Government Relations

Strategic, Proactive Leadership

CBOE® and its affiliates operate in a highly regulated environment. Laws passed by Congress and rules established by federal agencies, such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), greatly affect the market structure within which CBOE operates as well as numerous other areas of importance to CBOE and the investors CBOE serves. As a leader in the equities and derivatives marketplace, and an innovator in options and volatility products, CBOE is committed to proactively addressing key issues of interest and providing transparency into our strategic agenda.

For more information about key topics, please click on the links below.

Recently implemented regulatory capital rules governing banking organizations are inadvertently dampening liquidity in the options market because they do not take into account the risk reducing characteristics of options and instead impose unnecessarily inflated capital requirements for option positions that can be riskless or risk reducing.

Issue: Regulatory Capital Rules Governing Banking Organizations

The Basel Committee on Banking Supervision (Basel Committee) consists of senior representatives of bank supervisory authorities and central banks from many of the major financial jurisdictions, including the U.S. The Basel Committee adopted a framework to reduce systemic market risk by requiring banks to increase capital and/or decrease leverage for certain risk exposures (Basel III). The Office of the Comptroller of the Currency and Board of Governors of the Federal Reserve System have adopted rules in order to implement various aspects of Basel III in the U.S., including the manner in which Risk-Weighted Assets (RWA) are calculated. Unfortunately, current requirements obligate large U.S. bank holding companies to calculate their RWA using a standardized approach known as the Current Exposure Method (CEM). Under CEM, options risk is measured by notional amount, and the actual risk of exposure to option positions is ignored. For example, CEM fails to recognize that an option that is far out-of-the money will have a very low delta value (i.e., the option's value is less sensitive to changes in the value of the underlying security or index). CEM also fails to properly allow offsetting risks to be netted (i.e., offsetting of positions) when calculating capital charges.

Although the Basel Committee agreed to replace CEM by January 2017 with a more risk-sensitive method known as the Standardized Approach for measuring Counterparty Credit Risk exposures (SA-CCR), the Board of Governors of the Federal Reserve has not yet implemented SA-CCR, and the transition is not imminent. The effect is that CEM grossly overstates a bank's actual economic exposure to listed option positions, which requires banking organizations to hold capital that is disproportionate to the actual risks posed by the option positions, including via a bank-owned clearing firm's listed options business. This problem is especially acute in high notional value products like CBOE's S&P 500 Index options.

Impact: Bank-Owned Clearing Firms Clear the Majority of Market-Maker Transactions

All listed options transactions in the U.S. are cleared at the Options Clearing Corporation (OCC). The OCC is comprised of clearing members that effectively guarantee the performance of the parties to an options transaction. Option market-makers on exchanges like CBOE clear their trades through OCC clearing members. The vast majority of these clearing members are subsidiaries of bank-holding companies that are now subject to option-insensitive capital requirements that govern the method by which banking organizations calculate capital charges and affect the amount of capital the banking organizations must maintain.

Regulatory Capital Rules Unintentionally Harm the Listed Options Market

Current regulatory capital rules are not properly calibrated because they are not sufficiently risk sensitive. The regulatory capital rules fail to account for an options' delta and fail to fully recognize the offsetting of positions with opposite economic exposure (i.e., long positions and short positions). The gross overstatement of a bank's actual economic exposure requires banking organizations to hold capital that is disproportionate to the actual risks posed by a bank-owned clearing firm's listed options business. Thus, bank holding companies are increasingly less willing to maintain the capital necessary to allow their affiliates to clear options transactions. The immediate effect is that bank affiliated clearing firms are now instructing market-makers to curtail their options trading activity in order to reduce the bank affiliated clearing firm's regulatory capital footprint. This reduces liquidity in the options market to the detriment of investors.

Market-Makers are Critical to the Options Market

In the listed options market, liquidity is supplied by professional market-makers. Most investor orders are executed against market-maker quotations. Due in part to the dispersion of trading interest across hundreds of options series in a single options class, the majority of individual options series would have no posted liquidity if options market-makers were not present. In short, market-maker liquidity provision is critical to vibrant option markets, which is why the impact of detrimental bank capital regulations on market-maker liquidity is so concerning to CBOE.

