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42118 Federal Register / Vol. 70, No.

139 / Thursday, July 21, 2005 / Notices

Dated: July 15, 2005. SECURITIES AND EXCHANGE received eleven comment letters in
Jonathan G. Katz, COMMISSION response to the December 27, 2004
Committee Management Officer. Federal Register notice.7
[Release No. 34–52032; File No. SR–CBOE–
[FR Doc. E5–3900 Filed 7–20–05; 8:45 am] On April 15, 2005, the Exchange filed
Amendment No. 2 8 to the proposed rule
Self-Regulatory Organizations; change. The proposed rule change and
Chicago Board Options Exchange, Amendment Nos. 1 and 2 were
SECURITIES AND EXCHANGE Incorporated; Order Approving a published in the Federal Register on
COMMISSION Proposed Rule Change and May 3, 2005.9 The Commission received
Amendment Nos. 1 and 2 Thereto one comment in response to the May 3,
Sunshine Act Meeting Relating to Customer Portfolio and 2005 Federal Register notice.10
Cross-Margining Requirements The comment letters and the
Exchange’s responses to the
July 14, 2005. comments 11 are summarized below.
Notice is hereby given, pursuant to
the provisions of the Government in the I. Introduction 7 See letter from Anthony J. Saliba, President,
Sunshine Act, Public Law 94–409, that On January 15, 2002, the Chicago LiquidPoint, LLC, to Jonathan G. Katz, Secretary,
the Securities and Exchange Board Options Exchange, Incorporated Commission, dated January 21, 2005 (‘‘Saliba
Commission will hold the following (‘‘CBOE’’ or ‘‘Exchange’’) filed with the Letter’’); letter from Barbara Wierzynski, Executive
Vice President and General Counsel, Futures
meeting during the week of July 18, Securities and Exchange Commission Industry Association (‘‘FIA’’), and Gerard J. Quinn,
2005: (‘‘Commission’’), pursuant to Section Vice President and Associate General Counsel,
A Closed Meeting will be held on 19(b)(1) of the Securities Exchange Act Securities Industry Association (‘‘SIA’’), to Jonathan
of 1934 (‘‘Act’’) 1 and Rule 19b– 42 G. Katz, Secretary, Commission, dated January 14,
Thursday, July 21, 2005 at 2 p.m. 2005 (‘‘Wierzynski/Quinn Letter’’); letter from Craig
Commissioners, Counsel to the thereunder, a proposed rule change S. Donohue, Chief Executive Officer, Chicago
Commissioners, the Secretary to the seeking to amend its rules, for certain Mercantile Exchange, to Jonathan G. Katz,
Commission, and recording secretaries customer accounts, to allow member Secretary, Commission, dated January 18, 2005
organizations to margin listed, broad- (‘‘Donohue Letter’’); letter from Robert C. Sheehan,
will attend the Closed Meeting. Certain Chairman, Electronic Brokerages Systems, LLC, to
staff members who have an interest in based, market index options, index Jonathan G. Katz, Secretary, Commission, dated
the matters may also be present. warrants, futures, futures options and January 19, 2005 (‘‘Sheehan Letter’’); letter from
related exchange-traded funds according William O. Melvin, Jr., President, Acorn Derivatives
The General Counsel of the to a portfolio margin methodology. The Management, to Jonathan G. Katz, Secretary,
Commission, or his designee, has CBOE seeks to introduce the proposed Commission, dated January 19, 2005 (‘‘Melvin
certified that, in his opinion, one or rule as a two-year pilot program that
Letter’’); letter from Margaret Wiermanski, Chief
more of the exemptions set forth in 5 Operating & Compliance Officer, Chicago Trading
would be made available to member Company, to Jonathan G. Katz, Secretary,
U.S.C. 552b(c)(3), (5), (7), (9)(B), and organizations on a voluntary basis. Commission, dated January 20, 2005 (‘‘Wiermanski
(10) and 17 CFR 200.402(a) (3), (5), (7), The proposed rule change was Letter’’); e-mail from Jeffrey T. Kaufmann,
9(ii) and (10), permit consideration of published in the Federal Register on Lakeshore Securities, L.P., to Jonathan G. Katz,
the scheduled matters at the Closed Secretary, Commission, dated January 24, 2005
March 29, 2002.3 The Commission (‘‘Kaufmann Letter’’); letter from J. Todd Weingart,
