[Federal Register Volume 84, Number 218 (Tuesday, November 12, 2019)]
[Notices]
[Pages 61114-61120]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-24549]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87476; File No. SR-OCC-2019-807]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Advance Notice Related to Proposed Changes to The
Options Clearing Corporation's Rules, Margin Policy, Margin
Methodology, Clearing Fund Methodology Policy, and Clearing Fund and
Stress Testing Methodology To Address Specific Wrong-Way Risk
November 6, 2019.
Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act, entitled Payment, Clearing
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'')
\1\ and Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of
1934 (``Act'' or ``Exchange Act''),\3\ notice is hereby given that on
October 10, 2019, the Options Clearing Corporation (``OCC'') filed with
the Securities and Exchange Commission (``Commission'') an advance
notice 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 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).
\3\ 15 U.S.C. 78a et seq.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
This advance notice is submitted in connection with proposed
enhancements to OCC's Rules, margin policy and methodology, Clearing
Fund policy, and Clearing Fund and stress testing methodology to adopt
new margin charges and other risk measures to address the specific
wrong-way risk presented by certain cleared positions.
The proposed amendments to OCC's Rules are included in Exhibit 5A
of the filing. The proposed amendments to OCC's Margin Policy and
Margins Methodology are included in Exhibits 5B and 5C, respectively.
The proposed amendments to OCC's Clearing Fund Methodology Policy
(``CFM Policy'') and Stress Testing and Clearing Fund Methodology
Description (``Methodology Description'') are included in Exhibits 5D
and 5E, respectively. Material proposed to be added to the Rules,
Margin Policy and Margins Methodology as currently in effect is marked
by underlining, and
[[Page 61115]]
material proposed to be deleted is marked in strikethrough text;
however, the proposed Specific Wrong-Way Risk Add-On chapter of the
Margins Methodology is presented without marking to improve readability
as the entire chapter is newly proposed rule text.\4\ Material proposed
to be added to the CFM Policy and Methodology Description is marked by
double underlining, and material proposed to be deleted is marked in
double strikethrough text.\5\
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\4\ OCC also has filed a proposed rule change with the
Commission in connection with the proposed changes. See SR-OCC-2019-
010.
\5\ OCC also filed with the Commission proposed rule change and
advance notice filings concerning enhancements to its CFM Policy and
Methodology Description, which are currently pending Commission
review. See OCC filings SR-OCC-2019-009 and SR-OCC-2019-806. OCC has
marked proposed changes to the CFM Policy and Methodology
Description described herein in double marking to clearly
differentiate those changes from other changes currently pending
Commission review.
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The advance notice is available on OCC's website at https://www.theocc.com/about/publications/bylaws.jsp. All terms with initial
capitalization that are not otherwise defined herein have the same
meaning as set forth in the OCC By-Laws and Rules.\6\
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\6\ OCC's By-Laws and Rules can be found on OCC's public
website: http://optionsclearing.com/about/publications/bylaws.jsp.
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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
Written comments were not and are not intended to be solicited with
respect to the advance notice and none have been received. OCC will
notify the Commission of any written comments received by OCC.
(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment,
Clearing, and Settlement Supervision Act
Description of the Proposed Change
Background
As a central counterparty (``CCP''), OCC is exposed to wrong-way
risk, which is the risk that arises when exposure to a counterparty is
adversely correlated with the credit quality and probability of default
of that counterparty. Specific wrong-way risk (``SWWR'') arises when an
exposure to a participant is highly likely to increase when the
creditworthiness of that participant is deteriorating.\7\ For example,
SWWR arises where a Clearing Member's cleared positions contain equity
securities issued by the Clearing Member or its affiliates (i.e., the
Clearing Member Group) (such positions referred to herein as ``SWWR
Equity positions'') as the equity issued by the Clearing Member Group
may be assumed to have a price at or near zero in a default or
bankruptcy scenario, and those positions (e.g., equity used as a hedge,
stock loans, options on equity, single-stock futures) may experience
substantial losses. In addition, SWWR may arise where uncollateralized
exchange-traded notes (``ETNs'') issued by a Clearing Member or its
affiliates (``SWWR ETN positions'') are part of the Clearing Member's
cleared positions (these positions, collectively with ``SWWR Equity
positions,'' are hereinafter referred to as ``SWWR positions''). SWWR
may also arise when a Clearing Member posts equity securities or ETNs
issued by it or of its affiliates as margin collateral.
