[Federal Register Volume 65, Number 28 (Thursday, February 10, 2000)]
[Notices]
[Pages 6682-6684]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3089]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42388; International Series Release No. 1213; File No. 
SR-Phlx-99-30]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc. Respecting Non-Customized Cross-Rate Foreign Currency 
Option Margin Levels

February 4, 2000.

I. Introduction

    On August 5, 1999, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``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 amend its method of 
calculating initial and maintenance customer margin requirements for 
non-customized cross-rate foreign currency options (``Cross-Rate 
FCOs''). The Exchange amended the proposal on October 26, 1999.\3\
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    \1\ 15 U.S.C. 8s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange requested that the 
Commission approve the existing 4% add-on margin for all non-
customized cross-rate foreign currency options until February 4, 
2000, prior to the thirtieth day after the publication of the notice 
thereof in the Federal Register; provided statistical data to 
substantiate the proposed rule change; and made substantive changes 
to the proposed rule text. See Letter from Nandita Yagnik, Counsel, 
Phlx, to Hong-anh Tran, Attorney, Division of Market Regulation 
(``Division''), Commission, dated October 25, 1999 (``amendment No. 
1'').
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    The Commission published notice of the proposed rule change in the 
Federal Register on November 12, 1999.\4\ The Exchange filed a second 
amendment to the proposal on January 19, 2000.\5\ The Commission 
received no comments on the proposal. This order approves the proposed 
rule change, as amended.
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    \4\ Securities Exchange Act Release No. 42093 (November 3, 
1999), 64 FR 61682 (November 12, 1999) (File No. SR-Phlx-99-30).
    \5\ In Amendment No. 2, the Exchange made technical changes to 
the proposed rule text. Specifically, the Exchange proposes to 
modify the introductory portion of Commentary .16 to Phlx Rule 722 
to clarify that the Commentary .16 methodology applies to non-
customized Cross-Rate FCOs, but not to customized Cross-Rate FCOs. 
The Exchange also proposes replacing the word ``currency'' with the 
term ``currency pair'' throughout Paragraph (c) of Commentary .16, 
and adding the word ``the'' before the word ``base currency'' in 
Paragraph (a) of the same commentary. See Letter from Nadita Yagnik, 
Counsel, Phlx, to Hong-anh Tran, Attorney, Division of Market 
Regulation (``Division''), Commission, dated January 18, 2000 
(``Amendment No. 2'').
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II. Description of the Proposal

    The Exchange proposes to determine the add-on margin levels for all 
non-customized Cross-Rate FCOs using the methodology outlined in 
Commentary .16 to Phlx Rule 722, in lieu of the fixed four percent rate 
that the Exchange currently uses.
    In 1991, the Commission approved the Exchange's proposal to list 
and trade three non-customized Cross-Rate FCOs--German mark/Japanese 
yen, British pound/German mark and British pound/Japanese yen 
options.\6\ The Commission's 1991 order approved a four percent add-on 
margin level for the non-customized Cross-Rate FCOs for a one-year 
period only, because these products were new products and the 
Commission was concerned that the volatility in the underlying 
currencies could change significantly. Accordingly, the Commission 
stated that the Exchange should further analyze the add-on margin 
adequacy, and, within nine months, submit the analysis along with a 
proposed rule change to retain the margin level or establish a new 
level.
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    \6\ See Securities Exchange Act Release No. 29919 (November 7, 
1991), 56 FR 58109 (November 15, 1991) (``1991 Order``). Although 
the Exchange received approval for the British pound/Japanese yen 
Cross-rate FCO, the Exchange has not listed such a contract.
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    Based on the 1991 Order, the Exchange's customer margin

