32726 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations

2 47 FR 18619–18620 (April 30, 1982).

3Pub. L. No. 104–13, 109 Stat. 163 (1995).

short option positions and that,

subsequent to the adoption of Rule

1.17(c)(5)(iii), the SPAN margining

system was developed. SPAN uses

option pricing models to calculate the

theoretical gains and losses on an option

at various market prices of the

underlying commodity and is a

significant improvement in measuring

the risk of an option. All U.S.

commodity exchanges and many foreign

exchanges have adopted SPAN to assess

option risk. In addition, SPAN

recognizes trading strategies in which

short option positions are risk reducing

and SPAN has been tested and proven

to assess adequately the risk in the

customer’s portfolio.

B. Large Trader Positions

Commenters also noted that the

commodity exchanges closely monitor

large trader positions in each contract

market to identify those market

participants that may pose a financial

risk to the FCM carrying their account.

This includes option positions at

clearing firms carrying option

customers’ accounts. Safeguards such as

intraday variation margin calls,

continuous monitoring of the markets

and direct contact with the FCMs alert

the exchanges to any potential

problems.

C. Financial Surveillance

Commenters further noted that

additional protection exists in the form

of capital and segregation requirements

for FCMs. Commission regulations

require FCMs not only to maintain a

minimum amount of adjusted net

capital, but also to maintain a sufficient

amount of excess adjusted net capital. In

the event an FCM’s adjusted net capital

falls below an early warning level,

generally 150% of the minimum dollar

amount (e.g., 6% of customer segregated

funds), the FCM is required to notify the

Commission within five (5) business

days. The FCM must continue filing

financial reports monthly until the

FCM’s adjusted net capital is at or above

the early warning level for three

consecutive months. In calculating

adjusted net capital, FCMs must deduct

deficits and any undermargined

amounts in customer accounts. With

respect to the segregation requirements,

an FCM is required to deposit customer

funds in accounts designated for the

benefit of customers. The FCM must

also make a daily calculation showing

whether there are sufficient funds in

segregated accounts.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA)

5 U.S.C. 601 et seq., requires that

agencies, in proposing rules, consider

the impact of those rules on small

businesses. The Commission has

previously determined that FCMs are

not ‘‘small entities’’ for purposes of the

RFA.2 Therefore, the Chairperson, on

behalf of the Commission, hereby

certifies, pursuant to 5 U.S.C. 605(b),

that the action taken herein will not

have a significant economic impact on

a substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of

1995 3 imposes certain requirements on

federal agencies (including the

Commission) in connection with their

conducting or sponsoring any collection

of information as defined by the

Paperwork Reduction Act. While this

proposed rule has no burden, the group

of rules (3038–0024) of which this is a

part has the following burden:

Average burden hours per response:

128.

Number of respondents: 235.

Frequency of response: Monthly.

Copies of the OMB-approved

information collection package

associated with this rule may be

obtained from the Desk Officer, CFTC,

Office of Management and Budget,

Room 10202, NEOB Washington, DC

20503, (202) 395–7340.

List of Subjects in 17 CFR Part 1

Brokers, Commodity futures,

Consumer protection, Net capital

requirements, Reporting and

recordkeeping requirements.

In consideration of the foregoing and

pursuant to the authority contained in

the Commodity Exchange Act and, in

particular, Sections 4f, 4g and 8a(5)

thereof, 7 U.S.C. 6d, 6g and 12a(5), the

Commission hereby amends Chapter I of

Title 17 of the Code of Federal

Regulations as follows:

PART 1—GENERAL REGULATIONS

UNDER THE COMMODITY EXCHANGE

ACT

1. The authority citation for part 1

continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a,

6b, 6c, 6d, 6e, 6f, 6g, 6h, 6I, 6j, 6k, 6l, 6m,

6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a–1, 16, 16a, 19, 21, 23, and 24.

§ 1.17 [Amended]

2. Section 1.17(c)(5)(iii) is removed

and reserved.

Issued in Washington, DC on June, 10,

1998, by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 98–15975 Filed 6–15–98; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Parts 1 and 33

Final Rulemaking Permitting FuturesStyle Margining of Commodity Options

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rule.

SUMMARY: The Commodity Futures

Trading Commission (‘‘Commission’’) is

repealing Commission Regulation

33.4(a)(2) and amending Commission

Regulation 33.7(b). The Commission

also is implementing technical

amendments to its regulations imposing

financial and segregation requirements

on futures commission merchants

(‘‘FCMs’’) and introducing brokers

(‘‘IBs’’).

Regulation 33.4(a)(2) requires the

purchaser of a commodity option to pay

the full option premium at the initiation

of the transaction. Regulation 33.7

requires an FCM, or an IB in the case of

an introduced account, to provide each

option customer with a written option

disclosure statement prior to the

opening of the account.

The repeal of Regulation 33.4(a)(2)

will permit commodity options to be

margined using a ‘‘futures-style’’

margining system. Futures-style

margining requires both the purchaser

(‘‘long’’) and the seller (‘‘short’’) of a

commodity option to post risk-based,

original margin upon entering into an

option position. During the life of the

option, the option value is marked to

market daily, and gains and losses are

posted to the accounts of the long and

short position holders. The repeal does

not impose an obligation on exchanges

to adopt futures-style margining for

commodity options. Exchanges may

continue to use their current option

margining systems. Any exchange

wishing to implement futures-style

margining must submit proposed rules

for Commission review pursuant to

Section 5a(a)(12)(A) of the Commodity

Exchange Act (‘‘Act’’) and Commission

Regulation 1.41.