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\7\ See Securities Exchange Act Release No. 78961 (September 28,
2016), 81 FR 70786, 70816, n. 317 (October 13, 2016) (S7-03-14)
(``Standards for Covered Clearing Agencies''). See also Committee on
Payment and Settlement Systems and Technical Committee of the
International Organization of Securities Commissions, Principles for
financial market infrastructures (Apr. 16, 2012), available at
http://www.bis.org/publ/cpss101a.pdf.
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OCC currently accounts for SWWR as it relates to margin collateral
by generally prohibiting a Clearing Member from pledging equities
issued by it or one of its affiliates as margin collateral unless this
pledge provides a hedge against a cleared position in the same
account.\8\ OCC does not, however, currently account for SWWR as it
relates to cleared positions. As a result, OCC is proposing a new
``add-on'' charge \9\ for its margin methodology, the System for
Theoretical Analysis and Numerical Simulations (``STANS''),\10\ and new
stress test scenarios that may result in intra-day margin calls and, in
more extreme cases, intra-month increases in the size of OCC's Clearing
Fund \11\ to address the wrong-way risk of OCC's cleared positions
involving Clearing Member-issued securities. In addition, OCC proposes
to introduce certain restrictions on stock lending activity related to
SWWR positions.
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\8\ See OCC Rule 604, Interpretation and Policy .16.
\9\ Under OCC's Margin Policy, OCC may collateralize certain
exposures through the use of add-on charges.
\10\ 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/.
\11\ Under OCC's existing stress testing and Clearing Fund
methodology, OCC runs on a daily basis a set of stress test
scenarios designed to measure the exposure of the Clearing Fund to
the portfolios of individual Clearing Member Groups and determine
whether any such exposure is sufficiently large as to necessitate
OCC calling for additional resources so that OCC continues to
maintain sufficient financial resources to guard against potential
losses under a wide range of stress scenarios, including extreme but
plausible market conditions (``Sufficiency Scenarios,'' and such
scenarios collectively constituting ``Sufficiency Stress Tests'').
See Securities Exchange Act Release No. 83714 (July 26, 2018), 83 FR
37570 (August 1, 2018) (SR-OCC-2018-803) and Securities Exchange Act
Release No. 83735 (July 27, 2018), 83 FR 37855 (August 2, 2018) (SR-
OCC-2018-008). Under OCC Rule 609, the CFM Policy, and the
Methodology Description, if a Sufficiency Stress Test identifies
exposures that exceed 75% of the current Clearing Fund requirement
less deficits (the ``75% threshold'' or ``Sufficiency Stress Test
Threshold 1''), OCC may require additional margin deposits from the
Clearing Member Group(s) driving the breach. If a Sufficiency Stress
Test identifies exposures that exceed 90% of the current Clearing
Fund, OCC would perform an intra-month resizing of the Clearing
Fund. Id.
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Proposed Changes
OCC proposes to enhance its management of SWWR by: (1) Imposing
certain restrictions on stock lending activity at OCC; (2) adopting a
new SWWR margin add-on for STANS (``SWWR Add-on''); (3) introducing new
stress test scenarios to capture the SWWR of cleared positions
involving Clearing Member-issued ETNs beyond certain pre-defined
thresholds; and (4) making other clarifying and conforming changes to
the CFM Policy and Methodology Description. The proposed changes are
intended to address the credit risks arising from SWWR positions at
OCC. The proposed changes are described in detail below.
1. Prohibition on Lending Clearing Member/Affiliate-Issued Securities
OCC operates two programs for stock loan transactions: (1) The
Stock Loan/Hedge Program and (2) the Market Loan Program (collectively,
the ``Stock Loan Programs''). In the Stock Loan/Hedge Program,
prospective Lending and Borrowing Clearing Members identify each other
(independent of OCC), agree to bilaterally negotiated terms of the
stock loan (in this case, a ``Hedge Loan''), and then send the details
of the stock loan to the Depository Trust Company (``DTC'') designating
the stock loan as a Hedge Loan for guaranty and clearance at OCC. The
Lending Clearing Member then instructs DTC to transfer
[[Page 61116]]
a specified number of shares of Eligible Stock \12\ to the account of
the Borrowing Clearing Member, and the Borrowing Clearing Member
instructs DTC to transfer the appropriate amount of cash collateral to
the account of the Lending Clearing Member. In the Market Loan Program,
stock loans are initiated through the matching of bids and offers that
are either agreed upon by the Market Loan Clearing Members or matched
anonymously through a Loan Market (such stock loans being ``Market
Loans''). In order to initiate a Market Loan, the Loan Market sends a
matched transaction to OCC, which in turn sends two separate but linked
settlement instructions to DTC to effect the movement of Eligible Stock
and cash collateral between the accounts of the Market Loan Clearing
Members through OCC's account at DTC.
