[Federal Register Volume 59, Number 141 (Monday, July 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-18030]
[[Page Unknown]]
[Federal Register: July 25, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34405; File Nos. SR-CBOE-87-03; SR-PSE-87-21; SR-Phlx-
87-05]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Pacific Stock Exchange, Inc.; Philadelphia Stock Exchange, Inc.;
Order Approving Proposed Rule Changes and Notice of Filing and Order
Granting Accelerated Approval to Amendments to Proposed Rule Changes
Relating to Market Index Option Escrow Receipts
July 19, 1994.
I. Introduction
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ the Chicago Board Options
Exchange, Inc. (``CBOE''), the Pacific Stock Exchange, Inc. (``PSE'')
and the Philadelphia Stock Exchange, Inc. (``Phlx'')\3\ submitted to
the Securities and Exchange Commission (``SEC'' or ``Commission'')
proposed rule changes to permit, on a permanent basis, the use of cash,
cash equivalents, one or more qualified equity securities, or a
combination thereof, as collateral for market index option escrow
receipts (``MIOERs'') issued to cover short call positions in broad-
based stock index options.\4\ On May 12, 1994, May 25, 1994 and July 5,
1994, respectively, the CBOE, PSE and Phlx submitted to the Commission
Amendment Nos. 1, 7 and 5 to the proposed rule changes in order to
conform their proposals with recently approved amendments to the rules
of the Options Clearing Corporation (``OCC'').\5\
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\1\15 U.S.C. Sec. 78s(b)(1) (1982).
\2\17 CFR 240.19b-4 (1990).
\3\Hereinafter, the terms ``exchanges'' and ``self-regulatory
organizations'' (``SROs'') refer to the CBOE, PSE and Phlx.
\4\The Phlx also has proposed to allow the use of cash and cash
equivalents as collateral for escrow receipts issued to cover short
put positions in both broad-based stock index options and individual
stock options.
\5\See Securities Exchange Act Release No. 33549 (January 31,
1994), 59 FR 5629 (February 7, 1994) (File No. SR-OCC-89-04) (``OCC
approval order''). Amendments Nos. 1-6 to the PSE filing and
Amendments Nos. 1-4 to the Phlx filing requested extensions of the
pilot program and previously were approved by the Commission. See
infra, note 12.
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The proposed rule changes were noticed in Securities Exchange Act
Release Nos. 24253 (March 24, 1987), 52 FR 10433 (April 1, 1987) (File
No. SR-CBOE-87-03); 24708 (July 15, 1987), 52 FR 27604 (File No. SR-
PSE-87-21); and 24383 (April 23, 1987), 52 FR 15796 (April 30, 1987)
(File No. SR-Phlx-87-05). No comments were received on the proposals.
This order approves the proposed rule changes, including the most
recent amendments on an accelerated basis.
II. Background
For various reasons, such as state and federal regulations, many
institutions may write call options only on a covered basis in a cash
account.\6\ Many of these institutions, however, are legally restrained
from having deposits of cash or securities at a brokerage firm.
Accordingly, in lieu of such a deposit, a bank may issue to the broker
an escrow receipt on behalf of their mutual customer, in order to meet
the margin requirements for any short options the customer may have
written.\7\
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\6\In the context of a short call position, an options writer is
covered if he owns the securities underlying the options he has
written.
\7\Pursuant to Regulation T of the Board of Governors of the
Federal Reserve System (``Federal Reserve Board''), in a cash
account, an escrow agreement may be used in lieu of margin for a
short call option position if a bank hold the underlying security
for the customer writing the option. See 12 CFR 220.8(a)(4)(i)
(1990).
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Because it is difficult to apply the traditional concept of
``cover'' to broad-based, cash-settled index options,\8\ in 1984, the
Commission approved SRO proposals to allow index options writers to
enter into escrow agreements without requiring them to collateralize
the agreements with all the securities underlying the index.\9\ The
original MIOER program permitted the use of escrow receipts for short
call positions if, among other things, a bank or trust company held for
the customer a ``basket'' of at least ten qualified equity securities.
Due to inadequate recordkeeping procedures, settlement delay and
financial disincentives, many market participants found this program to
be impracticable and uneconomic, particularly in comparison to similar
products traded on commodities exchanges.\10\
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\8\Existing options on broad-based stock indexes overlie from 20
to over 2,000 securities. As a result, it can be impracticable for
an index options writer to be ``covered'' by having appropriate
positions in each component security. In addition, because index
options are cash-settled, the securities underlying an index option
are never delivered upon assignment.
