[Federal Register Volume 80, Number 3 (Tuesday, January 6, 2015)]
[Notices]
[Pages 568-570]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-30897]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 73961; File No. SR-OCC-2014-23]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change To Clarify That OCC Would 
Not Treat a Futures Transaction That Is an Exchange-for-Physical or 
Block Trade as a Non-Competitively Executed Trade If the Exchange on 
Which Such Trade Is Executed has Provided OCC With Representations That 
it Has Policies or Procedures Requiring That Such Trades Be Executed at 
Reasonable Prices and That Such Price Is Validated by the Exchange

December 30, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 19, 2014, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II and III below, which 
Items have been prepared 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).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    OCC proposes to amend its Rules to permit OCC to add an 
interpretation and policy clarifying that OCC would not treat a futures 
transaction that is an exchange-for-physical or block trade as a non-
competitively executed trade, and therefore subject to delayed 
acceptance for clearing, if the exchange on which such trade is 
executed has provided OCC with representations satisfactory to OCC that 
it has policies and procedures requiring such trades to be executed at 
reasonable prices and that such prices are validated by the exchange.

II. Clearing Agency'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.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

1. Purpose
    OCC is proposing to modify its By-Laws to add an interpretation and 
policy to Section 7 of Article XII of the By-Laws to clarify that OCC 
would not treat a futures transaction that is an exchange-for-physical 
(``EFP'') \3\ or block trade \4\ as a non-competitively executed trade, 
and therefore subject to delayed novation, if the exchange on which the 
futures EFP or block trade is executed has provided OCC with 
representations that it has rules, policies or procedures requiring 
that such trades be executed at reasonable prices and that such prices 
are validated by the exchange.
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    \3\ An EFP is a transaction between two parties in which a 
futures contract on a commodity or security is exchanged for the 
actual physical good.
    \4\ A block trade is a trade involving a large number of shares 
being traded at an arranged price between parties, outside of the 
open markets, in order to lessen the impact of such a large trade 
being made public.
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Background
    Under OCC's By-Laws, the novation of confirmed trades (i.e., 
transactions in options, futures, or other ``cleared contracts'' 
effected through an exchange and submitted to OCC for clearing) occurs 
at the ``commencement time'' for such transactions.\5\ The 
``commencement time'' for most confirmed trades is when daily position 
reports are made available to clearing members.\6\ However, 
transactions in certain cleared products and certain types of 
transactions, including non-competitively executed EFP and block 
trades, have delayed commencement times that are tailored to address 
risks specific to such products or transactions,\7\ such as the risks 
presented by off-market transactions.
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    \5\ Cleared Contracts and Commencement Time are defined terms 
set forth in Article 1, Section 1 of OCC's By-Laws.
    \6\ See OCC's By-Laws Article VI, Section 5. In a practical 
sense, however, most trades are novated upon proper submission to 
OCC for clearing since OCC's By-Laws, with limited exception, do not 
permit OCC to reject any confirmed trade due to the failure of the 
purchasing clearing member to pay any amount due to OCC at or before 
the settlement time. See also Securities Exchange Act Release No. 
65990 (December 16, 2011), 76 FR 79731 (December 22, 2011) (SR-OCC-
2011-17).
    \7\ Id.
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    When OCC began clearing EFP and block transactions, it established 
that the commencement time for such transactions is expressly 
conditioned upon the receipt by OCC of variation payments due from 
purchasing and selling clearing members because EFP and block trades 
could be executed away from the market and be executed at other than 
market prices. These factors were viewed as creating heightened 
exposure to OCC if a clearing member defaults on a trade executed at an 
off-market price and, as a result, Article XII, Section 7 of OCC's By-
Laws establishes that the commencement time for a futures transaction 
that is identified as an EFP or block trade is the time of the first 
variation payment after the trade is reported to OCC (typically 9:00 
a.m. Central Time the following business day).\8\ OCC delays its 
novation of these non-competitively executed futures trades because OCC 
is bound to pay the first variation settlement amount to the 
counterparty once novation has occurred, and if the agreed-upon price 
at which the trade is entered differs from the competitive market 
price, there is an increased likelihood that OCC may experience a loss 
if it is required to close out a defaulting purchaser's position. 
Accordingly, OCC does not novate, and thereby become a counterparty to, 
a non-competitively executed trade if OCC fails to receive the first 
variation payment when due.
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    \8\ See Securities Exchange Act Release No. 44727 (August 20, 
2001), 66 FR 45351 (August 28, 2001) (SR-OCC-2001-07).

