[Federal Register Volume 84, Number 242 (Tuesday, December 17, 2019)]
[Notices]
[Pages 68992-68995]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27087]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87718; File No. SR-OCC-2019-010]
Self-Regulatory Organizations; the Options Clearing Corporation;
Order Approving Proposed Rule Change Related to Proposed Changes to the
Options Clearing Corporation's Rules, Margin Policy, Margin
Methodology, Clearing Fund Methodology Policy, and Clearing Fund and
Stress Testing Methodology To Address Specific Wrong-Way Risk
December 11, 2019.
I. Introduction
On October 10, 2019, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2019-010 (``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 revise OCC's
Rules, margin policy and methodology, Clearing Fund policy, and
Clearing Fund and stress testing methodology to adopt new margin
charges and other risk measures to address the specific wrong-way risk
presented by certain cleared positions.\3\ The Proposed Rule Change was
published for public comment in the Federal Register on October 29,
2019.\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 84 FR 57890.
\4\ Securities Exchange Act Release No. 87387 (Oct. 23, 2019),
84 FR 57890 (Oct. 29, 2019) (SR-OCC-2019-010) (``Notice of
Filing''). OCC also filed a related advance notice (SR-OCC-2019-807)
(``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 November 12, 2019. Securities Exchange Act
Release No. 87476 (Nov. 6, 2019), 84 FR 61114 (Nov. 12, 2019) (SR-
OCC-2019-807).
\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 6
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\6\ Capitalized terms used but not defined herein have the
meanings specified in OCC's Rules and By-Laws, available at https://www.theocc.com/about/publications/bylaws.jsp.
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As a central counterparty (``CCP''), OCC is exposed to its Clearing
Members' positions. To the extent that the value of a Clearing Member's
positions is positively correlated with the creditworthiness of the
Clearing Member, OCC faces specific wrong-way risk (``SWWR'').\7\ OCC
proposes changes to address such SWWR. Specifically OCC proposes to:
(1) Adopt a new SWWR margin add-on charge for OCC's margin methodology
(``SWWR Add-on''); (2) introduce stress test scenarios to measure the
SWWR, to the extent not addressed in margin, of cleared positions
involving Clearing Member-
[[Page 68993]]
issued exchange-traded notes (``ETNs''); and (3) impose restrictions on
stock lending activity cleared by OCC.\8\
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\7\ SWWR arises when an exposure to a participant is highly
likely to increase when the creditworthiness of that participant is
deteriorating. See Securities Exchange Act Release No. 78961
(September 28, 2016), 81 FR 70786, 70816, n. 317 (October 13, 2016)
(S7-03-14) (``Covered Clearing Agency Standards'').
\8\ OCC also proposes clarifying and conforming changes to the
Clearing Fund Methodology Policy (``CFM Policy'') and Stress Testing
and Clearing Fund Methodology Description (``Methodology
Description'').
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A. SWWR Margin Add-On
As a general matter, OCC uses its System for Theoretical Analysis
and Numerical Simulations (``STANS'') methodology for calculating
Clearing Member margin requirements. OCC also incorporates add-on
charges to address risks not otherwise addressed by its STANS
methodology.\9\ OCC proposes to adopt a new margin add-on to address
SWWR at the Clearing Member account level (i.e., the SWWR Add-on). The
SWWR Add-on would address SWWR presented by cleared positions involving
equities and ETNs issued by a Clearing Member and its affiliates and
would comprise three components: (1) ``SWWR Equity Charge,'' (2) ``SWWR
ETN Charge,'' and (3) ``SWWR Residual.'' Each of these components is
discussed below.
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\9\ See e.g. Securities Exchange Act Release No. 86119 (Jun. 17,
2019), 84 FR 29267 (Jun. 21, 2019) (approving implementation of an
add-on charge ``to guard against potential shortfalls in margin
requirements that may arise due to the costs of liquidating the
portfolio of a defaulted Clearing Member.'')
