[Federal Register Volume 89, Number 17 (Thursday, January 25, 2024)]
[Notices]
[Pages 5062-5069]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-01386]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-99393; File No. SR-OCC-2024-001]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change by The Options Clearing
Corporation Concerning Its Process for Adjusting Certain Parameters in
Its Proprietary System for Calculating Margin Requirements During
Periods When the Products It Clears and the Markets It Serves
Experience High Volatility
January 19, 2024.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on January 10, 2024, The Options Clearing
Corporation (``OCC'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II, and III below, which Items have been prepared primarily by
OCC. The Commission is publishing this notice to solicit comments on
the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
This proposed rule change would codify OCC's process for adjusting
certain parameters in its proprietary system for calculating margin
requirements during periods when the products OCC clears and the
markets it serves experience high volatility. Proposed changes to OCC's
Margin Policy are submitted in Exhibit 5 to File No. SR-OCC-2024-001.
Material proposed to be added is marked by underlining and material
proposed to be deleted is marked with strikethrough text. 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.\3\
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\3\ OCC's By-Laws and Rules can be found on OCC's public
website: https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of these
statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
OCC is the sole clearing agency for standardized equity options
listed on national securities exchanges registered with the Commission.
OCC also clears certain stock loan and futures transactions. In its
role as a clearing agency, OCC guarantees the performance of its
Clearing Members for all transactions cleared by OCC by becoming the
buyer to every seller and the seller to every buyer (or the lender to
every borrower and the borrower to every lender, in the case of stock
loan transactions). These clearing activities could expose OCC to
financial risks if a Clearing Member fails to fulfil its obligations to
OCC. In its role as guarantor for all transactions cleared through OCC,
one of the more material risks related to a Clearing Member's failure
to perform is credit risk arising from the activity of the Clearing
Members whose performance OCC guarantees. OCC manages these financial
risks through financial safeguards, including the collection of margin
collateral from Clearing Members designed to, among other things,
address the market risk associated with a Clearing Member's positions
during the period of time OCC has determined it would take to liquidate
those positions.
OCC has established a proprietary system, the System for
Theoretical Analysis and Numerical Simulation (``STANS''), that runs
various models used to calculate each Clearing Member's margin
requirements. One of OCC's margin models generates variance forecasts
for the returns on individual equity securities, the result of which
OCC then includes as one of the inputs to the margin calculation. As
discussed in more detail below, OCC has observed that this particular
model may produce results that are ``procyclical,'' which means that
changes in margin requirements produced by the model may be positively
correlated with the overall state of the market and, if not
appropriately addressed, could threaten the stability of its members
during periods of heightened volatility.\4\ For example, procyclicality
may be evidenced by increasing margin in times of stressed market
conditions and low margin when markets are calm. A sudden, extreme
increase in margin requirements could stress a Clearing Member's
ability to obtain liquidity to meet its obligations to OCC,
particularly in periods of high volatility. If that Clearing Member
subsequently defaulted, the resulting suspension and liquidation of the
defaulting Clearing Member's positions could result in losses
chargeable to the mutualized Clearing Fund.\5\ Charging a loss to the
Clearing Fund may result in unexpected costs for non-defaulting
Clearing Members, stressing their ability to obtain liquidity to meet
their own financial obligations in stressed market conditions.
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\4\ See Standards for Covered Clearing Agencies, Exchange Act
Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70816 n.318 (S7-03-
14) (``In this context, procyclicality typically refers to changes
in risk-management practices that are positively correlated with
market, business, or credit cycle fluctuations that may cause or
exacerbate financial [in]stability.'').
\5\ A mutualized, pre-funded guaranty fund comprised of deposits
from each member, such as OCC's Clearing Fund, is another financial
safeguard commonly employed by central counterparties to address
credit risk as the guarantor of the products it clears.
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[[Page 5063]]
Regulations applicable to OCC require it to take certain measures
with respect to its margin models during periods of time when the
products cleared or markets served display high volatility. For
example, the SEC's Standards for Covered Clearing Agencies require OCC
to establish policies and procedures related to the review of OCC's
model parameters \6\ during periods of time when the products cleared
or markets served display high volatility, report the results to
appropriate decisionmakers, and use the results to evaluate the
adequacy of and adjust its model parameters.\7\ OCC understands that,
in implementing standards for central counterparties, U.S. regulators
chose not to adopt the types of prescriptive procyclicality controls
codified by financial regulators in other jurisdictions.\8\
Accordingly, regulatory guidance applicable to OCC provides that a
clearing agency should consider whether its margin model, ``to the
extent practicable and prudent, limits the need for destabilizing,
procyclical changes.'' \9\
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\6\ In general, a margin model parameter is a value estimated
from market or portfolio data used by OCC's margin models for the
purpose of calculating Clearing Member margin requirements. The
value of the parameter is associated with a specific point in time
and may change based on updates to the data used in its estimation.
\7\ See 17 CFR 240.17Ad-22(e)(6)(vi)(C), (D).
\8\ Compare Standards for Covered Clearing Agencies, Exchange
Act Release No. 78961, 81 FR 70819 (``[A] covered clearing agency
generally should consider in establish and maintaining policies and
procedures for margin . . . whether the model . . . to the extent
practicable and prudent, limits the need for destabilizing,
procyclical changes.''), and Central Counterparty (CCP) Risk and
Governance Subcommittee, Market Risk Advisory Committee of the U.S.
