[Federal Register Volume 85, Number 112 (Wednesday, June 10, 2020)]
[Notices]
[Pages 35446-35453]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-12519]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-89014; File No. SR-OCC-2020-003]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving Proposed Rule Change Related to Proposed Changes to The
Options Clearing Corporation's Framework for Liquidity Risk Management
June 4, 2020.
I. Introduction
On April 6, 2020, the Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2020-003 (``Proposed Rule Change'')
pursuant to Section 19(b) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to adopt a written
framework establishing OCC's approach to managing liquidity risk.\3\
The Proposed Rule Change was published for public comment in the
Federal Register on April 24, 2020.\4\ The Commission has received no
comments regarding the Proposed Rule Change.\5\ This order approves the
Proposed Rule Change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Notice of Filing infra note 4, at 85 FR 23095.
\4\ Securities Exchange Act Release No. 88690 (Apr. 20, 2020),
85 FR 23095 (Apr. 24, 2020) (File No. SR-OCC-2020-003) (``Notice of
Filing''). OCC also filed a related advance notice (SR-OCC-2020-802)
(``Advance Notice'') with the Commission pursuant to Section
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled the Payment, Clearing, and
Settlement Supervision Act of 2010 and Rule 19b-4(n)(1)(i) under the
Exchange Act. 12 U.S.C. 5465(e)(1). 15 U.S.C. 78s(b)(1) and 17 CFR
240.19b-4, respectively. The Advance Notice was published in the
Federal Register on May 8, 2020. Securities Exchange Act Release No.
88792 (May 1, 2020), 85 FR 27470 (May 8, 2020) (File No. SR-OCC-
2020-802).
\5\ Since the proposal contained in the Proposed Rule Change was
also filed as an advance notice, all public comments received on the
proposal are considered regardless of whether the comments are
submitted on the Proposed Rule Change or Advance Notice.
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II. Background
As noted above, OCC proposes to adopt a written framework
establishing OCC's approach to managing liquidity risk. This written
framework, the Liquidity Risk Management Framework (``LRMF''), sets
forth a comprehensive overview of OCC's liquidity risk management
practices and governs OCC's policies and procedures as they relate to
liquidity risk management. In connection with implementing the proposed
LRMF, OCC proposes to make revisions to its current rules regarding how
OCC (1) maintains sufficient liquidity resources to meet its settlement
obligations; (2) addresses foreseeable liquidity shortfalls not covered
by OCC's liquidity resources; (3) replenishes any of OCC's resources
employed during a stress event; (4) undertakes due diligence of OCC's
liquidity providers; and (5) requires each Clearing Member to have
procedures to ensure operational capacity to meet its obligations
arising from participation in OCC. OCC proposes to make conforming
changes throughout its rules to effect the substance of the changes
described below. Such changes would be made to OCC's Clearing Fund and
Stress Testing Methodology (``Methodology Description''), Risk
Management Framework Policy, Clearing Fund Methodology Policy,
Collateral Risk Management Policy, Counterparty Credit Risk Management
Policy (``CCRM Policy''), and Default Management Policy.
[[Page 35447]]
The proposed LRMF describes the primary liquidity risks OCC faces
when managing a Clearing Member default. To determine the amount of
resources it needs, OCC assumes a two-day period of risk (i.e., the
period between a Clearing Member default and the settlement of the
defaulted Clearing Member's obligations). According to OCC, the
potential liquidity obligations arising from a Clearing Member default
may include mark-to-market obligations on futures and stock loan
positions, trade premiums, cash-settled exercise and assignment
(``E&A'') activity, auction payments, settlements resulting from the
E&A of physically-settled options, and funding of OCC's liquidation
agents.\6\ Such obligations would represent the specific liquidity
risks that OCC would monitor, size, and manage as described in the
LRMF. OCC would consider such potential obligations when determining
its liquidity resources needs.
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\6\ See Notice of Filing, 85 FR at 23097.
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The proposed LRMF also describes factors that OCC would not
consider when determining its liquidity resources needs. Such factors
include margin deficits and other payments associated with a
liquidation (e.g., brokerage, bank, and legal fees), which OCC states
do not generally create immediate liquidity demands that could impede
settlement. OCC also does not consider the costs it would directly bear
to hedge open positions in its liquidity resource determinations
because OCC's primary goal is to liquidate positions prior to the need
for hedging. Additionally, the proposed LRMF identifies liquidity risks
that OCC would mitigate through tools other than the application of
liquidity resources. Such risks include the operational failure or
disruption of OCC's liquidity providers, custodian, or settlement bank
as well as potential concentration risks from key settlement banks and
liquidity providers.
The proposed LRMF identifies and defines the four categories of
liquidity resources that OCC would maintain: (1) ``Base Liquidity
Resources,'' (2) ``Available Liquidity Resources,'' (3) ``Required
Liquidity Resources,'' and (4) ``Other Liquidity Resources.'' The
proposed LRMF defines Base Liquidity Resources as assets that are
readily available and convertible into cash through prearranged funding
arrangements \7\ and required Clearing Fund cash on deposit.\8\ The
proposed LRMF defines Available Liquidity Resources as OCC's Base
Liquidity Resources plus Clearing Fund cash deposits in excess of the
minimum required amount.\9\ The proposed LRMF defines OCC's Required
Liquidity Resources, which are comprised of OCC's Available Liquidity
Resources plus any amount of cash margin deposits of a Clearing Member
Group required under the Contingency Funding Plan (described below).
Finally, the proposed LRMF describes OCC's Other Liquidity Resources,
which may or may not be available to OCC in a default situation (e.g.,
non-cash margin deposits of the defaulting Clearing Member, including
letters of credit, Government Securities, and Government Sponsored
Entity securities that may be liquidated for same-day or next day
settlement).
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\7\ OCC endeavors to maintain committed liquidity facilities
with both bank and non-bank counterparties. OCC maintains a
committed credit facility syndicated among various commercial banks.
OCC also attempts to maintain committed repurchase agreements, which
may be with either bank or non-bank counterparties.