Regulation 33.7(b) sets forth the terms

of the disclosure statement and
Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations 32727

1 62 FR 66569 (December 19, 1997).

2 63 FR 6112 (February 6, 1998).

3 46 FR 54500 (November 3, 1981).

4 51 FR 17464 (May 13, 1986); 51 FR 27529

(August 1, 1986). Subsequently, the Commission

approved the exchange trading of options on

agricultural futures and options on non-agricultural

physicals effective February 9, 1987. 52 FR 777

(January 9, 1987). On April 8, 1998, the

Commission approved a three-year pilot program

for the off-exchange trading of certain agricultural

trade options and also approved exchange trading

of options on agricultural physicals. 63 FR 18821

(April 16, 1998).

5Regulations 33.4 in pertinent part states:

§ 33.4 Designation as a contract market for the

trading of commodity options.

The Commission may designate any board of

trade...as a contract market for the trading of

options on contracts of sale for future delivery...

when the applicant complies with and carries out

the requirements of the Act (as provided in § 33.2),

these regulations, and the following conditions and

requirements with respect to the commodity option

for which the designation is sought:

(a) Such board of trade * * *

(2) Provides that the clearing organization must

receive from each of its clearing members, that each

clearing member must receive from each other

person for whom it clears commodity option

transactions, and that each futures commission

merchant must receive from each of its option

customers, the full amount of each option premium

at the time the option is purchased.

6See, 62 FR 66571–66572

7Supporting comments were submitted by:

Chicago Board of Trade; Chicago Mercantile

Exchange; New York Mercantile Exchange; Coffee,

Sugar & Cocoa Exchange, Inc.; New York Cotton

Exchange; Minneapolis Grain Exchange; National

Grain Trade Council; Commodity Floor Brokers &

Traders Association; National Grain and Feed

Association; Futures Industry Association; Board of

Trade Clearing Corporation; ABN Amro Chicago

Corporation; and Philip McBride Johnson of

Skadden, Arps, Slate, Meagher & Flom, and a

former Chairman of the Commission.

8The opposing comments were submitted by:

Andre ́ & CIE S.A. Lausanne; Transcatalana De

Comercio, S.A.; Garnac Grain Co., Inc.; Refinadora

De O ́ leos Brasil LTDA.; SAROC S.P.A.; Compagnie

Commerciale Andre ́; La Plata Cereal; Andre & CIE

(Singapore) PTE LTD.; The Options Clearing

Corporation; The Chicago Board Options Exchange;

The Clifton Group; and FIMAT Futures USA, Inc.

9The two comments were submitted by Lind

Waldock & Company and DKB Financial Futures

Corp.

10The SPAN margining system was developed by

the Chicago Mercantile Exchange and is currently

used by all domestic futures exchanges and clearing

organizations, except the Philadelphia Board of

Trade.

currently reflects the prohibition against

the margining of long option positions.

The Commission is amending the

disclosure statement to reflect the

permissibility of futures-style margining

for options.

EFFECTIVE DATE: July 16, 1998.

FOR FURTHER INFORMATION CONTACT:

Thomas Smith, Attorney, Division of

Trading and Markets, Commodity

Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, N.W.,

Washington, D.C. 20581. Telephone:

(202) 418–5495; or electronic mail:

tsmith@cftc.gov.

SUPPLEMENTARY INFORMATION:

I. Background

On December 19, 1997, the

Commission published for public

comment in the Federal Register a

proposal to repeal Commission

Regulation 33.4(a)(2) and proposed

amendments to the option disclosure

statements in Regulation 33.7(b) and

Appendix A to Regulation 1.55(c).1 The

original comment period was scheduled

to end on February 2, 1998, but was

extended by the Commission until

March 4, 1998.2

Regulation 33.4(a)(2) is one of several

regulations that were implemented as

part of a pilot program for the exchange

trading of options on non-agricultural

futures instituted by the Commission on

November 3, 1981.3 Regulation

33.4(a)(2) requires the purchaser of an

option to pay the full premium at the

initiation of the transaction. Overall, the

Commission’s experience with the pilot

program was positive, and the trading of

options on non-agricultural futures was

made permanent on August 1, 1986.4

Regulation 33.4(a)(2) requires

commodity options to be subject to a

‘‘stock-style’’ margining system that

obligates the option buyer to pay the full

purchase premium when the transaction

is initiated.5 The long is not required to

make any additional payments during

the life of the option. The option

premium is credited to the account of

the option seller, who must keep it

posted with his or her FCM. The short

also must deposit risk margin with his

or her FCM to cover potential adverse

market moves in the option position. If

the option increases in value, the short

must deposit additional funds into the

account. These funds, however, are not

transferred to the long, who must

exercise or offset the option in order to

realize any increase in its value. By

contrast, if the option value decreases,

the short may withdraw any excess

funds from its account.

Futures-style margining of commodity

options will require that both the long

and the short position holders post riskbased, original margin upon entering

into their option positions. The option

value will be marked to market daily

during the life of the option. Any

increase in value will result in a credit

to the long option holder’s account and

a corresponding debit against the short

option seller’s account. Conversely, any

decrease in value will result in a credit

to the short’s account and a

corresponding debit to the long’s

account.

