Portfolio Margin FAQ
FINRA has received questions regarding FINRA's portfolio margin pilot program set forth in NASD Rule 2520(g) and incorporated NYSE Rule 431(g). The portfolio margin program permits member firms to margin certain products according to a prescribed portfolio margin methodology, on a pilot basis, as explained in NYSE Information Notice 06-86 and NASD Notice to Members 07-11 (February 2007). To facilitate compliance with the program, FINRA addresses questions that have been raised with respect to the application of NASD Rule 2520(g) and NYSE 431(g) to particular circumstances. This Web page builds on Q&A published by NYSE Regulation in March 2007. New and updated items are marked as such.
Questions regarding portfolio margin may be directed to:
- Rudolph Verra, Managing Director, Credit Regulation, at (646) 315-8811;
- Glen Garofalo, Director, Credit Regulation, at (646) 315-8464; or
- Steve Yannolo, Principal Credit Specialist, Credit Regulation, at (646) 315-8621
NYSE Rule 431(g)(5)(B) and NASD Rule 2520(g)(5)(B) state that eligible participants must be approved to engage in uncovered short option transactions pursuant to NYSE Rule 721 and NASD Rule 2860. Eligible participants may include registered broker-dealers. Does the account of a registered broker-dealer need to be approved for uncovered short options under NYSE Rule 721 and NASD Rule 2860?
In addition, NYSE Rule 431(g)(15) and NASD Rule 2520(g)(15) require firms to ensure that portfolio margin accounts are in compliance with all other applicable rules promulgated in NYSE Rules 700 through 794 and NASD Rule 2860, respectively (i.e., FINRA's options rules). Do these other rules apply even to positions in the account that are not options? What does compliance with these rules entail? (Updated 06/08)
No, NYSE Rules 700 through 794 and NASD Rule 2860 apply only when positions in the account include options. NYSE and NASD options rules contain a broad array of requirements to address the specific risks that pertain to options transactions. The rules include, among other things, provisions requiring specific disclosure documents, additional diligence in approving the opening of accounts, and specific requirements for confirmations, account statements, suitability, recordkeeping and reporting.
The current NYSE and NASD rules contain language regarding assessing, reviewing and monitoring the amount of credit extended to eligible participants. Is it permissible for a firm to monitor its portfolio margin accounts by looking solely at the equity in the account against the margin requirements and require the customer to always have enough equity to cover his or her exposure?
In order for a customer to engage in portfolio margining, the customer must be approved to sell uncovered short option transactions. NYSE Rule 721(e) and NASD Rule 2860(b)(16)(E) require that firms implement and maintain specific procedures which include the following:
- Specific criteria and standards to be used in evaluating the suitability of a customer for writing uncovered short option transactions;
- Specific procedures for approval of accounts engaged in writing uncovered short option transactions, including written approval of such accounts by a Registered Options and Security Futures Principal;
- Designation of the Registered Options and Security Futures Principal as the person responsible for approving customer accounts which do not meet the specific criteria and standards for writing uncovered short option transactions and for maintaining written records of the reasons for every account so approved;
- Establishment of specific minimum net equity requirements for initial approval and maintenance of customer accounts engaged in the writing of uncovered short option transactions; and
- Requirements that customers approved for writing uncovered short options transactions be provided with a special written statement for uncovered short option writers approved by FINRA that describes the risks inherent in writing uncovered short options transactions, at or prior to the initial writing of an uncovered short options transaction [See NYSE Rule 726(c) and NASD Rule 2860(b)(11)(A)(2)].
In addition, FINRA expects firms to establish and maintain a minimum equity requirement for customers who seek to engage in portfolio margining. The establishment of credit limits per account is viewed as a best practice.
In reviewing a member firm's application to offer portfolio margining to customers, does FINRA require minimum equity to be maintained in individual accounts? (Updated 06/08)
Due to the additional leverage afforded to customers by portfolio margining, firms must establish minimum equity requirements. These requirements vary based upon the strength of the firm's risk management systems and procedures, and its ability to capture intra-day trading and market activity.