\8\ OCC's rules require Clearing Members to collectively
contribute $3 billion in U.S. dollar cash to the Clearing Fund.
\9\ OCC would only include excess cash deposits up to the amount
the required Clearing Fund size exceeds the minimum Clearing Fund
size as determined by OCC Rule 1001(b). Further, cash deposits in
excess of a Clearing Member's total Clearing Fund requirement would
not be included.
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A. Sufficiency of Liquidity Resources
The proposed changes include rules designed to ensure the
sufficiency of OCC's liquidity resources. Such rules address the
maintenance of liquidity resources designed to address a variety of
stress scenarios through the sizing of such resources and the
management of certain Clearing Member cash collateral withdrawals. The
proposal also describes OCC's approach to liquidity stress testing more
generally, including OCC's internal reporting processes related to
liquidity stress testing.
1. Maintenance of Liquidity Resources
To ensure that OCC identifies the appropriate amount of liquidity
resources it should maintain, OCC's proposed LRMF describes OCC's
overall approach to liquidity stress testing and liquidity resource
sizing. OCC's approach for liquidity stress testing would rely on the
stressed scenarios and prices generated under OCC's current stress
testing and Clearing Fund methodology.\10\
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\10\ See Securities Exchange Act Release No. 83735 (Jul. 27,
2018), 83 FR 37855 (Aug. 2, 2018) (File No. SR-OCC-2018-008);
Securities Exchange Act Release No. 83714 (Jul. 26, 2018), 83 FR
37570 (Aug. 1, 2018) (File No. SR-OCC-2018-803). OCC's current
methodology considers a range of stress scenarios and possible price
changes in liquidation periods, including but not limited to: (1)
Relevant peak historic price volatilities; (2) shifts in other
market factors including, as appropriate, price determinants and
yield curves; (3) the default of one or multiple members; (4)
forward-looking stress scenarios; and (5) reverse stress tests aimed
at identifying extreme default scenarios and extreme market
conditions for which the OCC's resources would be insufficient. See
Notice of Filing, 85 FR at 23098.
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Under the proposal, OCC's Board of Directors (``Board'') would, at
least annually, determine the size of OCC's Base Liquidity Resources
based on a recommendation from the Risk Committee of OCC's Board
(``RC''). The RC's recommendation would be based on an internal
analysis summarizing OCC's projected liquidity demands under a variety
of stress scenarios, including the sufficiency of OCC's Base Liquidity
Resources against extreme historical scenarios such as the 1987 market
break and 2008 financial crisis, and certain scenarios used to size
OCC's Clearing Fund.\11\
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\11\ Such analysis would also consider the parameters and
assumptions underlying OCC's stress testing system as well as the
then current composition of OCC's liquidity resources.
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OCC proposes to revise how the Methodology Description describes
key assumptions underlying OCC's calculation of its liquidity needs.
Such assumptions include: (1) A two-day liquidation horizon; (2) the
default of a Clearing Member sometime between the collection of
collateral on a given day and settlement of Clearing Member obligations
to OCC on the following day (i.e., the day of default, ``D''); (3) the
gross calculation of cash-settled option liquidity demands due on the
morning of D; (4) the National Securities Clearing Corporation
(``NSCC'') normally guarantees the settlement of any E&A transactions;
(5) the accounting of liquidity demands as required by relevant cross-
margin agreements; (6) that auction bids for a defaulting Clearing
Member's portfolio are represented by stressed prices at the contract
level; (7) that credits that occur on the first day of a liquidation
persist and are available to offset debits on subsequent days; (8) that
auction proceeds settle on D+2; (9) liquidity demands associated with
Specific Wrong Way Risk (``SWWR'') positions are included in the
appropriate calculations; \12\ and (10) no early exercise of options
occurs.\13\
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\12\ See Securities Exchange Act Release No. 87673 (Dec. 6,
2019), 84 FR 67981 (Dec. 12, 2019) (File No. SR-OCC-2019-807);
Securities Exchange Act Release No. 87718 (Dec. 11, 2019), 84 FR
68992 (Dec. 17, 2019) (File No. SR-OCC-2019-010).
\13\ OCC believes standard expiration is generally more
meaningful than early exercise risk when calculating the liquidity
risk associated with E&A activity. See Notice of Filing, 85 at 23101
n. 31. OCC provided data supporting this belief in a confidential
Exhibit 3 to the Proposed Rule Change.
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[[Page 35448]]
Under the proposal, OCC would also make certain assumptions
regarding the treatment of positions and cash flows based on timing.
OCC would assume that positions with an expiration date of D+1 or
greater will be liquidated via auction, and that option positions
expiring on D-1 or D would be liquidated through normal OCC cash
settlement processes or through physical settlement at NSCC. Under the
proposed approach, cash inflows would be assumed to reduce outflows
only for later dates.
To facilitate the maintenance of identified and collected liquidity
resources, OCC proposes to require a two-day notice period for the
substitution of non-cash collateral for cash in the Clearing Fund.
Currently, a Clearing Member may execute a same-day substitution of
Government Securities \14\ for cash deposits in the Clearing Fund.
Where substitution would not cause a Clearing Member's settlement
obligations to exceed the liquidity resources it has pledged to OCC,
OCC would retain discretion to waive the proposed notice period. OCC
stated that the proposed change is intended provide additional
certainty around the level of liquidity resources available to OCC at
any given time by fixing the amount of cash in the Clearing Fund, and
thereby fixing the amount of OCC's Available Liquidity Resources, for
any given two-day liquidation horizon.\15\
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\14\ OCC defines ``Government Securities'' as securities issued
or guaranteed by the United States or Canadian Government, or by any
other foreign government acceptable to the Corporation, except
Separate Trading of Registered Interest and Principal Securities
issued on Treasury Inflation Protected Securities (commonly called
TIP-STRIPS). OCC By-Laws, Article I, Section 1.G.(5), available at
https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.
\15\ See Notice of Filing, 85 FR at 23103.
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2. Liquidity Stress Testing
As noted above, OCC's liquidity stress testing would be based on
output of its current stress testing and Clearing Fund methodology.