\9\See, e.g., Securities Exchange Act Release Nos. 20619
(February 6, 1984), 49 FR 5221 (February 10, 1984) (File No. SR-
CBOE-83-31); and 21032 (June 8, 1984), 49 FR 24964 (June 18, 1984)
(File No. SR-PSE-84-07). At that time, the staff of the Federal
Reserve Board indicated that it believed a MIOER could be used as
cover in a cash account. See letter from Laura Homer, Securities
Credit Officer, Federal Reserve Board, to Richard G. Ketchum,
Associate Director, SEC, Division of Market Regulation, dated
January 27, 1984.
\10\In addition, OCC, at that time, did not accept escrow
receipts for index options margin. For further discussion of the
original MIOER program and the problems encountered thereunder, see
Securities Exchange Act Release No. 22323 (August 13, 1985), 50 FR
33439 (August 19, 1985) (File Nos. SR-Amex-84-33; SR-CBOE-84-28; SR-
NYSE-84-35; SR-PSE-85-19; SR-Phlx-85-18-- (``pilot approval
order'').
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Accordingly, in 1985, the Commission approved, on a pilot basis,
SRO proposals to change the type of property acceptable as an escrow
deposit.\11\ These pilot programs subsequently have been extended eight
times,\12\ in order to provide the exchanges and OCC with the
opportunity to resolve certain matters concerning the format of the
receipt and administration of the program.
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\11\See pilot approval order, supra note 10. The Commission
simultaneously approved the use by the clearing member of an escrow
receipt form, in lieu of margin payments to OCC. See Securities
Exchange Act Release No. 22324 (August 13, 1985), 50 FR 33443
(August 18, 1985) (File No. SR-OCC-85-07)
\12\See, e.g., Securities Exchange Act Release Nos. 23552
(August 25, 1986), 51 FR 31183 (September 2, 1986) (File No. SR-
CBOE-86-26); 24246 (March 23, 1987), 52 FR 10432 (April 1, 1987)
(File No. SR-CBOE-87-04); 24383 (April 23, 1987), 52 FR 15796 (April
30, 1987) (File No. SR-Phlx-87-05); 24405 (April 29, 1987), 52 FR
16969 (May 6, 1987) (File No. SR-PSE-87-10); 24708 (July 15, 1987),
52 FR 27604 (July 22, 1987) (File No. SR-CBOE-87-29; SR-PSE-87-21;
and SR-Phlx-87-22); 25242 (January 4, 1987), 53 FR 648 (January 11,
1988) (File No. SR-CBOE-87-55); 25486 (March 18, 1988), 53 FR 9722
(March 24, 1988) (File No. SR-Phlx-88-01 and SR-PSE-87-21); 25888
(July 6, 1988), 53 FR 26457 (July 13, 1988) (File No. SR-CBOE-88-11;
SR-PSE-87-21; and SR-Phlx-87-05); 26274 (November 10, 1988), 53 FR
46522 (November 17, 1988) (File No. SR-CBOE-88-21; SR-PSE-87-21; and
SR-Phlx-87-05); 27189 (August 28, 1989), 54 FR 37064 (September 6,
1989) (File No. SR-CBOE-89-16; SR-PSE-87-21; and SR-Phlx-89-46);
27657 (January 30, 1990), 55 FR 4295 (February 7, 1990) (File No.
SR-CBOE-90-01; SR-PSE-87-21; and SR-Phlx-90-02).
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Currently, a MIOER may be collateralized by cash, cash equivalents,
one or more qualified equity securities, or a combination thereof.
Pursuant to Regulation T, the term ``cash equivalents'' is defined to
mean the market value of any of the following instruments with one year
or less to maturity: (1) Securities issued or guaranteed by the United
States or its agencies; (2) negotiable bank certificates of deposit; or
(3) bankers acceptances issued by banking institutions in the United
States and payable in the United States.\13\ An equity security (other
than warrants, rights or options) is qualified to be used as collateral
for MIOERs issued to cover short call positions if it is traded on a
national securities exchange and substantially meets the listing
requirements of the New York Stock Exchange (``NYSE'') or American
Stock Exchange (``Amex'') or if it is enumerated on the current list of
over-the-counter margin stocks published by the Federal Reserve Board.
