[Federal Register Volume 89, Number 54 (Tuesday, March 19, 2024)]
[Notices]
[Pages 19629-19634]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-05734]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-99731; File No. SR-OCC-2023-801]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection To Advance Notice, as Modified by Partial
Amendment No. 1 and Amendment No. 2, Concerning Modifications to the
Amended and Restated Stock Options and Futures Settlement Agreement
Between the Options Clearing Corporation and the National Securities
Clearing Corporation
March 13, 2024.
I. Introduction
On August 10, 2023, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-OCC-2023-801 (``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 change terms related to the physical
settlement of equities arising out of certain futures and options
contracts.\4\ On August 30, 2023, notice of the Advance Notice was
published in the Federal Register to solicit public comment and to
extend the review period for the Advance Notice.\5\
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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.
\4\ See Notice of Filing infra note 5, at 88 FR 59988.
\5\ Securities Exchange Act Release No. 98214 (Aug. 24, 2023),
88 FR 59988 (Aug. 30, 2023) (File No. SR-OCC-2023-801) (``Notice of
Filing''). On Aug. 10, 2023, OCC also filed a related proposed rule
change (SR-OCC-2023-007) 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 Aug. 30, 2023, OCC seeks approval of
proposed changes to its rules necessary to implement the Advance
Notice. Securities Exchange Act Release No. 98215 (Aug. 24, 2023),
88 FR 59976 (Aug. 30, 2023) (File No. SR-OCC-2023-007). The initial
comment period for the related Proposed Rule Change filing closed on
Sept. 20, 2023. The Commission solicited further comment when it
subsequently instituted proceedings to determine whether to approve
or disapprove the Proposed Rule Change. The additional comment
period closed on Dec. 26, 2023. See Securities Exchange Act Release
No. 98932 (Nov. 14, 2023), 88 FR 80781 (Nov. 20, 2023) (File No. SR-
OCC-2023-007).
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On November 8, 2023, OCC filed Partial Amendment No. 1 to the
Advance Notice.\6\ On November 14, 2023, the Commission requested
additional information for consideration of the Advance Notice from
OCC, pursuant to Section 806(e)(1)(D) of the Clearing Supervision
Act,\7\ which tolled the Commission's period of review of the Advance
Notice until 120 days from the date the information requested by the
Commission was received by the Commission.\8\ On December 5, 2023, the
Commission received OCC's response to the Commission's request for
additional information.\9\ On January 23, 2024, OCC filed Amendment No.
2 to the Advance Notice, which was published in the Federal Register
for public comment on January 30, 2024.\10\ The Commission has received
public comment regarding the changes proposed in the Advance
Notice.\11\ The Commission is hereby providing notice of no objection
to the Advance Notice as modified by Partial Amendment No. 1 and
Amendment No. 2 (hereinafter defined as the ``Advance Notice'').
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\6\ Partial Amendment No. 1 delays implementation of the
proposed change. In Partial Amendment No. 1, OCC proposes to
implement the proposed rule change within 90 days of receiving all
necessary regulatory approvals and would announce the specific date
of implementation on its public website at least 14 days prior to
implementation. The delay is proposed in light of the technical
system changes that are required to implement the liquidity stress
testing enhancements and to be able to provide sufficient notice to
Clearing Members following receipt of approval.
\7\ 12 U.S.C. 5465(e)(1)(D).
\8\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); Memorandum from
the Office of Clearance and Settlement Supervision, Division of
Trading and Markets, titled ``Commission's Request for Additional
Information,'' available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-298099-727262.pdf.
\9\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); Memorandum from
the Office of Clearance and Settlement Supervision, Division of
Trading and Markets, titled ``Response to the Commission's Request
for Additional Information,'' available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-307799-792662.pdf.
\10\ See Securities Exchange Act Release No. 99427 (Jan. 24,
2024), 89 FR 5953 (Jan. 30, 2024) (File No. SR-OCC-2023-801)
(``Notice of Amendment'').
\11\ Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801.htm. The
Commission received one comment supporting the proposed changes. See
comment from John P. Davidson, Principal, Pirnie Advisory (Oct. 4,
2023), available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-268179-645042.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-2023-007/srocc2023007.htm. The Commission received comments on the proposed
rule change that express concerns unrelated to the substance of the
filing. See, e.g., comment from Gregory Englebert (Feb. 2, 2024)
(raising concerns about a conflict of interest in the role of
Financial Risk Management Officers as well as margin calls) comment
from Curtis H. (Feb. 3, 2024) (referencing short selling and
margin), and comment from CK Kashyap (Feb. 5, 2024) (referring to
broker risk management in response to margin).
