[Federal Register Volume 62, Number 93 (Wednesday, May 14, 1997)]
[Notices]
[Pages 26602-26605]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12638]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38584; File No. SR-OCC-97-04]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing and Order Granting Accelerated Approval of a Proposed 
Rule Change Relating to a Cross-Margining Agreement With the Chicago 
Mercantile Exchange and the Commodity Clearing Corporation

May 8, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on March 18, 1997, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') and on April 17, 1997, and April 
22, 1997, amended the proposed rule change as described in Items I and 
II below, which Items have been prepared primarily by OCC. The 
Commission is publishing this notice and order to solicit comments from 
interested persons and to grant accelerated approval of the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change facilitates the establishment of a cross-
margining arrangement among OCC, the Chicago Mercantile Exchange 
(``CME''), and the Commodity Clearing Corporation (``CCC'').

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any

[[Page 26603]]

comments it received on the proposed rule change. The text of these 
statements may be examined at the places specified in Item IV below. 
OCC has prepared summaries, set forth in sections (A), (B), and (C) 
below, of the most significant aspects of such statements.\2\
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    \2\ The Commission has modified the text of the summaries 
prepared by OCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The purpose of the proposed rule change is to facilitate the 
establishment of a cross-margining arrangement among OCC, CME, and CCC. 
The proposed cross-margining agreement (``Agreement'') to be entered 
into by the three organizations is patterned after the existing 
trilateral cross-margining agreement among OCC, The Intermarket 
Clearing Corporation (``ICC''), and CME. From the time the New York 
Stock Exchange sold the New York Futures Exchange (``NYFE'') to the New 
York Cotton Exchange (``Cotton Exchange''), OCC and the Cotton Exchange 
have been working together to move the clearance and settlement of NYFE 
products from ICC to the Cotton Exchange's clearinghouse, CCC. One 
obstacle to transferring the clearance and settlement services from ICC 
to CCC was the lack of a cross-margining program among OCC, CME, and 
CCC. The proposed rule change will facilitate the establishment of a 
cross-margining program that will allow NYFE participants to continue 
to receive the benefits of cross-margining after CCC assumes the 
clearance and settlement of NYFE products on April 29, 1997.\3\ The 
proposed Agreement will be modified as necessary from the existing OCC/
ICC/CME cross-margin agreement to accommodate CCC as a participating 
carrying clearing organization in place of ICC. As with the OCC/CME/ICC 
cross-margining agreement, the proposed Agreement will accommodate 
bilateral and trilateral cross-margining.
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    \3\ Currently, NYFE participants receive the benefits of cross-
margining through the OCC/ICC/CME cross-margining program.
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Existing Cross Margining Agreement
    The following describes the most important sections of the existing 
agreement among OCC, CME, and ICC that are being modified in order to 
effectuate the cross-margining program among OCC, CME, and CCC.\4\
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    \4\ For a complete description of the cross-margining agreement 
among OCC, CME, and ICC, see Securities Exchange Act Release No. 
32534 (June 28, 1993), 58 FR 36234 (order approving proposed rule 
changes relating to trilateral cross-margining.)
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    Section 2 of the Agreement provides for the designation of either 
OCC or CME as the ``designated clearing organization'' (``DCO'') for a 
joint clearing member or pair of affiliated clearing members. This 
section has been changed to allow the designation of the DCO to be made 
by agreement among OCC, CME, and the clearing members and not by the 
clearing members alone as it was in the OCC/ICC/CME cross-margining 
program. In addition, language designating OCC as DCO in place of CME 
where clearing members have selected CME as DCO has been deleted. This 
issue is covered under a separate proposed letter agreement among the 
clearing organizations which was filed with the Commission by amendment 
to this filing.\5\