Meeting. received two comment letters in Director of Floor Operations, Mann Securities, to
Commissioner Atkins, as duty officer, response to the March 29, 2002 Federal Jonathan G. Katz, Secretary, Commission, dated
voted to consider the items listed for the January 25, 2005 (‘‘Weingart Letter’’); letter from
Register notice.4 On April 2, 2004, the Charles Greiner III, LDB Consulting, Inc., to
closed meeting in closed session and Exchange filed Amendment No. 1 to the Jonathan G. Katz, Secretary, Commission, dated
that no earlier notice thereof was proposed rule change.5 The proposed January 26, 2005 (‘‘Greiner Letter’’); letter from Jack
possible. rule change and Amendment No. 1 were L. Hansen, Chief Investment Officer and Principal,
The Clifton Group, to Jonathan G. Katz, Secretary,
The subject matters of the Closed published in the Federal Register on Commission, dated February 1, 2005 (‘‘Hansen
Meeting scheduled for Thursday, July December 27, 2004.6 The Commission Letter’’); and letter from Barbara Wierzynski,
21, 2005, will be: Executive Vice President and General Counsel,
1 15U.S.C. 78s(b)(1). Futures Industry Association, and Ira D.
Formal orders of investigations; 2 17CFR 240.19b–4. Hammerman, Senior Vice President and General
Institution and settlement of injunctive 3 See Securities Exchange Act Release No. 45630 Counsel, Securities Industry Association, to
actions; and (March 22, 2002), 67 FR 15263 (March 29, 2002). Jonathan G. Katz, Secretary, Commission, dated
4 See letter from Carl E. Vander Wilt, Federal March 4, 2005 (‘‘Wierzynski/Hammerman Letter’’).
Institution and settlement of 8 See Partial Amendment No. 2 (‘‘Amendment No.
Reserve Bank of Chicago, to Jonathan G. Katz,
administrative proceedings of an Secretary, Commission, dated July 18, 2002 2’’). The Exchange submitted this partial
enforcement nature. (‘‘Vander Wilt Letter’’); and e-mail from Mike Ianni, amendment, pursuant to the request of Commission
Private Investor to, dated staff, to remove the paragraph under which any
At times, changes in Commission November 7, 2002 (‘‘Ianni E-mail’’). affiliate of a self-clearing member organization
priorities require alterations in the 5 See letter from Richard Lewandowski, Vice could participate in portfolio margining, without
scheduling of meeting items. President, Division of Regulatory Services, CBOE, to being subject to the $5 million equity requirement.
9 See Securities Exchange Act Release No. 34–
Michael A. Macchiaroli, Associate Director,
For further information and to Division of Market Regulation (‘‘Division’’), 51614 (April 26, 2005), 70 FR 22935 (May 3, 2005);
ascertain what, if any, matters have been Commission, dated April 1, 2004 (‘‘Amendment No. see also Securities Exchange Act Release No. 34–
added, deleted or postponed, please 1’’). The CBOE proposed Amendment No. 1 to make 51615 (April 26, 2005), 70 FR 22953 (May 3, 2005).
corrections or clarifications to the proposed rule, or 10 See letter from William H. Navin, Executive
to reconcile differences between the proposed rule Vice President, General Counsel, and Secretary, The
The Office of the Secretary at (202) and a parallel filing by the NYSE. See Securities Options Clearing Corporation, to Jonathan G. Katz,
551–5400. Exchange Act Release No. 46576 (October 1, 2002), Secretary, Commission, dated May 27, 2005
67 FR 62843 (October 8, 2002) (File No. SR–NYSE– (‘‘Navin Letter’’).
Dated: July 18 , 2005. 2002–19). 11 See letter from Timothy H. Thompson, Senior
Jonathan G. Katz, 6 See Securities Exchange Act Release No. 50886 Vice President, Chief Regulatory Officer, Regulatory
Secretary. (December 20, 2004), 69 FR 77275 (December 27, Services Division, CBOE, to Michael A.
2004); see also Securities Exchange Act Release No. Macchiaroli, Associate Director, Division of Market
[FR Doc. 05–14460 Filed 7–18–05; 4:01 pm] 50885 (December 20, 2004), 69 FR 77287 (December Regulation, Commission, dated May 2, 2005
BILLING CODE 8010–01–P 27, 2004). (‘‘CBOE Response’’). The Commission received the

