After years of fighting for it, and six years after a form of it was mandated by the Commodity Futures Modernization Act, equity traders will be eligible for portfolio margining. In late December, at the request of the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE), the Securities and Exchange Commission (SEC) expanded the scope of products eligible for risk-based, or portfolio margining.
The move should increase the competitiveness of U.S. markets by allowing margin requirements to reflect more accurately the reality of financial risk in the equities and equities options markets, and to bring the margin requirements more in line with less onerous non-U.S. regulations and those of the futures industry. Portfolio margining has been available for several years in Europe. Risk-based margining has been in testing on a limited basis for index options for one year, but Fimat was the only broker approved to participate.
“We are very happy about that. We didn’t want the extra expense of starting an offshore [entity],” says Steve Sanders, managing director at Interactive Brokers. “It creates a more level playing field.”
Randy Frederick, director of derivatives at Charles Schwab, says it is going to be hard to get people ready, but once brokers get approved for portfolio margining there will be tremendous benefits for all investors. “Once the average investor realizes the benefits, they are going to demand it and look for brokers who offer it,” Frederick says.
Previously, equities traders and equity-options traders were required to post margins as high as 50% under Regulation T, driving some traders and hedge funds to start offshore operations, which are not subject to U.S. rules, or to form joint back offices with clearing firms to reduce the expense of high margin requirements.
Frederick says the new standard will reduce margin on a typical BuyWrite position by 75% and create greater margin savings for other strategies.
For example, if a trader wants to buy a protective put on a stock position he could receive more than a 90% reduction in margin based on risk. Margin on a 100-share position on a $92 stock would be $4,600 under Reg. T. The cost of a put $2 below the market would be approximately $250; with portfolio margining the position margin would be approximately $400, according to Frederick.
“True risk-based margining frees up a tremendous amount of capital, allowing investors to more appropriately allocate assets in their accounts,” says CBOE Chairman and CEO William J. Brodsky. “The benefits to customers from these changes are profound and will revolutionize our market place.”
Portfolio margining will not mean lower margins across the board. Higher risk investments will require higher margin levels and cross margining with futures contracts is still not available. Frederick points out this doesn’t lower risk, but frees up capital. “I can put on a position and let it sit and the majority of my capital is not being tied up.”
The products affected include equities, equity options, security futures products, which include single stock futures and narrow-based indexes, and unlisted derivatives. The NYSE and CBOE now are taking applications for portfolio margining and the rule change will go into effect in April.