- If a firm has a real-time intra-day monitoring system whereby an account can be recalculated real-time (i.e., all trades, activity and price movements) whenever an order is entered and the firm has the ability to reject an order if the account does not have enough maintenance excess to meet the maintenance requirement, then $100,000 will be the minimum equity requirement.
- Prime brokerage and introduced accounts where trades may be executed away from the clearing firm must maintain $500,000 in equity, even if the firm has the intra-day capabilities described above. This requirement is consistent with the minimum net equity requirement outlined in the SEC's prime broker no-action letter dated January 25, 1994.
- Firms that do not have the intra-day capabilities as described above, but do not have any trades executed away, will be required to impose a minimum equity requirement of $150,000.
What actions must a firm take if an account does not meet a minimum equity deficiency by T + 3?
The account must be limited to transactions that would lower margin requirements. Any new transactions that would increase margin requirements in the portfolio margin account must be booked in either the cash account or the Regulation T margin account, until such time as the equity deficiency is satisfied.
If an introducing broker has intra-day capability, but the trades are executed away from the clearing firm and therefore not reported until the end of the day, what amount of minimum equity would FINRA require for the introducing broker? (Added 09/07)
Although the introducing broker has the capability to monitor accounts intra-day, the clearing broker-dealer is ultimately responsible for monitoring the accounts of the introducing broker and cannot rely on the introducing broker's intra-day monitoring. Therefore, because the trades are executed away, the customers of the introducing broker will have to maintain equity of $500,000. However, if the introducing broker is able to provide a real-time drop file of the trades that have been executed away to the clearing broker-dealer, then the minimum equity required would be $100,000 or $150,000, depending on the clearing broker-dealer's intra-day monitoring capabilities.
The NYSE and NASD rules state that "for purposes of the minimum equity requirement, all securities and futures accounts carried by a member firm for the same eligible participant may be combined provided ownership across accounts is identical." See NYSE Rule 431(g)(4)(C) and NASD Rule 2520(g)(4)(C). Can a portfolio margin customer use collateral held at a broker-dealer's foreign affiliate to satisfy the minimum equity requirement? (Updated 06/08)
No. Customers may not use collateral held at a foreign affiliate for minimum equity purposes. A customer can only use collateral held at an affiliate that is governed by the SEC or the CFTC. For example, if the parent company of a US broker-dealer has a futures affiliate that is governed by the CFTC, then the customer can use the collateral in the futures account for minimum equity purposes. However, an account held at a bank affiliate cannot be considered for the purposes of meeting the minimum equity requirement.
Does FINRA have expectations with respect to a firm's monitoring of concentrated positions within an individual customer account and across all accounts?
FINRA expects member firms to develop reports that identify a concentration of any individual security in both an individual account and across all accounts that are engaged in portfolio margining.
What action should be taken if a concentration is identified?
FINRA expects that a higher house margin requirement to be imposed on these positions.
If a Portfolio Margin customer only trades long/short equities in its account, with no listed option positions, is the account subject to a margin requirement of 15 percent?
The long/short positions will be subject to a valuation point range of +/- 15 percent. However, the customer will be expected to possess a certain level of sophistication, evidenced by approval to sell uncovered options, and a disclosure statement with a signed acknowledgement from the customer. In addition, the member firm is expected to have risk monitoring capabilities that include the imposition of higher "house" requirements as well as various stress testing scenarios and the ability to monitor concentrations of individual securities in a single account. FINRA strongly urges firms to establish higher house requirements for more volatile stocks, concentrated positions and low priced securities. FINRA has not prescribed stress testing levels, but expects firms at a minimum to conduct stresses up and down 25 percent.
If a customer deposits shares of a fully paid for money market mutual fund in a portfolio margin account, what would the requirement be?
FINRA would expect a one percent margin requirement.
FINRA rules impose a minimum margin requirement on "unlisted derivatives" equal to $.375 multiplied by the instrument's multiplier. The multiplier for standard listed options is generally 100. What is the multiplier for an unlisted contract?
It depends on the contract. The general rule should be to look to the underlying security as representing 100 shares of stock to form the basis of the calculation.
If the broker-dealer enters into an equity swap on 1000 shares of stock A, is the multiplier 1000?
