The margin is named in the rule

The Federal Register on Tuesday carried a three-page notice about an accounting line that most investors will never see and that every broker holding customer cash computes, daily or weekly. It is Item 13 of the customer reserve formula, and the question in front of the Securities and Exchange Commission is whether it should keep naming a single clearing house.

The applicant is Cboe Clear U.S., LLC. It filed Form CA-1 to register as a clearing agency on 30 June, amended it twice in July, and wants temporary registration to act as central counterparty for binary options that are securities: contracts that pay a fixed amount if something happens and nothing if it does not. On 18 September it filed a second application, the one published on Tuesday as Release No. 34-106493, asking for an exemption under section 36 of the Exchange Act.

The mechanics are narrow and the stakes are not. Rule 15c3-3, the customer protection rule, makes a broker that holds customer cash compute how much it owes those customers and keep that sum in a special reserve account at a bank. Some of what the broker has posted elsewhere on customers' behalf counts as a debit against the requirement, because it is customer money already locked up for customers. Item 13 allows that credit for "the amount of margin required and on deposit with OCC for all option contracts written or purchased in customer accounts". The Options Clearing Corporation is named in the rule.

Cboe's argument, as the Commission summarises it, is that the name is an accident of history. When the Commission adopted Item 13 and its Note F, the OCC "was the only clearing agency registered with the Commission to provide central counterparty services for securities options". Reading the item to exclude a second clearing house because it did not exist when the rule was written would, Cboe says, conflict with section 17A of the Exchange Act, which tells the Commission to have "due regard for the maintenance of fair competition among clearing agencies". It points out that Items 14 and 15, written later for security futures and for cleared Treasury trades, refer to "a registered clearing agency" rather than to anyone by name.

Without the exemption, Cboe says, its clearing members would face "a customer reserve computation penalty" for clearing customer options at CCUS rather than at the OCC. That is the practical point. A broker that can offset margin held at the OCC against its reserve requirement, but not the same margin held at Cboe's clearing house, has to lock up more of its own cash for the privilege of using the newcomer. Before any contract trades, the rule's wording makes the incumbent cheaper to use.

The conditions Cboe proposes are tight. The relief would cover only margin on customer positions in binary options, not options generally. CCUS must first be registered. Binary options would be "fully margined", with daily and intraday margin collection, a guaranty fund and a default waterfall, and margin changes would go through the Commission's rule-filing process. Customer margin would be kept "separately and independently" from margin on clearing members' own positions, and every condition that Note F applies to the OCC would apply to CCUS.

That scope says as much as the argument does. Binary options on securities are one way an exchange can offer event-style contracts inside the securities regime rather than the futures one. The prediction-market boom has so far run mostly on CFTC-regulated venues. A securities clearing house built for fixed-payout contracts, and a request to put its margin on the same footing as the OCC's, looks like preparation to compete for that business from the other side of the regulatory line.

The Commission asks three questions: whether Cboe's reasons justify an exemption, whether its conditions are enough, and whether the relief would have "a competitive impact" on broker-dealers and their customers. Comments are due by 20 October, three weeks from publication. The application itself is not printed in the Register; the Commission's notice is the public record of what it says.

The request does not ask the Commission to rewrite the rule. It asks for an order that would make the rule read as if it had been written after a second options clearing house existed. Whether the Commission grants that by order, or eventually by amending Item 13 to say "a registered clearing agency" as its neighbours do, the OCC's name in the formula is now a question with a file number.