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II. Background
The National Securities Clearing Corporation (``NSCC'') is a
clearing agency that provides clearing, settlement, risk management,
and central counterparty services for trades involving equity
securities. OCC is the sole clearing agency for standardized equity
options listed on national securities exchanges registered with the
Commission, including options that contemplate the physical delivery of
equities cleared by NSCC in exchange for cash (``physically settled''
options).\12\ OCC also clears certain futures contracts that, at
maturity, require the delivery of equity securities cleared by NSCC in
exchange for cash. As a result, the exercise and assignment of certain
options or maturation of certain futures cleared by OCC effectively
results in stock settlement obligations to be cleared by NSCC
(``Exercise and Assignment Activity'' or ``E&A Activity''). NSCC and
OCC maintain a legal agreement, generally referred to by the parties as
the ``Accord,'' that governs the processing of such E&A Activity for
firms that are members of both OCC and NSCC (``Common Members'').\13\
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\12\ The term ``physically-settled,'' as used throughout the OCC
Rulebook, refers to cleared contracts that settle into their
underlying interest (i.e., options or futures contracts that are not
cash-settled). When a contract settles into its underlying interest,
shares of stock are sent (i.e., delivered) to contract holders who
have the right to receive the shares from contract holders who are
obligated to deliver the shares at the time of exercise/assignment
in the case of an option and at the time of maturity in the case of
a future. 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.
\13\ Pursuant to OCC Rule 302, outside of certain limited
exceptions, every Clearing Member that effects transactions in
physically-settled options or futures must also be a participant of
NSCC.
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[[Page 19630]]
Under certain circumstances, the Accord currently allows NSCC not
to guaranty the settlement of securities arising out of E&A Activity
for a Common Member for whom NSCC has ceased to act (e.g., due to a
default by that member). To the extent NSCC chooses not to guaranty
such transactions of a defaulting Clearing Member, OCC would have to
engage in an alternate method of settlement outside of NSCC to manage
the default. This presents two issues. First, based on historical data,
the cash required for such alternative settlement could be as much as
$300 billion.\14\ Second, because NSCC's netting process dramatically
decreases the volume of securities settlement obligations that must be
addressed, settlement of physically-settled options and futures outside
of NSCC introduces significant operational complexities. Specifically,
without NSCC's netting process, OCC would have to coordinate a
significantly increased number of transactions on a broker-to-broker
basis rather than through a single central counterparty, and the total
value of settlement obligations that would need to be processed would
be significantly higher.\15\
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\14\ See Notice of Filing, 88 FR at 59989.
\15\ For example, in 2022 it is estimated that netting through
NSCC's continuous net settlement (``CNS'') accounting system reduced
the value of CNS settlement obligations from $519 trillion to $9
trillion, an approximately 98 percent reduction. See Notice of
Filing, 88 FR at 59989.
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OCC proposes to revise the Accord to address these liquidity and
operational issues. In particular, OCC and NSCC have agreed to modify
the Accord to require NSCC to accept E&A activity from OCC (i.e.,
guaranty the positions of a defaulting Common Member), provided that
OCC makes a payment to NSCC called the ``Guaranty Substitution
Payment,'' or ``GSP.'' The GSP is designed to cover OCC's share of the
incremental risk to NSCC posed by the defaulting Common Member's
positions. The total risk posed to NSCC by a defaulting Common Member
would be the sum of (i) the defaulter's unpaid deposit to the NSCC
Clearing Fund (``Required Fund Deposit''),\16\ and (ii) the defaulter's
unpaid Supplemental Liquidity Deposit (``SLD'').\17\ If OCC pays the
GSP to NSCC, NSCC would be obligated under the amended Accord to accept
that member's E&A activity from OCC and conduct settlement through
NSCC's netting process and systems. NSCC would calculate how much of
the defaulting Common Member's Required Fund Deposit and SLD are
attributable to the E&A Activity that OCC sends to NSCC, and that
amount would be the GSP. Based on historical data, OCC's GSP could be
as much as $6 billion, which is significantly less than the potential
$300 billion that could be required for alternative settlement outside
of NSCC.\18\
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\16\ The Required Fund Deposit is calculated pursuant to Rule 4
(Clearing Fund) and Procedure XV (Clearing Fund Formula and Other
Matters) of the NSCC Rules. See Notice of Filing, 88 FR at 59991,
n.28.
\17\ Under the NSCC Rules, in certain circumstances, NSCC
collects the Supplemental Liquidity Deposit, which is an additional
cash deposit from each of those Members who would generate the
largest settlement debits in stressed market conditions. See Rule 4A
of the NSCC Rules. See also Notice of Filing, 88 FR at 59991, n.29.
