[Federal Register: June 16, 1998 (Volume 63, Number 115)]
[Rules and Regulations]
[Page 32726-32732]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16jn98-10]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 33


Final Rulemaking Permitting Futures-Style Margining of Commodity
Options

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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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

[[Page 32727]]

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: [email protected]

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\
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    \1\ 62 FR 66569 (December 19, 1997).
    \2\ 63 FR 6112 (February 6, 1998).
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    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\
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    \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).
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    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.
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    \5\ Regulations 33.4 in pertinent part states:
    Sec. 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 Sec. 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.
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    Futures-style margining of commodity options will require that both
the long and the short position holders post risk-based, 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. Futures-style 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\
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    \6\ See, 62 FR 66571-66572
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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\
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    \7\ Supporting 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.
    \8\ The opposing comments were submitted by: Andre & CIE S.A.
Lausanne; Transcatalana De Comercio, S.A.; Garnac Grain Co., Inc.;
Refinadora De Oleos 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.
    \9\ The two comments were submitted by Lind Waldock & Company
and DKB Financial Futures Corp.
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    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\
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    \10\ The 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.
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    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

[[Page 32728]]

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 exchange-traded 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, up-front 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
futures-style 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 low-capital 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 futures-style 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

[[Page 32729]]

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.
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    \11\ The 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).
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    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 futures-style 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

[[Page 32730]]

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\
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    \12\ The 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) para.
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.
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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. Sec. 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. Sec. 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.
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    \13\ Pub. L. 104-13 (May 13, 1995).
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    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:


Sec. 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:

[[Page 32731]]

Sec. 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:


Sec. 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:


[[Page 32732]]


    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.


Sec. 33.4  [Amended]

    6. Section 33.4 is amended by removing and reserving paragraph
(a)(2).
    7. The disclosure statement in paragraph (b) of Sec. 33.7 is
amended by revising the text preceding paragraph (1) and paragraphs
(2)(v), (4) and (5) to read as follows:


Sec. 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
FUTURES-STYLE 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


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