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1. SWWR Equity Charge
The proposed SWWR Equity Charge is based on the assumption that,
when a Clearing Member defaults, the value of any equity security
issued by the Clearing Member or its affiliates would fall to zero. For
purposes of calculating the SWWR Equity Charge, OCC would value a
Clearing Member's positions accordingly (i.e., all stocks, single stock
futures, call options, and put options would be valued at zero).\10\
Any potential gain from the SWWR positions would be excluded by
defining the minimum SWWR Equity Charge as zero. OCC stated that the
purpose of the SWWR Equity Charge would be to provide protection from
the risk of potential market exposure to products based on a Clearing
Member Group's own equity in a default or bankruptcy scenario.\11\
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\10\ Because the SWWR arising from equities issued by a Clearing
Member or its affiliates would be fully covered as part of margins,
OCC proposes to remove such positions from Clearing Fund
calculations under OCC's Clearing Fund methodology and would revise
its Methodology Description accordingly.
\11\ See Notice of Filing, 84 FR at 57892.
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2. SWWR ETN Charge
The SWWR ETN Charge would be designed to address the risk that the
value of open positions related to uncollateralized ETNs issued by a
Clearing Member or its affiliates would be correlated with the Clearing
Member's credit quality. Similar to the SWWR Equity Charge, the SWWR
ETN Charge assumes that a degradation in the value of securities issued
by a Clearing Member or its affiliates would occur concurrently with
the Clearing Member's default. The SWWR ETN Charge, however, would not
assume a complete loss of value for the relevant securities (i.e., ETNs
issued by the Clearing Member or its affiliates). OCC states that such
uncollateralized ETNs are generally equivalent to unsecured senior
debt.\12\ OCC, in turn, proposes to utilize an industry standard
recovery rate assumption designed to reflect potential losses to ETN
positions for the purpose of setting the SWWR ETN Charge component of
the SWWR Add-on.
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\12\ See Notice of Filing, 84 FR at 57892.
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3. SWWR Residual
The SWWR Residual would ensure that implementation of the SWWR Add-
on would not reduce a Clearing Member's overall margin
requirements.\13\ To determine the SWWR Residual, OCC would first
calculate a ``base margin'' under on OCC's current methodology (i.e.,
not assuming any specific degradation in the value of securities issued
by a Clearing Member or its affiliates). Next, OCC would calculate a
``residual margin,'' which would represent the Clearing Member's margin
requirement for only those positions unaffected by the SWWR Equity
Charge and SWWR ETN Charge. Finally, the SWWR Residual would be the
difference between the residual margin and the base margin; however,
OCC would adjust the value of the SWWR Residual if the sum of the SWWR
Equity Charge, SWWR ETN Charge, and SWWR Residual would otherwise
reduce a Clearing Member's margin requirement.
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\13\ OCC noted that where a customer of a Clearing Member has
net short positions referencing that Clearing Member's issued
equities, such positions may actually present ``right-way risk,''
whereby the position would result in a gain or margin credit for
that account as the credit quality of the Clearing Member
deteriorates. See Notice of Filing, 84 FR at 57893, n. 20.
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B. SWWR Stress Test Scenarios
As noted above, the proposed SWWR ETN Charge would not assume a
complete loss of value for ETNs issued by a Clearing Member or its
affiliates. The SWWR Add-on, in turn, would not generate margin
requirements designed to cover a scenario in which the recovery rate
for such ETNs would be zero. To address such a scenario, OCC proposes
to introduce new scenarios into the set of stress tests that OCC uses
to test the sufficiency of its financial resources (``SWWR Sufficiency
Scenarios''). To construct the SWWR Sufficiency Scenarios, OCC would
revise certain of its existing stress test scenarios by assuming a
value of zero for ETNs issued by a Clearing Member or its affiliates.