Commodity Futures Trading Commission (``CFTC''), Recommendations
Regarding CCP Margin Methodologies, at 1 (Feb. 12, 2021), available
at https://www.cftc.gov/media/5776/GMAC_031121WFE/download
(describing the CFTC's ``principle-based approach to addressing
procyclical risk'' under CFTC Regulation 39.13), with Article 41,
Regulation (EU) No 648/2012 of 4 July 2012 of the European
Parliament and Council on OTC derivatives, central counterparties
and trade repositories (requiring CCPs to ``regularly monitor and,
if necessary, revise the level of its margins to reflect current
market conditions taking into account any potentially procyclical
effects of such revisions''), and Article 28, Regulatory technical
standards on CCPs i.e. Commission Delegated Regulation (EU) No 153/
2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012
of the European Parliament and of the Council with regard to
regulatory technical standards on requirements for CCPs (requiring
CCPs to adopt one of three anti-procyclicality margin measures).
\9\ Standards for Covered Clearing Agencies, Exchange Act
Release No. 78961, 81 FR 70819.
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To mitigate procyclical margin requirements during periods when
OCC's cleared products or the markets its serves experience high
volatility, OCC has established regular and high volatility control
settings under its margin methodology. OCC's price return model employs
bounds (i.e., the ``control sets'' implemented under regular or high
volatility settings) for certain parameters that are calculated daily
based on current market data.\10\ When OCC implements high volatility
control settings, those parameters are bounded differently than under
regular control settings. In general, these control settings help to
prevent significant overestimation of Clearing Member margin
requirements.\11\
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\10\ See infra notes 25-28 (describing the parameters to which
the bounds are applied).
\11\ See infra notes 33-34 and accompanying text (detailing
examples in which high volatility control settings were
implemented).
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To determine when implementation of high volatility control
settings may be appropriate, OCC monitors the volatility of the
products it clears and the markets it serves. Based on the results of
this monitoring, OCC may determine to implement high volatility control
settings for those model parameters. Under OCC's margin methodology,
these high volatility control settings may be applied to individual
securities, which are among several ``risk factors'' under OCC's margin
methodology, or globally across a class of risk factors (e.g.,
equities, indexes, volatility-based products, etc.).
OCC previously described its use of high volatility control
settings within STANS in its filing to establish its STANS Methodology
Description.\12\ The STANS Methodology Description, however, does not
provide specific details around the process for setting or applying
high volatility control settings. To ensure that OCC's rules include a
sufficient level of detail about material aspects of OCC's margin
system, OCC proposes to amend its Margin Policy, which is filed as a
rule with the Commission,\13\ to define material aspects of the high
volatility control setting process. This proposed rule change would
amend the Margin Policy to describe the process, including: (1) how OCC
sets and reviews the regular and high volatility control sets; (2) how
OCC monitors for market volatility and idiosyncratic price moves and
establishes thresholds to escalate the results of such monitoring for
consideration of whether high volatility control settings are
warranted; and (3) OCC's internal governance for implementing and
terminating high volatility control settings. OCC does not believe that
proposed revisions to its Margin Policy would have any practical effect
on Clearing Members or other market participants because OCC is not
proposing to change its current practices for setting member margin
requirements.
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\12\ See infra notes 29-30 and accompanying text.
\13\ See Exchange Act Release Nos. 99169 (Dec. 14, 2023), 88 FR
88163 (Dec. 20, 2023) (SR-OCC-2023-008); 98101 (Aug. 10, 2023), 88
FR 55775 (Aug. 16, 2023) (SR-OCC-2022-012); 96566 (Dec. 22, 2022),
87 FR 80207 (Dec. 29, 2022) (SR-OCC-2022-010); 91079 (Feb. 8, 2021),
86 FR 9410 (Feb. 12, 2021) (SR-OCC-2020-016); 90797 (Dec. 23, 2020),
85 FR 86592 (Dec. 30, 2020) (SR-OCC-2020-014); 87718 (Dec. 11,
2019), 84 FR 68992 (Dec. 17, 2019) (SR-OCC-2019-010); 86436 (July
23, 2019), 84 FR 36632 (July 29, 2019) (SR-OCC-2019-006); 86119
(June 17, 2019), 84 FR 29267 (June 21, 2019) (SR-OCC-2019-004);
83799 (Aug. 8, 2018), 83 FR 40379 (Aug. 14, 2018) (SR-OCC-2018-011);
82658 (Feb. 7, 2018), 83 FR 6646 (Feb. 14, 2018) (SR-OCC-2017-007).
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(1) Purpose
Background
STANS is OCC's proprietary risk management system for calculating
Clearing Member margin requirements.\14\ The STANS methodology utilizes
large-scale Monte Carlo simulations to forecast price and volatility
movements in determining a Clearing Member's margin requirement.\15\
STANS margin requirements are calculated at the portfolio level of each
Clearing Member account with positions in marginable securities and is
comprised of an estimate of a 99% expected shortfall \16\ over a two-
day time horizon, among other components. OCC uses the STANS
methodology to measure the exposure of portfolios of products cleared
by OCC and cash instruments in margin collateral.\17\
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\14\ An overview of the STANS methodology is on OCC's public
website: https://www.theocc.com/Risk-Management/Margin-Methodology.
\15\ See OCC Rule 601.
\16\ 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 is used in risk management to measure the
potential risk of loss for a given set of assets over a particular
time horizon.
\17\ Pursuant to OCC Rule 601(e)(1), OCC also calculates initial
margin requirements for segregated futures accounts on a gross basis
using the Standard Portfolio Analysis of Risk Margin Calculation
System (``SPAN''). CFTC Regulation 39.13(g)(8), requires, in
relevant part, that a derivatives clearing organization (``DCO'')
collect initial margin for customer segregated futures accounts on a
gross basis. While OCC uses SPAN to calculate initial margin
requirements for segregated futures accounts on a gross basis, OCC
believes that margin requirements calculated on a net basis (i.e.,
permitting offsets between different customers' positions held by a
Clearing Member in a segregated futures account using STANS) affords
OCC additional protections at the clearinghouse level against risks
associated with liquidating a Clearing Member's segregated futures
account. As a result, OCC calculates margin requirements for
segregated futures accounts using both SPAN on a gross basis and
STANS on a net basis, and if at any time OCC staff observes a
segregated futures account where initial margin calculated pursuant
to STANS on a net basis exceeds the initial margin calculated
pursuant to SPAN on a gross basis, OCC collateralizes this risk
exposure by applying an additional margin charge in the amount of
such difference to the account. See Exchange Act Release No. 72331
(June 5, 2014), 79 FR 33607 (June 11, 2014) (SR-OCC-2014-13).
