[Federal Register Volume 73, Number 141 (Tuesday, July 22, 2008)]
[Notices]
[Pages 42646-42648]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-16687]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58158; File No. SR-OCC-2007-20]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to the 
System for Theoretical Analysis and Numerical Simulations

July 15, 2008.

I. Introduction

    On December 14, 2007, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-OCC-2007-20 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 February 12, 2008.\2\ No 
comment letters were received. For the reasons discussed below, the 
Commission is granting approval of the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 57270 (February 5, 
2008), 73 FR 8098.
---------------------------------------------------------------------------

II. Description

    The proposed rule change permits the incorporation of certain forms 
of securities deposited as margin collateral into OCC's System for 
Theoretical Analysis and Numerical Simulations (``STANS'') risk 
management methodology. The purpose of the proposed rule change is to 
more accurately measure the risk in clearing members' accounts and 
thereby permit OCC to set margin requirements that more precisely 
reflect that risk. In connection with this rule change, it is also 
necessary to include additional flexibility in determining the amount 
of replacement collateral required when securities deposited as margin 
are withdrawn. In addition, because OCC believes that certain existing 
concentration limits and requirements regarding minimum share prices 
are no longer appropriately applied to securities that are underlying 
securities or to fund shares that track an index that is an underlying 
index for covered contracts, OCC is eliminating such requirements with 
respect to such securities.
    Overview of Rule Changes. OCC will incorporate certain common 
stocks and ETFs (defined as ``fund shares'' in Article I of OCC's By-
Laws) into the STANS margin calculation process.\3\ STANS is a large-
scale Monte Carlo-based risk management methodology used to measure 
risk associated with portfolios of cleared contracts. Currently, these 
forms of securities when deposited as collateral to satisfy margin 
requirements are priced on a nightly basis and are assigned a value 
equal to their end-of-day market price minus the haircut applicable to 
that form of collateral, an amount that varies according to asset type. 
While this method of valuing collateral has generally served OCC well 
in the past, it does not take into account the potential risk-reducing 
impact that the deposited collateral might have on a clearing member's 
portfolio. Under the rule change, cleared options positions and 
underlying securities in the forms indicated above will be analyzed as 
a single portfolio using STANS, thus providing a more accurate 
valuation of securities deposited as collateral in relation to the 
other positions in the account. The rule change will align risk 
management techniques utilized to manage market risk of options 
portfolios with those used to value margin deposits. There are two 
primary benefits expected from the rule change. First, margin 
requirements will be based on the risk of the combined portfolio that 
includes both cleared contracts and deposited collateral, thereby 
allowing the relevant intercorrelations of cleared contracts and 
deposited collateral to be taken into consideration rather than 
treating securities deposited as collateral as having fixed values. 
Second, the coverage provided by a

[[Page 42647]]

particular asset class (e.g., shares of IBM common stock) will be based 
on the historical volatility of that particular asset rather than by 
taking a flat ``haircut'' rate across a much broader class of assets 
(e.g., 30% haircut for common stock). For the period from August 16, 
2007, to September 10, 2007, OCC staff computed margin requirements for 
all existing accounts according to this proposed approach. The result 
showed an average daily reduction in risk margin requirements of 
approximately $1.2 billion, or 5%, as compared to OCC's current 
approach. At the same time that average daily collateral requirements 
will be reduced, the STANS calculations will also measure and 
compensate for added risk arising where risks are positively correlated 
rather than offsetting.
---------------------------------------------------------------------------

    \3\ For a description of STANS, refer to Securities Exchange Act 
Release No. 53322 (February 15, 2006) 71 FR 9403 (February 23, 2006) 
(File No. SR-OCC-2004-20).
---------------------------------------------------------------------------

