[Federal Register Volume 63, Number 233 (Friday, December 4, 1998)]
[Notices]
[Pages 67155-67157]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32329]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40708; File No. SR-CBOE-97-58]
Self-Regulatory Organizations; Notice of Filing of Amendment No.
1 to Proposed Rule Change by the Chicago Board Options Exchange,
Incorporated Relating to Capital and Margin Requirements for Joint Back
Office Arrangements
November 25, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on July 27, 1998, the Chicago Board Options Exchange, Incorporated
(``Exchange'' or ``CBOE'') filed with the Securities and Exchange
Commission (``Commission'') Amendment No. 1 to the proposed rule change
as described in Items I, II, and III below, which Items have been
prepared by the Exchange. The Commission is publishing this notice to
solicit comments on Amendment No. 1 to the proposed rule change from
interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The Exchange seeks to establish margin and net capital requirements
for Joint Back Office (``JBO'') participants and clearing firms. Under
the provisions of Regulation T promulgated by the Board of Governors of
the Federal Reserve System (``Federal Reserve Board''),\3\ a clearing
broker may extend good faith financing to an owner of the clearing
broker who is either a broker-dealer or an exchange member. These
financing relationships are referred to as ``JBO arrangements.''
---------------------------------------------------------------------------
\3\ See 12 CFR 220. Regulation T is entitled ``Credit by Brokers
and Dealers'' and was issued by the Federal Reserve Board pursuant
to the Act.
---------------------------------------------------------------------------
The text of the proposed rule change, as amended, is available at
the Office of the Secretary, the Exchange, and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
Sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
a. Background. The Exchange filed its JBO proposal with the
Commission on October 23, 1997, shortly after the New York Stock
Exchange (``NYSE'') submitted its own JBO filing.\4\ Notice of the
Exchange's proposal was issued on December 10, 1997.\5\ Among other
matters, the Exchange's JBO filing proposes minimum financial standards
for JBO participants and for the firms which clear JBO accounts.
---------------------------------------------------------------------------
\4\ The NYSE's JBO filing, SR-NYSE-97-28, was filed with the
Commission on October 2, 1997, and notice of its filing was issued
on December 29, 1997. See Securities Exchange Act Release No. 39497
(Dec. 29, 1997), 63 FR 899 (Jan. 7, 1998). The NYSE filed Amendment
No. 1 to its JBO filing on May 21, 1998, and Amendment No. 2 on
September 28, 1998. Notice of Amendment Nos. 1 and 2 was issued on
November 25, 1998. See Securities Exchange Act Release No. 40709
(Nov. 25, 1998).
\5\ See Securities Exchange Act Release No. 39418 (Dec. 10,
1997), 62 FR 66154 (Dec. 17, 1997).
---------------------------------------------------------------------------
In its 1996 amendments to Regulation T, the Federal Reserve Board
directed the securities self-regulatory organizations (``SROs'') to
develop appropriate standards for JBO participants and their clearing
firms.\6\ The Exchange anticipates that all SROs will implement uniform
standards for JBO arrangements. The NYSE formed a member firm
subcommittee to develop appropriate standards for JBO participants and
their clearing firms. The NYSE member firm subcommittee proposed that
clearing firms maintain a minimum of $25 million in tentative net
capital. The Exchange urged that an alternative standard be provided
for options market-maker clearing firms to accommodate the JBO
activities of the clearing firms' options market-maker clients. The
compromise standard of $10 million net capital was agreed upon and
incorporated into the JBO filings submitted by the Exchange and the
NYSE.
---------------------------------------------------------------------------
\6\ See Board of Governors of the Federal Reserve System Docket
No. R-0772 (Apr. 26, 1996), 61 FR 20386 (May 6, 1996).
---------------------------------------------------------------------------
Although at that time not all Exchange options market-maker
clearing firms needed to maintain the $10 million level of capital to
cover the haircut and financing needs of their market-maker and JBO
clients, it was believed their actual capital needs would grow to
exceed the $10 million standard by the time the Commission approved the
Exchange's JBO proposal. While the capital needs of options market-
marker clearing firms have in fact grown, they do not in all instances
consistently satisfy the $10 million level.\7\ As a result, the
Commission received a number of comment letters from Exchange member
firms that expressed concern over the $10 million standard.
