[Federal Register Volume 67, Number 203 (Monday, October 21, 2002)]
[Notices]
[Pages 64689-64692]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26682]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46653; File No. SR-OCC-2002-07]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to Clearing 
Security Futures Transactions and Arrangements With Associated 
Clearinghouses

October 11, 2002.

I. Introduction

    On May 9, 2002, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change File No. SR-OCC-2002-07 pursuant to section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and on 
August 9, 2002, amended the proposed rule change. Notice of the 
proposal was published in the Federal Register on August 16,

[[Page 64690]]

2002.\2\ On October 10, 2002, OCC again amended the proposed rule 
change. The October 10, 2002, amendment was for clarification and as 
such did not require publication of notice. No comment letters were 
received. For the reasons discussed below, the Commission is approving 
the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 46335 (August 9, 2002), 
67 FR 53634.
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II. Description

    Currently, under OCC's Rule 1303, OCC may open one or more omnibus 
accounts with an associate clearinghouse (``ACH'') \3\ for the purposes 
of enabling the ACH's clearing members that are not OCC clearing 
members to clear transactions in futures and futures options through 
the ACH rather than directly through OCC.\4\ Affiliates of OCC clearing 
members are permitted to clear transactions in futures through the ACH 
through January 1, 2003. The principal purpose of the proposed rule 
change is to extend this same accommodation to OCC clearing members and 
to provide that the initial period during which either OCC clearing 
members or their affiliates may clear through an ACH will end one year 
from the date when general trading in security futures commences rather 
than on a specified date. The proposed rule change also seeks 
Commission approval of the Agreement for Clearing and Settlement 
Services between OCC and OneChicago (``OCX'') (``OCX Clearing 
Agreement'') and the ACH Agreement between OCC and the Chicago 
Mercantile Exchange (``CME'').
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    \3\ ``Associate Clearinghouse'' is defined in Section 1 of OCC's 
By-Laws as ``a derivatives clearing organization regulated as such 
under the Commodity Exchange Act or a clearinghouse not located in 
the United States, which, in either case, has agreed with the 
Corporation to act in clearing transactions in certain cleared 
securities on behalf of its members. An associate clearinghouse 
shall be a Clearing Member for purposes of the By-Laws and Rules 
except to the extent otherwise provided in an agreement between the 
Corporation and the associate clearinghouse.''
    \4\ When filed, Chapter XIII of OCC's Rules governed security 
futures. Subsequently, OCC filed and the Commission approved SR-OCC-
2001-16, which amended Chapter XIII so that it now governs futures 
and futures options, which includes security futures. Securities 
Exchange Act Release No. 45946 (May 16, 2002), 67 FR 36056 (May 22, 
2002).
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1. Background

    OCC is preparing to clear security futures for a number of markets, 
including certain national securities exchanges that presently clear 
options through OCC and certain futures exchanges that are notice-
registered as national securities exchanges under section 6(g) of the 
Act. In SR-OCC-2001-07, OCC filed detailed rules for the clearance of 
security futures, including Rule 1303, which provides that OCC may 
agree with an ACH to carry omnibus accounts for the ACH in which the 
ACH may clear security futures transactions for certain of its clearing 
members.\5\ In SR-OCC-2001-07, the Commission also approved the 
Agreement for Clearing and Settlement Services between OCC and Nasdaq 
Liffe Markets, LLC \6\ (``NqLX Clearing Agreement'').
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    \5\ Securities Exchange Act Release No. 44727 (August 20, 2001), 
66 FR 45351 (order approving rules for clearance of security 
futures.) SR-OCC-2001-07 also amended Article I of OCC's By-Laws to 
include within the definition of ``associate clearinghouse'' a 
``derivatives clearing organization regulated as such under the 
Commodity Exchange Act.''
    \6\ Previously Nasdaq LIFFE, LLC.
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2. Amendments to Rule 1303

