[Federal Register Volume 63, Number 140 (Wednesday, July 22, 1998)]
[Notices]
[Pages 39338-39341]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-19439]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40208; File No. SR-Phlx-97-63]
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Order Granting Approval of Proposed Rule Change and Amendment No. 1
Thereto and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 2 to Proposed Rule Change To Adopt a New Method of
Calculating Initial and Maintenance Margin Requirements for Foreign
Currency Options
July 15, 1998.
I. Introduction
On December 22, 1997, the Philadelphia Stock Exchange, Inc.
(``Phlx'' or ``Exchange'') submitted to 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 that would adopt a new method of
[[Page 39339]]
calculating initial and maintenance customer margin requirements for
foreign currency options under Phlx Rule 722. 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
Phlx filed Amendment No. 1 to the proposed rule change on April 6,
1998.\3\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Amendment No. 1 to Phlx 97-63 and cover letter from
Nandita Yagnik, Counsel, Phlx, to Sharon Lawson, Senior Special
Counsel, Division of Market Regulation (``Division''), Commission,
dated April 3, 1998 (``Amendment No. 1''). Amendment No. 1
incorporates the original proposed rule change and amendments to the
original proposal into a Rule 19b-4 notice. In Amendment No. 1, the
Phlx proposes to amend its original proposal to: (1) conduct margin
reviews quarterly rather then 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;
and (3) revise Rule 722 to exclude the actual margin level for each
currency and instead, to distribute membership circulars announcing
the margin levels that are derived pursuant to proposed Commentary
.16 of Rule 722. Amendment No. 1 also incorporates changes
originally proposed in a letter from Michele R. Weisbaum, Vice
President and Associate General Counsel, Phlx, to Sharon Lawson,
Senior Special Counsel, Division, Commission, dated February 19,
1998.
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On April 20, 1998, the proposed rule change and Amendment No. 1
were published for comment in the Federal Register.\4\ No comments were
received on the proposal. On June 1, 1998, the Phlx filed Amendment No.
2 to the proposed rule change.\5\ This order approves the amended
proposed rule change including Amendment No. 2 to the proposed rule
change on an accelerated basis.
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\4\ See Securities Exchange Act Release No. 39856 (April 13,
1998) 63 FR 19554.
\5\ See Letter from Nandita Yagnik, Counsel, Phlx, to Sharon
Lawson, Senior Special Counsel, Division, Commission, dated May 29,
1998 (``Amendment No. 2''), In Amendment No. 2, the Phlx represents
that it will inform its membership and the public via memoranda and
circulars of the margin levels for each currency option immediately
following the quarterly reviews described in proposed Commentary .16
to Rule 722.
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III. Description of the Proposal
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.\6\ 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.\7\ Thus, the margin level for foreign currency options
has been set based on the historical pricing information for all
foreign currencies considered together. 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.
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\6\ 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%.
\7\ 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).
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In response to the Commission's recommendation that the Exchange
should set margin levels for each foreign currency option independently
and specify its procedure for setting these levels in its rules, the
Phlx is proposing to determine the applicable add-on percentage by
reviewing, on a quarterly calendar basis,\8\ 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'').
Pursuant to the proposal, 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.\9\ 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 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 during the most recent 3 year period. Finally, in
order to account for large price movements outside the established
margin level, if the quarterly review shows that the currency had a
price movement, either positive or negative, greater than two times the
margin level during the most recent 3 year period, the margin
requirement would be set at a level to meet a 99% confidence level
(``Extreme Outlier Test'').
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\8\ 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 martin reviews to be conducted
quarterly, promptly following the 15th of January, April, July and
October of each year. See Amendment No. 1, supra note 4.
\9\ 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.\10\ At this time, the margin
levels for Tier, I, II, and III customized cross rate options will
remain the same.
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\10\ See Phlx Rule 722(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. The Exchange also will inform its
membership and the pubic via memoranda and circulars of the margin
levels for each foreign currency option immediately following the
quarterly reviews described in proposed Commentary .16 of Rule 722.\11\
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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\11\ See Amendment No. 2, supra note 6.
\12\ As initially proposed, all changes to the add-on percentage
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. Because the actual
margin levels will not be set forth in Phlx Rule 722 pursuant to
Amendment No. 1 such changes will not trigger a requirement to
submit a Section 19(b)(3)(A) filing to the Commission. Instead,
changes to the margin levels as a result of the new calculation
methodology will be announced to the Phlx membership via circular,
as discussed above. Telephone conversation between Nandita Yagnik,
Counsel, Phlx, and Deborah Flynn, Division, Commission, on April 13,
1998.
