Customer Margin Rules Relating to Security Futures

Federal RegisterNov 24, 2020

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 41

RIN 3038-AE88

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-90244; File No. S7-09-19]

RIN 3235-AM55

Customer Margin Rules Relating to Security Futures

AGENCY:

Commodity Futures Trading Commission and Securities and Exchange Commission.

ACTION:

Joint final rule.

SUMMARY:

The Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) (collectively, the “Commissions”) are adopting rule amendments to lower the margin requirement for an unhedged security futures position from 20% to 15% and adopting certain conforming revisions to the security futures margin offset table.

DATES:

This rule is effective December 24, 2020.

FOR FURTHER INFORMATION CONTACT:

CFTC:

Melissa A. D'Arcy, Special Counsel and Sarah E. Josephson, Deputy Director, Division of Clearing and Risk, at (202) 418-5430; and Michael A. Penick, Economist at (202) 418-5279, and Ayla Kayhan, Economist at (202) 418-5947, Office of the Chief Economist, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.

SEC:

Michael A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at (202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202) 551-5522; Sheila Dombal Swartz, Senior Special Counsel, at (202) 551-5545; or Abraham Jacob, Special Counsel, at (202) 551-5583; Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

I. Background

II. Final Rule Amendments

A. Lowering the Minimum Margin Level From 20% to 15%

1. The Commissions' Proposal

2. Comments and Final Amendments

B. Conforming Revisions to the Strategy-Based Offset Table

1. The Commissions' Proposal

2. Comments and the Re-Published Strategy-Based Offset Table

C. Other Matters

III. Paperwork Reduction Act

A. CFTC

B. SEC

IV. CFTC Consideration of Costs and Benefits and SEC Economic Analysis (Including Costs and Benefits) of the Proposed Amendments

A. CFTC

1. Introduction

2. Economic Baseline

3. Summary of the Final Rules

4. Description of Costs

5. Description of Benefits Provided by the Final Rules

6. Discussion of Alternatives

7. Consideration of Section 15(a) Factors

B. SEC

1. Introduction

2. Baseline

3. Considerations of Costs and Benefits

4. Effects on Efficiency, Competition, and Capital Formation

5. Reasonable Alternatives Considered

V. Regulatory Flexibility Act

A. CFTC

B. SEC

VI. Other Matters

VII. Anti-Trust Considerations

VIII. Statutory Basis

I. Background

A security future is a futures contract on a single security or on a narrow-based securities index.

The Commodity Futures Modernization Act of 2000 (“CFMA”) lifted the ban on trading security futures and established a framework for the joint regulation of these products by the Commissions.

Among other things, the CFMA amended Section 7 of the Securities Exchange Act of 1934 (“Exchange Act”) to establish a margin program for security futures. Section 7(c)(2)(A) of the Exchange Act provides that it shall be unlawful for any broker, dealer, or member of a national securities exchange

to, directly or indirectly, extend or maintain credit to or for, or collect margin from any customer on, any security future unless such activities comply with the regulations prescribed by: (1) The Board of Governors of the Federal Reserve System (“Federal Reserve Board”); or (2) the Commissions jointly pursuant to authority delegated by the Federal Reserve Board.

See

Section 1a(44) of the Commodity Exchange Act (“CEA”) and Section 3(a)(55) of the Exchange Act (both defining the term “security future”). A “security future” is distinguished from a “security futures product,” which is defined to include a security future as well as any put, call, straddle, option, or privilege on a security future.

See

Section 1a(45) of the CEA and Section 3(a)(56) of the Exchange Act (both defining the term “security futures product”). Under Section 2(a)(1)(D)(iii)(II) of the CEA and Section 6(h)(6) of the Exchange Act, the Commissions may, by order, jointly determine to permit the listing of options on security futures. The Commissions have not exercised this authority. The amendments being adopted in this release relate to margin requirements for security futures and not for options on security futures. Most of the discussion in this release relates to security futures. The term “security futures products” will be used when discussing security futures and options on security futures.

See

Appendix E of Public Law 106-554, 114 Stat. 2763 (2000). Futures on security indexes that are not narrow-based are subject to the exclusive jurisdiction of the CFTC.

A futures commission merchant (“FCM”) (as defined in Section 1(a)(28) of the CEA) may be a member of a national securities exchange, a clearing member of a clearinghouse, or a customer of a clearing member of a clearinghouse.

Section 7(c)(2)(B) of the Exchange Act provides that the customer margin requirements for security futures products adopted by the Federal Reserve Board or jointly by the Commissions, “including the establishment of levels of margin (initial and maintenance),” must satisfy four requirements. First, they must preserve the financial integrity of markets trading security futures products.

Second, they must prevent systemic risk.

Third: (1) They must be consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act;

and (2) the initial and maintenance margin levels must not be lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options.

Fourth, excluding margin levels, they must be, and remain consistent with, the margin requirements established by the Federal Reserve Board under 12 CFR part 220 (“Regulation T”).

See

Section 7(c)(2)(B)(i) of the Exchange Act.

See

Section 7(c)(2)(B)(ii) of the Exchange Act.

See

Section 7(c)(2)(B)(iii)(I) of the Exchange Act. In this release, this provision of the statute is sometimes referred to as the “consistent with restriction.”

See

Section 7(c)(2)(B)(iii)(II) of the Exchange Act. In this release, this provision of the statute is sometimes referred to as the “not lower than restriction.”

See

Section 7(c)(2)(B)(iv) of the Exchange Act.

On March 6, 2001, the Federal Reserve Board delegated its authority under Section 7(c)(2)(A) of the Exchange Act to the Commissions.

Pursuant to that delegation, the Commissions adopted rules in 2002 establishing a margin program for security futures.

These rules require security futures intermediaries to collect margin from their customers.

A security futures intermediary is a creditor, as defined under Regulation T, with respect to its financial relations with any person involving security futures, and includes registered entities such as brokers-dealers and FCMs.

See

Letter from Jennifer J. Johnson, Secretary of the Board, Federal Reserve Board, to James E. Newsome, Acting Chairman, CFTC, and Laura S. Unger, Acting Chairman, SEC (Mar. 6, 2001) (“FRB Letter”);

see also Customer Margin Rules Relating to Security Futures,

Exchange Act Release No. 44853 (Sep. 26, 2001), 66 FR 50720 (Oct. 4, 2001) (“2001 Proposing Release”) (reprinting the FRB Letter in Appendix B).

See Customer Margin Rules Relating to Security Futures,

Exchange Act Release No. 46292 (Aug. 1, 2002), 67 FR 53146 (Aug. 14, 2002) (“2002 Adopting Release”).

See also

17 CFR 41.41 through 41.49 (CFTC regulations, hereinafter referred to as “CFTC Rule 41.42”, “CFTC Rule 41.43”

et seq.

) and 17 CFR 242.400 through 242.406 (SEC regulations,

hereinafter referred to as “SEC Rule 400”, “SEC Rule 401”

et seq.

). CFTC regulations referred to herein are found at 17 CFR chapter I, and SEC regulations referred to herein are found at 17 CFR chapter II.

See

CFTC Rule 41.45 and SEC Rule 403.

See also

CFTC Rule 41.43(a)(29) and SEC Rule 401(a)(1)(29) (both defining the term “security futures intermediary” to include a broker-dealer and an FCM). The term “security futures intermediary” includes FCMs that are clearing members or customers of clearing members. As of September 18, 2020, the Options Clearing Corporation (“OCC”) was the only clearinghouse for U.S. exchange-traded security futures.

Because a security future is both a security and a future, customers who wish to buy or sell security futures must conduct the transaction through a person registered both with the CFTC as either an FCM or an introducing broker (“IB”) and with the SEC as a broker-dealer.

The Commissions' rules include requirements governing: Account administration; type, form, and use of collateral; calculation of equity; withdrawals from accounts; and the treatment of undermargined accounts. The Commissions stated that “the inclusion of these provisions in the final rules satisfies the statutory requirement that the margin rules for security futures be consistent with Regulation T.”

See

2002 Adopting Release, 67 FR at 53155. As indicated above, Section 7(c)(2)(B)(iv) of the Exchange Act requires that margin requirements for security futures (other than levels of margin), including the type, form, and use of collateral, must be consistent with the requirements of Regulation T.

The Commissions' rules contemplate that all security futures intermediaries will pay to or receive from their customers a daily variation settlement (

i.e.,

the daily net gain or loss on a security future) as a result of all open security futures positions being marked to current market value by the clearing organization where the security futures are cleared.

In addition, the Commissions' rules establish minimum initial and maintenance margin levels for unhedged security futures equal to 20% of their “current market value.”

See

CFTC Rules 41.43(a)(32), 41.46(c)(1)(vi) and (c)(2)(iii), and 41.47(b)(1), and SEC Rules 401(a)(32), 404(c)(1)(vi) and (c)(2)(iii), and 405(b)(1).

See

CFTC Rule 41.45(b)(1) and SEC Rule 403(b)(1).

See also

CFTC Rule 41.43(a)(4) and SEC Rule 401(a)(4) (defining the term “current market value”).

The Commissions' rules permit a “self-regulatory authority” (“SRA”),

as that term is defined in the rules, to set initial and maintenance margin levels lower than 20% of the current market value for certain strategy-based offsetting positions involving security futures and one or more related securities or futures.

The SRA rules must meet the four criteria set forth in Section 7(c)(2)(B) of the Exchange Act and must be effective in accordance with Section 19(b)(2) of the Exchange Act and, as applicable, Section 5c(c) of the CEA.

In connection with these provisions governing SRA rules, the Commissions published a table identifying offsets for security futures that were consistent with the offsets permitted for comparable exchange-traded options (“Strategy-Based Offset Table”).

SRAs have adopted margin rules that permit strategy-based offsets between security futures and related positions based on the Strategy-Based Offset Table.

The Commissions' rules define the term “self-regulatory authority” to mean a national securities exchange registered under Section 6 of the Exchange Act, a national securities association registered under Section 15A of the Exchange Act, a contract market registered under Section 5 of the CEA or Section 5f of the CEA, or a derivatives transaction execution facility registered under Section 5a of the CEA.

See

CFTC Rule 41.43(a)(30) and SEC Rule 401(a)(30). The term “SRA” as used in this release refers to self-regulatory organizations (“SROs”) registered under the Exchange Act and self-regulatory authorities registered under the CEA. The term “securities SRO” as used in this release refers only to SROs registered under the Exchange Act.

See

CFTC Rule 41.45(b)(2) and SEC Rule 403(b)(2).

See also

2002 Adopting Release, 67 FR at 53158-61. The initial margin level is the required amount of margin that must be posted when the trade is executed. The maintenance margin level is the required amount of margin that must be maintained while the contract is open.

Section 19(b)(2) of the Exchange Act governs SRA rulemaking with respect to SEC registrants, and Section 5c(c) of the CEA governs SRA rulemaking with respect to CFTC registrants.

See

2002 Adopting Release, 67 FR at 53158-61.

See, e.g.,

FINRA Rule 4210(f)(10) and Cboe Rule 10.3(k).

The Commissions' rules also enumerate specific exclusions from the margin requirements for security futures, and those exclusions will continue under the final rule amendments.

For example, margin requirements that derivatives clearing organizations (“DCOs”) or clearing agencies impose on their clearing members are not subject to the 20% margin level requirement.

See

CFTC Rule 41.42(c)(2)(i) through (v) and SEC Rule 400(c)(2)(i) through (v).

See

CFTC Rule 41.42(c)(2)(iii) and SEC Rule 400(c)(2)(iii). The OCC is registered with the SEC as a clearing agency pursuant to Section 17A of the Exchange Act and registered with the CFTC as a DCO pursuant to Section 5b of the CEA.

There also is an exclusion providing that the required 20% initial and maintenance margin levels do not apply to financial relations between a customer and a security futures intermediary to the extent that they comply with a portfolio margining system under rules that meet the four criteria set forth in Section 7(c)(2)(B) of the Exchange Act and that are effective in accordance with Section 19(b)(2) of the Exchange Act and, as applicable, Section 5c(c) of the CEA.

Subsequent to the adoption of the Commissions' rules, and consistent with this exclusion, two securities SROs implemented portfolio margining rules that permit a broker-dealer to combine certain of a customer's securities and security futures positions in a securities account in order to compute the customer's margin requirements (“Portfolio Margin Rules”).

As discussed in more detail below, the Portfolio Margin Rules established a 15% margin level for unhedged exchange-traded options on an equity security or narrow-based equity index (sometimes referred to herein as “exchange-traded equity options”).

The 15% margin level also applies to unhedged security futures held in a securities account that is subject to Portfolio Margin Rules. There is no comparable portfolio margining system for security futures held in a futures account.

These same unhedged security futures positions, if held in a futures account, are subject to the required 20% initial and maintenance margin levels set forth in the Commissions' rules.

CFTC Rule 41.42(c)(2)(i) and SEC Rule 400(c)(2)(i).

See

FINRA Rule 4210(g) and Cboe Rule 10.4. The broker-dealer would need to be registered with the CFTC (as an FCM) to include security futures in the securities account.

See also

2019 Proposing Release, 84 FR 36437, n.36. FINRA Rule 4210 (Margin Requirements) was adopted as part of a new consolidated rulebook effective permanently on December 2, 2010, after the pilot program was approved and made available on August 1, 2008. Cboe rules on portfolio margining became effective permanently on July 8, 2008, after they were approved under a pilot program on April 2, 2007.

The amendments adopted in this release were motivated, in part, by changes made to margin requirements for certain exchange-traded options pursuant to securities SRO pilot programs offering risk-based portfolio margining rules. Those pilot programs were later made permanent after review and approval by the SEC.

See

2019 Proposing Release, 84 FR 36437, n.34-36.

For purposes of this rulemaking a “futures account” is an account that is maintained in accordance with the requirements of Sections 4d(a) and 4d(b) of the CEA.

See also

17 CFR 1.3 (CFTC Rule 1.3).

2019 Proposing Release

In July 2019, the Commissions proposed amending the security futures margin rules to lower the required initial and maintenance margin levels for an unhedged security futures position from 20% to 15% of its current

market value.

The Commissions sought to align margin requirements for security futures held in futures accounts and customer securities accounts that are not subject to the Portfolio Margin Rules with security futures and exchange-traded options held in customer securities accounts subject to the Portfolio Margin Rules (“Portfolio Margin Account”).