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\13\See 12 CFR 220.8(a)(3)(ii) (1990).
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The current escrow receipt program requires that, at the time the
option is written, the total value of the collateral underlying the
MIOER must be at least equal to the aggregate initial position value
(i.e., the index value at trade date times the applicable index
multiplier times the number of options contracts covered by the
collateral). Although the escrow deposit may include only one or even
no securities, the customer must affirm that he is writing index
options against a diversified portfolio. In addition, the issuing bank
or trust company must be approved by OCC if the receipt is to be
forwarded to OCC to meet the clearing member's margin obligations.\14\
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\14\There are also certain financial, regulatory and depository
standards for MIOER issuers. For further discussion of OCC's
monitoring obligations, see OCC approval order, supra, note 5.
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Thereafter, the terms of the MIOER\15\ specify that, if the value
of the collateral falls below 55% of the current position value, the
issuing bank or trust company promptly must notify the customer and
request that the escrow deposit be supplemented. If the value of the
collateral falls below 50% of the current position value, the bank or
trust company promptly must notify OCC and the broker who, in turn,
will disregard the MIOER and request that margin be deposited for the
previously covered short position.
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\15\Under the SROs' rules, escrow receipts must be in a form
satisfactory to the exchange. Because the Commission has only
reviewed the escrow receipt submitted by OCC, the Commission
previously has indicated that approval of these proposals is limited
to the use of escrow receipts containing terms and conditions
substantively identical to those in the OCC escrow receipt.
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III. Description of the Proposals
The exchanges' most recent amendments (Amendment Nos. 1, 7 and 5 to
the CBOE, PSE and Phlx filings, respectively) propose to convert their
MIOER programs\16\ from pilot to permanent status and to conform their
rules with recently approved amendments to OCC's rules.\17\ Despite
certain refinements, as discussed in more detail below, the current
rules will, for the most part, continue to apply.
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\16\See CBOE Rule 24.11(d); PSE Rule 7.16(d); and Phlx Rule
722(c).
\17\See OCC approval order, supra, note 5.
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First, the SROs proposals will limit acceptable ``cash
equivalents'' to securities issued or guaranteed by the United States
and having one year or less to maturity (``short-term United States
government securities''). As a result, securities issued or guaranteed
by agencies of the United States, certificates of deposit and bankers
acceptances will no longer be eligible as collateral for MIOERs issued
to cover short call position.
In addition, the definition of ``qualified equity securities'' will
be amended to incorporate all exchange-traded securities, whether or
not they meet NYSE or Amex listing standards. The proposals also will
make certain editorial changes to the exchanges' rules regarding the
use of over-the-counter securities to collateralize an escrow receipt,
in order to conform that language with the phrasing used in OCC's
rules.
The exchanges believe that the proposed rule changes are consistent
with Section 6 of the Act in general and, in particular, with Section
6(b)(5), in that they are designed to prevent fraudulent and
manipulative acts and practices, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, as well as to
protect investors and the public interest by establishing a MIOER
consistent with OCC rules and procedures.
IV. Discussion
The Commission finds that the proposed rule changes are consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, with the requirements of Section 6(b).\18\ In particular,
the Commission believes the proposals are consistent with the Section
6(b)(5) requirements that the rules of an exchange be designed to
promote just and equitable principles of trade, prevent fraudulent and
manipulative acts, and, in general, protect investors and the public
interest.
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\18\15 U.S.C. Sec. 78f(b) (1988).
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After careful review of the operation of the pilot programs, the
Commission has concluded that the revised MIOER should help provide a
safe and efficient mechanism by which index call options can be written
in a cash account. As set forth in more detail in its order approving
the pilot procedures,\19\ the commission believes that the range of
collateral permitted thereunder should provide market participants with
greater flexibility, prevent settlement delays and eliminate many of
the problems encountered under the original MIOER program. To the
extent that the revised escrow receipt is a cost-effective means for
institutions restricted to cash account transactions to manage
portfolio risk, its implementation on a permanent basis should
encourage broader participation in the index options market, thereby
adding depth and liquidity to that market.
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\19\See pilot approval order, supra, note 10.