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[[Page 5064]]
Forecasted returns on individual risk factors are an input to OCC's
calculation of margin requirements. A ``risk factor'' within STANS is a
product or attribute whose historical data is used to estimate and
simulate the risk for an associated product. Risk factors include the
returns on individual equity securities, returns on equity indexes, and
returns on implied volatility risk factors, among others.
OCC uses a GARCH \18\ model to generate variance forecasts for
price risk factors for all products and implied volatility with respect
to certain products. Following February 5, 2018, when the market
experienced extreme levels of volatility that caused a significant
spike in margin requirements, OCC's analysis demonstrated that GARCH is
extremely sensitive to sudden spikes in volatility, which can result in
margin requirements that OCC believes are unreasonable and
procyclical.\19\ For example, OCC observed that its GARCH model for
forecasting implied volatility \20\ produced forecasts for particular
S&P 500 Index (``SPX'') options that were four-fold larger than the
comparable market index. This led to margin requirements increasing by
80% overnight, with some margin requirements increasing ten-fold. In
reviewing OCC's analysis, the Commission acknowledged that the size of
such margin requirement increases was not necessarily commensurate with
the risk of those Clearing Member's portfolios, and that imposing such
a large, unexpected increase could impose a large, unexpected stress on
a Clearing Member during a period of high volatility.\21\ Since then,
OCC has taken several measures to mitigate such procyclicality,
including changes to its GARCH-based implied volatility model,\22\ and
a new model to replace GARCH for simulating implied volatility for SPX-
based options and volatility index futures.\23\ Even with such
revisions, however, the GARCH model may produce procyclical margin
results that are not commensurate with the risk of the products,
portfolios, or markets that OCC seeks to manage.\24\
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\18\ The acronym ``GARCH'' refers to an econometric model that
can be used to estimate volatility based on historical data.
\19\ See Exchange Act Release No. 84879 (Dec. 20, 2018), 83 FR
67392, 67393 (Dec. 29, 2018) (SR-OCC-2018-014).
\20\ In general, the implied volatility of an option is a
measure of the expected future volatility of the option's underlying
security at expiration, which is reflected in the current option
premium in the market.
\21\ See Exchange Act Release No. 84879, 83 FR 67394.
\22\ See id. at 67393.
\23\ See Exchange Act Release No. 95319 (July 19, 2022), 87 FR
44167 (July 25, 2022) (SR-OCC-2022-001).
\24\ See supra note 11 and accompanying text.
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To mitigate such procyclicality, OCC also applies numerical
constraints to certain statistical parameters that inform the model's
reaction to market volatility. Specifically, the GARCH model uses
statistical alpha ([alpha]),\25\ beta ([beta]),\26\ and gamma ([gamma])
\27\ parameters as part of its econometric model for updating risk
factors to reflect the most recent market data. Those statistical
parameters are calculated daily based on updated price data.\28\ As
described in OCC's STANS Methodology Description,\29\ OCC applies
numerical constraints (i.e., ``control settings'') to these GARCH
parameters after their initial calibration to mitigate the reactivity
of the model volatility forecast, which is a primary driver of margin
requirements for any equity or index.\30\ These constraints apply to
the calculation of margin for each Clearing Member.
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\25\ Alpha is the weight attached to the contribution to the
forecast variance from the price risk factor. Together with gamma,
it controls the model's reaction to recent market moves.
\26\ Beta is the weight attached to the contribution to the
forecast variance from the previous day's forecast. As such, it
concerns the persistence of volatility.
\27\ Gamma is the additional weight attached to the contribution
to the forecast variance from a negative return in the price risk
factor. Together with alpha, it controls the model's reaction to
recent market moves.
\28\ See Exchange Act Release No. 83326 (May 18, 2018), 83 FR
25081 (May 31, 2018) (SR-OCC-2017-022); Exchange Act Release No.
83305 (May 23, 2018), 83 FR 24536 (May 29, 2018) (SR-OCC-2017-811).
\29\ The STANS Methodology Description is intended to provide a
comprehensive description of the material aspects of OCC's risk-
based margin system. See Exchange Act Release No. 91079, 86 FR at
9410 (SR-OCC-2020-016).
\30\ See Exchange Act Release No. 85788 (Dec. 21, 2020), 85 FR
85788, 85793 (Dec. 29, 2020) (SR-OCC-2020-016) (``The STANS
Methodology Description would also describe the controls that may be
placed on the GJR-GARCH parameters after their initial calibration.
GARCH volatility forecasting models can be very reactive in certain
market environments. As a result, OCC may implement parameter
controls for risk factors and classes of risk factors, which are
subject to periodic review and approval by the MRWG.'').
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OCC refers to the constraints applicable under normal market
conditions as ``regular'' control settings. The STANS Methodology
Description further provides that OCC maintains projections of various
market conditions in which pre-determined constraints (i.e., a control
set) are appropriate and that specification of those conditions and the
control sets are based on continual quantitative research and may be
specific to risk factor types (e.g., equities or volatility indexes).