The Commissions also proposed certain conforming revisions to the Strategy-Based Offset Table.

Because the Commissions' proposal solely related to the reduction in “levels of margin” for security futures, the Commissions stated a preliminary belief that they did not implicate the requirement of Section 7(c)(2)(B)(iv) of the Exchange Act that the Commissions' rules be consistent with Regulation T.

See Customer Margin Rules Relating to Security Futures,

Exchange Act Release No. 86304 (July 3, 2019), 84 FR 36434 (July 26, 2019) (“2019 Proposing Release”). OneChicago, LLC (“OneChicago”) filed a rulemaking petition requesting that the minimum required margin for unhedged security futures be reduced from 20% to 15%.

See

Letter from Donald L. Horwitz, Managing Director and General Counsel, OneChicago, to David Stawick, Secretary, CFTC, and Nancy M. Morris, Secretary, SEC (Aug. 1, 2008) (“OneChicago Petition”), at 2.

See

2019 Proposing Release, 84 FR at 36437.

See

2019 Proposing Release, 84 FR at 36441-43.

See

2019 Proposing Release, 84 FR at 36440. As discussed above, Section 7(c)(2)(B)(iv) of the Exchange Act requires that margin requirements for security futures

(other than levels of margin),

including the type, form, and use of collateral, must be consistent with the requirements of Regulation T (emphasis added).

The Commissions received a number of comment letters in response to the proposal.

As discussed below, after considering the comments, the Commissions are adopting, as proposed, the amendments to the security futures margin rules to lower the required initial and maintenance margin levels for an unhedged security futures position from 20% to 15%. The Commissions also are publishing a revised Strategy-Based Offset Table as proposed.

The comment letters are available at

https://www.sec.gov/comments/s7-09-19/s70919.htm

and

https://comments.cftc.gov/PublicComments/CommentList.aspx?id=3013.

The Commissions address these comments in section II below (discussing the final rule amendments), and in section IV (including the CFTC's consideration of the costs and benefits of the amendments and the SEC's economic analysis (including costs and benefits) of the amendments).

Subsequent to the issuance of the 2019 Proposing Release, OneChicago, the only exchange listing security futures in the U.S., discontinued all trading operations on September 21, 2020. At this time, there are no security futures contracts listed for trading on U.S. exchanges. The final rule amendments in this release, however, would apply to customer margin requirements for security futures if an exchange were to resume operations or another exchange were to launch security futures contracts.

II. Final Rule Amendments

A. Lowering the Minimum Margin Level From 20% to 15%

1. The Commissions' Proposal

As discussed above, the current minimum initial and maintenance margin levels for an unhedged long or short position in a security future are 20% of the current market value of the position,

unless an exclusion applies.

For context, as discussed when adopting the margin requirements for security futures in 2002, the 20% margin levels were designed to be consistent with the margin requirements then in effect for an unhedged

short

at-the-money exchange-traded option held in a customer account where the underlying instrument is either an equity security or a narrow-based index of equity securities.

In this case, the margin requirement was 100% of the exchange-traded option proceeds, plus 20% of the value of the underlying equity security or narrow-based equity index.

This margin requirement on options continues to apply if the exchange-traded option is held in a securities account that is

not

subject to the Portfolio Margin Rules.

See

CFTC Rule 41.45(b) and SEC Rule 403(b).

See

CFTC Rule 41.42(c)(2)(i) through (v) and SEC Rule 400(c)(2)(i) through (v).

See

2002 Adopting Release, 67 FR at 53157 (“The Commissions believe that a security future is comparable to a short, at-the-money option . . .”); 2001 Proposing Release, 66 FR at 50725-26 (“The Commissions propose that the initial and maintenance margin levels required of customers for each security future carried in a long or short position be 20 percent of the current market value of such security future because 20 percent is the uniform margin level required for short, at-the-money equity options traded on U.S. options exchanges.”) (footnote omitted). In 2002, the margin requirement for a

long

exchange-traded equity option with an expiration exceeding nine months was 75% of the contract's in-the-money amount plus 100% of the amount, if any, by which the current market value of the option exceeded its in-the-money amount, provided the option is guaranteed by the carrying broker-dealer and has an American-style exercise provision. Otherwise, long exchange-traded options were not margin eligible and the customer needed to pay 100% of the purchase price. These requirements remain in place for long options contracts.

See

FINRA Rule 4210 and Cboe Rule 10.3.

This release generally discusses security futures on underlying equity securities and narrow-based equity security indexes because, while permitted, no exchange has listed security futures directly on one or more debt securities.

See

CFTC Rule 41.21(a)(2)(iii), 17 CFR 41.21(a)(2)(iii), and SEC Rule 6h-2, 17 CFR 240.6h-2 (both providing that a security futures may be based upon a security that is a note, bond, debenture, or evidence of indebtedness or a narrow-based security index composed of such securities).

See

FINRA Rule 4210 and Cboe Rule 10.3.

However, as a result of the more recent Portfolio Margin Rules, an unhedged short at-the-money exchange-traded equity option held in a Portfolio Margin Account is now subject to a lower margin level. More specifically, under the Portfolio Margin Rules, a broker-dealer can group options, security futures, long securities positions, and short securities positions in a customer's account involving the same underlying security and stress the current market price for each position at ten equidistant points along a range of positive and negative potential future market movements using a theoretical option pricing model that has been approved by the SEC.

In the case of an option on an equity security or narrow-based equity securities index, the ten equidistant stress points span a range from −15% to +15% (

i.e.,

−15%, −12%, −9%, −6%, −3%, +3%, +6%, +9%, +12%, +15%).

The gains and losses of each position in the portfolio are allowed to offset each other to yield a net gain or loss at each stress point.

The stress point that yields the largest potential net loss for the portfolio is used to determine the aggregate margin requirement for all the positions in the portfolio.

See

FINRA Rule 4210(g) and Cboe Rule 10.4.

This range of price movements (+/−) 15% is consistent with the prescribed 15% haircut for most proprietary equity securities positions under the SEC's net capital rule for broker-dealers.

See

17 CFR 240.15c3-1(c)(2)(vi)(J).

For example, at the −6% stress point, XYZ Company stock long positions would experience a 6% loss, short positions would experience a 6% gain, and XYZ Company options would experience gains or losses depending on the features of the options. These gains and losses are added up resulting in a net gain or loss at that point.

Because options are part of the portfolio, the greatest portfolio loss (or gain) would not necessarily occur at the largest potential market move stress points ((+/−) 15%). This is because a portfolio that holds derivative positions that are far out-of-the-money would potentially realize large gains at the greatest market move points as these positions come into the money. Thus, the greatest net loss for a portfolio conceivably could be at any market move stress point. In addition, the Portfolio Margin Rules impose a minimum charge based on the number of derivative positions in the account and that applies if the minimum charge is greater than the largest stress point charge.

Under the Portfolio Margin Rules, the margin requirement for a short at-the-money exchange-traded equity option generally would be 15% if there were no other products in the account eligible to be grouped with the option position to form a portfolio (

i.e.,

an unhedged position). Consequently, the Commissions proposed to lower the required initial and maintenance margin levels for unhedged security futures

from 20% to 15%.

In doing so, the Commissions preliminarily viewed unhedged exchange-traded equity options as comparable to security futures that may be held alongside the exchange-traded equity options in a Portfolio Margin Account.

The Commissions stated that Congress did not instruct the Commissions to set the margin requirement for security futures at the exact level as the margin requirements for exchange-traded equity options. Rather, pursuant to Section 7(c)(2)(B) of the Exchange Act, the Commissions must establish margin requirements that are “consistent” with the margin requirements for “comparable” exchange-traded equity options and set initial and maintenance margin levels that are not lower than the lowest level of margin for the comparable exchange-traded equity options.

See

2019 Proposing Release, 84 FR at 36438-40.

See

2019 Proposing Release, 84 FR at 36439 (“The Commissions are proposing to decrease the margin requirement for unhedged security futures from 20% to 15% in order to reflect the comparability between unhedged security futures and exchange-traded options that are held in risk-based portfolio margin accounts.”).

Under the proposal, unhedged security futures held in futures accounts and securities accounts that are not Portfolio Margin Accounts would be subject to the same initial and maintenance margin levels as unhedged security futures held in Portfolio Margin Accounts (

i.e.,

15%). Thus, the proposed 15% initial and maintenance margin levels for unhedged security futures would bring security futures held in futures accounts and securities accounts that are not Portfolio Margin Accounts into alignment with the required margin level for unhedged security futures held in Portfolio Margin Accounts. At the same time, the amendments would not lower the required margin levels for unhedged security futures below the lowest required margin level for unhedged exchange-traded equity options (

i.e.,

15%). As discussed below, margin levels for exchange-traded equity options are prescribed in rules promulgated by securities SROs.

See

12 CFR 220.12(f); FINRA Rule 4210; Cboe Rule 10.3.

see also

FINRA Portfolio Margin FAQ,

available at www.finra.org.

An exchange-traded equity option that cannot be grouped with any other risk reducing offsetting equity positions in a Portfolio Margin Account (

i.e.,

an unhedged position) does not receive the benefit of a lower margin requirement and is subject to a 15% margin level. Therefore, the greater leverage that can be achieved by grouping offsetting positions is not available to the customer in the case of an unhedged position. Given the absence of risk-reducing offsetting positions, the risk of the unhedged position held in a Portfolio Margin Account generally is no different than if the unhedged position was held outside of a Portfolio Margin Account. The same is true with respect to an unhedged security futures position held in a Portfolio Margin Account as compared to an unhedged security futures position held outside of a Portfolio Margin Account.

Moreover, there is no comparable portfolio margin system for security futures held in a futures account. Therefore, an unhedged security futures position held in a futures account is subject to the required 20% margin level even though the risk of the position is generally no different than if the position was held in a Portfolio Margin Account, given the absence of risk-reducing offsetting positions. In addition, as discussed above, in 2002, securities SROs had not yet proposed portfolio margin rules for exchange-traded options. With the adoption of the Portfolio Margin Rules, the lower 15% margin level for unhedged security futures and exchange-traded options held in Portfolio Margin Accounts became available as an alternative.

For these reasons, it is appropriate to use the margin level for an unhedged exchange-traded equity option held in a Portfolio Margin Account to establish a consistent margin level for security futures held outside of a Portfolio Margin Account.

In addition, as discussed above, Section 7(c)(2)(B) of the Exchange Act provides that: (1) The margin requirements for security futures must be consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act; and (2) the initial and maintenance margin levels for security futures must not be lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options. The statute requires that the Commissions establish customer margin requirements that are “consistent” with the margin requirements for “comparable” exchange-traded options. This provides the Commissions with some flexibility in establishing the margin levels for security futures, provided those margin requirements do not set initial and maintenance margin levels for security futures lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options.

Further, Section 7(c)(2)(B)(iii)(II) of the Exchange Act provides that the initial and maintenance margin levels for security futures must not be lower than the lowest level of margin required for

any

comparable exchange-traded option. It does not specify that the initial and maintenance margin levels must not be lower than the lowest level of margin required with respect to a given type of account. Therefore, it is appropriate to consider the lowest level of margin for an unhedged exchange-traded equity option held in a Portfolio Margin Account when setting initial and maintenance margin levels for security futures held outside of a Portfolio Margin Account (

i.e.,

held in a futures account or a securities account that is not a Portfolio Margin Account).

As discussed above, commenters requested that the Commissions provide for a corresponding change to margin levels for exchange-traded equity options to ensure any final rule is consistent with Section 7(c)(2)(B) of the Exchange Act. This comment is outside the scope of this rulemaking, which is focused on margin levels for security futures. Margin levels for exchange-traded equity options are set forth in securities SRO rules.

Securities SROs typically set margin levels for exchange-traded equity options through rule filings with the SEC under Section 19(b) of the Exchange Act.

See

12 CFR 220.12(f); FINRA Rule 4210; Cboe Rule 10.3.

Under Section 19(b) of the Exchange Act, securities SROs generally must file proposed rule changes with the SEC for notice, public comment, and SEC approval, prior to implementation. 15 U.S.C. 78s(b). Section 19(b)(1) of the Exchange Act requires each securities SRO to file with the SEC “any proposed rule or any proposed change in, addition to, or deletion from the rules of . . . [a] self-regulatory organization.” 15 U.S.C. 78s(b)(1).

Some commenters that raised concerns about the proposal's consistency with Section 7(c)(2)(B) of the Exchange Act also stated that the proposal would create a competitive advantage for security futures over exchange-traded equity options through preferential margin treatment for security futures held outside of a Portfolio Margin Account.

Cboe/MIAX Letter at 6.

These commenters noted that the Commissions recognized in 2001 that security futures can compete with, and be an economic substitute for, equity securities, such as equity options, and stated that the CFMA was specifically designed to avoid regulatory arbitrage between security futures and exchange-traded options.

These commenters believed that the proposal implies that exchange-traded options and security futures are not competing products and that the analysis in the proposal unfairly underestimates the utility of options.

They also stated that synthetic futures strategies are an important segment of today's options market, and could be used to compete with security futures. They stated that in June 2019 there were over 700,000 contracts traded on their exchanges that replicate long and short security futures.

Cboe/MIAX Letter at 6.

See also

2001 Proposing Release, 66 FR 50721 at n.10.

Cboe/MIAX Letter at 6.

Cboe/MIAX Letter at 7.

The Commissions acknowledge that security futures and exchange-traded equity options can have similar economic uses.

However, reducing the margin level for an unhedged security future held outside of a Portfolio Margin Account to 15% should not result in a competitive disadvantage for exchange-traded equity options, if security futures trading resumes. First, reducing the required margin levels for unhedged security futures to 15% will result in more consistent margin requirements between futures and securities accounts. Second, subject to certain requirements, customers may hold exchange-traded equity options in a Portfolio Margin Account, in which case the margin level for an unhedged position is 15%.

For example, commenters noted that to create a synthetic long (short) futures contract, which requires two options, an investor would buy (sell) a call option and sell (buy) a put option on the same underlying security with the same expiration date and strike price. Cboe/MIAX Letter at 6-7.

Finally, customers can hold security futures in a Portfolio Margin Account, in which case the required margin level is 15% for an unhedged position. Nonetheless, the vast majority of

security futures traded in the U.S. were held in futures accounts subject to required initial and maintenance margin levels of 20% for unhedged positions.

Therefore, the relative advantage of a required 15% margin level as compared to a required 20% margin level did not cause customers to migrate their security futures trading to Portfolio Margin Accounts.

