[House Report 115-810]
[From the U.S. Government Publishing Office]


115th Congress     }                                {         Report
                        HOUSE OF REPRESENTATIVES
 2d Session        }                                {         115-810

======================================================================



 
                     OPTIONS MARKETS STABILITY ACT

                                _______
                                

 July 10, 2018.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

Mr. Hensarling, from the Committee on Financial Services, submitted the 
                               following

                              R E P O R T

                        [To accompany H.R. 5749]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 5749) to require the appropriate Federal banking 
agencies to increase the risk-sensitivity of the capital 
treatment of certain centrally cleared options, and for other 
purposes, having considered the same, report favorably thereon 
with an amendment and recommend that the bill as amended do 
pass.
    The amendment is as follows:
  Strike all after the enacting clause and insert the 
following:

SECTION 1. SHORT TITLE.

  This Act may be cited as the ``Options Markets Stability Act''.

SECTION 2. RULEMAKING.

  Within 180 days of the date of enactment of this Act, the Board of 
Governors of the Federal Reserve System, the Federal Deposit Insurance 
Corporation, and the Comptroller of the Currency shall, jointly, issue 
a proposed rule, and finalize such rule within 360 days of the date of 
enactment of this Act, to adopt a methodology for calculating the 
counterparty credit risk exposure, at default, of a depository 
institution, depository institution holding company, or affiliate 
thereof to a client arising from a guarantee provided by the depository 
institution, depository institution holding company, or affiliate 
thereof to a central counterparty in respect of the client's 
performance under a derivative contract cleared through that central 
counterparty pursuant to the risk-based and leverage-based capital 
rules applicable to depository institutions and depository institution 
holding companies under parts 3, 217, and 324 of title 12, Code of 
Federal Regulations. In issuing such rule, the Board of Governors of 
the Federal Reserve System, the Federal Deposit Insurance Corporation, 
and the Comptroller of the Currency shall consider--
          (1) the availability of liquidity provided by market makers 
        during times of high volatility in the capital markets;
          (2) the spread between the bid and the quote offered by 
        market makers;
          (3) the preference for clearing through central 
        counterparties;
          (4) the safety and soundness of the financial system and 
        financial stability, including the benefits of central 
        clearing;
          (5) the safety and soundness of individual institutions that 
        may centrally clear derivatives or options on behalf of a 
        client, including concentration of market share;
          (6) the economic value of delta weighting a counterparty's 
        position and netting of a counterparty's position;
          (7) the inherent risk of the positions;
          (8) barriers to entry for depository institutions, depository 
        institution holding companies, affiliates thereof, and entities 
        not affiliated with a depository institution or depository 
        institution holding company to centrally clear derivatives or 
        options on behalf of market makers;
          (9) the impact any changes may have on the broader capital 
        regime and aggregate capital in the system; and
          (10) consideration of other potential factors that impact 
        market making in the options market, including changes in 
        market structure.

SEC. 3. REPORT TO CONGRESS.

  At the end of the 5-year period beginning on the date the final rule 
is issued under section 1, the Board of Governors of the Federal 
Reserve System shall submit to the Committee on Financial Services of 
the House of Representatives and the Committee on Banking, Housing, and 
Urban Affairs of the Senate a report detailing the impact of the final 
rule during such period on the factors described under paragraphs (1) 
through (10) of section 2.

                          PURPOSE AND SUMMARY

    On May 10, 2018, Representative Randy Hultgren introduced 
H.R. 5749, the ``Options Markets Stability Act''. The bill, as 
modified by an amendment in the nature of a substitute offered 
by Representative Bill Foster, directs the Federal Reserve, the 
Federal Deposit Insurance Company (FDIC), and the Comptroller 
of the Currency (OCC) to issue a proposed rule, and to finalize 
such rule within 360 days of enactment, to adopt a methodology 
for calculating the counterparty credit risk exposure under 
derivative contracts pursuant to risk-based and leverage-based 
capital rules.

