[Federal Register Volume 59, Number 25 (Monday, February 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-2724]


[[Page Unknown]]

[Federal Register: February 7, 1994]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33549; File No. SR-OCC-89-4]

 

Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving a Proposed Rule Change To Convert OCC's Index Option 
Escrow Receipt Program From Pilot to Permanent Status

January 31, 1994.
    On May 2, 1989, The Options Clearing Corporation (``OCC'') filed a 
proposed rule change (File No. SR-OCC-89-04) under Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'')\1\ to convert OCC's index 
option escrow receipt program from pilot to permanent status,\2\ to 
revise portions of OCC's index option escrow receipt form, and to amend 
certain OCC rules concerning index option escrow receipts. The 
Commission published notice of the proposal in the Federal Register on 
June 26, 1989.\3\ OCC amended the proposal on February 28 and July 3, 
1990.\4\ No public comments were received. For the reasons discussed 
below, the Commission is approving the proposal.
---------------------------------------------------------------------------

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\The Commission approved the program on a pilot basis on 
August 13, 1985. Securities Exchange Act Release No. 22324 (August 
13, 1985), 50 FR 33443.
    \3\Securities Exchange Act Release No. 26951 (June 21, 1989), 54 
FR 27840.
    \4\These amendments made technical, non-substantive revisions to 
OCC's proposal and, therefore, were not published for comment.
---------------------------------------------------------------------------

I. Description

A. Background

    The program permits OCC clearing members to deposit index option 
escrow receipts with OCC to satisfy the margin requirements arising 
from short call positions on index options in their customers' 
accounts. An OCC-approved custodian bank that holds an escrow deposit 
issues an index option escrow receipt to acknowledge that it holds a 
specific deposit of assets for the account of a specific customer of an 
OCC clearing member and to acknowledge that it will not release the 
property without OCC's written consent. An index option escrow receipt 
covers specific index options and obligates the issuing bank to hold 
the escrow deposit until OCC releases the escrow receipt or until OCC 
directs the issuing bank to make payment on the escrow receipt.

B. The Proposal

    The proposal converts the index option escrow receipt program from 
pilot to permanent status with several amendments. First, the proposal 
increases the cap on the value of index option escrow receipts an 
issuing bank may have outstanding. The index option escrow receipt 
currently requires the issuing bank to certify that the value of the 
cash and securities held by it pursuant to outstanding index option 
escrow receipts or the intrinsic value of all options covered by its 
outstanding index option escrow receipts does not exceed 25% of the 
equity attributable to that bank's outstanding capital stock. The 
proposal increases that cap from 25% to 100% of the issuing bank's 
outstanding capital stock.
    Second, the proposal alters requirements regarding the type of 
property acceptable as an escrow deposit. The proposal eliminates 
certificates of deposit and banker's acceptances as permissible escrow 
deposits and adds as a permissible escrow deposit U.S. government 
securities having one year or less until maturity.\5\
---------------------------------------------------------------------------

    \5\Cash, common stocks listed on a national securities exchange, 
and marginable over-the-counter stocks also are permissible escrow 
deposits.
---------------------------------------------------------------------------

    Third, the proposal gives OCC the authority to close out short 
option positions of a suspended member covered by index option escrow 
receipts and to draw on the proceeds of the escrow receipt to cover 
costs associated with such closing transactions.\6\ OCC may exercise 
this authority if the value of collateral deposited under the escrow 
receipt falls below a certain maintenance level, OCC requests an 
additional margin deposit to cover the deficit, and OCC suspends the 
member.
---------------------------------------------------------------------------

    \6\Currently, OCC must maintain short positions of a suspended 
member covered by an index option escrow receipt until it receives 
instructions from that suspended member or its representative.
---------------------------------------------------------------------------