In its petition, OneChicago stated that “because of operational issues at the securities firms, almost all security futures positions are carried in a futures account regulated by the CFTC and not in a securities account. The proposed joint rulemaking would permit customers carrying security futures in futures accounts to receive margin treatment consistent with that permitted under the [portfolio] margining provisions of CBOE.”

See

OneChicago Petition at 2 and 2019 Proposing Release 84 FR at 36440, n.67.

Some commenters that opposed lowering the required margin levels from 20% to 15% stated that industry solutions and rule changes that optimize the portfolio margining of security futures and exchange-traded equity options, including the portfolio margining of security futures in both securities and futures accounts, would be a more appropriate solution.

Cboe/MIAX Letter at 5. More specifically, to the extent securities accounts are not operationally optimal for security futures, the options exchanges support industry efforts to make improvements.

Id.

As discussed above, lowering the required margin levels from 20% to 15% is appropriate, consistent with Section 7(c)(2)(B) of the Exchange Act, and should not disadvantage exchange-traded equity options markets if security futures trading resumes. Moreover, the Commissions remain committed to continuing to coordinate on issues related to harmonizing portfolio margining rules and requirements, as well as increasing efficiencies in the implementation of portfolio margining. Further, to the extent securities accounts are not operationally suited for holding security futures, the Commissions support industry efforts to address this issue. Finally, the realization of any potential harmonization efforts or operational improvements with respect to portfolio margining will depend on firms offering such programs to their customers.

Response to Commenters' Request To Use Risk Models To Calculate Margin

In response to the Commissions' request for comments in the 2019 Proposing Release,

some commenters stated that the Commissions' rules should permit the use of risk models to calculate required initial and maintenance margin levels for security futures

—similar to how DCOs calculate margin requirements for futures and the OCC calculates margin requirements for its clearing members.

One of these commenters—OneChicago—believed that the required margin levels for security futures and the proposal to modify them were too conservative.

OneChicago characterized the Commissions' proposal as—“at best”—“a first-step towards the risk-based margining that is needed in the [security futures] marketplace.”

It further stated that 92% of the security futures traded on its exchange were “margined at a level greater than is set by the clearinghouse for comparable products, which are equity swaps” and that, under the proposal, 84% would still be margined at a greater level.

According to OneChicago's analysis, the Commissions' proposal to lower the required margin levels from 20% to 15% would have resulted in a 25% reduction in the value of margin collected (from $540 million to $410 million) for the period between September 1, 2018, and August 1, 2019; whereas using a margin model would have resulted in a 61% reduction (from $540 million to $210 million).

The Commissions asked, “[a]re there any other risk-based margin methodologies that could be used to prescribe margin requirements for security futures? If so, please identify the margin methodologies and explain how they would meet the comparability standards under the Exchange Act.” 2019 Proposing Release, 84 FR at 36441.

For purposes of this final rule, any references to using “risk models” or a “risk model approach” to calculate required initial margin levels is intended to mean the same thing. While there are different risk-based margin models, a key component of all such margin regimes is the use of modeling to generate expected potential future exposures that adjust over time in response to market conditions, credit risk, and other inputs.

Letter from Thomas G. McCabe, Chief Regulatory Officer, OneChicago (Aug. 26, 2019) (“OneChicago Letter”); Letter from Thomas G. McCabe, Chief Regulatory Officer, OneChicago (Oct. 7, 2019) (“OneChicago Letter 2”); Letter from Thomas G. McCabe, Chief Regulatory Officer, OneChicago (Apr. 27, 2020) (“OneChicago Letter 3”); OneChicago,

April 27, 2020 OneChicago Comment Letter Summary

(“OneChicago Letter 3 Summary”); Letter from Mike Ianni, individual (Aug. 29, 2019) (“Ianni Letter”); Letter from Scott A. La Botz, individual (Dec. 4, 2019) (“La Botz Letter”).

OneChicago Letter at 1.

OneChicago Letter at 1. In this release, the term “clearinghouse” may refer to a clearing organization or a clearing agency.

OneChicago Letter at 14. However, as discussed in more detail in section IV of this release, it is possible that under certain circumstances the margin requirement under a risk-based margin model may exceed the 15% of the current market value that is required under the final rules.

OneChicago believed that the “margin regime in place today and the proposed margin regime incentivizes market participants to transact in other environments.”

OneChicago stated that the trading volume on its exchange “has been plummeting in recent years.”

In the exchange's view, these issues would be addressed if the Commissions adopted a risk model approach to calculate required margin levels for security futures. As a more limited alternative, OneChicago suggested the Commissions could adopt a risk model approach for a class of security futures paired transactions executed on its exchange and known as “securities transfer and return spreads” (“STARS”).

OneChicago Letter at 2.

OneChicago Letter at 14.

OneChicago Letter at 19;

see also

Memorandum from the SEC's Division of Trading and Markets regarding a July 16, 2019, meeting with representatives of OneChicago.

Risk models calculate margin requirements by measuring potential future exposures based on statistical correlations between positions in a portfolio. For example, the OCC's risk model—known as the System for Theoretical Analysis and Numerical Simulations (“STANS”)—calculates a clearing member's margin requirement based on full portfolio Monte Carlo simulations.

The margin requirements in place today for exchange-traded equity options do not use risk models to calculate margin requirements for customer positions.

Rather, current rules prescribe margin requirements as a percent of a value or other amount of a single position or combinations of offsetting positions or, in the case of the Portfolio Margin Rules, stress groups of related positions across a preset range of potential percent market moves (

e.g.,

market moves of −15%, −12%, −9%, −6%, −3%, +3%, +6%, +9%, +12%, +15% in the case of exchange-traded equity options).

More information about the OCC's STANS model is available at

https://www.theocc.com/risk-management/Margin-Methodology/.

See, e.g.,

FINRA Rule 4210 and Cboe Rule 10.3.

The Commissions' required initial and maintenance margin levels for security futures (

i.e.,

20% of the current market value) are based on the margin requirements for exchange-traded equity options and are designed to be consistent with those requirements in accordance with Section 7(c)(2)(B) of the Exchange Act.

Consequently, implementing a risk model approach to calculate required margin levels for security futures would substantially alter how the required margin is calculated (or would be calculated under these amendments) and would substantially deviate from how customer margin requirements are calculated for exchange-traded equity options. It also could result in required

initial and maintenance margin levels for unhedged security futures that are significantly lower than the 20% margin level for unhedged exchange-traded equity options held outside a Portfolio Margin Account as well as the 15% margin level for unhedged exchange-traded equity options held in a Portfolio Margin Account.

See

2002 Adopting Release, 67 FR at 53156-61.

For these reasons, implementing a risk model approach to calculate margin for security futures would be inconsistent with how margin is calculated for exchange-traded equity options at this time and may result in margin levels for unhedged security futures positions that are lower than the lowest level of margin applicable to unhedged exchange-traded equity options (

i.e.,

15%). Consequently, because no exchange-traded equity options are subject to risk-based margin requirements, adopting a risk model approach at this time for security futures would conflict with the requirements of Section 7(c)(2)(B) of the Exchange Act that: (1) The margin requirements for security futures must be consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act; and (2) the initial and maintenance margin levels must not be lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options.

In this adopting release, the Commissions are considering OneChicago's proposed alternative risk model approach for margining security futures. However, as the discussion herein reflects, this alternative is not a viable one because the Commissions are not persuaded that it would satisfy the requirements of Section 7(c)(2)(B) of the Exchange Act at this time.

To address the conflict between a risk model approach and Section 7(c)(2)(B) of the Exchange Act, OneChicago argued that the Commissions could adopt a risk model approach because Section 7(c)(2)(B) of the Exchange Act can be read to require that the

level of protection

provided to the marketplace by the margin requirements for security futures must be consistent with the level of protection provided by the margin requirements for exchange-traded options.

Similarly, OneChicago argued that the statute can be construed to require that the level of protection provided by the margin requirements for security futures (rather than the margin levels) must not be lower than the lowest level of protection provided by the margin requirements for exchange-traded options.

See

OneChicago Letter at 30-35.

OneChicago pointed out that Section 7(c)(2)(B)(iii)(I) of the Exchange Act provides that “margin requirements” for a security future product must be consistent with the margin requirements for comparable option contracts traded on any exchange registered under the Exchange Act. OneChicago further noted that Section 7(c)(2)(B)(iv) of the Exchange Act also uses the phrase “margin requirements” but then qualifies it by excluding “levels of margin” from its provisions regarding consistency with Regulation T. Thus, OneChicago concluded that the phrase “margin requirements” in Section 7(c)(2)(B)(iii)(I) of the Exchange Act can be read to mean all aspects of margin requirements, including margin levels and the type, form, and use of collateral for security futures products.

OneChicago also argued that futures-style margining includes daily pay and collect variation margining, and options-style margining—in its view—does not include variation margining.

Consequently, OneChicago believed that, if Section 7(c)(2)(B)(iii)(I) of the Exchange Act is read to relate to levels of margin, the Commissions would be required to implement a daily pay and collect variation margin feature for options (or to eliminate this feature from the security futures margin requirements) in order to achieve the consistency required by the statute. OneChicago argued that this does not make sense and, therefore, the better reading of the statute is that it requires the level of protection provided by the security futures margin requirements to be consistent with and not lower than the lowest level of protection provided by the margin requirements for comparable exchange-traded options. And, according to OneChicago, in analyzing the level of protection provided by futures-style margining, the Commissions can consider the daily pay and collect variation margin feature to find that a risk model approach to calculating margin would be consistent with Section 7(c)(2)(B)(iii) of the Exchange Act.

For purposes of this discussion, the Commissions understand the phrase “futures-style margining” to refer to initial margin requirements based on the use of risk models, as well as the daily settlement of variation margin based on marking open positions to market. “Options-style margining” will refer to initial and maintenance margin requirements for exchange-traded equity options under the Exchange Act.

The Commissions agree with OneChicago that the phrase “margin requirements” in Section 7(c)(2)(B)(iii)(I) of the Exchange Act refers to all aspects of margin requirements, including margin levels and the type, form, and use of collateral for security futures products. However, the Commissions do not agree that the “consistent with” and “not lower than” restrictions in the statute do not apply to levels of margin. Section 7(c)(2)(B)(iii)(II) of the Exchange Act states, in pertinent part, that “initial and maintenance

margin levels

for a security future product [must] not be lower than the lowest level of margin, exclusive of premium, required for any comparable option contract traded on any exchange” registered under the Exchange Act (emphasis added).

The prefatory text of Sections 7(c)(2)(B)(iii)(I) and (II) of the Exchange Act also uses the term “levels of margin.” In particular, it provides that the Federal Reserve Board or the Commissions, pursuant to delegated authority, shall prescribe “regulations to establish margin requirements, including the establishment of

levels of margin

(initial and maintenance) for security futures products under such terms, and at such

levels,

” as the Federal Reserve Board or the Commissions deem appropriate (emphasis added).

Moreover, the legislative history of the CFMA includes an earlier bill.

In that earlier bill, the provisions governing the setting of margin requirements for security futures did not include the “consistent with” and “not lower than” restrictions in Sections 7(c)(2)(B)(iii)(I) and (II) of the Exchange Act, respectively.

Instead, the earlier bill would have required that the margin requirements for security futures must “prevent competitive distortions between markets offering similar products.”

The Senate Report on the earlier bill explained that “[u]nder the bill,

margin levels

on [security future] products would be required to be harmonized with the options markets.”

Thus, while the text of the earlier bill was not as explicit in terms of articulating the “consistent with” and “not lower than” restrictions, the Senate Report indicates that the objective was to harmonize

margin levels

between security futures and options to prevent competitive distortions. This objective was clarified in the text of Section 7(c)(2)(B) of the Exchange Act, as enacted. In light of this statutory text and the legislative history, the best reading of the statute is that the “consistent with” and “not lower than” restrictions apply to levels of margin.

See

S. Report 106-390 (Aug. 25, 2000).

See id.

at 39-40.

Id.

at 39.

Id.

at 5 (emphasis added).

Consequently, the levels of margin for unhedged security-futures must be consistent with the margin levels for comparable unhedged exchange-traded equity options, and not lower than the lowest level of margin for comparable unhedged exchange-traded equity options. Currently, the margin levels for comparable unhedged exchange-traded

equity options are determined through a percent of a value. Therefore, using a risk model approach for security futures would be inconsistent with how margin levels are currently determined for comparable exchange-traded equity options. Further, at this time, the lowest level of margin for comparable unhedged exchange-traded equity options is 15%. Accordingly, the margin levels for unhedged security futures cannot be lower than 15%.

OneChicago also cited legislative history to support its reading of the statute.

First, OneChicago cited statements that it believed demonstrated that “Congress intended to prevent the market for security futures from being ceded to overseas competitors” and that “Congress wanted to ensure that U.S. exchanges had the potential to compete with these product offerings in overseas markets.”

However, these statements do not bear on whether Sections 7(c)(2)(B)(iii)(I) and (II) of the Exchange Act apply to levels of margin. Rather, if OneChicago's view of Congressional intent is correct, it would support the notion that the CFMA was designed to establish a U.S. market for security futures to compete with overseas markets.

Further, Sections 7(c)(2)(B)(iii)(I) and (II) require a comparison of security futures margin requirements to U.S. exchange-traded option margin requirements—not to requirements of overseas security futures markets. For these reasons, these statements do not support OneChicago's reading of the statute or conflict with the Commissions' reading of the statute.

OneChicago Letter at 30-32.

OneChicago Letter at 30. The Commissions address comments relating to the competition with foreign securities markets in section IV below (including the CFTC's consideration of the costs and benefits of the amendments and the SEC's economic analysis, including costs and benefits, of the amendments).

The CFMA ended the prohibition on trading security futures in the United States at a time when this product was traded in overseas markets.

Second, OneChicago cited statements that it believed demonstrated “[t]here was concern, especially from options industry participants that [security futures] would directly compete with options and Congress wanted to make sure that participants did not migrate between futures and options for regulatory reasons” and that “Congress wanted to avoid regulatory arbitrage.”

It cited the following statements in support of this view:

OneChicago Letter at 30.

[T]he bill requires that margin treatment of stock futures must be consistent with the margin treatment for comparable exchange-traded options. This ensures that

margin levels

will not be set dangerously low and that stock futures will not have an unfair competitive advantage vis-a-vis stock options.

