined in paragraph (a) of Exchange Act Rule15c6–1 (17 CFR 240.15c6–1(a)), plus two businessdays.’’ 12 CFR 220.2. Currently, the standardsecurities settlement cycle under Rule 15c6–1 of theExchange Act is three business days, resulting in apayment period under Regulation T of five businessdays.

106 12 CFR 220.4(c).107 Under Regulation T, margin securities include:

(1) any security registered or having unlistedtrading privileges on a national securities exchange;(2) any security listed on the Nasdaq Stock Market;(3) any nonequity security; (4) any security issuedby either an open-end investment company or unitinvestment trust which is registered under Section8 of the Investment Company Act of 1940; (5) anyforeign margin stock; and (6) any debt securityconvertible into a margin security. 12 CFR 220.2.

108 15 U.S.C. 78c(a)(12).109 15 U.S.C. 78s(b)(2).

110 A notice-designated contract market is anational securities exchange registered pursuant toSection 6(a) of the Exchange Act (15 U.S.C. 78f(a)),a national securities association registered pursuantto Section 15A(a) of the Exchange Act (15 U.S.C.78o–3(a)), or an alternative trading system (‘‘ATS’’)as defined in Section 1a(1) of the CEA (7 U.S.C.1a(1)) that is designated as a contract marketpursuant to Section 5f of the CEA (7 U.S.C. 7b–1).

111 15 U.S.C. 78s(b).112 7 U.S.C. 7a–2(c). Notice-designated contract

markets are exempt from the requirements ofSection 5c of the CEA pursuant to Section5f(b)(1)(D) of the CEA (7 U.S.C. 7a–2(b)(1)(D)).

113 See also 66 FR 42256 (August 10, 2001) (CFTCrules implementing these procedures, codified in anew Part 40 of Title 17, Rules 40.5 and 40.6).

114 7 U.S.C. 7a–2(c)(1).115 7 U.S.C. 7a–2(c)(2).116 15 U.S.C. 78s(b)(2).117 The copy may be submitted to the CFTC

electronically, by facsimile, or by delivery of a hardcopy.

118 7 U.S.C. 7a–2.119 7 U.S.C. 7a–2(c).120 7 U.S.C. 7a–2(c)(2).121 7 U.S.C. 7a–2(c)(1).

customer’s margin account.104 UnderRegulation T, such a deposit must bemade in the form of cash, marginsecurities, exempted securities, or anycombination thereof, within one‘‘payment period’’ 105 after the margindeficiency was created or increased.106

For dealings in security futures, theCommissions propose that, underProposed CFTC Rule 41.47(a) andProposed SEC Rule 404(a), a broker,dealer or a member of a nationalsecurities exchange may accept from acustomer as collateral to satisfy itsmargin requirement, the following: cash,margin securities as defined inRegulation T,107 exempted securities asdefined in Section 3(a)(12) of theExchange Act,108 or other collateralpermitted under Regulation T to satisfya margin deficiency in the marginaccount.

The Commissions also propose underProposed CFTC Rule 41.47(b) andProposed SEC Rule 404(b) that nothingin the proposed rules would prevent aregulatory authority from prescribingmargin collateral requirements (otherthan margin levels) including the type,form, and use of collateral for securityfutures, as long as those requirementsare consistent with the requirements ofRegulation T, subject to approval by theSEC in accordance with Section 19(b)(2)of the Exchange Act.109

Finally, the Commissions proposeunder Proposed CFTC Rule 41.47(c) andProposed SEC Rule 404(c) that, forpurposes of this section, security futuresare not margin securities. This is toclarify that transactions and positions insecurity futures, like short options,would not have loan value for margin

purposes. As is the case with shortoptions, margin deposited on a long orshort security future represents aperformance bond to assureperformance on such contract.

The daily gains and losses on securityfutures are either credited to the partythat made a gain on such contract, ordebited from the account of the partythat had a loss, such that the margin ineach party’s account represents only therequired amount of performance bondon such contract. Because it is not anasset, a security future cannot be put upas collateral for another security orfutures transaction.

III. SEC and CFTC Rule ReviewProcesses Relating to MarginRequirements for Security FuturesProducts

A. CFTC Rule Review Process andProcedures for Notification of ProposedRule Changes Related to Margin

In general, designated contractmarkets, including ‘‘notice-designated’’contract markets,110 or registered DTFsthat propose to make a rule changeregarding their security futures marginrequirements (other than proposed rulechanges that result in higher marginlevels) must submit the proposed rulechange to the SEC for approval inaccordance with Section 19(b) of theExchange Act.111 In addition, contractmarkets designated pursuant to Section5 of the CEA and registered DTFs arealso required under Section 5c(c) of theCEA to make certain filings with theCFTC regarding rule changes, includingthose for security futures products.112

Because ATSs are not SROs under theExchange Act, notice-designatedcontract markets that are ATSs are notrequired to submit proposed rulechanges to the SEC for approval inaccordance with Section 19(b) of theExchange Act.

Section 5c(c) of the CEA provides fortwo alternative procedures by whichsuch a designated contract market orregistered DTF may implement aproposed rule change.113 First, in

accordance with Section 5c(c)(1) of theCEA, a proposed rule change may beimplemented by providing the CFTCwith a written certification that theproposed rule change complies with theCEA.114 Second, Section 5c(c)(2) of theCEA provides that, before theimplementation of a proposed rulechange, an entity may request that theCFTC grant prior approval of the rulechange.115

Proposed CFTC Rule 41.48(a) wouldrequire any notice-designated contractmarket that files a proposed rule changeregarding customer margin for securityfutures with the SEC for approval inaccordance with Section 19(b)(2) of theExchange Act 116 to concurrentlyprovide to the CFTC a copy of such aproposed rule change and anyaccompanying documentation filed withthe SEC.117 It is not required to provideany supplemental information, even ifsuch information is subsequentlyprovided to the SEC in the course of theSEC’s review of the proposed rulechange. The purpose of this proposedrule is to provide the CFTC, as a jointregulator of markets offering securityfutures products, with timelynotification of a proposed rule change.

Proposed CFTC Rule 41.48(b) setsforth the notification process forcontract markets designated pursuant toSection 5 of the CEA 118 and registeredDTFs. The process by which such anentity is to notify the CFTC of havingfiled a proposed rule change with theSEC will depend on which procedureunder Section 5c(c) of the CEA 119 theentity elects to follow.

Proposed CFTC Rule 41.48(b)(1)would apply to any designated contractmarket registered under section 5 of theCEA or registered DTF that elects toseek the prior approval of the CFTC fora proposed rule change, in accordancewith Section 5c(c)(2) of the CEA.120 Insuch case, the contract market or DTFwould file its requests with the SEC andCFTC concurrently.

Under Proposed CFTC Rule41.48(b)(2), an entity that elects toimplement a proposed rule change byfiling a written certification with theCFTC in accordance with Section5c(c)(1) of the CEA 121 is required toprovide a copy of the proposed rulechange and any accompanying



122 15 U.S.C. 78f(a).123 15 U.S.C. 78o–3(a).124 15 U.S.C. 78s(b)(1).125 See supra note 92.126 See supra note 93.

127 15 U.S.C. 78s(b)(1) and (b)(2). See Sections6(g)(4)(B)(ii) and 15A(k)(3)(B) of the Exchange Act(15 U.S.C. 78f(g)(4)(B)(ii) and 15 U.S.C. 78o–3(k)(3)(B), respectively). Proposed rule changesfiled under Sections 19(b)(1) and (b)(2) of theExchange Act are submitted pursuant to Rule 19b–4 and Form 19b–4. See 17 CFR 240.19b–4; 17 CFR249.819.

128 Section 19(b)(3) of the Exchange Act sets forththe categories of proposed rule changes that maytake effect upon filing with the SEC. 15 U.S.C.78s(b)(3).

129 15 U.S.C. 78s(b)(2).130 15 U.S.C. 78s(b)(7). See Sections 6(g)(4)(B)(i)

and 15A(k)(3)(A) of the Exchange Act (15 U.S.C.78f(g)(4)(B)(i) and 15 U.S.C. 78o–3(k)(3)(A),respectively). Section 19(b)(7) of the Exchange Actgrants to the SEC the authority to adopt rulesregarding the filing of proposed rule changes bySecurity Futures Product Exchanges and LimitedPurpose National Securities Associations. 15 U.S.C.78s(b)(7). The SEC has adopted Rule 19b–7 andForm 19b–7 to establish procedures for filingproposed rule changes pursuant to Section 19(b)(7)of the Exchange Act. See Rule 19b–7, 17 CFR240.19b–7, and Form 19b–7, 17 CFR 249.822;

Securities Exchange Act Release No. 44692 (August13, 2001), 66 FR 43721 (August 20, 2001).

131 7 U.S.C. 7a–2(c). Pursuant to Section 5c(c)(1)of the CEA (7 U.S.C. 7a–2(c)(1)), a registered entitymay elect to approve and implement any new ruleor rule amendment by providing the CFTC with awritten certification that the new rule or ruleamendment complies with the CEA.