    Under current Rule 1303(a), an OCC clearing member that is also an 
ACH clearing member may not have its futures transactions cleared 
through the ACH's omnibus account at OCC. Additionally, Rule 1303(b) 
currently provides that affiliates of OCC clearing members that are 
eligible to become OCC clearing members may not have their futures 
transactions cleared through an ACH's omnibus account at OCC past 
January 1, 2003.\7\
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    \7\ For purposes of Rule 1303, an entity is deemed to be an 
affiliated entity of a clearing member if the clearing member owns, 
directly or indirectly, at least 50% of the equity in such entity or 
if at least 50% of the equity of the clearing member and in such 
entity is, directly or indirectly, under common ownership. OCC rule 
1303(b).
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    OCC has learned that some OCC clearing members may initially have 
difficulty clearing futures, including security futures, through OCC 
because the systems these clearing members use to clear futures 
contracts are configured to interface with the clearing systems of 
commodity clearing organizations and not with OCC's systems. To 
accommodate these clearing members while they make the necessary system 
changes, OCC is amending Rule 1303(a) to allow OCC clearing members 
that are members of an ACH to clear their futures transactions through 
the ACH's omnibus account at OCC for a period of time.
    As with affiliates of OCC clearing members, an OCC clearing 
member's futures transactions can be cleared through an ACH's omnibus 
account at OCC only for the period specified in Rule 1303(b). That 
period was initially set to end on June 1, 2002, and was later extended 
to January 1, 2003.\8\ Because the commencement of trading in security 
futures has repeatedly been postponed, OCC is now setting the grace 
period at ``one year after the commencement of general trading in 
security futures.'' OCC believes that this is a reasonable period of 
time for OCC clearing members and their affiliates to make the 
necessary arrangements to clear futures directly through OCC. OCC 
nevertheless retains the ability under Rule 1303(b) to consent to a 
longer grace period if the circumstances of individual firms so 
require.
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    \8\ Securities Exchange Act Release No. 45946 (May 22, 2002), 67 
FR 36056 [File No. SR-OCC-2001-16].
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3. OCX Clearing Agreement

    OCX is a joint venture among CME, the Chicago Board Options 
Exchange, and the Chicago Board of Trade. OCX and OCC have entered into 
the OCX Clearing Agreement so that OCC may clear and settle security 
futures transactions that take place on OCX.\9\ OCC seeks Commission 
approval of the OCX Clearing Agreement because, as discussed below, it 
varies in several material respects from the NqLX Clearing Agreement 
approved by the Commission.\10\
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    \9\ The OCX Clearing Agreement is attached as Exhibit A to OCC's 
filing.
    \10\ A blackline version showing the differences between the 
NqLX Clearing Agreement and the OCX Clearing Agreement is attached 
as Exhibit A-1 to OCC's filing. OCC has filed with the Commission an 
amended and restated version of the NqLX Clearing Agreement, which 
has been amended to provide that OCC will clear and settle commodity 
futures (specifically, broad-based index options) traded on NqLX.
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    New Section 6(b), ``Clearing Members and Associate 
Clearinghouses,'' of the OCX Clearing Agreement requires OCC to 
designate CME as an ACH for OCX, subject to the terms of the ACH 
Agreement between OCC and CME (which terms are summarized below). The 
NqLX Clearing Agreement contains no similar provision. Section 6(b) of 
the OCX Clearing Agreement also provides that all present OCC clearing 
members and their successors may clear trades executed on OCX. However, 
future OCC clearing members will not be allowed to clear OCX trades 
without prior approval from OCX. OCX may require that future OCC 
clearing members become members of OCX as a condition to being allowed 
to clear trades executed on OCX. The NqLX Clearing Agreement contains 
no similar provision.
    Section 10(b), ``Risk Margin Offsets,'' of the OCX Clearing 
Agreement states that OCC will not make OCX products fungible with 
products traded on other markets, exchanges, or electronic trading 
platforms unless OCC is required to do so by law or has received prior 
written approval from OCX. The NqLX Clearing Agreement contains no 
similar provision.

[[Page 64691]]

    Section 13, ``Financial Arrangements,'' of the OCX Clearing 
Agreement states that OCC will charge clearing fees for trades executed 
on OCX to OCX rather than to clearing members. However, OCX will be 
required to pass OCC's fees through to OCC clearing member(s) on sides 
of OCX trades that are cleared directly through OCC.\11\ OCX negotiated 
a discount to the fees OCC normally charges for clearing services in 
exchange for giving up the right to participate in any year-end fee 
reductions or rebates. OCX may, however, opt into OCC's regular rebate-
eligible fee structure on a prospective basis at any time. The discount 
is greater for trade sides cleared through CME as an ACH reflecting the 
fact that CME is sharing the clearing function and the associated risk. 
OCC will charge no clearing fees when both sides are cleared through 
CME.
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    \11\ This requirement enables OCC to police ``the equitable 
allocation of reasonable dues, fees, and other charges among its 
participants' required under section 17A(b)(3)(D) of the Act.
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    Paragraph (b) of Section 14, ``CME as Associate Clearinghouse,'' of 
the OCX Clearing Agreement prohibits OCX from soliciting or providing 
incentives for CME members to clear OCX trades through CME rather than 
OCC. The reason for this restriction is discussed below in connection 
with related provisions of the ACH Agreement.

