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FED ER A L R ESER VE BANK
OF N EW YORK
[
Circular No. 8 6 2 3 1
August IS, 1979 J
EXCHANGE SPECIALISTS; CREDIT ON MUTUAL FUND SHARES
Comment Invited on Proposed Amendments to Regulation T
To A ll Brokers and Dealers, and Members of National
Securities Exchanges, in the Second Federal Reserve District:
The Federal Reserve Board has proposed amendments to its Regulation T—“Credit by
Brokers and Dealers”—that would (a) permit brokers and dealers to lend on mutual fund shares,
and (b) permit options specialists to buy and sell short, on a 25% margin basis, the stock under
lying the options in which they specialize.
Comment on the proposals should be submitted by October 15 and may be sent to our Consumer
Affairs and Bank Regulations Department.
M u tu a l f u n d s h a r e s
The first proposal would permit brokers and dealers to extend and maintain credit on fully
paid-for mutual fund shares deposited in a general account. Its purpose is to grant to broker-dealers
the same authority that banks and other lenders now have under Regulations U and G.
E x c h a n g e s p e c ia lis ts
The Board announced that its proposal affecting specialists and options market-makers includes
the following changes:
1.
Specialists and options market-makers would be able to use securities issued by the United States
Government or its agencies as collateral in their specialist accounts.
2.
Creditors extending credit to a specialist’s joint account would no longer be required to participate
in the account.
3.
Members of a national securities association, such as the National Association of Securities Dealers,
would be permitted to receive preferential credit for their market-making transactions if the SEC should
determine that they perform the function of specialists and have similar responsibilities.
4.
Several other changes, including: restricting “free-riding” on underlying stock positions carried in an
options market-makers account; affecting the timing of withdrawal of cash or securities from their accounts by
specialists and market-makers; and defining securities that may be carried on preferential credit terms in the
accounts of specialists and market-makers.
The purpose of the proposal, the Board said, is “to give a certain amount of flexibility to the
operations of brokers or dealers who finance the positions of those persons who have assumed
responsibility for maintaining continuous markets in designated securities without permitting
unwarranted speculation in the related securities used for ‘hedging’.”
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Enclosed—for member banks and brokers and dealers—is the full text of the Board’s
proposals. They will be published in the F e d e r a l R e g i s t e r and will also be made available upon
request. Questions or comments should be directed to our Consumer Affairs and Bank Regulations
Department (Tel. No. 212-791-5914).
T homas M. T im l e n ,
F ir s t V ic e P r e s id e n t.
Title 12- Banks and Banking
Chapter II - FEDERAL RESERVE SYSTEM
SUBCHAPTER A - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
[Reg. T; Docket No. R-0158]
PART 220 - CREDIT BY BROKERS AND DEALERS
Loan Value for Mutual Fund Shares
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Proposed rule.
SUMMARY: The proposal will permit brokers and dealers to extend credit
on fully paid for mutual fund shares deposited in a general account.
The present rule permits broker-dealers to extend and maintain credit
only on securities registered on a national securities exchange, those
included on the Board's List of OTC Margin Stock and on certain nonconvertible debt securities which are traded in the over-the-counter
market.
The Board intends the proposed rule to reduce significantly
the inequity which exists between broker-dealers and banks, who are
currently permitted to extend credit on mutual fund shares under
Regulation U, and lenders registered with the Board under Regulation
G who have the same authority.
DATE:
Comments must be received on or before October 15, 1979.
ADDRESS: Secretary, Board of Governors of the Federal Reserve System,
Washington, D. C. 20551. All material should be in writing and should
include the docket number R-0158.
FOR FURTHER INFORMATION CONTACT: Patsy Abelle, Senior Attorney, or
Theodore W. Prush, Senior Securities Regulations Analyst, Securities
Regulation Section, Division of Banking Supervision and Regulation,
Board of Governors of the Federal Reserve System, Washington, D. C. 20551
(202-452-2731 ).