\18\ See Notice of Filing, 88 FR at 59989.
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As noted above, OCC amended the Advance Notice after filing. The
primary purposes of the Amendment No. 2 were to provide for improved
information sharing between OCC and NSCC, and ensure that the new
process and timing for NSCC to calculate the GSP and OCC to pay the GSP
will be consistent with relevant process and timing requirements
necessitated by the industry transitions to a T+1 settlement cycle for
securities.\19\ OCC has labeled the proposed changes included in the
initial filing to allow OCC to pay the GSP to NSCC and enhance OCC's
liquidity stress testing as Phase 1 of the proposed changes, and the
additional changes in the amendment to enhance information sharing and
facilitate the transition to T+1 as Phase 2.\20\
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\19\ On Feb. 15, 2023, the Commission adopted rules to shorten
the standard settlement cycle for most broker-dealer transactions
from T+2 to T+1. See Securities Exchange Act Release No. 96930 (Feb.
15, 2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
\20\ OCC has proposed a two-step implementation based on the
categorization of changes as part of Phase 1 and Phase 2. See Notice
of Amendment, 89 FR at 5968.
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OCC also proposes to make conforming changes throughout its rules
to accommodate the changes summarized above, as well as a number of
changes to its rules to facilitate the proposed changes to the Accord
noted above. For example, OCC proposes to change its rules to permit
payment of the GSP to NSCC and revise other of its rules related to
liquidity risk management to account for the potential need to make
such a cash payment to NSCC.
A. Information Sharing and the Guaranty Substitution Payment
The proposed revisions to the Accord designed to introduce and
facilitate the new GSP include the following: changes designed to
facilitate improved information sharing between OCC and NSCC; changes
that would define the calculation of the GSP; changes that would define
the process and timing by which guaranty of the E&A Activity would
transfer from OCC to NSCC; \21\ and additional conforming changes to
the Accord to support these and the other changes described in more
detail below.
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\21\ Here, the ``transfer'' of the guaranty refers to the point
at which OCC's settlement guaranty with respect to E&A Activity ends
and NSCC's settlement guaranty begins.
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Improved Information Sharing. Currently, NSCC sends a file daily to
OCC defining which securities are eligible to settle through NSCC. OCC
then delivers to NSCC a file identifying securities to be physically
settled at NSCC as a result of E&A Activity. This process would
continue under the proposal, however, as part of Phase 1 NSCC would
also communicate the GSP daily to OCC.\22\ In Phase 2, NSCC would
continue to communicate the GSP daily to OCC, but the calculation would
differ, as described in more detail below.
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\22\ NSCC would communicate both the total amount of collateral
required to cover the risk presented by each common clearing member
and what percentage of that risk is attributable to OCC (i.e., the
GSP) and therefore OCC would need to pay to require NSCC to guaranty
the positions of a Common Member for whom NSCC has ceased to act. As
described further below, OCC proposes to incorporate the total risk
presented by each common member into its management of liquidity
risk.
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Also in Phase 2, OCC and NSCC would share additional information
beyond the daily exchange of position files and communication of the
GSP. Specifically, NSCC would communicate to OCC daily the single
largest GSP observed in the prior 12 months (the ``Historical Peak
GSP''), which would in turn provide a data point for discussion between
OCC and NSCC to confirm that OCC will likely be in a position to commit
to paying the actual GSP in the event of the default of a Common
Member.\23\ NSCC would also communicate a set of margin and liquidity-
related data to OCC daily (the ``GSP Monitoring Data''). The GSP
Monitoring Data would be for informational purposes and would
facilitate OCC's daily assessment of its ability to commit to pay the
actual GSP
[[Page 19631]]
in the event of the default of a Common Member.
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\23\ NSCC would provide the Historical Peak GSP to OCC daily,
and OCC would communicate to NSCC whether OCC has Clearing Fund cash
in excess of the Historical Peak GSP. If OCC does not have
sufficient cash in the Clearing Fund, this would allow OCC and NSCC
to escalate discussion of whether OCC will likely be in a position
to commit to paying the actual GSP (e.g., what other resources OCC
has, whether the actual GSP is likely to be as large as the
historical peak). The comparison of OCC's resources to the
Historical Peak GSP would not affect whether OCC is permitted to
send E&A Activity to NSCC.