Daily, OCC performs stress tests designed to: (1) Determine whether
OCC's collective financial resources are adequate to cover OCC's risk
tolerance (``Adequacy Scenarios''); (2) establish the monthly size of
the Clearing Fund based on the potential losses arising out of a 1-in-
80 year hypothetical market event; (3) measure the exposure posed by
individual Clearing Member Groups, and determine whether such exposure
necessitates OCC calling for additional financial resources
(``Sufficiency Scenarios''); and (4) monitor and assess the size of
OCC's pre-funded financial resource against a wide range of stress
scenarios that may include extreme but implausible and reverse stress
testing scenarios (``Informational Scenarios'').
OCC proposes to revise how the Methodology Description discusses
OCC's stress testing and reporting processes to support the
determination of its liquidity needs. OCC would change how it
constructs portfolios for stress tests as well as how it aggregates
stress test results consistent with the practices that OCC would follow
in an actual liquidation of a defaulter's portfolio. Currently, OCC's
processes focus on calculating the liquidating value of a portfolio.
OCC proposes to revise its description of this process in its
Methodology Description to highlight the importance of the timing of
the cash flows during a liquidation because offsetting cash flows may
occur on different days thus creating a liquidity demand during the
process without a loss at the end of the process.\16\
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\16\ OCC also proposes changes to clarify the structure of
Clearing Member accounts. For example, Clearing Members maintain
separate accounts for separate business types or cross-margining
arrangements. Further, positions and collateral credited to a
particular type of Clearing Member account (e.g., customer, firm or
market-maker) may be subject to a lien in favor of OCC, and such
liens (or lack thereof depending on the account) would be
contemplated in OCC's portfolio construction and aggregation
processes.
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OCC proposes to rely on the output from its Sufficiency Scenarios
and Adequacy Scenarios to evaluate its liquidity resources. Under the
proposed LRMF, OCC would assess its Base Liquidity Resources against
its Adequacy Scenarios. OCC's proposed processes for increasing its
Base Liquidity Resources as needed are described below. Similarly, OCC
would evaluate the sufficiency of its Available Liquidity Resources
based on the Sufficiency Scenarios.\17\ OCC's proposed process for
evaluating and supplementing its Available Liquidity Resources is also
described below. OCC also proposes to make other conforming and
organizational changes to the Methodology Description to reflect the
implementation of the new liquidity stress testing approach and make
other non-substantive clarifications to the document.\18\
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\17\ OCC also proposes to monitor and assess its liquidity
resources under the Informational Scenarios. OCC would not be
directly use the output of the Informational Scenarios to make
decisions regarding the size of OCC's liquidity resources.
\18\ For example, OCC would reorganize the document to relocate
content specific to credit stress testing to sections of the
document focused only on credit stress testing. OCC is also making
clarifying and conforming changes to differentiate the usage of
Adequacy, Sizing, Sufficiency, and Informational Scenarios for
credit and liquidity purposes. Further, OCC proposes changes to more
accurately describe the scope of volatility instruments cleared by
OCC.
OCC proposes to clarify that in most SWWR stress test scenarios,
SWWR Equity and ETN charges computed for margins are added to stress
scenario profit and loss calculations in order to account for SWWR
in the stress testing system. See Securities Exchange Act Release
No. 87673 (Dec. 6, 2019), 84 FR 67981 (Dec. 12, 2019) (File No. SR-
OCC-2019-807) and Securities Exchange Act Release No. 87718 (Dec.
11, 2019), 84 FR 68992 (Dec. 17, 2019) (File No. SR-OCC-2019-010).
OCC also proposes removing duplicative language regarding
Idiosyncratic Scenarios, Sizing Scenarios, and certain key
assumptions from the executive summary of the Methodology
Description because such information is covered in greater detail
later in later sections of the document.
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The proposed LRMF also sets forth certain internal reporting
processes related to OCC's liquidity stress testing. Daily, OCC staff
would be required to review the output of OCC's liquidity stress tests,
and such review could lead to a change in the size of OCC's Base
Liquidity Resources. At least monthly, OCC staff would be required to
develop and review reports detailing and analyzing OCC's daily stress
tests.\19\ OCC would use the analysis provided in such reports to
review the parameters and assumptions underlying OCC's stress tests.
OCC staff would conduct such analyses more frequently than monthly when
products cleared or markets served display high volatility or become
less liquid, or when the size or concentration of positions held by
OCC's participants increases significantly. OCC staff would be required
to provide a summary of the results from its at least monthly review to
OCC's Management Committee and the RC. At least annually, OCC staff
would be required to assess the adequacy of OCC's stress testing
methodology, and provide such assessment to the RC. Also at least
annually, OCC staff would be required to perform a review of risk
methodologies and the usage of any models to inform the management of
liquidity risk.
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\19\ Additionally, OCC staff would develop internal reports
regarding the sufficiency of OCC's liquidity resources.
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B. Foreseeable Shortfalls
In determining the sufficiency of its liquidity resources as
described above, OCC may identify a foreseeable liquidity shortfall. In
such a situation, OCC's proposed changes provide OCC tools designed to
address such foreseeable liquidity shortfalls not otherwise addressed
by OCC's liquidity resources. The proposed LRMF contemplates mechanisms
for increasing the size of OCC's Base Liquidity Resources. The proposed
LRMF also describes OCC's plan for collecting additional resources
[[Page 35449]]
when a Clearing Member Group's projected or actual liquidity risk
exceeds certain thresholds (``Contingency Funding Plan'').
1. Increasing Base Liquidity Resources
Under the proposed LRMF, OCC would maintain two tools by which it
could increase its Base Liquidity Resources. As noted above, OCC
maintains a committed credit facility with a syndicate of banks. The
committed credit facility includes an uncommitted accordion
feature,\20\ which OCC will endeavor to include in future iterations of
the facility.
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\20\ An accordion is an uncommitted expansion of a credit
facility generally on the same terms as a credit facility.
