[Federal Register Volume 86, Number 68 (Monday, April 12, 2021)]
[Notices]
[Pages 19061-19063]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-07454]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-91491; File No. SR-OCC-2021-801]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection To Advance Notice Relating to OCC's 
Establishment of Persistent Minimum Skin-in-the-Game

April 7, 2021.

I. Introduction

    On February 10, 2021, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-OCC-2021-801 (``Advance Notice'') 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 
(``Exchange Act'') \3\ to establish a persistent minimum level of skin-
in-the-game that OCC would contribute to cover default losses or 
liquidity shortfalls.\4\ The Advance Notice was published for public 
comment in the Federal Register on March 1, 2021,\5\ and the Commission 
has received comments regarding the changes proposed in the Advance 
Notice.\6\ The Commission is hereby providing notice of no objection to 
the Advance Notice.
---------------------------------------------------------------------------

    \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.
    \4\ See Notice of Filing infra note 5, at 86 FR 12057.
    \5\ Securities Exchange Act Release No. 91184 (Feb. 23, 2021), 
86 FR 12057 (Mar. 1, 2021) (File No. SR-OCC-2021-801) (``Notice of 
Filing''). On February 10, 2021, OCC also filed a related proposed 
rule change (SR-OCC-2021-003) with the Commission pursuant to 
Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder 
(``Proposed Rule Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-
4, respectively. In the Proposed Rule Change, which was published in 
the Federal Register on March 2, 2021, OCC seeks approval of 
proposed changes to its rules necessary to implement the Advance 
Notice. Securities Exchange Act Release No. 91199 (Feb. 24, 2021), 
86 FR 12237 (Mar. 2, 2021) (File No. SR-OCC-2021-003). The comment 
period for the related Proposed Rule Change filing closed on March 
23, 2021.
    \6\ Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-occ-2021-801/occ2021801.htm.
    Since the proposal contained in the Advance Notice was also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the Proposed Rule Change or the Advance Notice. 
Comments on the Proposed Rule Change are available at https://www.sec.gov/comments/sr-occ-2021-003/srocc2021003.htm.
---------------------------------------------------------------------------

II. Background \7\
---------------------------------------------------------------------------

    \7\ Capitalized terms used but not defined herein have the 
meanings specified in OCC's Rules and By-Laws, available at https://www.theocc.com/about/publications/bylaws.jsp.
---------------------------------------------------------------------------

    ``Skin-in-the-game,'' as a component of financial risk management, 
entails a covered clearing agency choosing, upon the occurrence of a 
default or series of defaults and application of all available assets 
of the defaulting participant(s), to apply its own capital contribution 
to the relevant clearing or guaranty fund in full to satisfy any 
remaining losses prior to the application of any (a) contributions by 
non-defaulting members to the clearing or guaranty fund, or (b) 
assessments that the covered clearing agency require non-defaulting 
participants to contribute following the exhaustion of such 
participant's funded contributions to the relevant clearing or guaranty 
fund.\8\
---------------------------------------------------------------------------

    \8\ See Securities Exchange Act Release No. 78961 (Sep. 28, 
2016), 81 FR 70786, 70806 (Oct. 13, 2016) (S7-03-14) (``Covered 
Clearing Agency Standards'').
---------------------------------------------------------------------------

    OCC's skin-in-the-game component of its financial risk management 
regime is described in its current rules, which provide for the use of 
OCC's own capital to mitigate losses arising out of a Clearing Member 
default.\9\ Specifically, OCC's rules provide for the offsetting of 
default losses remaining after the application of a defaulted Clearing 
Member's margin deposits and Clearing Fund contributions with OCC's 
capital in excess of 110 percent of the Target Capital Requirement at 
the time of the default.\10\ OCC's rules also provide for charging 
losses remaining after the application of OCC's excess capital to OCC 
senior management's deferred compensation \11\ as well as non-
defaulting Clearing Members.\12\
---------------------------------------------------------------------------

    \9\ See Securities Exchange Release No. 88029 (Jan. 24, 2020), 
85 FR 5500, 5502 (Jan. 30, 2020) (File No. SR-OCC-2019-007) (``CMP 
Approval Order'').
    \10\ See OCC Rule 1006(e), available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (last 
visited Mar. 16, 2021). See also CMP Approval Order at 5502.
    \11\ Such deferred compensation is in trust with respect to 
OCC's Executive Deferred Compensation Plan (``EDCP''). See OCC Rule 
101(e)(1), available at available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (last 
visited Mar. 16, 2021). The specific EDCP funds that comprise a 
portion of OCC's skin-in-the-game are referred to in OCC's rules as 
the ``EDCP Unvested Balance.'' See id.
    \12\ See OCC Rule 1006(b), available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (last 
visited Mar. 16, 2021). See also CMP Approval Order at 5502. The 
application the EDCP Unvested Balance in parallel with non-
defaulting Clearing Members' Clearing Fund contributions would 
necessarily occur before assessments related to the exhaustion of 
OCC's Clearing Fund.
---------------------------------------------------------------------------