OCC stated that the introduction of SWWR Sufficiency Scenarios would
enable OCC to more accurately measure its credit risks as they relate
to SWWR and better test the sufficiency of its overall financial
resources as well as to call for additional resources as
appropriate.\14\ OCC believes, therefore, it would have sufficient
financial resources to cover the SWWR associated with SWWR ETN
positions if such positions were to be liquidated for less than the
assumed recovery rate.\15\
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\14\ See Notice of Filing, 84 FR at 57893. OCC's current rules
authorize OCC to call for additional resources based on the results
of stress scenarios used to test the sufficiency of OCC's financial
resources. See Securities Exchange Act Release No. 83735 (Jul. 27,
2018), 83 FR 37855 (Aug. 2, 2018) (SR-OCC-2018-008). OCC's rules
also authorize adjustments to OCC's monthly Clearing Fund sizing
process based on the results of stress scenarios used to test the
sufficiency of OCC's financial resources. OCC believes, however,
that SWWR is more appropriately charged to the Clearing Member
presenting the risk. See Notice of Filing, 84 FR at 57893. Based on
that belief, OCC proposes to revise the CFM Policy such that the
results of the SWWR Sufficiency Scenarios would not be used to
adjust OCC's monthly Clearing Fund sizing.
\15\ See Notice of Filing, 84 FR at 57893.
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C. Stock Lending Restrictions
Through its stock loan programs,\16\ OCC novates stock loan
transactions and becomes the lender to each Borrowing Clearing Member
and the borrower to each Lending Clearing Member. OCC is exposed to
SWWR in such programs when a Clearing Member lends equity securities or
ETNs issued by the Clearing Member or its affiliates. To mitigate such
risks, OCC proposes prohibiting Clearing Members from lending equity
securities or ETNs issued by the Clearing Member or its affiliates
within OCC's stock loan programs. OCC does not believe that the
proposed prohibition would have a material impact on Clearing Members
because Clearing Members do not typically lend their own equity
securities, and borrowers do not typically accept equity securities
issued by their lending
[[Page 68994]]
counterparty.\17\ Further, market participants are able to engage in,
and would continue to be able to engage in, securities lending on an
uncleared basis outside of OCC.\18\
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\16\ OCC operates programs for clearing stock loan transactions
initiated either bilaterally between market participants or through
anonymous matching by a Loan Market. See Notice of Filing, 84 FR at
57891.
\17\ See Notice of Filing, 84 FR at 57892.
\18\ The proposed restrictions on lending activity cleared by
OCC would not prevent Clearing Members from lending equities or ETNs
issued by the Clearing Member or any affiliate outside of OCC.
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OCC proposes to implement the prohibition on Clearing Members
lending their own securities only on a going-forward basis. The
proposal would not affect stock lending activity cleared by OCC before
the implementation of the prohibition. Existing stock loan transactions
would, however, be subject to the SWWR Add-on described above.
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.\19\ 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 \20\ and Rules 17Ad-22(e)(4)
and (6) thereunder.\21\
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\19\ 15 U.S.C. 78s(b)(2)(C).
\20\ 15 U.S.C. 78q-1(b)(3)(F).
\21\ 17 CFR 240.17Ad-22(e)(4) and 17 CFR 240.17Ad-22(e)(6).
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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 (i) promote
the prompt and accurate clearance and settlement of securities
transactions, and to the extent applicable, derivatives agreements,
contracts, and transactions; and (ii) assure the safeguarding of
securities and funds which are in the custody or control of the
clearing agency or for which it is responsible.\22\ Based on its review
of the record, the Commission believes that the proposed changes are
designed to promote prompt and accurate clearance and settlement as
well as assure the safeguarding of securities and funds which are in
OCC's custody or control for the reasons set forth below.
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\22\ 15 U.S.C. 78q-1(b)(3)(F).
