Read I have been receiving a lot of questions with regards to portfolio margin text version

Portfolio Margin Requirements Frequently Asked Questions

Eligible Participants 1. Rule 431 (g)(5)(B) states that eligible participants must be approved to engage in

uncovered short option contracts pursuant to Rule 721. Eligible participants may include registered broker-dealers. Does the account of a registered broker-dealer need to be approved for uncovered short options under Rule 721? No. 2. In addition, Rule 431(g)(15) requires firms to "ensure that portfolio margin accounts are in compliance with all other applicable Exchange rules promulgated in Rules 700 through 795" (i.e., the Exchange's options rules). Do these other rules apply even to positions in the account that are not options? No. 3. What does compliance with these rules entail? Exchange Rules 700 through 795 deal with options, for example, Rule 700 Applicability, Definitions and References, Rule 704 Position Limits, and Rule 721 Opening of Accounts. 4. The latest rule contains language regarding assessing, reviewing and monitoring the amount of credit extended to eligible participants. Is it permissible for a firm to monitor its' portfolio margin accounts by looking solely at the equity in the account against the margin requirements and require the client to always have enough equity to cover his or her exposure? In order for a customer to engage in portfolio margining they must be approved to purchase or sell uncovered short option contracts. Exchange Rule 721(e) requires that firms implement and maintain specific procedures which include the following: ­ ­ ­ Specific criteria and standards to be used in evaluating whether a customer should be permitted to write uncovered short options; Specific procedures for approval of accounts engaged in writing uncovered short option contracts, including written approval of such accounts by a Registered Options Principal; Designation of the Senior Registered Options Principal or the Compliance Registered Options Principal as the person responsible for approving customer accounts which do not meet the specific criteria and standards for writing uncovered short option contracts and for maintaining written records of the reasons for every account so approved;



Establishment of specific minimum net equity requirements for initial approval and maintenance of customer accounts engaged in the writing of uncovered short option transactions; and Requirements that customers approved for writing uncovered short options be provided with a special written description of the risks inherent in engaging in uncovered short option transactions, at or prior to first doing so [See Rule 726(c)].

In addition, the Exchange expects firms to establish and maintain a minimum equity requirement for customers who seek to engage in portfolio margining. The establishment of credit limits per account is viewed as a best practice.

Minimum Equity 1. In reviewing member organizations' applications to offer portfolio margining to customers,

are you requiring minimum equity to be maintained in individual accounts? Because of the additional leverage afforded to customers through portfolio margining, we believe that firms should establish minimum equity requirements. These may vary based upon the strength of the firm's risk management systems and procedures and its' ability to capture intraday trading and market activity. At a minimum, prime brokerage and introduced accounts where trades may be executed away from the clearing firm are expected to maintain $500,000 of equity when the clearing firm is not able to promptly update its risk management systems to reflect intraday trades. This requirement is consistent with the minimum net equity requirement outlined in the SEC's prime broker no-action letter. We expect all other accounts to maintain no less than $150,000 of equity unless the firm has a real-time intraday monitoring system that captures all trades, activity, and price movements throughout the day, in which case we are comfortable with a $100,000 minimum. 2. What actions must a firm take if an account does not meet a minimum equity deficiency by T + 3? The account must be limited to risk reducing transactions. Any new transactions that would increase the risk in the portfolio margin account must be booked in either the cash account or the Regulation T margin account, until such time as the equity deficiency is satisfied.

Margin Requirements 1. Do you have expectations with respect to a firm's monitoring of concentrated positions

within an individual customer account and across all accounts? We expect member organizations to develop reports that identify a concentration of any individual security in both an individual account and across all accounts that are engaged in portfolio margining. 2. What action should be taken if a concentration is identified? We would expect a higher house margin requirement to be imposed on these positions.