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Federal Register / Vol. 70, No. 139 / Thursday, July 21, 2005 / Notices 42119

This Order approves the proposed rule, gain or loss on each position in the 15c3–1a is the OCC’s Theoretical
as amended.12 portfolio would be calculated at each of Intermarket Margining System
10 equidistant points (‘‘valuation (‘‘TIMS’’).
II. Description
points’’) set at and between the upper
(2) Cross-Margining
a. Summary of Proposed Rule Change and lower market range points. The
The CBOE has proposed to amend its range for non-high capitalization indices The Exchange’s proposed rule permits
rules, for certain customer accounts, to would be between a market increase of futures and futures options on broad-
allow member organizations to margin 10% and a decrease of 10%. High based US securities indices to be
listed broad-based securities index capitalization indices would have a included in the portfolios.
options, warrants, futures, futures range of between a market increase of Consequently, futures and futures
options and related exchange-traded 6% and a decrease of 8%.14 A options would be permitted offsets to
funds according to a portfolio margin theoretical options pricing model would the securities positions in a given
methodology. The CBOE seeks to be used to derive position values at each portfolio. Operationally, these offsets
introduce the proposed rule as a two- valuation point for the purpose of would be achieved through cross-
year pilot program that would be made determining the gain or loss. The margin agreements between the OCC
available to member organizations on a amount of margin (initial and and the futures clearing organizations
voluntary basis. maintenance) required with respect to a holding the customer’s futures
given portfolio would be the larger of: positions. Cross-margining would
b. Overview—Portfolio Margin (1) The greatest loss amount among the operate similar to the cross-margin
Computation valuation point calculations; or (2) the program that the Commission and the
(1) Portfolio Margin sum of $.375 for each option and future Commodity Futures Trading
in the portfolio multiplied by the Commission (‘‘CFTC’’) approved for
Portfolio margining is a methodology contract’s or instrument’s multiplier.
for calculating a customer’s margin listed options market-makers and
The latter computation establishes a proprietary accounts of clearing member
requirement by ‘‘shocking’’ a portfolio minimum margin requirement to ensure
of financial instruments at different organizations.19 For determining
that a certain level of margin is required theoretical gains and losses, and
equidistant points along a range from the customer. The margin for all
representing a potential percentage resultant margin requirements, the same
other portfolios of broad based US portfolio margin computation program
increase and decrease in the value of the securities index instruments within an
instrument or underlying instrument in will be applied to portfolio margin
account would be calculated in a similar accounts that include futures. Under the
the case of a derivative product. For manner.
example, the calculation points could be proposed rule, a separate cross-margin
Certain portfolios would be allowed
spread equidistantly along a range account must be established for a
offsets such that, at the same valuation
bounded on one end by a 10% increase customer.
point, for example, 90% of a gain in one
in market value of the instrument and portfolio may reduce or offset a loss in c. Margin Deficiency
at the other end by a 10% decrease in another portfolio.15 The amount of
market value. Gains and losses for each offset allowed between portfolios would Under the Exchange’s proposed rule,
instrument in the portfolio are netted at be the same as permitted under Rule account equity would be calculated and
each calculation point along the range to 15c3–1a for computing a broker-dealer’s maintained separately for each portfolio
derive a potential portfolio-wide gain or net capital.16 margin account and a margin call would
loss for the point. The margin Under the Exchange’s proposed rule, need to be met by the customer within
requirement is the amount of the the theoretical prices used for one business day (T+1), regardless of
greatest portfolio-wide loss among the computing profits and losses must be whether the deficiency is caused by the
calculation points. generated by a theoretical pricing model addition of new positions, the effect of
Under the Exchange’s proposed rule, that meets the requirements in Rule an unfavorable market movement, or a
a portfolio would consist of, and be 15c3–1a.17 These requirements include, combination of both. The portfolio
limited to, financial instruments in the among other things, that the model be margin methodology, therefore, would
customer’s account within a given non-proprietary, approved by a establish both the customer’s initial and
broad-based US securities index class Designated Examining Authority maintenance margin requirement.
(e.g., the S&P 500 or S&P 100).13 The (‘‘DEA’’) and available on the same d. $5.0 Million Equity Requirement
terms to all broker-dealers.18 Currently,
CBOE Response on June 1, 2005; see also letter from the only model that qualifies under Rule The Exchange’s proposed rule would
Timothy H. Thompson, Senior Vice President, Chief require a customer (other than a broker-
Regulatory Officer, Regulatory Services Division,
CBOE, to Michael A. Macchiaroli, Associate
14 These are the same ranges applied to options dealer or a member of a national futures
Director, Division of Market Regulation, market makers under Appendix A to Rule 15c3–1 exchange) to maintain a minimum
Commission, dated June 29, 2005. (17 CFR 240.15c3–1a), which permits a broker- account equity of not less than $5.0
12 By separate orders, the Commission also is dealer when computing net capital to calculate
securities haircuts on options and related positions million. This requirement can be met by
approving a parallel rule filing by the NYSE [SR–
NYSE–2002–19], and a related rule filing by the using a portfolio margin methodology. See 17 CFR combining all securities and futures
Options Clearing Corporation (‘‘OCC’’) [SR–OCC– 240.15c3–1a(b)(1)(iv)(A); Letter from Michael accounts owned by the customer and
2003–04]. See Securities Exchange Act Release No. Macchiaroli, Associate Director, Division of Market carried by the broker-dealer (as broker-
52031 (July 14, 2005) and Securities Exchange Act Regulation, Commission, to Richard Lewandowski,
Vice President, Regulatory Division, The Chicago dealer and futures commission
Release No. 52030 (July 14, 2005). In addition, the
staff of the Division of Market Regulation is issuing Board Options Exchange, Inc. (Jan. 13, 2000). merchant), provided ownership is
certain no-action relief related to the OCC’s rule
15 These offsets would be allowed between identical across all combined accounts.
filing. See letter from Bonnie Gauch, Attorney, portfolios within the High Capitalization, Broad The proposed rule would require that,
Division of Market Regulation, Commission, to Based Index Option product group and the Non-
High Capitalization, Broad Based Index product
in the event account equity falls below
William H. Navin, General Counsel, OCC, dated
July 14, 2005. group. the $5 million minimum, additional
13 A‘‘portfolio’’ is defined in the rule as ‘‘options 16 17 CFR 240.15c3–1a.
17 See 17 CFR 240.15c3–1a(b)(1)(i)(B).
of the same options class grouped with their 19 See Securities Exchange Act Release 26153