Thus, under futures-style margining,

the cash flows associated with option

contracts will be symmetric, as is the

case for cash flows for futures. Futuresstyle margining, however, will not alter

the fundamental nature of each party’s

overall obligation. A long’s potential for

loss will remain limited to the full

option premium and transaction costs.

As is the case now, a short’s potential

for loss will not be so limited.

In the Notice of Proposed

Rulemaking, the Commission identified

several potential benefits and potential

costs that may result from the adoption

of futures-style margining. The potential

benefits included the enhancement of

the financial integrity and market

liquidity that may result from the more

efficient cash flows associated with

futures-style margining. The potential

costs included an increase in the use of

leverage in the futures markets, an

increase in customer confusion,

including an increase in the opportunity

for unscrupulous individuals to mislead

unsophisticated option customers, and

transition costs to the industry in

adopting futures-style margining.6

II. Comments Received

The Commission received 27

comment letters on the proposal.

Supporting comments were submitted

by six futures exchanges, four trade

associations, one clearing organization,

one FCM and one law firm.7 Eight

commercial firms, two securities

options exchanges, one FCM and one

investment management firm submitted

opposing comments.8 Two FCMs

submitted comments that, while not

opposing the proposal, raised concerns

about the implementation and operation

of futures-style margining.9

The material issues raised by the

comment letters are set forth below. In

most instances, the issues raised were

previously identified by the

Commission in the Notice of Proposed

Rulemaking.

One commenter stated that many of

the cash flow benefits identified in the

Notice of Proposed Rulemaking could

be achieved by expanding the

availability of cross-margining between

futures markets and securities markets.

Another commenter stated that the

Standard Portfolio Analysis of Risk

(‘‘SPAN’’) margining system provides

market participants with many of the

cash flow benefits that are identified

with futures-style margining.10

The Commission recognizes that

cross-margining and the SPAN

margining system provide cash flow

benefits to market participants. The

Commission believes, however, that

futures-style margining could provide

additional cash flow benefits not
32728 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations

available through cross-margining or

SPAN. For example, cross-margining is

restricted to specified products with

offsetting risk characteristics that are

traded on different exchanges that have

cross-margining arrangements. In

contrast, futures-style margining could

be available for any futures exchangetraded options, and the cash flow

benefits would not be dependent on

preexisting arrangements between

exchanges. Similarly, under SPAN, the

long is still obligated to pay the full

option premium at the inception of the

transaction regardless of the portfolio’s

risk calculation. Thus, a trader who

hedged a short futures position with a

long option would be required to pay

the full option premium at the initiation

of the transaction under the stock-style

margining system, even though SPAN

would calculate the margin on the two

positions on a portfolio basis.

Two commenters expressed a concern

that futures-style margining will result

in an increase in the use of leverage in

the futures market. As the Commission

stated in the Notice of Proposed

Rulemaking, futures-style margining

will result in an increase in the amount

of leverage in the futures market. The

purchaser of an option will be able to

acquire an option position upon

payment of less than the full option

premium at the initiation of the

transaction. The option position will

then be marked to market on a daily

basis, with gains or losses posted to the

respective accounts of the long and

short position holders. The substitution

of a margining system for the full, upfront payment of the option also will

introduce a risk of default by the long

that does not exist under the stock-style

margining system.

The Commission believes, however,

that the leverage associated with long

options will not substantially increase

the risk to the financial integrity of the

markets. First, as the Commission noted

in the Notice of Proposed Rulemaking,

long option positions entail less total

risk than short options or long or short

futures positions. Under futures-style

margining, the maximum loss that a

long may incur on an option position

will continue to be limited to the full

option premium at the initiation of the

transaction. In contrast, holders of short

options or long or short futures

positions will continue to be subject to

much greater risk from adverse market

moves.

Second, with respect to the added risk

of default, FCMs that currently hold

customer accounts that include short

options and long and short futures

positions assess the creditworthiness of

each customer as part of their normal

business practices. Requiring such firms

to assess the creditworthiness of

potential option purchasers should not

require any significant adjustments in

such firms’ operating procedures in this

regard.

Third, the Commission is not

requiring that exchanges adopt futuresstyle margining for options. The

exchanges may continue to use their

current margining systems and require

option purchasers to pay the option

premium at the initiation of the

transaction. The Commission expects

that exchanges will not propose

adopting futures-style margining until

they have developed appropriate

systems and/or procedures to monitor

the margining of long option positions

and have considered the views and

market needs of their members and

other market participants.

Finally, an FCM may require that

option purchasers pay the full option

premium at the initiation of the

transaction even if the exchange permits

futures-style margining. Therefore,

FCMs that do not have the systems or

procedures to monitor the margining of

long option positions may elect to retain

the stock-style margining system even

though an exchange might permit

futures-style margining.

Several commenters expressed a

concern that futures-style margining

would benefit option buyers at the

expense of option sellers. The primary

concern of these commenters is that the

Commission did not demonstrate that

expected increases in option premiums

would sufficiently compensate option

sellers for their loss of interest income.

In the Notice of Proposed

Rulemaking, the Commission noted that

a futures-style margining system may

alter option pricing. Sellers of options

may charge a higher premium to

compensate for the loss of interest

income. Conversely, option buyers may

be willing to pay a higher premium

because they will not have to pay the

full premium up-front. The Commission

believes, however, that market forces

should ensure that pricing changes will

not benefit longs at the expense of

shorts. In this regard, commenters did

not submit any support for the assertion

that futures-style margining would

benefit option buyers at the expense of

option sellers.