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    \5\ Letter from Robert C. Rubenstein, OCC (April 21, 1997).
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    Section 5 of the Agreement includes language that provides that CCC 
has elected to use the margin calculations produced by the DCO's margin 
system for purposes of calculating the base margin requirement and risk 
margin requirement for any set of cross-margin accounts for which CCC 
is a carrying clearing organization. A provision also has been added to 
this section to provide that each clearing organization assumes the 
responsibility of determining that the margin requirements are adequate 
and that no clearing organization shall have liability to any other 
clearing organization based upon an allegation that any margin 
calculation was inadequate.
    Section 6 of the Agreement describes the acceptable forms of margin 
and the procedures by which margin deposits are released to the 
depositing clearing members. This section provides that common stocks 
deposited as initial margin are valued at the lower of the values 
determined under the rules of OCC or CME. This replaces language 
providing for valuation under OCC Rule 604(d) which prescribes 
valuation at seventy percent of current market value or such lesser 
rate as approved by the Commission or the Commodity Futures Trading 
Commission (``CFTC''). This section also provides that valuation of 
Treasury securities deposited as initial margin are valued at the lower 
of the values determined under the rules of OCC or CME. This replaces 
language providing for valuation under the rules of any clearing 
organization.
    In addition, Section 6 of the Agreement contains a new provision 
whereby CCC will be deemed to have given the necessary approval for the 
release of securities to the depositing clearing member unless CCC 
gives timely written objection to the release. These changes are 
intended for the protection of each clearing organization.
    Section 7 of the Agreement provides that CCC will be deemed to have 
given all necessary approvals and will not be required to execute or 
specifically authorize any instruction or direction to transfer with 
respect to CME acting as CCC's agent for the purposes of transfers of 
funds in connection with settlement unless CCC gives timely, written 
notice of CCC's objection to such instruction or direction to transfer.
    Similarly, this section has been changed to require CCC to obtain 
the approval of OCC and CME regarding the funds transfer instructions 
it gives to the applicable cross-margin clearing banks. In addition, a 
clearing member may not withdraw margin excess in excess of the amount 
of margin of that form deposited by the clearing member in the set of 
cross-margin accounts from which the withdrawal is requested.
    Finally, Section 7 of the Agreement provides procedures for 
intraday margin calls by CCC, including procedures for intraday margin 
call notification to clearing members and for withdrawal of variation 
margin in the event of margin excess. These changes also are intended 
to protect each clearing organization and to incorporate CCC's intraday 
margin call procedures into the cross-margining program.
    Section 8 of the Agreement provides that CCC is entitled to retain 
or receive a share of the surplus from a proprietary liquidating 
account that is the greater of its pro rata share of the equivalent 
unhedged risk \6\ or five percent of the surplus. OCC or CME is 
entitled to receive the remaining surplus provided that if both are 
carrying clearing organizations, each is entitled to fifty percent of 
the remaining surplus for application against losses sustained from a 
defaulting clearing member.
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    \6\ For purposes of the Agreement, ``equivalent unhedged risk'' 
is defined as the sum of the initial margin that will be required by 
each carrying clearing organization on contracts in each cross-
margin account by that carrying clearing organization without regard 
to contracts carried in cross-margining accounts at other clearing 
organizations.
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    Section 8 also sets forth the loss sharing procedures to be used in 
the event non-proprietary liquidating accounts are insufficient. If CCC 
is a carrying clearing organization, CCC will bear a share of the 
shortfall equal to the greater of its pro rata share of the daily 
equivalent unhedged risk or five percent of the liquidating deficit. 
OCC and CME, whichever is a carrying clearing organization, shall bear 
the remaining shortfall; however, if both OCC and

[[Page 26604]]