4. ACH Agreement

    OCC and CME have entered into the ACH Agreement \12\ so that CME 
may act as an ACH for purposes of clearing and settling transactions of 
certain CME clearing members executed on OCX. The ACH Agreement 
provides that CME generally will be treated as an OCC clearing member 
but with important exceptions. First, Section 2, ``CME an Associate 
Clearinghouse,'' states that CME may clear through its accounts at OCC 
only security futures traded on OCX. Second, Section 3, ``Applicability 
of the Rules,'' makes clear that CME is bound only by certain OCC 
rules, which generally speaking are those that apply to OCC's clearance 
and settlement of security futures contracts and to OCC's right to 
suspend clearing members including an ACH with certain modifications 
set forth in the ACH Agreement. CME is not subject to OCC's by-laws and 
rules requiring deposits to OCC's clearing fund and requiring risk 
margin deposits. Likewise, under Section 6, ``Risk Margin; Clearing 
Fund Contributions; Security Deposits,'' OCC is not required to 
contribute to CME's clearing fund or to post margin with CME.
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    \12\ Attached as Exhibit B to OCC's filing.
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    Given that each clearing organization has credit exposure to the 
other, OCC and CME have determined that the cost of mutual posting 
collateral by each with the other would outweigh any benefits to be 
obtained. Although OCC is exposed to some uncollateralized credit risk 
with respect to CME (and vice versa), that risk is considered minimal 
because CME's clearinghouse division is a registered derivatives 
clearing organization subject to regulation and oversight by the 
Commodity Futures Trading Commission (``CFTC'') and is believed by OCC 
to be well run and highly creditworthy. Sections 3(c), ``Applicability 
of the Rules,'' and 10, ``Application of Chapter XI of the Rules,'' of 
the ACH Agreement provide that if CME fails to deliver securities or 
funds to OCC, breaches certain of its obligations under the Commodity 
Exchange Act (``CEA'') or the ACH Agreement, or is in such financial or 
operational difficulty that OCC believes suspension of CME as an ACH is 
required, OCC may without notice liquidate all positions in the CME ACH 
omnibus accounts regardless of whether any CME clearing member is in 
default to CME. OCC may then apply the proceeds from the CME 
Proprietary Account (described below) against all obligations of CME 
under the ACH Agreement and the proceeds from the CME Customer Account 
(described below) against all obligations in that account.
    Where both sides of a matched trade are submitted to OCC for the 
accounts of regular OCC clearing members, CME will have no role in the 
transaction. Where one side of a matched trade is submitted for the 
account of a regular OCC clearing member and the other is submitted for 
the account of a CME clearing member, the CME member's transaction will 
clear in the ACH account and CME as ACH will be the OCC clearing member 
on the trade. If both sides of a matched trade are cleared through CME, 
there will be no effect on the open interest on OCC's books, and OCC 
will have no obligation on the trade except to the limited extent 
described below in the case of delivery obligations on physically-
settled stock futures. The rights and obligations of CME members with 
respect to security futures cleared through CME will be determined 
under the rules of CME, but Section 4(a) of the ACH Agreement requires 
that CME's rules provide that the terms of security futures cleared by 
CME will be identical to the terms of security futures cleared by OCC 
and that any adjustments to the terms of outstanding contracts must be 
identical and take effect at the same time to ensure fungibility and 
maintain a balanced open interest at both clearing organizations.
    Section 8, ``Allocation of Clearing Responsibilities,'' of the ACH 
Agreement is consistent with the terms of OCC Rule 1303 as amended in 
this filing. It is intended to permit the use of the ACH arrangements 
by CME members only to the extent that clearing through OCC directly 
might reasonably impose a hardship. An OCC clearing member that is or 
that has an affiliate that is a CME clearing member may clear through 
CME until one year after the commencement of security futures trading, 
at which point all trades of such entity must be cleared through OCC 
unless OCC consents to an extension of time. However, where a futures 
affiliate of an OCC clearing member is substantially larger than the 
clearing member, OCC has agreed to permit the affiliate to clear 
through CME indefinitely on the ground that where the principal 
business of the consolidated entities is a futures business it is 
inappropriate to compel all security futures clearing to be directed 
through the securities affiliate.\13\ A CME clearing member that is not 
an OCC clearing member and is not an affiliate of an OCC clearing 
member may clear its security futures trades through CME indefinitely. 
By generally requiring firms that are OCC clearing members or that have 
affiliates that are OCC clearing members to take the necessary steps to 
clear their security futures activity directly through the OCC clearing 
member, the ACH Agreement limits the mutual uncollateralized exposure 
between OCC and CME and minimizes the number of transactions that 
require coordinated clearance and settlement by two clearing 
organizations.\14\ For the same purpose of minimizing unnecessary use 
of the ACH arrangement, the OCX Clearing Agreement as noted above 
prohibits the ACH from soliciting its members to clear transactions 
through the ACH rather than through OCC.
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    \13\ Interpretations and Policies .01 to Rule 1303.
    \14\ In approving OCC's previous ACH arrangement with the 
Associate Clearing House Amsterdam, the Commission stated, ``As a 
general matter, the Commission believes that OCC-issued options 
should be cleared through full OCC clearing members and not through 
intermediaries created only for clearing purposes.'' Securities 
Exchange Act Release No. 24832 (August 21, 1987), 52 FR 32377, n.16 
[File No. SR-OCC-87-9].
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    In order to comply with the customer segregation rules under the 
CEA, Section 9(a), ``Maintenance of CME

