Self-Regulatory Organizations, Notice of Filing of Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Relating to Customized Cross-Rates Foreign Currency Option Margin Levels

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41256; International Series Release No. 1190; File No.

SR-PHLX-98-51]

Self-Regulatory Organizations, Notice of Filing of Proposed Rule

Change by the Philadelphia Stock Exchange, Inc. Relating to Customized

Cross-Rates Foreign Currency Option Margin Levels

April 6, 1999.

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 November 16, 1998, 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.

The PHLX amended the proposal on March 15, 1993.\3\ 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 Nandita Yagnik, Counsel, PHLX, to Hong-anh

Tran, Attorney, Division of Market Regulation (``Division''),

Commission, dated March 15, 1999 (``Amendment No. 1'').

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

Substance of the Proposed Rule Change

The Exchange proposes to amend PHLX Rule 722, Margin Accounts, to

codify its method of calculating customer margin requirements for

customized cross-rate foreign currency options (``CCRs'').\4\ The

required margin for CCRs is determined by combining the actual cost of

the CCR, or the ``premium,'' plus an extra or ``add-on'' amount that is

raised or lowered according to the volatility of the currencies

involved.\5\ The proposed method for calculating the margin for all

CCRs will be outlined in PHLX Rule 722, Tiers I and II, and Commentary

.15, with the exception of the margin for CCRs involving the Mexican

peso,\6\ which will be calculated in accordance with Commentary .16 and

will be placed in Tier III. Tier IV, which currently addresses Mexican

peso CCR margin levels, will be deleted. The text of the proposed rule

change follows. Proposed new language is italicized; proposed deletions

are in [brackets].

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\4\ CCRs are traded pursuant to PHLX Rule 1069. A CCR is an

option to purchase or sell an underlying currency that can be any

approved currency as defined pursuant to PHLX Rule 1009(c).

Moreover, the option's exercise price is denominated in another

approved currency (the trading currency), and neither the underlying

nor the trading currency is denominated in U.S. dollars.

\5\ The margin may also be reduced in ``out-of-the money''

situations, where the value of the option does not accord with

current market conditions. Notwithstanding, the margin cannot be

reduced to less than 100% of the current market value of the premium

plus .75% of the underlying component value.

\6\ The Exchange currently has Commission approval to trade, as

CCRs, the Mexican peso only against the Canadian dollar. Thus, CCR

options involving the Mexican peso include Canadian dollar/Mexican

peso and Mexican peso/Canadian dollar contracts. See PHLX Rule

1069(a)(1)(B).

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* * * * *

Margin Accounts

Rule 722.(a)-(c) No change.

(d) 1-2 No change.

3. Short Positions--Listed Options and Currency, Currency Index or

Stock Index Warrants. Subject to the exceptions set forth below, the

margin on any put or call option listed or traded on a registered

national securities exchange or association and issued by a registered

clearing corporation or any currency warrant, currency index warrant or

stock index warrant which is issued, guaranteed or carried ``short'' in

a customer's account shall be 100% of the current market value of the

option or warrant plus the percentage of the current market value of

the underlying security, foreign currency or index specified in column

II below.

Notwithstanding the margin required below, the minimum margin on

any put or call or any warrant issued, guaranteed or carried ``short''

in a customer's account may be reduced by any ``out-of-the-money-

amount'' (as defined below), but shall not be less than 100% of the

current market value of the option or warrant plus the percentage of

current market value of the underlying security, foreign currency or

index specified in column II below with the exception that the minimum

margin required on each such put option contract shall not be less than

the current option market value plus the minimum percentage set forth

in column III of the option's aggregate exercise price amount.

[[Page 18649]]

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II. Initial and/or

I. Type of option maintenance III. Minimum margin IV. Underlying component value

margin required required

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(1).............................. .................. No change........... ...................................

(2).............................. .................. No change........... ...................................

(3).............................. .................. No change........... ...................................

(4) Foreign Currencies........... (#) \3/4\%.............. The product of Units per foreign

currentcy contract and the closing

spot price.