                  BACKGROUND AND NEED FOR LEGISLATION

    In response to the 2008 financial crisis, the Basel 
Committee on Banking Supervision (Basel Committee) agreed to 
modify internationally negotiated bank regulatory standards 
known as the Basel Accords to increase bank capital 
requirements. On July 9, 2013, the federal banking regulators, 
including the Federal Reserve, Federal Deposit Insurance 
Corporation (FDIC), and the Office of the Comptroller of the 
Currency (OCC), issued a final rule to implement most of the 
Basel III recommendations.
    In addition to raising the simple leverage ratio, Basel III 
established a ``supplementary leverage ratio'' (SLR) that 
requires certain larger banking organizations to include 
leverage exposures that are both on and off the bank's balance 
sheet, which includes exposures arising from futures, options, 
and other derivative transactions. The SLR was intended to be 
``a simple, transparent, non-risk based leverage ratio to act 
as a credible supplementary measure to risk-based capital 
requirements.'' All banks with at least $250 billion in total 
assets and $10 billion in foreign assets must meet an SLR of 3 
percent. Banks subject to these rules were required to meet the 
SLR beginning in January 2018.
    Under Title VII of Dodd-Frank, certain over-the-counter 
(OTC) swaps were required to be centrally cleared in order to 
take advantage of the risk mitigating benefits of clearing. As 
a result, the role of clearing members and the amount of 
transactions cleared by these institutions has expanded 
significantly. However, businesses and end-users that use 
futures and swaps to manage business risks can only trade 
cleared derivatives through a clearing member, as they cannot 
access clearinghouses directly.
    Recently, in its October 6, 2017 Report on Capital Markets, 
issued pursuant to President Trump's February 3, 2017 Executive 
Order, the Department of Treasury identified the SLR as a risk-
insensitive capital rule that is discouraging central clearing 
and increasing costs to customers. The Treasury's report noted 
two particular problems with the SLR. The first--the treatment 
of initial margin--is addressed by H.R. 4659. The second 
problem--the current approach for calculating exposure for 
cleared options--is addressed by H.R. 5749.
    Under the Basel III rules, banks are required to calculate 
charges for cleared options using the standardized approach 
known as the Current Exposure Method (``CEM''). CEM is not 
properly calibrated for options because it is not sufficiently 
risk-sensitive, resulting in higher leverage ratio capital 
requirements for certain derivatives products (including 
exchange-traded derivatives) relative to risk-based measures. 
The CEM model, for example, requires options contracts to be 
sized on their notional face value rather than allowing for a 
risk adjustment to notional to reflect the actual exposure 
associated with these derivatives. Specifically, CEM does not 
permit a delta adjustment for the notional value measurement of 
options. Implementing a rule that would allow for a more risk-
adjusted approach to value centrally-cleared options as it 
relates to capital rules will better and more accurately 
reflect exposure and promote options market-marking activity. 
As IOSCO (the International Organization of Securities 
Commissions) noted the importance of market making in a May 
1999 paper, ``The market maker in general adds to the 
stability, liquidity and transparency (i.e. price discovery 
mechanism) of financial markets.''
    Moreover, the CEM measures exposures on a gross basis and 
is, therefore, overly restrictive in permitting netting and the 
offsetting of long and short positions. Typically, for example, 
market makers and others who maintain hedged positions will 
execute and clear offsetting trades. When done through the same 
Central Counterparty (CCP), the risk of such hedged positions 
is reduced, or even eliminated. The CEM, however, applies 
separately--on a gross basis--to each of the offsetting 
positions, compounding the capital that hedged traders' Futures 
Commissions Merchants (FCMs) must set aside, even though the 
hedged position has reduced exposure overall. By contrast, a 
trader with an unhedged, directional position--by definition 
more risky than a hedged position--will, from a CEM 
perspective, have less exposure than a hedger with two 
offsetting trades. Modernizing this calculation will 
incentivize the use of hedged positions, reduce the amount of 
capital required to place those positions, and reduce overall 
risk exposure.
    Options have sensitivity to the price of the underlying 
stock, such that at any given point in time, the value of an 
option will respond differently to changes in the price of the 
option's underlying shares. This market sensitivity is referred 
to as an option's delta. The CEM fails to account for the delta 
of options and fails to fully recognize the offsetting of 
positions with opposite economic exposure--i.e., long positions 
and short positions. Thus, the CEM requires banking 
organizations to hold capital that is disproportionate to the 
actual risks posed by a bank-owned clearing firm's listed 
options business. Accordingly, the CEM constrains the ability 
of options market-makers to accumulate positions (even 
offsetting positions), which hinders their ability to provide 
liquidity. The knock-on effects are increased costs to 
investors, heightened possibility of market dislocation during 
volatile environments, and the discouragement of centrally-
cleared products that help limit systemic risk.
    To remedy these problems, H.R. 5749, as amended, will 
require the Federal Reserve Board, the OCC, and the FDIC to 
issue a proposed rule to adopt a methodology for calculating 
the counterparty credit risk exposure under exchange-listed 
derivative contracts pursuant to risk-based and leverage-based 
capital rules. In devising such methodology, the banking 
regulators shall consider, among other things, the availability 
of liquidity provided by market makers during a period of high 
volatility, spreads between bids and quotes, the preference for 
central clearing, the safety and stability of the financial 
system and clearing institutions, the benefits of central 
clearing, and the inherent risk of the positions.
    The bill also requires the banking regulators to consider 
the economic value of an offset using ``delta weighting'' and 
``netting'' of correlated positions in the calculation. Delta 
weighting takes into account the price sensitivity of a 
derivative relative to changes in the price of the underlying 
asset and is the number of points than an option's price is 
expected to move for each one-point change in the underlying 
asset. Delta provides an indication of how the option's value 
will change with respect to price fluctuations in the 
underlying instrument, assuming all other variables remain the 
same. Netting acknowledges that counterparties may have 
correlated positions where one party is long and another is 
short on a specific position. Both of these policy changes can 
be found in the Basel Committee on Banking Supervision's 
``Standardized Approach for Counterparty Credit Risk 
Exposures'' (SACCR), a more risk-sensitive method. The Basel 
Committee agreed to replace CEM with SACCR by January 2017, but 
the transition to SACCR is not imminent in the United States.