See

146 Cong. Rec. H12497 (daily ed. Dec. 15, 2000) (Commodity Futures Modernization Act of 2000, speech of Rep. Dingell, Dec. 15, 2000) (emphasis added).

Our bill would also provide for joint jurisdiction with each agency maintaining its core authorities over the trading of single-stock users. The legislation would further require that

margin levels

on these products be harmonized with the options market.

See S. 2697—The Commodity Futures Modernization Act of 2000,

Joint Hearing Before the Committee on Agriculture, Nutrition, and Forestry United States Senate and the Committee on Banking, Housing, and Urban Affairs, (June 21, 2000) (“Senate Hearing”) at 3, statement of Sen. Lugar (emphasis added).

The SEC has always been charged with protecting investors and providing full and fair disclosure of corporate market information and preventing fraud and manipulation. The CFTC regulates commercial and professional hedging and speculation in an institutional framework. CFTC cannot regulate insider trading. Margin requirements are different. I hate to see investors shopping as to which instrument to use or to buy for that reason. So neither regulation nor the lack of it should pick winners and losers among products or exchanges and fair competition should.

See

Senate Hearing at 28, statement of Sen. Schumer.

OneChicago argued that these statements indicated that “[b]ill sponsors made a point to emphasize that they wanted market forces and not margin levels to determine winners and losers” and that “[m]argin needed to be set at a level that prevented it from impacting a market participant's decision on what products to trade.”

However, the Congressional concerns and statements identified by OneChicago—that security futures should not have an unfair competitive advantage over exchange-traded options—support a reading of Sections 7(c)(2)(B)(iii)(I) and (II) of the Exchange Act that is consistent with the approach the Commissions are adopting here, namely that the margin levels for security futures must be consistent with and not lower than the lowest level of margin for comparable exchange-traded options.

OneChicago Letter at 30-31.

Contrary to OneChicago's view, the statute does not provide a mechanism that would permit the Commissions to recalibrate margin requirements for security futures to foster greater use of the product. Rather, it contains restrictions that were designed to ensure that the margin requirements for these products were consistent with the margin requirements for comparable exchange-traded options, and not lower than the lowest level of margin for comparable exchange-traded options. This reading of the statute is supported by the following statement from the legislative history of the CFMA that OneChicago did not cite:

A provision in the bill directs that initial and maintenance

margin levels

for a security future product shall not be lower than the lowest level of margin, exclusive of premium, required for any comparable option contract traded on any exchange registered pursuant to section 6(a) of the Exchange Act of 1934. In that provision, the term lowest is used to clarify that in the potential case where

margin levels

are different across the options exchanges, security future product

margin levels

can be based off the

margin levels

of the options exchange that has the lowest

margin levels

among all the options exchanges. It does not permit security future product

margin levels

to be based on option maintenance margin levels. If this provision were to be applied today, the required initial

margin level

for security future products would be 20 percent, which is the uniform initial

margin level

for short at-the money equity options traded on U.S. options exchanges.

See

146 Cong. Rec. E1879 (daily ed. Oct. 23, 2000) (Commodity Futures Modernization Act of 2000, speech of Rep. Markey, Oct. 19, 2000) (emphasis added). As discussed above, the Commissions implemented the CFMA establishing 20% initial and maintenance margin levels for security futures.

Further, implementing a risk model approach in order to lower the margin requirements to levels in the way OneChicago suggested could create an incentive for market participants to trade security futures, if security futures trading resumes, rather than exchange-traded options precisely because of the more favorable margin treatment.

Based on the text of Section 7(c)(2)(B) of the Exchange Act and the legislative history (including the legislative history cited by OneChicago), the better reading of the statute is that it applies to levels of margin, and requires that initial and maintenance margin levels for security futures be: (1) Consistent with margin levels for comparable exchange-traded options; and (2) not lower than the lowest level of margin for comparable exchange-traded options. Currently, the lowest level of margin for an unhedged exchange-traded equity option is 15%. Consequently, a 15% margin level is the lowest level of margin permitted for an unhedged security future.

OneChicago argued that the Commissions could compare unhedged security futures to unhedged long option positions.

See

OneChicago Letter at 35. In its view, the initial and maintenance margin requirement for a long option is 0% and, therefore, a margin level for security futures that is lower than 15% would be appropriate. As discussed earlier, the margin level is 75% for certain long unhedged options with maturities greater than 9 months. However, this margin requirement relates to financing the purchase of a

long option position. Unlike the case with an unhedged short option, the margin does not serve as a performance bond to secure the customer's obligations if the option is assigned to be exercised. Initial margin for a security future serves as a performance bond.

See, e.g.,

OneChicago Letter at 4. Long options that do not meet the requirements to be subject to the 75% margin level must be paid in full. Thus, from a financing perspective, they have a 100% margin requirement (

i.e.,

they cannot be purchased through an extension of credit by the broker-dealer). For these reasons, the margin requirements for unhedged long exchange-traded options are not comparable to the margin requirements for security futures.

OneChicago argued further that “the margins have not been harmonized and are not consistent” because security futures “have variation pay/collect while options do not, which makes a strict comparison of initial margin percentages inappropriate.”

OneChicago stated that the concept of daily variation margin plays a critical role in the margin framework for security futures, and it believed that the failure to take variation margin into account biases the Commissions' margin rule against security futures.

OneChicago believed that variation margin rather than minimum initial and maintenance margin levels more effectively protects customers.

OneChicago argued that “the level of initial and maintenance margin should be considered not lower than comparable options when it provides a level of protection against default that is not lower than comparable options” and that this “reading would support the Commissions considering variation margin when looking at the appropriate level of initial margin.”

OneChicago Letter at 31.

OneChicago at 4-5; OneChicago Letter 2 at 5-6.

OneChicago Letter at 7.

OneChicago Letter at 34.

The Commissions, when adopting the margin requirements for security futures in 2002, modified the proposal to incorporate the concept of daily pay and collect variation margining into the final rules.

Variation settlement is any credit or debit to a customer account, made on a daily or intraday basis, for the purpose of marking-to-market a security future issued by a clearing agency or cleared and guaranteed by a DCO.

100

Therefore, in prescribing the required initial and maintenance margin levels for security futures, the Commissions' rules also account for daily variation margining.

101

See

CFTC Rules 41.43(a)(32), 41.46(c)(1)(vi) and (c)(2)(iii), and 41.47(b)(1), and SEC Rules 401(a)(32), 404(c)(1)(vi) and (c)(2)(iii), and 405(b)(1).

100

See

CFTC Rule 41.43(a)(32) and SEC Rule 401(a)(32).

101

See

2002 Adopting Release, 67 FR at 53157.

See also

FRB Letter (“The authority delegated by the Board is limited to customer margin requirements imposed by brokers, dealers, and members of national securities exchanges. It does not cover requirements imposed by clearing agencies on their members.”) and 2019 Proposing Release, 84 FR at 36435 at n.6 (describing variation settlement and maintenance margin).

The variation margin component of the futures and security futures margining regimes settles the mark-to-market gains or losses on the positions on a daily basis with FCMs collecting payments from their customers and DCOs collecting payments from FCMs. The margin requirements for exchange-traded equity options also account for daily mark-to-market gains or losses on an option position. In particular, margin rules for exchange-traded equity options require that a customer maintain a minimum level of equity in the account (

i.e.,

an amount that equals or exceeds the maintenance margin requirement). A mark-to-market gain will increase account equity and a loss will decrease account equity potentially generating a requirement for the customer to post additional collateral to maintain the minimum account equity requirement (

i.e.,

the maintenance margin requirement). In this way, the margin requirements for exchange-traded equity options cover the broker-dealer's exposure to the credit risk that arises when the customer's position incurs a mark-to-market loss, just as daily pay and collect variation margining protects the security futures intermediary.

Further, if a customer's security futures position has a mark-to-market gain, the clearing agency or DCO will pay the amount of the gain to the security futures intermediary. This is the pay feature of futures-style variation margining. However, if that variation margin payment remains in the customer's account at the security futures intermediary, the customer continues to have credit risk exposure to the intermediary. Similarly, if a customer's exchange-traded equity option has a mark-to-market gain that results in the account having equity above the maintenance margin requirement, the customer will have credit exposure to the broker-dealer with respect to the excess equity in the account.

For these reasons, the Commissions do not believe that the variation margin requirements for futures and security futures are a unique feature that is absent from the margin requirements for exchange-traded options insomuch as both requirements address mark-to-market changes in the value of the positions.

102

Further, there is no basis to conclude that the variation settlement process for security futures when coupled with a risk model approach to calculating required initial and maintenance margin levels for security futures would be consistent with the margin requirements for exchange-traded equity options. The margin requirements for exchange-traded equity options also account for changes in the mark-to-market value of the options, but they do not use risk models to calculate initial and maintenance margin levels.

102

See, e.g.,

SEC,

Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Order Approving Proposed Rule Change and Amendments Thereto,

Exchange Act Release No. 22189 (June 28, 1985) at n.10 (“Maintenance margin in the securities industry and variation margin in the commodities industry are basically intended to serve the same purposes”).

Moreover, as acknowledged by OneChicago, a risk model approach to calculating required initial and maintenance margin levels for unhedged security futures could result in margin levels that are significantly lower than the 20% margin level for exchange-traded equity options held outside a Portfolio Margin Account as well as the 15% margin level for exchange-traded equity options held inside a Portfolio Margin Account.

103

Consequently, given the “not lower than restriction” of Section 7(c)(2)(B)(iii)(II) of the Exchange Act, it would not be appropriate to set initial and maintenance margin levels for security futures using a risk model approach insofar as exchange-traded equity options are not permitted to rely upon a risk model approach.

103

See, e.g.,

OneChicago Letter at 1 and 14.

As an alternative to the statutory construction argument discussed above, OneChicago stated that “the Commissions can recognize that the concern at the time of the CFMA, that options and [security futures] would trade interchangeably, was unfounded as options and [security futures] are not comparable products.”

104

Consequently, Section 7(c)(2)(B)(iii)—in OneChicago's view—“was written into the Exchange Act in case the products proved comparable; because they have proven to not be comparable, it no longer needs to bind upon financial markets.”

105

Relatedly, OneChicago also argued that there are no exchange-traded options that are comparable to security futures and, therefore, the “consistent with” and “not lower than” restrictions of Section 7(c)(2)(B)(iii) of the Exchange Act are not implicated.

104

See

OneChicago Letter at 35.

105

Id.

The Commissions stated a preliminary belief when proposing the reduction of the required margin levels from 20% to 15% that an unhedged

security future was comparable to an unhedged exchange-traded equity option held in a Portfolio Margin Account.

106

This belief was grounded on the Commissions' view—when adopting the margin requirements for security futures—that an unhedged short at-the-money exchange-traded equity option is comparable to a security future.

107

106

See

2019 Proposing Release, 84 FR at 36435, 36438-40.

107

See

2002 Adopting Release, 67 FR at 53157; 2001 Proposing Release 66 FR at 50725-26.

OneChicago stated that security futures products are not comparable to exchange-traded equity options because the latter have different risk profiles than security futures, including dividend risk, pin risk, and early assignment risk.

108

Further, OneChicago stated that security futures are used for different purposes than exchange-traded equity options.

109

In this regard, OneChicago noted that security futures are delta one derivatives used in equity finance transactions and that they compete with other delta one transactions such as total return swaps, master security lending agreements, and master security repurchase agreements.

110

OneChicago commented that equity financing transactions can be used to provide customers with synthetic (long) exposure to a notional amount of a security, while the financing counterparty pre-hedges the position by accumulating an equivalent position in the underlying shares.

111

108

OneChicago Letter at 2, 9; OneChicago Letter 2 at 1-2.

109

OneChicago Letter at 2-3.

110

Delta one derivatives are financial instruments with a delta that is close or equal to one. Delta measures the rate of change in a derivative relative to a unit of change in the underlying instrument. Delta one derivatives have no optionality, and therefore, as the price of the underlying instrument moves, the price of the derivative is expected to move at, or close to, the same rate.

See also

2019 Proposing Release, 84 FR 36435, at n.14.

111

OneChicago Letter at 2.

OneChicago also provided statistical data and analysis to support its contention that security futures are not comparable to exchange-traded equity options.

112

In particular, OneChicago provided statistical data comparing trade size (number of contacts and notional value) between options and security futures and comparing security futures delivery rates with options exercise rates.

113

OneChicago stated that the delivery data makes “clear” that the “markets view and use the products differently.”

114

OneChicago also provided statistical data on correlations between open interest in security futures and equity options.

115

OneChicago stated that the data results show no correlation between changes in open interest in security futures and options.

116

112

The Commissions address the statistical data and analysis provided by OneChicago in more detail in section IV of this release. In addition to the statistical data and analysis discussed below, OneChicago provided statistical data and analysis on possible correlations between changes in price of the underlying security and changes in trading activity in security futures and equity options (

i.e.,

sensitivity to underlying price moves). OneChicago Letter 3 at 12-13. OneChicago stated that the results of this analysis were ambiguous. OneChicago Letter 3 Summary at 1.

113

OneChicago Letter 3 at 9-11.

114

OneChicago Letter 3 Summary at 1.

115

OneChicago Letter 3 at 14-15.

116

OneChicago Letter 3 Summary at 1.

After considering these comments, the Commissions note that under Section 7(c)(2)(b)(iii)(I) of the Exchange Act, customer margin requirements for security futures must be consistent with the margin requirements for comparable exchange-traded options. The Commissions recognize that security futures may not be identical to exchange-traded equity options and that there are differences between the products in terms of their risk characteristics and how they are used by market participants. However, the Commissions continue to believe that the approach taken in this release, with respect to margin levels, is sound because these products generally share similar risk profiles for purposes of assessing margin insofar as both products provide exposure to an underlying equity security or narrow-based equity security index.

117

Thus, both products can be used to hedge a long or short position in the underlying equity security or narrow-based equity security index. Each product also can be used to speculate on a potential price movement of the underlying equity security or narrow-based equity security index. Consequently, a financial intermediary's potential exposure to a customer's unhedged security future or unhedged exchange-traded equity option position is based on the market risk (

i.e.,

price volatility) of the underlying equity security or narrow-based equity security index.

117

Derivatives may be broadly described as instruments or contracts whose value is based upon, or derived from, some other asset or metric.