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OCC also requires Clearing Members to collectively contribute $3
billion in cash to the Clearing Fund (``CF Cash Requirement''). OCC's
current rules already authorize each of OCC's Executive Chairman, Chief
Executive Officer, and Chief Operating Officer (collectively, the
``OCEO'') individually to increase the CF Cash Requirement on a
temporary basis for the protection of OCC, Clearing Members or the
general public.\21\ OCC requires that such temporary increases be
reviewed by the RC. OCC proposes to expand its authority to set and to
temporarily increase the CF Cash Requirement. OCC proposes to authorize
its Board to adjust the CF Cash Requirement periodically except that
the Board would not be permitted to set the CF Cash Requirement at an
amount lower than $3 billion. OCC also proposes that the OCEO may
temporarily increase the CF Cash Requirement to respond to changing
business or market conditions,\22\ and to require that the RCs' review
of such an increase must (i) be based upon then-existing facts and
circumstances, (ii) be in furtherance of the integrity of OCC and the
stability of the financial system, and (iii) take into consideration
the legitimate interests of Clearing Members and market
participants.\23\ OCC also proposes to require that any increase in the
CF Cash Requirement be satisfied no later than the second business day
following notification unless the Clearing Member is notified by an
officer of OCC an alternative time to satisfy such obligation.\24\
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\21\ OCC utilized this authority in December 2019 when it
informed Clearing Members that OCC would exercise this authority on
January 3, 2020 to increase the CF Cash Requirement temporarily from
$3 billion to $3.5 billion during the monthly sizing of the Clearing
Fund. See Securities Exchange Act Release No. 88120 (Feb. 5, 2020),
85 FR 7812, 7814 n. 20 (Feb. 11, 2020) (File No. SR-OCC-2020-801).
\22\ OCC also proposes shifting the location of such
authorization in its rules from Rule 1002 to the proposed LRMF.
\23\ The criteria proposed for the RC's review are currently the
criteria required for a member of the OCEO to authorize a temporary
increase.
\24\ OCC currently requires such temporary increases to be
satisfied no later than one hour before the close of Fedwire on the
business day following notification by OCC. OCC stated that the
change is designed to provide more clarity and simplicity by more
closely aligning the timeframes for meeting an increase in the CF
Cash Requirement with the timing for satisfying Clearing Fund
deficits in the monthly and intra-month sizing processes. See Notice
of Filing, 85 FR at 23103.
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2. Addressing Shortfalls in Available Liquidity Resources
Currently, OCC forecasts daily settlement obligations 30 days prior
to a given settlement under normal market conditions and compares such
demands to its resources. Based on such analysis, OCC may require a
Clearing Member to deposit intra-day margin in the form of cash so that
OCC's liquid financial resources would be sufficient to cover the
Clearing Member's obligations. OCC proposes to replace its current
forecasting process with an analysis of OCC's resources measured
against the output of its Sufficiency Scenarios. Under the proposed
LRMF, OCC would take specific actions in the event that the output of
its Sufficiency Scenarios for a given Clearing Member Group were to
exceed one of two thresholds. Where OCC observes that the output of a
Sufficiency Scenario is in excess of 80 percent of OCC's Available
Liquidity Resources, OCC would initiate enhanced monitoring of the
Clearing Member Group's liquidity demand.\25\ Where OCC observes that
the output of a Sufficiency Scenario is in excess of 90 percent of
OCC's Available Liquidity Resources, OCC could require the Clearing
Member Group to provide additional cash collateral (``Required Cash
Deposits'').\26\ OCC proposes to amend its rules such that a Required
Cash Deposit could be imposed either as part of OCC's normal daily
margin process or as a special intra-day margin call.\27\
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\25\ OCC described the process comprising such enhanced
monitoring in a confidential Exhibit 3G provided as part of the
proposal.
\26\ The amount of a Required Cash Deposit would be equal to 90
percent of OCC's Available Liquidity Resources less the relevant
output of OCC's Sufficiency Scenario. Such a Required Cash Deposit
could be provided as a substitute for non-cash collateral. OCC would
generally require funding of Required Cash Deposits five business
days before the date of the projected demand but may require funding
up to 20 business days before the projected date as facts and
circumstances may warrant.
\27\ As proposed, OCC would generally require funding of
Required Cash Deposits five business days before the date of the
projected demand but could require funding up to 20 business days
before the projected date.
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Similar to margin calls designed to ensure the sufficiency of OCC's
financial resources, OCC proposes to establish two thresholds for
monitoring the potential impact of a Required Cash Deposit on the
relevant Clearing Member.\28\ If the Required Cash Deposit for an
individual Clearing Member were to exceed $500 million or 75 percent of
the Clearing Member's excess net capital, OCC staff would be required
to notify OCC's OCEO. If the Required Cash Deposit for an individual
Clearing Member were to exceed 100 percent of the Clearing Member's
excess net capital, OCC staff would escalate the matter to the OCEO,
any member of which would be authorized to approve such Required Cash
Deposit. The thresholds described above would be subject to annual
review and approval by the RC. Additionally, each member of the OCEO
would be authorized to approve temporary changes to the thresholds
described above.\29\
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\28\ See Securities Exchange Act Release No. 83735 (Jul. 27,
2018), 83 FR 37855, 37858 (Aug. 2, 2018) (File No. SR-OCC-2018-008);
Securities Exchange Act Release No. 83714 (Jul. 26, 2018), 83 FR
37570, 37572-73 (Aug. 1, 2018) (File No. SR-OCC-2018-803).
\29\ The RC would be obligated to review any temporary change in
thresholds within 20 days of the change to determine whether to make
such change a permanent part of OCC's rules. The RC's determination
must (i) be based upon then-existing facts and circumstances, (ii)
be in furtherance of the integrity of OCC and the stability of the
financial system, and (iii) take into consideration the legitimate
interests of Clearing Members and market participants.
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Under the proposed LRMF, OCC would also have authority to impose
Required Cash Deposits as a protective measure against a Clearing
Member subject to enhanced monitoring and surveillance pursuant to
OCC's watch level reporting process because OCC determines that the
Clearing Member presents increased credit risk.\30\ Specifically, OCC
proposes to authorize such a requirement by adopting new Rule 604(g).
