[Federal Register Volume 78, Number 204 (Tuesday, October 22, 2013)]
[Notices]
[Pages 62722-62726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-24631]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70619; File No. SR-FINRA-2013-027]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Granting Approval of a Proposed Rule Change
Relating to Amendments to FINRA Rules 2360 and 4210 in Connection With
OCC Cleared Over-the-Counter Options
October 7, 2013.
I. Introduction
On June 28, 2013, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to provide for the treatment of over-the-counter
(``OTC'') options cleared by The Options Clearing Corporation (``OCC'')
under FINRA's rules. The proposed rule change was published for comment
in the Federal Register on July 9, 2013.\3\ The Commission received one
comment letter on the proposal.\4\ This order approves the proposed
rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 69913 (July 2,
2013), 78 FR 41149 (``Notice'').
\4\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Alessandro Cocco, Managing Director, J.P. Morgan Clearing
Corporation, dated July 30, 2013 (``JP Morgan Clearing Letter'').
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II. Description
On December 14, 2012, the Commission approved new rules established
by OCC to clear and guarantee OTC options on the S&P 500 index.\5\
FINRA seeks to amend FINRA Rules 2360 (Options) and 4210 (Margin
Requirements) to provide for the application of existing FINRA rules to
[[Page 62723]]
OTC options cleared by the OCC (``OCC Cleared OTC Options''). FINRA
notes that, at this time, the OCC has only been approved by the
Commission to clear OTC options on the S&P 500 index.\6\ However, FINRA
states that the proposed rule change is intended to apply to any OCC
Cleared OTC Option.\7\
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\5\ See Securities Exchange Act Release No. 68434 (December 14,
2012), 77 FR 75243 (December 19, 2012) (Order Approving Proposed
Rule Change, as Modified by Amendment No. 1 Thereto, and Notice of
No Objection to Advance Notice, Modified by Amendment No. 1 Thereto,
Relating to the Clearance and Settlement of Over-the-Counter
Options) (``OCC Notice'').
\6\ See Notice, supra note 3, at 41151. See also OCC Notice,
supra note 5.
\7\ See Notice, supra note 3, at 41151.
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A. Amendments to Rule 2360 (Options)
FINRA Rule 2360 covers, among other things, the definitions,
position limits, exercise limits, reporting, suitability, and
disclosure requirements related to options and options trading.\8\
Under FINRA Rule 2360, options are generally classified as either
standardized,\9\ conventional,\10\ or as a FLEX Equity Option.\11\
FINRA states that, historically, all standardized options have been
traded on an exchange, and all conventional options have traded
OTC.\12\ FINRA proposes to amend Rule 2360 to treat OCC Cleared OTC
Options as conventional options for purposes of the rule.\13\ FINRA
states that FINRA Rule 2360 generally treats the categories of options
(i.e., standardized, conventional, FLEX Equity Options) the same,
except in the case of position limits, reporting, and the delivery of
disclosure documents.\14\ FINRA believes that in these enumerated areas
it is appropriate to treat OCC Cleared OTC Options as conventional
options.\15\ FINRA states that OCC Cleared OTC Options will otherwise
be subject to the same sales practice and other requirements that apply
to transactions in any category of options (including, among other
requirements, suitability, approval of account opening and
supervision).\16\
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\8\ See FINRA Rule 2360.
\9\ See FINRA Rules 2360(a)(31) (defining ``standardized equity
option'' as ``any equity options contract issued, or subject to
issuance by, The [OCC] that is not a FLEX Equity Option'') and
2360(a)(32) (defining ``standardized index options'' as ``any
options contract issued, or subject to issuance, by The [OCC] that
is based upon an index'').