One commenter stated that permitting

futures-style margining, which does not

require the up-front payment of option

premiums, may result in additional lowcapital customers entering the option

markets. The commenter argued that

such customers may not be very

knowledgeable about futures markets

and may be susceptible to unscrupulous

individuals seeking to take advantage of

them.

By amending the option disclosure

statement in Regulation 33.7 to reflect

the permissibility of futures-style

margining, the Commission is

attempting to ensure that potential

option customers receive adequate

notice concerning the risks of trading in

commodity options. In addition, the

distribution of the disclosure statement

does not relieve an FCM or IB from any

other disclosure obligations that it may

have under applicable law.

One commenter stated that futuresstyle margining will require some FCMs

to increase staff and upgrade systems

capabilities in order to perform

continuous intraday monitoring of long

option positions. The commenter

further stated that the increased costs

may be passed on to option customers,

thereby making trading more expensive.

The commenter also claimed that

exchanges should not be permitted to

offer futures-style margining until they

are able to provide continuous, updated

information regarding the volatility

levels of their options to their member

firms.

The Commission recognizes that

certain FCMs may be required to expend

additional capital to monitor properly

long option positions with the

implementation of a futures-style

margining system. However, many firms

already have such systems in place. As

noted above, short option positions are

currently margined and marked to

market on a daily basis. Firms that carry

short option positions on their books

must have monitoring and margining

systems in place in order to track

properly the short option positions. In

addition, futures-style margining has

been in place at the London

International Financial Futures and

Options Exchange for over ten years.

In addition, the Commission

anticipates that the exchanges will take

into consideration the views of their

members and other market participants

prior to proposing any changes to their

option margining systems. Moreover,

any proposal to adopt a futures-style

margining system must be submitted to

the Commission for review pursuant to

Section 5a(a)(12)(A) of the Act and

Commission Regulation 1.41. As part of

the review process, the Commission

may determine that publication of the

proposal in the Federal Register is

necessary in order to obtain the views

and comments of interested persons.

One commenter stated that the

Commission’s proposal lacked

specificity with respect to the

implementation and operation of a

futures-style margining system. The
Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations 32729

11The disclosure statement was developed by the

Commission in cooperation with various

international regulators and self-regulatory

organizations who also have adopted the statement

for use in their jurisdictions. The disclosure

statement permits firms doing multinational

business to use the same risk disclosure statement

for foreign and U.S.-based business. The

Commission adopted the disclosure statement on

July 5, 1994. 59 FR 34376 (July 5, 1994).

commenter argued that a lack of

specificity may result in the adoption of

different margining systems or

standards for each exchange or different

systems within one exchange. In

contrast, two other commenters stated

that exchanges should have discretion

to determine which option contracts

should be subject to a stock-style or

futures-style margining system as part of

the contract design process. In addition,

one of these two commenters stated that

an exchange should be afforded the

flexibility of designing margining

systems that result in a hybrid of the

stock-style and futures-style system. For

example, an exchange should have the

discretion to design an option contract

that would require the option buyer to

pay the full premium at the time of

purchase (stock-style) while also

allowing that customer to withdraw any

subsequent option value gains from the

account (futures-style).

By repealing Commission Regulation

33.4(a)(2), the Commission does not

intend to require that an exchange use

a uniform margining system for all of its

listed option markets or that the

exchanges adopt futures-style margining

in a concerted manner. While the

Commission recognizes that a uniform

margining system across all futures

markets might increase efficiency and

reduce potential confusion among

market participants, the Commission

believes that it is not its role to mandate

such a result. Each exchange should

have the discretion to design margining

systems that it believes are appropriate

for its option markets. Accordingly, the

Commission will review each proposal

to implement a futures-style margining

system on an individual basis.

III. Amendments to the Option

Disclosure Statement

A. Amendments to the Option

Disclosure Statement in Regulation

33.7(b)

Commission Regulation 33.7 was

issued as part of the initial option pilot

program in November 1981 and requires

an FCM, or an IB in the case of an

introduced account, to provide each

option customer with a detailed

disclosure statement prior to the

opening of an account. The customer is

required to sign an acknowledgment

indicating that he or she read and

understood the document before any

transaction is effected for that

customer’s account.

The disclosure statement, which is set

forth in Regulation 33.7(b), contains a

detailed description of option trading

and the risks associated with option

positions. The statement was drafted to

reflect the prohibition against the

margining of long option positions.

In the Notice of Proposed

Rulemaking, the Commission proposed

several amendments to the disclosure

statement to reflect the permissibility of

futures-style margining. The

Commission has determined to adopt

the amendments with one modification.

The Commission’s proposed

amendments included adding the

following language to the option

disclosure statement:

BOTH THE PURCHASER AND THE

GRANTOR SHOULD KNOW WHETHER THE

PARTICULAR OPTION IN WHICH THEY

CONTEMPLATE TRADING IS SUBJECT TO

A ‘‘STOCK-STYLE’’ OR ‘‘FUTURES-STYLE’’

SYSTEM OF MARGINING. UNDER A

STOCK-STYLE MARGINING SYSTEM, A

PURCHASER IS REQUIRED TO PAY THE

FULL PURCHASE PRICE OF THE OPTION

AT THE INITIATION OF THE

TRANSACTION. THE PURCHASER HAS NO

FURTHER OBLIGATION ON THE OPTION

POSITION. UNDER A FUTURES-STYLE

MARGINING SYSTEM, THE PURCHASER

DEPOSITS INITIAL MARGIN AND MAY BE

REQUIRED TO DEPOSIT ADDITIONAL

MARGIN IF THE MARKET MOVES

AGAINST THE OPTION POSITION. THE

PURCHASER’S TOTAL MARGIN

OBLIGATION, HOWEVER, WILL NOT

EXCEED THE ORIGINAL OPTION

PREMIUM. IF THE PURCHASER OR

GRANTOR DOES NOT UNDERSTAND HOW

OPTIONS ARE MARGINED UNDER A

STOCK-STYLE OR FUTURES-STYLE

MARGINING SYSTEM, HE OR SHE SHOULD

REQUEST AN EXPLANATION FROM THE

FUTURES COMMISSION MERCHANT

(‘‘FCM’’) OR INTRODUCING BROKER (‘‘IB’’).

