[Federal Register Volume 81, Number 215 (Monday, November 7, 2016)]
[Notices]
[Pages 78224-78228]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-26791]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79212; File No. SR-OCC-2016-013]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Concerning the Options 
Clearing Corporation's Margin Coverage During Times of Increase 
Volatility

November 1, 2016.
    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 October 18, 2016, 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 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

    This proposed rule change by OCC would modify the current process 
for systematically monitoring market conditions and performing 
adjustments to its margin coverage when current market volatility 
increases beyond historically observed levels.

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's margin methodology, the System for Theoretical Analysis and 
Numerical Simulations (``STANS''), is OCC's proprietary risk management 
system that calculates Clearing Members' \3\ margin requirements.\4\ 
STANS utilizes large-scale Monte Carlo simulations to forecast price 
movement and correlations in determining a Clearing Member's margin 
requirement.\5\ The STANS margin requirement is a portfolio calculation 
at the level of Clearing Member legal entity marginable net positions 
tier account (tiers can be customer, firm, or market marker) and 
consists of an estimate of 99% 2-day expected shortfall and an add-on 
for model risk (the concentration/dependence stress test charge).
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    \3\ See OCC By-Laws Article 1(C)(14).
    \4\ See Securities Exchange Act Release No. 53322 (February 15, 
2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-20). A detailed 
description of the STANS methodology is available at http://optionsclearing.com/risk-management/margins/.
    \5\ See OCC Rule 601.
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    The majority of risk factors utilized in the STANS methodology are 
total returns on individual equity securities. Other risk factors 
considered include: Returns on equity indices; changes in the 
calibrated coefficients of a model describing the yield curve for U.S. 
government securities; ``returns'' on the nearest-to-expiration futures 
contracts of various kinds; and changes in foreign exchange rates. For 
the volatility of each risk factor, the Monte Carlo simulations use the 
greater of: (i) The short-term volatility level predicted by the model; 
and (ii) an estimate of its longer-run level. In between the monthly 
re-estimations of all the models, volatilities are automatically re-
scaled to the greater of the short-term or the longer-run levels to 
mitigate pro-cyclicality \6\ in the margin levels. (This daily 
volatility measure is called the ``uniform scale factor.'') The uniform 
scale factor is a multiplier used in connection with STANS calculations 
to account for, among other things, the difference between short-term 
and long-term volatility forecasts for equities. It is specifically 
defined as the ratio of long-run volatility (10Y+) over short-run 
volatility (2Y). It is used to ``scale up'' the short-run volatility of 
the securities (e.g., IBM) that are subject to monthly update, in order 
to estimate long-run volatility. It is also used to capture data gaps 
between monthly updates.
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    \6\ A quality that is positively correlated with the overall 
state of the economy is deemed to be pro-cyclical.
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    An approach employed by OCC to mitigate pro-cyclicality within 
STANS is to estimate market volatility based on current market 
conditions (``current market estimate'') and compare this current 
market estimate to a long-run estimate of market volatility (``long-run 
market estimate''). This comparison utilizes certain market benchmarks 
(or factors), which serve as proxies for the overall volatility of an 
asset class or group of products. If the long-run market estimate for a 
factor is found to be greater than the current market estimate, the 
volatility estimates for all products tied to that factor are adjusted 
(or scaled) up in a manner proportionate to the relationship between 
the current market volatility and the long-run market volatility for 
that factor.
    Current STANS includes a single factor (``uniform scale factor''), 
which serves as the proxy for the equity asset class. This uniform 
scale factor is calibrated based on changes in the volatility of the 
Standard & Poor's 500[supreg] Index (``SPX'') and applied to all 
``equity-based products'' in the manner described above. Currently, the 
uniform scale factor is the only scale factor used in STANS. The 
proposed change is intended to enhance the STANS margin calculations by 
providing for the capability to increase the number of