                                HEARINGS

    The Subcommittee on Capital Markets, Securities, and 
Investments held a hearing examining matters relating to H.R. 
5749 on February 14, 2018.

                        COMMITTEE CONSIDERATION

    The Committee on Financial Services met in open session on 
June 14. 2018, and ordered H.R. 5749 to be reported favorably 
to the House as amended by a recorded vote of 54 yeas to 0 nays 
(recorded vote no. FC-188), a quorum being present. Before the 
motion to report was offered, the Committee adopted an 
amendment in the nature of a substitute offered by Mr. Foster 
by voice vote.

                            COMMITTEE VOTES

    Clause 3(b) of rule XIII of the Rules of the House of 
Representatives requires the Committee to list the record votes 
on the motion to report legislation and amendments thereto. The 
sole recorded vote was on a motion by Chairman Hensarling to 
report the bill favorably to the House as amended by a recorded 
vote of 54 yeas to 0 nays (recorded vote no. FC-188) a quorum 
being present.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



                      COMMITTEE OVERSIGHT FINDINGS

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the findings and recommendations of 
the Committee based on oversight activities under clause 
2(b)(1) of rule X of the Rules of the House of Representatives, 
are incorporated in the descriptive portions of this report.

                    PERFORMANCE GOALS AND OBJECTIVES

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, the Committee states that H.R. 5749 
will incentivize the use of hedged positions and reduce the 
amount of capital required to place positions and reduce 
overall exposure within option contracts.