(5) Cross-Rate................... 4% \3/4\%.............. The products Units per cross-rate

contract and the closing spot

price.

(6) Tier I Customized Cross-rate 4% \3/4\%.............. The product of Units per cross-rate

currency options. contract and the closing spot

price.

(7) Tier II Customized Cross-rate 6% \3/4\%.............. The product of Units per cross-rate

currency options. contract and the closing spot

price.

(8) Tier III Customized Cross- [7%]## \3/4\%.............. The product of Units per cross-rate

rate currency options. contract and the closing spot

price.

[(9) Tier IV Customized Cross- 17% \3/4\%.............. The product of Units per cross-rate

rate currency options. contract and the closing spot

price.

[(10)]9 7........................ .................. No change...........

[(11)]10......................... .................. No change...........

[(12)]11......................... .................. No change...........

[(13)]12......................... .................. No change...........

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# The margin requirement for foreign currency options will be determined pursuant to Commentary .16 of this Rule

722.

##The margin requirement for Tier III customized cross-rate foreign currency options will be determined pursuant

to Commentary .15 and .16 of this Rule 722.

Rule 722(d)4-5 No change.

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\7\ Pursuant to a telephone conversation between Nandita Yagnik,

Counsel, PHLX, and Hong-anh Tran, Attorney, Division, Commission,

dated April 6, 1999, the PHLX proposes to renumber items (10)

through (13) as items (9) through (12).

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Rule 722(e)-(i) No change.

* * * * *

Commentary

.01-.14 No change.

.15 For purposes of this rule, the Exchange shall designate the

tier level of the customized cross-rate currency options. The Exchange

shall make such determination for Tier I and Tier II options based upon

the correlation between the currency pairs. Currency pairs which

exhibit a correlation less than .25 over the preceding two year period

shall be placed in Tier II while all other currency pairs shall be

placed in Tier I. The correlations between the currency pairs in these

two tiers shall be reviewed no less frequently than on a monthly basis.

Tier III will include customized cross-rate currency options which

involve [either the Italian lira or Spanish peseta. Tier IV will

include customized cross-rate currency options which involve] the

Mexican peso[.] and the margin requirement will be determined according

to the methodology pursuant to Commentary .16 below.

.16 The margin requirement for any foreign currency put or call

option listed or traded on the Exchange and issued by a registered

clearing corporation which is issued, guaranteed or carried ``short''

in a customer's account, except for cross-rate currency options other

than customized cross-rate currency options based on the Mexican peso,

shall be the amount provided in paragraph (d)(3) of this Rule 722 and

shall be calculated as follows:

(a) The Exchange will review five day price movements over the most

recent three year period for each foreign currency underlying options

traded on the Exchange and will set a margin level which would have

covered the price changes over the review period at least 97.5% of the

time (``confidence level'').

(b) Subsequent reviews of five day price changes over the most

recent three year period will be performed quarterly on the 15th of

January, April, July and October of each year.

(c) If the results of subsequent reviews show that the confidence

level for any currency has fallen below 97%, the Exchange will increase

the margin requirement for that currency up to a 98% confidence level.

If the results show a confidence level between 97% and 97.5%, the

currency will be monitored monthly until the confidence level exceeds

97.5% for two consecutive months. If the results of a monthly review

show that the confidence level has fallen below 97%, the margin

requirement will be increased to a 98% confidence level. If the results

of any review show that the confidence level has exceeded 98.5%, the

margin level would be reduced to a level which would provide a 98%

confidence level.

(d) The Exchange will also review each currency for large price

movements outside the margin level (``extreme outlier test''). If the

results of any review show a price movement, either positive or

negative, of greater than two times the current margin level, the

margin requirement for that currency will be increased to a confidence

level of 99%.

(e) Pursuant to paragraph (i)(8) of this Rule 722, the Exchange may

also conduct reviews of currency margin levels at any time that market

conditions warrant.