[[Page 78225]]

scale factors used within STANS in cases where a more appropriate proxy 
has been identified for a particular asset class or group of products 
to measure the relationship between current vs. long-run market 
volatility.
Summary of the Proposed Change
    OCC believes that the current approach to scale factors in STANS 
would be improved by providing the functionality to establish multiple 
scale factors intended to more accurately measure the relationship 
between current and long-run market volatility with proxies that 
correlate more closely to groups of products within an asset class 
(e.g., Russell 1000 Index and Russell 1000 ETFs), which would enhance 
the accuracy of the margin requirements in STANS.\7\ Furthermore, OCC 
can improve the resiliency of its risk management framework for non-
equity asset classes where open interest cleared by OCC has grown, but 
where scale factors currently do not exist. By incorporating this 
process to scale margin coverages when current market volatility 
exceeds historically heightened levels that have been established to 
mitigate pro-cyclicality, OCC's margin methodology is able to 
expeditiously respond to severe changes in market volatility and thus 
better protect the integrity of our financial markets.
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    \7\ In this case, accuracy is measured against backtesting 
results. Pursuant to OCC's Model Risk Management Policy, an accurate 
99% value-at-risk model should expect exceedances at a rate of 1% 
per independent trial. If the exceedance rate is too high, the model 
is missing key risks; if the exceedance rate is too low, the model 
is not consistent with the organization's risk appetite. To the 
extent that the conditional variances of not all relevant risk 
factors move in lock-step to the conditional variance of SPX, 
multiple scale factors offers the opportunity to be more accurate.
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Scale Factor for Equity-Based Products
Current Uniform Scale Factor for Equity-Based Products
    The uniform scale factor for the SPX roughly represents the ratio 
of OCC's estimates of the long-run market volatility to the forecast 
market volatility determined by most recent 24-month daily historical 
returns.\8\ To determine the estimate of current market volatility, OCC 
relies on daily pricing information for equity securities and exchange-
traded funds over a twenty-four month period ending with the last day 
of the immediately preceding month. To populate this twenty-four month 
time series, OCC relies on external vendors, with which it maintains 
redundant relationships for resiliency,\9\ to adjust the daily pricing 
information to account for corporate actions involving these 
securities. This daily pricing information is received from its 
vendor(s) after the close of each month, at which time OCC updates its 
twenty-four month time series adding the new month and dropping the 
last month of data. This process of updating the time series on a 
monthly basis is referred to as a ``pending'' time series due to the 
batch process used to update the time series. The long-run time series 
used by the uniform scale factor is updated on a daily basis (i.e., 
non-pending update) with pricing information for the SPX dating back to 
January 1, 1946. OCC calculates the uniform scale factor each business 
day by comparing the current market volatility, using pending price 
updates to the long-run time series using non-pending, or current, 
market prices.
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    \8\ The uniform scale factor has been a part of STANS since it 
was installed in 2006. See Securities Exchange Act Release No. 53322 
(February 15, 2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-
20).
    \9\ Specifically, OCC maintains both a primary and backup data 
center that receive live price feeds from multiple price vendors. In 
the event of service disruption OCC is able to transition to an 
alternate data center and/or pricing vendor, as applicable.
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    The uniform scale factor is applied to all equity products and is 