\10\ See FINRA Rules 2360(a)(9) (defining ``conventional
option'' as ``any option contract not issued, or subject to
issuance, by The [OCC]'') and 2360(a)(8) (defining ``conventional
index option'' as ``any options contract not issued, or subject to
issuance, by The [OCC] that, as of the trade date, overlies a basket
or index of securities that: (A) Underlies a standardized index
option; or (B) Satisfies the following criteria: (i) The basket or
index comprises 9 or more equity securities; (ii) No equity security
comprises more than 30% of the equity security component of the
basket's or index's weighting; and (iii) Each equity security
comprising the basket or index: (a) Is a component security in
either the Russell 3000 Index or the FTSE All-World Index Series; or
(b) has (1) market capitalization of at least $75 million or, in the
case of the lowest weighted component securities in the basket or
index that in the aggregate account for no more than 10% of the
weight of the index, $50 million; and (2) trading volume for each of
the preceding six months of at least one million shares or, in the
case of each of the lowest weighted component securities in the
basket or index that in the aggregate account for no more than 10%
of the weight of the index, 500,000 shares'').
\11\ See FINRA Rule 2360(a)(16) (defining ``FLEX Equity Option''
as ``any options contract issued, or subject to issuance by, The
[OCC] whereby the parties to the transaction have the ability to
negotiate the terms of the contract consistent with the rules of the
exchange on which the options contract is traded'').
\12\ See Notice, supra note 3, at 41150. FLEX Equity Options
are, by definition, traded on an exchange. See supra note 11.
\13\ See Notice, supra note 3, at 41150.
\14\ See Notice, supra note 3, at 41150. FINRA states that FINRA
Rule 2360(b)(4) specifies exercise limits through incorporating by
reference options position limits under the rule, and that the
provision does not further differentiate by category of option.
Accordingly, the treatment of an option with respect to its position
limit is the same with respect to exercise limits. See Notice, supra
note 3, at 41150, n. 7.
\15\ See Notice, supra note 3, at 41152.
\16\ Id.
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Specifically, FINRA proposes to amend Rule 2360 to define an ``OCC
Cleared OTC Option'' as ``any put, call, straddle or other option or
privilege that meets the definition of an `option' under Rule
2360(a)(21) and is cleared by The [OCC], is entered into other than on
or through the facilities of a national securities exchange, and is
entered into exclusively by persons who are `eligible contract
participants' as defined in the Exchange Act.'' \17\ In addition, FINRA
proposes to amend the definitions of ``conventional option'' and
``conventional index option'' to include OCC Cleared OTC Options,\18\
and to amend the definitions of ``standardized equity option,''
``standardized index option,'' and ``FLEX Equity Option'' to
specifically exclude OCC Cleared OTC Options.\19\ FINRA also proposes
to amend the definition of ``expiration date'' to reflect that the
expiration date of OCC Cleared OTC Options may be customized by the
parties to the trade in accordance with the rules of the OCC, rather
than fixed by the OCC's rules.\20\
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\17\ See proposed FINRA Rule 2360(a)(19).
\18\ See proposed FINRA Rules 2360(a)(8) and (9).
\19\ See proposed FINRA Rules 2360(a)(16), (32), and (33).
\20\ See proposed FINRA Rule 2360(a)(14).
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In addition, FINRA proposes to amend Rule 2360 to provide that the
Characteristics and Risks of Standardized Options, also known as the
Options Disclosure Document (``ODD''), and the Special Statement for
Uncovered Option Writers (``Special Written Statement''), as further
described below, will not be required to be delivered to customers
effecting transactions in OCC Cleared OTC Options, which is consistent
with the treatment of conventional options under Rule 2360.\21\
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\21\ See proposed FINRA Rules 2360(b)(11)(A)(i) and (ii) and
2360(b)(16)(D).
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Finally, FINRA proposes to make technical, non-substantive changes
to FINRA Rule 2360 in order to renumber certain provisions to account
for the proposed new rule text and to reflect FINRA Manual style
convention.