SUPPLEMENTARY INFORMATION: In response to a request of the
InvestnEnt Company Institute the Board of Governors proposes to amend
Regulation T (12 CFR 220) to permit brokers and dealers to extend
and maintain credit on securities issued by open-end investment com
panies and unit investment trusts ("mutual fund shares"). The proposal
would permit a broker or dealer to extend credit only on fully paid
for mutual fund shares deposited in a margin account. Due to the
prohibition contained in section 11(d)(1) of the Securities Exchange
Act of 1934 credit may not be extended on the initial purchase of
such securities, in the absence of an exemption granted by the
Securities and Exchange Commission.
Under the Board's existing rule a broker-dealer is per
mitted to extend and maintain credit only on securities registered on a
national securities exchange, those included on the Board's List of
OTC Margin Stock and on certain non-convertible corporate debt
securities traded in the over-the-counter market. The Board's proposal
would allow a broker-dealer to extend credit on mutual funds shares
as well. Presently only banks under the provisions of Regulation U,
and lenders registered with the Board under Regulation G are permitted
to extend and maintain credit on investment company shares.
Mutual fund shares deposited in a margin account at a brokerdealer would be subject to the same margin requirement as any other margin
security. The margin requirement is set forth in section 220.8(a) of
Regulation T and is presently 50 per cent of current market value.
To aid in the consideration of this material by the Board,
interested persons are invited to submit relevant data, views, comments,
or arguments. Any such material should be submitted in writing to
the Secretary, Board of Governors of the Federal Reserve System,
Washington, 0. C. 20551 to be received not later than October 15, 1979.
All material submitted should include the docket number R-0158.
Such information will be made available for inspection and copying
upon request except as provided in section 261.6(a) of the Board's
Rules Regarding Availability of Information (12 CFR 261.6(a)).
Accordingly, pursuant to sections 7 and 23 of the Securities
Exchange Act of 1934, as amended (15 U.S.C. 78g and w) the Board
proposes to amend 12 CFR part 220 as follows:
Section 220.2 - Definitions
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(f)
The term "margin security" means any registered security,
OTC margin stock, OTC margin bond or any security issued by an open-end
investment company or uiit investment trust registered pursuant to section
o of the Investment Compary Act of 1940 (15 U.S.C. 80a-8).
By order of the Board of Governors of the Federal Reserve
System, August 3, 1979.
(signed) Theodore E. Allison
Theodore
Secretary
(SE A l )
2
E.
of
A lliso n
the
Board
Title 12- flanks and Banking
Chapter II - FEDERAL RESERVE SYSTEM
SUBCHAPTER A - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
[Reg. T; Docket No. R-0054]
PART 220 - CREDIT 8Y BROKERS AND DEALERS
Credit to Exchange Specialists
AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Proposed rule.
SUMMARY: This revision of a proposed amendment to the rule governing
credit to exchange specialists, which was published in the Federal Register
on May 5, 1977 (42 F.R. 22894), contains changes based upon comments
received on that proposal and recommendations of the Securities and
Exchange Commission Special Study of the Options Market. As revised,
the proposal will permit options specialists to both purchase and sell
short the stock underlying tne options in which they specialize, with a
25 percent margin requirement. No maintenance requirenent is imposed
in this revision unless tne account, if sold out, would have an unsecured
debit balance. The proposed amendment also recognizes new exchange rules
approved by the Securities and Exchange Commission which permit traditional
stock specialists to trade in puts and calls on their specialty stock
and provides comparable relief for such hedging activities. This proposed
rule is intended to give a certain amount of flexibility to the operations
of brokers or dealers who finance the positions of those persons who
have assumed responsibility for maintaining continuous markets in
designated securities without permitting unwarranted speculation in
the related securities used for "hedging".
DATE:
Comments must be received on or before October 15, 1979.