132 Pursuant to Section 5c(c)(2) of the CEA (7U.S.C. 7a–2(c)(2)), a registered entity may elect toseek prior approval of the CFTC for any new ruleor rule amendment.

133 15 U.S.C. 78s(b)(7)(B). Pursuant to this section,SEC action to abrogate a rule change will not affectthe validity or force of the rule change during theperiod it was in effect.

134 See Section 19(b)(7)(C) of the Exchange Act(15 U.S.C. 78s(b)(7)(C)). The SEC notes that itcurrently exercises similar authority pursuant toSection 19(b)(3)(C) of the Exchange Act (15 U.S.C.78s(b)(3)(C)) with respect to proposed rule changesfiled by the existing SROs, which are immediatelyeffective upon filing pursuant to Section 19(b)(3)(A)of the Exchange Act (15 U.S.C. 78s(b)(3)(A)).

135 15 U.S.C. 78f(g)(4)(B)(iii).136 15 U.S.C. 78o–3(k)(3)(C).137 15 U.S.C. 78s(b)(1).138 15 U.S.C. 78s(b)(7)(D)(i).139 15 U.S.C. 78s(b)(7)(D)(ii).

documentation that was filed with theSEC, concurrent with the SEC filing.Promptly after the SEC has approved theproposed rule change, the designatedcontract market or registered DTF willfile the written certification with theCFTC.

The CFTC has considered analternative procedure under which anentity would file its written certificationwith the CFTC at the same time as itfiles the proposed rule change with theSEC, rather than after the SEC approvesthe proposed rule change. Thisalternative could facilitate immediateimplementation of the rule change oncethe rule is approved by the SEC. TheCFTC notes, however, that if theproposed rule change were to bemodified during the SEC approvalprocess such that the rule approved bythe SEC was not the same rule that hadbeen certified to the CFTC, a newwritten certification would have to befiled before the rule, as approved, couldbe implemented.

Q 24 Are there preferable alternativemethods for meeting the dual filingrequirements for margin rule changes?For example, should designated contractmarkets and DTFs file a rulecertification with the CFTC at the sametime as the proposed rule change issubmitted to the SEC, and then file anew certification only if the proposedrule change is modified? Or, should anentity be able to choose whether to filea certification with the CFTC after SECapproval of such proposed rule changeor at the same time as filing theproposed rule change with the SEC?Commenters are asked to be specificwith respect to the costs andadministrative convenience of theproposed procedures or any alternativeprocedures they submit for the CFTC’sconsideration.

B. SEC Rule Review Process

National securities exchangesregistered pursuant to Section 6(a) of theExchange Act 122 and national securitiesassociations registered pursuant toSection 15A(a) of the Exchange Act 123

must file proposed rule changes,including those related to the trading ofsecurities futures products, with theSEC under Section 19(b)(1) of theExchange Act.124 Security FuturesProduct Exchanges 125 and LimitedPurpose National SecuritiesAssociations 126 must submit proposed

rule changes to the SEC in the followingthree circumstances.

First, Security Futures ProductExchanges and Limited PurposeNational Securities Associations arerequired to submit proposed rulechanges that relate to margin forsecurity futures products, except forthose that result in higher margin levels,under Sections 19(b)(1) and (b)(2) of theExchange Act.127 Section 19(b)(1) of theExchange Act states that proposed rulechanges are not effective unlessapproved by the SEC or otherwisepermitted in accordance with theprovisions of Section 19(b).128 Section19(b)(2) of the Exchange Act sets forththe standards by which the SEC mustdetermine whether a proposed rulechange submitted pursuant to Section19(b)(1) of the Exchange Act must beeither approved or disapproved.129

Specifically, the SEC is directed toapprove a proposed rule change if itfinds that such proposed rule change isconsistent with the requirements of theExchange Act, and the rules andregulations thereunder applicable tosuch SRO, or to disapprove a proposedrule change if it cannot make such afinding.

Second, proposed rule changes bySecurity Futures Product Exchanges andLimited Purpose National SecuritiesAssociations that relate to higher marginlevels, fraud or manipulation,recordkeeping, reporting, listingstandards, or decimal pricing forsecurity futures products, sales practicesfor security futures products for personswho effect transactions in securityfutures products, or rules effectuatingsuch SRO’s obligation to enforce thesecurities laws, must be submitted tothe SEC pursuant to new Section19(b)(7) of the Exchange Act.130 A

proposed rule change filed pursuant tothis section may take effect when: (1) Awritten certification has been filed withthe CFTC under Section 5c(c) of theCEA; 131 (2) the CFTC determines thatreview of the proposed rule change isnot necessary; or (3) the CFTC approvesthe proposed rule change.132 The SEC,after consultation with the CFTC, hasthe authority to summarily abrogate aproposed rule change that has takeneffect pursuant to Section 19(b)(7)(B) ofthe Exchange Act 133 if it appears to theSEC that such rule change undulyburdens competition or efficiency,conflicts with the securities laws, or isinconsistent with the public interest andthe protection of investors.134

Finally, in the event that the SECabrogates a proposed rule change,Security Futures Product Exchanges andLimited Purpose National SecuritiesAssociations would be required,pursuant to Sections 6(g)(4)(B)(iii) 135

and 15A(k)(3)(C) 136 of the ExchangeAct, respectively, to refile the proposedrule change pursuant to therequirements of Section 19(b)(1) of theExchange Act.137

The SEC must (within 35 days of thedate of publication of notice of the filingof the proposed rule change, or withinsuch longer period as the SEC maydesignate up to 90 days after such dateif the SEC finds such longer period tobe appropriate and publishes its reasonsfor so finding, or as to which the SROconsents) either by order approve theproposed rule change or, afterconsultation with the CFTC, institutedisapproval proceedings.138 Section19(b)(7)(D)(ii) of the Exchange Act 139

states that the SEC must approve a



140 15 U.S.C. 78s(b)(1).141 44 U.S.C. 3501 et seq.142 7 U.S.C. 19(a). 143 15 U.S.C. 78f(a).

144 See Paul H. Kupiec and A. Patricia White,Regulatory Competition and the Efficiency ofAlternative Derivative Product Margining Systems,16 The Journal of Futures Markets 943 (1996).

145 15 U.S.C. 78f(a).

proposed rule change that has beenabrogated and refiled under Section19(b)(1) of the Exchange Act 140 if theSEC finds that it does not undulyburden competition or efficiency, doesnot conflict with the securities laws,and is not inconsistent with the publicinterest or the protection of investors.

IV. Request for Comments

The Commissions solicit commentson all aspects of Proposed CFTC Rules41.43 through 41.48 and Proposed SECRules 242.400 through 242.404. Inaddition, the Commissions are seekingresponses to the numbered questionsposed throughout this proposal.

Commenters are welcome to offertheir views on any other matters raisedby the proposed rules.

V. Paperwork Reduction Act

A. CFTC

The Paperwork Reduction Act of 1995(‘‘PRA’’) 141 imposes certainrequirements on federal agencies(including the CFTC and the SEC) inconnection with their conducting orsponsoring any collection ofinformation as defined by the PRA. Theproposed rules do not require a newcollection of information on the part ofany entities subject to the proposedrules. Accordingly, the requirementsimposed by the PRA are not applicableto the proposed rules.

B. SEC

The PRA does not apply because theproposed rules do not imposerecordkeeping or information collectionrequirements, or other collections ofinformation which require approval ofthe Office of Management and Budgetunder 44 U.S.C. 3501, et. seq.

VI. Costs and Benefits of the ProposedRules

A. CFTC

Section 15(a) of the CEA 142 requiresthat the CFTC, before promulgating aregulation under the CEA or issuing anorder, consider the costs and benefits ofits action. By its terms, Section 15(a)does not require the CFTC to quantifythe costs and benefits of a new rule ordetermine whether the benefits of therule outweigh its costs. Rather, Section15(a) simply requires the CFTC to‘‘consider the costs and benefits’’ of itsaction.

Section 15(a) further specifies thatcosts and benefits shall be evaluated inlight of the following considerations: (1)

Protection of market participants andthe public; (2) efficiency,competitiveness, and financial integrityof futures markets; (3) price discovery;(4) sound risk management practices;and (5) other public interestconsiderations. Accordingly, the CFTCcould, in its discretion, give greaterweight to any one of the fiveconsiderations and could, in itsdiscretion, determine that,notwithstanding its costs, a particularrule was necessary or appropriate toprotect the public interest or toeffectuate any of the provisions or toaccomplish any of the purposes of theCEA.

The proposed rules constitute apackage of related rule provisions. Therules establish the amount of initial andmaintenance customer margin fortransactions in security futures. TheCFTC believes that the proposedcustomer margin requirements forsecurity futures are, in accordance withthe CFMA, consistent with the marginrequirements for comparable optioncontracts traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act.143 The CFTC isevaluating the costs and benefits of theproposed rules in light of the specificconsiderations identified in Section15(a) of the CEA:

1. Protection of market participantsand the public. In general, the proposedrules should further the protection ofmarket participants and the public.

