Bank Capital Rules
Issue: 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.
Our Position: Cboe has been supportive of the Federal Reserve, OCC, and FDIC proposal to replace the Current Exposure Method (CEM) with the Standardized Approach to Counterparty Credit Risk (SA-CCR). From Cboe's perspective, CEM's primary flaws arise from the methodology's insensitivity to actual risk. CEM does not account for the delta (i.e., market sensitivity) of an option position or fully recognize the offsetting of positions with opposite economic exposures.
In November 2019, the bank regulatory agencies approved the SA-CCR rulemaking. Banks are required to adopt SA-CCR by January 1, 2022, but may do so as early as April 1, 2020. The implementation of SA-CCR will help correct CEM's flaws by incorporating risk-sensitive principles, such as delta weighting options positions and more beneficial netting of derivative contracts that have economically meaningful relationships. Cboe therefore welcomes the early adoption of SA-CCR as an important step to ameliorate the effects of CEM and applauds the banking Agencies for approving the rulemaking, which included several of Cboe’s recommendations regarding appropriate netting sets. Cboe is monitoring the implementation of the final rule to ensure SA-CCR is adopted in a timely manner. If the final rule is not adopted quickly, in addition to the recently adopted SA-CCR rulemaking, Cboe believes it is advisable for the Federal Reserve to issue short-term interpretive relief that allows bank-owned clearing members to apply a more risk-sensitive methodology to listed options before the full implementation date of SA-CCR. This important action would help alleviate the liquidity dampening effect of current capital rules until such time as the banks fully implement SA-CCR on or before January 1, 2022.
Cboe's March 2019 Comment Letter in response to the Federal Reserve, FDIC, and OCC proposal to adopt the Standardized Approach to Counterparty Credit Risk (SA-CCR).
Cboe's September 2018 Comment Letter in response to the Financial Stability Board, Basel Committee on Banking Supervision, Committee on Payments and Market Infrastructures, and International Organization of Securities Commissions consultation on incentives to centrally clear over-the-counter (OTC) derivatives.
SEC Proposed Rule 18f-4 (Use of Derivatives by Investment Companies)
Issue: On November 25, 2019, the SEC re-proposed a rulemaking on funds' use of derivatives that would generally require mutual funds, ETFs, and closed-end funds to limit fund leverage and implement risk management programs specific to derivatives. The proposal also seeks to impose additional sales practice requirements on broker-dealers and investment advisers trading certain leveraged/inverse funds on behalf of retail customers. The new rulemaking modifies a 2015 proposal on funds’ use of derivatives that also sought to implement limits on fund leverage, as well as impose an asset coverage and segregation requirement, and, in some cases, require a formal derivatives trading risk management program. The new proposal meaningfully improves upon the 2015 proposal as well.
Our Position: Cboe applauds the Commission's focus on investor protection, however, Cboe urges the Commission to craft any final rule in as targeted a way as possible so as to not hinder the ability of funds to optimally utilize listed options. Exchange listed options are powerful and useful investment tools and their benefits should be enjoyed by a wide spectrum of investors. In response to the 2019 proposal, Cboe suggested, among other things, that the Commission revise the proposal to not encompass options and options strategies that do not result in a future payment obligation and therefore do not present the risk of undue speculation and that the proposed sales practice rules for leveraged and inverse funds are duplicative in many ways when viewed in combination with recently approved SEC Regulation Best Interest.Below please find additional information related to the 2019 and 2015 proposals, including Cboe's most recent comment letter.
Copycat OTC Derivatives
Issue: Certain market participants are steering institutional customers into so-called "copycat" over-the-counter (OTC) derivatives, which are opaque, off-exchange, privately-negotiated bilateral agreements with contract terms that are identical to, or substantially similar to, the contract terms of standardized options contracts traded on registered exchanges.
Our Position: Copycat OTC derivatives present unnecessary risks while avoiding the price discovery, price improvement and trade reporting functions of national securities exchanges to the detriment of customers and the public interest. Cboe encourages regulators to review broker-dealer activities in the OTC options marketplace to ensure broker-dealers are meeting their best execution requirements and otherwise acting in the best interest of their customers when effecting OTC options transactions.
Financial Transaction Tax
Issue: Financial Transaction Taxes (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.
Our Position: Any FTT on equities, options, and futures in the U.S. will ultimately increase costs for retail investors. FTTs change trading behaviors in unintended ways, which can cause market quality to suffer. Further, projected revenues often are not realized due to the behavioral changes.
Issue: The regulatory approval process for new exchange-traded products is overly burdensome, hampering innovation and preventing regular investors from realizing the benefits that flow from such innovation.
Our Position: Cboe is a strong supporter of product innovation. New, innovative products can confer significant benefit to investors. Cboe stands ready to work with interested parties on ways to improve regulatory structure and to promote innovation in ETPs.
European Union (EU) Clearing Equivalency
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 June 2021.
Our Position: Cboe Options, C2 Options, BZX Options, EDGX Options, and CFE 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 could be significant. Cboe Options supports the efforts of the SEC to address this issue and obtain equivalency for US clearinghouses for securities options.
Transaction Fee Pilot
Issue: On March 14, 2018, the SEC proposed new Rule 610T of Regulation NMS to implement a Transaction Fee Pilot for National Market System stocks. The Commission's stated purpose for the Pilot is to gather data to study the impact of transaction fees and rebates on order routing behavior, execution quality, and market quality, presumably to gather data to study "potential" conflicts of interest in broker order routing. The Commission proposes to include approximately 3,000 stocks in the Pilot, divided into three test groups that will limit exchange access fees and/or exchange rebates. The Commission proposes to implement the Pilot for a duration of two years with an automatic sunset at one year, giving the Commission the authority to suspend the sunset and allow the Pilot to continue for the full two-year term.
Our Position: Cboe generally supports the Commission's efforts to analyze current market structure and propose thoughtful improvements. However, the Pilot is likely to adversely impact market quality and investor experience, as well as disrupt the pricing structure for a material portion of the equities market. Cboe believes the Pilot is unnecessary, that data resulting from the Pilot will not yield useful information, and that potential conflicts of interest can be examined and addressed in much less intrusive ways and without subjecting the equities market and investors to potentially significant harm.
We believe the Commission should adopt less damaging alternatives that will allow the Commission to achieve their objectives before implementing a Pilot that will severely disrupt the equities market. For example, the Commission could strengthen and better articulate the Duty of Best Execution and develop greater broker-dealer transparency through existing SEC rules. These alternative actions would make the disruptive Pilot moot by targeting potential conflicts of interest more directly.
June 2017 testimony of Chris Concannon, President and Chief Operating Officer of Cboe Global Markets, 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.
Cboe Options' Press Release on position margining rules. The DFA provides for portfolio margining.
Cboe Options believes that options users who utilize VIX futures would benefit from portfolio margining.
SEC Proposal to Amend Rule 15b9-1 (Requiring FINRA Membership)
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.
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.
Issue: Supreme Court precedent has caused considerable uncertainty as to what types of inventions should be eligible to receive patent protection and has weakened an important system that mainstream companies rely on to protect their investments in new technologies.
Our Position: Intellectual property is a key economic driver and the protections afforded thereunder provide companies with security to invest in future innovations.
Issue: The European Commission is in the process of reviewing the MiFID II/MiFIR framework. One aspect of this review is whether to establish a consolidated tape ("CT") in Europe.
Our Position: The SIP model in the US serves the market extraordinarily well. We believe the establishment of a European CT, adapted to the nuances of the European market, will greatly benefit European markets and support the development of the Capital Markets Union. See here for more.