In this example, yes.
Eligible / Non-Eligible Products
Under the current pilot, unlisted derivatives are eligible products. But since the only permitted option valuation model is the OCC's TIMS model, this would seem to render it impossible to include unlisted derivatives in a portfolio margin account since the OCC only provides option price slides for listed options.
OCC's TIMS model can accommodate certain unlisted derivatives. In other instances firms would be required to have their proprietary pricing models approved by the SEC in order to effect transactions in unlisted derivatives within a portfolio margin account. If a listed security is the underlying asset and the terms of the option are similar to listed options, OCC should be able to price it. If contracts are more unique and custom tailored, the prices will have to come from the firm, pursuant to an SEC approved model.
Futures positions are permitted to be included in the portfolio margin account for the purpose of determining the margin requirements of product groups. Would the customer still be expected to meet any futures margin requirement as determined by the futures exchange?
The margin requirement is calculated on the combined futures and securities position and could be lower than the margin required by the futures exchange. However, until segregation issues between the SEC and the CFTC are resolved, the ability to combine securities and futures products into a single portfolio margin account will be unavailable.
Is an OTC derivative that has a non-margin equity security as its underlier eligible for portfolio margin?
No. Non-margin equity securities are not permitted in the portfolio margin account; therefore, any option or derivative based on that security is not permitted.
How would a non-margin equity security be handled in a portfolio margin account? (Updated 06/08)
A customer is not permitted to obtain a risk-based margin value for a non-margin equity security in a portfolio margin account. However, a non-margin equity security, whether held in a portfolio margin account, cash account, or strategy-based margin account, must have a 100 percent regulatory maintenance requirement applied on a daily basis if the broker-dealer is combining the maintenance excess figures. This is to preclude the possibility of a customer paying 100 percent for the purchase in a cash account, transferring the security to a portfolio margin account, and then using the excess maintenance loan value for withdrawals or additional transactions. If the broker-dealer keeps the portfolio margin excess figures separate and independent from any other excess figures, then this requirement does not apply.
Are mutual funds considered eligible products for portfolio margin? If so, is there any distinction made between open-ended and closed-end funds in terms of one being allowable and the other not?
Equity based mutual funds or other products such as Unit Investment Trusts and Exchange Traded Funds are eligible for portfolio margin, provided they meet the criteria for margin eligibility under Regulation T. Open-ended, equity based mutual funds are eligible for portfolio margin, provided the 30 day holding period as required under Section 11(d)(1) of the Securities Exchange Act of 1934 is satisfied. Money market mutual funds have a margin requirement of 1 percent; other open-ended funds require 15 percent.
Does FINRA allow customers to purchase fixed income products in a portfolio margin account?
The securities can be held in the portfolio margin account but are subject to strategy-based NYSE Rule 431 and NASD Rule 2520 margin requirements.
It is our understanding that all fixed income products, warrants and rights can be charged standard NYSE Rule 431 or NASD Rule 2520 margin requirements. This margin requirement can be added to the margin requirement from the equity products in the portfolio margin account. These two margin requirements can be met by the combined equity balance in the customer's account. Is this accurate?
This is correct. However, listed warrants would fall under the definition of margin security, and would be eligible for portfolio margining treatment, provided such warrants could be priced through TIMS.
Are baskets permitted in portfolio margining?
Reduced margin is available for baskets; the margin requirement will be equal to the haircuts promulgated in SEA Rule 15c3-1, provided the capitalization requirements are met.
The OCC's TIMS risk model cannot accommodate convertible bonds, yet they are eligible products for the portfolio margin account. How should a firm calculate the appropriate requirement? (Updated 06/08)
In order to calculate the requirement for convertible bonds, firms must utilize the P/L provided by TIMS for the underlying common stock, of which the requirement would be 15 percent. In addition, if there is a bond premium (market value of the bond less the value of the underlying stock if converted), the firm must add 15 percent of the bond premium to the requirement. The bond must also be readily convertible, i.e., within 90 calendar days and any cost to convert must be added to the requirement.