3. If a portfolio margin client only trades long/short equities in their account, with no listed option positions, is the account subject to a margin requirement of 15%? The long/short positions will be subject to a valuation point range of +/- 15%. However, the customer will be expected to possess a certain level of sophistication, evidenced by approval to purchase or sell uncovered options, and a disclosure statement with a signed acknowledgement from the customer. In addition, the member organization is expected to have risk monitoring capabilities which include the imposition of higher "house" requirements as well as various stress testing scenarios and the ability to monitor concentrations of individual securities in a single account. We expect firms to establish higher house requirements for more volatile stocks, concentrated positions and low priced securities. We have not prescribed stress testing levels, but expect firms at a minimum to conduct stresses up and down 25%. 4. If a customer were to deposit shares of a money market mutual fund in a portfolio margin account, what would the requirement be? We would expect a 1% margin requirement. 5. The rule imposes a minimum margin requirement on "unlisted derivatives" equal to $.375 multiplied by the instrument's multiplier. The multiplier for standard listed options is generally 100. What is the multiplier for an unlisted contract? It depends on the contract. The general rule should be to look to the underlying security as representing 100 shares of stock to form the basis of the calculation. 6. If the broker-dealer enters into an equity swap on 1000 shares of stock A, is the multiplier 1000? In this example, yes.

Eligible/Non-Eligible Products 1. Under the current pilot, unlisted derivatives are eligible products. But since the only

permitted option valuation model is the OCC's TIMS model, this would seem to render it impossible to include unlisted derivatives in a portfolio margin account since the OCC only provides option price slides for listed options. OCC's TIMS model can accommodate certain unlisted derivatives. In other instances firms would be required to have their proprietary pricing models approved by the SEC in order to effect transactions in unlisted derivatives within a portfolio margin account. If a listed security is the underlying and the terms of the option are similar to listed options, OCC should be able to price it. If contracts are more unique and custom tailored, the prices will have to come from the firm, pursuant to an SEC approved model.

2. Futures positions are permitted to be included in the portfolio margin account for the purpose of determining the margin requirements of product groups. But the client would still be expected to meet any futures margin requirement imposed by the futures exchange. Is this accurate? The margin requirement is calculated on the combined futures and securities position and could be lower than the margin required by the futures exchange. However, until segregation issues between the SEC and the CFTC are resolved, the ability to combine securities and futures products into a single portfolio margin account will be unavailable. 3. Is an OTC derivative that has a non-margin eligible security as its underlier eligible for portfolio margining? No. Non-margin eligible securities are not permitted in the portfolio margin account and therefore any option or derivative based on that security will not be permitted. 4. How would a non-margin eligible equity security that is part of a hedge be handled in a portfolio margin account? A customer will not be permitted to obtain margin value from a non-margin eligible security in a portfolio margin account. 5. Are mutual funds considered eligible products for portfolio margining? If so, is there any distinction made between open-ended and closed-end funds in terms of one being allowable and the other not? Equity based mutual funds or other products such as Unit Investment Trusts and Exchange Traded Funds are eligible for portfolio margining, provided they meet the criteria for margin eligibility under Regulation T. Open-ended, equity based mutual funds are eligible for portfolio margining, provided the 30 day holding period as required under Section 11(d)(1) of the Securities Exchange Act of 1934 is satisfied. Money market mutual funds will have a margin requirement of 1%; other open-ended funds will require 15%. 6. Is the Exchange going to allow customers to purchase fixed income products in a portfolio margin account, in effect, bypassing the standard margin account? The securities can be held in the portfolio margin account but will be subject to conventional Rule 431 margin requirements.

