[Federal Register Volume 66, Number 14 (Monday, January 22, 2001)]
[Notices]
[Pages 6726-6727]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-1653]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43837; File No. SR-OCC-00-12]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Accelerated Approval of a Proposed Rule Change Relating 
to the Creation of a Program to Relieve Strains on Clearing Members' 
Liquidity in Connection With Exercise Settlements

January 12, 2001.
    On November 27, 2000, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') and 
on January 8, 2001 amended, a proposed rule change (File No. SR-OCC-00-
12) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ Notice of the proposal was published in the Federal 
Register on December 28, 2000.\2\ No comment letters were received. For 
the reasons discussed below, the Commission is granting accelerated 
approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 43755, (December 20, 
2000), 65 FR 82431.
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Description

1. Background

    Under the Third Amended and Restated Options Exercise Settlement 
Agreement (the ``Accord'') dated February 16, 1995, between OCC and the 
National Securities Clearing Corporation (``NSCC''), OCC and NSCC each 
guarantee that if the other sustains a loss on liquidation of a common 
member \3\ with pending settlement activity at NSCC resulting from 
option exercises and assignments, it will make a payment to the other 
in an amount (which may be zero) determined by a formula set forth in 
the Accord.\4\
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    \3\ The Accord also covers situations where an OCC clearing 
member that is not an NSCC member settles option exercises and 
assignments through an NSCC member.
    \4\ For a description of the Accord's formula, refer to 
Securities Exchange Act Release No. 37731 (September 26, 1996), 61 
FR 51731.
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    Under the Accord, NSCC has until 6:00 a.m. Central Time on the day 
after an option exercise settlement date (E+4) to notify OCC that it 
has ceased to act or may cease to act for a common member. If NSCC 
fails to give such notice by that time, OCC is released from its 
guarantee obligation with respect to transactions for which E+3 was the 
settlement date. Because OCC is not released from its guarantee 
obligation until the morning of E+4, it must continue to hold margin on 
assignments settling on E+3 until E+4. This means that assets that a 
clearing member has deposited with OCC as margin for pending 
assignments cannot be used to settle or to finance settlement of those 
assignments. Instead, the clearing member must find other sources of 
financing, which can strain some clearing members' liquidity in months 
with heavy exercise and assignment activity.

2. The Rule Change

    In an effort to reduce the strains on liquidity resulting from the 
after-the-fact release of margin on pending assignments, OCC, in 
conjunction with NSCC and The Depository Trust Company (``DTC''), has 
worked out a program to allow OCC clearing members to withdraw equity 
securities \5\ deposited with OCC as margin and to pledge them to DTC 
participant lenders as collateral for loans. The proceeds of such loans 
will be disbursed by the lender directly to OCC and used to discharge 
settlement obligations of the clearing member at NSCC that were 
guaranteed by OCC. OCC's liability exposure to NSCC under the Accord 
will be correspondingly reduced as will OCC's need to continue to hold 
margin until E+4.
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    \5\ OCC plans to allow the use of Government securities as well 
once the necessary systems are developed. At December 31, 1999, 
OCC's margin deposits included over $36 billion in equities compared 
to $9 billion in Governments.
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    The program will work as follows:
     On the morning of E+3, a clearing member will learn from 
OCC the amount of the loan that it may collateralize with securities 
held by OCC as margin. That amount will be no less than the value 
assigned by OCC to such securities for margin purposes \6\ and will be 
no more than the lesser of (i) the margin requirement for the account 
from which the securities were to be withdrawn \7\ and (ii) the amount 
of OCC's guarantee exposure to NSCC (assuming that the clearing 
member's NSCC positions liquidated to a deficit).\8\
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    \6\ For example, if the clearing member had equity securities 
with a market value of $10 million on deposit in an account with OCC 
as margin (which OCC would value at $7 million for margin purposes), 
the amount of the loan collateralized by those securities would have 
to be not less than $7 million. If the loan amount were, for 
example, $6 million OCC would be exchanging $7 million worth of 
margin for a reduction of only $6 million in its guarantee exposure 
to NSCC.
    \7\ If, in the preceding example, the margin requirement in the 
relevant account were only $6 million, the loan would be limited to 
that amount, and OCC would only release equity securities with a 
market value of $8.57 million ($6 million in margin value). The 
remaining $1.43 million of securities would be excess margin, which 
the clearing member would be free to withdraw and pledge separately.
    \8\ If, in the preceding examples, OCC's guarantee exposure to 
NSCC were only $5 million, the loan would be limited to that amount, 
and OCC would only release equity securities with a value of $7.15 
million ($5 million in margin value). If the loan amount were in 
excess of $5 million, OCC would be releasing margin worth more than 
$5 million for a reduction of only $5 million in its guarantee 
exposure.
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     The clearing member will then contact its lender and 
arrange for the loan. When the terms of the loan are agreed upon, the 
clearing member will use a new Participant Terminal System screen 
developed by DTC to confirm both to the lender and to OCC the amount of 
the loan and the quantity and description of the securities to be 
withdrawn from OCC and pledged to the lender as collateral. The lender 
and OCC will use that information to validate the loan request.
     When both the lender and OCC approve the loan, DTC will 
transfer the securities from a ``pledged to OCC'' field in the clearing 
member's DTC account to a special OCC account at DTC. From that 
account, the securities will be pledged to the lender against receipt 
of the loan proceeds. The proceeds will thus be paid directly to OCC 
without passing through the hands of the clearing member.
     Upon receipt in the special OCC account, the loan proceeds 
will automatically be paid over to NSCC for the benefit of the clearing 
member resulting in a corresponding reduction in OCC's guarantee 
exposure to NSCC under the Accord.
     At the end of the day, DTC will automatically transfer the 
securities from a ``pledged to lender'' field in the special OCC 
account to a ``pledged to