See also Risk Disclosure Statement for Security Futures Contracts, available at https://www.nfa.futures.org/members/member-resources/files/security-futures-disclosure.pdf

and

Characteristics and Risks of Standardized Options, available at https://www.theocc.com/about/publications/character-risks.jsp.

In addition, both short security futures positions and certain exchange-traded options strategies produce unlimited downside risk. Investors in security futures and writers of options may lose their margin deposits and premium payments and be required to pay additional funds. In addition, a very deep-in-the money call or put option on the same security (with a delta of one) is an option contract comparable to a security futures contract. Further, as discussed above, one commenter contends that synthetic futures strategies are an important segment of today's options markets, that could compete with security futures, if trading in security futures resumes.

The margin requirements for security futures and short unhedged exchange-traded equity options are designed to ensure that the customer can perform on the contractual obligations imposed by these products. For these reasons, security futures and short exchange-traded equity options can be appropriately considered to be comparable products for the purposes of setting appropriate margin levels for security futures consistent with the provisions of Section 7(c)(2)(B) of the Exchange Act.

118

OneChicago also argued that the Commissions should compare the customer margin requirements for security futures with the margin requirements for over-the-counter total return swaps, equity index futures, and security futures traded overseas.

119

In response, Section 7(c)(2)(B) of the Exchange Act provides that the margin requirements for security futures must be consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act. The statute does not directly contemplate comparisons with the margin requirements for the products and markets identified by OneChicago. Rather, it requires comparisons to comparable exchange-traded options.

118

See

2019 Proposing Release, 84 FR at 36436.

119

OneChicago Letter at 11.

In this context, an unhedged security future is comparable to an unhedged exchange-traded equity option held in a Portfolio Margin Account for the purposes of setting margin requirements under Section 7(c)(2)(B) of the Exchange Act.

As an alternative to implementing a risk model approach for all security futures, OneChicago suggested implementing it on a more limited basis for security futures combinations that result in STARS transactions.

120

A STARS transaction combines two security futures to form a spread position. The front leg of the spread expires on the date of the STARS

transaction and the second (or back) leg expires at a distant date. OneChicago believed that a STARS transaction would be a substitute for an equity repo or stock loan transaction with the transfer of stock and cash accomplished through a security future transaction.

121

OneChicago suggested that it would be appropriate to margin STARS transactions at risk-based levels since they are exclusively used for equity finance transactions.

122

OneChicago also argued that risk-based margin treatment for a STARS transaction would be consistent with the Exchange Act and argued that there are no comparable options that trade as a spread on a segregated platform and no combinations of options can replicate the mechanics of a STARS transaction.

123

120

OneChicago Letter at 19;

see also

Memorandum from the Division of Trading and Markets regarding a July 16, 2019, meeting with representatives of OneChicago (July 29, 2019).

121

OneChicago Letter at 19-20. OneChicago noted that the expiration of the front leg results in a transfer of securities for cash on the next business day following the trade date (T+1). When the back leg expires, OneChicago noted that a reversing transaction takes place that returns both parties to their original positions. OneChicago Letter at 19.

122

OneChicago Letter at 19-20.

123

OneChicago Letter at 36.

The Commissions note that OneChicago has discontinued trading operations and is no longer offering STARS transactions. However, combining security futures into a STARS transaction does not change the fundamental nature of the security futures involved in the transaction—they remain security futures. In addition, as noted above, the front leg of the spread expires on the date of the STARS transaction, leaving only a single security future position in the customer's account until the expiration of the back leg at a later date. Consequently, for the reasons discussed above, it would not be consistent with Section 7(c)(2)(B) of the Exchange Act to implement a risk margin approach for security futures that are combined to create a STARS transaction.

To summarize, the Commissions are not persuaded by OneChicago's arguments that, at this time, implementing a risk model approach to calculating margin for security futures would be permitted under Section 7(c)(2)(B) of the Exchange Act. Moreover, implementing a risk model approach would substantially alter how the required minimum initial and maintenance margin levels for security futures are calculated. It also would be a significant deviation from how margin is calculated for listed equity options and other equity positions (

e.g.,

long and short securities positions). It would not be appropriate at this time to implement a different margining system for security futures, given their relation to products that trade in the U.S. equity markets. Implementing a different margining system for security futures may result in substantially lower margin levels for these products as compared with other equity products and could have unintended competitive impacts.

124

For these reasons, even if the Commissions were persuaded at this time that OneChicago's interpretation was permitted by the statute, the Commissions would not agree that it was the appropriate interpretation.

124

See

sections IV.A.6. (CFTC—Discussion of Alternatives) and IV.B.5. (SEC—Reasonable Alternatives Considered) (each discussing the use of risk-based margin models as an alternative to the final rule amendments in this release).

Consequently, the Commissions are adopting the amendments to reduce the required initial and maintenance margin levels for an unhedged security futures position from 20% to 15%, as proposed.

125

The Commissions continue to believe that these amendments—because they relate to levels of margin—do not implicate the requirement in Section 7(c)(2)(B)(iv) of the Exchange Act that margin requirements for security futures (other than levels of margin), including the type, form, and use of collateral, must be consistent with the requirements of Regulation T. The Commissions did not receive any comments objecting to this view.

The Commissions' margin requirements continue to permit SRAs and security futures intermediaries to establish higher margin levels and to take appropriate action to preserve their financial integrity.

126

OneChicago advocated for two modifications to this provision of the margin rules for security futures.

127

First, it suggested that only exchanges and clearinghouses that

list

and clear security futures products be given the authority to set higher margin levels, because they control the margin levels and thus the competitiveness of the competing venues.

128

In support of this suggestion, it identified an exchange that has prescribed 20% margin levels for security futures even though it does not list any security futures.

129

Relatedly, OneChicago recommended that the Commissions require that margin levels be set higher than the proposed 15% minimum level if justified by the risk of the security future and noted that while one SRA might set higher levels based on risk, another SRA may maintain the 15% levels.

130

126

See

CFTC Rule 41.42(c)(1) and SEC Rule 400(c)(1).

See

2019 Proposing Release, 84 FR at 36440.

127

OneChicago Letter at 17.

128

OneChicago Letter at 17.

129

The NYSE has rules related to margin levels for security futures, but it does not list any security futures.

130

OneChicago Letter at 17.

After considering these comments, the Commissions are not incorporating OneChicago's suggested modifications regarding establishing higher margin levels. The security futures margin rules establish minimum levels and do not set any limitations as to maximum levels. SRAs, including clearinghouses, and security futures intermediaries are permitted to raise margin requirements above 15% if justified by the risk of a security futures position. In addition, security futures intermediaries also are subject to rules that require them to raise margin requirements where appropriate to manage credit risk in customer accounts.

131

These rules provide SRAs and security futures intermediaries important flexibility to manage risk as they deem appropriate, including the ability to increase margin requirements for specific positions or customer accounts. Limiting the ability to increase margin requirements only to exchanges and clearinghouses that list and clear security futures would be inconsistent with this approach. For these reasons, it would not be appropriate to modify the provisions in the security futures margin requirements permitting SRAs and security futures intermediaries to set higher margin levels as suggested by OneChicago.

131

See e.g.,

FINRA Rule 4210(d) which requires FINRA members to establish procedures to: (1) Review limits and types of credit extended to all customers; (2) formulate their own margin requirements; and (3) review the need for instituting higher margin requirements, mark-to-markets and collateral deposits than are required by FINRA's margin rule for individual securities or customer accounts;

see also

FINRA Rule 4210(f)(8) (providing authority for FINRA, if market conditions warrant, to implement higher margin requirements).

See e.g.,

17 CFR 1.11 (CFTC Rule 1.11) (requiring FCMs to establish risk management programs that address market, credit, liquidity, capital and other applicable risks, regardless of the type of margining offered).

See also

National Futures Association (“NFA”) Rule 2-26

FCM and IB Regulations,

which states that any member or associate who violates CFTC Rule 1.11 (and other rules) shall be deemed to have violated an NFA requirement.

B. Conforming Revisions to the Strategy-Based Offset Table

1. The Commissions' Proposal

The Commissions' rules permit an SRA to set margin levels that are lower than 20% of the current market value of the security future in the case of an offsetting position involving security futures and related positions.

132

The SRA rules must meet the four criteria set forth in Section 7(c)(2)(B) of the Exchange Act and must be effective in accordance with Section 19(b)(2) of the

Exchange Act and, as applicable, Section 5c(c) of the CEA.

133

In connection with these provisions governing SRA rules, the Commissions published the Strategy-Based Offset Table.

134

132

See

CFTC Rule 41.45(b)(2) and SEC Rule 403(b)(2).

See also

2002 Adopting Release, 67 FR at 53158-61.

133

Section 19(b)(2) of the Exchange Act governs SRA rulemaking with respect to SEC registrants, and Section 5c(c) of the CEA governs SRA rulemaking with respect to CFTC registrants.

134

See

2002 Adopting Release, 67 FR at 53158-61.

The Commissions stated the belief that the offsets identified in the Strategy-Based Offset Table were consistent with the strategy-based offsets permitted for comparable offsetting positions involving exchange-traded options.

135

The Commissions further stated the expectation that SRAs seeking to permit trading in security futures will submit to the Commissions proposed rules that impose levels of required margin for offsetting positions involving security futures in accordance with the minimum margin requirements identified in the Strategy-Based Offset Table. SRAs have adopted rules consistent with the Strategy-Based Offset Table.

136

135

Id.

at 53159.

136

See, e.g.,

FINRA Rule 4210(f)(10) and Cboe Rule 10.3(k).

The Commissions proposed to re-publish the Strategy-Based Offset Table to conform it to the proposed 15% required margin levels.

137

The re-published Strategy-Based Offset Table would incorporate the 15% required margin levels for certain offsetting positions (as opposed to the current 20% levels) and would retain the same percentages for all other offsets.

137

See

2019 Proposing Release, 84 FR at 36441-36443.

2. Comments and the Re-Published Strategy-Based Offset Table

OneChicago recommended several changes to the Strategy-Based Offset Table, as proposed to be revised. First, OneChicago suggested reducing the margin requirement for “delta-neutral” positions from 5% to the lower of: (1) The total calculated by multiplying $0.375 for each position by the instrument's multiplier, not to exceed the market value in the case of long positions, or (2) 2% of the current market value of the security futures contract.

138

These recommended changes would not be appropriate. The 5% requirement was based on the minimum margin required by rules of securities SROs for offsetting long and short positions in the same security.

139

The 5% margin requirement for this strategy continues to exist in current securities SRO rules.

140

Accordingly, lowering the requirement as recommended by OneChicago would not be consistent with Section 7(c)(2)(B) of the Exchange Act.

138

OneChicago Letter at 15. This recommendation would apply to items 4, 10, 13, 17, 18, and 19 in the Strategy-Based Offset Table, as proposed to be revised.

See

2019 Proposing Release, 84 FR at 36441-43.

139

See

2002 Adopting Release, 67 FR at 53158, n.187.

140

See, e.g.,

FINRA Rule 4210(e)(1).

OneChicago also requested that the Commissions incorporate total return equity swaps into the Strategy-Based Offset Table.

141

OneChicago stated that total return equity swaps are an exact substitute for security futures. OneChicago did not specify whether it was referring to cleared or non-cleared total return equity swaps. In either case, it would not be appropriate to include them in the Strategy-Based Offset Table. Securities SRO margin rules for options do not, at this time, recognize offsets involving these products. Therefore, adding them to the Strategy-Based Offset Table would not be consistent with Section 7(c)(2)(B) of the Exchange Act.

141

OneChicago Letter at 16.

OneChicago further requested that offset positions margined at 10% should be lowered to 7.5% to mirror the magnitude of the reduction of minimum required margin levels from 20% to 15% for unhedged security futures.

142

This would make the margin requirements for offsets recognized in the Strategy-Based Offset Table lower than offsets for exchange-traded options currently permitted by securities SRO margin rules. Therefore, modifying the Strategy-Based Offset Table in this manner would not be consistent with Section 7(c)(2)(B) of the Exchange Act.

142

OneChicago Letter at 16. The reduction in margin from 10% to 7.5% would apply to items 2, 8, 9, 11,12 14, 15 and 16 in the Strategy-Based Offset Table, as proposed to be revised.

Finally, OneChicago suggested that the Commissions could simplify the Strategy-Based Offset Table by replacing it with an offset rule.

143

Under the suggested rule, offset positions would be margined at the greater of: (1) The total calculated by multiplying $0.375 for each position by the instrument's multiplier, not to exceed the market value in the case of long positions; or (2) 15% of the delta exposed portion of the portfolio. As discussed above, the Strategy-Based Offset Table is designed to permit offsets that are consistent with offsets recognized for comparable exchange-traded options under the securities SRO margin rules. For the reasons discussed above, the rule suggested by OneChicago would not be consistent with the permitted offsets for exchange-traded options and, consequently, would not be consistent with Section 7(c)(2)(B) of the Exchange Act.

143

OneChicago Letter at 16-17.

For the foregoing reasons, the Commissions are re-publishing the Strategy-Based Offset Table with the proposed revisions.

144

The Commissions expect that SRAs will submit to the Commissions proposed rules that impose levels of required margin for offsetting positions involving security futures in accordance with the minimum margin levels identified in the Strategy-Based Offset Table.

144

Item 1 of the revised Strategy-Based Offset Table lists the margin percentages for a long security future and a short security future. These percentages are the baseline, not offsets, but they are included in the table to preserve consistency with the earlier offset table.

Description of offset

Security underlying the security future

Initial margin requirement

Maintenance margin requirement

1. Long security future or short security future

Individual stock or narrow-based securities index

15% of the current market value of the security future

15% of the current market value of the security future.

2. Long security future (or basket of security futures representing each component of a narrow-based securities index

) and long put option

on the same underlying security (or index)

Individual stock or narrow-based securities index

15% of the current market value of the long security future, plus pay for the long put in full

The lower of: (1) 10% of the aggregate exercise price

of the put plus the aggregate put out-of-the-money

amount, if any; or (2) 15% of the current market value of the long security future.

3. Short security future (or basket of security futures representing each component of a narrow-based securities index

) and short put option on the same underlying security (or index)

Individual stock or narrow-based securities index

15% of the current market value of the short security future, plus the aggregate put in-the-money amount, if any. Proceeds from the put sale may be applied

15% of the current market value of the short security future, plus the aggregate put in-the-money amount, if any.

