[Federal Register Volume 69, Number 50 (Monday, March 15, 2004)]
[Notices]
[Pages 12190-12192]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5786]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49378; File No. SR-OCC-2003-11]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating To Clearing Member 
Trade Assignment Processing

March 9, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 
1934,\1\ notice is hereby given that on October 14, 2003, The Options 
Clearing Corporation (``OCC'') filed with the Securities and Exchange 
Commission (``Commission'') and on February 18, 2004, amended the 
proposed rule change, as described in Items I, II and III below, which 
Items have been prepared primarily by OCC. The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested persons.
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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 would amend OCC's by-laws and rules to 
update the clearing member trade assignment (``CMTA'') procedures, 
increase OCC's initial and minimum net capital requirements, and 
increase OCC's minimum clearing fund requirement.

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 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 this rule change is to amend OCC's by-laws and rules 
to update the description of the CTMA procedures, increase OCC's 
initial and minimum net capital requirements, and increase OCC's 
minimum clearing fund requirement for execution-only clearing members.
1. Background
    CMTA processing permits one clearing member (``carrying clearing 
member'') to authorize another clearing member (``executing clearing 
member'') to direct that exchange transactions be transferred to an 
account of the carrying clearing member for clearance and 
settlement.\3\ The executing clearing member executes the transaction 
itself or guarantees the broker that executed the transaction and 
directs the transaction to be cleared into an account of the carrying 
clearing member via the options exchanges' systems for reporting 
matching trade information to OCC. A carrying clearing member does not 
have the ability to approve or reject such a direction before the 
transaction is entered into the exchanges' systems for reporting to 
OCC.
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    \3\ The CMTA facility was developed to permit carrying clearing 
members to clear and settle transactions effected on an exchange 
where they are either not a member or do not maintain a presence for 
trade execution.
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    The matching trade information submitted by an exchange for a 
transaction that has been executed pursuant to a CMTA arrangement will 
identify both the carrying and executing clearing members by their 
assigned clearing numbers. OCC permits an executing clearing member to 
transfer transactions effected only on the exchange(s) designated by 
the carrying clearing member in a CMTA authorization filed with OCC. 
Accordingly, before a transaction is transferred to an account of the 
carrying clearing member for clearance, OCC's system confirms that (i) 
there is a valid CMTA arrangement between the carrying and executing 
clearing member and (ii) the exchange transaction was effected on a 
designated exchange. The carrying clearing member is then responsible 
for settling the trade and maintaining the resulting position. If their 
arrangement permits, a carrying clearing member may transfer the 
position back to the executing clearing member through OCC's systems to 
correct the execution member's good-faith error in identifying the 
carrying clearing member in the submitted trade information.\4\
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    \4\ This commonly occurs if the executing clearing member has 
transposed digits of a carrying clearing member's clearing number 
causing the transaction to clear in an account of a wrong clearing 
member (assuming a valid CMTA arrangement exists between the 
executing and misidentified carrying clearing member).
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    OCC's CMTA facility supports two distinct types of business. First, 
clearing members that execute transactions for correspondent brokers 
use the process to transfer transactions to the correspondent brokers' 
clearing firms. Second, firms that execute trades for institutional and 
other customers with prime brokerage arrangements use the process to 
transfer the trades to the prime broker clearing member.
2. Discussion
(a) CMTA Rule Changes
    Article VI, Sections 1 and 2, of OCC's by-laws and the term 
``authorized Exchange member'' as defined in Article I, Section 1, of 
OCC's by-laws provide the current framework for OCC's CMTA facility. In 
response to clearing member requests, OCC has been working with the 
options exchanges and a group of clearing members that act as prime 
brokers to update the description of the CMTA facility in OCC's rules. 
In particular, the group's efforts focused on more closely defining the 
rights and obligations of the clearing members that are parties to a 
CMTA arrangement in order to remove their regulatory and legal 
uncertainties. Proposed Rule 403 is the result of that collaborative 
effort, and it would operate as follows.
    Proposed Rule 403 will require clearing members that are parties to 
a CMTA arrangement to register and provide certain details of their 
arrangement with OCC. Such registration will be effective when the 
clearing members provide matching information regarding their 
arrangement.