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First, the Commission believes that the adoption of the SWWR Add-on
would be consistent with assuring the safeguarding of securities and
funds. To the extent that the value of a Clearing Member's positions is
positively correlated with the creditworthiness of the Clearing Member,
OCC faces SWWR. OCC's current margin methodology does not incorporate a
specific component designed to address SWWR for cleared positions. As
described above, the proposed SWWR Add-on would address SWWR arising
out of equities and ETNs issued by the relevant Clearing Member or its
affiliates underlying a Clearing Member's cleared positions. Further,
the SWWR Add-on would be designed to avoid any unintended reduction in
margin requirements resulting from ``right-way risk'' in a Clearing
Member's accounts.\23\ The Commission believes that the proposal would
provide for more comprehensive management of the potential risks posed
by the default of a Clearing Member because OCC would adopt an add-on
charge to address a risk not captured elsewhere in its margin
methodology. Management of such risks through the collection of margin
collateral could, in turn, help reduce the amount of credit losses that
would potentially be charged to the Clearing Fund contributions of
surviving Clearing Members. The Commission believes, therefore, that
the proposed SWWR charge would be consistent with assuring the
safeguarding of securities and funds posted by surviving Clearing
Members as collateral.
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\23\ See supra at note 13.
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Second, the Commission believes that introduction of the SWWR
Sufficiency Scenarios and the proposed prohibition of certain stock
lending activity as described above would be consistent with the
promotion prompt and accurate clearance and settlement. As an initial
matter, OCC is the only clearing agency for standardized U.S.
securities options listed on Commission-registered national securities
exchanges (``listed options'').\24\ The ETN component of the SWWR Add-
on would not address the exposures presented by a complete loss of
value for ETNs issued by the Clearing Member or its affiliates. To
address the potential credit exposure represented by the value of such
ETNs going to zero, OCC proposes to introduce the new SWWR Sufficiency
Scenarios described above. OCC would use the SWWR Sufficiency Scenarios
to test its total financial resources. The proposed introduction of new
scenarios to test the sufficiency of OCC's financial resources in the
Clearing Fund would address assumptions underlying OCC's proposed
margin methodology (i.e., a non-zero ETN recovery rate). OCC relies on
the resources in its Clearing Fund to manage the risk of losses arising
out of the default of a Clearing Member under extreme but plausible
market conditions. Additionally, prohibiting certain stock loan
activity that could generate losses in the event of a Clearing Member
default would avoid those potential losses all together. Strengthening
the methodology that OCC uses to manage its financial resources or
avoiding the risk of loss all together, strengthens OCC's ability to
manage Clearing Member defaults, which, in turn, facilitates the
clearance and settlement of listed options.
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\24\ See Securities Exchange Act Release No. 85121 (Feb. 13,
2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR-OCC-2015-02).
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The Commission believes, therefore, that the Proposed Rule Change
is consistent with the requirements of Section 17A(b)(3)(F) of the
Exchange Act.\25\
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\25\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(4) Under the Exchange Act
Rule 17Ad-22(e)(4) under the Exchange Act requires, in part, that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to effectively
identify, measure, monitor, and manage its credit exposures to
participants and those arising from its payment, clearing, and
settlement processes.\26\
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\26\ 17 CFR 240.17Ad-22(e)(4).
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As described above, OCC proposes to prohibit each Clearing Member
submitting for clearing any stock loan activity involving the lending
of equity securities or ETNs issued by such a Clearing Member or its
affiliates going forward. Under the proposal, OCC would identify those
stock loan transactions presenting SWWR and avoid any potential
exposures arising out of such transactions through the proposed
prohibition. Further, for those transactions that would not be affected
by the prohibition (i.e., existing transactions), OCC proposes to
measure, monitor, and manage its exposures through the use of the SWWR
Add-on described above and discussed below. Accordingly, the Commission
believes that OCC's proposal in the Proposed Rule Change to prohibit
certain stock loan transactions is consistent with Rule 17Ad-22(e)(4)
under the Exchange Act.\27\
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\27\ 17 CFR 240.17Ad-22(e)(4).
