Federal Register, Volume 84 Issue 239 (Thursday, December 12, 2019)

[Federal Register Volume 84, Number 239 (Thursday, December 12, 2019)]
[Notices]
[Pages 67981-67985]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-26727]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87673; File No. SR-OCC-2019-807]

Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection To Advance Notice 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 6, 2019.

I. Introduction

On October 10, 2019, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-OCC-2019-807 (``Advance Notice'') pursuant to Section
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled Payment, Clearing and Settlement
Supervision Act of 2010 (``Clearing Supervision Act'') \1\ and Rule
19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934
(``Exchange Act'') \3\ 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.\4\ The Advance Notice was published for public comment in
the Federal Register on November 12, 2019,\5\ and the

[[Page 67982]]

Commission has received no comments regarding the changes proposed in
the Advance Notice.\6\ The Commission is hereby providing notice of no
objection to the Advance Notice.
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\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ 15 U.S.C. 78a et seq.
\4\ See Notice of Filing infra note 5, at 84 FR 61114.
\5\ Securities Exchange Act Release No. 87476 (Nov. 6, 2019), 84
FR 61114 (Nov. 12, 2019) (File No. SR-OCC-2019-807) (``Notice of
Filing''). On October 10, 2019, OCC also filed a related proposed
rule change (SR-OCC-2019-010) with the Commission pursuant to
Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder
(``Proposed Rule Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-
4, respectively. In the Proposed Rule Change, which was published in
the Federal Register on October 29, 2019, OCC seeks approval of
proposed changes to its rules necessary to implement the Advance
Notice. Securities Exchange Act Release No. 87387 (Oct. 23, 2019),
84 FR 57890 (Oct. 29, 2019). The comment period for the related
Proposed Rule Change filing closed on November 19, 2019.
\6\ Since the proposal contained in the Advance Notice was also
filed as a proposed rule change, all public comments received on the
proposal are considered regardless of whether the comments are
submitted on the Proposed Rule Change or the Advance Notice.
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II. Background \7\
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\7\ 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'').\8\ 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-issued exchange-traded notes (``ETNs''); and
(3) impose restrictions on stock lending activity cleared by OCC.\9\
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\8\ 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'').
\9\ 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.\10\ 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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\10\ 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).\11\
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.\12\
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\11\ 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.
\12\ See Notice of Filing, 84 FR at 61116.
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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.\13\ 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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\13\ See Notice of Filing, 84 FR at 61117.
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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.\14\ 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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\14\ 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 61117, 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.\15\

[[Page 67983]]

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.\16\
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\15\ See Notice of Filing, 84 FR 61117. 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 61118. 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.
\16\ See Notice of Filing, 84 FR at 61117.
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C. Stock Lending Restrictions

Through its stock loan programs,\17\ 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 counterparty.\18\ 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.\19\
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\17\ 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
61115-16.
\18\ See Notice of Filing, 84 FR at 61116.
\19\ 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 transaction
would, however, be subject to the SWWR Add-on described above.

III. Commission Findings and Notice of No Objection

Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, the stated purpose of the Clearing
Supervision Act is instructive: To mitigate systemic risk in the
financial system and promote financial stability by, among other
things, promoting uniform risk management standards for systemically
important financial market utilities (``SIFMUs'') and strengthening the
liquidity of SIFMUs.\20\
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\20\ See 12 U.S.C. 5461(b).
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Section 805(a)(2) of the Clearing Supervision Act \21\ authorizes
the Commission to prescribe regulations containing risk-management
standards for the payment, clearing, and settlement activities of
designated clearing entities engaged in designated activities for which
the Commission is the supervisory agency. Section 805(b) of the
Clearing Supervision Act \22\ provides the following objectives and
principles for the Commission's risk-management standards prescribed
under Section 805(a):
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\21\ 12 U.S.C. 5464(a)(2).
\22\ 12 U.S.C. 5464(b).
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To promote robust risk management;
to promote safety and soundness;
to reduce systemic risks; and
to support the stability of the broader financial system.
Section 805(c) provides, in addition, that the Commission's risk-
management standards may address such areas as risk-management and
default policies and procedures, among other areas.\23\
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\23\ 12 U.S.C. 5464(c).
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The Commission has adopted risk-management standards under Section
805(a)(2) of the Clearing Supervision Act and Section 17A of the
Exchange Act (the ``Clearing Agency Rules'').\24\ The Clearing Agency
Rules require, among other things, each covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to meet certain minimum
requirements for its operations and risk-management practices on an
ongoing basis.\25\ As such, it is appropriate for the Commission to
review advance notices against the Clearing Agency Rules and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Clearing Supervision Act. As
discussed below, the Commission believes the changes proposed in the
Advance Notice are consistent with the objectives and principles
described in Section 805(b) of the Clearing Supervision Act,\26\ and in
the Clearing Agency Rules, in particular Rules 17Ad-22(e)(4) and
(6).\27\
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\24\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No.
68080 (October 22, 2012), 77 FR 66220 (Nov. 2, 2012) (S7-08-11). See
also Covered Clearing Agency Standards, 81 FR 70786. The Commission
established an effective date of December 12, 2016 and a compliance
date of April 11, 2017 for the Covered Clearing Agency Standards.
OCC is a ``covered clearing agency'' as defined in Rule 17Ad-
22(a)(5). The Commission established an effective date of December
12, 2016 and a compliance date of April 11, 2017 for the Covered
Clearing Agency Standards. OCC is a ``covered clearing agency'' as
defined in Rule 17Ad-22(a)(5).
\25\ 17 CFR 240.17Ad-22.
\26\ 12 U.S.C. 5464(b).
\27\ 17 CFR 240.17Ad-22(e)(4) and 17 CFR 240.17Ad-22(e)(6).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