underlying instruments and related instruments.’’ 18 Id. (Oct. 3, 1988), 53 FR 39567 (Oct. 7, 1988).

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42120 Federal Register / Vol. 70, No. 139 / Thursday, July 21, 2005 / Notices

equity must be deposited within three portfolio margin customer with a statements and acknowledgements,
business days (T+3). written risk disclosure statement at or which would allow a broker-dealer to
prior to the initial opening of a portfolio develop its own format, provided the
e. Net Capital
margin account. This disclosure acknowledgement contains substantially
The Exchange’s proposed rule would statement would highlight the risks and similar information and is approved by
provide that the gross customer describe the operation of a portfolio the Exchange in advance.
portfolio margin requirements of a margin account. The disclosure
broker-dealer may at no time exceed statement would be divided into two i. Rationale for Portfolio Margin
1,000 percent of the broker-dealer’s net sections, one dealing with portfolio Theoretical options pricing models
capital (a 10:1 ratio), as computed under margining and the other with cross- have become widely utilized since
Rule 15c3–1.20 This requirement is margining. The disclosure statement Fischer Black and Myron Scholes first
intended to place a ceiling on the would note that additional leverage is introduced a formula for calculating the
amount of portfolio margin a broker- possible in an account margined on a value of a European style option in
dealer can extend to its customers. portfolio basis in relation to existing 1973.25 Other formulas, such as the Cox-
f. Internal Risk Monitoring Procedures margin requirements. The disclosure Ross-Rubinstein model have since been
statement also would describe, among developed. Option pricing formulas are
The Exchange’s proposed rule would other things, eligibility requirements for now used routinely by option market
require a broker-dealer that carries opening a portfolio margin account, the participants to analyze and manage risk.
portfolio margin accounts to establish instruments that are allowed in the In addition, as noted, a portfolio margin
and maintain written procedures for account, and when deposits to meet methodology has been used by broker-
assessing and monitoring the potential margin and minimum equity dealers since 1994 to calculate haircuts
risks to capital arising from portfolio requirements are due. Further, there on option positions for net capital
margining. would be a summary list of the special purposes.26
g. Margin at the Clearing House Level risks of a portfolio margin account, The Board of Governors of the Federal
including the increased leverage, time Reserve System (the ‘‘Federal Reserve
The OCC will compute clearing house
frame for meeting margin calls, potential Board’’ or ‘‘FRB’’) in its amendments to
margin for the broker-dealer using the
for involuntary liquidation if margin is Regulation T in 1998 permitted SROs to
same portfolio margin methodology
not received, inability to calculate implement portfolio margin rules,
applied at the customer level. The OCC
future margin requirements because of provided they are approved by the
will continue to require full payment for
the data and calculations required, and Commission.27
all customer long option positions.
the OCC lien on long option positions. Portfolio margining brings a more risk
These positions, however, would be
The risks and operation of the cross- sensitive approach to establishing
subject to the OCC’s lien. This would
margin account are outlined in a margin requirements. For example, in a
permit the long options positions to
separate section of the disclosure diverse portfolio some positions may
offset short positions in the customer’s
statement. appreciate and others depreciate in
portfolio margin account. In conjunction Further, at or prior to the time a
with the Exchange’s rule proposal, the response to a given change in market
portfolio margin account is initially prices. The portfolio margin
OCC proposed amending OCC Rule 611 opened, the broker-dealer would be
and establishing a new type of omnibus methodology recognizes offsetting
required to obtain a signed potential changes among the full
account to be carried at the OCC and acknowledgement concerning portfolio
known as the ‘‘customer’s lien portfolio of related instruments. This
margining from the customer. A links the margin required to the risk of
account.’’ 21 In order to unsegregate the separate acknowledgement would be
long option positions, the Commission the entire portfolio as opposed to the
required for cross-margining. The individual positions on a position-by-
staff would have to grant certain relief acknowledgements would contain
from some requirements of Commission position basis.
statements to the effect that the Professional investors frequently
Rules 8c–1, 15c2–1, and 15c3–3.22 The customer has read the disclosure
OCC requested such relief on behalf of hedge listed index options with futures
statement and is aware of the fact that positions. Cross-margining would better
its members.23 long option positions in a portfolio
h. Risk Disclosure Statement and margin account are not subject to the 25 See Securities Exchange Act Release No. 34–
Acknowledgement segregation requirements under the 38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12, 1997)
The Exchange’s proposed rule would Commission’s customer protection (discussing the development of the options pricing
rules, and would be subject to a lien by approach to capital); see also Securities Exchange
require a broker-dealer to provide a Act Release No. 33761 (March 15, 1994), 59 FR
the OCC. 13275 (March 21, 1994).
20 17 CFR 240.15c3–1.
An additional acknowledgement form 26 See letter from Brandon Becker, Director,