Under the proposed rule, a Clearing Member may be required to satisfy
such required cash deposits through its daily margin requirements under
Rule 601 or through intra-day margin calls under Rule 609.
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\30\ OCC's watch level reporting process is outlined in its
Counterparty Credit Risk Management Policy. See Securities Exchange
Act Release No. 82312 (Dec. 13, 2017), 82 FR 60242 (Dec. 19, 2017)
(File No. SR-OCC-2017-009).
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C. Replenishment of Liquidity Resources
OCC's proposed changes include rules describing OCC's process for
replenishing liquidity resources employed during a stress event. The
proposal includes clarification of OCC's authority to borrow cash
collateral from the Clearing Fund. The proposal also clarifies OCC's
authority to reject substitutions that would affect non-cash
[[Page 35450]]
Clearing Fund collateral that has been used to access OCC's liquidity
facilities. Additionally, OCC proposes changes to its rules to allow
for the more timely declaration and allocation of certain losses
charged to the Clearing Fund.
The cash contributions to OCC's Clearing Fund serve as an important
source of liquidity for OCC to manage potential liquidity risks
associated with a Clearing Member default or the failure or operational
disruption of a bank or securities or commodities clearing
organization. Currently, OCC's rules permit OCC to use the Clearing
Fund for borrowing or otherwise obtaining funds to be used for
liquidity purposes. OCC has stated, however, that it would likely not
use Clearing Fund cash as collateral for a loan from a third-party.\31\
Rather, OCC would directly borrow Clearing Fund cash to manage the
financial obligations of a defaulted Clearing Member. OCC proposes to
amend its rules to clarify its authority to borrow directly from the
Clearing Fund.
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\31\ See Notice of Filing, 85 FR at 23106.
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The non-cash contributions to OCC's Clearing Fund provide a source
of collateral necessary for OCC to access sources of liquidity such as
OCC's liquidity facilities described above. Clearing Members may, from
time to time, substitute new collateral for collateral already
contributed to the Clearing Fund. OCC proposes to amend its rules to
clarify its authority to reject substitutions that would affect
collateral that OCC has already pledged as collateral to access its
liquidity facilities.
Under OCC's rules, amounts obtained through borrowing from the
Clearing Fund are not considered losses charged against the Clearing
Fund for a period of 30 days. Any transaction collateralized by
Clearing Fund contributions that is outstanding for more than 30 days
is considered an actual loss that OCC would then allocate to its
Clearing Members, who would then be required to replenish the Clearing
Fund. OCC proposes to amend its rules to authorize OCC to determine
that an outstanding transaction collateralized by Clearing Fund
contributions is a loss to be allocated to Clearing Members, even if
that transaction has been outstanding for less than 30 days, which in
turn would allow OCC to allocate the loss and replenish the Clearing
Fund in a timely manner.
D. Due Diligence of Liquidity Providers
OCC's ability to manage its liquidity risk is dependent on a
supporting institutions, such as settlement banks, custodian banks,
central banks, and liquidity providers. The proposed LRMF describes
OCC's overall framework for monitoring, managing, and limiting its
risks and exposures to these supporting institutions.\32\ This
framework includes onboarding and monitoring processes, including: (1)
Conducting due diligence to confirm each commercial institution meets
OCC's financial and operational standards; (2) confirming each
commercial institution's access to liquidity to meet its commitments to
OCC; (3) monitoring and managing direct, affiliated, and concentrated
exposures; and (4) conducting operational reviews of such institutions.
The proposed LRMF also sets forth OCC's requirements for performing due
diligence to confirm it has a reasonable basis to believe each of its
liquidity providers has (1) sufficient information to understand and
manage the potential liquidity demands of OCC and its associated
liquidity risk and (2) the capacity to perform as required under its
commitments to OCC, including the execution of periodic test borrows no
less than once every 12 months to measure the performance and
reliability of the liquidity facilities. Further, the proposed LRMF
describes OCC's use of accounts and services at the Federal Reserve
Bank of Chicago to custody funds to reduce counterparty credit risks.
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\32\ OCC's framework for monitoring, managing, and limiting its
risks and exposures to these supporting institutions is primarily
governed by OCC's CCRM. See Securities Exchange Act Release No.
82312 (Dec. 13, 2017), 82 FR 60242 (Dec. 19, 2017) (File No. SR-OCC-
2017-009).
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E. Participant Capacity
Currently, OCC requires that each Clearing Member have access to
sufficient financial resources to meet obligations arising from
clearing membership in extreme but plausible market conditions. OCC's
rules do not address circumstances in which a Clearing Member has
sufficient resources to meet its obligations but is unable to meet
settlement obligations due to a failure or operational issue at its
primary settlement bank. OCC proposes to require that each Clearing
Member maintain adequate procedures, including but not limited to
contingency funding, to ensure that it is able to meet its liquidity
obligations as OCC members.\33\
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\33\ OCC regularly examines its Clearing Members for adherence
to similar obligations arising out of OCC's membership requirements
in connection with its existing annual Clearing Member examination
process.
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III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Exchange Act directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to such organization.\34\ After carefully
considering the Proposed Rule Change, the Commission finds that the
proposal is consistent with the requirements of the Exchange Act and
the rules and regulations thereunder applicable to OCC. More
specifically, the Commission finds that the proposal is consistent with
Section 17A(b)(3)(F) of the Exchange Act\35\ and Rules 17Ad-22(e)(7)
and (18) thereunder.\36\
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\34\ 15 U.S.C. 78s(b)(2)(C).
\35\ 15 U.S.C. 78q-1(b)(3)(F).
\36\ 17 CFR 240.17Ad-22(e)(7) and 17 CFR 240.17Ad-22(e)(18).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act
Section 17A(b)(3)(F) of the Exchange Act requires, among other
things, that the rules of a clearing agency be designed to promote the
prompt and accurate clearance and settlement of securities
transactions.\37\ Based on its review of the record, the Commission
believes that the changes proposed in the Proposed Rule Change are
consistent with the promotion of prompt and accurate clearance and
settlement of securities transactions for the reasons described below.