2. Efficiency and competition. Asnoted above, the proposed marginrequirements are consistent with themargin requirements for comparableoption contracts traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act, as required under theCFMA, and apply to all exchangesoffering security futures. Accordingly,the proposed rules are not expected tohave a negative impact on competition.

3. Financial integrity of futuresmarkets and price discovery. Theproposed rules should have a positiveeffect on the financial integrity ofsecurity futures markets by protectingagainst systemic risk.

4. Sound risk management practices.The proposed rules are consistent withsound risk management practices.

5. Other public considerations. Theproposed rules would preserve thefinancial integrity of markets tradingsecurity futures and prevent systemicrisk, thereby benefiting the public. TheCFTC believes, however, that the rulesfall short of achieving the maximumbenefits at the lowest possible cost. TheCFTC believes that portfolio margining

for security futures would foster greatermarket efficiency and provide greaterbenefits to all market participants,without compromising the financialintegrity of the markets or giving rise tosystemic risk.144

After evaluating these considerations,the CFTC has determined to propose therules discussed above. The CFTC invitespublic comment on the application ofthe cost-benefit provision of Section15(a) of the CEA in regard to theproposed rules. Commenters are alsoinvited to submit any data that they mayhave quantifying the costs and benefitsof the proposed rules.

B. SECSection 7 of the Exchange Act, which

governs the amount of credit that maybe initially extended and subsequentlymaintained on any security (other thanan exempted security), was amended bythe CFMA to add provisions related tomargin for securities futures. On March6, 2001, the Federal Reserve Boarddelegated its authority under Section7(c)(2) of the Exchange Act to establishmargin requirements for security futuresto the SEC and CFTC. The SEC isproposing new Rules 400 through 404under the Exchange Act to establishsuch margin requirements.

Specifically, the CFMA amendedSection 7(c) of the Exchange Act torequire that the rules preserve thefinancial integrity of markets tradingsecurity futures products, preventsystemic risk, and to require that: (1)The margin requirements for a securityfuture be consistent with the marginrequirements for comparable optioncontracts traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act; 145 and (2) the initial andmaintenance margin levels for a securityfuture not be lower than the lowest levelof margin, exclusive of premium,required for any comparable optioncontract traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act, other than an option ona security future, and to ensure that themargin requirements (other than levelsof margin), including the type, form,and use of collateral for security futures,are and remain consistent with therequirements established by the FederalReserve Board under Regulation T.

The SEC requests comments on allaspects of this cost-benefit analysis,including identification of anyadditional costs and/or benefits of theproposed rules. The SEC encourages



146 For discussion on Regulation T, and theaccounts established thereunder, see supra notes15–27 and accompanying text.

147 Broker-dealers registered with the SEC underSection 15(b)(1) of the Exchange Act may journalany margin excess to the SMA. 15 U.S.C. 78o(b)(1).

148 15 U.S.C. 78g(c)(2)(B)(iii).149 Catrath, A., Adrangi, B and Alleder, M. (2001),

The Impact of Margins in Futures Markets:Evidence from the Gold and Silver Markets, TheQuarterly Review of Economics and Finance, 279.

150 The SEC staff examined all securities withaverage daily trading volume greater than 50,000,using data from 2000 from the Center for Researchin Security Prices (‘‘CRSP’’). Based on this data, theSEC staff calculated the daily price returns and the30–day historical price volatility for each of thesecurities examined.

Based on the assumption that cash and futuresprices typically move together, the SEC staffconducted a preliminary simulation, using actualsecurity price movements as estimates for would befutures price movements. Based upon these securityfutures’ price estimates, the staff determined themargin requirements for each of these securityfutures under both the 20 percent strategy-basedapproach and the traditional risk-based futuresapproach. The staff examined how often the fundsattributable to margin requirements are insufficientto cover the daily price movements of these securityfutures. This is relevant to the examination ofsystemic risk because a necessary condition forcustomer default to occur is the depletion of thefunds attributable to margin requirements(assuming no market risk to close out suchposition).

151 For further details on these issues, see Fishe,R. P. H., Goldberg, L.G., (1986), The Effects ofMargins on Trading in Futures Markets, Journal ofFutures Markets, 261; Fishe, P.H., Goldberg, L.A.,Gosnell, T.F. and Sinha, S. (1990), MarginRequirement in Futures Markets: Their Relationshipto Price Volatility, The Journal of Futures Markets,541.

152 See supra note 150.153 For an in depth discussion of how margin

would be computed under the proposed rules, seesupra notes 62–88 and accompanying text.

commenters to identify and supply anyrelevant data, analysis and estimatesconcerning the costs and benefits of theproposed rules.

1. CostsThere would likely be various

administrative costs to brokers, dealers,and members of national securitiesexchanges attributable to Proposed SECRules 400 through 404. Further, brokers,dealers, and members of nationalsecurities exchanges that choose toeffect transactions for customersinvolving, or carrying an account for acustomer containing, a security futureare responsible for assuring compliancewith these proposed rules and thuswould incur various costs. While theSEC is unable at this time to estimatethe extent of the costs that the proposedrules engender, it has identified belowareas where the proposed rules mayimpose costs.

a. Compliance With Regulation TProposed SEC Rule 400(b)(1) would

apply Regulation T to financial relationsbetween brokers, dealers, and membersof national securities exchanges andtheir customers with respect totransactions in security futures and anyrelated securities or futures contractsthat are used to offset positions in suchsecurity futures, to the extent consistentwith the proposed rules.146

Under this proposed rule, securityfutures transactions would be recordedin a Margin Account. The proposedmargin level requirements represent aperformance bond to guarantee contractperformance by both the buyer andseller of such contract. Any settlementvariation would be credited to (ordebited from) the Margin Account.147

The application of Regulation Tprovisions by brokers, dealers, ormembers of national securitiesexchanges to their customers’ securityfutures positions would require theseentities to incur certain costs, such asmaking systems changes, and hiringpersonnel, in adhering to Regulation Tprovisions.

The SEC requests comments, data,and estimates on all aspects of the costsof implementing Regulation Tprovisions pertaining to securityfutures.

b. Levels of MarginProposed SEC Rule 402(b)(1) sets the

level of margin at 20 percent of current

market value. The 20 percent level ofmargin is necessary to fulfill thestatutory requirement that the marginrequirements for security futures beconsistent with the margin requirementsfor comparable options contracts tradedon any national securities exchangeregistered under Section 6(a) of theExchange Act.148

The SEC notes that the 20 percentmargin level may appear to be highwhen compared to marginingmethodologies currently used forfutures other than security futures. Apotential cost of these higher marginrequirements is that they may lead toreduced interest in trading securityfutures and, therefore, foregone hedgingopportunities.

However, while margin requirementson non-security futures contractsgenerally range from 2–10 percent,149

SEC staff, based on its analysis,estimates that applying traditionalfutures risk-based margining methods tosecurity futures would require margin ofgreater than 10 percent.150 Further,economic research has thus far not beenable to establish a strong relationshipbetween futures margin levels andinterest in the product.151 On the otherhand, SEC staff estimates that theproposed margin levels would reducethe chances that a margin accountwould not contain sufficient funds tocover a given day’s price movementfrom approximately 5 percent using

traditional risk-based futures marginingto 0.3 percent.152 Therefore, while themargin levels proposed for securityfutures may impose a cost, the SECbelieves that the proposed margin levelswould lower chances of customerdefault and therefore lower systemicrisk to the markets. For these reasons,and the statutory mandate that requirescomparability between security futuresmargin and options margin, the SECpreliminarily believes that the proposedmargin levels would be appropriate.

The SEC requests comments, data,and estimates on all aspects of the costsassociated with the margin leveldescribed in Proposed SEC Rule402(b)(1).

c. Computation of Margin

Proposed SEC Rule 402(b)(1) wouldrequire that brokers, dealers, andnational securities exchange memberscompute and ensure, on a daily basis,that the initial and maintenance marginlevels for each customer’s securityfuture carried or held by such entity are20 percent of the current market valueof such contract. This requirement isdesigned to assure contract performanceand the integrity of the marketplace.153

In addition, all market participants payor receive daily settlement variationpayments (i.e., the daily net gain or losson a security future) as a result of allopen futures positions being marked tocurrent market value by the clearingorganization.

The SEC believes that the dailyrequired computation of the initial andmaintenance margin requirements andthe collection and disbursement of dailysettlement variation for security futuresby brokers, dealers, or nationalsecurities exchanges members wouldrequire these entities to program orreprogram their computer systems toimplement the margin computationsand the settlement variation proceduresfor securities futures. These entities mayalso incur additional data storage costsand resource costs associated with thesecalculations. The SEC requestscomments, data, and estimates on allaspects of the costs associated with theproposed calculations for margin onsecurity futures, including whetherProposed SEC Rule 402(b)(1) under theExchange Act is likely to require theseentities mentioned above to increase thenumber of staff, or result in additionalresource burdens, to perform andimplement the required calculations.



