[Federal Register Volume 82, Number 24 (Tuesday, February 7, 2017)]
[Notices]
[Pages 9613-9617]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-02443]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79915; File No. SR-OCC-2017-801]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Advance Notice Concerning The Options Clearing 
Corporation's Margin Coverage During Times of Increased Volatility

February 1, 2016.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 (``Payment, Clearing 
and Settlement Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the 
Securities Exchange Act of 1934 (``Act''),\2\ notice is hereby given 
that on January 4, 2017, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') an 
advance notice described in Items I, II and III below, which Items have 
been prepared by OCC. The Commission is publishing this notice to 
solicit

[[Page 9614]]

comments on the advance notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This proposed 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 Advance Notice

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the advance notice and 
discussed any comments it received on the advance notice. 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 and B below, 
of the most significant aspects of these statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants or Others

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

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, 
Clearing, and Settlement Supervision Act

Purpose of the Proposed Change
    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 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 proposes a number of enhancements to its STANS margin 
methodology that are designed to more accurately compute Clearing 
Member margin requirements to reflect the risk of Clearing Member 
portfolios. Specifically, OCC proposes to: (1) Adjust the longer-run 
volatility forecast used in OCC's computation of the uniform scale 
factor so that it would rely only on post-1957 price information (i.e., 
price information since the introduction of the SPX) in order to more 
accurately account for the behavior of SPX returns only since the 
inception of the index; (2) expand the number of scale factors used 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; (3) apply relevant scale factors to the greater of (i) the 
estimated variance of 1-day return scenarios or (ii) the historical 
variance of the daily return scenarios of a particular instrument, as a 
floor to mitigate procyclicality; and (4) implement processing changes 
that would update the statistical models for common factors related to 
Treasury securities on a daily basis. The proposed changes are 
discussed in more detail below.
    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\ By

[[Page 9615]]

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 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-Procyclical 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.

[[Page 9616]]

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 approximately 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.
    In order to inform Clearing Members of the proposed change, OCC 
provided a general update at a recent OCC Roundtable \15\ 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.\16\ Finally, OCC would discuss the 
proposed change with its cross-margin clearing house partners to ensure 
they are aware of the proposed change.\17\
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    \15\ 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.
    \16\ Specifically, OCC will discuss with those Clearing Members 
how they plan to satisfy any increase in their margin requirements 
associated with the proposed change.
    \17\ 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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Consistency With the Payment, Clearing and Settlement Supervision Act
    OCC believes that the proposed change concerning scale factors 
described above is consistent with Section 805(b)(1) of the Payment, 
Clearing and Settlement Supervision Act \18\ because the proposed 
change would promote robust risk management.
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    \18\ 12 U.S.C. 5464(b)(1).
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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 
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, and the introduction of daily statistical 
updates for the Treasury yield curve model would cause STANS to more 
accurately compute Clearing Member margin requirements to reflect the 
risk of Clearing Member portfolios thereby promoting robust risk 
management in that 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 would be reduced. Further, the 
proposed changes would promote robust risk management by making 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.
Anticipated Effect on and Management of Risk
    OCC believes that the proposed changes would reduce the nature and 
level of risk presented to OCC because, in several respects, the 
modification of the uniform scale factor used in STANS and the 
introduction of new scale factors would increase the accuracy of OCC's 
margin calculations. First, OCC would simplify its process for 
establishing the uniform scale factor by basing it on the one-day 
variances \19\ of the SPX returns, rather than an approximation of the 
margin coverage on a hypothetical position in the SPX. OCC believes 
that this simplified approach would mitigate operational and regulatory 
risks by making the approach to the uniform scale factor less complex 
and more readily understood by OCC's staff, regulators and other 
parties interested in OCC's risk management framework.
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    \19\ The one-day conditional variance of a risk factor is the 
variance of the one-day innovation (typically a log-return) one day 
into the future in the sense of random variables (i.e., based on an 
indexed filtration and a probability measure).
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    For use with certain exchange-traded funds, OCC proposes to 
implement in STANS four new scale factors that would be based on the 
Russell 2000[supreg] Index, Dow Jones Industrial Average Index, NASDAQ-
100 Index and S&P 100 Index. The separately forecasted volatility for 
each of these indexes would be represented in the resulting scale 
factor. OCC believes applying a scale factor based on an index to which 
certain exchange-traded funds are more

[[Page 9617]]

closely correlated than the SPX would mitigate risk because it would 
enhance the accuracy of margin requirements in STANS.
    Under the proposed change, a floor of the sample variance would be 
introduced with respect to each scale factor. The sample variance floor 
would mitigate pro-cyclicality risk in the relevant return scenarios 
because it would potentially result in the collection of more margin 
during periods of relatively lower market volatility. In the absence of 
using the sample variance as a floor, the margin collected could drop 
significantly during periods of low volatility and then dramatically 
increase when, between monthly updates to a pending time series, market 
events cause increases in the variance of the underlying data set for 
the scale factor.
    OCC would also 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. 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 mitigate the risk that the 
model would become stale between monthly updates.
    For the foregoing reasons, OCC believes that the proposed change 
would enhance OCC's management of risk and reduce the nature or level 
of risk presented to OCC.

III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date the proposed change was filed with the Commission or (ii) the date 
any additional information requested by the Commission is received. OCC 
shall not implement the proposed change if the Commission has any 
objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission or the Board of Governors of the Federal Reserve System 
providing the clearing agency with prompt written notice of the 
extension. A proposed change may be implemented in less than 60 days 
from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    OCC shall post notice on its Web site of proposed changes that are 
implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the advance 
notice 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-2017-801 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-OCC-2017-801. 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 advance notice that are filed 
with the Commission, and all written communications relating to the 
advance notice 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_17_801.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-2017-801 and 
should be submitted on or before February 28, 2017.

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-02443 Filed 2-6-17; 8:45 am]
 BILLING CODE 8011-01-P