Options are Important Risk Mitigation Tools

Options are first and foremost incredibly useful and powerful risk mitigation tools that can help protect an investor's financial portfolio. From buying puts to hedge the downside risk of owning a stock to writing covered calls to collect income and cap potential losses, listed options strategies are protective tools employed by institutions, pension funds, and individual investors. Importantly, option positions can offset one-another and curtail risk. More option positions should not necessarily equate to higher capital requirements - options used in combination often reduce risk and should thereby reduce a capital requirement - not increase it.

We Need a Solution

Market-maker liquidity is the backbone of the options industry. A regulatory capital regime that unintentionally causes market-makers to limit their options trading activity will reduce liquidity and harm all options users, including individual investors and pension funds.

CBOE stands ready to work with interested parties on a meaningful solution which could include:

  • Interpretive relief from the Board of Governors of the Federal Reserve that will allow bank-owned clearing members to apply a more risk-sensitive methodology to listed options.
  • Adoption of SA-CCR: Although the members of the Basel Committee, including the U.S., agreed to adopt the more risk-sensitive RWA calculation method knows as SA-CCR by January 2017, the United States has not yet implemented SA-CCR and is not close to implementing SA-CCR.
  • Legislation that properly identifies the risk profile of listed options.

Bank Capital Summary Sheet

Additional Information:

CBOE is also concerned that the Basel III supplemental leverage ratio, currently scheduled to go into effect in 2018, will not adequately take into consideration its effect on the U.S. options and futures markets. The leverage ratio is a separate requirement that is defined as the capital measure (the numerator), which constitutes Tier 1 capital, divided by the exposure measure (the denominator). CBOE is concerned that the leverage ratio does not account for the fact that segregated customer initial margin for centrally cleared derivatives, which is designed to reduce the clearing firm's exposure in order to guarantee the customer's performance, cannot be used to leverage the customer's clearing member firm. Absent any capital recognition for such reduced exposure, clearing firms may incur unnecessarily high capital costs that do not accurately reflect the exposure reduction achieved from segregated customer initial margin for cleared derivatives.

Read CBOE's July 2016 Joint Comment Letter on bank capital regulation

Read CBOE's January 2016 Comment Letter on the Federal Reserve Board's Total Loss-Absorbing Capacity (T-LAC) Proposal

Read CBOE's October 2015 Joint Comment Letter on bank capital regulation.

Issue: Certain market participants are steering institutional customers into opaque and non-exchange traded bilateral option "contracts." These so-called "copycat" OTC derivatives have terms that are similar to contracts currently listed and traded on registered exchanges, including CBOE.

Our Position: CBOE believes this practice neither benefits nor fully protects users of such products and subjects customers to unnecessary risk. This practice also deprives the exchange marketplace of valuable liquidity which impacts all market participants. CBOE believes (1) OTC option trading should be transparent as is listed option trading; (2) firms utilizing OTC options should be monitored for best execution compliance; and (3) OTC options that substantially mirror the terms of listed options should not be allowed.

Additional Information:
Read CBOE's Comment Letter to the SEC which was submitted on October 2, 2014. The letter asserts our concern regarding the use of OTC options by market participants where substantially similar listed options are available.

Issue: A financial transaction tax (FTT) is a levy on a particular financial transaction. FTTs differ based on the type of financial transaction that is taxed and the way in which the tax revenue is spent. FTTs on the purchase or sale of exchange-traded-products such as stocks, futures, and options have been proposed for a myriad of reasons, including: to reduce volatility in the market; reduce speculation; prevent the next financial crisis; or simply to raise tax revenue. For example, a member of the Illinois House of Representatives proposed the Financial Transaction Tax Act (FTTA) in order to raise revenue for the State of Illinois by taxing transactions occurring on exchanges located in Chicago at a rate of $1 to $2 per contract. On the national level, legislators have also proposed versions of a financial transaction tax including a 0.5% tax on the sale of stocks and smaller levies on bonds and derivatives as well as a tax on excessive levels of order cancellations.

Our Position: CBOE believes FTTs have the potential to seriously harm the markets. The securities and futures markets provide valuable and powerful financial hedging products for investors large and small. CBOE is concerned that an FTT, however well-meaning, will have serious unintended consequences. Also, a tax on excessive order cancellations could unintentionally harm market quality if it were levied against registered market-makers for quoting interest that is continuously re-pricing. This, in turn, would hurt retail investors who rely on and trade with market-maker provided liquidity.