4. Long security future and short position in the same security (or securities basket

) underlying the security future

Individual stock or narrow-based securities index

The initial margin required under Regulation T for the short stock or stocks

5% of the current market value as defined in Regulation T of the stock or stocks underlying the security future.

5. Long security future (or basket of security futures representing each component of a narrow-based securities index

) and short call option on the same underlying security (or index)

Individual stock or narrow-based securities index

15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any. Proceeds from the call sale may be applied

15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any.

6. Long a basket of narrow-based security futures that together tracks a broad based index

and short a broad-based security index call option contract on the same index

Narrow-based securities index

15% of the current market value of the long basket of narrow-based security futures, plus the aggregate call in-the-money amount, if any. Proceeds from the call sale may be applied

15% of the current market value of the long basket of narrow-based security futures, plus the aggregate call in-the-money amount, if any.

7. Short a basket of narrow-based security futures that together tracks a broad-based security index

and short a broad-based security index put option contract on the same index

Narrow-based securities index

15% of the current market value of the short basket of narrow-based security futures, plus the aggregate put in-the-money amount, if any. Proceeds from the put sale may be applied

15% of the current market value of the short basket of narrow-based security futures, plus the aggregate put in-the-money amount, if any.

8. Long a basket of narrow-based security futures that together tracks a broad-based security index

and long a broad-based security index put option contract on the same index

Narrow-based securities index

15% of the current market value of the long basket of narrow-based security futures, plus pay for the long put in full

The lower of: (1) 10% of the aggregate exercise price of the put, plus the aggregate put out-of-the-money amount, if any; or (2) 15% of the current market value of the long basket of security futures.

9. Short a basket of narrow-based security futures that together tracks a broad-based security index

and long a broad-based security index call option contract on the same index

Narrow-based securities index

15% of the current market value of the short basket of narrow-based security futures, plus pay for the long call in full

The lower of: (1) 10% of the aggregate exercise price of the call, plus the aggregate call out-of-the-money amount, if any; or (2) 15% of the current market value of the short basket of security futures.

10. Long security future and short security future on the same underlying security (or index)

Individual stock or narrow-based securities index

The greater of: 5% of the current market value of the long security future; or (2) 5% of the current market value of the short security future

The greater of: (1) 5% of the current market value of the long security future; or (2) 5% of the current market value of the short security future.

11. Long security future, long put option and short call option. The long security future, long put and short call must be on the same underlying security and the put and call must have the same exercise price. (Conversion)

Individual stock or narrow-based securities index

15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any, plus pay for the put in full. Proceeds from the call sale may be applied

10% of the aggregate exercise price, plus the aggregate call in the money amount, if any.

12. Long security future, long put option and short call option. The long security future, long put and short call must be on the same underlying security and the put exercise price must be below the call exercise price. (Collar)

Individual stock or narrow-based securities index

15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any, plus pay for the put in full. Proceeds from the call sale may be applied

The lower of: (1) 10% of the aggregate exercise price of the put plus the aggregate put out-of-the-money amount, if any; or (2) 15% of the aggregate exercise price of the call, plus the aggregate call in-the-money amount, if any.

13. Short security future and long position in the same security (or securities basket

) underlying the security future

Individual stock or narrow-based securities index

The initial margin required under Regulation T for the long stock or stocks

5% of the current market value, as defined in Regulation T, of the long stock or stocks.

14. Short security future and long position in a security immediately convertible into the same security underlying the security future, without restriction, including the payment of money

Individual stock or narrow-based securities index

The initial margin required under Regulation T for the long security

10% of the current market value, as defined in Regulation T, of the long security.

15. Short security future (or basket of security futures representing each component of a narrow-based securities index

) and long call option or warrant on the same underlying security (or index)

Individual stock or narrow-based securities index

15% of the current market value of the short security future, plus pay for the call in full

The lower of: (1) 10% of the aggregate exercise price of the call, plus the aggregate call out-of-the-money amount, if any; or (2) 15% of the current market value of the short security future.

16. Short security future, Short put option and long call option. The short security future, short put and long call must be on the same underlying security and the put and call must have the same exercise price. (Reverse Conversion)

Individual stock or narrow-based securities index

15% of the current market value of the short security future, plus the aggregate put in-the-money amount, if any, plus pay for the call in full. Proceeds from the put sale may be applied

10% of the aggregate exercise price, plus the aggregate put in-the-money amount, if any.

17. Long (short) a basket of security futures, each based on a narrow-based securities index that together tracks the broad-based index

and short (long) a broad based-index future

Narrow-based securities index

5% of the current market value of the long (short) basket of security futures

5% of the current market value of the long (short) basket of security futures.

18. Long (short) a basket of security futures that together tracks a narrow-based index

and short (long) a narrow based-index future

Individual stock and narrow-based securities index

The greater of: (1) 5% of the current market value of the long security future(s); or (2) 5% of the current market value of the short security future(s)

The greater of: (1) 5% of the current market value of the long security future(s); or (2) 5% of the current market value of the short security future(s).

19. Long (short) a security future and short (long) an identical security future traded on a different market

Individual stock and narrow-based securities index

The greater of: (1) 3% of the current market value of the long security future(s); or (2) 3% of the current market value of the short security future(s)

The greater of: (1) 3% of the current market value of the long security future(s); or (2) 3% of the current market value of the short security future(s).

Baskets of securities or security futures contracts replicate the securities that compose the index, and in the same proportion.

Generally, unless otherwise specified, stock index warrants are treated as if they were index options.

“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 exercise price” with respect to an index option means the exercise price multiplied by the index multiplier.

“Out-of-the-money” amounts are 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 current index value and the applicable index multiplier; and (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.

“In-the-money” amounts are 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; and (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 current index value and the applicable index multiplier.

Two security futures are considered “identical” for this purpose if they are issued by the same clearing agency or cleared and guaranteed by the same derivatives clearing organization, have identical contract specifications, and would offset each other at the clearing level.

C. Other Matters

One commenter urged the Commissions to make clear, where appropriate, that margin rules of general applicability do not apply to security futures.

145

Specifically, this commenter requested clarification about the intersection of the security futures rules and CFTC general margin requirements under part 39 of the CFTC's regulations for DCOs.

146

The commenter cited to a CFTC rule proposal related to customer initial margin requirements as an example of a rule of general applicability that should be addressed by the Commissions. Earlier this year, the CFTC adopted changes to the DCO core principles, including 17 CFR 39.13(g)(8)(ii) (CFTC Rule 39.13(g)(8)(ii)) relating to customer initial margin requirements.

147

As the CFTC noted in the 2019 Proposing Release

148

and in the final rule adopting changes to DCO core provisions,

149

the CFTC's Division of Clearing and Risk issued an interpretative letter in September 2012 stating that the specific initial margin requirements under CFTC Rule 39.13(g)(8)(ii) do not apply to security futures positions.

150

CFTC Letter No. 12-08 is still in effect and may be relied upon by market participants. The CFTC believes that CFTC Letter No. 12-08 addresses the commenter's concerns, and the CFTC will not be revising the position taken by the CFTC's Division of Clearing and Risk in this rulemaking.

145

See

FIA Letter at 2.

146

See

FIA Letter at 2;

see also

CFTC Letter No. 12-08 (Sept. 14, 2012); 2019 Proposing Release, 84 FR 36437, at n.40.

147

See Derivatives Clearing Organization General Provisions and Core Principles,

85 FR 4800 (Jan. 27, 2020) (amending certain CFTC regulations applicable to registered DCOs).

148

2019 Proposing Release, 84 FR 36437, at n.40.

149

Derivatives Clearing Organization General Provisions and Core Principles,

85 FR at 4812.

150

CFTC Letter No. 12-08 (Sept. 14, 2012) at 10,

available at https://www.cftc.gov/csl/12-08/download.

III. Paperwork Reduction Act

A. CFTC

The Paperwork Reduction Act of 1995 (“PRA”)

151

imposes certain requirements on Federal agencies (including the CFTC and the SEC) in connection with their conducting or sponsoring any collection of information as defined by the PRA. The final rule amendments do not require a new collection of information on the part of any entities subject to these rules. Accordingly, the requirements imposed by the PRA are not applicable to these rules.

151

44 U.S.C. 3501

et seq.

B. SEC

The PRA

152

imposes certain requirements on Federal agencies (including the CFTC and the SEC) in connection with their conducting or sponsoring any collection of information as defined by the PRA. The final rule amendments do not contain a “collection of information” requirement within the meaning of the PRA. Accordingly, the PRA is not applicable.

152

Id.

IV. CFTC Consideration of Costs and Benefits and SEC Economic Analysis (Including Costs and Benefits) of the Proposed Amendments

A. CFTC

1. Introduction

These final rule amendments will permit customers in security futures to pay a lower minimum margin level for an unhedged security futures position. The final rules set required initial margin for each long or short position in a security future at 15% of the current market value. In connection with this change, the Strategy-Based Offset Table will be restated so that it is consistent with the reduction in the minimum initial margin.

Section 15(a) of the CEA requires the CFTC to consider the costs and benefits of its actions before promulgating a regulation under the CEA or issuing certain orders.

153

Section 15(a) further specifies that the costs and benefits shall be evaluated in light of five broad areas of market and public concern: (1) Protection of market participants and the public; (2) efficiency, competitiveness, and financial integrity of futures markets; (3) price discovery; (4) sound risk management practices; and (5) other public interest considerations. The CFTC considers the costs and benefits resulting from its discretionary determinations with respect to the Section 15(a) factors below. Where reasonably feasible, the CFTC has endeavored to estimate quantifiable costs and benefits. Where quantification is not feasible, the CFTC identifies and describes costs and benefits qualitatively.

153

7 U.S.C. 19(a).

The CFTC requested comments on all aspects of the costs and benefits associated with the proposed rule amendments. In particular, the CFTC requested that commenters provide data and any other information upon which the commenters relied to reach their conclusions regarding the CFTC's proposed considerations of costs and benefits.

154

The Commissions received comments that indirectly address the costs and benefits of the proposed amendments. Relevant portions of the comments are discussed in the analysis below.

154

The CFTC sought “estimates and views regarding the specific costs and benefits for a security futures clearing organization, exchange, intermediary, or trader that may result from the adoption of the proposed rule amendment.” 2019 Proposing Release, 84 FR at 36446-47.

The CFTC's consideration of costs and benefits includes a brief description of the economic baseline against which to compare the rule amendments, a summary of the amendments, and separate, detailed discussions of the costs and benefits of the amendments. Then, the CFTC examines alternatives offered by commenters. Finally, the CFTC considers each of the section 15(a) factors under the CEA.

2. Economic Baseline

The CFTC's economic baseline for this analysis is the twenty percent margin requirement on security futures positions that was adopted in 2002 and exists today in CFTC Rule 41.45(b)(1), along with the offsetting positions table under CFTC Rule 41.45(b)(2) (Strategy-Based Offset Table). In the 2002 Adopting Release, the Commissions finalized a set of security futures margin rules that complied with the statutory

requirements under Section 7(c)(2)(B) of the Exchange Act. The rules state that, “the required margin for each long or short position in a security future shall be twenty (20) percent of the current market value of such security future.”

155

The rules also allow SRAs to set margin levels lower than the 20% minimum requirement for customers with “an offsetting position involving security futures and related positions.”

156

In addition, the rules that were finalized under the 2002 Adopting Release permit certain customers to take advantage of exclusions to the minimum margin requirement for security futures.

155

CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1).

See

CFTC Rule 41.43(a)(4), 17 CFR 41.43(a)(4) (defining the term “current market value.”).

156

CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2).

The CFTC has considered the costs and benefits of the rule amendments as compared with the baseline of the current minimum initial and maintenance margin levels for unhedged security futures, which is 20% of the current market value of such security future. The CFTC notes that OneChicago, the only exchange listing security futures in the U.S., discontinued all trading operations on September 21, 2020. At this time, there are no security futures contracts listed for trading on U.S. exchanges. This release considers the costs and benefits that would occur if OneChicago were to resume operations or another exchange were to launch security futures contracts.

3. Summary of the Final Rules

The final rules lower the required initial and maintenance margin levels for an unhedged security futures position from 20% to 15% of the current market value of such a security futures position. In addition, the final rules make certain revisions to the Strategy-Based Offset Table in line with the revised margin requirement. These amendments to the security futures margin rules bring margin requirements for security futures held in futures accounts, or securities accounts that are not Portfolio Margin Accounts, into alignment with the required margin level for unhedged security futures held in Portfolio Margin Accounts. The final rules do not make any other changes to the security futures margin requirement regime.

4. Description of Costs

As a general matter, the CFTC believes that if security futures trading resumes, the final rules will reduce costs relative to existing CFTC Rule 41.45(b)(1) because the final rules decrease the level of margin required for an unhedged security futures position from 20% to 15%. The CFTC has determined that, because there is no security futures trading at this time, there may be new startup costs such as operational or technology costs associated with calculating security futures customer margin if a new exchange were to launch security futures trading. Such costs would be less significant for OneChicago, if it were to resume operations, given that the infrastructure for calculating such margin already exists and would not require major reprogramming or changes beyond costs that would be incurred to relaunch security futures contracts. One commenter noted that the final rules' “margin requirements will be simpler to administer and risk manage for intermediaries that facilitate trading in the market, and better aligns with customer use of these products.”

157

The Commissions received no other comments regarding this cost.

157

See

FIA Letter at 2.

As set forth in the 2019 Proposing Release, the CFTC identified a number of risk-related costs that could result from the final rules and discusses each below.

i. Risk-Related Costs for Security Futures Intermediaries and Customers

One risk-related cost to consider, if security futures trading resumes, is the potential cost to security futures intermediaries and their customers that would result from a default of either an intermediary or a customer.

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Reducing margin requirements for security futures could expose security futures intermediaries and their customers to losses in the event that margin collected is insufficient to protect against market moves. Pursuant to the OCC's bylaws, any security futures intermediary that is a clearing member of OCC grants a security interest to OCC for any account it establishes and maintains, and therefore a customer's assets may be obligated to OCC upon default.

159

As a result, security futures intermediaries that are FCMs could be exposed to a loss if the 15% margin rate for security futures is insufficient, to offset losses associated with a customer default. However, this risk is mitigated by the fact that if the FCM determines that a 15% margin level is insufficient to cover the inherent risk of the customer position, the FCM has the authority to collect additional margin from its customers, in excess of the minimum requirement, in order to protect its financial integrity.

