[Federal Register Volume 69, Number 117 (Friday, June 18, 2004)]
[Notices]
[Pages 34207-34209]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13744]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49841; File No. SR-OCC-2003-11]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving a Proposed Rule Change Relating to Clearing Member 
Trade Assignment Processing

June 9, 2004.
    On October 14, 2003, pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 \1\ (``Act''), The Options Clearing Corporation 
(``OCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-OCC-2003-11) and 
on February 18, 2004, amended the proposed rule change. Notice of the 
proposal was published in the Federal Register on March 18, 2004.\2\ 
The Commission received one comment letter.\3\ 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. 49378 (Mar. 9, 2004), 69 
FR 12190 (Mar. 15, 2004).
    \3\ Letter from John Berton and Georgia Bullitt, Ad Hoc CMTA 
Committee of the Securities Industry Association, March, 22, 2004.
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I. Description

    The proposed rule change will amend OCC's By-Laws and Rules to 
expand its clearing member trade assignment (``CTMA'') processing 
procedures, to increase OCC's initial and minimum net capital 
requirements, and to increase OCC's minimum clearing fund requirement 
for execution-only clearing members.

A. Background

    CMTA processing permits one clearing member (``carrying clearing 
member'') to authorize another clearing member (``executing clearing 
member'') to direct that its exchange transactions be transferred to an 
account of the carrying clearing member for clearance and 
settlement.\4\ Generally, 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 through 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.
    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 members 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.\5\
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    \4\ 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.
    \5\ 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.

B. CMTA Rule Changes

    The new OCC 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. Rule 403 will also establish certain actions for 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.\6\
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    \6\ 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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[[Page 34208]]

    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.\7\ 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 completed pursuant to 
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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    \7\ OCC 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.\8\
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    \8\ 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.\9\ 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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    \9\ 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.

C. Increases in Net Capital and Minimum Clearing Fund Requirements

    OCC has also reassessed the risks associated with CMTA 
transactions. Wth the 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 will increase its initial and minimum net capital 
requirements for all clearing members and will increase the minimum 
clearing fund deposit for execution-only firms. Initial required net 
capital will be increased from $1 million to $2.5 million, and minimum 
net capital would be increased from $750,000 to $2 million.\10\ The 
minimum clearing fund deposit for execution-only firms will be 
increased from $150,000 to $150,000 plus $15 times the firm's average 
daily executed volume for the preceding calendar month. 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\ 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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    The special net capital requirements for firms providing facilities 
management services and stock settlement services are being increased 
proportionately.\11\ 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. Clearing members will be given a 
one-year grace period from October 1, 2003, to achieve compliance with 
the new requirements. However, the 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 of this approval order, provided that such clearing members 
undertake not to engage in a CMTA execution business during the period 
of such extention.
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    \11\ Securities Exchange Act Release No. 49478 (Mar. 25, 2004), 
69 FR 17258 (Apr. 1, 2004) [File No. SR-OCC-2003-09] (proposing new 
OCC Rule 309A).
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    Execution-only clearing members pose a special risk because they do 
not ordinarily carry positions 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. Accordingly, OCC will 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 will 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.

II. Comment Letter

    John Berton and Georgia Bullitt, on behalf of the Ad Hoc CMTA 
Committee of the Securities Industry Association, expressed their 
support for the proposed rule. Among other things, they contended that 
it will provide ``definitional clarity regarding the CTMA process and 
appropriate procedures to protect against systemic risk in connection 
with options clearing.''

III. Discussion

    Section 17A(b)(3)(F) of the Act \12\ requires that the rules of a 
clearing agency be designed to promote the prompt and accurate 
clearance and

[[Page 34209]]

settlement of securities transactions and to assure the safeguarding of 
securities and funds that are in the custody or control of the clearing 
agency or for which it is responsible. The Commission finds that the 
proposed rule change is consistent with OCC's obligations under Section 
17A(b)(3)(F) because it substantially clarifies the rights and 
responsibilities of OCC members that participate in the CMTA facility, 
which should help OCC promote the prompt and accurate clearance and 
settlement of securities transactions and also provide greater 
certainty and transparency over how CMTA transactions will be 
processed. In addition, increasing members' net capital and minimum 
clearing fund requirements should appropriately protect itself against 
the greater risk it faces as a result of its expansion of its CMTA 
services.
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    \12\ 15 U.S.C. 78q-1(b)(3)(F).
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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 \13\ and 
the rules and regulations thereunder.
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    \13\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2003-11) be, and hereby 
is, approved.

    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).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13744 Filed 6-17-04; 8:45 am]
BILLING CODE 8010-01-P