    OCC reviewed feedback received in connection with the initial 
filing of its current rules, relevant papers from

[[Page 19062]]

industry participants and stakeholders concerning skin-in-the-game, and 
regulatory regimes in jurisdictions outside the United States.\13\ 
OCC's current rules do not, however, dedicate OCC's excess capital for 
use solely as skin-in-the-game, or guaranty that OCC maintain a minimum 
amount of skin-in-the-game.\14\
---------------------------------------------------------------------------

    \13\ See Notice of Filing, 86 FR at 12058-59. For example, OCC 
is cognizant of the European Market Infrastructure Regulation's 
expectation that skin-in-the-game be a minimum of 25 percent of the 
central counterparty's regulatory capital requirement. See Notice of 
Filing, 86 FR at 12059.
    \14\ See Notice of Filing, 86 FR at 12060.
---------------------------------------------------------------------------

    Establishing the Minimum Corporate Contribution. OCC proposes to 
establish a persistent minimum level of skin-in-the-game that OCC would 
contribute to cover default losses or liquidity shortfalls. Such skin-
in-the-game would consist of a minimum amount of OCC's own pre-funded 
resources that OCC would contribute prior to charging a loss to the 
Clearing Fund (the ``Minimum Corporate Contribution'') and the EDCP 
Unvested Balance.\15\ As proposed, funds comprising the Minimum 
Corporate Contribution would be excluded from OCC's liquid net assets 
funded by equity (``LNAFBE'') for purposes of meeting OCC's Target 
Capital Requirement to ensure that OCC may maintain the Minimum 
Corporate Contribution exclusively for default management.\16\
---------------------------------------------------------------------------

    \15\ OCC does not propose altering its rules regarding the use 
or sizing of the EDCP Unvested Balance.
    \16\ In addition to the Minimum Corporate Contribution, OCC 
would continue to commit its LNAFBE greater than 110 percent of its 
Target Capital Requirement prior to charging a loss to the Clearing 
Fund. As proposed, OCC would apply the Minimum Corporate 
Contribution to address default losses before applying its excess 
LNAFBE.
---------------------------------------------------------------------------

    OCC proposes to define the Minimum Corporate Contribution to mean 
the minimum level of OCC's own funds maintained exclusively to cover 
credit losses or liquidity shortfalls, the level of which OCC's Board 
of Directors (the ``Board'') shall determine from time to time. To 
facilitate implementation of OCC's proposal, the Board approved an 
initial Minimum Corporate Contribution at such a level that OCC's total 
skin-in-the-game (i.e., the sum of the Minimum Corporate Contribution 
and OCC's current EDCP Unvested Balance) would equal 25 percent of 
OCC's Target Capital Requirement. OCC stated that, in setting the 
initial Minimum Corporate Contribution, the Board considered factors 
including, but not limited to, the regulatory requirements in each 
jurisdiction in which OCC is registered or in which OCC is actively 
seeking recognition, the amount similarly situated central 
counterparties commit of their own resources to address participant 
defaults, the EDCP Unvested Balance, OCC's LNAFBE greater than 110 
percent of its Target Capital Requirement, projected revenue and 
expenses, and other projected capital needs.\17\
---------------------------------------------------------------------------

    \17\ See Notice of Filing, 86 FR at 12060.
---------------------------------------------------------------------------

    Replenishing the Minimum Corporate Contribution. OCC proposes that, 
in the event it were to apply a portion of the Minimum Corporate 
Contribution to address losses or shortfalls arising out of a Clearing 
Member default, the size of the Minimum Corporate Contribution would be 
temporarily reduced, for a period of 270 days, to the amount remaining 
after its application.\18\ Each application of the Minimum Corporate 
Contribution would trigger a new 270-day period.\19\ Under the 
proposal, OCC would be obligated to notify Clearing Members of any such 
reduction of the Minimum Corporate Contribution. OCC believes that 270 
calendar days, or approximately nine months, is sufficient time for OCC 
to accumulate the funds necessary to reestablish the Minimum Corporate 
Contribution.\20\
---------------------------------------------------------------------------

    \18\ For example, if the Minimum Corporate Contribution were 
$100 million and OCC applied $25 million to address default losses, 
then the Minimum Corporate Contribution would be temporarily set at 
$75 million.
    \19\ For example, if OCC were to contribute a portion of the 
Minimum Corporate Contribution on day 1 and another portion 100 days 
later, the Minimum Corporate Contribution would remain temporarily 
reduced until day 370.
    \20\ See Notice of Filing, 86 FR at 12060. OCC stated that the 
analysis on which its belief is based is the same analysis on which 
OCC relied to set various thresholds related to OCC's plan for 
replenishing its regulatory capital. See id.
---------------------------------------------------------------------------

    OCC proposes change to its Rules, Capital Management Policy, 
Default Management Policy, Clearing Fund Methodology Policy, and 
Recovery and Orderly Wind-Down Plan to effectuate the changes described 
above.