154 For a discussion of who is considered an‘‘exempted borrower,’’ see supra notes 54–55 andaccompanying text.

155 For discussion on forms of collateral, seesupra notes 102–109 and accompanying text.

156 Such requirements would be proposed byregulatory authority rules approved by the SECpursuant to Section 19(b)(2) of the Exchange Act,and as applicable, subject to notice to the CFTC inaccordance with Section 5c(c) of the CEA.

157 For an in depth discussion on offsets, seesupra notes 74–88 and accompanying text.

158 15 U.S.C. 78c(f).

d. Notification Requirements RegardingExempted Borrowers

Proposed SEC Rule 400(b)(3)(iv)(A)would exclude from the proposedmargin regulation margin arrangementsbetween a creditor and a borrower withrespect to the borrower’s financing ofproprietary positions in security futures,based on the creditor’s good faithdetermination that the borrower is an‘‘exempted borrower.’’ 154

Proposed SEC Rule 402(e) wouldprovide that once a broker, dealer, or amember of a national securitiesexchange ceases to qualify as anexempted borrower, it must notify thecreditor (i.e., the broker, dealer, or anational securities exchange memberholding the position) of this fact beforeestablishing any new security futurepositions because any new securityfuture positions would be subject to theproposed rules.

The notification requirement underProposed SEC Rule 402(e) is likely toresult in various minor costs, includingpersonnel time for preparing thenotification by any means ofcommunication, and sending suchnotification by a broker, dealer, ormember of a national securitiesexchange that is required to send anotification to its creditor because it hasceased be an exempted borrower. TheSEC requests comments and estimateson the costs associated with thisnotification requirement.

e. Time Limits for Collection of Margin

Proposed SEC Rules 403(a) and (b)together would require that the amountof initial and maintenance marginrequired by the proposed rules beobtained as promptly as possible and, inany event, within three business daysafter the position is established, orwithin such shorter time period as maybe imposed by applicable regulatoryauthority rules approved by the SEC inaccordance with Section 19(b)(2) of theExchange Act. The SEC believes that thebrokers, dealers, or national securitiesexchange members that are effectingtransactions in security futures willneed to gather information to determinefor each customer’s account involvingsecurity futures when margin on suchposition must be obtained from itscustomers. The SEC requests comments,data, and cost estimates relating to thetime limits for collection of marginrequirements.

2. Benefits

The benefits of Proposed SEC Rules400 through 404 are related to thebenefits that will accrue as a result ofthe enactment of the CFMA. Byrepealing the ban on single stock futuresand futures on narrow-based securityindexes, the CFMA will enable a greatervariety of financial products to betraded that potentially could facilitateprice discovery and the ability to hedge.Investors will benefit by having a widerchoice of financial products to buy andsell, and markets and marketparticipants will benefit by having theability to trade these products. Theserules are a prerequisite to thecommencement of trading in the newproducts, and therefore, they are also aprerequisite to any benefits that mayderive from the availability of theseproducts.

a. Benefits to Brokers, Dealers, andMembers of National SecuritiesExchanges

Proposed SEC Rule 402(b)(1) wouldprovide that the minimum initial andmaintenance margin levels for eachsecurity future would be 20 percent ofthe current market value of suchcontract. Moreover, Proposed SEC Rule404(a) would provide that a broker,dealer or member of a nationalsecurities exchange may accept ascollateral cash, margin securities,exempted securities, or other collateralpermitted under Regulation T to satisfya margin deficiency in the marginaccount.155 Proposed SEC Rule 404(b)further provides that a regulatoryauthority may prescribe margincollateral requirements (other thanmargin levels) including the type, form,and use of collateral for security futures,that are consistent with therequirements under Regulation T.156

The SEC preliminarily believes thatthe margin levels and other marginrequirements proposed would providesound protection from customer defaultby reducing chances of depletion ofmargin accounts, and therefore reducesystemic risk associated with the tradingof these new products.

b. Benefits to Customers

Additionally, Proposed SEC Rule402(d) would provide that customers bepermitted to offset positions involvingsecurity futures with certain related

securities or futures.157 Such offsetswould be proposed by regulatoryauthority rules that would be approvedby the SEC pursuant to Section 19(b)(2)of the Exchange Act if such offsets wereconsistent with the Exchange Act,including the requirement that marginrequirements for security futures be noless restrictive than those imposed onoptions. These offsets likely wouldprovide benefits to customers becausesuch rules would recognize the hedgednature of the certain specified combinedstrategies and would permit lowermargin requirements that better reflectthe true risk of those strategies. Becausesecurity futures are new products,however, the SEC is unable at this timeto quantify these benefits and thereforerequests comments, data, and estimatesregarding these benefits.

c. Regulatory Benefits

Proposed SEC Rule 400(b)(1) wouldprovide, to the extent consistent withthe proposed rules, that Regulation Tapplies to financial relations, includingmargin arrangements, between acreditor and a customer with respect tosecurity futures and any relatedsecurities or futures contracts that areused to offset positions in securityfutures. This provision is designed toensure that existing and future FederalReserve Board interpretations ofRegulation T would apply and that,therefore, margin requirements forsecurity futures would remainconsistent without further action by theCommissions.

C. Request for Comments

To assist the SEC and the CFTC intheir evaluation of the costs and benefitsthat may result from the proposedrulemaking, commenters are requestedto provide analysis and data relating tothe anticipated costs and benefitsassociated with the proposed rules.Specifically, the SEC and the CFTCrequest commenters to address whetherthe proposed rules would generate theanticipated benefits or imposeadditional costs on U.S. investors orothers.

VII. Consideration of Burden onCompetition, Promotion of Efficiency,and Capital Formation

Section 3(f) of the Exchange Act 158

requires the SEC, whenever it is engagedin rulemaking and is required toconsider or determine whether an actionis necessary or appropriate in the publicinterest, to consider whether the action



159 15 U.S.C. 78w(a)(2).160 Id.161 15 U.S.C. 78c(f).162 15 U.S.C. 78w(a)(2).

163 5 U.S.C. 601 et seq.164 47 FR 18618–21 (April 30, 1982).165 Id. at 18619.166 66 FR 44960, 44964 (August 27, 2001).167 66 FR 42256, 42268 (August 10, 2001).168 47 FR at 18619.169 A broker or dealer that is registered with the

SEC and that limits its futures activities to thoseinvolving security futures products, may noticeregister with the CFTC as an FCM in accordancewith Section 4f(a)(2) of the CEA (7 U.S.C. 6f(a)(2)).

170 7 U.S.C. 6f(a)(1).

171 See Exchange Act Rule 15c3–1(a)(2), 17 CFR240.15c–1(a)(2).

172 15 U.S.C. 78f(a).173 5 U.S.C. 603(a).174 5 U.S.C. 605(b).175 See 7 U.S.C. 1(a)(23).176 See 47 FR 18618–21 (April 30, 1982). See also

66 FR 14262, 14268 (March 9, 2001).

will promote efficiency, competition,and capital formation. In addition,Section 23(a)(2) of the Exchange Actrequires the SEC, in adopting rulesunder the Exchange Act, to consider theimpact on competition of any rules itadopts.159 Section 23(a)(2) of theExchange Act further provides that theSEC may not adopt a rule that wouldimpose a burden on competition notnecessary or appropriate in furtheranceof the purposes of the Exchange Act.160

The rules proposed today would imposeinitial and maintenance marginrequirements on brokers, dealers andmembers of national securitiesexchanges that collect customer marginfor security futures. The SEC hasconsidered the proposed rules in light ofthe standards set forth in Sections3(f) 161 and 23(a)(2) 162 of the ExchangeAct.

The SEC preliminarily believes thatthe proposed rules should promoteefficiency by setting forth clearguidelines for brokers, dealers, andmembers of national securitiesexchanges when collecting customermargin related to security futures.Further, the SEC believes that theproposed rules will provide soundprotection from customer default byreducing chances of depletion of marginaccounts, and therefore reduce systemrisk associated with the trading of thesenew products.

The SEC also preliminarily believesthat the proposed rules would notimpose any significant burden oncompetition. The proposed rules serveonly to set forth margin requirements forsecurity futures, including establishingmargin levels and margin collateralrequirements. Lastly, the SECpreliminarily believes that the proposedrules would not have any impact oncapital formation because the proposedrules would merely establish rulesgoverning the collection of customermargin. The SEC notes that theseproposed margin requirements wouldprotect brokers, dealers, and members ofnational securities exchanges fromcustomers’ default, thus encouragingparticipation by these marketparticipants in the trading of futurescontracts on both single stocks andnarrow-based indexes. Therefore, theSEC preliminarily believes that therecould be an increased demand for theunderlying securities, resulting inincreased capital formation.Nevertheless, the SEC believes that thebenefits to the capital formation process

principally flow from the CFMA itself,which lifts the ban on trading of singlestock futures and narrow-based indexstock futures.