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The Guaranty Substitution Payment. As described above, NSCC would
communicate to OCC the GSP amount each day. In the event of a Common
Member default, this is the amount OCC would need to pay to require
NSCC to guaranty the positions of the defaulting Common Member. Under
both Phases 1 and 2, the GSP for a given member would be the amount
necessary to cover the risk posed by the member's E&A Activity, and
would be calculated by determining the portion of the defaulting
Clearing Member's Required Fund Deposit and SLD that the member owes to
NSCC that is attributable to the member's E&A Activity at OCC. The
calculation of OCC's portion of the Required Fund Deposit obligation
would differ between Phases 1 and 2, with a precise calculation in
Phase 2 replacing a proxy from Phase 1.
In Phase 1, NSCC would approximate the percentage of the member's
Required Fund Deposit attributable to E&A Activity by referencing the
day-over-day change in gross market value of the Common Member's
positions at NSCC. OCC acknowledges that this gross market value proxy
methodology overestimates or underestimates the Required Fund Deposit
attributable to a Common Member's E&A Activity, but states that current
technology constraints prohibit NSCC from performing a precise
calculation of the GSP on a daily basis for every Common Member. The
Phase 2 changes to the Accord would introduce a more precise allocation
of the Required Fund Deposit portion of the GSP, which would help
eliminate the potential over- or under-estimation of OCC's portion of
the Required Fund Deposit.\24\ Specifically, in Phase 2, NSCC would
calculate OCC's portion of the Required Fund Deposit as a difference
between the Required Fund Deposit of the Common Member's entire
portfolio and the Required Fund Deposit of the Common Member's
portfolio prior to the submission of E&A Activity. This more precise
calculation would completely replace the Phase 1 gross market value
proxy. Under both Phases 1 and 2, the SLD portion of the GSP would be
the Common Member's unpaid SLD associated with any E&A Activity.
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\24\ See Notice of Amendment, 89 FR at 5964-65. OCC and NSCC
agreed that performing the necessary technology build during Phase 1
would delay the implementation of the proposal. NSCC will
incorporate those technology updates in connection with Phase 2 of
this proposal. See Notice of Amendment, 89 FR at 5957, n.32.
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Guaranty Transfer. As described above, the purpose of the proposed
changes is to increase the circumstances under which NSCC must assume
the obligation to guaranty E&A Activity. Currently, the guaranty for
such transactions transfers from OCC to NSCC after NSCC has received
Required Fund Deposits from the Common Members. The guaranty would not
transfer if a member fails to satisfy its obligations to NSCC. Under
the proposed changes, the guaranty would transfer after NSCC has
received Required Fund Deposits from the Common Members or at such time
that OCC pays the GSP if a Common Member fails to satisfy its
obligations to NSCC.
B. Liquidity Risk Management
The changes to the Accord regarding the GSP and transfer of the
guaranty are designed to resolve a potential gap in OCC's liquidity
risk management. As noted above, the potential liquidity exposure to
OCC posed by E&A Activity would be dramatically reduced by the proposed
changes because it would go through NSCC's netting process. However,
that reduction would only occur if OCC has sufficient liquid resources
to pay the GSP. The potential payment of the GSP is, therefore, a
liquidity demand that OCC must manage.
OCC's Liquidity Risk Management Framework (``LRMF'') sets forth a
comprehensive overview of OCC's liquidity risk management practices and
governs OCC's policies and procedures as they relate to liquidity risk
management.\25\ OCC proposes changes to the LRMF as well as to OCC's
Comprehensive Stress Testing & Clearing Fund Methodology, and Liquidity
Risk Management Description \26\ to incorporate the GSP into OCC's
liquidity stress testing practices by treating the GSP as a potential
liquidity demand.\27\
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\25\ See Securities Exchange Act Release No. 89014 (June 4,
2020), 85 FR 35446 (June 10, 2020) (File No. SR-OCC-2020-003).
\26\ OCC provided a marked version of the Comprehensive Stress
Testing & Clearing Fund Methodology, and Liquidity Risk Management
Description to the Commission as exhibit 5D to File No. SR-OCC-2023-
801.
\27\ OCC would incorporate this potential liquidity demand at
the level of a group of affiliated members.
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To implement this change, OCC would add an amount representing the
potential GSP to each member account on each day on which options
expire. The amount would be based on historical data. Specifically, OCC
would add the peak GSP observed in the prior 12 months for the member
to the potential liquidity risk posed by the member.\28\ The reliance
on the peak GSP observed in a 12-month lookback, however, raises two
issues that OCC proposes to address in its management of liquidity
risk.
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\28\ OCC states that the one-year lookback allows for the best
like-to-like application of a historical GSP as there is a cyclical
nature to option standard expirations with quarterly (i.e., Mar.,
June, Sept., and Dec.) and Jan. generally being more impactful than
non-quarterly expirations. See Notice of Filing, 88 FR at 59998. OCC
states further that the one-year lookback allows behavior changes of
a Clearing Member to be recognized within an annual cycle. See id.