    Fourth, the proposal eliminates from the index option escrow 
receipt a clause requiring issuing banks to certify that they will not 
permit customers to subject the escrow deposit to any lien or 
encumbrance. The proposal adds language to the escrow receipt which 
precludes the issuing bank from subjecting the escrow deposit to any 
right (including any right of set-off), charge, security interest, 
lien, or claim of any kind in favor of the issuing bank or any person 
claiming through the issuing bank.
    Fifth, the proposal revises the index option escrow receipt to 
permit issuing banks to value escrow deposits at the end of the day 
rather than throughout the day in connection with their obligation to 
request additional customer collateral or to notify OCC of a collateral 
deficiency. Currently, an issuing bank must (1) request from the 
customer a supplemental escrow deposit if at any time the value of the 
escrow deposit decreases below 55% of the underlying index option's 
value and (2) notify OCC if at any time the value of the escrow deposit 
decreases below 50% of the underlying index option's value. Under the 
proposal, these obligations will not be triggered unless the applicable 
thresholds are hit at the close of any business day rather than at any 
time. Banks have represented to OCC that they are unable to conduct 
intraday monitoring of the value of escrow deposits.
    Finally, the proposal contains several technical amendments to the 
index option escrow receipt and corresponding OCC rules. For instance, 
the index option escrow receipt now specifies that written notification 
from an issuing bank to OCC of a collateral deficiency may be by 
facsimile or other electronic transmission if followed by immediate 
telephone confirmation. Throughout Rule 1801, the proposal replaces the 
term ``market value'' with the term ``value'' when referring to 
deposited property because the methods for valuing the various types of 
property eligible for deposit are described in OCC Rule 1801(f). The 
proposal also eliminates ``initial position value'' as a definitional 
term in Rule 1801(c) because that term is not used elsewhere in OCC 
Rule 1801. The proposal replaces the term ``agent'' with the term 
``duly authorized representative'' in the index option escrow receipt. 
The proposal revises the index option escrow receipt to require issuing 
banks to include the value of collateral backing index participation 
escrow receipts in computing limitations on the amount of escrow 
receipts they can issue. The revised index option escrow receipt 
requires issuing banks to certify that they hold escrow deposits as 
``trustee or custodian'' for the account of customers rather than 
merely as ``custodian'' and specifies that the issuing banks hold the 
escrow deposits in accordance with the terms of the index option escrow 
receipt rather than in accordance with OCC rules.

II. Discussion

    The Commission believes that OCC's proposal is consistent with the 
Act and in particular with section 17A(b)(3)(F) thereunder.\7\ That 
section requires, among other things, that the rules of a clearing 
agency be designed to remove impediments to and perfect the mechanism 
of a national system for the prompt and accurate clearance and 
settlement of securities transactions and to assure the safeguarding of 
funds and securities in the clearing agency's custody or control or for 
which it is responsible.
---------------------------------------------------------------------------

    \7\15 U.S.C. 78q-1(b)(3)(F) (1988).
---------------------------------------------------------------------------

    With regard to OCC's safeguarding obligations under the Act, OCC 
has implemented procedures designed to diminish the risks associated 
with the program. As discussed above and in the Commission order 
approving the program on a pilot basis,\8\ these risk reduction 
measures include: (1) The requirement that the issuing bank monitor 
daily the value of escrow deposits and take appropriate action (i.e., 
collection of additional collateral and/or notification to OCC) if that 
value falls below certain thresholds;\9\ (2) escrow deposit eligibility 
standards whereby only liquid assets are eligible to underlie escrow 
receipts; and (3) OCC's new authority to close out the short positions 
of a suspended clearing member covered by index option escrow receipts 
and to draw on the proceeds of those receipts to cover liquidation 
costs.
---------------------------------------------------------------------------

    \8\Securities Exchange Act Release No. 22324 (August 13, 1985), 
50 FR 33443.
    \9\If the value of the deposit decreases below 55% of the index 
option's value, the issuing bank must notify the clearing member and 
request that the deposit be supplemented. If the value of the 
deposit decreases below 50% of the index option's value, the issuing 
bank must notify OCC. In that event, OCC may disregard the escrow 
receipt and may require margin on the short positions.
---------------------------------------------------------------------------

    OCC also has rules and procedures governing banks designated by OCC 
as custodian banks (i.e., banks authorized to issue index option escrow 
receipts). These controls include: (1) financial standards (e.g., 
issuing banks must have shareholder equity of not less than $20 
million); (2) regulatory standards (e.g., issuing banks must be 
supervised and examined by state or federal authorities); and (3) 
depository standards (e.g., issuing banks must file certain financial 
statements with OCC). Moreover, OCC requires each custodian bank to 
supply OCC with a letter from the bank's independent auditors 
describing the adequacy of the custodian bank's procedures relating to 
the issuance of index option escrow receipts.

III. Conclusion

    In conclusion, the Commission believes that OCC's index option 
escrow receipt program should encourage broader participation in the 
index options market and is designed to provide adequate safeguards to 
protect OCC and its clearing members from financial loss.
    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the Act and, in particular, 
with Section 17A of the Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-89-04) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
---------------------------------------------------------------------------

    \10\17 CFR 200.30-3(a)(12) (1993).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2724 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M