21 See SR–OCC–2003–04, Securities Exchange Act would be required for a cross-margin Division, Commission, to Mary Bender, First Vice
Release No. 51330 (March 8, 2005). As noted above, account. It would contain similar President, Division of Regulatory Services, CBOE,
the Commission is approving the OCC’s rule filing. statements as well as statement to the and Timothy Hinkes, Vice President, OCC, dated
See Securities Exchange Act Release No. 52030 March 15, 1994; see also ‘‘Net Capital Rule,’’
effect that the customer is aware that Securities Exchange Act Release No. 38248
(July 14, 2005).
22 17 CFR 240.8c–1, 17 CFR 240.15c2–1 and 17 futures positions are being carried in a (February 6, 1997), 62 FR 6474 (February 12, 1997).
CFR 240.15c3–3, respectively. securities account, which would make 27 See Federal Reserve System, ‘‘Securities Credit
23 See Letter from William H. Navin, Executive them subject to the Commission’s Transactions; Borrowing by Brokers and Dealers’’;
Vice President, General Counsel, and Secretary, The customer protection rules, and Regulations G, T, U and X; Docket Nos. R–0905, R–
Options Clearing Corporation, to Michael A. 0923 and R–0944, 63 FR 2806 (January 16, 1998).
Macchiaroli, Associate Director, Division of Market
Securities Investor Protection Act of More recently, the FRB encouraged the
Regulation, Commission, dated January 13, 2005. 1970 (‘‘SIPA’’) 24 in the event the broker- development of a portfolio margin approach in a
As noted above, the staff of the Division of Market dealer becomes financially insolvent. letter to the Commission and the CFTC delegating
Regulation is issuing a no-action letter providing The Exchange would prescribe the authority to the agencies to jointly prescribe margin
such relief. See letter from Bonnie Gauch, Attorney, regulations for security futures products. See letter
Division of Market Regulation, Commission, to
format of the written disclosure from the FRB to James E. Newsome, Acting
William H. Navin, General Counsel, OCC, dated Chairman, CFTC, and Laura S. Unger, Acting
July 14, 2005. 24 24 5 U.S.C. 78aaa et seq. Chairman, Commission, dated March 6, 2001.