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\37\ 15 U.S.C. 78q-1(b)(3)(F).
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OCC proposes to adopt rules describing OCC's (i) primary liquidity
risks; (ii) liquidity resources; (iii) requirements for liquidity
provider due diligence; and (iv) requirements for procedures designed
to ensure Clearing Member capacity to meet liquidity obligations
arising out of participation in OCC. The Commission believes that
having rules and policies that clearly determine and describe OCC's
liquidity risks and resources would facilitate OCC's ability to size
its liquidity resources commensurate with the risks it faces. OCC
proposes to size and test the sufficiency of its liquidity resources
based on its current credit stress tests, which include extreme
historical scenarios such as the 1987 market break and 2008 financial
crisis. Additionally, to support the application of OCC's current
financial resource stress testing methodology to the management of
liquidity risk, OCC proposes to revise its Methodology Description to
describe the key assumptions underlying the
[[Page 35451]]
calculation of OCC's liquidity needs. The Commission believes that
measuring the sufficiency of OCC's resources based on extreme
historical scenarios would support OCC's ability to manage such
scenarios should they arise again. Further, the Commission believes
that the incorporation of the key assumptions described above would
strengthen OCC's understanding of its ability to meet its settlement
obligations on time and in the required currency. Further, the proposal
would require daily, monthly, and annual liquidity stress test-related
reporting. The Commission believes that such reporting is necessary to
provide risk management information to decision-makers within OCC
because it would allow OCC to monitor its liquidity exposures under a
variety of foreseeable stress scenarios, and to call for additional
liquid resources in the form of cash deposits to ensure that OCC
continues to maintain sufficient liquid resources to meet its
settlement obligations with a high degree of confidence. Finally, the
proposal would require OCC to conduct due diligence of its liquidity
providers and would require each Clearing Member to maintain policies
and procedures to ensure its ability to meet its obligations arising
out of participation in OCC. The Commission believes that such due
diligence and membership requirements would allow OCC to more closely
monitor the financial and operational capacity of its liquidity
providers and Clearing Members. Such monitoring, in turn, would
increase the likelihood that liquidity resources would be available to
OCC when necessary.
OCC is the only clearing agency for standardized U.S. securities
options listed on Commission-registered national securities exchanges
(``listed options'').\38\ Strengthening OCC's overall approach to
liquidity risk management, strengthens OCC's ability to manage Clearing
Member defaults, which, in turn, facilitates the clearance and
settlement of listed options. The Commission believes that the Proposed
Rule Change would promote the prompt and accurate clearance and
settlement of securities transactions and is, therefore, consistent
with the requirements of Section 17A(b)(3)(F) of the Exchange Act.\39\
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\38\ See Securities Exchange Act Release No. 85121 (Feb. 13,
2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR-OCC-2015-02).
\39\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(7) Under the Exchange Act
Rule 17Ad-22(e)(7) under the Exchange Act requires that a covered
clearing agency establish, implement, maintain, and enforce written
policies and procedures reasonably designed to effectively measure,
monitor, and manage the liquidity risk that arises in or is borne by
the covered clearing agency, including measuring, monitoring, and
managing its settlement and funding flows on an ongoing and timely
basis, and its use of intraday liquidity.\40\
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\40\ 17 CFR 240.17Ad-22(e)(7).
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1. Consistency With Sections (i), (vi), and (vii) of Rule 17Ad-22(e)(7)
Rule 17Ad-22(e)(7)(i) under the Exchange Act requires that the
covered clearing agency's policies and procedures be designed to
require the maintenance of sufficient liquid resources at the minimum
in all relevant currencies to effect same-day and, where appropriate,
intraday and multiday settlement of payment obligations with a high
degree of confidence under a wide range of foreseeable stress scenarios
that includes, but is not limited to, the default of the participant
family that would generate the largest aggregate payment obligation for
the covered clearing agency in extreme but plausible market
conditions.\41\
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\41\ 17 CFR 240.17Ad-22(e)(7)(i).
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As described above in section II.A.1., the Propose Rule Change
includes OCC's method for sizing its liquidity resources. First, the
proposed LRMF describes OCC's overall approach to liquidity stress
testing and liquidity resource sizing by relying on the stressed
scenarios and prices generated under OCC's current stress testing and
Clearing Fund methodology, which the Commission has reviewed closely
and believes would be consistent with identifying a wide range of
foreseeable stress scenarios.\42\ Specifically, the size of OCC's Base
Liquidity Resources would be based upon an internal analysis
summarizing OCC's liquidity demands under a variety of stress
scenarios, including the sufficiency of OCC's Base Liquidity Resources
against extreme historical scenarios such as the 1987 market break and
2008 financial crisis. Second, OCC proposes to describe key assumptions
underlying the calculation of its liquidity needs--such as a two-day
liquidation horizon--as well as the treatment of cash flows such that
cash inflows would be assumed to reduce outflows only for later dates.
Finally, OCC would impose a two-day notice requirement on substitutions
of Clearing Fund collateral to ensure access to cash Clearing Fund
contributions throughout the two-day liquidation period. Taken
together, the Commission believes that these proposed changes are
reasonably designed to ensure that OCC sizes and maintains it liquidity
resources consistent with the requirements of Rule 17Ad-22(e)(7)(i)
under the Exchange Act.\43\
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\42\ See Securities Exchange Act Release No. 83735 (Jul. 27,
2018), 83 FR 37855, 37862-63 (Aug. 2, 2018) (File No. SR-OCC-2018-
008); Exchange Act Release No. 83714 (Jul. 26, 2018), 83 FR 37570,
37577-78 (Aug. 1, 2018) (File No. SR-OCC-2018-803).
\43\ 17 CFR 240.17Ad-22(e)(7)(i).