[[Page 12191]]

    Rule 403 would also establish certain checks to be performed by 
OCC's system to verify that a valid CMTA registration exists. 
Transactions that fail these checks will be transferred to a designated 
account or, if such designation has not been made, to the customers' 
account or segregated futures account of the executing clearing member, 
as applicable. A carrying clearing member is responsible for each 
transaction transferred to its account pursuant to a CMTA arrangement, 
subject to its right to return the resulting position for certain 
specified reasons (as explained below). Notwithstanding that right, the 
carrying clearing member is responsible to effect premium or margin 
settlement, as applicable, on the business day after the trade was 
executed for any positions carried in its accounts after nightly 
processing.\5\
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    \5\ Certain exchanges submit matching trade information on a 
real time or intermittent basis during a trading day. OCC 
immediately processes such submissions and makes updated position 
information available for clearing member review throughout the day. 
For transactions effected on such exchanges, clearing members may be 
able to effect a return before OCC closes its window for the 
submission of returns, in which case the executing clearing member 
would be responsible for any premium or margin settlement.
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    A position transferred pursuant to a CMTA arrangement may be 
returned to the executing clearing member upon notice for reasons to be 
specified in a standard agreement.\6\ The reasons that are being 
considered include: (i) The matching trade information did not conform 
to the trade information supplied to the carrying clearing member by 
the customer on whose behalf the trade was executed (e.g., transaction 
was for a put option in a particular series rather than a call option); 
(ii) the carrying clearing member's reasonable belief that the trade 
involved a violation of applicable law, rule, or regulation (e.g., 
failure to deliver a prospectus); (iii) the carrying clearing member no 
longer carries the account of the customer on whose behalf the trade 
was executed or has restricted the customer's ability to use the CMTA 
process; or (iv) the carrying clearing member was misidentified in the 
matching trade information. Returns must be effected in accordance with 
specified procedures by a prescribed cutoff time before trading 
commences on the business day after trade date. OCC will transmit 
certain information regarding the reasons given for a return, but will 
not validate the stated reasons. A position that has been assigned, 
exercised, or matured may not be transferred or returned under Rule 403 
and will be dealt with in accordance with the provisions of the CMTA 
agreement between the clearing members.
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    \6\ The clearing members have formed an ad hoc committee under 
the auspices of the Securities Industry Association to collaborate 
on a standard form agreement. That agreement is currently in draft 
form.
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    A carrying clearing member may not effect a return after the 
prescribed cutoff time. Initiating a return after the applicable cutoff 
time might subject the carrying clearing member to disciplinary action. 
In the case of a position returned to an executing clearing member due 
to a misidentification of the carrying clearing member, the executing 
clearing member may retransfer the position to the correct carrying 
clearing member in order to correct the error.\7\
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    \7\ There is no approval process associated with position 
transfers between clearing members to correct clearing errors. OCC 
determined not to include an approval process for such transfers 
based on discussions with clearing members during the development of 
ENCORE Release 3.0. Clearing members claimed that an approval 
process would be inefficient from an operational and administrative 
perspective, would increase system overhead, and would adversely 
affect their ability to review position changes on a timely basis.
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    A registered CMTA arrangement may only be terminated as specified 
in Rule 403, which permits clearing members to either mutually or 
unilaterally terminate the arrangement.\8\ Terminations by mutual 
agreement will be effective when OCC receives notice of termination 
from both clearing members. Unilateral terminations will be effective 
the next business day after notice of the termination has been given to 
OCC and the other clearing member. Transactions effected after the 
effective time of a termination will be treated as failed CMTAs and 
will be the responsibility of the executing clearing member.
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    \8\ OCC has retained the right to terminate all CMTA 
arrangements of a suspended clearing member.
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    Other rule changes relating to CMTAs include additional definitions 
of terms used in CMTA processing (e.g., ``carrying clearing member'' 
and ``executing clearing member'') and other conforming changes.
(b) Increases in Net Capital and Minimum Clearing Fund Requirements
    OCC has also reassessed the risks associated with CMTA 
transactions. A small number of OCC's clearing members conduct an 
``execution only'' business (i.e., their sole business is to execute 
transactions that are then given up to carrying clearing members for 
clearance and settlement). These firms' membership approval and 
clearing fund deposits are premised on the fact that they pose limited 
position risk to OCC because they do not normally carry positions. The 
average net capital of these firms is substantially less than the 
average net capital of OCC's clearing members, although each firm's net 
capital is above OCC's current initial requirement and each firm 
maintains the minimum clearing fund deposit of $150,000.
    With the proposed increase in the number of permissible reasons for 
returning a position, OCC believes that there is an increased 
possibility that executing clearing members, including execution-only 
firms, will be required to make premium or margin settlement for a 
position before it can be closed out or otherwise managed. To address 
this possibility, OCC has proposed to increase its initial and minimum 
net capital requirements for all clearing members and to increase the 
minimum clearing fund deposit for execution-only firms. Initial 
required net capital would be increased from $1 million to $2.5 
million, and minimum net capital would be increased from $750,000 to $2 
million.\9\ The minimum clearing fund deposit for execution-only firms 
would be increased from $150,000 to $150,000 plus $15 times the firm's 
average daily executed volume for the preceding calendar month.
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    \9\ These new capital standards are consistent with the capital 
requirements of other clearing organizations. For example, the 
Chicago Mercantile Exchange's initial net capital requirement is $2 
million, while the Board of Trade Clearing Corporation is $2.5 
million.
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    To determine the amount of the increase in net capital 
requirements, OCC analyzed the instances when positions were carried in 
the accounts of execution-only clearing members for the twelve-month 
period ending July 31, 2003.\10\ Based on that analysis, OCC determined 
that a minimum net capital of $2 million would have been sufficient to 
avoid any additional position related margin calls. Currently, minimum 
net capital is $750,000. Initial net capital historically has been set 
above the minimum net capital amount, and OCC has determined to set the 
initial net capital requirement at $2.5 million. Currently, initial net 
capital is $1 million. The increases are being applied to all clearing 
members because over 80% of OCC's clearing members are eligible to use 
the CMTA facility.
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    \10\ The instances in which positions were carried in execution-
only clearing members' accounts was relatively low with the greatest 
rate of ``returned'' positions for such firms was 4.11%.
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    The special net capital requirements for firms providing facilities 
management services \11\ and stock

