[Federal Register Volume 72, Number 123 (Wednesday, June 27, 2007)]
[Notices]
[Pages 35291-35293]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-12425]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55939; File No. SR-OCC-2007-06]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating to Credit Default 
Basket Options

June 21, 2007.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on April 20, 2007, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') and on June 16, 2007, amended the 
proposed rule change 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 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 purposed rule change would permit OCC to clear and settle 
credit default basket options (``CDBOs'').

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 these 
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 permit OCC to clear 
and settle CDBOs, which are options related to the creditworthiness of 
an issuer or guarantor (``reference entity'') of one or more specified 
debt securities (``reference obligations''). CDBOs are proposed to be 
traded by the Chicago Board Options Exchange (``CBOE'').\3\ CDBOs are 
binary options that pay a fixed amount to the holder of the option upon 
the occurrence of a ``credit event'' affecting the reference 
obligations.\4\ Characteristics of CDBOs are described below, followed 
by an explanation of the specific rule changes being proposed in order 
that OCC may clear and settle them.
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    \3\ Securities Exchange Act Release No. 55938 (June 21, 2007) 
(notice of filing of proposed rule change) [File No. SR-CBOE-2007-
26].
    \4\ ``Binary'' options (also sometimes referred to as 
``digital'' options) are ``all-or-nothing'' options that pay a fixed 
amount if automatically exercised and otherwise pay nothing.
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Description of Credit Default Basket Options
    CDBOs are structured as binary options with an automatic exercise 
feature. They are very similar to Credit Default Options (``CDOs'') 
that were recently approved for trading by CBOE and clearing by OCC 
except that CDBOs are based upon multiple reference entities instead of 
a single reference entity.\5\ A CDBO will be automatically exercised 
and an exercise settlement amount will be payable if a ``credit event'' 
occurs with respect to any one of the reference entities at any time 
prior to the last day of trading. As in the case

[[Page 35292]]

of a CDO, a ``credit event'' is generally defined as any failure to pay 
on any of the reference obligations or any other occurrence that would 
constitute an ``event of default'' or ``restructuring'' under the terms 
of any of the reference obligations of a particular reference entity 
and that the listing exchange has determined would be a credit event 
for purposes of the CDBO.
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    \5\ Securities Exchange Act Release No. 55871 (June 6, 2007), 72 
FR 32372 (June 12, 2007) [File No. SR-CBOE-2006-84]. See also 
Securities Exchange Act Release No. 55872 (June 6, 2007), 72 FR 
32693 (June 13, 2007) [File No. SR-OCC-2007-01].
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    CDBOs may be thought of as a bundle of CDOs in that there is a 
fixed exercise settlement amount that is determined for each of the 
reference entities included in the basket of reference entities 
underlying the CDBO. The exercise settlement amount may be the same for 
all of the reference entities or it may be different for each one.
    CDBOs come in two types: Multiple payout CDBOs and single payout 
CDBOs. A multiple payout CDBO is automatically exercised each time 
there is a credit event affecting any one of the reference entities. 
Once the CDBO has been exercised with respect to that reference entity 
such reference entity is removed from the basket. In the unlikely event 
that a CDBO is exercised with respect to all of the reference entities 
in the basket, the expiration of the option would be accelerated. A 
single payout CDBO, on the other hand, is automatically exercised only 
the first time that a credit event is confirmed with respect to any one 
of the reference entities. A single payout CDBO cannot be exercised 
again with respect to any other reference entity and its expiration 
date will be accelerated. With either a multiple payout CDBO or a 
single payout CDBO, the exercise settlement amount is the exercise 
settlement amount that was assigned by the listing exchange to the 
reference entity affected by the credit event.
By-Law and Rule Amendments Applicable to CDOs
    In order to accommodate the clearing and settlement of CDBOs, OCC 
proposes to amend the By-Law Article and Rule Chapter that were adopted 
for CDOs.
1. Terminology--Article I, Section 1 and Article XIV, Section 1 of the 
By-Laws
    The definition of ``option contract'' in Article I of the By-Laws 
is amended to include CDBOs. ``Adjustment event'' and ``credit event'' 
are defined in Article XIV by reference to the rules of the listing 
exchange. The terms ``credit event confirmation'' and ``credit event 
confirmation deadline'' are used, respectively, to refer to the notice 
that must be provided by the listing exchange or other reporting 
authority to OCC that a credit event has occurred (and that a CDBO will 
therefore automatically be exercised) and to the deadline for receipt 
of such notice if it is to be treated as having been received on the 
business day on which it is submitted. Credit event confirmations 
received after the deadline on the expiration date but before the 
expiration time will be given effect but may result in delayed exercise 
settlement.
    OCC is also amending the definition of the term ``exercise 
settlement amount'' in Article XIV for purposes of CDBOs. The exercise 
settlement amount of a CDBO is the amount specified by the exchange on 
which the option is traded that will be paid in settlement when a CDBO 
is automatically exercised as a result of a credit event affecting a 
particular reference entity. The exercise settlement amount for each 
reference entity will be determined by the exchange at the time of 
listing when the exchange fixes the other variable terms for the 
options of a particular class or series.
    OCC is replacing the definitions of ``variable terms,'' 
``premium,'' and ``multiplier'' in Article I of the By-Laws with 
revised definitions in Article XIV, Section 1, that are applicable to 
CDBOs. The term ``class'' is also redefined in Article XIV, Section 1. 
To be within the same class, CDBOs must have the same reporting 
authority, which OCC anticipates will ordinarily be the listing 
exchange. This is necessary because of the degree of discretion that 
the reporting authority will have in determining whether a credit event 
has occurred.
    Other terms that were created or amended for CDOs will be modified 
to apply to CDBOs as well.
2. Terms of Cleared Contracts--Article VI, Section 10(e)
    A new paragraph (e) is added to Article VI, Section 10 so that an 
exchange is required to designate the exercise settlement amount and 
expiration date for a series of CDBOs at the time the series is opened 
for trading. Section 10(e) also reminds the reader that CDBOs are 
subject to adjustment under Article XIV.
3. Rights and Obligations--Article XIV, Section 2
    Article XIV, Section 2A defines the general rights and obligations 
of holders and writers of CDBOs. As noted above, the holder of a CDBO 
that is automatically exercised has the right to receive the fixed 
exercise settlement amount for the particular reference entity affected 
by a credit event, and the assigned writer has the obligation to pay 
that amount.
4. Adjustments of Credit Default Basket Options--Article XIV, Section 
3; Determination of Occurrence of Credit Event--Article XIV, Section 4
    Article XIV, Section 3 provides for adjustment of CDBOs in 
accordance with the rules of the listing exchange. For example, CBOE's 
proposed rules provide for adjustment of CDBOs in the case of certain 
corporate events affecting the reference obligations, and OCC proposes 
simply to defer to those rules and to the determinations of CBOE 
pursuant to those rules. Accordingly, as in the case of CDOs, OCC will 
have no responsibility for adjustment determinations with respect to 
CDBOs.
    Similarly, Section 4 provides that the listing exchange for a class 
of CDBOs will have responsibility for determining the occurrence of a 
credit event that will result in automatic exercise of the options of 
that class with respect to a particular reference entity. The listing 
exchange has the obligation to provide a credit event confirmation to 
OCC in order to trigger the automatic exercise.
5. Exercise and Settlement--Chapter XV of the Rules and Rule 801
    CDBOs would not be subject to the exercise-by-exception procedures 
applicable to most other options under OCC's Rules but would instead be 
automatically exercised prior to or at expiration if the specified 
criterion for exercise is met. The procedures for the automatic 
exercise of CDBOs, as well as their assignment and settlement 
(including during periods when a clearing member is suspended), are set 
forth in Rules 1501 through 1505 of new Chapter XV and in revised Rule 
801(b).
6. Special Margin Requirements--Rule 601; Deposits in Lieu of Margin--
Rule 1506
    As in the case of CDOs, OCC will not initially margin CDBOs through 
its ``STANS'' system in the same way that other options are margined. 
Because of the fixed payout feature of CDOs and CDBOs, further systems 
development is needed to accommodate these options in STANS on a 
portfolio basis. Until such development is completed, elements of STANS 
will be used to determine the expected liquidating value of each class 
of CDBOs and CDOs by extracting certain information regarding the 
default probability from the listed equity options on the common stock 
of the reference entity and the market price of the CDBOs and CDOs. 
Expected liquidating values can then be derived from simulated price 
movements in the stock over a range of values. Thus, general principles 
of