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III. Discussion
The Commission finds that the proposed rule change, as amended,
[[Page 39340]]
relating to the calculation of customer margin requirements for foreign
currency options is consistent with the requirements of Section 6 of
the Act \13\ and the rules and regulations thereunder applicable to a
national securities exchange.\14\ Specifically, the Commission believes
that the proposed rule change is consistent with and furthers the
objectives of Section 6(b)(5) of the Act \15\ in that the amendment and
codification of the methodology used to calculate initial and
maintenance customer margin requirements for foreign currency options
should remove impediments to and perfect the mechanism of a free and
open market in a manner consistent with the protection of investors and
the public interest.
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\13\ 15 U.S.C. 78f.
\14\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\15\ 15 U.S.C. 78f(b)(5).
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The Commission believes that the Exchange's proposed methodology
for determining customer margin requirements for each foreign currency
independently, rather than determining one margin level from the
combined historical volatilities of all underlying foreign currencies
together, is reasonable and should adequately account for the
historical and potential volatility of each of the traded foreign
currencies. By setting margin levels for each foreign currency option
separately, the Commission believes that the margin requirements
established pursuant to this approach will better reflect the specific
risks associated with each individual foreign currency option.
As discussed above, the Exchange will calculate the applicable add-
on percentage by reviewing, on a quarterly basis, five-day price
changes over the preceding three-year period for each underlying
currency and will set the add-on percentage at a level sufficient to
cover those price changes at least 97.5% of the time. The Commission
believes that this methodology should allow the Phlx to reasonably
determine an appropriate add-on percentage for each individual
currency. In addition, the Exchange must conduct reviews at least
quarterly of the volatility of each foreign currency and must take
immediate steps to increase the existing customer margin requirements
if the existing margin levels are deemed to be inadequate. The Extreme
Outlier Test will also ensure adequate margin by monitoring for large
currency price movements that are outside the normal range. As
discussed above, the Extreme Outlier Test would require margin
confidence levels to be increased to 99% if the underlying currency has
had a price movement of greater than two times the margin level over
the last 3 years. Moreover, the Commission notes that the Exchange
continues to have authority to conduct reviews of foreign currency
margin levels at any time that market conditions warrant. The
Commission fully expects the Exchange to exercise this authority to
review the adequacy of existing foreign currency margin levels during
times of significant volatility in the foreign currency markets, in
addition to the routine quarterly reviews. The new margin methodology,
coupled with the Extreme Outlier Test, routine quarterly and as-needed
reviews, has been designed to reduce risks arising from inadequate
margin levels for foreign currency options and should help to ensure
adequate margin is required to cover contract obligations. Accordingly,
the Commission believes that consistent with Section 6(b)(5) of the
Act,\16\ the Phlx's proposal will serve to protect investors and the
public interest by reducing the risks that can arise from inadequate
margin levels.
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\16\ 15 U.S.C. 78f(b)(5).
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The Commission notes that the calculation methodology, rather than
the actual margin level for each currency, will be set forth in
Commentary .16 to Rule 722. Instead, the Phlx proposes to distribute
circulars to its membership periodically to announce the margin levels
derived pursuant to the proposed methodology. As discussed above, the
Phlx proposes to distribute circulars to its membership announcing the
margin levels derived pursuant to Commentary .16 of Rule 722,
immediately following is quarterly reviews of the applicable add-on
percentages, and at any time that a particular margin level changes.
The Commission believes that providing information about margin
requirements initially, on a quarterly basis, and whenever there is a
change in a margin level should ensure that Exchange members and others
with a interest in trading foreign currency options listed on the Phlx
are provided with adequate notice of the applicable margin
requirements.
The Commission finds good cause for approving Amendment No. 2 to
the proposed rule change prior to the thirtieth day after publication
in the Federal Register. The Commission notes that Amendment No. 2
merely increases the frequency of distribution of circulars informing
the Exchange's membership of the margin levels for each foreign
currency option. As discussed above, the Commission believes that
issuing circulars immediately following the proposed quarterly reviews
of margin levels strengthens the Phlx's proposal by ensuring interested
Exchange members and other market participants receive adequate notice
of the applicable add-on percentages. For these reasons, the Commission
believes that the proposed Amendment No. 2 raises no issues of
regulatory concern. Accordingly, the Commission finds that good cause
exists, consistent with Sections 19(b) and 6(b)(5) of the Act,\17\ to
accelerate approval of Amendment No. 2 to the proposed rule change.
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\17\ 15 U.S.C. 78s(b) and 78f(b)(5).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2, including whether Amendment No. 2
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
submissions, 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 at the Commission's
Public Reference Room, 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 August 12, 1998.
Conclusion
For the foregoing reasons, the Commission finds that the Phlx's
proposal, as amended, to change Phlx's method of calculating initial
and maintenance margin requirements for foreign currency options under
Rule 722 is consistent with the requirements of the Act and the rules
and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\18\ that the proposed rule change (SR-Phlx-97-63), as amended, is
approved.
\18\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulations,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12).
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[[Page 39341]]
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-19439 Filed 7-21-98; 8:45 am]
BILLING CODE 8010-01-M