[[Page 12192]]

settlement services \12\ are being increased proportionately. A firm 
providing such services will be required to have a minimum net capital 
of $4 million plus $200,000 times the number of firms over four that it 
services.
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    \11\ Proposed OCC Rule 309A [File No. SR-OCC-2003-09].
    \12\ Proposed OCC Rule 309A [File No. SR-OCC-2003-09].
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    The proposed increases in OCC's net capital requirements will not 
be unduly burdensome. Only two OCC clearing members (one of which is an 
execution-only firm) maintain net capital below the proposed minimum of 
$2 million. (No firm that provides facilities management services or 
stock settlement services will be affected by the proposed increase for 
those firms.) Although clearing members will be given a one-year grace 
period from October 1, 2003, to achieve compliance with the new 
requirements, OCC's membership/margin committee shall have the 
discretion to extend that deadline to a date no later than October 1, 
2006, for clearing members admitted to membership after the date that 
this proposed rule change is approved by the Commission, provided that 
such clearing members undertake not to engage in a CMTA execution 
business during the period of such extention.
    Execution-only clearing members pose a special risk because they do 
not ordinarily carry position overnight and therefore do not ordinarily 
deposit margin with OCC. This means that if a position is returned to 
an execution-only member and if the execution-only member fails to make 
settlement, the only asset of the member that OCC can draw upon to 
liquidate the position is the member's clearing fund deposit. Today, 
execution-only members maintain the minimum clearing fund deposit of 
$150,000 because OCC's clearing fund requirements are based on 
positions maintained during the preceding month, and execution-only 
firms ordinarily do not maintain positions. To determine a new minimum 
clearing fund requirement for execution-only members, OCC analyzed 
executed trade activity for the four execution-only clearing members 
over a period where total volume was deemed to be within normal ranges 
and assessed the net price change risk (through simulation) of the 
contracts executed by the firms relative to average daily executed 
volume. Dividing net price change risk by average daily executed volume 
resulted in net risk per contract of $15.85. OCC proposes to increase 
the minimum clearing fund requirement for execution-only members to 
$150,000 plus $15 times average daily executed volume for the preceding 
month. Execution-only firms will also be given the one-year grace 
period described above to comply with this new minimum.
    OCC also proposed to make conforming changes to the definitional 
provisions of its by-laws, qualification standards for admission, 
various financial responsibility rules, and the rule defining monthly 
contributions to the clearing fund.
    OCC believes that the proposed rule change is consistent with 
Section 17A of the Act because it fosters the prompt and accurate 
clearance and settlement of securities transactions, the safeguarding 
of funds and securities, and the protection of investors and the 
persons facilitating transactions by and acting on behalf of investors.

B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    OCC has not solicited or received written comments with respect to 
the proposed rule change.

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

    Within thirty-five days of the date of publication of this notice 
in the Federal Register or within such longer period (i) as the 
Commission may designate up to ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (a) By order approve the proposed rule change or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 5th Street, NW., Washington, DC 20549-0069. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-OCC-2003-11. This file number should be included on the 
subject line if e-mail is used. To help the Commission process and 
review your comments more efficiently, comments should be sent in 
either hardcopy or by e-mail but not by both methods. Copies of the 
submission, all subsequent amendments, all written statements with 
respect to the rule filing that are filed with the Commission, and all 
written communications relating to the rule filing between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room in Washington, DC. Copies of such filing will also be 
available for inspection and copying at OCC's principal office and on 
OCC's Web site at http://www.optionsclearing.com/publications/rules/proposed_changes/proposed_changes.jsp. All submissions should refer 
to File No. SR-OCC-2003-11 and should be submitted by April 5, 2004.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\13\
Jill M. Peterson,
Assistant Secretary.
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    \13\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 04-5786 Filed 3-12-04; 8:45 am]
BILLING CODE 8010-01-P