used to adjust individual equity current market volatility estimates on 
a daily basis based on the comparison of the current market volatility 
and the long-run volatility estimate, which is updated daily. Should it 
be observed that the current market volatility is less than the long-
run volatility, all products tied to the uniform scale factor will be 
adjusted higher based on the ratio of the long-run volatility estimate 
to the current market volatility estimate to account for the observed 
change in volatility. In addition, the uniform scale factor is also 
used to account for the fact that the distribution of returns for the 
SPX has a ``fat tail'' \10\ because the scale factor seeks to match 
estimates of expected margin shortfalls under the scenarios in STANS 
for a hypothetical long position in the SPX.
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    \10\ A fat-tailed distribution is a probability distribution 
that exhibits large skewness or kurtosis. Compared with a standard 
normal distribution or bell curve, it has a higher probability of 
occurrence of extreme events.
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    The uniform scale factor resulting from the calculations described 
above is applied as a multiplier to hypothetical returns on a long 
portfolio of equities produced during the Monte Carlo market scenarios 
run within STANS. By ``scaling up'' hypothetical returns in this way, 
the uniform scale factor relies on an assumption that more recent 
behavior of SPX returns will provide an appropriate proxy for the 
volatility in equity price returns that occur between monthly updates 
of price data for the pending short-run time series. Accordingly, the 
uniform scale factor helps OCC set margin requirements that account for 
this proxy to ensure that Clearing Members maintain margin assets that 
would be sufficient in light of historical volatility of the SPX.
Proposed Changes to the Uniform Scale Factor for Equity-Based Products
    The average longer-run volatility forecast used in OCC's 
computation of the uniform scale factor currently relies on daily 
pricing information for component securities of the SPX dating back to 
January of 1946. This time series predates, however, the 1957 
introduction of the SPX. To accurately account for the behavior of SPX 
returns only since the inception of the index, OCC proposes to adjust 
the longer-run volatility forecast so that it would rely only on the 
post-1957 information. OCC believes that this approach would reduce 
model risk \11\ and improve the quality of the data by avoiding the 
need to make assumptions related to the composition of the index before 
its actual development.\12\
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    \11\ OCC defines ``model risk'' as the potential for adverse 
consequences of incorrect or misused model outputs and reports.
    \12\ As defined in OCC's Model Risk Management Policy, Model 
Risk, in the sense of material exposure to the consequences of poor 
assumptions, is reduced by making models adhere accurately to 
observed phenomena. In this case, by reducing the role of the 
uniform scale factor as a proxy between monthly updates of 
univariate models for risk factors and by allowing certain risk 
factors to bypass the monthly update process, as described below, 
OCC believes that this proposed change would reduce model risk.
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Proposed New Scale Factors for Equity-Based Products
    To more accurately measure the relationship between current and 
long-run market volatility with proxies that correlate more closely to 
certain products carried within the equity asset class, OCC proposes to 
expand the number of scale factors to include: (1) Russell 2000[supreg] 
Index (12/29/1978); (2) Dow Jones Industrial Average Index (9/23/1997); 
(3) NASDAQ-100 Index (2/4/1985) and (4) S&P 100 Index (1/2/1976).\13\ 
While the SPX scale factor will continue to serve as the default scale 
factor for most equity products, the index options, futures and ETFs 
which map to these indexes will be assigned to these scale factors and 
whose current volatility estimates will be adjusted