The STANS Methodology Description further provides that the assumptions
and individual application of the parameter controls for risk factors
and classes of risk factors are subject to periodic review and approval
by OCC's Model Risk Working Group (``MRWG''), a cross-functional group
responsible for assisting OCC's management in overseeing OCC's model-
related risk comprised of representatives from relevant OCC business
units, including Quantitative Risk Management, Model Risk Management,
and Corporate Risk Management. OCC refers to implementation of high
volatility control settings to an individual risk factor as
``idiosyncratic'' control settings and implementation across all or a
class of risk factors as ``global'' control settings.
OCC has implemented global settings on only a few occasions. For
example, OCC implemented global control settings for equities, indexes,
volatility-based products and short ETF products from March 9, 2020
until April 9, 2020 in connection with the market volatility associated
with the onset of the COVID-19 pandemic and on January 27, 2021 for
volatility-based products in connection with market volatility caused
by the so-called ``meme stock'' episode. On March 9, 2020, for example,
when the SPX experienced a return of approximately -7.5%, coverage for
SPX options under regular control settings would have increased from
long coverage \31\ of -11.77% and short coverage of 11.69% to -18.54%
and 19.44%, respectively.\32\ MRWG approved implementing global control
settings based on a 50% weighting between regular and high volatility
control settings, resulting in long and short coverage of -13.60% and
14.42%. These coverages were selected based on their alignment with the
two-day short and long coverage determined from SPX implied volatility;
-13% and 14%, respectively.\33\ Aggregate margin
[[Page 5065]]
requirements calculated using the global control settings were $84.2
billion, compared to $103.2 billion had OCC used regular control
settings.\34\
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\31\ In this context, the coverage rate for a security is the
change in risk of the security express as a percentage of the price
of the security when the market closes.
\32\ OCC has included as confidential Exhibit 3A to File No SR-
OCC-2024-001 responses to questions from OSC concerning drafts of
this proposed rule change, including data concerning the coverage
rates under control sets reviewed by the MRWG on March 9, 2020.
\33\ OCC has also included as confidential Exhibit 3B to SR-OCC-
2024-001 an internal OCC memorandum concerning high volatility
control settings describing, among other things, how when
implementing global control settings on March 9, 2020, the MRWG
compared resulting coverages from different weightings against the
coverage rates that could be derived through implied option
volatility to evaluate of coverage rates under alternative
parameters sets.
\34\ OCC has included as confidential Exhibit 3C to SR-OCC-2024-
001 responses to questions from Staff of the Commission's Office of
Clearance and Settlement (``OSC'') dated November 20, 2020
concerning OCC's March 9, 2020 implementation of global control
settings, including, among other things, as assessment of the impact
on margin.
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OCC has implemented idiosyncratic control settings for individual
risk factors more frequently.\35\ For example, on April 28, 2023, FRM
implemented idiosyncratic control settings with respect to a risk
factor for a security that experienced multi-day jumps in stock
price,\36\ including from $6.72 to $20 on April 27, 2023 and from $20
to $108.20 on April 28, 2023, which resulted in corresponding short
coverage levels under regular control settings increasing from 98% to
5695%.\37\ After implementing idiosyncratic control settings for that
risk factor, aggregate margin requirements decreased $2.6 billion. OCC
did not observe any daily backtesting exceedances associated with
implementing idiosyncratic control settings for this risk factor.
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\35\ From December 2019 to August 2023, for example, OCC
implemented high volatility control settings lasting various
durations (ranging from a single day to 190 days, with a median
period of 10 days) for more than 200 individual risk factors. See
Exhibit 3A, supra note 32 (providing a list of instances in which
OCC implemented global and idiosyncratic control settings).
\36\ While no options were listed on the security, certain
Clearing Members maintained cleared stock loan positions and
collateral deposits in that security.
\37\ See Exhibit 3A, supra note 32 (providing responses
concerning an April 28, 2023 implementation of idiosyncratic control
settings).
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In general, OCC has not observed backtesting exceedances
attributable to the implementation of global or idiosyncratic
volatility control settings. Currently, OCC monitors margin sufficiency
at the Clearing Member account level to identify backtesting
exceedances. Account exceedances are investigated to determine the
cause of the exceedance, including whether the exceedance can be
attributed to the implementation of high volatility control settings.
No account level exceedance has been attributed to the implementation
of high volatility control settings. OCC also performs model
backtesting on all risk factors with listed derivatives or stock loan
positions, or securities pledged as collateral within Clearing Member
accounts, including for risk factors subject to high volatility control
settings. Model backtesting has not identified an issue with the
adequacy of margin coverage associated with the implementation of
idiosyncratic control settings. OCC also conducted instrument-level
backtesting over a two-year time horizon on securities for which
idiosyncratic control settings were implemented. Of the 14 out of 244
securities for which 2-day expected shortfall coverages was less than
99%, OCC found that the coverages with regular control settings would
not have been significantly different.\38\ Only one risk factor had 2-
day expected shortfall short coverage under 99% while on idiosyncratic
control settings that would have been above 99% on regular control
settings, driven by one additional 2-day expected shortfall short
exceedance.\39\ However, this single occurrence did not contribute to
any Clearing Member account-level exceedance. Based on this study, OCC
believes that application of high volatility control settings does not
have a significant negative effect on the sufficiency of OCC's margin
coverage.
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\38\ See Exhibit 3A, supra note 32 (providing responses to
requests for backtesting data and analysis).
\39\ Id.
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Proposed Changes
OCC proposes to amend its Margin Policy to add a new section \40\
addressing control settings so that OCC's rules would include a
sufficient level of detail about the high volatility control setting
process currently maintained in other internal OCC procedures,
including (1) how OCC sets and reviews the regular and high volatility
control sets; (2) how OCC monitors for market volatility and
idiosyncratic price moves and establishes thresholds to escalate the
results of such monitoring for consideration of whether high volatility
control settings are warranted; and (3) OCC's internal governance for
implementing and terminating high volatility control settings.