The SEC requests comments on theimpact of the proposed rules oncompetition, efficiency and capitalformation.

VIII. Regulatory Flexibility ActCertifications

A. CFTCThe Regulatory Flexibility Act

(‘‘RFA’’) 163 requires that federalagencies, in promulgating rules,consider the impact of those rules onsmall entities. The proposed ruleswould affect designated contractmarkets, registered DTFs, and FCMs.The CFTC has previously establishedcertain definitions of ‘‘small entities’’ tobe used by the CFTC in evaluating theimpact of its rules on small entities inaccordance with the RFA.164

In its previous determinations, theCFTC has concluded that contractmarkets are not small entities forpurposes of the RFA, based on the vitalrole contract markets play in thenational economy and the significantamount of resources required to operateas SROs.165 Recently, the CFTCdetermined that notice-designatedcontract markets are not small entitiesfor purposes of the RFA.166 In addition,the CFTC has determined that othertrading facilities subject to itsjurisdiction, including registered DTFs,are not small entities for purposes of theRFA.167

The CFTC also has previouslydetermined that FCMs are not smallentities for purposes of the RFA, basedon the fiduciary nature of FCM-customer relationships as well as therequirements that FCMs meet certainminimum financial requirements.168

The CFTC is proposing to determinethat notice-registered FCMs,169 for thereasons applicable to FCMs registered inaccordance with Section 4f(a)(1) of theCEA,170 are not small entities forpurposes of the RFA. Brokers or dealersthat carry customer accounts andreceive or hold funds for thosecustomers, and are notice-registered asFCMs for the purpose of trading security

futures, similarly have a fiduciaryrelationship with their customers andmust meet analogous minimumfinancial requirements.171

Additionally, the CFTC notes thatCongress mandated that customermargin for security futures be consistentwith the margin requirements forcomparable option contracts traded onany exchange registered pursuant toSection 6(a) of the Exchange Act.172 Inproposing these rules, the Commissionshave striven to fulfill this requirementin the least burdensome way possible.

Accordingly, the Acting Chairman, onbehalf of the CFTC, certifies pursuant to5 U.S.C. 605(b), that the proposed ruleswill not have a significant economicimpact on a substantial number of smallentities. The CFTC invites the public tocomment on this finding and on itsproposed determination that notice-registered FCMs are not small entitiesfor purposes of the RFA.

B. SEC

Section 3(a) of the RFA 173 requiresthe SEC to undertake an initialregulatory flexibility analysis of theproposed rules on the small entitiesunless the Chairman certifies that therule, if adopted, would not have asignificant economic impact on smallentities.174 Proposed Rules 400 through404 would apply to brokers, dealers andmembers of national securitiesexchanges.

Introducing brokers (‘‘IBs’’) and FCMmay register as broker-dealers by filingForm BD–N. However, because IBscannot collect customer margin they arenot subject to these rules.175 In addition,the CFTC has concluded that FCMs arenot considered small entities for thepurposes of the RFA.176 Accordingly,there are no FCMs or IBs that are smallentities that would be affected by theproposed rules.

The proposed rules would also applyto broker-dealers and members ofnational securities exchanges. With oneexception, all members of nationalsecurities exchanges registered underSection 6(a) of the Exchange Act areregistered broker-dealers. The SECbelieves that some small broker-dealerscould be affected by the proposals, butthat the proposals will not have asignificant impact on a substantialnumber of small broker-dealers.



177 7 U.S.C. 1(a)(16) and (17).

In addition, national securitiesexchanges registered under Section 6(g)of the Exchange Act may have memberswho are floor brokers or floor traderswho are not registered broker-dealers.Floor brokers and floor traders,however, are not eligible to clearsecurities transactions or collectcustomer margin, and thus would not besubject to the proposed rules.177

Accordingly, the Chairman of the SEChas certified that the proposed rules, ifadopted, would not have a significanteconomic impact on a substantialnumber of small entities. Thiscertification is attached as Appendix Ato this notice.

The SEC invites commenters toaddress whether the proposed ruleswould have a significant economicimpact on a substantial number of smallentities, and if so, what would be thenature of any impact on small entities.The SEC requests that commentersprovide empirical data to support theextent of such impact.

IX. Statutory Basis and Text ofProposed Rules

The SEC is proposing Rules 400through 404 pursuant to the ExchangeAct, particularly Sections 3(b), 6, 7(c),15A and 23(a). Further, these rules areproposed pursuant to the authoritydelegated jointly to the SEC, togetherwith the CFTC, by the Federal ReserveBoard in accordance with Exchange ActSection 7(c)(2)(A). See Appendix B.

List of Subjects

17 CFR Part 41

Brokers, Margin, Reporting andrecordkeeping, Security futuresproducts.

17 CFR Part 242

Brokers and Securities.

Commodity Futures TradingCommission

17 CFR Chapter I

In accordance with the foregoing,Title 17, chapter I of the Code of FederalRegulations is proposed to be amendedas follows:

PART 41—SECURITY FUTURES

1. The authority citation for Part 41 isrevised to read as follows:

Authority: Sections 206, 251 and 252, Pub.L. 106–554, 114 Stat. 2763; 7 U.S.C. 1a, 2, 6f,6j, 7a–2, 12a; 15 U.S.C. 78g(c)(2).

2. Part 41 is amended by adding§§ 41.43 through 41.48 to read asfollows:

§ 41.43 Customer margin—authority,purpose and scope.

(a) Authority and purpose. Sections41.43 through 41.48 are issued by theCommodity Futures TradingCommission (CFTC), jointly with theSecurities and Exchange Commission(SEC) 17 CFR 242.400 through 242.404,pursuant to authority delegated by theBoard of Governors of the FederalReserve System under Section 7(c)(2)(A)of the Securities Exchange Act of 1934(the ‘‘Exchange Act’’) (15 U.S.C.78g(c)(2)(A)). Its principal purpose is toregulate margin collected by brokers,dealers, and members of nationalsecurities exchanges relating tocustomers’ transactions in securityfutures and imposes, among otherrequirements, minimum customerinitial and maintenance margin levelsfor such security futures positions.

(b) Scope of section. (1) Regulation T(12 CFR part 220) shall apply tofinancial relations, including marginarrangements, between a creditor and acustomer with respect to securityfutures and any related securities orfutures contracts that are used to offsetpositions in such security futures, to theextent consistent with this part.

(2) This part does not preclude aregulatory authority or creditor fromimposing additional marginrequirements on security futures,including higher margin levels and risk-sensitive criteria, consistent with thispart, or from taking appropriate actionto preserve its financial integrity.

(3) This part does not apply to:(i) Financial relations between a

customer and a creditor to the extentthat they comply with a portfoliomargining system under rules that havebecome effective in accordance withSection 19(b)(2) of the Exchange Act (15U.S.C. 78s(b)(2)) and, as applicable,Section 5c(c) of the CommodityExchange Act (the ‘‘Act’’) (7 U.S.C. 7a–2(c));

(ii) Financial relations between aforeign branch of a creditor and aforeign person involving foreignsecurity futures;

(iii) Margin requirements that clearingagencies registered with the SEC or theCFTC impose on their members; and

(iv) Credit extended, maintained, orarranged by a creditor to or for amember of a national securitiesexchange or a registered broker or dealerif:

(A) Such creditor makes a good faithdetermination that the borrower is anexempted borrower;

(B) The borrower otherwise qualifiesfor exemption pursuant to Section7(c)(3) of the Exchange Act (15 U.S.C.78g(c)(3)); or

(C) The borrower is a member of anational securities exchange or anational securities association registeredunder Section 15A(a) of the ExchangeAct (15 U.S.C. 78o–3(a)) and theborrower:

(1) Does not directly or indirectlyaccept or solicit orders from anycustomer or provide advice to anycustomer in connection with the tradingof security futures; and

(2) Is registered with such exchange orsuch association as a security futuresdealer, pursuant to regulatory authorityrules that have become effective inaccordance with Section 19(b)(2) of theExchange Act (15 U.S.C. 78s(b)(2)) and,as applicable, Section 5c(c) of the Act (7U.S.C. 7a–2(c)), that:

(i) Require such member to beregistered as a floor trader or a floorbroker with the CFTC under Section4f(a)(1) of the Act (7 U.S.C. 6f(a)(1)), oras a dealer with the SEC under Section15(b) of the Exchange Act (15 U.S.C.78o(b));

(ii) Require such member to complywith applicable SEC or CFTC net capitalrequirements;

(iii) Require such member to maintainrecords sufficient to prove compliancewith this paragraph (b)(3)(iv)(C) and therules of the exchange or association ofwhich the borrower is a member;

(iv) Require such member to holditself out as being willing to buy and sellsecurity futures for its own account ona regular or continuous basis; and

(v) Provide for disciplinary action,including revocation of such member’sregistration as a security futures dealer,for such member’s failure to complywith §§ 41.43 through 41.48 or the rulesof the exchange or association.