For a convertible bond that is not readily convertible, firms may charge 15 percent of the market value of the convertible bond provided that the bond is not included in any hedge strategy. For example, if a portfolio margin account is long a convertible bond and short the common stock, the requirement would be 15 percent on the long convertible bond and 15 percent on the short common stock.
In order for a firm to margin a convertible bond in a portfolio margin account, it must also include the convertible bond in a proprietary or third-party risk methodology when calculating house requirements or when conducting stress tests; otherwise, the bond cannot be included in any hedge strategy and must be margined separately.
Eligible products under NYSE Rule 431(g)(6)(B) and NASD Rule 2520(g)(6)(B) include foreign equity securities and options on foreign equity securities that are "margin equity securities." Are these foreign options covered by TIMS, and if not can firms seek SEC approval of their own pricing models for such options?
If the options are listed on a foreign exchange, OCC anticipates that it will be able to price and stress such foreign options using TIMS.
A broker-dealer has a security position that under FINRA rules is eligible for portfolio margin, yet the TIMS model does not recognize it. How should the broker-dealer handle the security for portfolio margin purposes? (Added 09/07)
Generally, a security that is eligible for portfolio margin under FINRA rules can still be considered eligible even if the TIMS model does not recognize it. However, the broker-dealer should first contact the OCC to determine why the security is not recognized by TIMS. Depending on the outcome, the broker-dealer can also contact FINRA's Credit Regulation Department to discuss the details of the security in question.
Are REITs and when-issued securities eligible for a portfolio margin account? (Added 06/08)
A when-issued security is permitted in the portfolio margin account, provided it is a margin equity security as defined in FINRA rules. REITs are not permitted in the portfolio margin account because they are generally backed by, among other things, real estate holdings.
Can you clarify the new day trading requirements? The new FINRA rules seem to indicate that for an account with equity less than $5 million the customer is permitted to engage in day trading as long as the transactions are part of a hedge strategy. (Updated 06/08)
If the account has less than $5 million in equity, day trading can still occur, provided the member firm has the ability to apply the appropriate day trading requirements of the FINRA Rules (NASD Rule 2530(f)(8) and NYSE Rule 431(f)(8)). If the securities subject to day trading are a part of a hedge strategy, then FINRA does not consider the collective transactions as day trades and therefore it would not subject the account holder to the day trading requirements. A hedge strategy for the purpose of FINRA rules means a transaction or series of transactions that reduce or offset a material portion of the risk in a portfolio.
For portfolio margin accounts that do not establish and maintain equity of $5 million, member firms that have the capability to charge the required margin at the time an order is entered and prohibit the trade from being executed if an account does not have enough maintenance excess, are not required to calculate any day trading requirements pursuant to NYSE Rule 431 and NASD Rule 2520. FINRA recognizes that in this instance, a customer will not exceed his/her day trade buying power and therefore will not incur a day trade margin call.
How should a firm calculate the day trading margin requirements in an account that does not have $5 million in equity? (Updated 06/08)
For equity securities, the day trading requirement is 15 percent of the market value, calculated using the same methodology as in strategy-based margin accounts. The option day trade requirement for non-pattern day traders is 100 percent of the premium on the long or short transaction, whichever occurred first. For pattern day traders, if the firm can substantiate that the purchase transaction took place prior to the sell transaction, then the day trade requirement is also 100 percent of the premium of the purchase transaction. Otherwise, firms should apply the highest TIMS valuation point that is applicable to the short option involved in the day trade as the requirement. The highest valuation point shall be 8 percent of the underlying market value for high capitalization, broad-based market index options, 10 percent of the underlying market value for non-high capitalization, broad-based market index options, and 15 percent for equity options and narrow-based index options. However, the requirement shall not be less than the $37.50 per standard contract minimum.
In addition, when a portfolio margin customer, who is a pattern day trader, incurs a day trading call, their account is subject to the limitations imposed by NYSE Rule 431(f)(8)(B)(iv)(2)(b) and NASD Rule 2520(f)(8)(B)(iv)(b)(2). This action results in equal treatment for both strategy-based and portfolio margin pattern day trading customers who exceed their day trading buying power. That is, a pattern day trading portfolio margin customer who has incurred a day trading call will have their buying power reduced to two times regulatory maintenance excess for equity securities and the customer will lose the ability to rely on time and tick. In addition, both pattern and non-pattern day trading customers should not make a practice of incurring day trading margin calls. FINRA staff has interpreted FINRA rules such that customers with more than three day trading calls within a 12-month period should be restricted from exceeding their day trading buying power for 90 days.