160

Moreover, the FCM has an incentive to manage the risk of a customer's default and could collect additional margin to do that.

158

In this context, an intermediary default describes a clearing member that experiences a default event under the terms of a clearinghouse's rules and procedures. Such default events generally include a failure to deliver funds in a timely manner (

e.g.,

failure to satisfy a margin call).

See

OCC Rule 1102(a)—Suspension, and OCC's Clearing Member Default Rules and Procedures,

available at https://ncuoccblobdev.blob.core.windows.net/media/theocc/media/risk-management/default-rules-and-procedures.pdf.

159

See

OCC Bylaws, Article VI—Clearance of Confirmed Trades, Section 3—Maintenance of Accounts, Interpretations and Policies .07, adopted September 22, 2003,

available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.

160

See

CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).

If security futures trading resumes, a similar risk-related cost might arise where an FCM collects only the minimum margin required from customers in order to maintain or expand its customer business, when it has determined or should have determined that additional margin is required to cover the inherent risk of the customer position. Lower margin requirements might facilitate an FCM permitting its customers to take on additional risk in their positions in order to increase business for the FCM. Such additional risks could put the FCM at risk if one of its customers defaulted on its payment obligations, and other customers of the FCM could face losses if the FCM or one of its fellow customers defaulted.

Another risk-related cost could stem from the possibility of increased leverage among security futures customers. Customers posting less initial margin to cover security futures positions might be able to increase their overall market exposure and thereby increase their leverage. Increased leverage in the security futures markets could increase risks to overall financial stability and result in costs to the broader financial markets insofar as security futures customers, security futures intermediaries, and DCOs participate in financial markets other than security futures.

As discussed in the proposal, the CFTC considered two final potential risk-related costs (incentives for FCMs to collect less margin and increased leverage at the customer level). The Commissions received no comments regarding these costs. The CFTC believes these theoretical costs are mitigated, to some degree, by regulations that apply to security futures intermediaries that are registered as FCMs. For example, FCMs are subject to capital requirements under CFTC regulations,

161

and in instances where

the security futures intermediary is jointly registered with the SEC as a broker-dealer FCM, the SEC's capital rules also apply.

162

In addition, FCMs are required to establish a system of risk management policies and procedures pursuant to CFTC Rule 1.11.

163

This risk management program is designed to incentivize the FCM to protect itself and its customers against a variety of risks, including the risk of inadequate margin coverage and increased leverage. The regulatory regime to which FCMs are subject is designed to require them to fully account for the potential future exposures of their customers' security futures positions in the form of initial and maintenance margin.

161

See

CFTC Rule 1.17, 17 CFR 1.17.

162

See

SEC Rule 240.15c3-1, 17 CFR 240.15c3-1.

163

Under CFTC Rule 1.11, FCMs are required to establish risk management programs that address market, credit, liquidity, capital and other applicable risks, regardless of the type of margining offered.

See also

NFA Rule 2-26

FCM and IB Regulations,

which states that any member or associate who violates CFTC Rule 1.11 (and other rules) shall be deemed to have violated an NFA requirement.

Finally, as explained in the 2019 Proposing Release, risk-related costs to the security futures intermediary have been further mitigated by the fact that the vast majority of OneChicago's open interest was held by eligible contract participants (“ECPs”), as defined in Section 1a(18) of the CEA.

164

OneChicago provided data to support this statement prior to the issuance of the 2019 Proposing Release. Generally speaking, ECPs are financial entities or individuals with significant financial resources or other qualifications that make them appropriate persons for certain investments.

165

The CFTC believes that because ECPs are well capitalized investors, they may be less likely to default and transmit risks throughout the financial system. According to the data provided by OneChicago, over 99% of the notional value of OneChicago's products was held by ECPs as of March 1, 2016, and March 1, 2017.

166

The Commissions received no comments regarding this data. However, the CFTC notes that an exchange that, in the future, launches security futures may decide to market such contracts to retail customers that are not ECPs.

164

See also

CFTC Rule 1.3, 17 CFR 1.3.

165

For example, an individual can qualify as an ECP if the individual has amounts invested on a discretionary basis, the aggregate of which is in excess of: (i) $10,000,000; or (ii) $5,000,000 if the individual also enters into an agreement, contract, or transaction in order to manage the risk associated with an asset owned or liability incurred, or reasonably likely to be owned or incurred, by the individual.

166

The CFTC sought comments on all aspects of its considerations of costs and benefits in the 2019 Proposing Release. In particular, the CFTC requested data and any other information and did not receive any comments questioning this data, or updated data from OneChicago. As a result, the CFTC continues to refer to the data provided by OneChicago relating to time periods in 2016 and 2017.

ii. Appropriateness of Margin Requirements

If security futures trading resumes, a possible risk-related cost of lowering margin requirements for security futures is that a DCO may not have sufficient margin on deposit to cover the potential future exposure of cleared security futures positions. However, the risk management expertise at security futures intermediaries and DCOs, as well as the general applicability of CFTC Rule 39.13 to security futures,

167

supports the conclusion that DCOs and security futures intermediaries will continue to manage the risks of these products effectively even with lower minimum margin requirements.

168

167

As noted above and elsewhere, the general requirements of CFTC Rule 39.13 (17 CFR 39.13) are applicable to security futures intermediaries and DCOs with respect to security futures, however, the specific provision of CFTC Rule 39.13(g)(8)(ii) relating to customer initial margin requirements has been addressed separately by CFTC Letter No. 12-08 and that remains unchanged by this final rule.

168

As discussed above, security futures intermediaries are authorized to collect margin above the amounts required by the Commissions. However, if security futures trading resumes, security futures intermediaries could be incentivized to lower their margin rates in order to compete for customer business as for-profit entities. If security futures intermediaries were to engage in competition for business based on margin pricing, it is possible that security futures intermediaries would collect only the required level of margin (

i.e.,

15% under the final rule change), regardless of the market conditions, which could impair their ability to protect against market risk and losses.

If security futures trading resumes, the risk security futures customers and/or intermediaries would face from reducing initial and maintenance margin would be addressed at the clearinghouse level because there are additional protections under CFTC regulations. For example, CFTC Rule 39.13(g)(2)(i) requires a DCO to establish initial margin requirements that are commensurate with the risks of each product and portfolio.

169

In addition, CFTC Rules 39.13(g)(2)(ii) and (iii) require that initial margin models meet set liquidation time horizons and have established confidence levels of at least 99%.

170

These DCO initial margin requirements are distinct from the margin requirements to which customers are subject pursuant to these final rules and, along with other risk-reducing measures, serve to mitigate the possibility that a DCO may default (possibly resulting in a systemic event). In the event that a DCO were to determine that a 15% margin level for security futures would be insufficient to satisfy a DCO's obligation under CFTC Rule 39.13, the DCO would be required to collect additional margin from its clearing members.

171

169

CFTC Rule 39.13(g)(2)(i) is not addressed in CFTC Letter No. 12-08.

170

CFTC Rules 39.13(g)(2)(ii) and (iii) are not addressed in CFTC Letter No. 12-08. In accordance with these rules, OCC Rules 601(c) and 601(e) provide for initial margin for segregated futures customer accounts to be calculated pursuant to the Standard Portfolio Analysis of Risk (“SPAN”) on a gross basis, as well as calculating on a net basis initial margin requirements for each segregated futures accounts using STANS. OCC's scan ranges for the SPAN margin models provide coverage for a minimum 99% confidence level.

171

The CFTC expects that any difference between the margin charged at the DCO and the margin charged by the security futures intermediary will be addressed by additional margin calls, if necessary. The DCO can require additional margin from its clearing members (which in some cases will be the security futures intermediary), to cover changes in market positions. DCOs and clearing members are familiar with margin call procedures and have established rules to efficiently transfer funds when needed. If a customer's account has insufficient funds to meet the margin call, its clearing member may provide the amount to the DCO and collect it from the customer at a later time. In this scenario, the clearing member may take on a liability or additional risk on the customer's behalf for a short period of time. The CFTC notes that this practice is the same for security futures as it is for other products subject to clearing and it does not view this temporary shifting of risk between the clearing member and the customer as a unique source of risk to security futures. Furthermore, this amendment lowering the required margin from 20% to 15% does not alter the relationship between DCOs and their clearing members, or the relationship between clearing members and their customers. The CFTC acknowledges that it is possible that DCOs and security futures intermediaries will collect different levels of margin, but it is not necessarily a result of the final rules. Moreover, the difference in margin collected is not an unmitigated source of risk for the security futures intermediaries because they have the authority to collect additional funds from their customers in the event of a margin call and can choose to set margin levels higher than the minimum level required by the Commissions.

The CFTC observes that customer margin requirements for security futures held by security futures intermediaries are materially distinct from initial margin requirements for DCOs. The initial margin requirements used by DCOs typically are risk-based, and CFTC rules are designed to permit DCOs to use risk-based margin models to determine the appropriate level of margin to be collected, subject to CFTC regulations in Part 39, as applicable.

In addition to the initial margin requirements at the DCO level, clearing members are required to satisfy certain financial resources requirements, including a “capital” requirement, to demonstrate that they can withstand certain risks under “extreme but plausible market conditions.”

172

Furthermore, the DCO is required to maintain its own financial resources, which may include its own capital, guaranty fund deposits by clearing members, default insurance, assessments for additional guaranty fund contributions, and other financial resources, as permitted.

173

In combination, financial resource requirements for clearing members, initial margin contributions, guaranty fund contributions, and other resources provide additional protections at the DCO level against the risk that a default by a customer or security futures intermediary will create systemic risk.

172

17 CFR 39.12 (CFTC Rule 39.12(a)(2)) (defining the capital requirement for clearing

members with cross-references to the CFTC's part 1 rules for FCMs and the SEC's rules for broker-dealers).

173

See generally

17 CFR 39.11(a) through (e) (CFTC Rule 39.11(a) through (e)).

See also

17 CFR 1.12 (CFTC Rule 1.12) (setting forth minimum financial requirements for FCMs and IBs).

In the event that a clearing member defaults on its obligations to the DCO, the DCO has a number of ways to manage associated risks, including transferring (or porting) the positions of the defaulted clearing member and using the defaulting clearing member's margin and other collateral on deposit to cover any losses. In order to cover the losses associated with a clearing member default, the DCO would typically draw from (in order): (1) The initial margin posted by the defaulting clearing member; (2) the guaranty fund contribution of the defaulting clearing member; (3) the DCO's own capital contribution; (4) the guaranty fund contribution of non-defaulting clearing members; and (5) an assessment on the non-defaulting clearing members. In the event that a DCO could not transfer the positions of the defaulted clearing member, it could liquidate those positions. Taken together, these mutualized risk mitigation capabilities are largely unique to clearinghouses, and help to ensure that they remain solvent when dealing with defaults of their members, their members' customers, and/or other periods of stressed market conditions.

As noted in the 2019 Proposing Release, the CFTC reviewed data from security futures markets under normal market conditions and concluded that a 15% level of margin would be sufficient to cover daily price moves in most instances (

i.e.,

more than 99.5%).

174

This is consistent with what the CFTC expects from risk-based margin regimes at DCOs. The Commissions received no comments regarding this data analysis. In addition, no commenters provided any quantitative data in support or refutation of the CFTC's risk analysis. Therefore, the CFTC continues to believe that the final rules will not have a substantial negative impact on (1) the protection of market participants or the public, (2) the financial integrity of security futures markets in the United States, if trading resumes, or (3) sound risk management practices of DCOs or security futures intermediaries.

174

Conducting a value-at-risk analysis of 74 of the most liquid security futures contracts during a limited time-frame (November 2002-June 2010), CFTC staff found that there were 195 instances where a 15% margin was insufficient and 99 instances where a 20% margin was insufficient. For all observations, a 15% margin was sufficient for 99.81% of all observations while a 20% margin was sufficient for 99.91% of all observations. While the period covered by this study does include the high volatility exhibited in 2008, it does not include the comparably high volatility exhibited in early spring 2020.

iii. Potential Costs Related to Competition and Market Arbitrage

One commenter responded to the 2019 Proposing Release with concerns that a change in margin requirements for security futures would provide an advantage to security futures and create a competitive disadvantage for exchange-traded equity options.

175

This commenter explained that exchange-traded equity options are regularly used to establish synthetic long and short exposures that produce exposures that are nearly identical to exposure created by security futures.

176

According to this commenter, there exists the possibility that the lower margin requirements for security futures could result in customers shifting from trading in equity options to security futures, which in turn, could result in decreased liquidity and less price discovery in the equity options markets.

175

Cboe/MIAX Letter at 2.

176

Cboe/MIAX Letter at 6.

However, another commenter argued there may be reason to doubt that changes in trading behavior would be precipitated by the lower margin levels set forth in these final rules. OneChicago provided data to support its view that security futures (referred to as “single stock futures” in OneChicago Letter 3) and equity options did not trade interchangeably.

177

The five analyses that OneChicago conducted were valuable to the CFTC's consideration of costs and benefits.

177

OneChicago Letter 3 at 2.

In particular, OneChicago provided analysis comparing SPX (S&P 500) options to E-mini S&P 500 futures contracts.

178

This analysis indicates that the products do not trade interchangeably and that the ratios of SPX options open interest to E-mini futures open interest, and SPX options volume to E-mini futures volume are not correlated with the margin rate on the E-mini S&P 500 futures contracts.

179

The CFTC recognizes that there are many reasons why customers decide to trade in one product over another (including tax ramifications), and that security futures and equity options are not perfect substitutes. The CFTC acknowledges that if security futures trading resumes, lower margin requirements could increase trading in security futures above their historical volumes (and some of that activity could be from customers that previously traded equity options). However, a customer's choice of trading instrument is not determined solely by margin requirements.

178

The CFTC notes that the E-mini futures contracts are not security futures, but are futures regulated solely by the CFTC (

i.e.,

they are not jointly regulated by the CFTC and SEC). The comparison between E-mini futures contracts and SPX options is still helpful to understand the interplay between the futures and equity options markets.

179

According to OneChicago's analysis, there is a statistically significant negative correlation between SPX options and E-mini futures. OneChicago Letter 3 at 6.

Another reason to doubt the negative competitive impact of these final rules on exchange-traded equity options is that the 2008 adoption of Portfolio Margin Rules for exchange-traded equity options did not cause security futures customers to migrate their positions to those products, even though it arguably provided those options with a competitive advantage over security futures because of the lower minimum margin rate.

