Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by the Philadelphia Stock Exchange, Inc. to Amend its Method of Calculating Initial and Maintenance Margin Requirements for Foreign Currency Options

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39856; File No. SR-Phlx-97-63]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change and Amendment No. 1 Thereto by the Philadelphia Stock Exchange,

Inc. to Amend its Method of Calculating Initial and Maintenance Margin

Requirements for Foreign Currency Options

April 13, 1998.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that

on December 22, 1997, the Philadelphia Stock Exchange, Inc. (``Phlx''

or ``Exchange'') filed with the Securities and Exchange Commission

(``SEC'' or ``Commission'') the proposed rule change as described in

Items I, II, and III below, which Items have been prepared by the Phlx.

On February 20, 1998, the Phlx filed a Letter Amendment to the proposed

rule change.\3\ The Phlx filed Amendment No. 1 to the proposed rule

change on April 6, 1998.\4\ The Commission is publishing this notice to

solicit comments on the proposed rule change, as amended, from

interested persons.

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\1\ 15 U.S.C. 78s(b)(1).

\2\ 17 CFR 240.19b-4.

\3\ See Letter from Michele R. Weisbaum, Vice President and

Associate General Counsel, Phlx, to Sharon Lawson, Senior Special

Counsel, Division of Market Regulation (``Division''), Commission,

dated February 19, 1998 (``Letter Amendment''). In the Letter

Amendment, the Phlx proposes to amend its proposed rule change to:

(1) conduct margin reviews quarterly rather than semi-annually; (2)

monitor currencies monthly when the confidence level falls to

between 97% and 97.5% until the confidence level exceeds 97.5% for

two consecutive months, rather than just one month; and (3) revise

Rule 722 to exclude the actual margin level for each currency and to

note that instead, the Phlx will distribute membership circulars

announcing the margin levels that are derived pursuant to Commentary

.16 of Rule 722.

\4\ See Letter from Nandita Yagnik, Counsel, Phlx, to Sharon

Lawson, Senior Special Counsel, Division, Commission, dated April 3,

1998 (``Amendment No. 1''). Amendment No. 1 incorporates the

original proposed rule change and Letter Amendment into a Rule 19b-4

notice.

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I. Self-Regulatory Organization's Statement of the Terms of

Substance of the Proposed Rule Change

The Phlx proposes to amend Phlx Rule 722 to codify its method of

calculating initial and maintenance customer margin requirements for

foreign currency options. Under proposed new Commentary .16 to Rule

722, the Exchange would calculate the margin requirements for each

foreign currency separately, rather than determining one margin level

for all foreign currencies based upon the historical pricing

information for all foreign currencies together.

The complete text of the proposed rule change is available at the

Office of the Secretary, Phlx and at the Commission.

II. Self-Regulatory Organization's Statements Regarding the Purpose

of, and Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the Phlx included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. The Phlx has prepared summaries, set forth in sections

A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

1. Purpose

Currently, the Exchange calculates the margin requirement for

customers that assume short foreign currency option positions by adding

4% of the current market value of the underlying foreign currency

contract to the option premium price less an adjustment for the out-of-

the-money amount of the option contract.\5\ The 4% add-on percentage

was adopted in 1986 and provided for initial margin which would cover

the aggregate underlying foreign currencies' historical volatility over

a seven day period with a 95% confidence level over the latest nine

month period.\6\ This add-on percentage is now reviewed by the Exchange

every quarter to assure that it provides for a 97.5% confidence level

over a five day period. Recently, the Exchange has listed new foreign

currency options such as the Spanish peseta and the Italian lira \7\

and has received approval to trade options on the Mexican peso.\8\ In

determining the appropriate margin levels for these new currencies, the

Commission has indicated that it believes that the Exchange should set

margin levels for each foreign currency option independently and that

it should state its specific procedure for setting these levels in its

rules. The purpose of this proposal is to address this issue by

adopting new foreign currency options margin procedures as proposed in

Commentary .16 to Rule 722.

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\5\ This 4% ``add-on'' percentage is applicable to the following

foreign currencies: Australian dollar, British pound, Canadian

dollar, German mark, European Currency Unit, French franc, Japanese

yen and Swiss franc. The Spanish peseta and the Italian lira

currently have a 7% add-on percentage and the Mexican peso has an

add-on percentage of 17%.

\6\ See Securities Exchange Act Release No. 22469 (September 26,

1985) 50 FR 40663 (October 4, 1985) (order approving File Nos. SR-

Amex-84-29, SR-CBOE-84-27, SR-NASD-85-15, SR-PSE-84-20, SR-Phlx-84-

32 and SR-Phlx-85-18 and establishing a uniform margin system for

options products).

\7\ See Securities Exchange Act Release No. 36255 (September 20,

1995) 60 FR 50229 (September 28, 1995) (order approving File Nos.

SR-Phlx-95-20 and SR-Phlx-95-21).

\8\ See Securities Exchange Act Release No. 39460 (December 17,

1997) 62 FR 67425 (December 24, 1997) (order approving File No. SR-

Phlx-97-22).