7. It is our understanding that all fixed income products, warrants and rights can be charged standard Rule 431 margin requirements. This margin requirement can be added to the margin requirement from the equity products in the portfolio margin account. These two margin requirements can be met by the combined equity balance in the client's account. Is this accurate? This is correct. However, warrants would fall under the definition of margin security, and would be eligible for portfolio margining treatment, provided such warrants could be priced through TIMS. 8. Are baskets permitted in portfolio margining? Reduced margin is available for baskets; the margin requirement will be equal to the haircuts promulgated in SEA Rule 15c3-1, provided the capitalization requirements are met. 9. The definition of eligible products appears to include convertible bonds. What restrictions apply to including convertible bonds in portfolio margining -- e.g., must they be convertible within a certain period of time? What if conversion requires a cash payment? The bond must be readily convertible, i.e., within 90 calendar days and any loss on the conversion or cost to convert must be added to the requirement. 10. Eligible products under Rule 431(g)(6)(B) include foreign equity securities and options on foreign equity securities that are "margin eligible securities." Are these foreign options covered by TIMS, and if not can firms seek to obtain SEC approval of their own pricing models for such options? If they are listed on a foreign exchange, OCC anticipates that it will be able to price and stress such foreign options using TIMS.

Day Trading 1. Can you clarify the new Day Trading requirements? The new rules seem to indicate that

for an account with equity less than $5 million the client will be permitted to engage in day trading as long as the transactions are part of a hedge strategy. If the account does not have the $5 million in equity, day trading can still occur, provided the member organization has the ability to apply the day trading requirements of paragraph (f)(8) of Rule 431. If the securities subject to day trading are a part of a hedge strategy, then the Exchange does not consider the collective transaction as day trades and therefore it would not subject the account holder to the day trading requirements. A hedge strategy for the purpose of this rule means a transaction or series of transactions that reduce or offset a material portion of the risk in a portfolio.

For portfolio margin accounts that do not establish and maintain equity of $5 million dollars, member organizations that have the capability to charge the required margin at the time an order is entered and prohibit the trade from being executed if an account does not have enough maintenance excess, may be exempt from the day trading requirements under Rule 431. The Exchange recognizes that in this instance, a customer will not exceed his/her day trade buying power and therefore will not incur a day trade margin call. 2. How should a prime broker calculate the day trading margin requirements on an account that does not have $5 million in equity? Firms should apply the TIMS margin requirement as the day trading requirement, e.g. 15% for equity securities. However, customers should not make a practice of incurring day trading margin calls. We have interpreted the rule such that accounts with more than three day trading calls within a 12 month period should be restricted from exceeding their day trading buying power for 90 days. 3. Can a firm use intraday excess to calculate the day trading margin requirements under Rule 431(f)(8)(B)? Yes, if a firm has intraday capability to re-price the account to determine if there is sufficient excess equity in the account at the time the order is received, and to automatically block the transaction if there is insufficient excess equity. 4. If all portfolio margin calls are due in 3 days, what is the rule's intent with respect to day trading calls? We know that in strategy based accounts day trade calls are due in 5 days. We expect that day trade calls will be due within three business days as well.

Net Capital 1. When should a firm take a capital charge for a portfolio margin deficiency given that the

information that is needed in order to make an accurate computation may not be available until the following day? The capital charge should be taken at the close of business on T+1. 2. A firm may not permit "aggregate portfolio margin requirements" to exceed 10 times its net capital. If a firm's house requirement is higher than the minimum requirement under the TIMS/Rule 431 methodology, which is used for purposes of determining "aggregate portfolio margin requirements"? The TIMS/Rule 431 requirement should be used.

3. Can a firm exclude from "aggregate portfolio margin requirements" the margin required for positions that are carried in the portfolio margin account, but that are not eligible for portfolio margining (e.g., non-equity securities that are margined in accordance with standard Rule 431 requirements)? Yes. 4. NYSE Info Memo 06-86 requires firms to monitor the aggregate amount of portfolio margin credit extended in relation to the firm's net capital, and to limit such credit to 1000 percent of net capital. Was this intended to impose a limit on credit extended that is different from the limit on "aggregate portfolio margin requirements" under the Rule? No, it is the aggregate requirement.