ADDRESS: Secretary, Board of Governors of the Federal Reserve System,
Washington, D. C. 2U551. All material submitted should be in writing and
should include the docket number R-0054.
FOR FURTHER INFORMATION CONTACT: Laura Homer, Chief Attorney, or
Theodore W. Brush, Senior Securities Regulations Analyst, Securities
Regulation Section, Division of Banking Supervision and Regulation, Board
of Governors of the Federal Reserve System, Washington, D. C. 20551
(202-4 52-2781).
SUPPLEMENTARY INFORMATION: The May 5, 1977 proposal was intended to assist
option specialists in performing their market-making function by permitting
them, in certain circumstances, to purchase or sell short, on preferential
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credit terms, the securities underlying the options in which they specialize.
A specialist is a person registered on a securities exchange as a specialist
in a particular security. In general, a specialist is required to assist
in maintaining a fair and orderly market, either alone or in a competitive
framework, for that security on the floor of the exchange. Although market
makers in the over-the-counter market are not presently within the category,
the proposed rule provides for their inclusion if the SEC determines they
have parallel responsibilities and functions. The revised proposal
would broaden the scope of permitted offset transactions for lower priced
options by redefining the definition of an “in or at the money" option
"hedging'1 transaction. The proposal also eliminates the requirement
that a creditor participate in all joint account arrangements, and permits
a specialist or market-maker to use fully paid for government securities
as collateral in his account. In addition, the proposal restricts
"free-riding" in a market-maker account, and establishes the conditions
under which excess funds or securities may be withdrawn from the account.
To aid in the consideration of this material by tne Board,
interested persons are invited to submit relevant data, views, comments,
or arguments. Any such material should be submitted in writing to the
Secretary, Board of Governors of the Federal Reserve System,
Washington, D. C. 20551 to be received not later than October 15, 1979.
All material submitted should include the docket number R-0054. Such
information will be made available for inspection and copying upon
request except as provided in section 261.1(a) of the Board's Rules
Regarding Availability of Information (12 CFR 261.6(a)).
Pursuant to sections 7 and 23 of the Securities and Exchange
Act of 1934, as amended (15 U.S.C. 78g and w) the Board proposes to amend
12 CFR part 220 as follows:
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220.4 - SPECIAL ACCOUNTS
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>c
(g)
Specialist's account. (1) In a specialist's account, a
creditor may effect, carry or clear for specialists who are members of a
national securities exchange or registered securities association such
member's designated specialist transactions or transactions of any joint
account in which all participants, or all participants other than the
creditor, are registered and act as specialists.
(2) A specialist in options is permitted to establish in this
account a long or short position in the securities underlying the options
in which the specialist makes a market, and a specialist in securities other
than options is permitted to purchase or write options overlying the securities
in which the specialist makes a market, only under one or more of the
following conditions (such transactions are referred to in this
paragraph as "permitted offset transactions"):
(i) The account holds short options positions which
are "in or at the money" and are not offset by long or short options
positions for an equal or greater number of shares of the same underlying
securities which are "in or at the money;"
(ii) The account holds long options positions which are
"in or at the money" and are not offset by long or short options positions
of an equal or greater number of shares of the same underlying securities
which are “in or at the money;"
(iii) The account held a short option position against
which an exercise notice was tendered;
(iv)
The account held a long option position which was
exercised;
(v) The account holds net long positions in securities
other than options in which the specialist makes a market; or,
(vi) The account holds net short positions in securities
other than options in which the specialist makes a market.
(3)
The maximum loan value of securities which may be used
as collateral in the account shall be:
(i)
No more than 1UU per cent of the current market
value of long positions in securities in which the specialist makes
a market;
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(ii) Ho more than 1U0 per cent of the current market
value of any wholly-owned margin securities or exempted securities
issued by the U. S. Government or agencies thereof;
(iii) 7b per cent of the current market value of any
underlying securities or overlying options that are purchased and held
in the account under the terms of paragraph (g)(2) of this section and
for five full business days thereafter;
(iv) The maximum loan value prescribed by the Board in
§220.8 (the Supplement to Regulation T) when the underlying securities
or overlying options no longer serve as permitted offsets.