* * * * *

II. Self-Regulatory Organization's Statements of 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 proposal. 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 offers an array of foreign currency option

products (``FCOs''), including among others, standardized and

customized (the category into which CCRs fall) currency options which

have differing

[[Page 18650]]

margin requirements. The Exchange currently lists standardized foreign

currency options \8\ that include standardized options on eight foreign

currencies (``Standardized FCOs'').\9\ The Exchange also lists two

cross-rate (``Standardized CRs) \10\ currency options. The Exchange

also presently lists customized foreign currency options (``Customized

FCOs'') \11\ that include customized strikes (``Customized

Strikes''),\12\ customized inverse FCOs (``Customized Inverses''),\13\

and CCRs.

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\8\ Standardized options carry specific contract terms for

features such as contract size, strike price intervals, expiration

dates, price quoting and premium settlement.

\9\ The eight foreign currencies previously approved for listing

were the Australian dollar, British pound, Canadian dollar, German

mark, European Currency Unit, French franc, Japanese yen and Swiss

franc. See PHLX Rule 1009(c). The base currency (which is the

currency in which premiums are quoted and paid) for these

Standardized FCOs is the U.S. dollar. See Securities Exchange Act

Release Nos. 19133 (October 14, 1982), 47 FR 46946 (October 21,

1982) (File No. SR-Phlx-81-4) (regarding the listing and trading of

standardized options based on the British pound, German mark, Swiss

franc, Canadian dollar and Japanese yen); 20822 (April 4, 1984), 49

FR 14611 (April 12, 1984) (File No. SR-Phlx-84-1) (regarding the

listing and trading of Standardized FCOs based on the French franc);

22853 (February 3, 1986), 51 FR 5129 (February 11, 1986) (File No.

SR-Phlx-85-10) (regarding the listing and trading of Standardized

FCOs based on the European Currency Unit); and 23945 (December 30,

1986), 52 FR 633 (January 7, 1987) (File No. SR-Phlx-86-38)

(regarding the listing and trading of Standardized FCOs based on the

Australian dollar).

\10\ The Exchange presently offers two Standardized CRs, the

Deutsche mark/Japanese yen and the British pound/Deutsche mark. The

Exchange also has approval to trade a third standardized CR, the

British pound/Japanese yen, however, it has not yet been made

available for trading. See Securities Exchange Act Release No. 29919

(November 7, 1991), 56 FR 58109 (November 15, 1991) (File Nos. SR-

Phlx-90-12; SR-Phlx-91-03; SR-Phlx-91-23).

\11\ Customized options allow users to customize all aspects of

a currency option including: choice of exercise price, the

expiration dates of up to two years, and premium quotation as either

units of currency or percent of underlying value. Presently, the

Exchange lists customized, not standardized, currency options

involving the Italian lira, the Spanish peseta, and the Mexican

peso. See PHLX Rules 1009(c) and 1069.

\12\ The Exchange offers Customized Strikes on any approved

currency presently listed under PHLX Rule 1009(c). Customized

Strikes provide FCO traders and their customers with the ability,

within certain limits, to trade an FCO with any exercise price it

chooses on a specific approved currency even if that price does not

correspond to an exercise price of a listed standardized FCO. See

Securities Exchange Act Release No. 34925 (November 1, 1994), 59 FR

55720 (November 8, 1994) (File No. SR-Phlx-94-18).

\13\ A Customized Inverse is a Customized FCO where the

underlying currency (the currency in which an FCO settles) is the

U.S. dollar. The Exchange presently provides for the trading of

Customized Inverses on any of the approved currencies. See

Securities Exchange Act Release No. 34925 (November 1, 1994), 59 FR

55720 (November 8, 1994) (File No. SR-Phlx-94-18).

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The add-on margin calculation methodology for Standardized FCOs is

based on a methodology, outlined in Commentary .16 to PHLX Rule

722.\14\ Standardized CRs presently carry an initial and maintenance

add-on margin of 4%, which covers greater than 96% of all seven-day

price movements over the preceding one-year period.\15\ Customized

Inverses and Customized Strikes that trade in U.S. dollars are

currently margined following the same methodology as the Exchange's

Standardized FCOs (see Commentary .16 to PHLX Rule 722).