(Emphasis added.)

One commenter stated that the

statement—THE PURCHASER’S TOTAL

MARGIN OBLIGATION, HOWEVER,

WILL NOT EXCEED THE ORIGINAL

OPTION PREMIUM—while strictly true,

could be open to honest

misinterpretation. The commenter

stated that under certain circumstances

a long option position holder may incur

margin payment obligations that exceed

the initial option premium. For

example, an FCM may require risk

margin that exceeds the option

premium. In addition, a bought option

may first increase substantially in value

immediately after purchase and then

lose nearly all of its value on the next

day. If the option owner had withdrawn

the initial value increase from the

account, he or she would be required to

make a large daily variation margin

payment to the FCM to settle the

subsequent value loss. In such

situations, the variation margin

payments on the second day may

exceed the initial option premium.

Accordingly, the commenter proposed

that the sentence be modified to state:

THE PURCHASER’S TOTAL

SETTLEMENT VARIATION MARGIN

OBLIGATION OVER THE LIFE OF THE

OPTION, HOWEVER, WILL NOT EXCEED

THE ORIGINAL OPTION PREMIUM,

ALTHOUGH SOME INDIVIDUAL PAYMENT

OBLIGATIONS AND/OR RISK MARGIN

REQUIREMENTS MAY AT TIMES EXCEED

THE ORIGINAL OPTION PREMIUM.

The Commission concurs with the

commenter and is amending the risk

disclosure statement to include the

above sentence in lieu of the proposed

sentence.

B. Proposed Amendments to Appendix

A of Regulation 1.55(c)

Appendix A of Commission

Regulation 1.55(c) contains a generic

risk disclosure statement applicable to

the Commission’s disclosure

requirements for domestic and foreign

commodity futures and commodity

option transactions.11 The disclosure

statement includes a discussion of the

risks associated with the futures-style

margining of options, which has been

permitted on certain foreign exchanges,

including the London International

Financial Futures and Option Exchange.

In the Notice of Proposed

Rulemaking, the Commission proposed

minor amendments to the risk

disclosure statement to reflect explicitly

the permissibility of futures-style

margining for options traded on U.S.

markets. Upon reconsideration, the

Commission has determined that the

disclosures in the risk disclosure

statement, as currently drafted, are

appropriate. Accordingly, the

Commission is not amending Appendix

A to Commission Regulation 1.55(c).

IV. Technical Amendments

In the Notice of Proposed

Rulemaking, the Commission requested

comment on any amendments that

would need to be made to the

Commission’s regulations governing net

capital requirements for FCMs and IBs

to reflect the permissibility of futuresstyle margining. No comments were

received on this point.

Several of the Commission’s

regulations impose financial

requirements on FCMs and IBs. In

various sections of those regulations,

reference is made to the manner in

which an FCM’s net capital requirement
32730 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations

12The Commission’s Division of Trading and

Markets previously has issued guidance on the

proper accounting and segregation treatment of

exchange-traded options subject to a stock-style

margining system. See, Financial and Segregation

Interpretation No. 8—Proper Accounting,

Segregation and Net Capital Treatment of Exchange

Traded Option Transactions, Comm. Fut. L. Rep.

(CCH) ¶ 7118 (Division of Trading and Markets,

August 12, 1982). The Commission may determine

that it would be appropriate to revise this

Interpretation if exchanges seek to implement

futures-style margining. 13Pub. L. 104–13 (May 13, 1995).

is to be calculated. The calculation

excludes the value of long options

positions because such options, under

current methodologies, are fully paid for

and pose no financial risk to the FCM.

The Commission, as suggested in the

Notice of Proposed Rulemaking, is

making technical amendments to these

regulations in order to reflect the

permissibility of a futures-style

margining system for commodity

options and to make clear that only the

value of fully paid for long options may

be excluded from the capital

requirement formula. Specifically, the

Commission is amending the definition

of customer funds in Regulation 1.3(gg)

and certain reporting requirements and

financial requirements set forth in

Regulations 1.12(b)(2), 1.17(a)(1)(i)(B),

1.17(e)(1)(ii), 1.17(h)(2)(vi)(C)(2),

1.17(h)(2)(vii)(A)(2),

1.17(h)(2)(vii)(B)(2),

1.17(h)(2)(viii)(A)(2), 1.17(h)(3)(ii)(B),

and 1.17(h)(3)(v)(B).12

V. Conclusion

The Commission is repealing

Regulation 33.4(a)(2), amending the

option disclosure statement in

Regulation 33.7(b) and implementing

technical amendments to several

financial regulations in order to permit

the futures-style margining of

commodity options. The repeal of

Regulation 33.4(a)(2) is consistent with

the Commission’s ongoing commitment

to implement regulatory reforms that

reduce unnecessary burdens on the

futures industry while also preserving

important customer protections and

market safeguards. In this regard, it has

been seventeen years since the

Commission authorized the first option

pilot program. During that time, option

trading volume has grown from less

than 2 million transactions a year to

over 100 million transactions a year.