CME are carrying clearing organizations, each will bear fifty percent 
of the remaining shortfall. This is different from the OCC/ICC/CME 
cross-margining agreement which provides that OCC and ICC together are 
to bear fifty percent of losses together and CME was to bear the 
remaining fifty percent. Because CCC is not acting as an equal 
participant in the current cross-margining program, this agreement has 
been drafted to reflect that CCC will not engage in the same level of 
clearing activity as OCC and CME.\7\
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    \7\ Conversation between Robert C. Rubenstein, OCC, and Jeffrey 
S. Mooney, Attorney, Division of Market Supervision, Commission 
(April 18, 1997).
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    Section 11 of the Agreement is new and provides that no clearing 
organization will have any liability to another clearing organization 
as the result of any action taken or not taken in its capacity as a DCO 
unless such action or inaction constitutes willful misconduct.
    Section 13 of the Agreement sets forth who may terminate the 
Agreement and who may withdraw from the agreement. Section 13 allows 
OCC, CME, and CCC to terminate the Agreement without cause by 
delivering notice of termination specifying a termination date not less 
than ninety days following the date on which notice is sent. OCC and 
CME also may jointly agree to remove CCC as a party to the Agreement by 
delivering written notice of termination specifying a termination date 
not less than ninety days following the date on which notice is sent.
    Section 13 also provides that if CCC is the defaulting party or 
gives notice of default under the Agreement, the Agreement is 
terminated with respect to CCC only. This section further provides that 
the Agreement will remain in effect between OCC and CME in the event 
that the termination date is established with respect only to CCC. This 
is intended to facilitate the continuity of the Agreement in the event 
that CCC no longer participates in the cross-margining program.
    With regard to information sharing, Section 15 of the Agreement 
provides that CCC has the same mutual obligation to notify the other 
clearing organizations if it is notified by the Cotton Exchange or NYFE 
of the application of any special surveillance procedures to a clearing 
member. These changes also are intended to protect each clearing 
organization.
    Finally, Section 17 of the Agreement provides that the Agreement is 
to be deemed a ``netting contract'' for purposes of Title IV, Subtitle 
A of the Federal Deposit Insurance Corporation Improvement Act of 1991 
(``FDICIA''). The parties to the Agreement do not intend this amendment 
to override any interpretation of FDICIA. Instead, the parties intend 
this amendment to protect the viability of the Agreement under 
circumstances that may give rise to application of FDICIA.
Clearing Member Agreements
    Various forms of agreements are required to be executed by 
participating clearing members and market professionals participating 
in the cross-margining programs established by the cross-margining 
agreement.\8\ Specifically, these agreements are the: (1) Proprietary 
cross-margin account agreements and security agreement for a joint 
clearing member; (2) proprietary cross-margin account agreement and 
security agreement for affiliated clearing members; (3) non-proprietary 
cross-margin account agreement and security agreement for a joint 
clearing member; (4) non-proprietary cross-margin account agreement and 
security agreement for affiliated clearing members; (5) subordination 
agreement for cross-margining for a joint clearing member; and (6) 
subordination agreement for cross-margining for affiliated clearing 
members.
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    \8\ A copy of each agreement has been submitted with the 
proposed rule change and is available for inspection and copying in 
the Commission's Public Reference Room or at the principal office of 
OCC.
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    Each agreement is based on the comparable existing agreement used 
in the current OCC/CME/ICC cross-margining program, and each is 
modified as necessary to accommodate cross-margining with CME and CCC 
as participating carrying clearing organizations.
    Each agreement also provides that the agreement will become 
effective upon execution or upon receipt of all necessary regulatory 
approvals from the Commission and the CFTC. The purpose of this 
provision is to allow clearing members to have the agreements executed 
and in place on the date of regulatory approval to avoid any delays 
that may occur from obtaining signatures after regulatory approval.
    OCC believes that the proposed rule change is consistent with the 
purposes and requirements of Section 17A(b)(3)(F) of the Act because 
cross-margining enhances the safety of the clearing system while 
providing lower clearing margin costs to participants.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    OCC does not believe that the proposed rule change will impose any 
burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received from Members, Participants or Others