1. Position Limits
FINRA Rule 2360(b)(3)(A) imposes position limits on the number of
options contracts in each class on the same side of the market (i.e.,
aggregating long calls and short puts, or long puts and short calls)
that can be held or written by a member, a person associated with a
member, a customer or a group of customers acting in concert.\22\ In
general, position limits for standardized equity options are determined
according to a five-tiered system in which more actively traded stocks
with larger public floats are subject to higher position limits.\23\
FINRA Rule 2360 provides that the position limit established by the
rules of an options exchange for a particular equity option is the
applicable position limit for purposes of FINRA Rule 2360.\24\
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\22\ See Notice, supra note 3, at 41150.
\23\ Id. See also FINRA Rule 2360(b)(3)(A). The position limits
for standardized and conventional options overlying specified
exchange-traded funds are established in FINRA Rule 2360,
Supplemental Material .03. See Notice, supra note 3, at41150, n.10.
\24\ See Notice, supra note 3, at 41150. See also FINRA Rule
2360(b)(3)(A).
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In general, conventional equity options are subject to the same
position limits as the standardized equity options overlying the same
security.\25\ In instances where the equity security is not subject to
a standardized option, the applicable position limit for the
conventional option is the lowest tier (25,000 contracts) unless the
security is in an index designated by FINRA that meets the volume and
float criteria specified by FINRA \26\ or the member can otherwise
demonstrate to FINRA's Market Regulation Department that the underlying
security meets the standards for a higher position limit.\27\
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\25\ See Notice, supra note 3, at 41150. See also FINRA Rule
2360(b)(3)(A)(viii). There are differences in the available equity
option hedge exemptions for standardized options and conventional
options. See Notice, supra note 3, at 41150, n.11. See also Rule
2360(b)(3)(A)(vii).
\26\ See e.g., Notice to Members 07-03 (January 2007) (which
provides that the FTSE All-World Index Series is a designated index
for this purpose) and Regulatory Notice 13-20 (May 2013) (which
provides that the NASDAQ Global Large Mid Cap Index is an additional
designated index for this purpose).
\27\ See Notice, supra note 3, at 41150. See also FINRA Rule
2360(b)(3)(A)(viii).
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[[Page 62724]]
Conventional index options are not subject to position limits while
standardized index options are subject to the position limit as
specified on the exchange on which the option trades.\28\ Position
limits for FLEX Equity Options are governed by the rules of the
exchange on which such options trade.\29\
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\28\ See Notice, supra note 3, at 41150. See also Notice to
Members 94-46 (June 1994) (relating to conventional index options)
and FINRA Rule 2360(b)(3)(B) (relating to standardized index
options).
\29\ See Notice, supra note 3, at 41150. See also FINRA Rule
2360(b)(2).
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Position limits for standardized equity options contracts of the
put class and call class on the same side of the market overlying the
same security are not aggregated with the conventional equity options
contracts or FLEX Equity Options contracts overlying the same security
on the same side of the market.\30\
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\30\ See Notice, supra note 3, at 41151. See also FINRA Rule
2360(b)(3)(A)(viii). Because conventional index options are not
subject to any position limits, FINRA Rule 2360 does not address
aggregation of conventional index options with standardized index
options overlying the same index. See Notice, supra note 3, at
41151, n. 16.
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FINRA proposes that OCC Cleared OTC Options be subject to the
position limits applicable to conventional options.\31\ FINRA states
that OCC Cleared OTC Options are similar to FLEX Equity Options because
they are cleared by the OCC, are non-uniform, and give investors the
ability to designate certain terms of the option.\32\ However, FINRA
believes that OCC Cleared OTC Options are more analogous to
conventional options, since they are not traded on an exchange.\33\
FINRA also notes that that the counterparties to OCC Cleared OTC
Options must be ``eligible contract participants'' as defined in the
Act \34\ and are thus more sophisticated investors likely to be aware
of the risks of options trading.\35\
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\31\ See Notice, supra note 3, at 41151.