§ 41.44 Customer margin—definitions.(a) For purposes of this part only, the

following terms shall have the meaningsset forth in this section.

(1) Contract multiplier means thenumber of units of a narrow-basedsecurity index expressed as a dollaramount, in accordance with the terms ofthe security future contract.

(2) On any day, current market valuemeans with respect to a security future:

(i) If the instrument underlying suchsecurity future is a stock, the product ofthe daily settlement price of suchsecurity future as shown by anyregularly published reporting orquotation service, and the applicablenumber of shares per contract; or

(ii) If the instrument underlying suchsecurity future is a narrow-basedsecurity index, as defined in section3(a)(55)(B) of the Exchange Act (15U.S.C. 78c(a)(55)(B)), the product of thedaily settlement price of such security



future as shown by any regularlypublished reporting or quotationservice, and the applicable contractmultiplier.

(3) Examining authority with respectto a creditor means:

(i) The regulatory authority of whichsuch creditor is a member, if suchcreditor is a member of only oneregulatory authority;

(ii) The regulatory authoritydesignated responsibility by the SECpursuant to § 240.17d–1 of this title forexamining such creditor for compliancewith applicable financial responsibilityrules, if a regulatory authority is sodesignated; or

(iii) The regulatory authoritydesignated in accordance with § 1.52 ofthis chapter, if such creditor is amember of more than one regulatoryauthority and the SEC, pursuant to§ 240.17d–1 of this title, has notdesignated responsibility for examiningsuch creditor for compliance withapplicable financial responsibility rules.

(4) Initial margin means the margin asdefined in Section 3(a)(57)(A) of theExchange Act (15 U.S.C. 78c(a)(57)(A)),that is required when a security futureposition is opened.

(5) Maintenance margin means themargin, as defined in Section 3(a)(57)(A)of the Exchange Act (15 U.S.C.78c(a)(57)(A)), that is required to bemaintained in a customer’s securitiesaccount, as defined in § 1.3(ww) of thischapter, or futures account, as definedin § 1.3(vv) of this chapter, at the end ofeach trading day.

(6) Regulation T means Regulation Tpromulgated by the Board of Governorsof the Federal Reserve System (‘‘FederalReserve Board’’), 12 CFR part 220.

(7) Regulatory authority means a self-regulatory organization that is registeredas a national securities exchange underSection 6 of the Exchange Act (15 U.S.C.78f) or a registered securities associationunder Section 15A of the Exchange Act(15 U.S.C. 78o–3).

(8) Daily settlement price means, withrespect to a security future, thesettlement price of such security futuredetermined at the close of trading eachday, under the rules of the applicableexchange or clearing organization.

(b) Terms used in this part and nototherwise defined in this section shallhave the meaning set forth in RegulationT (12 CFR part 220).

(c) Terms used in this part and nototherwise defined in this section or inRegulation T (12 CFR part 220) shallhave the meaning set forth in theExchange Act.

§ 41.45 Customer margin—customermargin levels for security futures.

(a) Applicability. No broker, dealer ormember of a national securitiesexchange may effect a transactioninvolving, or carry an accountcontaining, a security future positionwith or for a customer, withoutobtaining proper and adequate marginas set forth in this section.

(b) Amount of customer margin—(1)General rule. The minimum initial andmaintenance margin levels for eachsecurity future contract shall be 20percent of the current market value ofsuch contract.

(2) Exceptions. Provided that suchhigher margin levels or calculationmethods have become effective inaccordance with Section 19(b) of theExchange Act (15 U.S.C. 78s(b)), nothingin this section shall prevent a regulatoryauthority from:

(i) Requiring initial and/ormaintenance margin levels that arehigher than the minimum margin levelsspecified in paragraph (b)(1) of thissection; or

(ii) Using a method for calculatingrequired initial and/or maintenancemargin that may result in margin levelsthat are higher than the minimummargin levels specified in paragraph(b)(1) of this section.

(c) Procedures for certain margin leveladjustments. An exchange registeredunder Section 6(g) of the Exchange Act(15 U.S.C. 78f(g)), or a nationalsecurities association registered underSection 15A(k) of the Exchange Act (15U.S.C. 78o–3(k)), may raise or lower therequired margin level to a level notlower than that specified in this section,in accordance with Section 19(b)(7) ofthe Exchange Act (15 U.S.C. 78s(b)(7)).

(d) Offsetting positions.Notwithstanding the minimum marginlevels specified in paragraph (b)(1) ofthis section, customers with offsetpositions involving security futures andone or more related securities or futurescontracts may, pursuant to regulatoryauthority rules that have becomeeffective in accordance with Section19(b)(2) of the Exchange Act (15 U.S.C.78s(b)(2)) and, as applicable, Section5c(c) of the Act (7 U.S.C. 7a–2(c)), haveinitial or maintenance margin levels thatare lower than the levels specified inparagraph (b)(1) of this section,provided that such margin levels are notlower than the lowest customer marginlevels required for any comparableoffset positions involving optioncontracts traded on any exchangeregistered pursuant to Section 6(a) of theExchange Act (15 U.S.C. 78f(a)).

(e) Change in exempted borrowerstatus. Once a broker, dealer, or a

member of a national securitiesexchange ceases to qualify as anexempted borrower, it shall notify thecreditor of this fact before establishingany new security future positions. Anynew security future positions will besubject to the provisions of this part.

§ 41.46 Customer margin—time limits forcollection of margin.

(a) Initial margin. The amount ofinitial margin required or permitted by§ 41.45 shall be obtained by the creditoras promptly as possible and in anyevent within three business days afterthe position is established, or withinsuch shorter time period as may beimposed by applicable regulatoryauthority rules that have becomeeffective in accordance with section19(b)(2) of the Exchange Act (15 U.S.C.78s(b)(2)) and, as applicable, section5c(c) of the Act (7 U.S.C. 7a–2(c)).

(b) Maintenance margin. The amountof maintenance margin required orpermitted by § 41.45 shall be obtainedby the creditor as promptly as possibleand in any event within three businessdays after the margin deficiency iscreated or increased, or within suchshorter time period as may be imposedby applicable regulatory authority rulesthat have become effective inaccordance with section 19(b)(2) of theExchange Act (15 U.S.C. 78s(b)(2)) and,as applicable, section 5c(c) of the Act (7U.S.C. 7a–2(c)).

(c) Extension of time limits. The timelimits for collection of initial marginmay be extended upon application bythe creditor to its examining authority tothe extent permitted by applicableregulatory authority rules that havebecome effective in accordance withsection 19(b)(2) of the Exchange Act (15U.S.C. 78s(b)(2)) and, as applicable,Section 5c(c) of the Act (7 U.S.C. 7a–2(c)).

§ 41.47 Customer margin—forms ofcollateral.

(a) A broker, dealer or a member of anational securities exchange may acceptas margin collateral:

(1) Cash;(2) Margin securities;(3) Exempted securities as defined in

section 3(a)(12) of the Exchange Act (15U.S.C. 78c(a)(12)); or

(4) Other collateral permitted underRegulation T (12 CFR part 220) to satisfya margin deficiency in the marginaccount.

(b) Nothing in this section shallprevent a regulatory authority fromprescribing margin collateralrequirements (other than margin levels)including the type, form, and use ofcollateral for security futures, that are



consistent with the requirementsestablished by the Federal ReserveBoard, pursuant to section 7(c)(1)(A)and (B) of the Exchange Act (15 U.S.C.78g(c)(1)(A) and (B)), subject to approvalby the SEC in accordance with section19(b)(2) of the Exchange Act (15 U.S.C.78s(b)(2)) and, as applicable, subject tonotice to the CFTC in accordance withsection 5c(c) of the Act (7a U.S.C. 7a–2(c)).

(c) For the purposes of this section,security futures are not marginsecurities.

§ 41.48 Customer margin—filing proposedmargin rule changes with the CFTC.

(a) Notification requirement fornotice-registered contract markets. Anyregulatory authority that is registeredwith the CFTC as a designated contractmarket under section 5f of the Act (7U.S.C.7b–1) shall, when filing aproposed rule change regardingcustomer margin for security futureswith the SEC for approval in accordancewith section 19(b)(2) of the ExchangeAct (15 U.S.C. 78s(b)(2)), concurrentlyprovide to the CFTC a copy of suchproposed rule change and anyaccompanying documentation filed withthe SEC.

(b) Filing requirements under the Act.Any regulatory authority that isregistered with the CFTC as adesignated contract market orderivatives transaction executionfacility under section 5 of the Act (7U.S.C. 7) shall, when filing a proposedrule change regarding customer marginfor security futures with the SEC forapproval in accordance with section19(b)(2) of the Exchange Act (15 U.S.C.78s(b)(2)), notify the CFTC as follows:

(1) If the regulatory authority elects torequest CFTC prior approval for theproposed rule change pursuant tosection 5c(c)(2) of the Act (7 U.S.C. 7a–2(c)(2)), it shall concurrently file theproposed rule change with the CFTC inaccordance with § 40.5 of this chapter.