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change, and none were received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Section 17A(b)(3)(F) \9\ of the Act requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency or 
for which it is responsible. Section 17A(a)(2)(A)(ii) \10\ of the Act 
directs the Commission to use its authority under the Act to facilitate 
the establishment of transactions in securities, securities options, 
contracts of sale for future delivery and options thereon, and 
commodity options. The Commission believes that the proposed rule 
change is consistent with these requirements under the Act.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F).
    \10\ 15 U.S.C. 78q-1(a)(2)(A)(ii). Congress added this section 
to the Act as part of the Market Reform Act of 1990. Pub. L. No. 
101-432, 104 Stat. 963 (1990).
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    Similar to other cross-margining arrangements to which OCC is a 
party, the current proposal links and coordinates the clearance and 
settlement facilities of OCC, CME, and CCC with respect to shared 
management of risks associated with the clearing members' intermarket 
portfolios and with respect to information sharing regarding the 
financial condition of participating joint and affiliated members. The 
Commission views cross-margining arrangements as a significant risk 
reduction method because they provide a means whereby individual 
clearing organizations do not have to independently manage the risk 
associated with some components (i.e., the futures or options 
component) of a clearing member's total portfolio. Therefore, cross-
margining programs serve to help OCC assure the safeguarding of 
securities and funds and to facilitate the establishment of linked or 
coordinated facilities for the clearance and settlement of futures and 
options, transactions in securities.\11\
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    \11\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
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    In addition, since it granted approval of the first cross-margining 
program in 1988,\12\ the Commission repeatedly has found that cross-
margining programs are

[[Page 26605]]

consistent with clearing agency responsibilities under Section 17A of 
the Act. Cross-margining programs, among other things, enhance clearing 
member liquidity and systemic liquidity both in times of normal trading 
and in times of market stress. Under routine trading, clearing members 
who participate in a cross-margining program have lower initial margin 
deposits. Reduced margin requirements help clearing members manage 
their cash flow by increasing available cash to be used for other 
purposes. In times of market stress and high volatility, lower initial 
margin requirements could prove crucial in maintaining the liquidity of 
clearing members and therefore would enhance liquidity in the market as 
a whole. By enhancing market liquidity, cross-margining arrangements 
remove impediments to and help perfect the mechanism of a national 
system for the prompt and accurate clearance and settlement of 
securities transactions.\13\
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    \12\ Securities Exchange Act Release No. 26153 (October 3, 
1998), 53 FR 39567 (order approving non-proprietary cross-margining 
program between OCC and ICC).
    \13\ Shortly after the 1987 market break, then Treasury 
Secretary Nicholas F. Brady referred to the clearance and settlement 
system as the weakest link in the nation's financial system and 
noted that improvements to the clearance and settlement system, such 
as those provided by cross-margining arrangements, would ``help 
ensure that a securities market failure does not become a credit 
market failure.'' The Market Reform Act of 1989: Joint Hearings on 
S. 648 before Subcom. on Securities and the Senate Comm. on Banking, 
Housing and Urban Affairs, 101 st Cong., 1st Sess. 225 (Oct. 26, 
1989) (statement of Nicholas F. Brady, Secretary of the Treasury).
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    The cross-margining program in the present proposed rule change is 
based on the OCC/ICC/CME model and retains virtually all of the 
important safety provisions of the OCC/ICC/CME cross-margining program, 
the Commission believes the cross-margining programs proposed here is 
consistent with clearing agencies' statutory requirements to assure the 
safeguarding of funds and securities which are in their custody or 
control or for which they are responsible.
    OCC has requested that the Commission find good cause for approving 
the proposed rule change prior to the thirtieth day after publication 
of the notice of filing. The Commission finds good cause for approving 
the proposed rule change prior to the thirtieth day after publication 
of the notice of the filing because accelerated approval will allow 
OCC, CME, and CCC to establish the cross-margining program and will 
allow the continuity of clearance and settlement services for NYFE 
products after CCC assumes the clearance and settlement of NYSE 
products. In addition, the Commission does not expect to receive any 
adverse comments on the present rule change.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submission 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submissions, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. Sec. 552, will be available for inspection and copying in 
the Commission's Pubic Reference Room, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filings will also be available 
for inspection and copying at the principal office of OCC. All 
submissions should refer to the file number SR-OCC-97-04 and should be 
submitted by June 4, 1997.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-97-04) be and hereby is 
approved on an accelerated basis.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-12638 Filed 5-13-97; 8:45 am]
BILLING CODE 8010-01-M