Additional Information:
Testimony of Edward Provost on Illinois Financial Transaction Tax (6/7/16)

Issue: There are increasing calls by regulators for changes to the tax code that would effectively eliminate important gain/loss treatment afforded to traders of certain derivative contracts including non-equity options (e.g., index options such as SPX). This treatment, known as 60/40 treatment under Section 1256, provides that 60% of a capital gain or loss may be treated as a long-term capital gain and 40% may be treated as a short- term capital gain, even if the position was held for less than one year. This 60/40 rule was enacted over 30 years ago in an effort to alleviate the effects of a mark-to-market tax regime on market makers providing critical liquidity.

Our Position: CBOE believes that eliminating 60/40 treatment is a perilous misstep at a time when use of responsible investing tools should be encouraged instead of discouraged. Further, this change would increase costs for professional liquidity providers, who are vital to making markets in these derivatives, which in turn would likely increase costs to investors as well. CBOE is eager to work with legislators on both sides of the aisle to ensure that investors are not adversely affected by this proposed nuanced change to the tax code.

Issue: On December 11, 2015, the SEC proposed Rule 18f-4 under the Investment Company Act of 1940, which is intended to create a comprehensive approach to the use of derivatives by mutual funds, closed-end funds, exchange-traded funds and companies that elect to be treated as business development companies. The proposed rule would implement portfolio limitations on derivatives trading, impose an asset coverage and segregation requirement, and, in some cases, require a formal derivatives trading risk management program.

Our Position: CBOE questions the need to include listed options in the rulemaking. CBOE suggests the Commission reexamine the asset segregation and portfolio limitation requirements of the proposed rule to ensure they will not impede proven and prudent investment strategies.

Additional Information:

CBOE's March 2016 Comment Letter

U.S. Securities Markets Coalition's March 2016 Comment Letter

Issue: Under EU regulations, certain EU entities such as EU banks must take a punitive capital charge if they transact business through a non-qualifying clearinghouse. A non-EU clearinghouse is deemed qualified if it has been recognized by the EU as subject to equivalent regulation. The European Commission adopted the EU-US equivalence decision on March 15, 2016, which ensures that central counterparties registered with the CFTC will be able to obtain recognition in the EU. However, the EU still does not currently recognize the US as having equivalent regulation over US-based clearinghouses for SEC regulated securities options. The implementation date for these punitive capital charges has been extended to December 15, 2017.

Our Position: CBOE, C2, BZX, and EDGX use OCC as their clearinghouse. OCC is a clearinghouse for both securities options and futures. The adverse consequences to non-recognition of SEC regulated clearinghouses would be very significant. CBOE supports the efforts of the SEC to address this issue and obtain equivalency for US clearinghouses for securities options.

Additional Information:
Read WFE's Letter about the Impact of EU Clearinghouse Recognition Delays.

Issue: The SEC created a committee to review equity market structure. The committee is lacking in exchange and listed company representation. Further, the committee has proposed recommendations that are well beyond the scope of equity market structure.

Our Position: CBOE believes that regulatory market structure reviews and changes should be addressed in a holistic manner that contemplates impact on the options market and all market stakeholders.

Additional Information:
CBOE's May 2015 Comment Letter to the SEC Equity Market Structure Advisory Committee

CBOE's January 2016 Comment Letter to the SEC Equity Market Structure Advisory Committee

June 2017 testimony of Chris Concannon, President and Chief Operating Officer of CBOE Holdings Inc., before the Subcommittee on Capital Markets, Securities and Investment - U.S. House Committee on Financial Services - Hearing entitled "U.S. Equity Market Structure Part I: A Review of the Evolution of Today's Equity Market Structure and How We Got Here"

Issue: Portfolio Margin is a margin methodology that sets margin requirements for an account based on the entirety of the account and results in a more efficient use of capital. In general, positions in index option class groups that are highly correlated may be netted against each other based on allowed percentage amounts to determine the overall profit/loss of an account. For example, in a securities portfolio margin account, cash-index options and exchange-traded funds within the same class groups may be netted to determine the overall profit/loss of the account as a whole at various assumed up and down market moves in the underlying. The greatest loss from among the assumed market moves, if any, is the margin requirement, subject to a per contract minimum. Also, some security-based swaps may be held in a futures account for portfolio margin purposes. Customers benefit from PM because margin requirements calculated on net risk are generally lower than alternative position or strategy based methodologies for determining margin requirements.