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First, future liquidity exposures may exceed past exposures, so
holding enough liquidity to meet historical demands does not ensure
that OCC will hold enough to meet future exposures. To address this
issue, OCC proposes to incorporate a member's total Required Fund
Deposit and SLD obligations to NSCC (not just the portion represented
in the GSP), into its liquidity risk management. As with most risk
management, there is no guaranty that a future GSP could not exceed
OCC's stress test exposures, but the proposed change increases the
likelihood that OCC would have sufficient cash to pay the GSP.\29\
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\29\ For example, assume the largest member obligation to NSCC
would have been $100, but the largest GSP (representing the amount
attributable to E&A Activity) would only have been $75. Rather than
hold $75 and hope that the future exposures do not exceed past
demands, OCC would hold $100 to cover a future GSP.
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Second, the more E&A Activity that OCC sends to NSCC, the larger
the amount of Required Fund Deposit and SLD attributable to E&A
Activity. However, the level of E&A Activity varies predictably based
on the expiration cycle of options such that different expiration
cycles consistently present different volumes. Put simply, different
expiration cycles are likely to pose different levels of liquidity risk
to OCC in the form of the potential size of the GSP. Based on its
analysis, OCC proposes to separate expirations into five
categories.\30\ For each day, OCC proposes to apply the peak obligation
observed over the prior 12 months within the relevant expiration
category for that day.\31\ The five categories that
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OCC proposes to employ are the following:
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\30\ OCC provided its analysis supporting the specific
categories to the Commission in confidential Exhibit 3E to File No.
SR-OCC-2023-007. The confidential Exhibit 3E sets forth data related
to OCC's liquidity stress testing for Sufficiency and Adequacy
scenarios with and without the inclusion of the GSP, including
Available Liquidity Resources, Minimum Cash Requirement thresholds,
and liquidity breaches.
\31\ For example, for a standard monthly expiration, which is
typically the third Friday of the month, OCC would look at the peak
obligation observed across all standard monthly expirations in the
preceding 12 months.
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Standard Monthly Expiration: typically the third Friday of
each month;
End of Week Expirations: the last business day of the
week, excluding the third Friday of each month;
End of Month Expirations: the last trading day of the
month;
Bank Holiday Expirations: days where banks are closed but
the markets are open; \32\
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\32\ The Bank Holiday category recognizes that for Veterans Day
and Columbus Day, the equity and equity derivative markets are open
for trading, but the banking system is closed. Because of this,
settlement at NSCC encompasses two days of equity trading and E&A
Activity. This creates the possibility of a significant outlying GSP
requirement due to the settlement of two days of activity
simultaneously. In OCC's view this necessitates the ability to
separately risk manage such occurrences through the creation of the
Bank Holiday category. Additional supporting data in support of the
creation of the Bank Holiday Expiration category is included as
Exhibit 3E to File No. SR-OCC-2023-007.
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Daily Expirations: all other days with an expiration that
do not fall into any of the categories above (typically most Mondays
through Thursdays).
Notwithstanding this categorization and the underlying analysis,
OCC proposes to impose two floors to certain expirations. First, the
peak obligation applied in the End of Week, End of Month, and Bank
Holiday categories cannot be lower than the peak obligation observed in
the Daily Expirations category. Second, the obligation applied in the
Standard Monthly Expiration category cannot be lower than the peak
obligation observed in either the End of Week, End of Month, or Daily
Expiration category. As discussed below, the imposition of the floors
would help OCC control for the possibility of an unusually large
liquidity demand that is not related to the different expiration
cycles.
The liquidity risk management changes described above are part of
Phase 1. Additionally, OCC proposes changes to its Rules and By-Laws to
allow OCC to pay the GSP out of its liquid resources.\33\ Under Phase
2, OCC proposes to make further clarifying and definitional changes in
the LRMF, but the substance of the Phase 1 changes would persist in
Phase 2.
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\33\ For example, OCC proposes changes to its rules to allow OCC
to borrow funds from the Clearing Fund to pay the GSP, which is
consistent with OCC's use of the Clearing Fund to address other
liquidity needs such as to cover losses resulting from a member's
failure to satisfy an obligation on a confirmed trade accepted by
OCC. See OCC Rule 1006(a)(i).