[[Page 6727]]

lender'' field in the clearing member's DTC account, leaving the 
clearing member in the same position as if it had been able to pledge 
the securities to the lender without OCC's intermediation.
    Upon allowing securities to be withdrawn and pledged under the 
program, OCC will reduce its margin requirement in the account from 
which the secruties were withdrawn by an amount equal to the value 
assigned to the securities for margin purposes. The account will, 
however, be required to be fully margined the next morning.
    Initially, clearing members will be permitted to withdraw and 
pledge securities held by OCC as margin only on settlement dates for 
exercises of expiring equity options. OCC may at a future date decide 
to make the program available on other exercise settlement dates as 
well.

3. Timing

    Historically, the heaviest volume of option expirations and hence 
exercises occurs in January. In January 2000, 26,099,346 option 
contracts expired, accounting for 41.9% of total open interest. Open 
interest as of November 21, 2000, included 26,378,070 contracts 
expiring in January 2001 (43.2% of total open interest). OCC believes 
that it is important to have the new program in place in time for the 
January 2001 expiration to help relieve potential strains on liquidity 
resulting from the large volume of exercise activity expected to occur 
at that time.

II. Discussion

    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. For the reasons set forth below, the 
Commission believes that OCC's proposed rule change is consistent with 
OCC's obligations under the Act.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F).
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    The central purpose of the rule change is to allow a clearing 
member to use assets that it has deposited with OCC as margin for 
pending assignments to settle and to finance settlement of those 
assignments. The rule change should relieve clearing members from the 
responsibility of finding other sources of financing that could strain 
some clearing members' liquidity in months with heavy exercise and 
assignment activity. The Commission believes that OCC's program by 
which clearing members will withdraw and pledge securities that are 
deposited with OCC as margin and by which OCC in return will receive 
loans from DTC participant lenders is a safe and acceptable method by 
which clearing members' will finance their settlement obligations at 
NSCC. Accordingly, the Commission finds that OCC's program satisfies 
OCC's obligations to assure the safeguarding of securities and funds 
which are in the custody or control of OCC or for which it is 
responsible.
    OCC has requested that the Commission find good cause for approving 
the proposed rule change prior to the thirty day after publication of 
the notice of filing. The Commission finds good cause for approving the 
proposed rule change prior to the thirty day after publication of the 
notice of filing because accelerated approval will permit OCC to 
implement its program before the January 2001 expiration.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular Section 17A of the Act and the rules and regulations 
thereunder.
    It Is Therefore Ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-00-12) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 01-1653 Filed 1-19-01; 8:45 am]
BILLING CODE 8010-01-M