\32\ Id.
\33\ Id.
\34\ See 15 U.S.C. 78c(a)(65) which states that an ``eligible
contract participant has the same meaning as in section 1a of the
Commodity Exchange Act.'' The Commodity Exchange Act details the
requirements for eligibility as an ``eligible contract participant''
which generally require a sufficient regulated status or a specified
minimum amount of assets. See 7 U.S.C. 1(a)(18). See also the OCC
By-Laws, Article XVII, Section 6(f)(iv) (requiring that where a
transaction in an OCC Cleared OTC Option is effected for the account
of a customer, the customer is an ``eligible contract
participant''); and OCC Notice, supra note 5 at 75244.
\35\ See Notice, supra note 3, at 41151.
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Accordingly, pursuant to the proposal, OCC Cleared OTC Options on
an equity security will be subject to the position limit of the greater
of (i) 25,000 contracts or (ii) any standardized equity options
position limit for which the underlying security qualifies, and OCC
Cleared OTC Options will not be aggregated with any standardized option
counterpart.\36\ OCC Cleared OTC Options on an index, consistent with
the treatment of conventional index options, will not be subject to any
position limits.
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\36\ Id.
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2. Reporting Obligations
FINRA Rule 2360(b)(5)(A)(i)(a) generally requires all members to
report to FINRA with respect to each account that has established an
aggregate position of 200 or more conventional option contracts
(whether long or short) of the put class and the call class on the same
side of the market covering the same underlying security or index.\37\
Such reporting requirement with respect to positions in conventional
index options, however, applies only to an option that is based on an
index that underlies, or is substantially similar to an index that
underlies, a standardized index option.\38\ FINRA Rule
2330(b)(5)(A)(i)(b) generally requires only those members that are not
members of the options exchange upon which the standardized options are
listed to report to FINRA with respect to each account that has
established an aggregate position of 200 or more conventional option
contracts (whether long or short) of the put class and the call class
on the same side of the market covering the same underlying security or
index.\39\ Because there is no comparable exchange regulatory regime
that applies to members trading OCC Cleared OTC Options, FINRA believes
that OCC Cleared OTC Options should be treated as conventional options
so that all members must report positions of 200 or more contracts on
the same side of the market covering the same underlying security or
index to FINRA, as is the case for all conventional options.\40\
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\37\ Id.
\38\ Id. See also FINRA Rule 2360(b)(5)(A)(i)(a).
\39\ See Notice, supra note 3, at 41151.
\40\ Id.
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3. Disclosure Documents
FINRA Rule 2360(b)(11)(A)(1) requires members to deliver the ODD to
customers at or prior to the time the customer's account is approved
for trading options issued by the OCC, and thereafter to deliver to
customers applicable amendments to the ODD.\41\ The ODD describes
standardized options and FLEX Equity Options, but does not address OTC
options, and members are not required to deliver the ODD with respect
to such options.\42\ In addition, FINRA Rule 2360(b)(11)(A)(2) requires
members to deliver the Special Written Statement, which describes the
risks related to writing uncovered short options, to customers approved
to write uncovered short options transactions.\43\ Similar to the ODD
delivery requirements, the requirement to deliver the Special Written
Statement only applies to transactions in options issued by the OCC
(historically listed options).\44\
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\41\ Id.
\42\ See Notice, supra note 3, at 41151-41152.
\43\ See Notice, supra note 3, at 41152.
\44\ See FINRA Rule 2360(b)(11)(A)(2). See also Notice, supra
note 3, at 41152.
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Pursuant to the proposal, and consistent with the treatment of
transactions in conventional options, FINRA members will not be
required to deliver the ODD or Special Written Statement to customers
that engage in transactions in OCC Cleared OTC Options.\45\ FINRA
states that it believes such delivery requirements are unnecessary
because the counterparties to OCC Cleared OTC Options must be
``eligible contract participants'' as defined in the Act,\46\ and thus,
are more sophisticated investors who are likely to be aware of the
risks associated with trading OTC options.\47\
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\45\ Id.