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C. Transition to T+1
Phase 1 of the proposed changes are primarily designed to provide
OCC the right to require NSCC to accept and guaranty the E&A Activity
of a Common Member even if that member has not met its obligations to
NSCC. The mechanism by which OCC would exercise that right would be the
payment of the GSP to NSCC, and OCC would account for such payment as a
potential liquidity demand that it must manage. Phase 1 does not,
however, materially change the time at which OCC would cease (and NSCC
would start) to guaranty the E&A Activity.\34\
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\34\ The Commission described the current timing and process
under which OCC's guaranty ceases and NSCC's guaranty attaches in a
prior order. See Securities Exchange Act Release No. 81266 (July 31,
2017), 82 FR 36484, 36486-87 (Aug. 4, 2017) (File No. SR-OCC-2017-
013).
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Under the current Accord, NSCC's guaranty attaches (and OCC's
ceases) when NSCC has received all Required Fund Deposits taking into
account the E&A Activity.\35\ Currently, NSCC's guaranty would not
attach if a Common Member defaults on its obligations to NSCC. Under
Phase 1 of the proposed changes, however, OCC would have the
opportunity to pay the GSP to NSCC as an effective substitution for the
defaulted member's obligations with respect to the E&A Activity. Phase
1, therefore, allows for a change in who pays NSCC, but does not alter
the timing of payment.
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\35\ See id. at 36487.
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Phase 2 will alter the timing of payment, primarily to accommodate
the transition from a T+2 settlement cycle to a T+1 settlement
cycle.\36\ Under the current process, which takes place in a T+2
settlement cycle, there is sufficient time after expiration for NSCC
and OCC to determine whether a member has defaulted before NSCC begins
to process settlement of the E&A Activity. However, in a T+1 settlement
cycle, settlement processing could begin before NSCC or OCC become
aware of a member default. Thus, in a T+1 environment, the timing and
process by which OCC's guaranty would cease (and NSCC's would attach)
would need to shift.
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\36\ See Securities Exchange Act Release No. 96930 (Feb. 15,
2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
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Specifically, under Phase 2, OCC would commit to payment of the GSP
(regardless of whether a member has defaulted) prior to NSCC's
acceptance of E&A Activity. If OCC is unable to commit to pay the GSP,
NSCC would be permitted, but not required, to reject the E&A Activity.
The process would vary slightly between expirations occurring on a
Friday and expirations occurring Monday through Thursday. For a Friday
expiration, NSCC would communicate the GSP to OCC and OCC would
subsequently commit to pay the GSP on Saturday morning. For Monday
through Thursday expirations, OCC's transmission of the E&A Activity
itself to NSCC would constitute a commitment by OCC to pay the GSP
related to that E&A Activity.\37\ For all expirations, OCC would send
the E&A Activity to NSCC by 1 a.m. the morning after expiration (e.g.,
1 a.m. Saturday for a Friday expiration). This would help ensure that,
in a T+1 settlement environment, NSCC has OCC's commitment to pay the
GSP before NSCC must begin processing any E&A Activity from OCC.
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\37\ The requirement to commit prior to calculation of the final
GSP for E&A Activity arising Monday through Thursday highlights the
importance of the improved information sharing described above.
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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 systemically
important financial market utilities (``SIFMUs'') and strengthening the
liquidity of SIFMUs.\38\
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\38\ See 12 U.S.C. 5461(b).
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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.\39\ 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):\40\
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\39\ 12 U.S.C. 5464(a)(2).
\40\ 12 U.S.C. 5464(b).
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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.\41\
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\41\ 12 U.S.C. 5464(c).
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The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and Section 17A of the
Exchange
[[Page 19633]]
Act (the ``Clearing Agency Rules'').\42\ 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.\43\ 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,\44\ and in the Clearing Agency Rules, in particular
Rules 17Ad-22(e)(1), (e)(7), and (e)(20).\45\
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\42\ 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 Securities Exchange Act Release No. 78961 (Sept. 28, 2016), 81
FR 70786 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing Agency
Standards''). OCC is a ``covered clearing agency'' as defined in
Rule 17Ad-22(a)(5). See 17 CFR 240.17Ad-22(a)(5).
\43\ 17 CFR 240.17Ad-22.
\44\ 12 U.S.C. 5464(b).
\45\ 17 CFR 240.17Ad-22(e)(1); 17 CFR 240.17Ad-22(e)(7); and 17
CFR 240.17Ad-22(e)(20).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
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. In particular, the proposal is consistent with
promoting robust risk management, promoting safety and soundness,
reducing systemic risks, and supporting the stability of the broader
financial system.\46\
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\46\ 12 U.S.C. 5464(b).