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\14\ See Securities Exchange Act Release No. 40208 (July 5,

1998), 63 FR 39388 (July 22, 1998) (File No. SR-Phlx-97-63).

\15\ See Securities Exchange Act Release No. 29919 (November 7,

1991), 56 FR 58109 (November 15, 1991) (File No. SR-Phlx-90-12); SR-

Phlx-91-03; SR-Phlx-91-23).

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The add-on margin requirements for CCRs,\16\ however, developed

differently from that of Standardized FCOs, or Standardized CRs. The

Exchange developed a method for determining add-on margin levels for

currency pairs using a tiered system, believing that it would prove

burdensome to determine the margin level for each currency pair due to

the numerous combinations of approved currencies.\16\ Under the tiered

system, margin levels are determined based upon the correlations

between all the possible combinations of approved currencies, thus

significantly reducing the burden on the Exchange to calculate the

margin levels for each individual currency pair.

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\16\ The add-on margin treatment for Customized Strikes based on

CCRs (i.e., a CCR with a customized strike price) follows the same

tiered system as CCRs.

\17\ See Securities Exchange Release No. 34925 (November 1,

1994), 59 FR 55720 (November 8, 1994) (File No. SR-Phlx-94-18).

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Changes to the Margin for CCRs Involving Italian Lira and Spanish

Peseta

There are four tiers in the system (I-IV), each of which provides

an overall margin for short CCR positions, which include an add-on

percentage amount for both initial and maintenance margins (e.g., 4%

for Tier I) as well as a set minimum add-on margin requirement, which

is currently \3/4\% for each tier. Currently, Tier III applies to CCRs

involving the Italian lira and the Spanish peseta, such that any CCRs

involving those currencies would have an add-on margin requirement of

7%.\18\ The Exchange now proposes to set add-on margins for CCRs

involving the Italian lira and the Spanish peseta following the same

correlation method used for CCRs other than the Mexican peso.\19\ For a

pair of approved currencies, this method examines the correlation

between the daily price change for one of those currencies with the

daily price change for the other currency for the preceding two-year

period. If the correlation is greater than or equal to .25, then the

add-on margin level is 4% for that currency pair (i.e., Tier I). If the

correlation is below .25, then the add-on margin level for the currency

pair is 6% (i.e Tier II).Commentary .15 to PHLX Rule 722 (as well as

the chart within that Rule) will be amended to reflect these changes to

the status of CCRs involving the Italian lira and the Spanish peseta.

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\18\ The Exchange indicates that when the Commission approved

CCRs on the Italian lira and the Spanish peseta, the margin level of

7% was determined by the frequency of distributions method

reflecting at least 97.5% of all seven day price movements over the

preceding three-year period. Specifically, the 7% margin covered

98.84% and 99.10% of all seven day price changes over the three-year

review period involving the Italian lira and the Spanish peseta,

respectively.

\19\ The PHLX represents that the Italian lira and Spanish

peseta have become more established currencies in the currency

market, and therefore should be margined in accordance with margins

for other approved currencies in a customized cross-rate context.

Specifically, the risks involved in trading CCRs involving the lira

or peseta have now been reduced so that the 7% customer margin add-

on percentage for either case, based on at least 97.5% confidence

level, is no longer necessary.

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The PHLX Examinations Department will review the correlation

between the currency of pairs monthly. The currency pairs underlying

the customized cross-rate options may move between Tiers I and II

depending upon their correlation to each other in the preceding period.

If the monthly review reveals that any combination of approved

currencies should be in a different tier based on the correlation, the

Exchange will implement the change immediately, and promptly notify the

membership and Commission.