Intra-Day Monitoring 1. The rule requires procedures for monitoring intra-day exposures in portfolio margin

accounts. In many prime brokerage accounts, executions are done away and the prime broker may not know the transactions until the end of the day. What is expected with respect to intra-day monitoring? In prime brokerage accounts where trades are executed away the Exchange encourages firms to obtain real time drop copies of the trades. In the absence of a requirement to do so, firms must analyze such accounts once a day, after the close. For these accounts, trades can be disaffirmed after the overnight evaluation of the closing positions. For smaller accounts, especially those that are one sided (not adequately hedged and therefore just have a 15% one sided cushion rather than 15% on each side of a more market neutral account) and those accounts that trade actively during the day or are concentrated, the Exchange expects firms to impose higher house maintenance requirements.

Margin Deficiencies 1. The rule is unclear with respect to the date that house calls are due. Is it up to the firm to

define the due date (longer than 3 days) for a portfolio margin house call? Firms must adhere to the three business days for house calls as well.

2. If a Prime Broker account has a margin deficiency, and a trade is reported at the end of the business day that increases the risk in the account, what action should the Prime Broker take? The Prime Broker can accept the trade but the customer must meet the margin requirements within 3 business days and the account equity must be brought up to the $500,000 minimum. 3. If a customer had a standard margin account and a portfolio margin account, whereby the legal name and the tax ID are the same, does collateral have to be transferred from the standard margin account to satisfy a margin deficiency in the portfolio margin account? No, in this situation they do not have to transfer the collateral. As long as the standard margin account has sufficient excess, the margin deficiency in the portfolio margin account can be considered met. However, the SMA in the Regulation T margin account must be reduced by the amount of the portfolio margin deficiency in order to prevent a customer from utilizing the available excess for additional transactions in the Regulation T margin account. 4. Firms may not permit eligible participants to make a practice of liquidations to meet a portfolio margin deficiency, but liquidations to eliminate deficiencies caused solely by adverse market movements may be disregarded [See Rule 431(g)(10)(E)]. How does a firm distinguish between deficiencies that arose due to market movements vs. trading activity, particularly in the context of an actively traded account? Firms that cannot distinguish between adverse market movements and new transactions should take a conservative view and consider all margin deficiencies as resulting from the account holder's trading activities. 5. What are the ramifications of a customer making a practice of liquidations? If a customer has three liquidations in a rolling twelve month period, we would expect the firm to restrict the account to funds on hand for 90 days.

Portfolio Margin Account Management 1. If a customer has a Regulation T account and portfolio margin account, how should the

two accounts be treated for segregation purposes? The Regulation T and portfolio margin accounts should be combined when calculating segregation requirements under SEA Rule 15c3-3.

2. Are special custody, and third party agreements, permissible in a portfolio margin account? Such arrangements are generally in place because the customer is legally prohibited from maintaining assets at the broker-dealer. Special custody arrangements can be extended to a portfolio margin account. 3. A firm is not planning to open new accounts for portfolio margin customers. Instead, they intend to take an existing margin account, isolate the eligible products from the noneligible products and apply the appropriate TIMS and Rule 431 requirements. Is this permissible? Yes, provided that the customer is eligible for portfolio margining and the firm is able to identify the portfolio margin accounts and the positions eligible for portfolio margining. However, the firm will have to provide to the Exchange with a file of all portfolio margin positions in the prescribed format in order for the Exchange to isolate those positions that are margined under the TIMS methodology.

Other Portfolio Margin Topics 1. Does the Exchange have a particular format it expects firms to use in their applications for

approval to engage in portfolio margining? Firms should refer to the guidance contained in the Information Memo issued on December 21, 2006 (06-86). 2. The current pilot is due to expire on July 31, 2007. Is there an expectation that the pilot will be made permanent after that date? Our current intention is to extend the pilot so that we can get more experience and potentially make changes before the rule is finalized. 3. Is STANS now approved to be used for portfolio margining? No, STANS is only used at the clearing level for self-clearing OCC member firms. TIMS will continue to be the methodology used for portfolio margining and for broker-dealer net capital requirements under SEA Rule 15c3-1. 4. How often does the Exchange expect internal audit to conduct a review of the margining process? We expect the firm's internal audit to conduct a review within the first year of implementation. The schedule thereafter can be determined by any findings in the initial audit.


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