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Rule 17Ad-22(e)(7)(vi) under the Exchange Act requires that the
covered clearing agency's policies and procedures be reasonably
designed to determine the amount and regularly test the sufficiency of
its liquid resources held for purposes of meeting the minimum liquid
resource requirement under paragraph (e)(7)(i) of this section by, at a
minimum: (A) Conducting stress testing of its liquidity resources at
least once each day using standard and predetermined parameters and
assumptions; (B) conducting a comprehensive analysis on at least a
monthly basis of the existing stress testing scenarios, models, and
underlying parameters and assumptions used in evaluating liquidity
needs and resources, and considering modifications to ensure they are
appropriate for determining the clearing agency's identified liquidity
needs and resources in light of current and evolving market conditions;
(C) conducting a comprehensive analysis of the scenarios, models, and
underlying parameters and assumptions used in evaluating liquidity
needs and resources more frequently than monthly when the products
cleared or markets served display high volatility or become less
liquid, when the size or concentration of positions held by the
clearing agency's participants increases significantly, or in other
appropriate circumstances described in such policies and procedures;
and (D) reporting the results of its analyses under Rules 17Ad-
22(e)(7)(vi)(B) and (C) to appropriate decision makers at the covered
clearing agency, including but not limited to, its risk management
committee or board of directors, and using these results to evaluate
the adequacy of and adjust its liquidity risk management methodology,
model parameters, and any other relevant aspects of its liquidity risk
[[Page 35452]]
management framework.\44\ Rule 17Ad-22(e)(7)(vii) under the Exchange
Act requires that the covered clearing agency's policies and procedures
be reasonably designed to ensure the performance of model validation of
its liquidity risk models not less than annually or more frequently as
may be contemplated by the covered clearing agency's risk management
framework.\45\
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\44\ 17 CFR 240.17Ad-22(e)(7)(vi).
\45\ 17 CFR 240.17Ad-22(e)(7)(vii).
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As described above in section II.A.2., OCC proposes to implement
liquidity stress testing based on the output of its current stress
testing and Clearing Fund methodology. After reviewing and assessing
the proposal, including the methodology and results of OCC's proposed
application of such output to its new liquidity stress testing
approach, the Commission believes that the proposed changes described
above are consistent with Rule 17Ad-22(e)(7)(vi) because OCC would
assess its Base and Available Liquidity Resources against a set of
stress scenarios, including extreme historical scenarios such as the
1987 market break and 2008 financial crisis. Further, the key
assumptions described above in section II.A.1. would facilitate the
application of OCC's current Clearing Fund stress testing outputs to
the management of liquidity risk in a manner that would be consistent
with OCC's management of credit risk. The Commission continues to
believe that OCC current stress testing methodology improved the
testing of OCC's financial resources and increased the likelihood that
OCC maintains sufficient resources at all times.\46\ Similarly, the
Commission believes that the application of such a methodology to
liquidity risk management would improve the testing of OCC's liquidity
resources and increase the likelihood that OCC maintains sufficient
liquid resources at all times. Further, the Commission believes that
applying a consistent risk management approach across OCC's credit and
liquidity risk exposures would support OCC's ability to maintain a more
consistent, comprehensive view of its risk management processes more
broadly.
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\46\ See Securities Exchange Act Release No.83714 (Jul. 26,
2018), 83 FR 37570, 37578 (Aug. 1, 2018) (File No. SR-OCC-2018-803).
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Additionally, the Commission believes that the daily review of
liquidity stress tests, which may lead to a change in OCC's Base
Liquidity Resources would be consistent with the daily stress testing
requirements of Rule 17Ad-22(e)(7)(vi)(A). Similarly, the Commission
believes that the at least monthly analysis of daily stress tests for
review of the parameters and assumptions underlying OCC stress tests
with more frequent analysis as required would be consistent with the
monthly comprehensive analysis requirements set forth in Rules 17Ad-
22(e)(7)(vi)(B) and (C). Likewise, the Commission believes that
providing a summary of such monthly reporting, as well as an annual
assessment of the adequacy of OCC's liquidity resources based on such
reporting, to OCC's Management Committee and the RC would be consistent
with the reporting requirements of Rule 17Ad-22(e)(7)(vi)(D). Finally,
the Commission believes that the review of risk methodologies and the
usage of any models to inform the management of liquidity risk at least
annually would be consistent with the model validation requirements set
forth in Rule 17Ad-22(e)(7)(vii).
Taken together and for the reasons discussed above, the Commission
believes that proposed approach to liquidity stress testing and
reporting is consistent with the requirements of Rules 17Ad-
22(e)(7)(vi) and (vii) under the Exchange Act.\47\
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\47\ 17 CFR 240.17Ad-22(e)(7)(vi) and (vii).
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2. Consistency With Section (viii) of Rule 17Ad-22(e)(7)
Rule 17Ad-22(e)(7)(viii) under the Exchange Act requires that the
covered clearing agency's policies and procedures be reasonably
designed to address foreseeable liquidity shortfalls that would not be
covered by the covered clearing agency's liquid resources and avoid
unwinding, revoking, or delaying the same-day settlement of payment
obligations.\48\
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\48\ 17 CFR 240.17Ad-22(e)(7)(viii).
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As described above in section II.B.1., OCC proposes to revise the
available mechanisms for increasing its Base Liquidity Resources. The
Commission believes such changes would be consistent with the
requirements of Rule 17Ad-22(e)(7)(viii) because they would allow OCC
to address settlement obligations that could exceed its Base Liquidity
Resources, which could otherwise lead to liquidity shortfalls.
Specifically, by allowing OCC's Board to adjust the CF Cash
Requirement, OCC would be able to adjust to increases in its liquidity
needs by acquiring additional pre-funded liquidity resources.
Similarly, the Commission believes that the proposed changes to the
OCEO's authority to temporarily increase the CF Cash Requirement would
allow OCC to quickly react to changes in both OCC's liquidity needs and
liquidity resources while still preserving the required analysis and
existing factors that OCC must consider under its current rules.