---------------------------------------------------------------------------
\7\ The Exchange has represented that all Exchange options
market-maker clearing firms currently maintain net capital
sufficient to meet the proposed $7 million net capital standard.
However, fluctuations in a clearing firm's net capital may occur due
to changes in daily net deductions for the options market-maker and
JBO participant accounts carried. Many clearing firms maintain
revolving subordinated loan arrangements in order to cover such
potential capital swings. According to the Exchange, there is a one
time charge to establish such a facility of approximately $10,000
per $1 million (1%). The cost to maintain such a facility, undrawn,
approximates $10,000 per year per $1 million (1%), or $28 per day.
The cost to draw down such a facility approximates $95,000 per year
per $1 million of drawn funds (at 1% over an 8\1/2\% prime), or $264
per day. Drawn down revolving subordinated debt may be repaid
beginning the following day, with the term of the loan not to exceed
1 year. The Exchange believes these costs do not appear to be
excessively burdensome to clearing firms that carry the accounts of
JBO participants.
---------------------------------------------------------------------------
b. Amendment No. 1. In response to the concerns of its members, the
Exchange seeks to amend its JBO filing
[[Page 67156]]
to reduce from $10 million to $7 million, the proposed net capital
requirement for JBO clearing firms. The Exchange also proposes to allow
options market-maker clearing firms, that elect to operate under this
alternative standard, to be permitted to maintain net capital of less
than $7 million for a period not to exceed three consecutive business
days. Immediate notice to the Exchange would be required when a JBO
clearing firm's net capital drops below the $7 million requirement, or
its tentative net capital drops below the $25 million requirement. In
addition, such a clearing firm would be subject to prohibitions against
the withdrawal of equity capital and prohibitions against reduction,
prepayment, and repayment of subordination agreements as specified in
the commission's net capital rule.\8\
---------------------------------------------------------------------------
\8\ The commission's net capital rule, ``Net Capital
Requirements for Brokers or Dealers,'' is designated as Rule 15c3-1.
See 17 CFR 240.15c3-1(e) and 17 CFR 240.15c3-1d(b).
---------------------------------------------------------------------------
The Exchange believes the proposed ``three business day'' provision
is consistent with other provisions of the Commission's net capital
rule.\9\ The provision would make allowances for fluctuations in net
capital resulting from daily changes in market-maker and JBO
participant related clearing firm capital charges. The Exchange
believes this provision will permit clearing firms to avoid unnecessary
and inadvertent violations of the margin requirement at certain times
such as options expiration week when capital needs are more volatile.
---------------------------------------------------------------------------
\9\ The Commission's net capital rule requires that the ratio of
options market-maker gross deductions to adjusted net capital not
exceed 10:1 for a period of more than three consecutive business
days. See 17 CFR 240.15c3-1.
---------------------------------------------------------------------------
If approved, the proposal would provide JBO participants and
clearing firms already conducting JBO business at the time of the
Commission's approval six months to implement such changes. The
proposed rule change would be applied within thirty calendar days of
the Commission's approval for all other Exchange members seeking to
engage in such JBO businesses.
In addition, the Exchange seeks to amend its JBO proposal to
specify that, should the equity in a JBO participant's account fall
below $1 million and the deficiency is not eliminated within five
business days, the account shall lose its JBO status. Thereupon, the
clearing member carrying the account would be required to apply the
standard Regulation T and Exchange Rule 12.3 customer margin
requirements. This provision mirrors the JBO proposal presented by the
NYSE.