The Commission believes that the proposal contained in OCC's
Advance Notice is consistent with the stated objectives and principles
of Section 805(b) of the Clearing Supervision Act. Specifically, as
discussed below, the Commission believes that the changes proposed in
the Advance Notice are consistent with promoting robust risk management
in the area of credit risk, promoting safety and soundness, reducing
systemic risks, and supporting the stability of the broader financial
system.\28\
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\28\ 12 U.S.C. 5464(b).
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First, the Commission believes that the adoption of the SWWR Add-on
would be consistent with the promotion of robust risk management at
OCC. 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.\29\ Adopting an add-on charge to address a risk not
captured elsewhere in OCC's margin methodology would provide for more
comprehensive management of OCC's risks, consistent with the promotion
of robust risk management.
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\29\ See infra at note 14.
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Second, the Commission believes that introduction of the SWWR
Sufficiency Scenarios would be consistent with the

[[Page 67984]]

promotion of robust risk management at OCC. 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.
Introducing new scenarios to test the sufficiency of OCC's financial
resources generally and to address assumptions underlying OCC's margin
methodology more specifically (i.e., a non-zero ETN recovery rate),
would be consistent with the promotion of robust risk management.
Third, the Commission believes that the collection of resources to
address the exposures discussed above and the proposed prohibition of
certain stock lending activity as described above would be consistent
with the promotion of safety and soundness at OCC. The collection of
additional financial resources, whether in margin or Clearing Fund
contributions, would better enable OCC to manage the potential losses
arising out of a Clearing Member default. Prohibiting certain stock
loan activity that could generate losses in the event of a Clearing
Member default would avoid those potential losses all together.
Avoiding or holding resources to address such losses would promote
OCC's safety and soundness.
Finally, the Commission believes that the proposal is generally
consistent with reducing systemic risk and supporting the broader
financial system. As discussed above, OCC proposes to identify and
manage SWWR posed by the cleared positions of its Clearing Members. OCC
proposes to collect resources to address such risks as margin and, for
more extreme scenarios, as Clearing Fund contributions. Additionally,
OCC would prohibit stock loan transactions that give rise to SWWR.
Prohibiting such activity and collecting additional margin to
collateralize exposures created by permitted activity could reduce the
probability that OCC would mutualize a loss arising out of the close-
out of a defaulted Clearing Member that generated SWWR. While
unavoidable under certain circumstances, reducing the probability of
loss mutualization during periods of market stress could reduce the
transmission of financial risks arising from a Clearing Member default
to non-defaulting Clearing Members, their customers, and the broader
options market. Further, OCC maintaining additional Clearing Fund
contributions would further reduce the potentiality that OCC would need
to call for additional resources from Clearing Members in times of
market stress. The Commission believes, therefore, that the proposed
changes would be consistent with the reduction of systemic risk and
supporting the stability of the broader financial system.
Accordingly, and for the reasons stated above, the Commission
believes the changes proposed in the Advance Notice are consistent with
Section 805(b) of the Clearing Supervision Act.\30\
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\30\ 12 U.S.C. 5464(b).
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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.\31\
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\31\ 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 Advance Notice to prohibit certain
stock loan transactions is consistent with Rule 17Ad-22(e)(4) under the
Exchange Act.\32\
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\32\ 17 CFR 240.17Ad-22(e)(4).
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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.\33\ 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).\34\
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\33\ 17 CFR 240.17Ad-22(e)(4)(i) and 17 CFR 240.17Ad-
22(e)(4)(iii).
\34\ 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 Advance Notice are consistent with Rule 17Ad-
22(e)(4)(i), (iii), and (vi) under the Exchange Act.\35\
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\35\ 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.\36\
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\36\ 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

[[Page 67985]]

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.\37\ 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.\38\
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\37\ See infra at note 14.
\38\ 17 CFR 240.17Ad-22(e)(6)(i).
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IV. Conclusion

It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Clearing Supervision Act, that the Commission does not object to
Advance Notice (SR-OCC-2019-807) and that OCC is authorized to
implement the proposed change as of the date of this notice or the date
of an order by the Commission approving proposed rule change SR-OCC-
2019-010 whichever is later.

By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-26727 Filed 12-11-19; 8:45 am]
BILLING CODE 8011-01-P