[[Page 35293]]

STANS will be applied, but each class of CDBOs and CDOs will be treated 
as a separate portfolio and will not be included within the entire 
portfolio of a particular account. An exception to this will be in the 
case where a firm has a net long position in CDBO or CDO contracts that 
are not required to be segregated and the risk computed under this 
methodology is less than 100% of the premium value of the net long 
position, the excess long value will be used to cover requirements 
associated with other cleared contracts. This margin methodology will 
result in a more conservative risk estimate than if the contracts were 
fully integrated in STANS since offsets in the risk calculation between 
these products and others will not be recognized except to the extent 
of any excess long value. Ultimately, CDBOs will be incorporated into 
the STANS system and will be valued and margined on a risk basis.
    OCC does not propose to accept escrow deposits in lieu of clearing 
margin for CDBOs. Therefore, Rule 1506 states that Rule 610, which 
otherwise would permit such deposits, does not apply to CDBOs.
7. Acceleration of Expiration Date--Rule 1507
    This provision would accelerate the expiration date of a single 
payout CDBO when the option is deemed to have been automatically 
exercised on any day prior to the expiration date and to accelerate the 
expiration date of a multiple payout CDBO when the option is deemed to 
have been automatically exercised with respect to every reference 
entity underlying such option prior to the expiration date.
    The proposed changes to OCC's By-Laws and Rules are consistent with 
the purposes and requirements of Section 17A of the Act, as amended, 
because they are designed to promote the prompt and accurate clearance 
and settlement of transactions in, including exercises of, credit 
default basket options, to foster cooperation and coordination with 
persons engaged in the clearance and settlement of such transactions, 
to remove impediments to and perfect the mechanism of a national system 
for the prompt and accurate clearance and settlement of such 
transactions, and in general to protect investors and the public 
interest. They accomplish these purposes by applying substantially the 
same rules and procedures to these transactions as OCC applies to 
similar transactions in other cash-settled options except to the extent 
that special rules and procedures are required in order to accommodate 
unique features of CDBOs. Other than as described in this Item II, the 
proposed rule change is not inconsistent with the existing rules of 
OCC, including rules proposed to be amended.

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

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

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 such 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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml) or
     Send an e-mail to [email protected]. Please include 
File Number SR-OCC-2007-06 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2007-06. 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, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, 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. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of OCC and on OCC's Web 
site at http://www.theocc.com/publications/rules/proposed_changes/sr_occ_07_06.pdf. All comments received will be posted without change; 
the Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-OCC-
2007-06 and should be submitted on or before July 12, 2007.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\6\
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    \6\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-12425 Filed 6-26-07; 8:45 am]
BILLING CODE 8010-01-P