[[Page 6683]]

requirements for short positions for non-customized Cross-Rate FCOs 
equaled the add-on margin of four percent of the current market value 
of the foreign currency underlying the FCO contract, plus 100 percent 
of the market value of the FCO contract, reduced by any ``out-of-the-
money amounts'' \7\ but in no event be less than 100 percent of the 
market value of the FCO contract plus a ``minimum add-on margin 
amount'' \8\ The Exchange represented that this add-on margin level was 
sufficient to cover each non-customized cross-rate product's historical 
price volatility over seven-day intervals (for the July 30, 1990 to 
July 30, 1991 time period) with a confidence level of at least 96 
percent.
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    \7\ For foreign currency put options, ``out-of-the-money-
amounts'' equal the aggregate exercise price of the option minus the 
product of units per foreign currency contract and the closing spot 
price. See Phlx Rule 722(d).
    For foreign currency call options, ``out-of-the-money-amounts'' 
equal the product of units per foreign currency contract and the 
closing spot price minus the aggregate exercise price of the option. 
See id.
    \8\ The minimum add-on margin on any call carried ``short'' in a 
customer's account is equal to \3/4\% of the current market value of 
the underlying FCO contract; the minimum add-on margin on any such 
put option contract is equal to \3/4\% of the option's aggregate 
exercise price amount. See id.
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    Due to an oversight, the Exchange did not file the required 
analysis of the adequacy of the add-on margin nor the proposed rule 
change within nine months of the 1991 Order. Following this discovery, 
the Exchange in 1999 filed a proposed rule change to temporarily codify 
the four percent add-on margin level while it considered a method of 
determining add-on margin, on a permanent basis, for all non-customized 
Cross-Rate FCOs.\9\ The Commission's order approving that proposed rule 
change permitted the Exchange to apply a four percent add-on margin 
level for all non-customized Cross-Rate FCOs for a six-month period 
until November 4, 1999.
    On August 5, 1999, the Exchange filed the current proposed rule 
change to determine the add-on margin levels for non-customized Cross-
Rate FCOs using the methodology outlined in Commentary .16 to Phlx Rule 
722, in lieu of the four percent rate that the Exchange currently uses.
    The Exchange currently uses the Commentary .16 methodology to 
calculate the add-on margin for standardized FCOs (where the base 
currency is denominated in U.S. dollars). The Commentary .16 
methodology bases the add-on margin percentage for a foreign currency 
option on the volatility of the foreign currency underlying the option 
(the ``underlying currency'') relative to the ``trading currency.'' 
\10\ To implement this change, the Exchange proposes to amend the text 
of Commentary .16, and the chart in Rule 722, to clarify that the 
Exchange will set the add-on margin for Cross-Rate FCOs based on all 
five-day price movements of the base currency vis-a-vis the underlying 
currency for the contract.
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    \9\ See Securities Exchange Act Release No. 41365 (May 4, 1999), 
64 FR 25946 (May 13, 1999) SR-Phlx-99-12) (``1999 Order'').
    \10\ The underlying currency is the currency in which a foreign 
currency option settles. The base currency is the currency in which 
premiums are quoted and paid.
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    In particular, the Exchange proposes to review five day price 
movements of the base currency relative to the underlying currency over 
the most recent three year period and would set the add-on margin level 
at a level sufficient to cover those price changes at least 97.5 
percent of the time. If subsequent quarterly reviews show that the 
existing add-on margin level for any non-customized cross-rate FCO 
currency pair provides a confidence level below 97 percent, the 
Exchange would increase the add-on margin requirement for that currency 
pair to a level that would have covered those price movements at a 98 
percent confidence level. If a subsequent quarterly review shows a 
confidence level between 97 percent and 97.5 percent, the add-on margin 
level would remain the same but would be subject to monthly follow-up 
reviews until the confidence level exceeds 97.5 percent for two 
consecutive months (then the Exchange would put it back on the 
quarterly review cycle). If a monthly follow-up review showed that the 
confidence level dropped below 97 percent, the Exchange would increase 
the add-on margin level to a 98 percent confidence level. Generally, if 
any review shows that the confidence level exceeds 98.5 percent, the 
Exchange would reduce the add-on margin level to a 98 percent 
confidence level. But to account for the possibility of unexpectedly 
large price movements, if any review show that a Cross-Rate FCO 
currency paid had a five-day price movement, either positive or 
negative, greater than two times the existing add-on margin level, the 
Exchange would set the add-on margin requirement for that currency pair 
to a 99 percent confidence level (``Extreme Outlier Test''). In 
addition to the routine reviews described above, the Exchange would 
continue to have authority to impose a higher margin level at any time, 
if market conditions so warrant.
    The Exchange filed an amendment to the proposed rule change on 
October 26, 1999. The amendment requested that the Commission grant 
accelerated approval to the amendment so that the Exchange could 
continue to apply the four percent add-on margin for all Cross-Rate FCO 
products until February 4, 2000. This would provide additional time for 
the Commission to consider the proposed rule change, while ensuring 
that trading of these products would continue following November 4, 
1999, when the existing four percent add-on margin would have expired.
    Based on the data supplied by the Exchange on October 26, 1999 for 
the three-year period of July 16, 1996 through July 15, 1999, the 
Commentary .16 methodology would produce add-on margins for British 
pound/Deutsche mark and Deutsche mark/Japanese yen non-customized 
Cross-Rates (which are currently listed on the Exchange) of 3.5 percent 
and 4 percent, respectively, covering 99 percent and 97.5 percent 
confidence level, respectively. The British pound/Deutsche mark FCO 
contract would have been margined at a 99 percent confidence level 
because the extreme outlier test would have applied. The British pound/
Japanese yen Cross-Rate contract, which is currently not listed on the 
Exchange, would have an add-on margin of 5 percent, covering 97.5 
percent confidence level.

