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July 15, 2007

New Margin Rules Hurt Dealers

By Peter Chapman

The advent of portfolio margining will make life tougher for options market makers.

The pros are likely to face stiffer competition as brokerage customers step up their options trading under new rules that reduce their margin requirements. According to a recent study, the line between market makers and certain types of market participants will blur.

Brad Bailey, an analyst at Boston-based research house Aite Group, predicts that "active, sophisticated retail and proprietary shops, as well as smaller hedge funds, will see the greatest advantage under portfolio margining." For market makers, the impact is negative.

The new method of calculating the amount of margin necessary to support stock and options positions was approved by the Securities and Exchange Commission this spring.

It makes it possible for brokers to extend more liberal margin terms to their customers, potentially similar to those available to professional market makers.

That is likely to drive more trading and more quote competition. "A customer being provided with additional leverage will trade more-likely, materially more," Philip Pendergraft, chief executive and chief operating officer of clearing firm Penson Worldwide, said recently.

The SEC agrees. "It is likely to present new challenges to traditional market makers as customers can now use the leverage available through portfolio margining to better compete," Elizabeth King, an associate director in the SEC's Division of Market Regulation, said at a recent conference.

Smaller customers will benefit more than bigger ones, Bailey said, because large hedge funds have always been able to get around the margining rules.