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\12\ OCC's By-Laws define ``Eligible Stock'' to mean, in part,
any security that is eligible for lending in the Stock Loan/Hedge
Program and the Market Loan Program. See Article I, Section 1.E(3)
of the OCC By-Laws. Eligible Stock may include ETNs issued by OCC's
Clearing Members.
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Regardless of whether a transaction is initiated under the Stock
Loan/Hedge Program or Market Loan Program, OCC novates the transaction
and becomes the lender to the Borrowing Clearing Member and the
borrower to the Lending Clearing Member. As the principal counterparty
to the Borrowing and Lending Clearing Members, OCC guarantees the
return of the full value of cash collateral to a Borrowing Clearing
Member and guarantees the return of the Loaned Stock (or value of that
Loaned Stock) to the Lending Clearing Member.\13\ As noted above, OCC
may be exposed to SWWR in its Stock Loan Programs where Clearing
Members lend equity securities or ETNs issued by the Clearing Member or
its affiliates. Specifically, the lending of Clearing Member or Member
Affiliate-issued equity or ETNs creates a long exposure and liability
in the case when a Clearing Member defaults and its own or affiliated
equity or ETN declines.
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\13\ Under the Market Loan Program, OCC also provides a limited
guaranty of dividend and rebate payments.
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OCC proposes to mitigate SWWR in its Stock Loan Programs by
prohibiting Clearing Members from lending any Eligible Stock issued by
such Clearing Member or any affiliate of such Clearing Member. The
proposed restriction would apply to both SWWR Equity positions and SWWR
ETN positions. OCC does not believe that the proposed restriction on
lending SWWR Equity positions would have a material impact on Clearing
Members in the Stock Loan Programs as Clearing Members do not typically
engage in lending of their own equity securities and borrowers
typically do not accept equity securities issued by their lending
counterparty.\14\ The proposed restrictions on lending SWWR ETN
positions would, however, impact a very small segment of Clearing
Members that lend SWWR ETNs.\15\ OCC believes that the impact of the
proposed changes would be limited by the fact that, unlike listed
options, Clearing Members are able to lend SWWR positions on an
uncleared basis outside of OCC. The proposed restrictions on lending
activity in the Stock Loan Programs would not prevent Clearing Members
from lending equities or ETNs issued by the Clearing Member or any
affiliate of such Clearing Member on a bilateral basis if members wish
to do so.
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\14\ As of the start of September 2019, OCC had 107 Clearing
Members, of which 64 have member or affiliate-issued securities
eligible for lending in the Stock Loan Programs. OCC analyzed SWWR
Equity lending activity for its Clearing Members from January 2018
through the beginning of September 2019. During this period, less
than 10 Clearing Members had stock lending activity in SWWR Equity
positions, and loans of SWWR Equity positions constituted less than
three percent of each of those Clearing Members' average notional
stock lending activity for the period.
\15\ OCC analyzed SWWR ETN lending activity for its Clearing
Members from January 2018 through the beginning of September 2019.
Only 11 of OCC's 107 Clearing Members have member or affiliate
issued ETNs. During this period, less than 10 Clearing Members had
stock lending activity for SWWR ETN positions. For the majority of
these Clearing Members, lending in SWWR ETN positions constituted
approximately 13 percent or less of each of those Clearing Members'
average notional stock lending activity for the period. For Clearing
Members that averaged higher notational lending activity, OCC has
observed significant reductions in this activity over recent months.
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The proposed prohibition on lending Clearing Member or Member
Affiliate-issued Eligible Stock would be included in new OCC Rules
2202(f) and 2202A(f) for the Stock Loan/Hedge Program and Market Loan
Program, respectively. OCC would also make conforming changes to its
Margin Policy and Margins Methodology to reflect the newly proposed
restrictions in stock lending activity.
The proposed change would only apply to stock lending activity as
of the time of implementation of the proposed change. The proposed
change would not be applied retroactively to existing open positions,
and Clearing Members with open stock loans involving Clearing Member or
Member Affiliate-issued Eligible Stock would not be forced to terminate
those existing positions. Any SWWR stock lending positions in existence
as of the implementation of the proposed change would be subject to the
SWWR charges described below until such positions are closed out
through the normal course stock loan termination process.