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\40\ This new section would be added to the ``Margin
Methodology'' section of the Margin Policy and the subsections would
be renumbered to reflect the addition.
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(1) How OCC Sets and Reviews Regular and High Volatility Control Sets
First, OCC proposes to amend the Margin Policy to add a subsection
under the new control settings section that would address how OCC
reviews and sets the regular and high volatility control sets (i.e.,
the bounds applied to the GARCH parameters under regular and
idiosyncratic control settings).\41\ The Margin Policy would require
that FRM conduct a review of the control sets on an at-least annual
basis, and any recommended changes would require MRWG approval. With
respect to the regular control set, the Margin Policy would further
provide that such review would assess whether the GARCH parameter
bounds are appropriately risk-based, including, but not limited to,
assessing whether they align with the 95th percentile of the parameter
calibrations over the prior review period. The Margin Policy would
further provide that the review of the high volatility control set
would assess whether the control settings effectively mitigate
procyclicality while remaining appropriately risk-based, including, but
not limited to, whether the bounds keep the day-over-day change in 2-
day expected shortfall coverage within a factor of approximately 1.5
assuming price shocks based on observed returns for top risk
factors.\42\ These additions to the Margin Policy are intended to
describe OCC's current process and internal procedures for setting the
regular and idiosyncratic control sets.\43\
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\41\ The high volatility control value sets are sometimes
referend to as idiosyncratic control settings because, in practice,
the high volatility control set is what OCC applies when
implementing idiosyncratic control settings. As discussed above,
when implementing global control settings, MRWG evaluates and
selects a control setting with different weightings between the
regular control set and high volatility control set based on an
assessment of which blended approach generates a coverage level that
converges with the implied volatility of the SPX. See supra note 33
and accompanying text.
\42\ The return shocks are maintained in and updated in
accordance with model whitepapers that support the STANS Methodology
Description. The current return shocks for index and volatility
products are based on the largest observed downward and updated
price moves, respectively. The current return shock for equities is
a -15% return based on large observed negative returns for a sample
of individual equites. OCC has included the model whitepaper as
confidential Exhibit 3D to File No. SR-OCC-2024-001. The whitepaper
is redlined with anticipated updates based on the most recent annual
review of the high volatility control setting process and edits
intended to capture feedback from OSC staff in connection with its
review of a draft of this proposal.
\43\ OCC has included the periodic reviews presented to MRWG
since 2020 in confidential Exhibit 3E to File No. SR-OCC-2024-001.
OCC believes that such changes to the control sets would be
reasonably and fairly implied by the Margin Policy, as proposed to
be amended.
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(2) How OCC Monitors for and Escalates High Volatility to Appropriate
Decisionmakers
OCC currently conducts daily monitoring for high market volatility
and idiosyncratic price moves for individual securities against
thresholds that, if breached, would require escalation to appropriate
[[Page 5066]]
decisionmakers to evaluate the adequacy of and make adjustments to
OCC's model parameters. Specifically, Pursuant to the Clearing Fund
Methodology Policy and the procedures thereunder, OCC has established
thresholds related to high market volatility, low market liquidity, and
significant increases in position size or concentration that would
trigger an intra-month meeting of the MRWG to review stress test
results.\44\ The underlying procedure refers to such thresholds as
``CCA Monitoring Thresholds'' because they are associated with SEC
requirements for when a covered clearing agency must perform certain
required monthly reviews on a more frequent basis.\45\
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\44\ See Exchange Act Release No. 83406 (June 11, 2018), 83 FR
83406 (June 15, 2018) (SR-OCC-2018-008) (describing how the Clearing
Fund Methodology Policy ``would require that OCC maintain procedures
for determining whether, and in which circumstances'' stress testing
review must be completed more frequently than monthly ``when the
products cleared or markets served display high volatility,'' among
other possible triggers).
\45\ See 17 CFR 17Ad-22(e)(4)(iv)(C) (with respect to stress
testing); 17Ad-22(e)(6)(vi)(C) (with respect the risk-based margin
system); 17Ad-22(e)(7)(vi)(C) (with respect to liquidity resource
sufficiency).
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While these thresholds are set in accordance with the Clearing Fund
Methodology Policy with respect to its stress testing procedures, OCC
uses the same thresholds as triggers for review of its risk-based
margin system, including (1) more frequent sensitivity analysis of its
margin model and a review of OCC's parameters and assumptions for
backtesting, and (2) with respect to the high volatility threshold,
escalation to the MRWG for consideration of whether to implement global
control settings. However, unlike the Clearing Fund Methodology Policy,
the Margin Policy does not currently reference how the thresholds are
set. As proposed to be amended, the ``Margin Monitoring'' section of
the Margin Policy would be amended to add a discussion of the CCA
Monitoring Thresholds.\46\ That section would refer to the CCA
Monitoring Thresholds established under the Clearing Fund Methodology
Policy and its underlying procedure. The Margin Policy would further
provide that the CCA Monitoring Thresholds are reviewed annually by the
MRWG and the Stress Testing Working Group (``STWG'') to ensure they
remain adequate to identify periods of high market volatility,\47\ low
market liquidity, and significant increases in position size/
concentration. The MRWG and STWG would be required to approve any
changes to the thresholds.
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\46\ The subsections in the ``Margin Monitoring'' section would
be renumbered accordingly to reflect this addition.