During this period of remarkable

growth, the Commission, exchanges,

FCMs and market participants have

gained extensive experience on the

operations of the option markets. In

light of this experience and upon

consideration of all the comments, the

Commission believes that with adequate

disclosure to public customers it is no

longer necessary for the Commission to

require option purchasers to pay the full

option premium at the initiation of the

transaction.

VI. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act

(‘‘RFA’’), 5 U.S.C. § 601 et seq., requires

that agencies, in promulgating rules,

consider the impact of those rules on

small businesses. The rules discussed

herein will affect contract markets,

clearing organizations, FCMs and IBs.

The Commission has established certain

definitions of ‘‘small entities’’ to be used

by the Commission in evaluating the

impact of its rules on such small entities

in accordance with the RFA. Contract

markets and FCMs have been

determined not to be small entities

under the RFA. 47 FR 18616 (April 30,

1982). Furthermore, the then Chairman

of the Commission previously has

certified on behalf of the Commission

that comparable rules affecting clearing

organizations do not have a significant

economic impact on a substantial

number of small entities. 51 FR 44866,

44868 (December 12, 1986).

With respect to IBs, the Commission

has stated that it is appropriate to

evaluate within the context of a

particular rule proposal whether some

or all IBs should be considered to be

small entities and, if so, to analyze that

economic impact on such entities at that

time. The proposed rule amendments

would not require any IB to alter its

current method of doing business as

FCMS have the responsibility of

administering customer funds. Further,

these rule amendments, as proposed,

should impose no additional burden or

requirements on IBs and, thus, if

adopted would not have a significant

economic impact on a substantial

number of IBs.

Therefore, the Chairperson, on behalf

of the Commission, hereby certifies

pursuant to 5 U.S.C. § 605(b) that the

action taken herein would not have a

significant economic impact on a

substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of

1995 13 imposes certain requirements on

federal agencies (including the

Commission) in connection with their

conducting or sponsoring any collection

of information as defined by the

Paperwork Reduction Act.

While Rules 1.3, 1.12, and 1.17 do not

effect the burden, the group of rules

(3038–0024) of which Rules 1.3, 1.12,

and 1.17 are a part have the following

burden.

Average burden hours per response:

128.

Number of respondents: 3,148.

Frequency of responses: on occasion.

While Rule 33.7 does not effect the

burden, the group of rules (3038–0007)

of which Rule 33.7 is a part has the

following burden.

Average burden hours per response:

50.57.

Number of respondents: 190,422.

Frequency of responses: on occasion.

Copies of the information collection

submission to the Office of Management

and Budget are available from the CFTC

Clearance Officer, 1155 21st Street,

N.W., Washington, D.C. 20581, (202)

418–5160.

List of Subjects

17 CFR Part 1

Commodity Futures, Reporting and

recordkeeping requirements.

17 CFR Part 33

Commodity Futures, Domestic

exchange-traded commodity option

transactions, Consumer protection,

Fraud.

In consideration of the foregoing, and

pursuant to the authority contained in

the Commodity Exchange Act and, in

particular, sections 2(a)(1), 4b, 4c, and

8a thereof, 7 U.S.C. 2a, 6b, 6c, and 12a,

the Commission hereby amends Chapter

I of Title 17 of the Code of Federal

Regulations as follows:

PART 1—GENERAL REGULATIONS

UNDER THE COMMODITY EXCHANGE

ACT

1. The authority citation for Part 1

continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a,

6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m,

6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a–1, 16, 16a, 19, 21, 23, and 24.

2. Section 1.3 is amended to revise

paragraph (gg)(2)(iv) to read as follows:

§ 1.3 Definitions

* * * * *

(gg) * * *

(2) * * *

(iv) Representing accruals (including,

for purchasers of a commodity option

for which the full premium has been

paid, the market value of such

commodity option) to an option

customer.

* * * * *

3. Section 1.12 is amended by revising

paragraph (b)(2) to read as follows:
Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations 32731

§ 1.12 Maintenance of minimum financial

requirements by futures commission

merchants and introducing brokers.

* * * * *

(b) * * *

(2) 6 percent of the following amount:

The customer funds required to be

segregated pursuant to the Act and the

regulations in this part and foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by such

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each such customer shall

be limited to the amount of customer

funds in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

4. Section 1.17 is amended by revising

paragraphs (a)(1)(i)(B), (e)(1)(ii),

(h)(2)(vi)(C)(2), (h)(2)(vii)(A)(2),

(h)(2)(vii)(B)(2), (h)(2)(viii)(A)(2),

(h)(3)(ii)(B) and (h)(3)(v)(B) to read as

follows:

§ 1.17 Minimum financial requirements for

futures commission merchants and

introducing brokers.

