SIFMA Credit & Margin Section Newsletter. 255th Issue January 2013

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1 SIFMA Credit & Margin Section Newsletter 255th Issue January 2013 Mr. Steve Yannolo, Project Manager, Credit Regulation was a guest speaker at The Credit & Margin Section monthly meeting on January 17, 2013 held at Bayards at Hanover Square. The following is a summary of Mr. Yannolo s speech: As usual I will give my disclosure statement: Any options and/or comments that I make tonight are not necessarily shared by FINRA, but rather my own. Good evening. To get right to it, the new interpretation handbook came into existence by taking a lot of the Regulation Notices and we took those Provisions and put them into this version of the handbook. Secondly, we took the Portfolio Margin FAQs which have been out there since 2007 and put them into the interpretation handbook. I want to just gloss over some of the subject matter that we covered. Bond Ratings for Foreign Debt Securities, Short Non-Equity Convertible Securities, Money Market Mutual Funds, New Interpretation for Net Asset Value of Money Market Funds including Provisions from RN08-60 that discuss conditions in the Credit Markets that may result in the NAV of certain funds decline below $1.00 per share. The expanded interpretation for Reverse Repurchase Agreements generated a lot of conversation and it is still going on today. Our intent was to simply and clarify existing interpretations. There are two interpretations in the handbook today. Exempted Securities shall be maintained in a special account and subject to the same requirements as in a margin account. This is still in draft and not finalized. New interpretation for Exempted Securities Mutual Fund and Exempted Securities Exchange Traded Funds. We took the provisions from RN (Margin Requirements for exempted securities mutual fund and exempted securities EFTs) and codified in an interpretation. Joint Back Office Arrangements a new interpretation for the use of other assets. To meet the minimum equity in a JOB Account, it allows members to consider a participating broker-dealer s assets held at an affiliate which is governed by the SEC or the CFTC in order to satisfy the $1million minimum equity requirement. There is also a new interpretation for Non-Margin Eligible Securities in a Non-Purpose Credit Account which resulted from RN (treatment of non-margin eligible equity securities). It clarifies the condition under which loan value can be extended in a non-purpose loan account. Members may extend credit only on those securities that are collateralizing a margin debit, and

2 that can be liquidated to satisfy supported by such securities, based on a rolling 20 business day median trading volume, otherwise it is a 100% maintenance requirement. In this regard, members shall have written supervisory procedures describing the methods used to obtain the volume information and the documentation to support compliance with this requirement and shall be made available to FINRA upon request. We also added language regarding offshore mutual funds. They will be exempt from this provision and will be afforded maintenance loan value to collateralize non-purpose loans only based on a 25% maintenance margin requirement, provided the fund has an affiliation with a US-based fund registered with the SEC pursuant to the Investment Company Act of 1940 and the fund shares can be liquidated/redeemed daily. We amended the current interpretation for the reduction of marginable shares for margin and capital charge computations. What this did was clarify that when determining the number of shares to be considered saleable for purposes of the capital charge computation, members must consider the amount of shares saleable under Rule 144, the number of shares held at the member and the number of shares held away. This determination can be made by such methods as reviewing public information and/or obtaining a letter from the customer attesting to the total amount of control or restricted shares that are owned and/or held away. Members can determine the amount of shares that are held away. The amount of shares considered saleable for the capital charge computation must be reduced by such shares. If a determination as to the total amount of shares owned and/or held away cannot be made, the members must consider all the shares held in their possession as not saleable. We amended the interpretation for concentration or volatile securities which will include low priced securities. When extending credit in a strategy based or portfolio margin account, members should consider the risk associated with concentrations in single securities, lowpriced, or volatile securities. A new interpretation for hedging strategies in option positions as well as leveraged exchange traded fund options. This includes provision from RN which increased margin requirements for leveraged ETFs. It also clarifies how options on leveraged ETFs are to be calculated with examples. Day Trading Requirements. There is a new interpretation regarding Approved Specialist and Market Maker Accounts. The account of an approved specialist or market maker, as defined in paragraph (e)(5), shall be exempt from the day trading requirements. All other accounts maintained by the specialist or market maker shall be subject to such day trading requirements. 2