\47\ With respect to the high market volatility thresholds
relevant to this filing, OCC's current thresholds are based on a
statistical 1-in-18 month return calculated daily from the previous
10 years of market data for the S&P 500 and VIX indexes. As of
August 3, 2023, the thresholds translated to a 38.12% return for VIX
and a -4.52% return for the SPX. Developmental evidence supporting
the CCA Monitoring Threshold for high volatility has been provided
in the model whitepaper. See Exhibit 3D, supra note 42. However, as
discussed above, the CCA Monitoring Thresholds and the method for
reviewing and updating them would be maintained in the procedures
supporting the Clearing Fund Methodology Policy. As such, OCC
believes the CCA Monitoring Thresholds for high volatility and
updates thereto consistent with the Margin Policy would be
reasonably and fairly implied by the Margin Policy.
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To monitor for volatility experienced by individual risk factors
that may merit implementing idiosyncratic control settings, the Margin
Policy would require FRM to monitor securities against thresholds for
idiosyncratic price moves that would be established in its procedures
(``Idiosyncratic Thresholds'').\48\ The Idiosyncratic Thresholds may
employ a tiered structure that takes into account the type and
magnitude of OCC's risk exposure to the security (e.g., whether it is
an optionable security with open interest, accepted as collateral, and/
or an Eligible Security under OCC's Stock Loan Programs), the value of
the security, the magnitude of the price move, and the coverage
rates.\49\ The Margin Policy would further reflect that on an at-least
annual basis, FRM reviews whether the Idiosyncratic Thresholds, and the
related instances when idiosyncratic control settings were applied
during the review period, appropriately capture products experiencing
high volatility. Any change to the Idiosyncratic Thresholds would
require MRWG review and approval.
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\48\ OCC has included a copy of these procedures as Exhibit 3F
to File No. SR-OCC 2024-001, which are redlined with anticipated
changes arising from feedback received from OSC staff in connection
with a review of a draft of this proposed rule change.
\49\ See id. Currently, FRM Staff reviews a daily report of
projected coverages for selected risk factors (excluding securities
that do not have listed options and are not eligible as either
collateral or as part of OCC's Stock Loan Programs) with an absolute
value of simple return greater than 20% or, for securities under $1
or are missing a current or prior days' closing price, with an
absolute value of log return greater than 100%. Securities meeting
these thresholds are then filtered to identify those with more than
$100 million in prior day risk exposure and a greater-than 3 times
day-over-day increase in coverage. In addition, the thresholds
filter for those securities for which regular parameter short
coverages is greater than 350%. With respect to securities without
listed options, the short coverage threshold also requires that the
prior day risk exposure be greater than $10 million. As discussed
below, the Idiosyncratic Thresholds would be maintained in
procedures supporting the Margin Policy, reviewed at-least annually,
and updated with MRWG approval. As such, OCC believes the
Idiosyncratic Thresholds and updates thereto consistent with the
Margin Policy would be reasonably and fairly implied by the Margin
Policy.
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(3) How OCC Implements and Terminates High Volatility Control Settings
When the monitoring thresholds discussed above are breached,
appropriate decisionmakers at OCC determine whether to implement
idiosyncratic or global control settings. Specifically, for breaches of
the CCA Monitoring Threshold for high volatility, the Margin Policy
would require that FRM escalate the matter to the MRWG and make a
recommendation as to whether global control settings should be applied
to all risk factors or a class of risk factors. The Margin Policy would
require MRWG approval to implement global control settings. In making
that determination, the Margin Policy would describe how MRWG would
review coverage rates under potential control settings generated by
taking a weighting of the bounds for regular and high volatility
control sets. The Margin Policy would further require that MRWG make
this determination considering factors including, but not limited to,
which blended control value sets generate coverage levels that converge
with the implied volatility of the SPX.
The Margin Policy would also provide for how OCC would revert back
to regular control settings after having implemented global control
settings. Such reversion would also require MRWG approval. The Margin
Policy would further provide that when making a determination that
market volatility has decreased to a level where global control
settings are no longer required, the MRWG would consider factors
including, but not limited to, whether SPX coverage rates produced
under regular control settings have converged with the initial coverage
rates when global control settings were first implemented.
With respect to breaches of the Idiosyncratic Thresholds, the
Margin Policy would provide that FRM maintains authority to implement
idiosyncratic control settings for an individual risk factor.
Implementation of such idiosyncratic high volatility control settings
would require approval of an FRM Officer.\50\ In practice, FRM applies
the high volatility control set to a risk factor each time the
Idiosyncratic
[[Page 5067]]
Thresholds are breached. However, the FRM Officer would retain
authority under the Margin Policy to maintain regular control settings
in the case of exceptional circumstances, including, for example, due
to implementation of global control settings, operational issues such
as production processing problems, or edge cases for which the FRM
Officer determines that further refinement of the Idiosyncratic
Thresholds is warranted. If the FRM Officer determines not to implement
idiosyncratic control settings in edge cases, the Margin Policy would
require that the FRM Officer present proposed changes to the
Idiosyncratic Thresholds that reflect the exception within 30 days to
the MRWG for review and, subject to MRWG discretion, approval. The
Margin Policy would also provide for an FRM Officer's authority to
approve idiosyncratic control settings based on additional
considerations such as market moves, expected shortfall risk
contribution, and changes in Clearing Member positions.\51\
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\50\ Officers are identified in OCC's By-Laws. See OCC By-Law
Art IV. In this context, an FRM officer would include any member of
FRM appointed by the Chief Executive Officer or Chief Operating
Officer, including a Managing Director, Executive Director or
Executive Principal. See id. Sec. 9.
\51\ For example, an FRM Officer may use this authority to
implement hypothetical scenarios for securities in cases where the
securities fell just short of one element in the Idiosyncratic
Thresholds' tiered structure, but where breaches of other elements
weighed in favor of applying idiosyncratic control settings in the
FRM Officer's judgment. See Exhibit 3A, supra note 32 (detailing an
example in which an FRM Officer used this authority when a security
was just below the $100 million threshold for prior day risk
exposure, but an FRM Officer approved implementing idiosyncratic
control settings based on the significant day-over-day increase to
short coverage combined with the size of the exposure).