Can a firm use intraday excess to calculate the day trading margin requirements under NYSE Rule 431(f)(8)(B) and NASD Rule 2520(f)(8)(B)?
Yes, if a firm has intraday capability to re-price the account to determine if there is sufficient excess equity in the account at the time the order is received, and to automatically block the transaction if there is insufficient excess equity.
If all portfolio margin calls are due in three business days, what are the requirements under FINRA rules with respect to day trading calls? We know that in strategy-based accounts, day trade calls are due in five business days.
Day trade calls are due within three business days as well.
A portfolio margin customer creates an intra-day hedge strategy and trades out of the strategy later in the day. If the broker-dealer's risk model does not clearly identify the transactions as a bona fide intra-day hedge strategy, but the customer's own risk model does, can the broker-dealer utilize the analysis from the customer's risk model to determine whether or not the transaction was a day trade? (Added 06/08)
Yes. However, the customer must be able to provide the broker-dealer with an analysis that can be validated by the broker-dealer, and the broker-dealer must be able to determine, to the best of its ability, that the transactions in question did create an intra-day hedge strategy. Absent this information, the transactions would be considered a day trade. In addition, the broker-dealer must retain a record of its validation and a record of the customer's risk model analysis.
When should a firm take a capital charge for a portfolio margin deficiency given that the information that is needed in order to make an accurate computation may not be available until the following day?
The capital charge should be taken at the close of business on T+1.
A firm may not permit "aggregate portfolio margin requirements" to exceed 10 times its Net Capital. If a firm's house requirement is higher than the minimum requirement under the TIMS/NYSE Rule 431 and NASD Rule 2520 methodology, which is used for purposes of determining "aggregate portfolio margin requirements"?
The TIMS/NYSE Rule 431 and NASD Rule 2520 requirement should be used.
Can a firm exclude from "aggregate portfolio margin requirements" the margin required for positions that are carried in the portfolio margin account, but that are not eligible for portfolio margining (e.g., non-equity securities that are margined in accordance with standard NYSE Rule 431 and NASD Rule 2520 requirements)?
NYSE Information Memo 06-86 and NASD Notice to Members 07-11 (February 2007) require firms to monitor the aggregate amount of portfolio margin credit extended in relation to the firm's Net Capital, and to limit such credit to ten times Net Capital. Does this impose a limit on credit extended that is different from the limit on "aggregate portfolio margin requirements" under FINRA rules?
No, it is the same as the aggregate requirement.
FINRA rules require procedures for monitoring intra-day exposures in portfolio margin accounts. In many prime brokerage accounts, executions are done away and the prime broker may not know the transactions until the end of the day. What is expected with respect to intra-day monitoring?
In prime brokerage accounts where trades are executed away, FINRA encourages firms to obtain real time drop copies of the trades. In the absence of a requirement to do so, firms must analyze such accounts once a day, after the close. For these accounts, trades can be disaffirmed after the overnight evaluation of the closing positions. For smaller accounts, especially those that are one sided (not adequately hedged and therefore just have a 15 percent one sided cushion rather than 15 percent on each side of a more market neutral account) and those accounts that trade actively during the day or are concentrated, FINRA expects firms to impose higher house maintenance requirements.
What is the due date for a portfolio margin house call?
Three business days.
If a prime broker account has a margin deficiency, and a trade is reported at the end of the business day that increases the risk in the account, what action should the prime broker take?
The prime broker can accept the trade, but the customer must meet the margin requirements within three business days and the account equity must be brought up to the $500,000 minimum.
If a customer had a standard margin account and a portfolio margin account with the same legal name and tax ID, does collateral have to be transferred from the standard margin account to satisfy a margin deficiency in the portfolio margin account?