3 New interpretation for Option Spreads. The simultaneous assignment and exercise, or the simultaneous assignment and closing transaction, of the short and long option contracts that comprise a spread within the same business day shall not be considered day trades, provided an initial and/or maintenance margin call was not outstanding as a result of the transactions that comprised the spread strategy. New interpretation regarding Option Spread As Day Trades Option transactions executed to create an option spread may be treated as one option transaction for the purpose of applying day trade requirements. Thus, only one day trade will be deemed to have occurred when all components of a spread ( legs ) are opened contemporaneously and closed contemporaneously intra-day. A written record of the time of each executed option transaction must be maintained to substantiate that all the components of the option spread were established, and subsequently closed, contemporaneously. Absent such written record, each component must be treated separately. Non-pattern day trader: The day trade requirement for option spreads shall be 100% of the net dollar amount of the option spread position executed first. If the option spread position executed first results in a net credit to the account, the day trading margin requirement will be an amount equal to 100% of the credit. Pattern day trader: The day trade requirement for option spreads shall be the greater margin requirement between the two option spread transactions that constitute a day trade. However, if the member can substantiate that the option spread with the lower requirement was executed first, then the day trade requirement shall be the margin requirement for that option spread. Once again, a written record of the time of each executed option transaction must be maintained to substantiate that the spread with the lower requirement was executed first. New interpretation regarding Outstanding Day Trade Calls We have clarified how day trading requirements are to be calculated for customers who have an outstanding day trade call aged five business days or less. Calculations to determine day trading buying power and day trade calls shall be determined based on the maintenance margin requirement of the security that is day traded. In addition, the day trading buying power for an equity and non-equity security shall be decreased by 50 percent, and the day trade requirement shall be increased by 50 percent, not to exceed 100 percent. Concerning options, the day trading buying power will remain one times the maintenance margin excess and the day trade requirement will remain at 100 percent. We have also provided examples for a margin eligible equity security, a Non-Equity Security Corporate Debt, a U.S. Government Debt security and a leveraged Exchange Traded Fund. 3

4 New interpretation regarding changes to Portfolio Margin Policies and Procedures Whenever a member approved for portfolio margin decides to affect a material change to its margin policies and/or procedures that directly or indirectly affect portfolio margin accounts, it must notify FINRA in writing before the changes are implemented. FINRA s staff will review the changes and discuss them with the member organization. Examples of material changes include, but are not limited to, revisions of the member s minimum equity requirements, new products or services offered to portfolio margin customers, changes to a member s customer base, or changes to its house requirements. New interpretation regarding the Portfolio Margin Survey Members shall submit to FINRA, at such times as may be designated, or on an ongoing basis, in such form and within such time period as may be prescribed, various statistics related to their portfolio margin business. We will reference FINRA Rule-4521(a) which is Notifications, Questionnaires and Reports. New interpretation regarding Introducing Broker-Dealers (IBD) Carrying and clearing broker-dealers offering portfolio margin to its introducing broker-dealers cannot rely solely on the due diligence performed by an IBD. Members will be expected to perform their own independent review of prospective IBD customers in order to determine if they have the financial wherewithal to meet their commitments. Consequently, procedures for such independent review are to be documented in the member s portfolio margin application and written supervisory procedures, and all pertinent documentation shall be made available to FINRA upon request. New interpretation regarding Control and Restricted Securities Shares of control and restricted securities must be deemed saleable in order to be eligible in a portfolio margin account. Members should ensure that all the terms and conditions of Securities Act Rule 144 or Rule 145 have been completely satisfied, including any applicable holding period, and thus are immediately saleable pursuant to Rules 144 and 145(d). The maintenance margin requirement will be the same as if the shares were not control or restricted stock. New interpretation regarding Additional Requirements for Minimum Equity Deficiencies The requirements and provision for minimum equity deficiencies shall apply to all portfolio margin accounts regardless of whether an account is below the regulatory minimum equity or the member s internal minimum equity requirement. 4

5 New interpretation regarding Liquidation of House Maintenance Deficencies Provided a regulatory portfolio margin deficiency does not exist, a customer may liquidate positions in order to meet a margin deficiency that is based solely on the member s house portfolio margin requirements. New interpretation regarding Hedging Transactions A hedging transaction that would reduce the risk and result in a lower maintenance margin requirement will not be considered a liquidation. New interpretation regarding Delayed Executions FINRA will not consider a portfolio margin deficiency as having been created by an order with a delayed execution, but instead by market depreciation, provided all of the following conditions are met: (i) (ii) (iii) the execution takes place on the same business day the order was entered and can be substantiated by the member; the account had sufficient maintenance margin excess to withstand the additional maintenance margin requirement at the time the order was entered and; the maintenance margin requirement was pended until the order was executed. At this point, I will say good evening and thank you for inviting me here tonight. Brian J. Warshaw, President Michael T. Curley Editor 5