As currently amended, both the Exchange's and the NYSe's JBO
filings contain provisions which, for the purpose of net capital
computation, require the member organization carrying the account of a
JBO participant to deduct from net worth any amount by which the equity
in a JBO participant's account is below the haircuts required by the
Commission's net capital rule. However, the NYSE's requirements for JBO
arrangements, which are proposed to be set forth within its margin rule
(NYSE Rule 431), would permit, for certain specified securities, a
lesser amount to be deduced in lieu of the Exchange Act Rule 15c3-1
haircut on such securities.\10\ The proposed alternative deduction is
the NYSE's maintenance margin requirement for the specified securities
when held in ``exempt accounts.'' \11\ The Exchange's JBO filing does
not incorporate an alternative deduction because, unlike the NYSE, the
Exchange has not promulgated special maintenance margin requirements
for exempt accounts, and for particular securities held in those
accounts. However, Exchange member organizations that also are members
of the NYSE can elect to be bound by the margin rules of the NYSE as
permitted under Exchange Rule 12.11.\12\ By electing to be bound by
NYSE margin rules, organizations that are members of both the Exchange
and the NYSE may avoid a violation of the Exchange's rules if they wish
to utilize the alternative deduction proposed by the NYSE. At this
time, the Exchange is not proposing rules to implement specialized
maintenance requirements as an alternative to the haircut deduction for
the organizations that are members of the Exchange only. The Exchange
believes that special, lower maintenance margin requirements would not
be critical to most of its member firms because the JBO accounts they
carry do not have a concentration in the specified securities.
---------------------------------------------------------------------------
\10\ Under the NYSE's JBO proposal, the alternative deduction
would apply to transactions in securities covered by paragraphs
(e)(2)(F) and (e)(2)(G) of NYSE Rule 431. The Commission notes that
the NYSE has submitted a separate rule filing, SR-NYSE-98-14
(``Related Filing''), that would revise the types of securities
included in paragraphs (e)(2)(F) and (e)(2)(G) of NYSE Rule 431 to
include: exempted securities, mortgage related securities, major
foreign sovereign debt securities, highly rated foreign sovereign
debt securities, and investment grade debt securities. The
Commission has published notice of the NYSE's Related Filing but has
not taken any dispositive action on the proposal. See Securities
Exchange Act Release No. 40278 (July 29, 1998), 63 FR 41882 (Aug. 5,
1998).
\11\ The Related Filing proposes to adopt a new paragraph
(a)(13) to NYSE Rule 431 that would define an ``exempt account'' as:
a member organization; non-member broker-dealer; ``designated
account;'' or any person having a net worth of at least $40 million.
The Related Filing also proposes to revise existing paragraph (a)(3)
of NYSE Rule 431 to define a ``designated account'' as the account
of: (i) a bank; (ii) a savings association; (iii) an insurance
company; (iv) an investment company; (v) a state or political
subdivision thereof; or (vi) a pension or profit sharing plan.
\12\ Exchange Rule 12.11 specifies that in lieu of meeting the
Exchange's margin requirements, a member firm may elect to be bound
by the initial and maintenance margin requirements of the NYSE. If
such an election is made, the member firm is bound to comply with
the NYSE's margin rules as though they were part of the Exchange's
rules.
---------------------------------------------------------------------------
The Exchange believes the revised capital requirements for JBO
clearing firms and the delayed date of effectiveness for existing JBO
businesses, as proposed by Amendment No.1, are responsive to the
concerns raised by its members.
2. Statutory Basis
The Exchange believes the proposed rule change, as amended, is
consistent with and furthers the objectives of Section 6(b)(5) of the
Act,\13\ in that it is designed to perfect the mechanisms of a free and
open market and to protect investors and the public interest. The
Exchange further believes its proposal is designed to ensure the
reasonableness of JBO arrangements as directed by the Federal Reserve
Board in its recent amendments to Regulation T.\14\
---------------------------------------------------------------------------
\13\ 15 U.S.C. 78f(b)(5).
\14\ See note 6 supra.
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange believes the proposed rule change will not impose any
inappropriate burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received from Members, Participants or Others
The Exchange did not solicit or receive written comments with
respect to the proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding, or (ii) as to
which the Exchange consents, the Commission will:
(A) by order approve the proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
[[Page 67157]]
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1, including whether the proposed
rule change, as modified by Amendment No. 1, is consistent with the
Act. Persons making written submissions should file six copies thereof
with the Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of the submissions, all
subsequent amendments, all written statements with respect to the
proposed rule change that are filed with the Commission, and all
written communications relating to the proposed rule change between the
Commission and any persons, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying in the Commission's Public
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such filing will also be available for inspection and copying
at the principal office of the Exchange. All submissions should refer
to File No. SR-CBOE-97-58 and should be submitted by December 28, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
---------------------------------------------------------------------------
\15\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-32329 Filed 12-3-98; 8:45 am]
BILLING CODE 8010-01-M