* * * * *

(a)(1)(i) * * *

(B) Four percent of the following

amount: The customer funds required to

be segregated pursuant to the Act and

the regulations in this part and the

foreign futures or foreign options

secured amount, less the market value

of commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(e) * * *

(1) * * *

(ii) For a futures commission

merchant or applicant therefor, 7

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(h) * * *

(2) * * *

(vi) * * *

(C) * * *

(2) For a futures commission

merchant or applicant therefor, 7

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(vii) * * *

(A) * * *

(2) For a futures commission

merchant or applicant therefor, 7

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(B) * * *

(2) For a futures commission

merchant or applicant therefor, 10

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(viii) * * *

(A) * * *

(2) For a futures commission

merchant or applicant therefor, 6

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(3) * * *

(ii) * * *

(B) For a futures commission

merchant or applicant therefor, 6

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

(v) * * *

(B) For a futures commission

merchant or applicant therefor, 7

percent of the following amount: The

customer funds required to be

segregated pursuant to the Act and the

regulations in this part and the foreign

futures or foreign options secured

amount, less the market value of

commodity options purchased by

customers on or subject to the rules of

a contract market or a foreign board of

trade for which the full premiums have

been paid: Provided, however, That the

deduction for each customer shall be

limited to the amount of customer funds

in such customer’s account(s) and

foreign futures and foreign options

secured amounts;

* * * * *

PART 33—REGULATION OF

DOMESTIC EXCHANGE TRADED

COMMODITY OPTION TRANSACTIONS

5. The authority citation for Part 33

continues to read as follows:
32732 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 /Rules and Regulations

Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6b, 6c,

6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o,

7, 7a, 7b, 8, 9, 11, 12a, 12c, 13a, 13a–1, 13b,

19, and 21.

§ 33.4 [Amended]

6. Section 33.4 is amended by

removing and reserving paragraph (a)(2).

7. The disclosure statement in

paragraph (b) of § 33.7 is amended by

revising the text preceding paragraph (1)

and paragraphs (2)(v), (4) and (5) to read

as follows:

§ 33.7 Disclosure.

* * * * *

(b) * * *

Options Disclosure Statement

BECAUSE OF THE VOLATILE NATURE

OF THE COMMODITIES MARKETS, THE

PURCHASE AND GRANTING OF

COMMODITY OPTIONS INVOLVE A HIGH

DEGREE OF RISK. COMMODITY OPTION

TRANSACTIONS ARE NOT SUITABLE FOR

MANY MEMBERS OF THE PUBLIC. SUCH

TRANSACTIONS SHOULD BE ENTERED

INTO ONLY BY PERSONS WHO HAVE

READ AND UNDERSTOOD THIS

DISCLOSURE STATEMENT AND WHO

UNDERSTAND THE NATURE AND EXTENT

OF THEIR RIGHTS AND OBLIGATIONS

AND OF THE RISKS INVOLVED IN THE

OPTION TRANSACTIONS COVERED BY

THIS DISCLOSURE STATEMENT.

BOTH THE PURCHASER AND THE

GRANTOR SHOULD KNOW WHETHER THE

PARTICULAR OPTION IN WHICH THEY

CONTEMPLATE TRADING IS AN OPTION

WHICH, IF EXERCISED, RESULTS IN THE

ESTABLISHMENT OF A FUTURES

CONTRACT (AN ‘‘OPTION ON A FUTURES

CONTRACT’’) OR RESULTS IN THE

MAKING OR TAKING OF DELIVERY OF

THE ACTUAL COMMODITY UNDERLYING

THE OPTION (AN ‘‘OPTION ON A

PHYSICAL COMMODITY’’). BOTH THE

PURCHASER AND THE GRANTOR OF AN

OPTION ON A PHYSICAL COMMODITY

SHOULD BE AWARE THAT, IN CERTAIN

CASES, THE DELIVERY OF THE ACTUAL

COMMODITY UNDERLYING THE OPTION

MAY NOT BE REQUIRED AND THAT, IF

THE OPTION IS EXERCISED, THE

OBLIGATIONS OF THE PURCHASER AND

GRANTOR WILL BE SETTLED IN CASH.

BOTH THE PURCHASER AND THE

GRANTOR SHOULD KNOW WHETHER THE

PARTICULAR OPTION IN WHICH THEY

CONTEMPLATE TRADING IS SUBJECT TO

A ‘‘STOCK-STYLE’’ OR ‘‘FUTURES-STYLE’’

SYSTEM OF MARGINING. UNDER A

STOCK-STYLE MARGINING SYSTEM, A

PURCHASER IS REQUIRED TO PAY THE

FULL PURCHASE PRICE OF THE OPTION

AT THE INITIATION OF THE

TRANSACTION. THE PURCHASER HAS NO

FURTHER OBLIGATION ON THE OPTION

POSITION. UNDER A FUTURES-STYLE

MARGINING SYSTEM, THE PURCHASER

DEPOSITS INITIAL MARGIN AND MAY BE

REQUIRED TO DEPOSIT ADDITIONAL

MARGIN IF THE MARKET MOVES

AGAINST THE OPTION POSITION. THE

PURCHASER’S TOTAL SETTLEMENT

VARIATION MARGIN OBLIGATION OVER

THE LIFE OF THE OPTION, HOWEVER,

WILL NOT EXCEED THE ORIGINAL

OPTION PREMIUM, ALTHOUGH SOME

INDIVIDUAL PAYMENT OBLIGATIONS

AND/OR RISK MARGIN REQUIREMENTS

MAY AT TIMES EXCEED THE ORIGINAL

OPTION PREMIUM. IF THE PURCHASER

OR GRANTOR DOES NOT UNDERSTAND

HOW OPTIONS ARE MARGINED UNDER A

STOCK-STYLE OR FUTURES-STYLE

MARGINING SYSTEM, HE OR SHE SHOULD

REQUEST AN EXPLANATION FROM THE

FUTURES COMMISSION MERCHANT

(‘‘FCM’’) OR INTRODUCING BROKER (‘‘IB’’).