III. Discussion and Notice of No Objection

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, the stated purpose of the Clearing 
Supervision Act is instructive: To mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for SIFMUs and 
strengthening the liquidity of SIFMUs.\21\
---------------------------------------------------------------------------

    \21\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe regulations containing risk management 
standards for the payment, clearing, and settlement activities of 
designated clearing entities engaged in designated activities for which 
the Commission is the supervisory agency.\22\ Section 805(b) of the 
Clearing Supervision Act provides the following objectives and 
principles for the Commission's risk management standards prescribed 
under Section 805(a): \23\
---------------------------------------------------------------------------

    \22\ 12 U.S.C. 5464(a)(2).
    \23\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     To promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among other areas.\24\
---------------------------------------------------------------------------

    \24\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------

    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange Act (the ``Clearing Agency Rules'').\25\ The Clearing Agency 
Rules require, among other things, each covered clearing agency to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for its operations and risk management practices on an 
ongoing basis.\26\ As such, it is appropriate for the Commission to 
review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act. As 
discussed below, the Commission believes the changes proposed in the 
Advance Notice are consistent with the objectives and principles 
described in Section 805(b) of the Clearing Supervision Act,\27\ and in 
the Clearing Agency Rules, in particular Rule 17Ad-22(e)(2).\28\
---------------------------------------------------------------------------

    \25\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (Oct. 22, 2012), 77 FR 66220 (Nov. 2, 2012) (S7-08-11). See 
also Covered Clearing Agency Standards, 81 FR 70786. OCC is a 
``covered clearing agency'' as defined in Rule 17Ad-22(a)(5).
    \26\ 17 CFR 240.17Ad-22.
    \27\ 12 U.S.C. 5464(b).
    \28\ 17 CFR 240.17Ad-22(e)(2).
---------------------------------------------------------------------------

A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the proposal contained in OCC's 
Advance Notice is consistent with the stated objectives and principles 
of Section 805(b) of the Clearing Supervision Act.\29\ Specifically, as 
discussed below,

[[Page 19063]]

the Commission believes that the changes proposed in the Advance Notice 
are consistent with promoting robust risk management, promoting safety 
and soundness, reducing systemic risks, and supporting the stability of 
the broader financial system.\30\
---------------------------------------------------------------------------

    \29\ As noted above, the Commission considers all public 
comments received on the proposal regardless of whether the comments 
are submitted on the Proposed Rule Change or the Advance Notice. One 
commenter raised issues related solely to the consistency of the 
proposal with the requirements of Section 17A of the Exchange Act. 
See letter from Richard J. McDonald, Susquehanna International Group 
(``SIG''), dated March 30, 2021, to Vanessa Countryman, Secretary, 
Commission (``SIG Letter''), available at https://www.sec.gov/comments/sr-occ-2021-003/srocc2021003.htm.
    Specifically, SIG expressed concern regarding (i) the extent to 
which OCC fees, dues, and other charges would be used to finance the 
equity windfall of OCC shareholders and their commercial interests 
and (ii) the effect of the proposal on the protection of investors 
and the public interest. The Commission's evaluation of the Advance 
Notice is conducted under the Clearing Supervision Act and, as noted 
above, generally considers whether the proposal will mitigate 
systemic risk and promote financial stability. The Commission notes 
that SIG has not explained or demonstrated how the retention of 
capital, derived from clearing fees, for use as skin-in-the-game 
would cause the proposal to be inconsistent with the Clearing 
Supervision Act. The SIG Letter is directed at the Proposed Rule 
Change and will be addressed in that context.
    \30\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    The Commission continues to regard skin-in-the-game as a potential 
tool to align the various incentives of a covered clearing agency's 
stakeholders, including management and clearing members.\31\ OCC's 
current rules provide for the application of excess capital as skin-in-
the-game. The Commission believes that OCC's proposal to set aside 
capital to maintain a minimum amount of skin-in-the-game strengthens 
OCC's existing skin-in-the-game rules. OCC's current rules align senior 
management's personal economic incentives with OCC's overall risk 
management incentives,\32\ but do not guaranty that an amount of OCC 
capital would be set aside to ensure a pre-determined minimum level of 
skin-in-the-game. The Commission believes that holding a Minimum 
Corporate Contribution, in addition to the EDCP unvested balance, to 
ensure such a minimum level of skin-in-the-game would help to align 
OCC's economic incentives as a corporation with risk management more 
broadly, thereby promoting robust risk management at OCC.
---------------------------------------------------------------------------

