[Federal Register Volume 76, Number 26 (Tuesday, February 8, 2011)]
[Notices]
[Pages 6838-6839]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-2645]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-63819; File No. SR-CBOE-2010-106]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Approving a Proposed Rule Change, as Modified by
Amendment No. 1, To Amend Margin Requirements for Credit Options
February 2, 2011.
I. Introduction
On December 1, 2010, the Chicago Board Options Exchange,
Incorporated (``Exchange'' or ``CBOE'') 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 as described below. On December
14, 2010, the Exchange filed Amendment No. 1 to the proposed rule
change.\3\ The proposed rule change was published for comment in the
Federal Register on December 21, 2010.\4\ The Commission received no
comment letters on the proposed rule change. 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\3\ Amendment No. 1 to SR-CBOE-2010-106 replaced and superseded
the original rule filing in its entirety.
\4\ See Securities Exchange Act Release No. 63546 (December 15,
2010), 75 FR 80099 (December 21, 2010) (``Notice'').
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II. Description of the Proposal
The Exchange proposes to amend Rule 12.3(l), Margin Requirements,
to make CBOE's margin requirements for Credit Options consistent with
FINRA Rule 4240, Margin Requirements for Credit Default Swaps. CBOE's
Credit Options consist of two variations--Credit Default Options and
Credit Default Basket Options. Credit Default Options and Credit
Default Basket Options are also referred to as ``Credit Event Binary
Options.'' Effectively, both contracts operate in the same manner as
credit default swap contracts.
As with a credit default swap contract, the buyer of a Credit
Option contract is buying protection from the seller of the Credit
Option. This protection is in the form of a monetary payment from the
Credit Option seller to the Credit Option buyer in the event that the
issuer of debt securities, or Reference Entity, specified as underlying
the Credit Option contract has a Credit Event,\5\ consequently
defaulting on the payment of principal and interest on its debt
securities. When a Credit Option buyer and seller initially open their
positions via a transaction consummated on the Exchange, the Credit
Option buyer's account is charged (debited) for the cost of the
protection. The Credit Option seller's account is credited. For the
protection, there is only a one-time debit and credit to the buyer and
seller, respectively. If, prior to expiration of the Credit Option, a
Credit Event \6\ occurs, the Credit Option contract is settled with a
credit to the Credit Option buyer's account for a predetermined payout
amount (e.g., $1,000), based on the Exchange's contract specifications.
The Credit Option seller's account is debited (charged) for the payout
amount.
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\5\ See Securities Exchange Act Release No. 63352 (November 19,
2010), 75 FR 73155 (November 29, 2010) (order approving SR-CBOE-
2010-046). CBOE amended its rules to permit it to, among other
things, list credit options designating a single credit event, such
as failure-to-pay default, another event of default, or a
restructuring. See also CBOE Rules 29.2 and 29.2A.
\6\ Id.
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Credit Default Options have a single Reference Entity. Credit
Default Basket Options have multiple Reference Entities. If a Credit
Default Basket
[[Page 6839]]
Option is specified as having a single payout, settlement is triggered
when any one of the component Reference Entities has a Credit Event and
thereafter the option ceases to exist. The payout is the settlement
amount attached to that one Reference Entity. If a Credit Default
Basket Option is specified as having multiple payouts, a settlement is
triggered when any one of the component Reference Entities has a Credit
Event,\7\ but the option continues to exist until its expiration.
Therefore, additional settlements would be triggered if, and as, any
Credit Events occur in respect of the remaining Reference Entity
components. The payout is the settlement amount attached to each
particular Reference Entity.
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\7\ Id.