No, in this situation they do not have to transfer the collateral. As long as the standard margin account has sufficient maintenance excess, the margin deficiency in the portfolio margin account can be considered met. However, the Special Memorandum Account (SMA) in the Regulation T margin account must be reduced by the amount of the portfolio margin deficiency in order to prevent a customer from utilizing the available excess for additional transactions in the Regulation T margin account.
FINRA rules stipulate that firms may not permit eligible participants to make a practice of liquidations to meet a portfolio margin deficiency, but liquidations to eliminate deficiencies caused solely by adverse market movements may be disregarded. [See NYSE Rule 431(g)(10)(E) and NASD Rule (g)(10)(E)]. How does a firm distinguish between deficiencies that arise due to market movements vs. trading activity, particularly in the context of an actively traded account?
Firms that cannot distinguish between adverse market movements and new transactions should take a conservative view and consider all margin deficiencies as resulting from the account holder's trading activities.
What are the ramifications of a customer making a practice of liquidations? (Updated 09/07)
If a customer has three liquidations within a rolling twelve-month period, FINRA expects the firm to restrict the account to funds on hand for 90 days. However, if upon review a firm does not restrict an account after the third liquidation, then a waiver of the 90 day restriction must be granted, in writing, by two officers of the firm and maintained for audit purposes. Firms should also be aware that granting waivers as a practice may be regarded as a circumvention of FINRA rules.
A customer purchases an equity security in a portfolio margin account. The firm captures an intra-day deficiency. The customer puts on a risk reducing transaction and on an intra-day basis eliminates the deficiency. Under FINRA rules, would this be considered a liquidation? (Added 09/07)
No, because the transactions occurred during the same day. From an operational standpoint, it may be difficult for a customer to meet the deficiency intra-day by the deposit of funds and/or securities. Taking market action intra-day to eliminate the deficiency would not result in the penalization of the customer. It is only if the customer did the risk reducing transaction on a subsequent day that FINRA would consider it to be a liquidation.
Portfolio Margin Account Management
If a customer has a Regulation T account and portfolio margin account, how should the two accounts be treated for segregation purposes?
The Regulation T and portfolio margin accounts should be combined when calculating segregation requirements under SEA Rule 15c3-3.
Are special custody and third party agreements permissible in a portfolio margin account?
Such arrangements are generally in place because the customer is legally prohibited from maintaining assets at the broker-dealer. Special custody arrangements can be extended to a portfolio margin account.
A firm is not planning to open new accounts for portfolio margin customers. Instead, they intend to take an existing margin account, isolate the eligible products from the non-eligible products and apply the appropriate TIMS and NYSE Rule 431 and NASD Rule 2520 requirements. Is this permissible?
Yes, provided the customer is eligible for portfolio margining and the firm is able to identify the portfolio margin accounts and the positions eligible for portfolio margining. However, the firm will have to provide to FINRA a file of all portfolio margin positions in the prescribed format in order for FINRA to isolate those positions that are margined under the TIMS methodology.
Can portfolio margin be applied to omnibus accounts? (Added 09/07)
Yes, provided the omnibus credit is extended in accordance with section 220.7(f) of Regulation T. In this case both the clearing broker-dealer and the carrying broker-dealer that maintains the omnibus account must be approved for portfolio margin. Both broker-dealers would have to submit an application to their DEA and go through the review and approval process. Customers of the omnibus broker-dealer would be subject to the provisions of NYSE Rule 431(g) and NASD Rule 2520(g).
Other Portfolio Margin Topics
Does FINRA have a particular format it expects firms to use in their applications for approval to engage in portfolio margining?
Firms should refer to the guidance contained in NYSE Information Memo 06-86 and NASD Notice to Members 07-11.
Is STANS now approved for portfolio margining use?
No, STANS is only used at the clearing level for self-clearing OCC member firms. TIMS is the approved methodology for portfolio margining and for broker-dealer net capital requirements under SEA Rule 15c3-1.
How often should a firm's internal audit conduct a review of the margining process?
FINRA expects the firm's internal audit to conduct a review within the first year of implementation. The schedule thereafter can be determined by any findings in the initial audit.