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Federal Register / Vol. 70, No. 139 / Thursday, July 21, 2005 / Notices 42121

align their margin requirements with the should not delay implementation of the actions necessary to enable portfolio
actual risks of these hedged positions. proposed rule change and noted that it margining along with the cross-margin
This could reduce the risk of forced intends to file a proposed rule component.
liquidations. Currently, an option amendment that would offer alternative
IV. Discussion and Commission
(securities) account and futures account methods for meeting the minimum
of the same customer are viewed as equity requirement after the industry
separate and unrelated. Moreover, an becomes acclimated to the portfolio After careful review, the Commission
option account currently must be margin methodology and its operational finds that the proposed rule change, as
liquidated if the risk in the positions has aspects. amended, is consistent with the
increased dramatically or margin calls Several commenters stated that other requirements of the Act and the rules
cannot be met, even if gains in the products should be eligible for portfolio and regulations thereunder applicable to
customer’s futures account offset the margining,34 such as equities,35 as well a national securities exchange.42 In
losses in the options account. If the as OCC-cleared equity derivatives.36 particular, the Commission believes that
accounts are combined (i.e., cross- One commenter stated that other risk- the proposed rule change is consistent
margined), unnecessary liquidation may based algorithms, such as SPAN,37 that with Section 6(b)(5) of the Act 43 in
be avoided. This could lessen the are recognized by other clearing particular, in that it is designed to
severity of a period of high volatility in organizations should be permitted for perfect the mechanism of a free and
the market by reducing the number of calculating the portfolio margin open market and to protect investors
liquidations. requirement, in addition to the OCC’s and the public interest. The
TIMS.38 Commission notes that the proposed
III. Summary of Comments Received In addition, one commenter stated portfolio margin rule change is intended
and CBOE Response that the Securities Investor Protection to promote greater reasonableness,
The Commission received a total of Corporation (‘‘SIPC’’) would need to accuracy and efficiency with respect to
fourteen comment letters to the amend its rules in order to provide SIPA Exchange margin requirements for
proposed rule.28 The comments, in protection to futures and options on complex listed securities index option
general, were supportive. One futures in a securities account.39 The strategies. The Commission further
commenter stated that ‘‘portfolio Exchange disagrees and notes that the notes that the cross-margining capability
margining would enable CBOE to more proposed rule change was amended, at with related index futures positions in
accurately reflect the risk exposure of the request of Commission staff, to eligible accounts may alleviate
options and related positions- require the immediate transfer to excessive margin calls, improve cash
potentially reducing the trading costs of another broker-dealer or the liquidation flows and liquidity, and reduce
market participants and increasing the of a cross-margin account in the event volatility. Moreover, the Commission
liquidity and efficiency of the that a broker-dealer becomes insolvent. notes that approving the proposed rule
market.’’ 29 Some commenters, however, In addition, the Exchange believes that change would be consistent with the
recommended changes to specific amendments to Commission Rule 15c3– FRB’s 1998 amendments to Regulation
provisions of the proposed rule change. 3 could provide customers holding both T, which sought to advance the use of
Seven of the comment letters securities and futures with protection portfolio margining.
specifically objected to the $5.0 million under SIPA. Under the proposed rule changes, the
equity requirement.30 Three One commenter, the OCC, strongly Commission notes that a broker-dealer
commenters noted that the requirement urged the Commission to move forward choosing to offer portfolio margining to
blocks certain large institutions from promptly with the approval of the its customers must employ a
participating in portfolio margining proposed rule changes, and contended methodology that has been approved by
because these institutions hold assets at that additional regulatory actions are the Commission for use in calculating
a custodian bank and, consequently, necessary in order to implement the haircuts under Rule 15c3–1a. As stated
would not hold $5.0 million in an proposed pilot programs.40 These other above, currently, TIMS is the only
account with a broker-dealer.31 Five regulatory actions include: Commission approved methodology. While some
commenters raised the issue that approval of SR–OCC–2003-04; a commenters recommended expanding
securities index options will be at a Commission ‘‘no-action’’ letter in the choice of models, the Commission
disadvantage compared with connection with SR–OCC–2003–04; an believes that requiring a broker-dealer to
economically similar CFTC regulated exemptive order from the CFTC; and use a model that qualifies for calculating
index futures, because futures accounts amendments to Commission Rule 15c3– haircuts under Commission Rule 15c3–
have no minimum equity requirement.32 3. The Exchange agrees with the OCC 1a maintains a consistency with the
The Exchange believes that the that approval of the OCC rule filing and Commission’s net capital rule and
comments directed at the $5.0 million issuance of the ‘‘no-action’’ letter are across potential portfolio margin pricing
equity requirements have merit, necessary to enable portfolio margining, models. As a result, portfolio margin
particularly with respect to certain types including cross-margining, to be requirements would vary less from firm
of accounts that must hold assets at a utilized.41 The Exchange also urged the to firm. The Commission notes,
custodial bank.33 The Exchange, Commission to complete all regulatory however, that like Rule 15c3–1a, the
however, stated that these comments proposed rule permits the use of another
34 See Wiermanski Letter; Saliba Letter; and theoretical pricing model, should one be
28 See supra notes 4, 7 and 10. Donohue Letter. developed in the future.44
29 See Vander Wilt Letter. 35 See Saliba Letter.