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The Advance Notice is consistent with promoting robust risk
management, specifically liquidity risk management, as well as safety
and soundness primarily because the introduction of the GSP would allow
OCC to require NSCC to accept E&A Activity in the event of a Common
Member default, so long as OCC pays the GSP to NSCC. Processing E&A
Activity through NSCC's netting system would significantly reduce the
risk posed by such E&A Activity by reducing the volume and value of
settlement obligations.\47\ It would also reduce OCC's potential
liquidity demands as a result of the E&A Activity from an amount that
could exceed its available liquid resources to an amount that would
fall well within its current liquid resources. Reducing OCC's liquidity
risk in this manner is consistent with both sound risk management
practices and safety and soundness more broadly. The information
sharing contemplated under the proposed changes is also consistent with
promoting robust risk management because it will allow OCC to better
understand and monitor its exposures and provide for more dialogue
between NSCC and OCC, which could, in turn, allow them to better manage
the risks posed by the E&A Activity.
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\47\ As noted above, it is estimated that, in 2022, netting
through NSCC's CNS accounting system reduced the value of CNS
settlement obligations by approximately 98% or $510 trillion from
$519 trillion to $9 trillion. See Notice of Filing, 88 FR at 59977.
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To the extent the proposed changes are consistent with promoting
OCC's safety and soundness, they are also consistent with reducing
systemic risks and 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.\48\ The proposed changes would support OCC's ability to
continue providing services to the options markets by addressing losses
and shortfalls arising out of the default of a Common Member. OCC's
continued operations would, in turn, 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. Further, Phase 2 is consistent with
supporting the stability of the broader financial system because the
proposed changes in Phase 2 are designed to support the shortening of
the standard settlement cycle for most broker-dealer transactions from
T+2 to T+1.
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\48\ See Financial Stability Oversight Council (``FSOC'') 2012
Annual Report, Appendix A, https://home.treasury.gov/system/files/261/here.pdf (last visited Feb. 17, 2022).
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Accordingly, and for the reasons stated above, the changes proposed
in the Advance Notice are consistent with Section 805(b) of the
Clearing Supervision Act.\49\
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\49\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(1) Under the Exchange Act
Rule 17Ad-22(e)(1) under the Exchange Act requires, in part, that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to provide for a
well-founded, clear, transparent, and enforceable legal basis for each
aspect of its activities in all relevant jurisdictions.\50\ In adopting
Rule 17Ad-22(e)(1), the Commission provided guidance that a covered
clearing agency generally should consider in establishing and
maintaining policies and procedures that address legal risk.\51\ The
Commission stated that a covered clearing agency should consider, inter
alia, whether its contracts are consistent with relevant laws and
regulations.\52\
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\50\ 17 CFR 240.17Ad-22(e)(1).
\51\ See Covered Clearing Agency Standards, 81 FR at 70802.
\52\ See id.
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On February 15, 2023, the Commission adopted a final rule to
shorten the standard settlement cycle for most broker-dealer
transactions from two business days after the trade date to one
business day after the trade date.\53\ Currently, and under Phase 1,
the terms of the Accord are designed for consistency with a T+2
settlement cycle. As described above, the terms of the Accord under
Phase 2, which OCC intends to implement on the T+1 compliance date
established by the Commission,\54\ would be designed for consistency
with a T+1 settlement cycle.
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\53\ See Securities Exchange Act Release No. 96930 (Feb. 15,
2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
\54\ See Notice of Amendment, 89 FR at 5968.
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Accordingly, the proposal to amend the Accord to conform to a T+1
settlement cycle is consistent with Rule 17Ad-22(e)(1) under the
Exchange Act.\55\
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\55\ 17 CFR 240.17Ad-22(e)(1).
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C. Consistency With Rule 17Ad-22(e)(7) Under the Exchange Act
Rule 17Ad-22(e)(7) under the Exchange Act requires that a covered
clearing agency establish, implement, maintain, and enforce written
policies and procedures reasonably designed to effectively measure,
monitor, and manage the liquidity risk that arises in or is borne by
the covered clearing agency, including measuring, monitoring, and
managing its settlement and funding flows on an ongoing and timely
basis, and its use of intraday liquidity.\56\ In adopting Rule 17Ad-
22(e)(7), the Commission provided guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address liquidity risk.\57\ The Commission
stated that a covered clearing agency should consider, inter alia,
whether it maintains sufficient liquid resources in all relevant
currencies to settle securities-related payments and meet
[[Page 19634]]
other payment obligations on time with a high degree of confidence
under a wide range of stress scenarios.\58\
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\56\ 17 CFR 240.17Ad-22(e)(7).
\57\ See Covered Clearing Agency Standards, 81 FR at 70823.
\58\ See id.