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Based on their experience with the pilot program, however, the
SROs, along with OCC, have proposed certain minor refinements to the
types of property acceptable as collateral for MIOERs issued to cover
short call positions. As the Commission noted in regard to the recently
approved OCC proposal,\20\ these new standards will ensure that only
liquid assets are eligible to underlie escrow receipts. Specifically,
the Commission believes that the proposed rule changes are a reasonable
response to OCC's finding that certificates of deposit and bankers
acceptances present an undue risk to OCC because it has no means of
ensuring that issuers of such instruments are financially sound.\21\
Thus, the Commission agrees with the SROs that limiting ``cash
equivalents'' to short-term United States government securities will
enhance the integrity of escrowed collateral. Moreover, the changes to
the definition of ``qualified equity security'' are consistent with the
Federal Reserve Board's definition of ``margin security'' or existing
OCC rules.
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\20\See OCC approval order, supra, note 5.
\21\In contrast to its monitoring of MIOER issuers, OCC receives
no financial information on banks issuing certificates of deposit or
bankers' acceptances. Because of the potential exposure if the
issuer fails and the instruments become worthless, OCC proposed
eliminating them as eligible types of collateral. See Securities
Exchange Act Release No. 26951 (June 21, 1989), 54 FR 26870 (June
26, 1989) (File No. SR-OCC-89-04). OCC also found that few customers
utilize such instruments. Id.
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Finally, the Commission has determined that the escrow receipt
contains safeguards (e.g., minimum collateral levels; the requirement
that issuing banks or trust companies notify customers and OCC of
reductions in collateral\22\ that should help ensure the adequacy of
the collateral posted and diminish the risks associated with MIOERs. To
date, the SROs' experience with the pilot program supports the
Commission's earlier conclusion that, absent extremely unusual
circumstances, the value of the collateral should be greater than the
cash difference between the current index value and the exercise price
of the option (i.e., the amount that must be delivered upon
assignment).\23\ The Commission therefore believes that implementation
on a permanent basis is now appropriate.
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\22\For further discussion of value requirements and incentives
for the industry to police itself, see supra, notes 14-15 and
accompanying text.
\23\See pilot approval order, supra, note 10.
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The Phlx proposal regarding the types of property acceptable as
collateral for escrow receipts issued to cover short put positions\24\
is identical to existing rules in other options markets.\25\ The
Commission finds that the Phlx proposal will provide sufficient
investor protection while facilitating hedging transactions in both
broad-based stock index options and individual stock options.
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\24\See supra, note 4.
\25\See, e.g., NYSE Rule 431(f)(2)(H)(iv).
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The commission finds good cause for approving Amendment Nos. 1, 7
and 5 to the CBOE, PSE and Phlx proposals, respectively, prior to the
thirtieth day after the date of publication of notice of filing
thereof. These amendments merely conform the exchanges proposals with
recently approved amendments to OCC rules.\26\ Finally, the Commission
did not receive any comments on either original CBOE, PSE and Phlx
proposals or the comparable OCC proposal, both of which were noticed
for he full statutory period.
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\26\For further discussion of the substance of these amendments,
see supra, notes 16-17 and accompanying text. See also OCC approval
order, supra note 5.
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Interested persons are invited to submit written data, views and
arguments concerning the most recent amendments to the proposed rule
changes. Persons making written submissions should file six copies
thereof with the Secretary, Securities and Exchange Commission, 450
Fifth Street, NW., Washington, DC 20549. Copies of the submission, all
subsequent amendments, all written statements with respect to the
proposed rules changes that are filed with the Commission, and all
written communications relating to these amendments 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. Sec. 552, will
be available for inspection and copying in the Commission's Public
Reference Section, 450 Fifth Street, NW., Washington, DC 20549. Copies
of such filings will also be available at the principal offices of the
CBOE, PSE and Phlx. All submissions should refer to File Nos. SR-CBOE-
87-03; SR-PSE-87-21; and SR-Phlx-87-05 and should be submitted by
August 15, 1994.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\27\ that the proposed rule changes permitting, on a permanent
basis, the use of cash, cash equivalents, one or more qualified
securities, or a combination of the foregoing, as collateral for escrow
receipts issued to cover short call positions in broad-based stock
index options, in lieu of margin (SR-CBOE-87-03; SR-PSE-87-21; and SR-
Phlx-87-05) hereby are approved.
\27\15 U.S.C. 78s(b)(2) (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\28\
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\28\17 CFR 200.30-3(a)(12) (1990).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-18030 Filed 7-22-94; 8:45 am]
BILLING CODE 8010-01-M