2. SWWR Add-on
OCC proposes to adopt a new margin add-on (i.e., the SWWR Add-on)
to address SWWR from cleared positions involving Clearing Member and
affiliate issued equities and ETNs. The SWWR Add-on would be calculated
for each margin tier account of a Clearing Member Group having
positions related to either publicly traded equities or ETNs issued by
the Clearing Member Group and would cover all types of positions
(equity used as collateral, equity and ETN options, single-stock
futures). The proposed SWWR Add-on is comprised of three main
components: (1) ``SWWR Equity Charge,'' (2) ``SWWR ETN Charge,'' and
(3) ``SWWR Residual.'' Each of these components is discussed below.
a. SWWR Equity Charge
Under the proposal, when a Clearing Member defaults, it is assumed
that the price of any equity security issued by the Clearing Member
Group would fall to zero. As a result, OCC would calculate the SWWR
Equity Charge by assuming that a Clearing Member's and its affiliates'
equity securities would be priced at zero and value all cleared
positions accordingly (i.e., all stocks, single stock futures, call
options, and put options would be valued at zero) to provide full
protection for the risk of potential market exposure to products on a
Clearing Member Group's own equity in a default or bankruptcy scenario.
In each margin account, the profit and loss (``P&L'') of SWWR Equity
positions would be calculated as the difference of the theoretical
value of such securities (i.e., zero) and the closing price of the
position multiplied by the net quantity.\16\ Moreover, any potential
gain from the SWWR positions would be excluded by flooring the SWWR
Equity Charge at zero.\17\ As a result, OCC believes that the proposed
SWWR Equity Charge would adequately cover the SWWR arising from a
Clearing Member's SWWR Equity positions.
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\16\ Because SWWR of equity-related positions would be fully
covered as part of margins, these positions would be removed from
Clearing Fund shortfall calculations under OCC's stress testing and
Clearing Fund methodology. Accordingly, OCC proposes to revise its
Methodology Description to reflect the exclusion of SWWR Equity
positions from the synthetic accounts used in OCC's stress testing.
\17\ For example, suppose the P&L from the SWWR equity price
going to 0 for all SWWR equity-related positions were a loss of $1
million. The SWWR Equity Charge in this case would be $1 million. If
the P&L were a gain of $1 million, the SWWR Equity Charge would be
$0.
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b. SWWR ETN Charge
In addition to SWWR that arises from equity securities issued by a
Clearing Member or its affiliates, OCC is also exposed to SWWR from
open positions related to the uncollateralized ETNs issued by a
Clearing Member/Group, which are adversely correlated with the credit
quality of that Clearing Member Group. These ETNs are generally
equivalent to unsecured senior debt issued by the Clearing Member/
Group. While a Clearing Member default can be triggered by its failure
to meet other obligations, the firm may or may not default on its ETNs.
Hence, the recovery rate for ETNs is uncertain and could be between 0%
and 100%.
To address SWWR presented by ETNs issued by a Clearing Member/
Group, OCC proposes to calculate an SWWR ETN Charge as part of the SWWR
Add-on. OCC notes that, unlike SWWR Equity positions, for which it is
assumed that the price of any equity security issued by the Clearing
Member Group would fall to zero, the recovery rate for ETNs would not
necessarily fall to zero. As a result, the proposed SWWR ETN Charge
would utilize an industry standard recovery rate assumption designed to
reflect the credit risk associated with such ETN positions.\18\ OCC
would also adopt additional stress test scenarios to monitor and
measure SWWR ETN position exposures and allow for OCC to call for
additional financial resources from its Clearing Members when certain
thresholds are breached. These SWWR stress test scenarios are discussed
in further detail below.
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\18\ ETNs issued by a Clearing Member Group would still be
stressed in OCC's Clearing Fund as only a part of the credit risk is
covered by the SWWR ETN Charge. Additionally, any credit from margin
assets would be adjusted by the direct charges related to the risk
of the equity and ETNs issued by each Clearing Member Group.
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c. SWWR Residual
To ensure that OCC appropriately calculates margins to capture SWWR
Equity and SWWR ETN position exposures, OCC proposes to include an SWWR
Residual component in SWWR Add-on. Under the proposal, OCC would
continue to calculate base STANS margin requirements for Clearing
Members with SWWR positions including SWWR Equity and SWWR ETN
positions under its current methodology (i.e., without assuming that
all SWWR Equity positions fall to a value of zero and without assuming
all SWWR ETN positions are valued at the recovery rate times their
current price).\19\ OCC would then also calculate a residual STANS
margin with the SWWR Equity and SWWR ETN positions removed since for
SWWR their P&L would be captured through the SWWR Equity and SWWR ETN
Charges. The SWWR Residual would then be the difference between the
residual margin and the base margin. If the sum of the SWWR Equity
Charge, SWWR ETN Charge and SWWR Residual would result in a net credit
to the Clearing Member,\20\ then the SWWR Residual would be adjusted to
ensure that OCC always uses a more conservative measure that captures
the greater of either the base STANS margin or the residual STANS
margin plus the SWWR Equity and SWWR ETN Charges.\21\
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\19\ STANS margin requirements are comprised of the sum of
several components, each reflecting a different aspect of risk. The
base component of the STANS margin requirement for each account is
obtained using a risk measure known as 99% Expected Shortfall. The
Expected Shortfall component is established as the estimated average
of potential losses higher than the 99% value at risk threshold. The
term ``value at risk'' or ``VaR'' refers to a statistical technique
that, generally speaking, is used in risk management to measure the
potential risk of loss for a given set of assets over a particular
time horizon. This base component is then adjusted by the addition
of a stress test component, which is obtained from consideration of
the increases in 99% Expected Shortfall that would arise from market
movements that are especially large and/or in which various kinds of
risk factors exhibit perfect or zero correlations in place of their
correlations estimated from historical data (``Dependence Add-on''),
or from extreme adverse idiosyncratic movements in individual risk
factors to which the account is particularly exposed
(``Concentration Add-on'').