\46\ See supra note 34.
\47\ See Notice, supra note 3, at 41152.
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B. Amendments to Rule 4210 (Margin Requirements)
FINRA Rules 4210(f)(2) and 4210(g) set forth the strategy-based
margin and portfolio margin requirements for transactions in
options.\48\ FINRA states that, in general, the margin requirements for
options listed on an exchange (i.e., cleared and guaranteed by the OCC)
are lower than the margin requirements for conventional options (i.e.,
OTC options).\49\ For the purposes of margin requirements, FINRA
proposes to treat OCC Cleared OTC Options the same as other cleared and
guaranteed options (historically ``listed options''), in light of the
clearing and guaranteeing functions performed by the OCC.\50\ FINRA
notes that the proposed beneficial margin treatment for OCC Cleared OTC
Options may only be applied by a member after the OTC
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option has been accepted for clearing and is guaranteed by the OCC.\51\
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\48\ Id.
\49\ Id. See also FINRA Rules 4210(f)(2)(A)(xxiv) and
4210(g)(2)(A) for the definitions of ``listed'' and ``listed
option,'' respectively, and FINRA Rules 4210(f)(2)(A)(xxvii) and
4210(g)(2)(H) for the definitions of ``OTC'' and ``unlisted
derivative,'' respectively.
\50\ See Notice, supra note 3, at 41152.
\51\ Id.
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FINRA proposes to amend certain existing definitions under FINRA
Rule 4210 in order to provide for the same margin treatment for OCC
Cleared OTC Options as other cleared and guaranteed options.
Specifically, FINRA proposes to amend the definition of ``listed'' in
Rule 4210(f)(2)(A)(xxiv) to include OCC Cleared OTC Options and to
amend the definition of ``OTC'' in Rule 4210(f)(2)(A)(xxvii) to
specifically exclude OCC Cleared OTC Options.\52\ FINRA also proposes
conforming amendments to Rule 4210(g)(2)(A) regarding portfolio margin
requirements to provide that a ``listed option'' includes options
issued and guaranteed by a registered clearing agency, including OCC
Cleared OTC Options, and to Rule 4210(g)(2)(H) to provide that an
``unlisted derivative'' includes, among other things, an option that is
neither traded on a national securities exchange, nor issued and
guaranteed by a registered clearing agency, and shall not include an
OCC Cleared OTC Option.\53\
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\52\ See Notice, supra note 3, at 41153.
\53\ Id.
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III. Comment Letter
As previously noted, the Commission received one comment letter on
the proposal.\54\ The commenter expresses support for FINRA's proposal
to treat OCC Cleared OTC Options the same as other cleared and
guaranteed options under FINRA Rule 4210 governing margin
requirements.\55\ The commenter states that it concurs with FINRA's
belief that the risk posed by OCC Cleared OTC Options is similar to
that of other cleared and guaranteed options, and that it is,
therefore, appropriate to afford OCC Cleared OTC Options the same
margin treatment as listed options.\56\
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\54\ See supra note 4.
\55\ See JP Morgan Clearing Letter, supra note 4, at 1.
\56\ Id.
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IV. Discussion
After careful review of the proposed rule change and the comment
letter received, the Commission finds that the proposed rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder that are applicable to a national securities
association.\57\ In particular, the Commission finds that the proposed
rule change is consistent with Section 15A(b)(6) of the Act,\58\ which
requires, among other things, that the rules of a national securities
association be designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in facilitating
transactions in securities, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest.
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\57\ In approving the proposed rule change, the Commission has
considered the proposed rule change's impact on efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f).