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[[Page 68995]]
Rules 17Ad-22(e)(4)(i) and (iii) under the Exchange Act require
that a covered clearing agency's policies and procedures meet the
requirements of Rule 17Ad-22(e)(4) by maintaining financial resources
at the minimum to enable OCC to cover a wide range of foreseeable
stress scenarios that include, but are not limited to, the default of
the participant family that would potentially cause the largest
aggregate credit exposure for OCC in extreme but plausible market
conditions.\28\ Further, Rule 17Ad-22(e)(4)(vi) under the Exchange Act
requires that a covered clearing agency's policies and procedures meet
the requirements of Rule 17Ad-22(e)(4) by testing the sufficiency of a
covered clearing agency's total financial resources available to meet
the minimum financial resource requirements under Rules 17Ad-
22(e)(4)(i) through (iii).\29\
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\28\ 17 CFR 240.17Ad-22(e)(4)(i) and 17 CFR 240.17Ad-
22(e)(4)(iii).
\29\ 17 CFR 240.17Ad-22(e)(4)(vi).
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As described above and discussed below, the proposed SWWR Add-on is
designed to measure and manage OCC's credit exposures to Clearing
Members to the extent those exposures arise out of SWWR related to
cleared positions. One component of the SWWR Add-on--the SWWR ETN
Charge--would not, however, fully cover OCC's potential exposure
through margin because it would not assume a complete loss of value for
ETNs issued by the Clearing Member or its affiliates. To address the
potential credit exposure represented by the value of ETNs issued by
the Clearing Member or its affiliates going to zero, OCC proposes to
introduce the new SWWR Sufficiency Scenarios described above. OCC would
use the SWWR Sufficiency Scenarios to test its total financial
resources and to call for additional resources as necessary to ensure
the resources it holds would be sufficient to enable OCC to cover
exposures arising under the relevant stress scenarios. Accordingly, and
for the reasons stated above, the Commission believes the changes
proposed in the Proposed Rule Change are consistent with Rule 17Ad-
22(e)(4)(i), (iii), and (vi) under the Exchange Act.\30\
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\30\ 17 CFR 240.17Ad-22(e)(4)(i); 17 CFR 240.17Ad-22(e)(4)(iii);
17 CFR 240.17Ad-22(e)(4)(vi).
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C. Consistency With Rule 17Ad-22(e)(6) Under the Exchange Act
Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to cover, if the
covered clearing agency provides central counterparty services, its
credit exposure to participants by establishing a risk-based margin
system that, at a minimum, considers, and produces margin levels
commensurate with, the risks and particular attributes of each relevant
product, portfolio, and market.\31\
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\31\ 17 CFR 240.17Ad-22(e)(6)(i).
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As noted above, OCC faces SWWR to the extent that the value of a
Clearing Member's positions is positively correlated with the
creditworthiness of the Clearing Member. OCC proposes to cover its
exposure to such SWWR posted by its Clearing Members through the
introduction of the SWWR Add-on. The SWWR Add-on consists of three
components. Two of those components--the SWWR Equity Charge and SWWR
ETN Charge--are designed to produce margin levels commensurate with the
particular attributes of certain products that OCC clears in terms of
the likely recovery available in the event of a default by the issuing
Clearing Member. Further, the SWWR Residual would ensure that the
introduction of the SWWR Add-on could not inadvertently weaken OCC's
current margin methodology due to the potential existence of ``right-
way risk'' in a Clearing Member's accounts.\32\ Accordingly, and for
the reasons stated above, the Commission believes the adoption of a
margin add-on charge designed to cover exposures arising out of SWWR is
consistent with Rule 17Ad-22(e)(6)(i) under the Exchange Act.\33\
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\32\ See supra at note 13.
\33\ 17 CFR 240.17Ad-22(e)(6)(i).
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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 \34\ and the rules and regulations thereunder.
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\34\ 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,\35\ that the Proposed Rule Change (SR-OCC-2019-010) be,
and hereby is, approved.
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\35\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\36\
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\36\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2019-27087 Filed 12-16-19; 8:45 am]
BILLING CODE 8011-01-P