    OCC is also adding an exception to collateral minimum price and 
concentration limits with respect to certain securities deposited as 
collateral. Currently, eligible collateral securities deposited with 
OCC must (1) have a market value greater than $10 per share and (2) be 
traded on a national securities exchange, the Nasdaq Global Market, or 
the Nasdaq Capital Market. Additionally, the aggregate value of margin 
attributed to a single security cannot exceed 10% of a clearing 
member's total margin requirement. These criteria were designed to 
limit deposits to liquid, readily marketable securities and to avoid 
concentrations of deposits in a single security. OCC is adding an 
exception to these eligibility and concentration requirements for 
securities that are deliverable upon exercise of a contract cleared by 
OCC or, in the case of ETFs, that track an index underlying cleared 
contracts whether or not the particular ETF is an underlying security. 
OCC believes that this exception will permit and encourage the use of 
collateral that closely hedges related options positions. The exception 
will apply only to the approximately 2,800 exchange-listed equity 
securities that currently underlie listed options. Thus, OCC's existing 
minimum value and concentration restrictions will continue to apply to 
the approximate 7,200 exchange-listed equity securities that do not 
underlie listed options.
    OCC is also making a minor amendment to the current requirement 
that the aggregate value of margin attributed to a single security 
cannot exceed 10% of the total margin requirement in an account. The 
amendment will base the calculation on the clearing member's actual 
margin deposits rather than the clearing member's total margin 
requirement in the account. Thus, the requirement as amended will limit 
the value given to deposits in any single security to no more than 10% 
of the market value of a member's aggregate margin deposits in the 
account. This test is very similar in purpose and effect to the current 
test, but OCC believes it will be much easier to administer than the 
current test when collateral is included in STANS.
    In addition, OCC will need a different means for addressing 
substitutions of collateral where a security that has been valued in 
STANS is being replaced during the business day. STANS performs 
multiple portfolio revaluations during the business day using current 
prices of collateral and cleared contracts. While the revaluations 
include updated positions in cleared contracts reflecting intraday 
trading activity, they do not at present include updated collateral 
positions reflecting withdrawals and substitutions. In addition, it is 
operationally too intensive, given the complexity of the STANS 
methodology and the frequency of substitution requests, to recalculate 
the STANS requirement for each such collateral withdrawal/deposit. 
Although OCC intends ultimately to make further systems changes to 
address these issues in more efficient ways, OCC has developed an 
approach that provides the necessary protection to the clearing system 
by taking a conservative view of the estimated impact that a 
withdrawal/deposit would have on the member's requirement.
    OCC will treat margin collateral substitutions and withdrawals in 
the same manner that substitutions and withdrawals of specific and 
escrow deposits are treated. In the case of a margin withdrawal or 
deposit, OCC will incorporate an adjustment factor, based on the 
historical volatility of the security, equal to the estimated impact 
(within the 99% confidence interval) of the security on the projected 
liquidating value of the account. For example, if a clearing member 
deposited $300 in IBM stock and IBM is given a risk adjustment factor 
of 10%, the deposited stock would be given a value of $270 ($300 x 
[100% -10%]) in intraday excess collateral value to be used against 
releases to account for the potential negative risk impact of adding 
the stock to the portfolio. If the clearing member then released $200 
of Google stock and Google is given a risk adjustment factor of 12%, 
the clearing member would be required to maintain $224 ($200 x [100% + 
12%]) in excess collateral to account for the negative impact of 
removing Google from the portfolio.
    Changes to OCC's Rules to Implement the Foregoing Concepts. OCC's 
Rule 601, ``Margin Requirements,'' currently states in paragraph (c) 
that margin assets may be incorporated into the Monte Carlo 
calculations as an alternative to valuing such assets under Rule 604, 
``Form of Margin Assets.'' OCC now proposes merely to add an 
Interpretation to Rule 601 to indicate that OCC is implementing this 
alternative to the extent that it will be incorporating common stocks 
and ETFs into the STANS calculation of expected net liquidating value. 
Rule 604(b)(4), which governs the deposit of equity and debt issues to 
satisfy margin requirements, would be amended to provide exceptions to 
the per share minimum price and concentration limits and to provide 
that concentration limits will be measured in relation to the aggregate 
margin on deposit rather than to the margin requirement in an account. 
Rule 604(b)(4) is also proposed to be amended to reflect the fact that 
Nasdaq is now registered as a national securities exchange. An 
Interpretation is proposed to be added to Rule 608, ``Withdrawals of 
Margin,'' to give OCC the flexibility to adopt the interim method of 
dealing with collateral withdrawals and substitutions as described 
above. The proposed changes in Rules 609, ``Intraday Margin,'' and 
706(c), ``Cross-Margining Settlement Procedures,'' would reflect minor 
conforming changes and nonsubstantive updates to streamline the rules 
and add flexibility.
    OCC proposes to put all of the foregoing proposed rule changes into 
effect simultaneously upon appropriate notice to clearing members once 
systems changes needed for full implementation are in place. The 
published text of OCC's Rules would not be modified until that time 
although this rule change would be published as pending approval or 
approved but not yet implemented, as the case may be.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to assure the safeguarding 
of securities and funds which are in its custody or control or for 
which it is responsible.\4\ The Commission approved OCC's STANS risk 
management methodology for the purpose of calculating clearing member 
margin in February 2006 and has monitored the results of the 
methodology through quarterly reports from OCC.\5\ The proposed rule 
change to include certain common stocks and