\20\ For example, where a customer of a Clearing Member has net
short positions referencing that Clearing Member's issued equities,
such positions may actually present so-called ``right-way risk''
whereby the position would result in a gain or margin credit for
that account as the credit quality of the Clearing Member
deteriorates.
\21\ For example, suppose that there are no SWWR ETN positions
and the Expected Shortfall of a portfolio including all positions
was a $10 million loss and the Expected Shortfall with the SWWR
Equity-related positions removed was a greater loss of $11 million.
In this case, the SWWR Residual would be -$1 million. If the
Expected Shortfall with the SWWR Equity-related positions removed
was reduced to a loss of $9 million then the SWWR Residual would
depend on the SWWR Equity Charge: If the SWWR Equity Charge was more
negative than -$1 million, then the SWWR Residual would be +$1
million; if the SWWR Equity Charge was $0, then SWWR Residual would
be $0; and if SWWR Equity Charge was between $0 and -$1 million
(e.g., -$0.4 million), then SWWR Residual would be positive and the
opposite value of SWWR Equity Charge (e.g., +$0.4 million). Thus,
the sum of the SWWR Equity Charge, SWWR ETN Charge, and SWWR
Residual cannot be positive.
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3. Enhancements to Sufficiency Stress Test Scenarios for ETNs
OCC proposes to revise its CFM Policy and Methodology Description
to introduce new stress test scenarios designed to capture SWWR
exposures for Clearing Member-issued ETNs that are not accounted for in
the SWWR ETN Charge and that exceed certain thresholds of OCC's
Clearing Fund (``SWWR Sufficiency Scenarios'').\22\ Under the proposal,
certain Sufficiency Scenarios \23\ would be evaluated with Clearing
Member-issued ETNs declining to zero within the respective Clearing
Member's accounts. Such scenarios would include, but would not be
limited to, the 1987 ``Black Monday'' market event on a Cover 1 basis
and the two most extreme moves from the 2008 historical market event on
a Cover 2 basis.
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\22\ OCC notes that it may also develop additional Informational
Scenarios to monitor SWWR; however, these Informational Scenarios
would not be used to call for additional financial resources from
Clearing Members.
\23\ See supra note 1111.
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SWWR Sufficiency Scenarios would value Clearing Member-issued ETNs
at a price of zero within their own accounts capturing impacts to any
cleared positions tied to those ETNs. Calls, equities, and single-stock
futures would all be valued at zero and puts would be valued at their
strike price. For these scenarios, margin assets for shortfall
calculations would not be adjusted by the SWWR ETN Charge. In addition,
other scenarios may be created that embed the SWWR Equity risk by not
excluding positions related to the Clearing Member Group's own equity
but using an equity price of zero to value all related products.
In the event an SWWR Sufficiency Scenario identifies exposures that
exceed 75% of the current Clearing Fund requirement less deficits, OCC
may require additional margin deposits from the Clearing Member
Group(s) driving the breach. If an SWWR Sufficiency Stress Scenario
identifies exposures that exceed 90% of the current Clearing Fund, OCC
would perform an intra-month resizing of the Clearing Fund. The
proposed change would enable OCC to more accurately measure its credit
risks as they relate to SWWR and better test the sufficiency of its
overall financial resources and would allow OCC to call for additional
financial resources when SWWR ETN position exposures exceed certain
thresholds of OCC's Clearing Fund. As a result of these proposed
enhancements, OCC believes it would have sufficient financial resources
to cover the SWWR associated with SWWR ETN positions if such positions
were to be liquidated for less than the assumed recovery rate.