Currently, futures and securities options, including VIX® futures and VIX options cannot be held in either the same securities or futures account. However, the Dodd-Frank Act (DFA) amended various SEC and CFTC statutes to enable securities to be held in a futures account or futures to be held in a securities account. To give effect to these amendments, SEC and CFTC action is needed either in the form of an exemptive order or rule or regulation, and the SEC and CFTC together need to promulgate rules to ensure transactions and accounts are subject to comparable requirements to the extent practicable for similar products.

Our Position: CBOE advocates strongly for portfolio margining of index futures in a securities account. CBOE believes that the ability to hold index futures and securities in a single account, and for margin to be calculated based on the entirety of the account and not assessed separately by instrument would result in a more efficient use of customers' capital and help avoid liquidating transactions in times of market stress.

Additional Information:
Read CBOE's Press Release on position margining rules. The DFA provides for portfolio margining.

CBOE believes that options users who utilize VIX futures would benefit from portfolio margining.

Issue: In 2015, the SEC proposed amendments to SEC Rule 15b9-1, which, together with Section 15(b)(9) of the Securities Exchange Act of 1934 ("Act"), provides an exemption from the requirement that broker-dealers must be members of a registered national securities association (i.e., FINRA).

Our Position: CBOE is concerned that the proposed amendments may inadvertently require FINRA membership of broker-dealers that are members of an exchange, or multiple exchanges, and whose primary business involves executing transactions on the exchange(s) of which the broker-dealers are members, which would needlessly impact numerous exchange members without furthering the congressional aims of Section 15(b)(9) of the Act or Rule 15b9-1.

Additional Information:

CBOE's Joint September 2016 Comment Letter

CBOE's June 2015 Comment Letter

Issue: On November 24, 2015, the CFTC approved the issuance of a rulemaking proposal for public comment regarding automated trading on futures exchanges. The proposed rulemaking, referred to as Regulation AT, proposed various risk controls; transparency measures; standards for system development, testing, and monitoring; and reporting and record-keeping requirements related to automated trading on futures exchanges. The rulemaking also proposed to establish a registration requirement for certain proprietary trading firms with direct electronic access to a futures exchange.

On November 4, 2016, the CFTC approved the issuance of a revised Regulation AT rulemaking proposal for public comment. The revised rulemaking proposed certain changes to the original proposal, including: requiring risk controls at two levels instead of three; eliminating the proposed AT Person annual reporting obligations and replacing them with an annual certification; narrowing the definition of AT Person by imposing a volume threshold; and requiring Commission approval in order to obtain source code from an AT Person.

Our Position Overall, and as CFE states in its comment letters to the CFTC regarding the original and revised proposed rulemakings, CFE agrees that it is important to manage the risks associated with automated trading and believes that sufficient regulation of futures exchanges is already in place to address the concerns of the proposed rulemaking. Should the CFTC decide to proceed with final adoption of the proposal, CFE's comment letters to the CFTC also recommends changes to specific aspects of the proposal.

Additional Information:
Read the CFTC Fact Sheet regarding proposed Regulation AT.

CFE's March 2016 Comment Letter

CFE's May 2017 Comment Letter

Issue: The National Market System ("NMS") Plan Governing the Consolidated Audit Trail ("CAT NMS Plan") was approved by the SEC in order to create, implement, and maintain a consolidated audit trail ("CAT") that captures customer and order event information for orders in NMS securities, across all markets, from the time of order inception through routing, cancellation, modification, or execution in a single, consolidated data source. The CAT NMS Plan applies to stock, stock options and index options, but it does not apply to, and thus will not capture order and transaction data for, stock index futures or options on index futures.

Our Position: CBOE believes incorporating futures data into CAT would create a more comprehensive audit trail, which would further enhance the surveillance programs of the self-regulatory organizations, the SEC, and the CFTC.

Additional Information:
Read CBOE's July 2016 Comment Letter on the CAT Proposal
Read the CAT NMS Plan