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[[Page 569]]

EFP and Block Trades Subject to Price Checks
    In the time since OCC adopted Article XII, Section 7 of its By-
Laws, the Commodity Futures Trading Commission (``CFTC'') has adopted 
Regulation 1.73, which requires clearing futures commission merchants 
(``FCMs'') to establish certain risk controls, including risk based 
limits for bilaterally executed transactions and for block trades.\9\ 
In light of this requirement and other proposed regulatory developments 
that may affect EFP and block trades in futures,\10\ certain exchanges 
that permit such transactions have requested that OCC review its By-
Laws regarding delayed novation of futures EFP and block trades 
(hereinafter, ``Block Trades''). Specifically, such exchanges have 
implemented rules, supported by policies and procedures, which require 
their market participants to execute Block Trades at reasonable prices 
that are verified by the exchange. These rules, policies and procedures 
leverage risk controls implemented by FCMs, as applicable. These 
exchanges have inquired as to whether Block Trades continue to present 
the same risk to OCC as they did before such rules, policies or 
procedures were in place. OCC reviewed its practices with respect to 
delayed novation of Block Trades and determined that it will novate 
Block Trades when daily position reports are made available provided 
that the exchange that submitted such Block Trades to OCC represents to 
OCC that the exchange has in place rules, policies and procedures to 
verify the reasonableness of the price of Block Trades it submits to 
OCC for clearance and settlement, and that such price is validated by 
the exchange.
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    \9\ See 17 CFR 1.73. Specifically, Regulation 1.73 requires FCMs 
to: (1) Establish risk-based limits in the proprietary account and 
in each customer account based on position size, order size, margin 
requirements, or similar factors; (2) screen orders for compliance 
with the risk-based limits; and (3) monitor for adherence to the 
risk based limits intra-day and overnight.
    \10\ Specifically, the CFTC has proposed regulations requiring 
Designated Contract Markets (i.e., futures exchanges) to determine 
whether or not the price of a block trade is fair and reasonable 
considering: (1) The size of the block trade, (2) the price and size 
of other block trades in any relevant markets at the applicable 
time, and (3) the circumstances of the market or the parties to the 
block trade. See proposed CFTC Regulation 38.503. 75 FR 80572, 
80592. See also proposed Appendix B of part 38 of the CFTC's 
proposed regulations concerning Core Principle 9. 75 FR 80572, 
80630. The CFTC has also proposed to adopt similar regulations 
concerning EFP trades. See proposed CFTC Regulation 38.505. 75 FR 
80572, 80593.
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    OCC has determined that Block Trades that are subject to price 
reasonability checks do not present the same settlement risks discussed 
above in relation to non-competitively executed Block Trades. 
Specifically, should a clearing member that executed a reasonably 
priced Block Trades fail to pay its first variation payment to OCC in 
respect such trade, OCC expects to liquidate the futures positions at 
the prevailing market price and likely obtain sufficient funds, or have 
sufficient funds in its clearing fund, to pay, or reimburse itself for, 
the first variation settlement to the counterparty to the trade. This 
is the same risk management methodology OCC uses for all other 
competitively executed trades in cleared contracts that OCC accepts for 
clearance and settlement on a daily basis. Accordingly, OCC proposes to 
exclude Block Trades from the delayed novation provisions of Article 
XII, Section 7 by adding an interpretation and policy thereto that 
provides for the treatment of Block Trades as competitively executed 
trades provided that the Block Trades are reported by an exchange that 
represents to OCC that it performs a price reasonableness check on the 
trade, and that such price is validated by the exchange.
Verification of Exchange Rules, Policies and Procedures Related to 
Price Reasonableness
    Before permitting an exchange to submit Block Trades that will not 
be subject to delayed novation, OCC will require an exchange to provide 
OCC with a certification that the exchange has rules, policies or 
procedures as they relate to verifying the reasonableness of the price 
of the Block Trade. Specifically, OCC will require an exchange to 
certify that its rules, policies or procedures provide that the price 
at which a Block Trade is executed must be fair and reasonable in light 
of: (i) The size of the Block Trade; (ii) the prices and sizes of other 
transactions in the same contract at the relevant time; and (iii) the 
prices and sizes of transactions in other relevant markets, including, 
without limitation, the underlying cash market or related futures 
markets, at the relevant time.\11\ An exchange will also have to 
certify that its rules, policies or procedures require one or both 
parties to a Block Trade to report the trade details of the Block Trade 
to the exchange within a reasonable period of time (i.e., within 10 
minutes of the time of execution or, if the Block Trade is executed 
outside of regular trading hours, within 15 minutes of the commencement 
of trading on the next business day). OCC believes that it is 
appropriate to rely on price reasonableness checks performed by 
exchanges trading futures because they are self-regulatory 
organizations subject to regulatory oversight, including routine 
examinations. Moreover, OCC will presume that all Block Trades 
submitted by an exchange that represents that it has price 
reasonableness rules, policies or procedures in place will submit to 
OCC Block Trades that have undergone a price reasonableness check.
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    \11\ For example, OneChicago LLC (``OCX'') Rule 417 governs 
Block Trades executed on OCX and provides that such trades be 
executed on a designated trading platform that will automatically 
verify that Block Trades were executed at competitive prices by 
price verification software for price reasonableness.
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    In addition to exchanges implementing rules, policies or procedures 
regarding the price reasonableness checks for Block Trades, exchanges 
are able to use existing authority to notify OCC to disregard, pursuant 
to Article VI, Section 7(c) of OCC's By-Laws, any Block Trade submitted 
to OCC that was executed at an unreasonable price, since such a trade 
could not be properly cleared under the proposed interpretation but 
instead would fall within the non-competitively executed category and 
therefore be subject to delayed novation. Such a notification would be 
delivered to OCC along with other trades ``busted'' by an exchange and 
in accordance with an operational process that currently occurs every 
day before daily position reports are distributed. OCC believes that 
this measure appropriately protects OCC in the event OCC receives a 
Block Trade at an unreasonable price. Moreover, OCC and the exchanges 
maintain an informal ongoing dialogue about operational matters, which 
OCC will use to confirm the continued application of price 
reasonableness controls.
2. Statutory Basis
    OCC believes that the proposed rule change is consistent with 
Section 17A(b)(3)(F) of the Act,\12\ because the proposed rule change 
will ensure that the rules of OCC are designed to promote the prompt 
and accurate clearance and settlement of securities transactions as 
well as remove impediments to and perfect the mechanism of a national 
system for the prompt and accurate clearance and settlement of 
securities transactions. As described above, the proposed rule change 
implements an Interpretation and Policy that sets forth the specific 
criteria that must be met by a futures exchange before OCC would 
consider a Block Trade submitted to OCC by such