III. Discussion

    Upon careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\11\ The Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act, which requires, inter alia, 
that the rules of an exchange promote just and equitable principles of 
trade and facilitate transactions in securities.\12\ In particular, the 
proposed rule change will make the required margin on non-customized 
Cross-Rate FCOs better reflect existing economic circumstances and 
therefore will better correlate the margin requirement with the risk 
associated with holding a short position in a non-customized Cross-Rate 
FCO.
    The Exchange proposes to set the add-on margin based on the five-
day price movements (excluding weekends) of the underlying currency 
relative to the base currency over the most recent three-year period, 
by setting the add-on margin percentage at a level that would cover 
those price movements at a specified confidence level, typically 97.5 
percent.

[[Page 6684]]

    The Commission finds that the use of the Commentary .16 methodology 
to set add-on margins for non-customized Cross-Rate FCOs, in lieu of 
the fixed four percent requirement the Exchange currently uses, 
potentially provides a more economically meaningful margin. The 
currencies involved in the non-customized Cross-Rate FCOs that the 
Exchange is authorized to list and trade--the British pound, Deutsche 
mark, and Japanese yen--are all relatively stable currencies and it is 
reasonable to assume that those currencies' future volatility will be 
linked to their past volatility. Also, the Exchange has the authority 
to apply a higher add-on margin than required by the Commentary .16 
methodology, when appropriate.\13\ Use of the Commentary .16 
methodology further would promote efficiency because the Exchange will 
not have to file a proposed rule change with the Commission each time 
Commentary .16 methodology changes the add-on margin levels.
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    \11\ In approving this rule, the Commission has considered the 
proposal's impact on efficiency, competition, and capital formation. 
15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f(b)(5).
    \13\ See Phlx Rule 722(i)(8).
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    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. In 
Amendment No. 2, the Exchange made two general technical changes to 
Commentary .16 to Phlx Rule 722, by clarifying that Commentary .16 was 
applicable to non-customized Cross-Rate FCOs but not to customized 
Cross-Rate FCSs, and by clarifying that paragraph (c) of Commentary .16 
focuses on currency pairs, i.e., movements of currencies vis-a-vis each 
other. The amendment did not raise any new regulatory issues. 
Accordingly, the Commission believes that there is good cause to 
approve Amendment No. 2 to the proposal on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2, including whether the amendment 
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 in the Commission's 
Public Room. Copies of the 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-99-30 and should be submitted by March 
2, 2000.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-Phlx-99-30) is approved, as 
amended.

    \14\ 15 U.S.C. 78s(b)(2).

    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. 00-3089 Filed 2-9-00; 8:45 am]
BILLING CODE 8010-01-M