30 See Ianni Letter; Weingart Letter; Wiermanski 36 See Sheehan Letter.

42 In approving this proposed rule change, the
37 SPAN is the Chicago Mercantile Exchange’s
Letter; Hansen Letter; Greiner Letter; Saliba Letter; Commission notes that it has considered the
and Melvin Letter. Standard Portfolio Analysis System, which is used proposed rule’s impact on efficiency, competition,
31 See Weingart Letter; Wiermanski Letter; and by many futures exchanges to calculate margin. and capital formation. 15 U.S.C. 78c(f).
38 See Donohue Letter.
Melvin Letter. 43 15 U.S.C. 78f(b)(5).
32 See Weingart Letter, Wiermanski Letter; 39 See Wierzynski/Hammerman Letter. 44 See also Securities Exchange Act Release No.
Hansen Letter; Saliba Letter; and Sheehan Letter. 40 See Navin Letter.
34-38248 (February 6, 1997), 62 FR 6474 (February
33 See CBOE Response. 41 See supra notes 21 and 23. Continued

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42122 Federal Register / Vol. 70, No. 139 / Thursday, July 21, 2005 / Notices

The Commission notes the objections (‘‘FICC’’), and on May 4, 2005, the FICC, and NSCC to identify their
of certain commenters to the $5 million National Securities Clearing Corporation respective Top Tier members were
minimum equity requirement. The (‘‘NSCC’’) filed with the Securities and revenues, clearing fund contributions,
Commission believes that the Exchange Commission (‘‘Commission’’) settlement amounts, and trading
requirement circumscribes the number the proposed rule changes described in volumes. Connectivity testing for the
of accounts able to participate and adds Items I, II, and III below, which items Top Tier members was initiated on
safety in that such accounts are more have been prepared primarily by DTC, January 1, 2004. Due to the critical
likely to be of significant financial FICC, and NSCC. On June 7, 2005, importance of being able to assess
means and investment sophistication. NSCC amended its proposed rule whether a Top Tier member has
Finally, the Commission notes that change.2 The Commission is publishing sufficient operational capabilities, DTC,
several commenters recommended this notice to solicit comments on the FICC, and NSCC have determined that
expanding the products eligible for proposed rule changes from interested they need the ability to fine any Top
portfolio margining. The Exchange’s parties. Tier member that does not test.5
proposed rule limits the instruments Currently, each member of DTC, FICC,
eligible for portfolio margining to listed I. Self-Regulatory Organization’s
Statement of the Terms of Substance of and NSCC that is designated as Top Tier
products based on broad-based US is advised of this status and is provided
securities indices, which tend to be less the Proposed Rule Change
with information on the testing
volatile than narrow-based indices and DTC, FICC, and NSCC are seeking to requirements. Under DTC, FICC, and
non-index equities. The Commission establish a fine for members who fail to NSCC’s current procedures, if testing is
believes this limitation is appropriate conduct connectivity testing for not completed by a Top Tier member by
for the pilot program, which should business continuity purposes. the end of June, a reminder notice is
serve as a first step toward the possible II. Self-Regulatory Organization’s sent to the member. Thereafter, another
expansion of portfolio margining to Statement of the Purpose of, and reminder notice is sent in October and,
other classes of securities. Statutory Basis for, the Proposed Rule if necessary, again in December.
V.Conclusion Change The reminder notice sent in December
would advise that if testing is not
It is therefore ordered, pursuant to In its filing with the Commission, completed by December 31, a fine of
Section 19(b)(2) of the Act,45 that the DTC, FICC, and NSCC included $10,000 will be imposed. These fines
proposed rule change (File No. SR– statements concerning the purpose of would be collected from members in
CBOE–2002–03), as amended, is and basis for the proposed rule changes January of the following year. The
approved on a pilot basis to expire on and discussed any comments they Membership and Risk Management
July 31, 2007. received on the proposed rule changes. Committee would be notified of all
For the Commission, by the Division of The text of these statements may be members that were fined for failing to
Market Regulation, pursuant to delegated examined at the places specified in Item complete connectivity testing.
authority.46 IV below. DTC, FICC, and NSCC have
In the event that any member fails to
J. Lynn Taylor, prepared summaries, set forth in
complete connectivity testing for two
Assistant Secretary. sections (A), (B), and (C) below, of the
successive years, the fine that would be
most significant aspects of such
[FR Doc. E5–3870 Filed 7–20–05; 8:45 am] imposed at that time would be $20,000.
BILLING CODE 8010–01–P Failure to complete testing for more
(A) Self-Regulatory Organization’s than two successive years would result
Statement of the Purpose of, and
SECURITIES AND EXCHANGE Statutory Basis for, the Proposed Rule FICC, and NSCC, and others in the financial
COMMISSION Change industry to manage business continuity capabilities.
DTC, FICC, and NSCC developed their testing of
[Release No. 34–52043; File Nos. SR–DTC– The purpose of these filings is to Top Tier firms based on the guidelines outlined in
2005–04, SR–FICC–2005–10, and SR– modify the rules of DTC, FICC, and the white paper.
NSCC–2005–05] NSCC to provide that DTC, FICC, and 5 Pursuant to DTC Rule 2, ‘‘Participants and