[[Page 42648]]

fund shares deposited by OCC members as margin in the daily STANS risk 
calculation is consistent with the purpose of the methodology, which is 
to provide an accurate measure of the market risk in a clearing 
member's account. The proposed rule change also amends OCC's rules 
regarding the calculation of concentration limits and collateral 
substitution to allow OCC to more easily implement the inclusion of 
margin deposits in the STANS calculation. As noted above, OCC expects 
to collect approximately 5 percent less margin under the proposed rule 
change than it currently collects. However, this is because of the 
increased diversification benefit allowed by the risk measurement under 
STANS and not because of a decrease in OCC's risk tolerance in 
calculating margin. Accordingly, because the proposed rule change 
should not affect the purpose of the STANS methodology to provide OCC 
with sufficient collateral in the event a member becomes insolvent or 
otherwise fails to meet its obligations to OCC, it should assure the 
safeguarding of securities and funds which are in OCC's custody or 
control or for which it is responsible.
---------------------------------------------------------------------------

    \4\ 15 U.S.C. 78q-1(b)(3)(F).
    \5\ Securities Exchange Act Release No. 53322 (February 15, 
2006), 71 FR 9403 (February 25, 2006) (File No. SR-OCC-2004-20).
---------------------------------------------------------------------------

    The proposed rule change also adds an exception to the collateral 
minimum price and concentration limits in OCC's rules for securities 
that are deliverable upon exercise of a contract cleared by OCC or, in 
the case of ETFs, that track an index underlying cleared contracts 
whether or not the particular ETF is an underlying security. The 
minimum price and concentration limits in OCC's rules are designed to 
assure that OCC will be able to collect sufficient collateral in the 
event it needs to liquidate securities deposited as margin. This type 
of liquidity risk should not apply if the security deposited as margin 
is deliverable upon exercise of the clearing member's cleared contracts 
or if the security is an exchange traded fund that tracks an index 
underlying the clearing member's cleared contracts. Accordingly, the 
proposed rule change to add this exception to the collateral minimum 
price and concentration limits should not affect OCC's ability to 
assure the safeguarding of securities and funds which are in OCC's 
custody or control or for which it is responsible.

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 Section 17A of the Act and the rules and regulations 
thereunder.\6\
---------------------------------------------------------------------------

    \6\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition and 
capital formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2007-20) be and hereby 
is approved.

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\7\
---------------------------------------------------------------------------

    \7\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Acting Secretary.
 [FR Doc. E8-16687 Filed 7-21-08; 8:45 am]
BILLING CODE 8010-01-P