OCC notes that, under its current CFM Policy, in the event results
of a daily Sufficiency Stress Test over the final
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five business days preceding the monthly Clearing Fund sizing exceed
90% of the projected Clearing Fund size for the upcoming month, the
Clearing Fund size is set such that the peak Sufficiency Stress Test
draw is no greater than 90% of the Clearing Fund size. OCC proposes to
revise the CFM Policy to provide that OCC generally does not intend to
mutualize exposures resulting from the proposed SWWR Sufficiency
Scenarios and therefore SWWR Sufficiency Scenarios would not be
included for purposes of this anti-procyclicality measure. The proposed
change is generally aligned with OCC's intention to appropriately
charge individual Clearing Members based on the SWWR they bring to OCC.
4. Other Clarifying and Conforming Changes to CFM Policy and
Methodology Description
In addition to the proposed changes described above, OCC would
revise the CFM Policy and Methodology Description to provide that, with
respect to stress test portfolio construction, SWWR single-name equity
positions would be removed from stress test portfolios as they are
fully collateralized in margins. Additionally, the Methodology
Description would be revised to provide that when adding STANS margin
asset amounts to scenario gains and losses, the SWWR Equity Charge,
SWWR ETN Charge, and certain other Add-ons from STANS margin asset
amounts are excluded.
Finally, OCC would revise its Methodology Description to clarify
that for Idiosyncratic Scenarios,\24\ the four riskiest names used to
calculate idiosyncratic stress test exposures would exclude any equity
issued by the Clearing Member's own firms and make other clarifying,
non-substantive changes to the Methodology Description concerning
stress testing price shocks for products with multiple risk factors and
Idiosyncratic Scenarios that are unrelated to the proposal described
herein.
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\24\ OCC has proposed in separate proposed rule change and
advance notice filings to adopt a new set of stress scenarios to be
used in the monthly sizing of OCC's Clearing Fund that are designed
to capture the risks of extreme moves in individual or small subsets
of securities (``Idiosyncratic Scenarios''). These Idiosyncratic
Scenarios would consider the four single-name securities with the
worst P&L in a Clearing Member's portfolio. See supra note 5.
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Clearing Member Outreach
To inform Clearing Members of the proposed changes, OCC has
provided an overview of the proposed changes to the Financial Risk
Advisory Council (``FRAC''), a working group comprised of exchanges,
Clearing Members and indirect participants of OCC. OCC has also
performed direct outreach to Clearing Members that would be most
impacted by the proposed changes. To-date, OCC has not received any
material objections or concerns in response to this outreach.
Implementation Timing
OCC expects to implement the proposed changes within sixty (60)
days after the date that OCC receives all necessary regulatory
approvals for the proposed changes. OCC will announce the
implementation date of the proposed change by an Information Memorandum
posted to its public website at least two (2) weeks prior to
implementation.
Expected Effect on and Management of Risk
The proposed changes are designed to enhance OCC's overall
framework for managing credit risk and reduce the overall level of risk
presented to and presented by OCC. OCC believes that prohibiting
Clearing Members from lending their own or Member Affiliate-issued
securities in the Stock Loan Programs and introducing the proposed SWWR
Add-on charge would improve OCC's ability to manage the credit risks
presented by its Clearing Members' SWWR positions and would reduce the
risk that OCC's financial resources would be insufficient in the event
of a Clearing Member default. As a result, the proposed change is
designed, in general, to enhance OCC's framework for measuring and
managing its credit risks so that it can continue to provide prompt and
accurate clearance and settlement of securities and derivatives
transactions in the event of a Clearing Member default.
In addition, OCC believes that introducing new SWWR Sufficiency
Scenarios designed to capture SWWR exposures for Clearing Member-issued
ETNs that are not accounted for in the SWWR ETN Charge would provide
OCC with a more comprehensive approach to managing OCC's credit risks
as they relate to SWWR ETN positions. The proposed change would enable
OCC to more accurately measure its credit risks and better test the
sufficiency of its overall financial resources and would allow OCC to
call for additional financial resources when those exposures exceed
certain thresholds of OCC's Clearing Fund.
OCC also proposes a number of other clarifying and conforming
changes to its CFM Policy and Methodology Description required to
implement the proposed SWWR Add-on and SWWR Sufficiency Scenarios
described herein and to more clearly describe OCC's stress testing
practices. OCC believes that these changes would enhance OCC's overall
framework for measuring and managing its credit risks so that it can
continue to provide prompt and accurate clearance and settlement of
securities in the event of a Clearing Member default.