Pledgees,’’ participants must furnish, upon DTC’s

NSCC may impose a fine on any request, information sufficient to demonstrate
Self-Regulatory Organizations; The member that is required to conduct
Depository Trust Company, Fixed operational capability. In addition, DTC Rule 21,
connectivity testing for business ‘‘Disciplinary Sanctions,’’ allows DTC to impose
Income Clearing Corporation, and continuity purposes and fails to do so. fines on participants for any error, delay or other
National Securities Clearing In the aftermath of September 11, conduct detrimental to the operations of DTC.
Corporation; Notice of Filing of 2001, and in conjunction with a Pursuant to GSD Rule 3, ‘‘Responsibility,
Proposed Rule Changes To Establish a Operational Capability, and Other Membership
financial industry white paper, DTC, Standards of Comparison-Only Members and
Fine for Members Failing To Conduct FICC, and NSCC require connectivity Netting Members,’’ the GSD may require members
Connectivity Testing testing for critical (‘‘Top Tier’’) to fulfill operational testing requirements as the
GSD may at any time deem necessary. Pursuant to
July 15, 2005. members.4 The criteria used by DTC, MBSD Rule 1, Section 3 of Article III, all MBSD
Pursuant to Section 19(b)(1) of the applicants and members agree to fulfill operational
2 The NSCC amendment proposes to amend
Securities Exchange Act of 1934 testing requirements and related reporting
NSCC Rule 48, Section 1, to increase the maximum requirements that may be imposed to ensure the
(‘‘Act’’),1 notice is hereby given that on disciplinary fine for a single offense from $10,000 continuing operational capability of the applicant.
May 13, 2005, The Depository Trust to $20,000. Pursuant to NSCC Rule 15, ‘‘Financial
Company (‘‘DTC’’), on May 3, 2005, the 3 The Commission has modified the text of the
Responsibility and Operational Capability,’’
Fixed Income Clearing Corporation summaries prepared by DTC, FICC, and NSCC. members must furnish to NSCC adequate
4 The Federal Reserve, Office of the Comptroller assurances of their financial responsibility and
of the Currency, and the Commission issued operational capability as NSCC may at any time
12, 1997) (discussing in Part II.A. the use of TIMS ‘‘Interagency Paper on Sound Practices to deem necessary. In addition, NSCC Rule 48,
versus other pricing models). Strengthen the Resilience of the U.S. Financial ‘‘Disciplinary Procedures’’, allows NSCC to impose
45 15 U.S.C. 78s(b)(2).
System.’’ [68 FR 17809 (April 11, 2003)]. This a fine on participants for any error, delay, or other
46 17 CFR 200.30–3(a)(12).
document provided guidelines that required core conduct that is determined to be detrimental to the
1 15 U.S.C. 78s(b)(1). clearing and settlement organizations, such as DTC, operations of NSCC.

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