A PERSON SHOULD NOT PURCHASE

ANY COMMODITY OPTION UNLESS HE OR

SHE IS ABLE TO SUSTAIN A TOTAL LOSS

OF THE PREMIUM AND TRANSACTION

COSTS OF PURCHASING THE OPTION. A

PERSON SHOULD NOT GRANT ANY

COMMODITY OPTION UNLESS HE OR SHE

IS ABLE TO MEET ADDITIONAL CALLS

FOR MARGIN WHEN THE MARKET MOVES

AGAINST HIS OR HER POSITION AND, IN

SUCH CIRCUMSTANCES, TO SUSTAIN A

VERY LARGE FINANCIAL LOSS.

A PERSON WHO PURCHASES AN

OPTION SUBJECT TO STOCK-STYLE

MARGINING SHOULD BE AWARE THAT,

IN ORDER TO REALIZE ANY VALUE FROM

THE OPTION, IT WILL BE NECESSARY

EITHER TO OFFSET THE OPTION

POSITION OR TO EXERCISE THE OPTION.

OPTIONS SUBJECT TO FUTURES-STYLE

MARGINING ARE MARKED TO MARKET,

AND GAINS AND LOSSES ARE PAID AND

COLLECTED DAILY. IF AN OPTION

PURCHASER DOES NOT UNDERSTAND

HOW TO OFFSET OR EXERCISE AN

OPTION, THE PURCHASER SHOULD

REQUEST AN EXPLANATION FROM THE

FCM OR IB. CUSTOMERS SHOULD BE

AWARE THAT IN A NUMBER OF

CIRCUMSTANCES, SOME OF WHICH WILL

BE DESCRIBED IN THIS DISCLOSURE

STATEMENT, IT MAY BE DIFFICULT OR

IMPOSSIBLE TO OFFSET AN EXISTING

OPTION POSITION ON AN EXCHANGE.

THE GRANTOR OF AN OPTION SHOULD

BE AWARE THAT, IN MOST CASES, A

COMMODITY OPTION MAY BE EXERCISED

AT ANY TIME FROM THE TIME IT IS

GRANTED UNTIL IT EXPIRES. THE

PURCHASER OF AN OPTION SHOULD BE

AWARE THAT SOME OPTION CONTRACTS

MAY PROVIDE ONLY A LIMITED PERIOD

OF TIME FOR EXERCISE OF THE OPTION.

THE PURCHASER OF A PUT OR CALL

SUBJECT TO STOCK-STYLE OR FUTURESSTYLE MARGINING IS SUBJECT TO THE

RISK OF LOSING THE ENTIRE PURCHASE

PRICE OF THE OPTION—THAT IS, THE

PREMIUM CHARGED FOR THE OPTION

PLUS ALL TRANSACTION COSTS.

THE COMMODITY FUTURES TRADING

COMMISSION REQUIRES THAT ALL

CUSTOMERS RECEIVE AND

ACKNOWLEDGE RECEIPT OF A COPY OF

THIS DISCLOSURE STATEMENT BUT

DOES NOT INTEND THIS STATEMENT AS

A RECOMMENDATION OR ENDORSEMENT

OF EXCHANGE-TRADED COMMODITY

OPTIONS.

* * * * *

(2) * * *

(v) An explanation and understanding of

the option margining system;

* * * * *

(4) Margin requirements. An individual

should know and understand whether the

option he or she is contemplating trading is

subject to a stock-style or futures-style system

of margining. Stock-style margining requires

the purchaser to pay the full option premium

at the time of purchase. The purchaser has

no further financial obligations, and the risk

of loss is limited to the purchase price and

transaction costs. Futures-style margining

requires the purchaser to pay initial margin

only at the time of purchase. The option

position is marked to market, and gains and

losses are collected and paid daily. The

purchaser’s risk of loss is limited to the

initial option premium and transaction costs.

An individual granting options under

either a stock-style or futures-style system of

margining should understand that he or she

may be required to pay additional margin in

the case of adverse market movements.

(5) Profit potential of an option position.

An option customer should carefully

calculate the price which the underlying

futures contract or underlying physical

commodity would have to reach for the

option position to become profitable. Under

a stock-style margining system, this price

would include the amount by which the

underlying futures contract or underlying

physical commodity would have to rise

above or fall below the strike price to cover

the sum of the premium and all other costs

incurred in entering into and exercising or

closing (offsetting) the commodity option

position. Under a future-style margining

system, option positions would be marked to

market, and gains and losses would be paid

and collected daily, and an option position

would become profitable once the variation

margin collected exceeded the cost of

entering the contract position.

Also, an option customer should be aware

of the risk that the futures price prevailing at

the opening of the next trading day may be

substantially different from the futures price

which prevailed when the option was

exercised. Similarly, for options on physicals

that are cash settled, the physicals price

prevailing at the time the option is exercised

may differ substantially from the cash

settlement price that is determined at a later

time. Thus, if a customer does not cover the

position against the possibility of underlying

commodity price change, the realized price

upon option exercise may differ substantially

from that which existed at the time of

exercise.

* * * * *

Issued in Washington, D.C., on this 10th

day of June, 1998, by the Commodity Futures

Trading Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 98–15977 Filed 6–15–98; 8:45 am]

BILLING CODE 6351–01–P