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Finally, the Margin Policy would provide for reversion from
idiosyncratic control settings to regular control settings.
Specifically, the Margin Policy would provide that generally, an FRM
Officer will approve such reversion when the coverage rates under the
regular control set converges with the initial coverage rate when
idiosyncratic control settings were first implemented or when the
coverage rates decline to or below the coverage rate under the
Idiosyncratic Thresholds that triggered the idiosyncratic control
settings.\52\ However, to account for possible unforeseen and
unanticipated situations, the Margin Policy would provide that
idiosyncratic control settings may be applied for a longer or shorter
period at the discretion of the FRM Officer.
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\52\ For example, under the current Idiosyncratic Control
Settings, discussed above in note 49, an FRM Officer would approve
reverting to regular control settings when the short coverage
declines to 350% or below.
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(2) Statutory Basis
OCC believes that the proposed rule change is consistent with
Section 17A of the Exchange Act \53\ and the rules and regulations
thereunder applicable to OCC. Section 17A(b)(3)(F) of the Act \54\
requires, in part, that the rules of a clearing agency be designed to
promote the prompt and accurate clearance and settlement of securities
transactions, and in general, to protect investors and the public
interest. The proposed changes are intended to codify OCC's process for
adjusting parameters in STANS in response to broad market volatility or
idiosyncratic price moves for individual securities. As discussed
above, the GARCH model has been observed to overreact to changes in
volatility.\55\ Such sudden increases in margin requirements may stress
certain Clearing Members' ability to obtain liquidity to meet those
requirements, particularly in periods of high volatility, and could
result in a Clearing Member being delayed in meeting, or ultimately
failing to meet, its daily settlement obligations to OCC. A resulting
suspension of a defaulting Clearing Member may result in losses
chargeable to the mutualized Clearing Fund deposits of non-defaulting
Clearing Members, which could result in unexpected costs for those
Clearing Members. The proposed changes are intended to support the high
volatility control settings process designed to mitigate the
procyclicality of its GARCH model that may cause or exacerbate such
financial instability. For these reasons, OCC believes the proposed
changes to OCC's rules would support processes reasonably designed to
promote the prompt and accurate clearance and settlement of securities
transactions, and in general, to protect investors and the public
interest, in accordance with Section 17A(b)(3)(F) of the Act.\56\
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\53\ See 15 U.S.C. 78q-1.
\54\ 15 U.S.C. 78q-1(b)(3)(F).
\55\ See supra notes 19-23, 34-35, and accompanying text.
\56\ Id.
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OCC believes that the proposed changes are also consistent with SEC
Rule 17Ad-22(e)(6), which requires, in part, that a covered clearing
agency 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, considers, and produces margin levels commensurate with, the
risks and particular attributes of each relevant product, portfolio,
and market.\57\ Commission guidance with respect to SEC Rule 17Ad-
22(e)(6) further provides that a covered clearing agency should
consider whether its margin model, ``to the extent practicable and
prudent, limits the need for destabilizing, procyclical changes.'' \58\
As noted above, OCC's GARCH model demonstrates sensitivity to sudden
spikes in volatility, which can at times result in overreactive margin
requirements that OCC believes are unreasonable and procyclical.\59\
Based on its analysis,\60\ OCC believes that the high volatility
control settings reduce the oversensitivity of the variance forecasts
for price risk factors while continuing to produce margin levels
commensurate with the risks presented during periods of sudden, extreme
volatility, consistent with Rule 17Ad-22(e)(6)(i).\61\
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\57\ See 17 CFR 240.17Ad-22(e)(6)(i).
\58\ Standards for Covered Clearing Agencies, Exchange Act
Release No. 78961, 81 FR 70819.
\59\ See supra notes 19-21 and accompanying text.
\60\ See supra notes 38-39 and accompanying text.
\61\ 17 CFR 240.17Ad-22(e)(6)(i).
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SEC Rule 17Ad-22(e)(6) further requires that a covered clearing
agency's policies and procedures be reasonably designed to monitoring
its risk-based margin system on an ongoing basis, including by
conducting a review of its parameters during periods of time when the
products cleared or markets served display high volatility, report the
results to appropriate decisionmakers, and use the results to evaluate
the adequacy of and adjust its model parameters.\62\ The proposed
changes to the Margin Policy would require that (i) FRM monitor for
periods when the products cleared or markets served display high
volatility; (ii) FRM escalate the results of its monitoring to
appropriate decisionmakers; and (iii) FRM or MRWG may implement high
volatility control settings to adjust the GARCH model parameters based
on specified criteria. OCC believes that FRM and MRWG are the
appropriate decisionmakers for making determinations about these margin
parameter adjustments because they are composed of the subject matter
experts most familiar with the performance of and risks associated with
OCC's margin models. In addition, OCC believes it appropriate that
implementation of global control settings require MRWG approval. MRWG
is comprised of both first- and second-line personnel, including
personnel in OCC's Model Risk Management business unit, who, under
OCC's Risk Management Framework, are responsible for evaluating model
parameters and assumptions and providing effective and independent
challenge through
[[Page 5068]]
OCC's model lifecycle.\63\ Accordingly, OCC believes that this cross-
departmental group is the appropriate governing body for reviewing and
approving such adjustments to OCC's model parameters during periods of
high market volatility, consistent with Rules 17Ad-22(e)(6)(vi).\64\
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\62\ 17 CFR 240.17Ad-22(e)(6)(vi).