(4)
The amount to be included in the adjusted debit balance
of the account shall be:
(i) Hot less than 1U0 per cent of the current market
value of either the securities sold short or the options written where
such positions qualify as specialist transactions;
(ii) 12b per cent of the current market value of the
securities sold short or the options written and held in the account
under the terms of paragraph (g)(2) of this section and for five full
business days thereafter;
(iii) The amount prescribed by the Board in §220.8
(the Supplement to Regulation T) when the underlying securities or
overlying options no longer serve as permitted offsets plus, for
short positions in securities other than options, the current
market value of the securities sold short.
(b) Except as required by paragraph (g)(8), on any day
when additional margin is required as a result of transactions in the
account, the creditor shall issue a call for a deposit of cash or
securities having loan value and allow the specialist a maximum of
five full business days to make a deposit sufficient to meet the call.
(6)
On any day when the account of an options specialist
no longer holds an option position against which the underlying security
permitted to be purchased or sold short in the account under the terms
of paragraph (g)(2) of this section can be offset, or when the account
of a specialist in securities other than options no longer holds security
positions against which the overlying options permitted to be purchased
or written in the account under the terms of paragraph (g)(2) of this
section can be offset, the creditor shall have five full business days
to either liquidate the position or obtain a deposit into the account
of cash or securities equal to the deposit that would be required to
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establish such a position in the general account, reduced by a sura equal
to 25 per cent of the current market value of tne security. The requirement
to liquidate the position or obtain additional margin need not be met if
a new offsetting position is established in tne interim. To prevent "free
riding" in the account, a creditor who has not obtained the required
deposit is prohibited for a 30 day period from extending any further credit
to finance in the account transactions in securities in which the
specialist is not registered to make a market.
(7) On any day when a specialist requests a withdrawal of cash
or securities from the account the creditor shall value non-specialist
securities positions in the account in accordance with the provisions
of »220.8 (tne Supplement to Regulation T) and value specialist posi
tions on a "good faith" loan basis. Withdrawals shall be permitted to the
extent that the debit balance in tne account does not exceed the value
of all of the positions.
(8) On ary day when the account would liquidate to a deficit,
the creditor shall not extend any further credit in the account, and
shall issue a call for additional collateral which shall be met by noon
of the following business day. In the event sufficient collateral is
not deposited in the account the creditor shall liquidate existing positions
in the account.
(9)
(i ) The provisions of this paragraph are available to a
specialist (or a market-maker designated as a specialist) who is a
member of a national securities exchange or registered securities associa
tion which submits to the Board of Governors of the federal Reserve
System reports suitable for supplying current information regarding the
use of specialist credit;
(ii) The term "joint account" is an account in which the
creditor may participate and which by written agreement permits the
commingling of the security positions of the participants and provides
for a sharing of profits and losses from tne account on some predetermined
ratio;
(iii) The term "underlying security" means the security
which will be delivered upon exercise of the option and does not include
a security convertible into the underlying security;
(iv) The term "overlying option" means (1) a put option
purchased or a call option written against an existing long position
in a specialist's or market-maker's account, or (2) a call option purchased
or a put option written against a short position in a specialist's or
market-maxer's account.
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(v)
The term "in or at the money" means, with respect to
a call option, that the current market price of the underlying security
is not more than the greater of 5 per cent or $2.50 below the exercise
price of the option, and, with respect to a put option, the current
market price of the underlying security is not more than the greater of
5 per cent or $2.5U above the exercise price of the option.
By order of the Board of Governors of the Federal Reserve
System, August 8, 197 9.
(signed) Theodore E. Allison
Theodore E. Allison
Secretary of the Board
(SEAL)
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@FedFRASER