(2) If the regulatory authority elects toimplement a proposed rule change bywritten certification pursuant to section5c(c)(1) of the Act (7 U.S.C. 7a–2(c)(1)),it shall concurrently provide to theCFTC a copy of the proposed rulechange and any accompanyingdocumentation filed with the SEC.Promptly after obtaining SEC approvalfor the proposed rule change, suchregulatory authority shall file its writtencertification with the CFTC inaccordance with § 40.6 of this chapter.

Dated: September 26, 2001.

By the Commodity Futures TradingCommission.Jean A. Webb,Secretary.

Securities and Exchange Commission

17 CFR Chapter IIIn accordance with the foregoing,

Title 17, chapter II, part 242 of the Codeof Federal Regulations is proposed to beamended as follows:

PART 242—REGULATIONS M ANDATS

1. The authority citation for part 242is revised to read as follows:

Authority: 15 U.S.C. 77g, 77q(a), 77s(a),78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l,78m, 78mm, 78n, 78o(b), 78o(c), 78o(g),78q(a), 78q(b), 78q(h), 78w(a), 78dd–1, 80a–23, 80a–29, and 80a–37.

2. Sections 242.400 through 242.404are added to read as follows:

§ 242.400 Customer margin requirementsfor security futures—Authority, purposeand scope.

(a) Authority and purpose. Sections242.400 through 242.404 are issued bythe Securities and ExchangeCommission (SEC), jointly with theCommodity Futures TradingCommission (CFTC) 17 CFR 41.43through 41.48, pursuant to authoritydelegated by the Board of Governors ofthe Federal Reserve System undersection 7(c)(2)(A) of the SecuritiesExchange Act of 1934 (‘‘Act’’) (15 U.S.C.78g(c)(2)(A)). Its principal purpose is toregulate margin collected by brokers,dealers, and members of nationalsecurities exchanges relating tocustomers’ transactions in securityfutures and imposes, among otherrequirements, minimum customerinitial and maintenance margin levelsfor such security futures positions.

(b) Scope of section. (1) Regulation T(12 CFR part 220) shall apply tofinancial relations, including marginarrangements, between a creditor and acustomer with respect to securityfutures and any related securities orfutures contracts that are used to offsetpositions in such security futures, to theextent consistent with this part.

(2) This part does not preclude aregulatory authority or creditor fromimposing additional marginrequirements on security futures,including higher margin levels and risk-sensitive criteria, consistent with thispart, or from taking appropriate actionto preserve its financial integrity.

(3) This part does not apply to:(i) Financial relations between a

customer and a creditor to the extentthat they comply with a portfolio

margining system under rules that havebecome effective in accordance withsection 19(b)(2) of the Act (15 U.S.C.78s(b)(2)) and, as applicable, section5c(c) of the Commodity Exchange Act(‘‘CEA’’) (7 U.S.C. 7a–2(c));

(ii) Financial relations between aforeign branch of a creditor and aforeign person involving foreignsecurity futures;

(iii) Margin requirements that clearingagencies registered with the SEC or theCFTC impose on their members; and

(iv) Credit extended, maintained, orarranged by a creditor to or for amember of a national securitiesexchange or a registered broker or dealerif:

(A) Such creditor makes a good faithdetermination that the borrower is anexempted borrower;

(B) The borrower otherwise qualifiesfor exemption pursuant to section7(c)(3) of the Act (15 U.S.C. 78g(c)(3));or

(C) The borrower is a member of anational securities exchange or nationalsecurities association registeredpursuant to section 15A(a) of the Act (15U.S.C. 78o–3(a)) and the borrower:

(1) Does not directly or indirectlyaccept or solicit orders from anycustomer or provide advice to anycustomer in connection with the tradingof security futures; and

(2) Is registered with such exchange orsuch association as a security futuresdealer, pursuant to regulatory authorityrules, approved by the SEC inaccordance with section 19(b)(2) of theAct (15 U.S.C. 78s(b)(2)), that:

(i) Require such member to beregistered as a floor trader or a floorbroker with the CFTC under section4f(a)(1) of the CEA (7 U.S.C. 6f(a)(1)), oras a dealer with the SEC under section15(b) of the Act (15 U.S.C. 78o(b));

(ii) Require such member to complywith applicable SEC or CFTC net capitalrequirements;

(iii) Require such member to maintainrecords sufficient to prove compliancewith this paragraph (b)(3)(iv)(C) and therules of the exchange or association ofwhich the borrower is a member;

(iv) Require such member to holditself out as being willing to buy and sellsecurity futures for its own account ona regular or continuous basis; and

(v) Provide for disciplinary action,including revocation of such member’sregistration as a security futures dealer,for such member’s failure to complywith §§ 242.400 through 242.404 or therules of the exchange or association.

§ 242.401 Definitions.(a) For purposes of this part only, the

following terms shall have the meaningsset forth in this section.



(1) Contract multiplier means thenumber of units of a narrow-basedsecurity index expressed as a dollaramount, in accordance with the terms ofthe security future contract.

(2) On any day, current market valuemeans with respect to a security future:

(i) If the instrument underlying suchsecurity future is a stock, the product ofthe daily settlement price of suchsecurity future as shown by anyregularly published reporting orquotation service, and the applicablenumber of shares per contract;

(ii) If the instrument underlying suchsecurity future is a narrow-basedsecurity index, as defined in section3(a)(55)(B) of the Act (15 U.S.C.78c(a)(55)(B)), the product of the dailysettlement price of such security futureas shown by any regularly publishedreporting or quotation service, and theapplicable contract multiplier.

(3) Examining authority with respectto a creditor means:

(i) The regulatory authority of whichsuch creditor is a member, if suchcreditor is a member of only oneregulatory authority;

(ii) The regulatory authoritydesignated responsibility by the SECpursuant to § 240.17d–1 of this chapterfor examining such creditor forcompliance with applicable financialresponsibility rules, if a regulatoryauthority is so designated; or

(iii) The regulatory authoritydesignated in accordance with § 1.52 ofthis title, if such creditor is a memberof more than one regulatory authorityand the SEC, pursuant to § 240.17d–1 ofthis chapter, has not designatedresponsibility for examining suchcreditor for compliance with applicablefinancial responsibility rules.

(4) Initial margin means the margin asdefined in section 3(a)(57)(A) of the Act(15 U.S.C. 78c(a)(57)(A)), that isrequired when a security future positionis opened.

(5) Maintenance margin means themargin, as defined in section 3(a)(57)(A)of the Act (15 U.S.C. 78c(a)(57)(A)), thatis required to be maintained in acustomer’s securities account orcommodity interest account at the endof each trading day.

(6) Regulation T means Regulation Tpromulgated by the Board of Governorsof the Federal Reserve System (‘‘FederalReserve Board’’), 12 CFR part 220.

(7) Regulatory authority means a self-regulatory organization that is registeredas a national securities exchange undersection 6 of the Act (15 U.S.C. 78f) ora registered securities association undersection 15A of the Act (15 U.S.C. 78o–3).

(8) Daily settlement price means, withrespect to a security future, thesettlement price of such security futuredetermined at the close of trading eachday, under the rules of the applicableexchange or clearing organization.

(b) Terms used in this part and nototherwise defined in this section shallhave the meaning set forth in RegulationT (12 CFR part 220).

(c) Terms used in this part and nototherwise defined in this section or inRegulation T (12 CFR part 220) shallhave the meaning set forth in the Act.

§ 242.402 Customer margin for securityfutures.

(a) Applicability. No broker, dealer ormember of a national securitiesexchange may effect a transactioninvolving, or carry an accountcontaining, a security future positionwith or for a customer, withoutobtaining proper and adequate marginas set forth in this section.

(b) Amount of customer margin—(1)General rule. The minimum initial andmaintenance margin levels for eachsecurity future contract shall be twenty(20) percent of the current market valueof such contract.

(2) Exceptions. Provided that suchhigher margin levels or calculationmethods have become effective inaccordance with Section 19(b) of the Act(15 U.S.C. 78s(b)), nothing in thissection shall prevent a regulatoryauthority from:

(i) Requiring initial and/ormaintenance margin levels that arehigher than the minimum margin levelsspecified in paragraph (b)(1) of thissection; or

(ii) Using a method for calculatingrequired initial and/or maintenancemargin that may result in margin levelsthat are higher than the minimummargin levels specified in paragraph(b)(1) of this section.

(c) Procedures for certain margin leveladjustments. An exchange registeredunder section 6(g) of the Act (15 U.S.C.78f(g)), or a national securitiesassociation registered under section15A(k) of the Act (15 U.S.C. 78o–3(k)),may raise or lower the required marginlevel to a level not lower than thatspecified in this section, in accordancewith section 19(b)(7) of the Act (15U.S.C. 78s(b)(7)).