[[Page 64692]]

Accounts,'' of the ACH Agreement requires CME to have two accounts at 
OCC, one for proprietary positions and one for customer positions. Each 
will function as an omnibus account containing the positions and margin 
carried by CME members for whom CME acts as an ACH. The ``CME 
Proprietary Account'' will carry only transactions of persons whose 
accounts on the books of the carrying CME clearing member are 
``proprietary accounts'' as defined in CFTC Regulation 1.3(y). The 
``CME Customer Account'' will carry only transactions of customers of 
CME clearing members and will be subject to the customer protection 
provisions of the CFTC. In accordance with those provisions, Section 
9(b) of the ACH Agreement provides that OCC will have a lien on the 
positions in the CME Customer Account as security for CME's obligations 
to OCC only with respect to positions and transactions in that account. 
In contrast, OCC will have a lien on and security interest in the 
positions in the CME Proprietary Account as security for all 
obligations of CME to OCC under the ACH Agreement.
    As noted above, OCC has agreed in Section 4 of the ACH Agreement to 
perform a limited role in connection with delivery obligations of CME 
clearing members arising from physically-settled security futures in 
CME member accounts. CME will require each of its clearing members that 
trades physically-settled security futures to enter into arrangements 
satisfactory to OCC through which an OCC stock clearing member will 
agree to act on the CME clearing member's behalf for the purpose of 
settling through the facilities of National Securities Clearing 
Corporation (``NSCC'') or otherwise delivery obligations arising from 
maturing security futures contracts in its accounts at CME. Promptly 
following the close of trading on the last trading day prior to 
maturity of any series of physically-settled security futures, CME will 
notify OCC of the identity of each OCC clearing member that will be 
obligated to receive or to deliver stock on behalf of CME members and 
the quantity of each underlying stock to be received or delivered. OCC 
will include these receive and deliver obligations with the other 
receive and deliver obligations of its clearing members in its reports 
to NSCC in accordance with OCC Rule 913. In the event that settlement 
is rejected by NSCC for any reason, settlement will be completed 
between the delivering and receiving OCC clearing members in accordance 
with OCC's rules, but CME will be responsible to OCC for any loss 
reasonably determined by OCC to have been incurred by it as a result of 
an OCC clearing member default in connection with settlements arising 
from security futures contracts in CME clearing member accounts. OCC 
will not require the delivering OCC clearing member or receiving OCC 
clearing member to deposit margin with OCC with respect to settlements 
attributable to security futures in CME clearing member accounts but 
will instead look to the credit of CME.

III. Discussion

    Section 19(b)(2) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. For the reasons set forth below, the Commission believes 
that OCC's proposed rule change is consistent with OCC's obligations 
under Section 17A(b)(3)(F) which requires that the rules of a clearing 
agency be designed to promote the prompt and accurate clearance and 
settlement of securities transactions.\15\
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    \15\ 15 U.S.C. 78q-1(b)(3)(F).
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    By providing a transition period for those OCC members that are 
also ACH members to adopt their systems to clear securities futures 
through OCC and by adopting the OCX Agreement and the ACH Agreement, 
OCC is further establishing itself as a facility capable of providing 
for the prompt and accurate clearance and settlement of security 
futures transactions. Accordingly, the Commission finds that the 
proposed rule change is consistent with OCC's obligations under section 
17A of the Act.

IV. 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 with the requirements of section 17A of the Act and the 
rules and regulations thereunder applicable.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2002-07) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-26682 Filed 10-18-02; 8:45 am]
BILLING CODE 8010-01-P