The Exchange also proposes including an additional adjustment for

``out-of-the-money amounts'' in those CCRs involving the Italian lira

or the Spanish peseta. This adjustment is currently applied to the

overall initial and maintenance margin for all the currency pairs

currently in Tiers I and II, but not to those involving the Italian

lira or the Spanish peseta.\20\

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\20\ See Securities Exchange Act Release 34925 (November 1,

1994), 59 FR 55720 (November 8, 1994) (File No. SR-Phlx-94-18); and

See Securities Exchange Act Release No. 40208 (July 5, 1998), 63 FR

39338 (July 22, 1998) (File No. SR-Phlx-97-63).

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Changes to Add-On Margin for CCRs Involving the Mexican Peso

Tier IV presently applies to CCRs involving the Mexican peso.\21\

Tier IV

[[Page 18651]]

requires an initial and/or maintenance add-on margin of 17%, and covers

99% of all five-day price movements over the preceding three-year

period. Currently, under Tier III, there is a 7% initial and/or

maintenance add-on margin. Under the proposal, the 7% add-on will be

eliminated and the margin requirement for Tier III CCRs will be

determined pursuant to Commentary .15 and .16 of PHLX Rule 722, as

amended.\22\ The Exchange now proposes to delete Tier IV and to amend

Tier III to apply to margin levels for CCRs involving the Mexican peso.

Under the proposed method for calculating the add-on margin for CCRs

involving the Mexican peso, the Exchange will still review five-day

price movements over the most recent three-year period but the

calculation as proposed would cover cover at least 97.5% of all such

five-day price movements rather than the current 99%. This

determination is the same as that currently applied to Standardized

FCOs covered by Commentary .16 to PHLX Rule 722. The PHLX Examinations

Department will review margin levels for CCRs involving the Mexican

peso quarterly, at the same time such review is conducted for

Standardized FCOs. The Exchange indicates that applying the add-on

margin methodology outlined in Commentary .16 to Mexican peso CCRs will

eliminate the need to state the actual add-on margin levels for

Canadian dollar/Mexican peso and Mexican peso/Canadian dollar CCR

contracts. Instead, the Exchange proposed to provide notice of the add-

on margin levels for Mexican peso CCRs quarterly via circulars to the

membership, the other market participants, and the Commission. The

notice will follow the schedule outlined for quarterly reviews

conducted for Standardized FCOs.

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\21\ The Mexican peso may only be traded as CCRs against the

Canadian dollar. See PHLX Rule 1069(a)(1)(B); See Securities

Exchange Act Release No. 34925 (November 1, 1994), 59 FR 55720

(November 8, 1994) (File No. SR-Phlx-94-18).

\21\ The Exchange is proposing to amend Commentary .15 to remove

the Italian lira and Spanish peseta CCRs from Tier III, to remove a

reference to Tier IV, and to move CCRs involving Mexican pesos to

Tier III, to note that margin for Mexican peso CCRs is to be

calculated pursuant to Commentary .16. The Exchange is proposing to

amend Commentary .16 to clarify that CCRs involving the Mexican peso

are to be calculated under the formula set out in that commentary.

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2. Statutory Basis

The proposed rule change is consistent with Section 6 of the

Act,\23\ and specifically Section 6(b)(5) thereof,\24\ in that it is

designed (a) to promote just and equitable principles of trade; (b) to

foster cooperation and coordination with persons engaged in regulating,

clearing, settling, and processing information with respect in CCRs;

and (c) to facilitate transactions in securities by establishing a

methodology for the calculation of margin levels for CCRs that will

remain consistent and ease the burden of determining new margin levels

for each currency traded in the customized environment.

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\23\ 15 U.S.C. 78f(b).

\23\ 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 of such date if it finds such longer period to

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

which the Exchange consents, the Commission will:

A. By order approve 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 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 20549-0609.

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 with 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 Exchange.

All submissions should refer to File No. SR-Phlx-98-51 and should

be submitted by May 6, 1999.

For the Commission by the Division of Market Regulation,

pursuant to delegated authority.\25\

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\25\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-9356 Filed 4-14-99; 8:45 am]

BILLING CODE 8010-01-M