   NEW BUDGET AUTHORITY, ENTITLEMENT AUTHORITY, AND TAX EXPENDITURES

    The Committee has not received an estimate of new budget 
authority contained in the cost estimate prepared by the 
Director of the Congressional Budget Office pursuant to Sec. 
402 of the Congressional Budget Act of 1974. In compliance with 
clause 3(c)(2) of rule XIII of the Rules of the House, the 
Committee opines that H.R. 5749 will not establish any new 
budget or entitlement authority or create any tax expenditures.

                 CONGRESSIONAL BUDGET OFFICE ESTIMATES

    The cost estimate prepared by the Director of the 
Congressional Budget Office pursuant to Sec. 402 of the 
Congressional Budget Act of 1974 was not submitted timely to 
the Committee.

                       FEDERAL MANDATES STATEMENT

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995.
    The Committee has determined that the bill does not contain 
Federal mandates on the private sector. The Committee has 
determined that the bill does not impose a Federal 
intergovernmental mandate on State, local, or tribal 
governments.

                      ADVISORY COMMITTEE STATEMENT

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                  APPLICABILITY TO LEGISLATIVE BRANCH

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of the section 
102(b)(3) of the Congressional Accountability Act.

                         EARMARK IDENTIFICATION

    With respect to clause 9 of rule XXI of the Rules of the 
House of Representatives, the Committee has carefully reviewed 
the provisions of the bill and states that the provisions of 
the bill do not contain any congressional earmarks, limited tax 
benefits, or limited tariff benefits within the meaning of the 
rule.

                    DUPLICATION OF FEDERAL PROGRAMS

    In compliance with clause 3(c)(5) of rule XIII of the Rules 
of the House of Representatives, the Committee states that no 
provision of the bill establishes or reauthorizes: (1) a 
program of the Federal Government known to be duplicative of 
another Federal program; (2) a program included in any report 
from the Government Accountability Office to Congress pursuant 
to section 21 of Public Law 111-139; or (3) a program related 
to a program identified in the most recent Catalog of Federal 
Domestic Assistance, published pursuant to the Federal Program 
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No. 
98-169).

                   DISCLOSURE OF DIRECTED RULEMAKING

    Pursuant to section 3(i) of H. Res. 5, (115th Congress), 
the following statement is made concerning directed rule 
makings: The Committee estimates that the bill requires a 
directed rule making within the meaning of such section. 
Specifically, the bill directs the Federal Reserve, the Federal 
Deposit Insurance Company (FDIC), and the Comptroller of the 
Currency (OCC) to issue a proposed rule, and to finalize such 
rule within 360 days of enactment, to adopt a methodology for 
calculating the counterparty credit risk exposure under 
derivative contracts pursuant to risk-based and leverage-based 
capital rules.

             SECTION-BY-SECTION ANALYSIS OF THE LEGISLATION

Section 1. Short title

    This Section cites H.R. 5749 as the ``Options Markets 
Stability Act''.

Section 2. Rulemaking

    This section requires the Federal Reserve Board, the OCC, 
and the FDIC to issue a proposed rule, and to finalize such 
rule within 360 days of enactment, to adopt a methodology for 
calculating the counterparty risk exposure under exchange-
listed derivative contracts pursuant to risk-based and 
leverage-based capital rules. It also sets forth issues that 
should be considered in issuing such rule.

Section 3. Report to Congress

    This section requires the Federal Reserve Board to issue a 
report to Congress--at the end of the 5-year period beginning 
on the date the final rule is issued--detailing the impact of 
the final rule during that period on the factors described in 
section 2.

         CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED

    H.R. 5749 does not repeal or amend any section of a 
statute. Therefore, the Office of Legislative Counsel did not 
prepare the report contemplated by clause 3(e)(1)(B) of rule 
XIII of the House of Representatives.

                                  [all]