[[Page 78226]]

based on the aforementioned methodology.
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    \13\ The dates in parentheticals are the dates from which OCC 
has historical data on the specified index.
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    Consistent with OCC's existing Margin Policy,\14\ OCC will evaluate 
the performance and use of these scale factors and determine if changes 
to the mapping of products to scale factors or the addition of new 
scale factors are warranted. Prior to any changes being implemented OCC 
would present its findings to the Enterprise Risk Management Committee 
and obtain approval to make the recommended enhancements.
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    \14\ OCC's Margin Policy describes OCC's approach to prudently 
managing market and credit exposures presented by its Clearing 
Members.
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Proposed Anti-Procylical [sic.] Measure for Equity-Based Scale Factors
    In order to mitigate against pro-cyclicality, OCC intends to apply 
the relevant scale factor to the greater of (i) the estimated variance 
of the 1-day return scenarios or (ii) the historical variance of the 
daily return scenarios of a particular instrument, as a floor. OCC 
believes this floor would mitigate pro-cyclicality in the relevant 
return scenarios because it would result in a higher estimate of 
volatility during periods of relatively lower market volatility than if 
only the estimated variance in (i) above was used.
Scale Factor for Non-Equity-Based Products
Proposed New Scale Factors for Non-Equity-Based Products
    In addition to equity products, OCC has observed a growth in the 
open interest in other asset classes, most notably the volatility asset 
class, for which an equity-based scale factor would not be applicable 
based on negligible correlations observed. To be able to monitor and 
respond to material changes in the volatility of these asset classes 
while also mitigating pro-cyclicality, OCC proposes to introduce 
additional scale factors in STANS related to volatility contracts.
    For the volatility asset class, different from equities, volatility 
characteristics are differentiated based on the term of an instrument. 
As a result, the implementation of the scale factor will be different 
from the implementation for the equity asset class. Individual products 
would be linked within STANS to a particular scale factor not only in 
accordance with price correlations, but will also consider term 
structure (i.e., non-equity futures contracts of different 
maturities).\15\
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    \15\ OCC would adopt scale factors specific to existing 
volatility indices, which include volatility indices on the S&P 500 
(VIX and VXST), Russell 2000 (RVX), gold (GVZ), oil (OVX), emerging 
markets (VXEEM), Brazil (VXEWZ), Nasdaq 100 (VXN) and 10-year 
Treasury Notes (VXTYN).
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    With regard to the scale factor(s) applicable to implied volatility 
indexes, the data set would consist of index closing prices for certain 
volatility indices with a time series that would run from October 1, 
2004 (based on available historical data). Applying scale factors to 
hypothetical returns in this asset class, as is done today for equity-
based products, will help ensure that OCC's margin requirements capture 
shifts in market volatility in these non-equity asset classes, and OCC 
believes these enhancements would generally promote a more accurate 
approach to margining within STANS,\16\ particularly when markets are 
volatile.
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    \16\ See notes. 4 & 8, supra.
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Proposed Daily Statistical Updates for the Treasury Yield Curve Model
    In addition to implementing the scale factors described above, OCC 
is also proposing to implement processing changes that would update the 
statistical models for common factors related to Treasury securities on 
a daily basis. These model changes would allow OCC to monitor and 
respond to material changes in the volatility of Treasury securities 
while also mitigating pro-cyclicality without implementing a scale 
factor specific to Treasury securities. OCC believes that updating its 
Treasury securities models on a daily basis is a more appropriate way 
to monitor and respond to material changes in the volatility of 
Treasury securities while also mitigating pro-cyclicality since the 
Treasury yield curve model is relatively less complex, with only three 
factors, and the structure of the Treasuries securities model does not 
lend itself to a returns-based scale factor (as is used with equity and 
volatility derivatives, as described above).
    Specifically, OCC is proposing to enhance its existing yield curve 
model that OCC uses to project U.S. Treasury security returns, which is 
updated monthly. The model contains underlying data set and time series 
information for Treasury securities, which run from February 4, 2008 
(based on available historical data) and, after implementing the 
proposed enhancements, the model would be updated on a daily basis as 
new data and time series information becomes available. The proposed 
enhancements would promote a more accurate approach to margining within 
STANS, as it relates to Treasury securities, particularly when markets 
are volatile because the daily statistical updates would prevent the 
model from becoming stale between monthly updates.
Impact Analysis and Outreach
    Based on simulation testing for the period from January 14, 2015, 
to March 6, 2015, risk margins (i.e., expected shortfall plus the 
concentration/dependence add-on) would have been 5.2% higher in 
aggregate as a consequence of these changes. This is mostly due to 
higher coverage for the Russell 2000 Index and index ETF products under 
the new methodology. The absolute variation in risk margins relative to 
production was greater than 5% of Clearing Member capital for about 11% 
of Clearing Member-days over the simulation period.
    In order to inform Clearing Members of the proposed change, OCC 
provided a general update at a recent OCC Roundtable \17\ meeting and 
would continue to provide updates at Roundtable meetings on a quarterly 
basis going forward. In addition, OCC would publish an Information 
Memorandum to all Clearing Members describing the proposed change and 
will provide additional periodic Information Memoranda updates prior to 
the implementation date. OCC would also provide at least thirty days 
prior notice to Clearing Members before implementing the change. 
Additionally, OCC would perform targeted and direct outreach with 
Clearing Members that would be most impacted by the proposed change and 
OCC would work closely with such Clearing Members to coordinate the 
implementation and associated funding for such Clearing Members 
resulting from the proposed change.\18\ Finally, OCC would discuss the 
proposed change with its cross-margin clearing house partners to ensure 
they are aware of the proposed change.\19\
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    \17\ The OCC Roundtable was established to bring Clearing 
Members, exchanges and OCC together to discuss industry and 
operational issues. It is comprised of representatives of the senior 
OCC staff, participant exchanges and Clearing Members, representing 
the diversity of OCC's membership in industry segments, OCC-cleared 
volume, business type, operational structure and geography.
    \18\ Specifically, OCC will discuss with those Clearing Members 
how they plan to satisfy any increase in their margin requirements 
associated with the proposed change.
    \19\ Cross-margin accounts are not uniquely affected by the 
proposed change and would be affected by the proposed change in the 
same manner as any other type of OCC account.
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2. Statutory Basis
    OCC believes that the proposed rule changes are consistent with 
Section