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OCC's LRMF sets forth a comprehensive overview of OCC's liquidity
risk management practices and governs OCC's policies and procedures as
they relate to liquidity risk management. As described above, the
potential cash necessary to manage a member default without utilizing
NSCC's settlement process could exceed OCC's available liquid
resources. The proposed changes to the Accord would allow OCC to send
E&A Activity to NSCC even in the event of a Common Member default,
which, based on an analysis of historical data, would reduce OCC's
potential liquidity to an amount that is within the scope of its
current resources.
To take advantage of the proposed changes to the Accord, OCC must
be prepared to make a cash payment to NSCC (i.e., the GSP). OCC
proposes to recognize that potential payment obligation as an input to
OCC's liquidity risk processes. In particular, OCC proposes to consider
the full amount of a Common Member's past obligations to NSCC rather
than consider only the portion of such obligation attributable to E&A
Activity. OCC's reliance on historical data would allow it to
approximate, but not predict potential future exposures. Reliance
solely on past GSP requirements would not position OCC to cover a
future peak GSP. The incorporation of the full amount of a Common
Member's past obligations, however, would provide a buffer to increase
the likelihood that OCC would be in a position to pay a future GSP that
exceeds historical GSP requirements. OCC also proposes to align its
measurement of the potential obligation to pay NSCC with the cyclical
nature of the products that OCC clears,\59\ and to increase its
information sharing with NSCC, which would allow OCC to better monitor
the potential liquidity need posed by the GSP.
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\59\ Alignment with the cyclical nature of the products would be
achieved, as described above, through the use of expiration
categories when incorporating collateral requirements into OCC's
stress testing. To balance this process, however, OCC would also
impose floors across expiration categories that would help control
for the possibility for an unusually large liquidity demand that is
not related to the different expiration cycles.
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Accordingly, the proposed changes to the Accord regarding the GSP
and to OCC's internal liquidity risk management rules are consistent
with Rule 17Ad-22(e)(7) under the Exchange Act.\60\
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\60\ 17 CFR 240.17Ad-22(e)(7).
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D. Consistency With Rule 17Ad-22(e)(20) Under the Exchange Act
Rule 17Ad-22(e)(20) under the Exchange Act requires that a covered
clearing agency establish, implement, maintain, and enforce written
policies and procedures reasonably designed to identify, monitor, and
manage risks related to any link the covered clearing agency
establishes with one or more other clearing agencies, financial market
utilities, or trading markets.\61\ For the purposes of Rule 17Ad-
22(e)(20), ``link'' means, among other things, a set of contractual and
operational arrangements between two or more clearing agencies,
financial market utilities, or trading markets that connect them
directly or indirectly for the purpose of participating in
settlement.\62\
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\61\ 17 CFR 240.17Ad-22(e)(20).
\62\ 17 CFR 240.17Ad-22(a)(8).
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In adopting Rule 17Ad-22(e)(20), the Commission provided guidance
that a covered clearing agency generally should consider in
establishing and maintaining policies and procedures that address
links.\63\ Notably, the Commission stated that a covered clearing
agency should consider whether a link has a well-founded legal basis,
in all relevant jurisdictions, that supports its design and provides
adequate protection to the covered clearing agencies involved in the
link.\64\
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\63\ See Covered Clearing Agency Standards, 81 FR at 70841.
\64\ Id.
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As described above, the Accord is a contractual arrangement between
NSCC and OCC that governs the processing of E&A Activity, which
consists of settlement obligations arising out of certain products
cleared by OCC. The Accord, therefore, is a link for the purposes of
Rule 17Ad-22(e)(20). The specific legal basis for the Accord to conform
to a T+1 settlement cycle was discussed above in section III.B.
Likewise, Section III.C. discussed the ways the Accord provides
adequate protection to both OCC and NSCC by introducing the GSP,
enhancing information sharing between OCC and NSCC, and ensuring that
OCC and NSCC have the tools and information they need to monitor the
potential liquidity need posed by the GSP.
For the reasons discussed in those sections, the Accord between OCC
and NSCC has a well-founded legal basis that supports its design and
provides adequate protection to the covered clearing agencies involved
in the Accord. Accordingly, the proposed changes to the Accord are
consistent with Rule 17Ad-22(e)(20) under the Exchange Act.\65\
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\65\ 17 CFR 240.17Ad-22(e)(20).
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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-2023-801) as modified by Partial Amendment No. 1
and Amendment No. 2, and that OCC is AUTHORIZED to implement the
proposed changes as of the date of this notice or the date of an order
by the Commission approving proposed rule change SR-OCC-2023-007,
whichever is later.
By the Commission.
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-05734 Filed 3-18-24; 8:45 am]
BILLING CODE 8011-01-P