180

Moreover, the vast majority of security futures customers would have been eligible for lower margin requirements but did not move their positions from futures accounts to Portfolio Margin Accounts, which were margined under the Portfolio Margin Rules (

i.e.,

margin required was equal to 15% for an unhedged position). The CFTC believes that, if trading in security futures resumes, the final rules' amendments are unlikely to create a competitive disadvantage for exchange-traded equity options, as the 15% margin rate is already in effect for positions held in a Portfolio Margin Account.

180

A competitive advantage for options may have existed because options are held in a securities account by default. In contrast, most security futures positions were held in futures accounts, and in order for a trader to take advantage of the lower margin rate for a security futures position, such a trader would have to move those positions into a different type of account (

i.e.,

from a futures account to a securities account) with associated costs.

OneChicago's closure after years of much lower trading activity than in exchange-traded equity options suggests that security futures in the U.S. may

have been operating at a competitive disadvantage to related markets. However, based on publicly available Eurex volume data,

181

security futures trading on U.S. stocks in other jurisdictions is lower than trading in security futures on European companies, even on the Eurex exchange in Germany where margin requirements are calculated using risk-based methodologies.

182

Therefore, factors other than margin requirements may be influencing demand for security futures (

e.g.,

tax ramifications or availability of competing products). Nonetheless, the CFTC expects that lowering the security futures margin requirement to 15% from 20% will help mitigate this competitive disadvantage and could encourage a resumption of security futures trading in the U.S.

181

See

Eurex statistics published daily,

available at https://www.eurexchange.com/exchange-en/data/statistics.

182

Trading by U.S. persons in security futures contracts listed on Eurex is subject to certain conditions under an SEC order and a CFTC staff advisory. Provided that a number of conditions are met, only qualified U.S. persons are permitted to trade security futures on a single security issued by a foreign private issuer or a narrow-based security index that is listed on a non-U.S. exchange that is not required to register with the SEC.

See

SEC's

Order under Section 36 of the Securities Exchange Act of 1934 Granting an Exemption from Exchange Act Section 6(h)(1) for Certain Persons Effecting Transactions in Foreign Security Futures and under Exchange Act Section 15(a)(2) and Section 36 Granting Exemptions from Exchange Act Section 15(a)(1) and Certain Other Requirements,

Exchange Act Release No. 60194 (June 30, 2009), 74 FR 32200 (Jul. 7, 2009), and Division of Clearing and Intermediary Oversight Advisory Concerning the Offer and Sale of Foreign Security Futures Products to Customers Located in the United States,

available at https://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/ssproject/fsfpadvisory.pdf

(June 8, 2010).

iv. Costs and Benefits Associated With Requested Changes to the Margin Offsets Table

The Commissions are updating and restating the table of offsets for security futures to reflect the new (15%) minimum margin requirement. The CFTC believes that if security futures trading resumes, lowering the margin requirements for certain offsets will not increase costs to customers, security futures intermediaries, or DCOs. The categories of permissible offsets will remain the same and there is no change to the inputs used to calculate the offset, other than to decrease the initial and maintenance margin on all security futures from 20% to 15%. Moreover, the same risk to the customers and security futures intermediaries will exist if the Commissions decrease the margin required for security futures trading combinations eligible for offsets as it will with security futures without an offset.

As discussed above, OneChicago suggested that the Commissions make a number of changes to the Strategy-Based Offset Table.

183

OneChicago asked that the Offset Table be amended to account for customers holding delta-neutral positions (

e.g.,

a customer holds an equal and opposite position in stock and/or a security future).

184

Although the CFTC agrees that it would make sense to account for a neutral position when setting margin levels, the CFTC believes the revised margin offset table included in this release balances the efficiencies of offsetting positions against the outstanding risks associated with these financial products in light of the fact that equity markets and security futures markets are subject to separate regulatory oversight. In addition, as explained above, the Commissions determined that lowering the offset table requirements further is inconsistent with current securities SRO rules, and thus would be inconsistent with the Exchange Act. For this reason, the Commissions are not adopting OneChicago's requested amendments to the Strategy-Based Offset Table.

183

OneChicago Letter at 15-17.

184

According to OneChicago's suggestion, margin for delta-neutral positions should be equal to the lower of: (1) The total calculated by multiplying $0.375 for each position by the instrument's multiplier, not to exceed the market value in the case of long positions, or (2) 2% of the current market value of the security futures contract. OneChicago Letter at 15.

OneChicago also asked that the Commissions add total return equity swaps to the Strategy-Based Offset Table.

185

Total return equity swaps serve a similar, if not identical, economic function to security futures contracts as commonly used at OneChicago. Providing an offset for swaps could incentivize customers to trade in either product, or this combination of products, and could result in increased liquidity. Adding a new product to the offset table would provide a benefit to customers trading in total return equity swaps and security futures because those customers would be subject to lower margin requirements. However, as stated above, the Commissions have determined that adding a total return swap offset to the Strategy-Based Offset Table would be inconsistent with securities SRO rules at this time and thus would be inconsistent with the Exchange Act. For this reason, the Commissions are not adopting this suggested change to the Strategy-Based Offset Table.

185

OneChicago Letter at 16.

In addition, OneChicago recommended that the Commissions reduce the maintenance margin required for certain types of positions from 10% to 7.5%.

186

A lower margin requirement under the offset table would provide an individual customer with an offsetting position a small benefit. However, as stated above, the Commissions have determined that lowering the margin requirement for certain strategies from 10% to 7.5% in the Strategy-Based Offset Table would be inconsistent with securities SRO rules at this time and thus would be inconsistent with the Exchange Act. For this reason, the Commissions are not adopting this suggested change to the Strategy-Based Offset Table.

186

OneChicago Letter at 16. As suggested by OneChicago, the reduction in margin from 10% to 7.5% would apply to items 2, 8, 9, 11, 12, 14, 15, and 16 in the Strategy-Based Offset Table.

Finally, OneChicago requested that the Commissions simplify the Strategy-Based Offsets Table overall by replacing the table with a rule. The CFTC has not identified specific benefits associated with adopting a rule rather than updating the Strategy-Based Offsets Table. However, the CFTC believes that any structural change to the offset table that is adopted for the security futures regime but not for the equity options regime could introduce uncertainty and confusion in the markets, and could inhibit customers seeking the reduced margin benefits of offsetting positions. OneChicago stated that the rule change it identified would not result in margin levels that are lower than margin levels required under the Strategy-Based Offset Table for exchange-traded equity options under Portfolio Margin Rules. As stated above, the Commissions have determined that replacing the Strategy-Based Offsets Table with a rule would be inconsistent with the securities SRO rules at this time and thus would be inconsistent with the Exchange Act. For this reason, the Commissions are not adopting this suggested change to the Strategy-Based Offset Table.

Although the Commissions are not revising the Strategy-Based Offset Table as requested by OneChicago, the CFTC believes the offsets described in this release will, if security futures trading resumes, offer certain benefits and will not increase costs by materially decreasing protections or increasing risks. Again, as added assurance that there are multiple levels of risk protection for security futures, the CFTC notes that security futures intermediaries and customers will continue to be required to comply with daily mark-to-market and variation

settlement procedures applied to security futures, as well as the large trader reporting regime that applies to futures accounts.

187

Under the CFTC's large trader reporting regime, clearing members and FCMs (as well as foreign brokers) file reports with the CFTC containing futures and options position information for traders that have positions at or above certain reporting thresholds.

See

part 17 of the CFTC's regulations and 17 CFR 15.03(b) (CFTC Rule 15.03(b)).

5. Description of Benefits Provided by the Final Rules

The CFTC believes that the final rules will, if security futures trading resumes, produce significant benefits by reducing minimum margin requirements for security futures positions to levels equal to margin levels for exchange-traded options. The amendment to CFTC Rule 41.45(b)(1) will align customer margin requirements for security futures held in a futures or a securities account with those that are held in a Portfolio Margin Account. The CFTC believes this alignment may increase competition by establishing a level playing field between security futures carried in a Portfolio Margin Account and security futures carried in a futures account or a securities account that is not subject to Portfolio Margin Rules should OneChicago begin offering these products again or new market entrants emerge.

This benefit is expected to apply most directly to customers with security futures positions held in futures accounts because they cannot be margined under Portfolio Margin Rules. According to OneChicago, because of operational issues, almost all security futures positions were carried in futures accounts.

188

As a result, almost all, if not all, security futures were held in futures accounts and subject to the CFTC's customer account requirements. Therefore, any reduction in customer initial and maintenance margin requirements, if security futures trading resumes, would be expected to benefit all or close to all security futures customers because they historically held positions in futures accounts and did not benefit from Portfolio Margin Rules.

188

See

OneChicago Petition at 2.

Additionally, the reduced minimum margin level could, if security futures trading resumes, facilitate more trading in security futures than would otherwise occur, which could enhance the likelihood a revival would succeed and increase market liquidity to the benefit of market participants and the public.

189

Increased liquidity could contribute to the financial integrity of security futures markets overall. For example, market liquidity may be particularly beneficial in the context of a customer default at an FCM, when the FCM must manage the defaulting customer's security futures positions through transferring or liquidating those positions.

190

189

OneChicago represented that one of its customers (Jurrie Reinders, Societe General) believed that the “uncompetitive” margin requirements for security futures have reduced trading volumes. OneChicago Letter at 29.

190

As noted above, the FIA Letter stated that the final rules would help FCMs manage their risk.

See

FIA Letter, at 2.

See also

discussion of CFTC rules under parts 1 and 39, above.

The lower minimum margin requirement also could, if security futures trading resumes, decrease the direct cost of trading in security futures. In response to the Commissions' request for comments providing data, OneChicago estimated that for the time period between September 1, 2018, and August 1, 2019, the notional value of margin collected on OneChicago positions would be reduced by $130 million if the lower 15% margin requirement had been in place.

191

This would have represented significant savings in the amount of margin required to be paid by and collected from customers in satisfaction of the CFTC's part 41 margin requirements. A decrease in trading costs, through lower minimum margin requirements should OneChicago begin offering these products again or new market entrants emerge, also may increase capital efficiency because additional funds would be available for other uses.

191

OneChicago estimated that between September 1, 2018, and August 1, 2019, the notional value of margin collected on OneChicago positions was approximately $540 million (under a 20% minimum margin requirement) compared to $410 million that would have been collected under the final rules (under a 15% minimum margin requirement). OneChicago Letter at 14.

As noted above, the final rules may have beneficial competitive effects vis-à-vis domestic markets. In addition, lowering the minimum margin requirement may enable a U.S. security futures exchange to better compete in the global marketplace, where security futures traded on foreign exchanges are subject to risk-based margin model requirements that are generally lower than those applied to security futures traded in the U.S.

192

Apart from OneChicago's letters and a comment from one of its customers, the Commissions received no comments regarding benefits associated with increased domestic or global competition.

192

OneChicago stated that the Eurex exchange lists futures on U.S. stocks with risk-based margins that are lower than the 20% margin for futures on the same stocks that were listed at OneChicago (OneChicago Letter at 13). However, based on publicly available data, the volume on Eurex for futures on U.S. stocks is much lower than occurred at OneChicago even as security futures volume is high for stocks in European companies.

The final rules restate the table of offsets for security futures to reflect the proposed 15% minimum margin requirement. As discussed in detail above, these offsets will, if security futures trading resumes, provide the benefits of capital efficiency to customers because offsets recognize the unique features of certain specified combined strategies and would permit margin requirements that better reflect the risk of these strategies. Moreover, the same benefits of lowering margin costs for customers and increasing business in security futures could result from lowering margin requirements for offsetting security futures positions.

6. Discussion of Alternatives

Although the CFTC did not identify any alternatives in the proposal,

193

commenters suggested a number of alternative security futures margin options, along with other suggestions for the Commissions to consider. This discussion of those alternatives includes certain commenter proposals that the Commissions still do not believe are viable at this time for the reasons discussed by the Commissions in more detail above.

193

See

2019 Proposing Release, 84 FR at 36446. In the proposal, the CFTC stated that it did not believe that there were any reasonable alternatives to consider given statutory constraints tied to current practices in the exchange-traded equity options market.

Id.

at n. 92.

i. Reducing Contract Sizes for Security Futures

One commenter, citing a statement by SEC Commissioner Jackson, indicated that the Commissions failed to consider reasonable alternatives such as reducing the contract size for security futures.

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According to Commissioner Jackson's Statement, “reducing contract size could also increase access to single-stock futures for the most popular securities and improve efficiency.”

195

The CFTC agrees that changing the contract size for security futures might make the products more attractive to a wider group of market participants, resulting in increased liquidity,

196

but

would not change the overall amount of margin required for a given position. Thus, the CFTC believes that this alternative would be less effective at increasing liquidity than lowering margin requirements. Reducing the security futures contract size would lower the initial capital expenditure for a customer and could attract wider participation, but could possibly increase transaction costs, as a percentage of overall initial costs in putting on the position.

197

As explained above, the Commissions anticipate that these final rules may produce greater liquidity in security futures, as well as create more efficient capital distribution. Market participants will be able to reallocate funds that are saved on lower margin levels. Under this alternative, market participants would not benefit from any increased capital efficiencies. Because reducing contract sizes does not provide the same capital efficiency opportunities to customers, the CFTC does not believe it offers as many benefits as the final rules.

194

Letter from the Jeffrey Mahoney, General Counsel, Council of Institutional Investors (Aug. 26, 2019) (“CII Letter”) at 4.

See also

Commissioner Robert J. Jackson Jr., Public Statement, Statement on Margin for Security Futures (July 3, 2019),

available at https://www.sec.gov/news/public-statement/jackson-statement-margin-security-futures

(“Commissioner Jackson's Statement”).

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Commissioner Jackson's Statement.

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A security futures exchange could change the contract size for security futures by amending terms of the security futures contract such that one security futures contract represents only 50 shares of the underlying stock instead of 100.

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The increase in transaction costs would be the result of the fixed cost staying the same, but the initial expenditure being lower.

ii. Rules-Based Margin With Flexible Margin Collection Intervals

One commenter agreed with Commissioner Jackson's concern that the proposal did not consider other reasonable alternatives such as a rules-based margin regime that includes flexible margin collection, or settlement intervals, which is an idea proposed by former SEC economists.

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According to the economists' research paper on this topic, security futures that are subject to strategy-based margining ma

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