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CBOE notes that the current Exchange margin requirements for Credit
Options were established before FINRA implemented margin requirements
for credit default swaps (FINRA Rule 4240). In order to be consistent
with FINRA margin requirements and establish a level playing field for
similar instruments, CBOE's proposed amendments adopt the FINRA
requirements to a large extent. For Credit Default Options, which
overlie a single Reference Entity, CBOE proposes to adopt FINRA's
margin percentage table for credit default swaps. With respect to
Credit Default Basket Options, CBOE is adopting the margin percentage
table that FINRA requires for CDX indices because, like an index, a
Credit Default Basket Option involves multiple component Reference
Entities. CBOE proposes to revise the FINRA column headings to fit
Credit Options. FINRA Rule 4240 requires the percentage to be applied
to the notional amount of a credit default swap. CBOE's proposed rules
would require that the percentage be applied to the settlement value of
a Credit Option to arrive at a margin requirement because the
settlement value of a Credit Option is analogous to the notional amount
of a credit default swap. CBOE's proposed rules incorporate all other
relevant aspects of FINRA 4240, such as risk monitoring procedures and
guidelines, and concentration charge (net capital) requirements.
CBOE's proposed rules would require no margin in the case of a
spread (i.e., long and short Credit Options with the same underlying
Reference Entity or Entities.) This differs from FINRA Rule 4240, which
requires margin of 50% of the margin required on the long or short
(credit default swap), whichever is greater. CBOE is proposing no
margin because the long and short are required to have the same
underlying Reference Entity. Moreover, Credit Options are standardized
and are settled through The Options Clearing Corp.
CBOE's proposed rules would also require no margin on a short
Credit Default Option that is offset with a short position in a debt
security issued by the Reference Entity underlying the option. This
language differs from the debt security offset allowed under FINRA Rule
4240. However, applicable margin must still be collected on the short
position in a debt security as prescribed pursuant to applicable margin
rules. Rule 4240 requires no margin for a long credit default swap
contract that is paired with a long position in the underlying debt
security. However, CBOE believes this type of offset does not appear to
be workable in respect of a Credit Default Option.
The proposal will become effective on a pilot basis to run a
parallel track with FINRA Rule 4240. FINRA Rule 4240 operates on an
interim pilot basis which is currently scheduled to expire on July 16,
2011.\8\ If the Exchange were to propose an extension of the Credit
Option Margin Pilot Program or should the Exchange propose to make the
Pilot Program permanent, then the Exchange would submit a filing
proposing such amendments to the Pilot Program.
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\8\ See Securities Exchange Act Release No. 63391 (November 30,
2010), 75 FR 75718 (December 6, 2010) (notice of filing for
immediate effectiveness extending FINRA Rule 4240 margin interim
pilot program to July 16, 2011).
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III. Discussion and Commission's Findings
After careful consideration, the Commission finds that the proposed
rule change, as modified by Amendment No. 1, is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange.\9\ In particular, the
Commission finds that the proposal is consistent with Section 6(b)(5)
of the Act,\10\ which requires, among other things, that the rules of
an exchange be designed to promote just and equitable principles of
trade, remove impediments to and perfect the mechanism of a free and
open market and a national market system, and, in general, protect
investors and the public interest. In the Commission's view, because it
is consistent with FINRA Rule 4240, the proposed rule change will
provide for a more uniform application of margin requirements for
similar products.
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\9\ In approving this proposed rule change, the Commission notes
that it has considered the proposed rule's impact on efficiency,
competition, and capital formation. 15 U.S.C. 78c(f).
\10\ 15 U.S.C. 78f(b)(5).
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The Commission further believes that it is appropriate to approve
the proposal on a pilot basis to expire on July 16, 2011. In
particular, the Commission notes that CBOE's proposed pilot program
will parallel FINRA's pilot program. This will allow the Commission and
CBOE to monitor the effects of the pilot on the markets and investors
and consider appropriate adjustments, as necessary.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\11\ that the proposed rule change (SR-CBOE-2010-106), as modified
by Amendment No. 1, is approved.
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\11\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-2645 Filed 2-7-11; 8:45 am]
BILLING CODE 8011-01-P