\58\ 15 U.S.C. 78o-3(b)(6)
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The Commission finds the proposed treatment of OCC Cleared OTC
Options under FINRA Rule 2360 is consistent with the Act. FINRA
represents that, other than with respect to the requirements relating
to position limits, reporting, and the delivery of disclosure
documents, OCC Cleared OTC Options will be subject to the same options
sale practice and other requirements (such as account opening
procedures and standards for supervision and suitability) as apply to
all categories of options.\59\ FINRA also notes that the proposed rule
change fosters innovation in the market by accommodating a new product
in OCC Cleared OTC Options while balancing the need to protect
investors and the public interest by regulating such product in a
rational regulatory framework.
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\59\ See supra notes 14-16 and accompanying text.
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As previously stated by the Commission, position limits are
intended to prevent the establishment of options positions that can be
used or might create incentives to manipulate or disrupt the underlying
market so as to benefit the options position, are designed to minimize
the potential for mini-manipulation and for corners or squeezes of the
underlying market, and serve to reduce the possibility for disruption
of the options market itself, especially in illiquid options
classes.\60\ FINRA states that its proposal for OCC Cleared OTC Options
is consistent with the purposes of position limits highlighted above.
Additionally, FINRA notes that it uses the options position information
reported to it as part of its ongoing market surveillance operations
and to support its monitoring efforts for any market manipulation or
disruption related to the accumulation or disposition of large options
positions, and that the information reported enables FINRA to identify
large positions held or written by a member that could pose a financial
risk to the member or its clearing firm.\61\ As such, the Commission
finds that FINRA's proposal to subject OCC Cleared OTC Options to the
position limits and reporting requirements applicable to conventional
options is consistent with the Act.
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\60\ See Securities Exchange Act Release No. 40087 (June 12,
1998), 63 FR 33746, 33748 (June 19, 1998) (Order Granting Approval
and Notice of Filing and Order Granting Accelerated Approval to
Amendment No.1 and Amendment No. 2 to Proposed Rule Change Relating
to an Amendment to the NASD's Options Position Limit Rule File No.
SR-NASD-98-23).
\61\ See Notice, supra note 3, at 41151.
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With respect to the delivery of disclosure documents, the
Commission finds that it is consistent with the Act to treat
transactions in OCC Cleared OTC Options consistent with conventional
options and to not require delivery of the ODD or Special Written
Statement to customers transacting in OCC Cleared OTC Options. As noted
by FINRA, OTC options are not addressed in the ODD. Furthermore, the
counterparties to transactions in OCC Cleared OTC Options must be
``eligible contract participants'' as defined in the Act and,
therefore, are more sophisticated investors likely to be aware of the
risks of options trading.\62\
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\62\ See supra note 34.
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Finally, the Commission finds the proposed margin treatment of OCC
Cleared OTC Options under FINRA Rule 4120 is consistent with the Act.
As noted by FINRA, the margin requirement for options listed on an
exchange (and cleared and guaranteed by the OCC) generally is lower
than the margin requirement for OTC options (not cleared or guaranteed
by the OCC). As noted by FINRA, the reasons underlying the more
favorable margin treatment for listed (and OCC cleared and guaranteed)
options apply with equal force to OCC Cleared OTC Options because the
clearing and guaranteeing functions performed by the OCC reduce the
counterparty credit risk of these OTC options, likening them to the
same level of risk as listed options.\63\
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\63\ The Commission notes that the sole comment letter received
on the proposal supported FINRA's proposed margin treatment of OCC
Cleared OTC Options and agreed with FINRA that the risks related to
OCC Cleared OTC Options are similar to the risks related to listed
options, and, thus, similar margin requirements would be
appropriate. See JP Morgan Clearing Letter, supra note 4.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\64\ that the proposed rule change (SR-FINRA-2013-027) be, and
hereby is, approved.
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\64\ 15 U.S.C. 78s(b)(2).
[[Page 62726]]
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For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\65\
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\65\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-24631 Filed 10-21-13; 8:45 am]
BILLING CODE 8011-01-P