[[Page 78227]]

17A(b)(3)(F) of the Act,\20\ because they would assure the safeguarding 
of securities and funds in the custody and control of OCC by enhancing 
the current approach for monitoring market conditions and performing 
adjustments to OCC's margin coverage on both equity and non-equity 
based derivatives products for which OCC provides clearance and 
settlement services when current volatility increase beyond 
historically observed levels. OCC uses the margin it collects from a 
defaulting Clearing Member to protect other Clearing Members from loss 
as a result of the defaulting Clearing Member. By more accurately 
computing Clearing Member margin requirements OCC can assure the 
safeguarding of securities and funds in its custody and control.
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    \20\ 15 U.S.C. 78q-1(b)(3)(F).
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    The proposed model changes described above would enhance the manner 
in which OCC computes margin requirements for Clearing Members. 
Specifically, the proposed changes to the Uniform Scale Factor for 
equity-based products to rely only on post-1957 information would 
reduce model risk and improve the quality of data by avoiding 
unnecessary assumptions related to the composition of the SPX before 
its inception. The proposed four new scale factors for equity-based 
products would more accurately measure the relationship between current 
and long-run market volatility with proxies that are correlated more 
closely to certain products within the equity asset class. The proposed 
introduction of new scale factors for non-equity based products, for 
both the volatility assets class and the implied volatility indexes 
will promote a more accurate approach to margining STANS, when markets 
experience shifts in volatility. The proposed daily statistical updates 
for the Treasury yield curve model would allow OCC to monitor and 
response to material changes in the volatility of Treasury securities 
while also mitigating pro-cyclicality. Taken together, the changes to 
the uniform scale factor, the addition of new equity-based scale 
factors, the addition of non-equity based scale factors and 
introduction of daily statistical updates for the Treasury yield curve 
model cause STANS to more accurately compute Clearing Member margin 
requirements to reflect the risk of Clearing Member portfolios thereby 
reducing the risk that Clearing Member margin assets would be 
insufficient should OCC need to use such assets to close-out the 
positions of a defaulted Clearing Member. Further, the proposed rule 
changes would make it less likely that the default of a Clearing Member 
would stress the financial resources available to OCC, which include 
mutualized resource funds deposited by non-defaulting Clearing Members 
as Clearing Fund.
    OCC believes that the proposed rule changes are also consistent 
with Rule 17Ad-22(b)(2) \21\ because they would limit OCC's credit 
exposures to its participants under normal market conditions and use 
risk-based models and parameters to set OCC's margin requirements. As 
described above, the risk-based model and parameter changes to the 
uniform scale factor, the addition of new equity-based scale factors, 
the addition of non-equity based scale factors and introduction of 
daily statistical updates for the Treasury yield curve model cause 
STANS to more accurately compute Clearing Member margin requirements. 
By more accurately computing Clearing Member margin requirements, OCC 
reduces its credit exposure to its Clearing Members.
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    \21\ 17 CFR 240.17Ad-22(b)(2).
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    The proposed rule changes are not inconsistent with the existing 
rules of OCC, including any other rules proposed to be amended.

(B) Clearing Agency's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impact or 
impose any burden on competition.\22\ The proposed rule change would 
allow OCC to adjust Clearing Member margin requirements when current 
volatility increases beyond historical levels. While as a result of the 
proposed rule change Clearing Members may experience daily margin 
fluctuations of up to ten percent, such fluctuations are equal in 
amount to fluctuations Clearing Members typically experience as a 
result of changes in market price, volatility or interest rates. 
Therefore, OCC believes that 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. In addition, the 
proposed rule change would be applied uniformly to all Clearing Members 
in establishing their margin requirements.
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    \22\ 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 
impact or 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 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-2016-013 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-OCC-2016-013. 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

[[Page 78228]]

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 
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/components/docs/legal/rules_and_bylaws/sr_occ_16_013.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-2016-013 and 
should be submitted on or before November 28, 2016.
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    \23\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated Authority.\23\
Brent J. Fields,
Secretary
[FR Doc. 2016-26791 Filed 11-4-16; 8:45 am]
 BILLING CODE 8011-01-P