As described above in section II.B.2., OCC proposes a new
Contingency Funding Plan, which would be described in OCC's rules. The
Commission believes that OCC's proposed Contingency Funding Plan would
be consistent with the requirements of Rule 17Ad-22(e)(7)(viii) because
it would allow OCC to collect additional liquidity resources to address
settlement obligations that could exceed OCC's Available Liquidity
Resources, which could otherwise lead to liquidity shortfalls. In
particular, the Contingency Funding Plan would provide for enhanced
monitoring of any Clearing Member Group whose projected liquidity
exposures under OCC's Sufficiency Scenarios exceed 80 percent of OCC's
Available Liquidity Resources. Such monitoring should, in turn,
facilitate OCC's ability to take further action as necessary, for
example by temporarily increasing OCC's CF Cash Requirement. The
Contingency Funding Plan would also provide OCC with additional
liquidity resources in the form of cash margin deposits in the event
that either (i) a Clearing Member Group's projected liquidity exposures
under OCC's Sufficiency Scenarios exceed 90 percent of OCC's Available
Liquidity Resources or (ii) it becomes necessary to impose protective
measures on a Clearing Member on OCC's Watch List.\49\
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\49\ Such authority would be tempered by OCC's monitoring of the
potential effect of calling for such resources based on the absolute
value of the requirement as well as the size of the requirement
relative to the affected Clearing Member's excess net capital.
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Taken together and for the reasons discussed above, the Commission
believes that proposed changes authorizing OCC to collect liquidity
resources to address settlement obligations that could exceed its Base
or Available Liquidity Resources are consistent with the requirements
of Rule 17Ad-22(e)(7)(viii) under the Exchange Act.\50\
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\50\ 17 CFR 240.17Ad-22(e)(7)(viii).
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3. Consistency With Section (ix) of Rule 17Ad-22(e)(7)
Rule 17Ad-22(e)(7)(ix) under the Exchange Act requires, in part,
that the covered clearing agency's policies and procedures be designed
to effectively manage liquidity risk by, at a minimum, describing the
covered clearing agency's process to replenish any liquid resources
that the clearing agency may employ during a stress event.\51\
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\51\ 17 CFR 240.17Ad-22(e)(7)(ix).
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[[Page 35453]]
As described above in section II.C., OCC proposes to clarify and
amend its rules related to borrowing Clearing Fund collateral.
Specifically, OCC proposes to clarify its authority to borrow cash
directly from the Clearing Fund and to reject substitution requests
that would require the withdrawal of non-cash collateral that OCC has
pledged to access a liquidity facility. The proposal would also
authorize OCC to charge as a loss amounts obtained through borrowing
against the Clearing Fund earlier than currently permitted under OCC's
rules, thereby permitting OCC to require Clearing Members to provide
collateral to replenish the Clearing Fund earlier than would otherwise
be permitted under its existing rules. Taken together, the Commission
believes that the proposed changes concerning OCC borrowing of Clearing
Fund collateral and losses related to such borrowing are consistent
with the requirements of Rule 17Ad-22(e)(7)(ix) under the Exchange
Act.\52\
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\52\ 17 CFR 240.17Ad-22(e)(7)(ix).
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4. Consistency With Section (iv) of Rule 17Ad-22(e)(7)
Rule 17Ad-22(e)(7)(iv) under the Exchange Act requires that the
covered clearing agency's policies and procedures be designed to
require the undertaking of due diligence to confirm that it has a
reasonable basis to believe each of its liquidity providers, whether or
not such liquidity provider is a clearing member, has: (A) Sufficient
information to understand and manage the liquidity provider's liquidity
risks; and (B) the capacity to perform as required under its
commitments to provide liquidity to the covered clearing agency.\53\
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\53\ 17 CFR 240.17Ad-22(e)(7)(iv).
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As described above in section II.D., the proposed LRMF explicitly
contemplates OCC's due diligence for supporting institutions, including
liquidity providers, to confirm OCC has a reasonable basis to believe
each of its liquidity providers has (1) sufficient information to
understand and manage the potential liquidity demands of OCC and its
associated liquidity risk and (2) the capacity to perform as required
under its commitments. Such due diligence would include the execution
of periodic tests at least once every 12 months to measure the
performance and reliability of OCC's liquidity facilities. The
Commission believes that proposed rules setting forth such due
diligence requirements are consistent with the requirements of Rule
17Ad-22(e)(7)(iv) under the Exchange Act.\54\
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\54\ Id.
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Accordingly, the Commission believes that implementation of
Proposed Rule Change would be consistent with Rule 17Ad-22(e)(7) under
the Exchange Act.\55\
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\55\ 17 CFR 240.17Ad-22(e)(7).
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C. Consistency With Rule 17Ad-22(e)(18) Under the Exchange Act
Rule 17Ad-22(e)(18) under the Exchange Act requires, in part, that
a covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to establish
objective, risk-based, and publicly disclosed criteria for
participation, which require participants to have sufficient financial
resources and robust operational capacity to meet obligations arising
from participation in the clearing agency.\56\
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\56\ 17 CFR 240.17Ad-22(e)(18).
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As described above in section II.E., OCC proposes to require that
each Clearing Member maintain adequate procedures, including but not
limited to contingency funding. More specifically, the proposed change
would require Clearing Members to maintain procedures to address a
failure or operational issue at a Clearing Member's settlement bank.
Such a requirement would be in addition to the current requirement that
Clearing Members have access to sufficient financial resources to meet
obligations arising from clearing membership in extreme but plausible
market conditions. The Commission believes that requiring Clearing
Members to maintain such procedures would help to ensure that Clearing
Members have the operational capacity to meet obligations arising from
participation in OCC. The Commission believes, therefore, that the
proposed change is consistent with the requirements of Rule 17Ad-
22(e)(18) under the Exchange Act.\57\
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\57\ Id.
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
Proposed Rule Change is consistent with the requirements of the
Exchange Act, and in particular, the requirements of Section 17A of the
Exchange Act \58\ and the rules and regulations thereunder.
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\58\ In approving this Proposed Rule Change, the Commission has
considered the proposed rules' impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\59\ that the Proposed Rule Change (SR-OCC-2020-003) be,
and hereby is, approved.
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\59\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\60\
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\60\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-12519 Filed 6-9-20; 8:45 am]
BILLING CODE 8011-01-P