[[Page 570]]

exchange to not be subject to the delayed novation time set forth in 
Article XII, Section 7 of OCC's By-Laws. The proposed rule change 
therefore ensures that OCC's rules explain the time at which OCC would 
novate Block Trades and thereby promotes the prompt and accurate 
clearance and settlement of securities transactions. In addition, as a 
result of OCC novating certain Block Trades at commencement time, the 
proposed rule change removes impediments to and perfects the mechanisms 
of a national system for the prompt and accurate clearance and 
settlement of securities transactions because the time at which OCC 
novates trades submitted by exchanges for clearance and settlement will 
be more uniform across different product types. The proposed rule 
change is not inconsistent with the existing rules of OCC, including 
any other rules proposed to be amended.
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    \12\ 15 U.S.C. 78q-1(b)(3)(F).
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(B) Clearing Agency's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose any 
burden on competition.\13\ The proposed rule change will provide that 
Block Trades executed at reasonable prices will not be subject to 
delayed novation by OCC. The proposed rule change would not unfairly 
inhibit access to OCC's services or disadvantage or favor any 
particular user in relationship to another user because the proposed 
rule change would be applied uniformly to all Block Trade transactions, 
regardless of the identity of the clearing member for whose account the 
trade was reported and the exchange through which the trade is reported 
to OCC. Moreover, the proposed interpretation to Article XII, Section 7 
will apply uniformly to all futures exchanges that submit trades to OCC 
for clearance and settlement.
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    \13\ 15 U.S.C. 78q-1(b)(3)(I).
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    For the foregoing reasons, OCC believes that the proposed rule 
change is in the public interest, would be consistent with the 
requirements of the Act applicable to clearing agencies, and would not 
impose a burden on competition.

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants, or Others

    Written comments on the proposed rule change 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 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate 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 or disapprove 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. 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 email to [email protected]. Please include 
File Number SR-OCC-2014-23 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-OCC-2014-23. This file 
number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the 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/components/docs/legal/rules_and_bylaws/sr_occ_14_23.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-2014-23 and should be submitted on or before January 
27, 2015.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2014-30897 Filed 1-5-15; 8:45 am]
BILLING CODE 8011-01-P