(d) Offsetting positions.Notwithstanding the minimum marginlevels specified in paragraph (b)(1) ofthis section, customers with offsetpositions involving security futures andone or more related securities or futurescontracts may, pursuant to regulatoryauthority rules approved by theCommission in accordance with section

19(b)(2) of the Act (15 U.S.C. 78s(b)(2)),have initial or maintenance marginlevels that are lower than the levelsspecified in paragraph (b)(1) of thissection, provided that such marginlevels are not lower than the lowestcustomer margin levels required for anycomparable offset positions involvingoption contracts traded on any exchangeregistered pursuant to section 6(a) of theAct (15 U.S.C. 78f(a)).

(e) Change in exempted borrowerstatus. Once a broker, dealer, or amember of a national securitiesexchange ceases to qualify as anexempted borrower, it shall notify thecreditor of this fact before establishingany new security future positions. Anynew security future positions will besubject to the provisions of this part.

§ 242.403 Time limits for collection ofmargin.

(a) Initial margin. The amount ofinitial margin required or permitted by§ 242.402 shall be obtained by thecreditor as promptly as possible and inany event within three (3) business daysafter the position is established, orwithin such shorter time period as maybe imposed by applicable regulatoryauthority rules approved by theCommission in accordance with section19(b)(2) of the Act (15 U.S.C. 78s(b)(2)).

(b) Maintenance margin. The amountof maintenance margin required orpermitted by § 242.402 shall be obtainedby the creditor as promptly as possibleand in any event within three (3)business days after the margindeficiency is created or increased, orwithin such shorter time period as maybe imposed by applicable regulatoryauthority rules approved by the SEC inaccordance with section 19(b)(2) of theAct (15 U.S.C. 78s(b)(2)).

(c) Extension of time limits. The timelimits for collection of initial marginmay be extended upon application bythe creditor to its examining authority tothe extent permitted by applicableregulatory authority rules approved bythe Commission in accordance withsection 19(b)(2) of the Act (15 U.S.C.78s(b)(2)).

§ 242.404 Forms of collateral.(a) A broker, dealer or a member of a

national securities exchange may acceptas margin collateral:

(1) Cash;(2) Margin securities;(3) Exempted securities as defined in

section 3(a)(12) of the Act (15 U.S.C.78c(a)(12)); or

(4) Other collateral permitted underRegulation T (12 CFR part 220) to satisfya margin deficiency in the marginaccount.



178 See 47 FR 18618, 18618–21 (April 30, 1982).See also 66 FR 14262, 14268 (March 9, 2001).

(b) Nothing in this section shallprevent a regulatory authority fromprescribing margin collateralrequirements (other than margin levels)including the type, form, and use ofcollateral for security futures, that areconsistent with the requirementsestablished by the Federal ReserveBoard, pursuant to Section 7 (c)(1)(A)and (B) of the Act (15 U.S.C.78g(c)(1)(A) and (B)), subject to approvalby the Commission in accordance withsection 19(b)(2) of the Act (15 U.S.C.78s(b)(2)) and, as applicable, subject tonotice to the CFTC in accordance withsection 5c(c) of the CEA (7 U.S.C. 7a–2(c)).

(c) For the purposes of this section,security futures are not marginsecurities.

Dated: September 26, 2001.By the Securities and Exchange Commission.

Margaret H. McFarland,Deputy Secretary.

Note: Appendix A and B to the preamblewill not appear in the Code of FederalRegulations.

Appendix A—Regulatory FlexibilityAct Certification

I, Harvey L. Pitt, Chairman of the Securitiesand Exchange Commission (the‘‘Commission’’), hereby certify, pursuant to 5U.S.C. § 605(b), that the rules proposed inSection 242.400, et seq., under the SecuritiesExchange Act of 1934 (‘‘Exchange Act’’),which would regulate margin collected bybrokers, dealers, and members of nationalsecurities exchanges relating to customers’transactions in security futures and impose,among other requirements, minimumcustomer initial and maintenance marginlevels for such security futures positions,would not, if adopted, have a significanteconomic impact on a substantial number ofsmall entities.

The proposed rules would affect brokers,dealers, and members of national securitiesexchanges. Futures commission merchants(‘‘FCMs’’) and introducing brokers (‘‘IBs’’)may register as broker-dealers by filing FormBD–N. The Commodities Futures TradingCommission has concluded that FCMs arenot considered small entities for the purposesof RFA.178 In addition, because IBs cannotcollect customer margin they are not subjectto these rules. Accordingly, there are noFCMs or IBs that are small entities thatwould be affected by the proposed rules.

The proposed rules would also apply tobroker-dealers and members of nationalsecurities exchanges. With one exception, allmembers of national securities exchangesregistered under Section 6(a) of the Exchange

Act are registered broker-dealers. TheCommission believes that some small broker-dealers could be affected by the proposals,but that the proposals would not have asignificant impact on a substantial number ofsmall broker-dealers.

In addition, national securities exchangesregistered under Section 6(g) of the ExchangeAct may have members who are floor brokersor floor traders who are not registered broker-dealers. Floor brokers and floor traders,however, are not eligible to clear securitiestransactions or collect customer margin, andthus would not be subject to the proposedrules.

Accordingly, the proposed rules, ifadopted, would not have a significanteconomic impact on a substantial number ofsmall entities.

Dated: September 25, 2001.Harvey L. Pitt,Chairman.

Appendix B

March 6, 2001.Mr. James E. Newsome,Acting Chairman, Commodity Futures

Trading Commission, Three LafayetteCentre, 21st Street, NW., Washington, DC20581

Ms. Laura S. UngerActing Chairman, Securities and Exchange

Commission, 450 Fifth Street, NW.,Washington, DC 20549.

Dear Acting Chairman Newsome andActing Chairman Unger: Section 206(b) of theCommodity Futures Modernization Act of2000 (CFMA) amends the SecuritiesExchange Act of 1934 (SEA), in part byadding a new section 7(c)(2) to provide theBoard of Governors of the Federal ReserveSystem with authority to prescribe marginregulations for brokers, dealers, and membersof national securities exchanges extendingcredit to or collecting margin from customerson security futures products. The Board mustprescribe regulations establishing initial andmaintenance margin levels for these contractsor delegate the authority jointly to theCommodity Futures Trading Commissionand the Securities Exchange Commission (theCommissions).

The Board has long taken the position thatthe regulatory authorities most familiar withthe operation of the financial markets shouldplay a key role in federal oversight of marginpolicy for these markets. In addition, theBoard believes that the most importantfunction of customer margin requirementsshould be prudential, that is, protection oflenders from credit losses. The Commissionshave responsibility for regulating thesecurities and futures markets and willjointly oversee the exchanges trading securityfutures products. Furthermore, theCommissions are responsible for all otherprudential supervision of the broker-dealersand exchange members covered by the newmargin authority. These factors lead theBoard to conclude that the SecuritiesExchange Commission and the Commodity

Futures Trading Commission, jointly, are themost appropriate entities to exercise thefunctions assigned to the Board under section7(c)(2) of the SEA.

Accordingly, the Board hereby delegates itsauthority under section 7(c)(2) of the SEA tothe Commodity Futures Trading Commissionand the Securities Exchange Commission,jointly, until further notice from the Board.The authority delegated by the Board islimited to customer margin requirementsimposed by brokers, dealers, and members ofnational securities exchanges. It does notcover requirements imposed by clearingagencies on their members. Furthermore, theBoard notes that section 7(c)(3) exempts thefinancing of proprietary positions of certainbroker-dealers and members of securitiesexchanges as well as the financing of theirmarket making and underwriting activitiesfrom the scope of federal margin regulation.Under the CFMA, futures commissionmerchants (FCMs), floor brokers, and floortraders who trade security futures productsmust become broker-dealers or members of anational securities exchange, and therefore,may be exempt under section 7(c)(3) fromregulation pursuant to the delegatedauthority when they obtain credit. Theexempt status of FCMs and floor brokers willdepend upon whether a substantial portionof their business consists of transactions withpersons other than broker-dealers. In thecurrent open-outcry environment, the Boardbelieves that floor traders act as marketmakers and therefore would be exempt. TheBoard expects to have further discussionswith the Commissions to identify theconditions under which floor traders wouldact as market makers in an electronic tradingenvironment.

The Board requests that the CommodityFutures Trading Commission and theSecurities Exchange Commission, eitherjointly or severally, report to the Boardannually on their experience exercising thedelegated authority. In particular, the Boardrequests that the Commissions provide anassessment of progress toward adopting morerisk-sensitive, portfolio-based approaches tomargining security futures products. TheBoard has encouraged the development ofsuch approaches by, for example, amendingits Regulation T so that portfolio marginingsystems approved by the Securities ExchangeCommission can be used in lieu of thestrategy-based system embodied in theBoard’s regulation. The Board anticipatesthat the creation of security future productswill provide another opportunity to developmore risk-sensitive, portfolio-basedapproaches for all securities, includingsecurity options and security futuresproducts.

Very truly yours,Jennifer J. Johnson,Secretary of the Board.

[FR Doc. 01–24574 Filed 10–3–01; 8:45 am]BILLING CODES 6351–01–P; 8010–01–P


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