    \31\ Covered Clearing Agency Standards, 81 FR at 70805-06.
    \32\ See Securities Exchange Act Release No. 87257 (Oct. 8, 
2019), 84 FR 55194, 55199 (Oct. 15, 2019) (File No. SR-OCC-2019-
805).
---------------------------------------------------------------------------

    Holding a defined Minimum Corporate Contribution, as opposed to an 
undefined amount of excess capital, may help to incentivize OCC further 
to maintain the appropriate amount of resources to manage a Clearing 
Member default, consistent with the promotion of safety and soundness 
at OCC. Further, the Commission believes that, to the extent the 
proposed changes are consistent with promoting OCC's safety and 
soundness, they are also consistent with supporting the stability of 
the broader financial system. OCC has been designated as a SIFMU, in 
part, because its failure or disruption could increase the risk of 
significant liquidity or credit problems spreading among financial 
institutions or markets.\33\ The Commission believes that the proposed 
changes would help support the maintenance of OCC as a going concern 
following a Clearing Member default, which in turn would help support 
the stability of the financial system by reducing the risk of 
significant liquidity or credit problems spreading among market 
participants that rely on OCC's central role in the options market. 
Finally, the Commission believes that the proposed changes to increase 
OCC's pre-determined default management resources are consistent with 
the reduction of systemic risk because such increase enhances the 
ability of OCC to absorb and contain the spread of any losses that 
might arise from a member default.
---------------------------------------------------------------------------

    \33\ See Financial Stability Oversight Council (``FSOC'') 2012 
Annual Report, Appendix A, https://home.treasury.gov/system/files/261/here.pdf (last visited Mar. 17, 2021).
---------------------------------------------------------------------------

    Accordingly, and for the reasons stated above, the Commission 
believes the changes proposed in the Advance Notice are consistent with 
Section 805(b) of the Clearing Supervision Act.\34\
---------------------------------------------------------------------------

    \34\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

B. Consistency With Rule 17Ad-22(e)(2) Under the Exchange Act

    Rule 17Ad-22(e)(2) under the Exchange Act requires that a covered 
clearing agency establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to provide for governance 
arrangements that, among other things, are clear and transparent; 
clearly prioritize the safety and efficiency of the covered clearing 
agency; and support the public interest requirements of the Exchange 
Act.\35\ In adopting Rule 17Ad-22(e)(2), the Commission discussed 
comments it received regarding the concept of skin-in-the-game as a 
potential tool to align the various incentives of a covered clearing 
agency's stakeholders, including management and clearing members.\36\ 
And, while the Commission declined to include a specific skin-in-the-
game requirement in the rule, it stated its belief that ``the proper 
alignment of incentives is an important element of a covered clearing 
agency's risk management practices,'' and noted that skin-in-the-game 
``may play a role in those risk management practices in many 
instances.'' \37\ OCC's current rules require the application 
management compensation and excess capital as skin-in-the-game, which 
in turn should help further align the interests of OCC's stakeholders, 
including OCC management and Clearing Members.\38\
---------------------------------------------------------------------------

    \35\ 17 CFR 240.17Ad-22(e)(2).
    \36\ Covered Clearing Agency Standards, 81 FR at 70805-06.
    \37\ Covered Clearing Agency Standards, 81 FR at 70806.
    \38\ See CMP Approval Order at 5507.
---------------------------------------------------------------------------

    As described above, OCC's proposal would not reduce the resources 
OCC would apply to address default losses or remove the current skin-
in-the-game component of OCC's rules. Rather, OCC proposes to set aside 
a defined amount of capital for the sole purpose of absorbing losses 
and shortfalls arising out of a Clearing Member default. OCC has 
clearly stated the factors that the Board would consider when 
determining the amount of resources to hold as skin-in-the-game, a 
portion of which would comprise the Minimum Corporate Contribution. OCC 
also proposes to establish a clear process for addressing reductions in 
the Minimum Corporate Contribution arising out of a Clearing Member's 
default. Accordingly, the Commission believes that the proposed changes 
to establish a persistent minimum level of skin-in-the-game are 
consistent with Rule 17Ad-22(e)(2) under the Exchange Act.\39\
---------------------------------------------------------------------------

    \39\ 17 CFR 240.17Ad-22(e)(2).
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission does not object to 
Advance Notice (SR-OCC-2021-801) and that OCC is authorized to 
implement the proposed change as of the date of this notice or the date 
of an order by the Commission approving proposed rule change SR-OCC-
2021-003, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-07454 Filed 4-9-21; 8:45 am]
BILLING CODE 8011-01-P