Consistency With the Payment, Clearing and Settlement Supervision Act
The stated purpose of the Clearing Supervision Act is to mitigate
systemic risk in the financial system and promote financial stability
by, among other things, promoting uniform risk management standards for
systemically important financial market utilities and strengthening the
liquidity of systemically important financial market utilities.\25\
Section 805(a)(2) of the Clearing Supervision Act \26\ also authorizes
the Commission to prescribe risk management standards for the payment,
clearing and settlement activities of designated clearing entities,
like OCC, for which the Commission is the supervisory agency. Section
805(b) of the Clearing Supervision Act \27\ states that the objectives
and principles for risk management standards prescribed under Section
805(a) shall be to:
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\25\ 12 U.S.C. 5461(b).
\26\ 12 U.S.C. 5464(a)(2).
\27\ 12 U.S.C. 5464(b).
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promote robust risk management;
promote safety and soundness;
reduce systemic risks; and
support the stability of the broader financial system.
OCC believes that the proposed changes described herein are
consistent with the objectives and principles of Section 805(b) of the
Clearing Supervision Act \28\ and the risk management standards adopted
by the Commission in Rule 17Ad-22 under the Act for the reasons set
forth below.\29\
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\28\ Id.
\29\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016),
81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards for Covered
Clearing Agencies''). OCC is a ``covered clearing agency'' as
defined in Rule 17Ad-22(a)(5) and therefore must comply with the
requirements of Rule 17Ad-22(e).
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OCC believes the proposed changes are consistent with the
objectives and principles of Section 805(b) of the Clearing Supervision
Act.\30\ The proposed changes are designed to improve OCC's overall
framework for managing SWWR brought by its Clearing Members. OCC
believes that prohibiting Clearing Members from
[[Page 61119]]
lending their own or Member Affiliate-issued securities in the Stock
Loan Programs and introducing the proposed SWWR Add-on charge would
enhance OCC's ability to manage the credit risks presented by its
Clearing Members' SWWR positions and would reduce the risk that OCC's
financial resources would be insufficient in the event of a Clearing
Member default. In addition, OCC believes that introducing new SWWR
Sufficiency Scenarios designed to capture SWWR exposures for Clearing
Member-issued ETNs that are not accounted for in the SWWR ETN Charge
would provide OCC with a comprehensive approach to managing OCC's
credit risks as they relate to SWWR ETN positions. The proposed change
would enable OCC to more accurately measure its credit risks and better
test the sufficiency of its overall financial resources and would allow
OCC to call for additional financial resources when those exposures
exceed certain thresholds of OCC's Clearing Fund. OCC also proposes a
number of other clarifying and conforming changes to its CFM Policy and
Methodology Description required to implement the proposed SWWR Add-on
and SWWR Sufficiency Scenarios described herein and to more clearly
describe OCC's stress testing practices. Accordingly, OCC believes the
proposed changes are designed to promote robust risk management,
promote safety and soundness, reduce systemic risks, and support the
stability of the broader financial system.
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\30\ 12 U.S.C. 5464(b).
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OCC also believes the proposed changes are consistent with the risk
management standards adopted by the Commission in Rule 17Ad-22 under
the Act. Rule 17Ad-22(b)(2) \31\ requires a registered clearing agency
that performs CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to, in
part, use margin requirements to limit its credit exposures to
participants under normal market conditions and use risk-based models
and parameters to set such margin requirements. In addition, Rules
17Ad-22(e)(6)(i) and (v) \32\ require a covered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to cover its credit
exposures to its participants by establishing a risk-based margin
system that, at a minimum: (1) Considers and produces margin levels
commensurate with the risks and particular attributes of each relevant
product, portfolio, and market, and (2) uses an appropriate method for
measuring credit exposure that accounts for relevant product risk
factors and portfolio effects across products.
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\31\ 17 CFR 240.17Ad-22(b)(2).
\32\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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The proposed changes to OCC's margin and Clearing Fund policies and
methodologies to adopt the SWWR Add-on would utilize a risk-based model
designed to limit OCC's credit exposures to Clearing Members that
present SWWR exposure to OCC through the clearing of Clearing Member-
issued equity and ETN positions. OCC believes the proposed SWWR Add-on
is reasonably designed to produce margin levels commensurate with the
risks and particular attributes SWWR Equity and ETN positions and would
use an appropriate method for measuring credit exposure that accounts
for relevant product risk factors such as SWWR.
The proposed SWWR Add-on would include both an SWWR Equity Charge
and SWWR ETN Charge to address the SWWR attributes and exposures
presented to OCC by each type of product. For example, the SWWR Equity
Charge assumes that when a Clearing Member defaults the price of any
equity security issued by the Clearing Member Group would fall to zero.
