Salomon Smith Barney
October 25, 2002
Mr. Jonathan Katz, Secretary
Re: OneChicago, LLC - Notice of Filing of Proposed Rule Change by OneChicago Relating to Customer Margin Requirements for Security Futures - File No. SR-OC-2002-01; Release No. 34-46555
Dear Mr. Katz:
Salomon Smith Barney ("SSB")1 appreciates the opportunity to comment on the Rule Change proposal filed by OneChicago, LLC, on September 26, 20002, relating to Customer Margin.
SSB has reviewed the letter dated October 23, 2002, filed with the Commission by Morgan Stanley and Goldman Sachs & Co. urging the Commission to reject the "Market Maker Exclusion" provision contained in the proposed Rule Change. SSB endorses the general conclusions set forth in the Morgan Stanley and Goldman Sachs comment letter, and also urges the Commission to reject OneChicago's proposal. If adopted, OneChicago's proposed Market Maker Exclusion would (1) unnecessarily expose the marketplace to increased systemic risk; (2) contradict the spirit and intent of the Commodity Futures Modernization Act of 2000 ("CFMA") by creating a significant disparity in treatment of security options market makers and security futures market makers; and (3) exceed the scope of the discretion provided to self-regulatory organizations ("SROs") by the Commission and the CFTC in defining entities eligible for exemption from federal margin requirements associated with security futures trading.
1. Increased Systemic Risk
OneChicago's proposed Rule Change would expose the market place to increased systemic risk by virtue of its expansive definition of "market maker." The proposed definition would include nearly all floor brokers in any futures product as well as a significant number of member firms that are proprietary traders. Such an expansive definition could encourage excessive leverage and risk taking by floor brokers and member firms, regardless of whether they provide liquidity to facilitate customer trading in security futures. By creating a broad class of market participants who are not required to post minimum margin, the rule could result in an FCM or broker dealer holding significant credit risk.
2. Disparity in Treatment of Security Options Market Makers and Security Futures Market Makers
The CFMA requires that the margin requirements for security futures be "consistent with the margin requirements for comparable option contracts." Under OneChicago's proposal for security futures, there would be no capital requirements for a floor broker who qualifies for the market maker exclusion from customer margin or on its carrying broker or FCM. Conversely, an options market maker or its clearing firm is subject to net capital haircuts imposed by Rule 15c3-1of the Securities Exchange Act of 1934 (the "Act"). This lack of comparability could create the competitive advantage for security futures that the CFMA sought to avoid.
3. The Definition is Inconsistent with the Discretion Afforded SROs
The joint margin release by the Commission and the CFTC provides that member firms whose revenue is derived form trading "listed financial-based derivatives" might be an appropriate class to reference for the exclusion. The release defines "financial-based derivatives" as being limited to "security futures, stock index futures, stock and index options, foreign currency futures and options, and interest rate futures and options." (67 Fed. Reg. 157 at p.53153 (Aug. 14, 2002). Therefore, OneChicago's expansion of the class of exempt borrowers beyond member firms that trade in "financial-based derivatives" appears to be unfounded.
SSB believes that security futures could be a valuable product in assisting market participants to manage risk and enhance their trading strategies, and should be given every opportunity to succeed. However, because security futures are leveraged, the regulatory regimen must ensure that the product is subject to a sensible margining system. OneChicago's proposal could create a significant gap in that system. Therefore, SSB urges the Commission to reject the OneChicago Rule Change until it is revised to address the issues described above.
Should you have any questions, please feel free to contact me at (212) 732-8918.
Cc: Annette Nazareth, Esq.