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The Exchange is proposing to determine the applicable add-on

percentage by reviewing, on a quarterly calendar basis,\9\ five-day

price changes over the preceding three-year period for each underlying

currency and set the add-on percentage at a level which would have

covered those price changes at least 97.5% of the time (``confidence

level''). If the results of subsequent reviews show that the current

margin level provides a confidence level below 97%, the Exchange will

increase the margin requirement for that individual currency up to a

98% confidence level. If the confidence level is between 97% and 97.5%,

the margin level will remain the same but will be subject to monthly

follow-up reviews until the confidence level exceeds 97.5% for two

consecutive months.\10\ If during the course of the monthly follow-up

reviews, the confidence level drops below 97%, the margin level will be

increased to a 98% level and if it exceeds 97.5% for two consecutive

months, the currency will be taken off monthly reviews and will

[[Page 19555]]

be put back on the quarterly review cycle. If the currency exceeds

98.5%, the margin level will be reduced to a 98% confidence level.

Finally, in order to account for large price movements outside the

margin level, if the review shows that the currency had a price

movement, either positive or negative, greater than two times the

margin level, the margin requirement would be set at a level to meet a

99% confidence level (``extreme outlier test'').

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\9\ Although the Phlx initially proposed semi-annual margin

reviews, in Amendment No. 1, the Phlx proposes to amend Commentary

.16(b) of Rule 722 to require margin reviews to be conducted

quarterly, on the 15th of January, April, July and October of each

year. See Amendment No. 1, supra note 4.

\10\ As initially proposed, it was unclear whether monthly

margin reviews would be required once the confidence level equaled

97.5%. Amendment No. 1 makes clear that the confidence level must

exceed 97.5% for two consecutive months before the currency will no

longer be reviewed monthly. See Amendment No. 1, supra note 4.

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The quarterly reviews will be conducted promptly following the 15th

of January, April, July and October of each year. In addition to the

routine reviews described above, the Exchange continues to have

authority to impose a higher margin level at any time in between

reviews if market conditions so warrant.\11\ At this time, the margin

levels for Tier I, II, and III customized cross rate options will

remain the same.

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\11\ See Phlx Rule 772(i)(8).

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Finally, the Phlx proposes to revise Rule 722 so that while the

calculation methodology will be outlined in Commentary .16, the actual

margin level for each currency will not be stated. Instead, the

Exchange will distribute circulars to the membership announcing the

margin levels that are derived pursuant to the methodology in

Commentary .16 to Rule 722. In addition, any time that a particular

margin level changes based on a review or otherwise pursuant to Rule

722, the new margin requirement will be announced via circular to the

membership.\12\

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\12\ As initially proposed, all changes to the add-on

percentages for individual currencies set forth in Phlx Rule 722

would have required a proposed rule change to be filed with the

Commission pursuant to Section 19(b)(3)(A) of the Act. As changes to

the margin levels for individual currencies will not require changes

to Phlx Rule 722 and instead, will be announced to the Phlx

membership via circular, such changes will not trigger a requirement

to subject a 19(b)(3)(A) filing to the Commission. Telephone

conversation between Nandita Yagnik, Counsel, Phlx, and Deborah

Flynn, Division, Commission, on April 13, 1998.

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2. Statutory Basis

The Exchange believes that the proposed rule change is consistent

with Section 6 of the Act \13\ in general, and in particular, with

Section 6(b)(5),\14\ in that it is designed to promote just and

equitable principles of trade, prevent fraudulent and manipulative acts

and practices, to foster cooperation and coordination with persons

engaged in regulating, clearing, settling, processing information with

respect to, and facilitating transactions in securities, to remove

impediments to and perfect the mechanism of a free and open market and

a national market system, as well as to protect investors and the

public interest by establishing margin levels for foreign currency

options which reflect the specific risks associated with each

individual currency.

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\13\ 15 U.S.C. 78f.

\14\ 15 U.S.C. 78f(b)(5).

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B. Self-Regulatory Organization's Statement on Burden on Competition

The Phlx does not believe that the proposed rule change will impose

any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants or Others

No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days or such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the Phlx consents, the Commission will:

(A) By order approve such proposed rule change, or,

(B) Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning the foregoing, including whether the proposed rule

change, as amended, is consistent with the Act. Persons making written

submissions should file six copies thereof with the Secretary,

Securities and Exchange Commission, 450 Fifth Street, NW, Washington,

DC 20549. Copies of the submission, all subsequent amendments, all

written statements with respect to the proposed rule change that are

filed with the Commission, and all written communications relating to

the proposed rule change between the Commission and any person, other

than those that may be withheld from the public in accordance with the

provisions of 5 U.S.C. 552, will be available for inspection and

copying in the Commission's Public Reference Section, 450 Fifth Street,

NW, Washington, DC 20549. Copies of such filing will also be available

for inspection and copying at the principal office of the Phlx. All

submissions should refer to File No. SR-Phlx-97-63 and should be

submitted by May 11, 1998.

For the Commission by the Division of Market Regulation,

pursuant to delegated authority.\15\

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\15\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-10340 Filed 4-17-98; 8:45 am]

BILLING CODE 8010-01-M