\63\ See Exchange Act Release No. 95842, 87 FR at 58413 (File
No. SR-OCC-2022-010) (filing to establish OCC's Risk Management
Framework). OCC Risk Management Framework is available on OCC's
public website: https://www.theocc.com/risk-management/risk-management-framework.
\64\ 17 CFR 240.17Ad-22(e)(6)(vi).
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In addition, OCC believes that proposed changes to promote aspects
of the high volatility control setting process to OCC's rule-filed
Margin Policy are consistent with Section 19(b) of the Exchange Act
\65\ and SEC Rule 19b-4 \66\ thereunder, which require a self-
regulatory organization to file proposed rule changes with the
Commission. In particular, SEC Rule 19b-4 provides that proposed rule
changes subject to this filing requirement include stated policies,
practices and interpretations of the self-regulatory organization,
which the Commission defines to include, among other things, ``any
material aspect of the operation of the facilities of the self-
regulatory organization,'' \67\ regardless of whether the stated
policy, practice or interpretation is made generally available. SEC
Rule 19b-4 provides certain exceptions to the filing requirement,
including if the stated policy, practice or interpretation is
``reasonably and fairly implied by an existing rule of the self-
regulatory organization.'' \68\ OCC's use of high volatility control
settings is currently addressed in OCC's STANS Methodology Description,
a rule of OCC.\69\ This proposed rule change would describe other
aspects of the high volatility control setting process, including (1)
how OCC establishes and maintains regular and high volatility control
sets; (2) how OCC monitors for and escalates high market volatility and
idiosyncratic price moves to appropriate decisionmakers for
consideration of whether high volatility control settings are
warranted; and (3) OCC's internal governance for implementing and
terminating high volatility control settings. OCC believes that
promoting these aspects of the high volatility control setting process
to the Margin Policy would ensure that its rules contain sufficient
detail about material aspects of its margin system.
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\65\ 15 U.S.C. 78s(b).
\66\ 17 CFR 240.19b-4.
\67\ 17 CFR 240.19b-4(a)(6)(i).
\68\ 17 CFR 240.19b-4(c)(1).
\69\ See supra notes 29-30 and accompanying text.
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OCC further believes that other internal procedures and technical
documents concerning the execution of the high volatility control
settings would be reasonably and fairly implied by its rules, as
amended--including the regular and high volatility control sets, the
thresholds used to escalate price movements and market volatility to
appropriate decisionmakers to consider implementing high volatility
control settings, and the method for reviewing and updating those
control sets and thresholds based on the latest market data.\70\
Continuing to maintain these details in OCC internal procedures that
are reasonably and fairly implied by OCC's rules would allow OCC to
adjust the high volatility control settings process in response to
novel situations, changing market conditions and additional
quantitative research as OCC's processes mature. Accordingly, OCC
believes that the proposed rule change is consistent with Section 19(b)
of the Exchange Act \71\ and the regulations thereunder.
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\70\ See supra notes 43, 47, and 49.
\71\ 15 U.S.C. 78s(b).
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For the above reasons, OCC believes that the proposed rule change
is consistent with Section 17A of the Exchange Act \72\ and the rules
and regulations thereunder applicable to OCC.
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\72\ 15 U.S.C. 78q-1.
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(B) Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) of the Exchange Act \73\ requires that the
rules of a clearing agency not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Act. The
proposed changes merely codify requirements related to the
administration of OCC's high volatility control settings, which, when
implemented, apply to all Clearing Members that hold cleared positions
within the scope of the high volatility control settings. Accordingly,
OCC does not believe that the proposed rule change would unfairly
inhibit access to OCC's services.
---------------------------------------------------------------------------
\73\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
While high volatility control settings implemented under the
proposed changes may impact different accounts to a greater or lesser
degree depending on the composition of positions in each account, OCC
does not believe that such impacts would impose any burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act. As discussed above, OCC is obligated under the
Exchange Act and the regulations thereunder to review its model
parameters during periods of time when the products cleared or markets
served display high volatility, report the results to appropriate
decisionmakers, and use the results to evaluate the adequacy of and
adjust its model parameters.\74\ As discussed above, OCC believes the
proposed changes to its rules support a high volatility control setting
process that is reasonably designed to monitor volatility in the
products and markets served by OCC and escalate the results of that
monitoring to appropriate OCC decisionmakers, who would evaluate
whether adjustments to OCC's model parameters through use of control
settings is warranted. In addition, the changes would support a process
designed to mitigate procyclicality observed with the GARCH model,
which OCC believes would help ensure that its margin requirements
remain commensurate with the risks presented by its Clearing Members'
activity, consistent with SEC Rule 17Ad-22(e)(6)(i).\75\ Accordingly,
OCC believes that the proposed rule change would not impose any burden
or impact on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act.
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\74\ See 17 CFR 240.17Ad-22(e)(6)(vi)(C)-(D).
\75\ 17 CFR 240.17Ad-22(e)(6)(i).
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(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments were not and are not intended to be solicited with
respect to the proposed change and none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) by order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.
[[Page 5069]]
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
file number SR-OCC-2024-001 on the subject line.
Paper Comments
Send paper comments in triplicate to Vanessa Countryman,
Secretary, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-1090.
All submissions should refer to file number SR-OCC-2024-001. 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 (https://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for 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
a.m. and 3 p.m. Copies of the filing also will be available for
inspection and copying at the principal office of OCC and on OCC's
website at https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
Do not include personal identifiable information in submissions;
you should submit only information that you wish to make available
publicly. We may redact in part or withhold entirely from publication
submitted material that is obscene or subject to copyright protection.
All submissions should refer to file number SR-OCC-2024-001 and
should be submitted on or before February 15, 2024.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\76\
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\76\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-01386 Filed 1-24-24; 8:45 am]
BILLING CODE 8011-01-P