As a result, OCC would calculate the SWWR Equity Charge by assuming
that a Clearing Member's and its affiliates' equity securities would be
priced at zero and value all cleared positions accordingly to provide
full protection for the risk of potential market exposure to products
on a Clearing Member Group's own equity in a default or bankruptcy
scenario. Moreover, the SWWR Add-on charge would include an SWWR
Residual component to ensure that OCC takes the more conservative of
the base STANS margin requirement or margin requirements including the
SWWR Equity Charge (particularly in circumstances where using the SWWR
Equity Charge would result in a net credit to the Clearing Member).
In addition, OCC would adopt an SWWR ETN Charge to address the SWWR
presented by Clearing Member-issued ETNs. ETNs have different
characteristics than equity securities and more closely reflect those
characteristics of other unsecured debt obligations. For example, if a
Clearing Member defaults that does not necessarily imply that it will
automatically default on its ETNs. Therefore, ETNs are not necessarily
valued at 0 and in fact may retain 100% of their value and be exposed
to normal market risk. OCC proposes to measure the risk of these
positions using an industry standard recovery rate assumption designed
to calculate a margin charge that reflects the expected credit risk
associated with such ETN positions. The potential market risk of the
ETNs would still be covered by including ETNs in regular margin
calculations, whereas the SWWR Equity positions are assumed to be
heading towards bankruptcy and necessarily valued near 0 in a default
situation.
For these reasons, OCC believes the proposed SWWR Add-on would
enhance OCC's margin system by providing for a risk-based model that:
(1) Sets margin requirements designed to limit OCC's SWWR exposures to
its participant; (2) considers and produces margin levels commensurate
with the risks and particular attributes SWWR positions cleared by OCC;
and (3) uses an appropriate method for measuring such SWWR exposures
consistent with the requirements of Rules 17Ad-22(b)(2), (e)(6)(i) and
(e)(6)(v).\33\
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\33\ 17 CFR 240.17Ad-22(b)(2), (e)(6)(i), and (e)(6)(v).
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Rules 17Ad-22(e)(4)(iii) and (vi) \34\ require that a covered
clearing agency establish, implement, maintain and enforce written
policies and procedures reasonably designed to effectively identify,
measure, monitor, and manage its credit exposures to participants and
those arising from its payment, clearing, and settlement processes,
including by: (1) Maintaining additional financial resources at the
minimum to enable it to cover a wide range of foreseeable stress
scenarios that include, but are not limited to, the default of the
participant family that would potentially cause the largest aggregate
credit exposure for the covered clearing agency in extreme but
plausible market conditions and (2) testing the sufficiency of its
total financial resources available to meet these minimum financial
resource requirements. OCC believes that introducing new SWWR
Sufficiency Scenarios designed to capture SWWR exposures for Clearing
Member-issued ETNs that are not accounted for in the SWWR ETN Charge
would enable OCC to more accurately measure its credit risks and better
test the sufficiency of its overall financial resources, particularly
in stressed marked conditions. The proposed change would also allow OCC
to call for additional financial resources when those exposures exceed
certain thresholds of OCC's Clearing Fund. The proposed change is
therefore designed to enhance OCC's overall framework for measuring and
managing its credit risks and would reduce the risk that OCC's
financial resources would be
[[Page 61120]]
insufficient in the event of a Clearing Member default consistent with
Rules 17Ad-22(e)(4)(iii) and (vi).\35\
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\34\ 17 CFR 240.17Ad-22(e)(4)(iii) and (vi).
\35\ Id.
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Rule 17Ad-22(e)(4) \36\ generally requires that a covered clearing
agency establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
arising from its payment, clearing, and settlement processes. By
prohibiting Clearing Members from lending Eligible Stock issued by the
Clearing Member or any affiliate of such Clearing Member, OCC would
mitigate the SWWR that currently exists in its Stock Loan Programs and
thereby reduce the risk that OCC's financial resources would be
insufficient in the event such a Clearing Member would default. OCC
believes the proposed change is therefore reasonably designed to help
OCC manage the credit risks associated with SWWR Equity and SWWR ETN
positions in the Stock Loan Programs and is therefore consistent with
Rule 17Ad-22(e)(4).\37\
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\36\ 17 CFR 240.17Ad-22(e)(4).
\37\ Id.
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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 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 website 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 Clearing Supervision 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-2019-807 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-2019-807. 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 website (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 website 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 the self-regulatory
organization.
All comments received will be posted without change. Persons
submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
All submissions should refer to File Number SR-OCC-2019-807 and
should be submitted on or before November 27, 2019.
By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-24549 Filed 11-8-19; 8:45 am]
BILLING CODE 8011-01-P