[Federal Register Volume 89, Number 180 (Tuesday, September 17, 2024)]
[Notices]
[Pages 76171-76176]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-21035]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-100998; File No. SR-OCC-2024-009]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of Proposed Rule Change by The Options Clearing 
Corporation Concerning Its Backtesting Framework and To Establish a 
Resource Backtesting Margin Charge

September 11, 2024.

I. Introduction

    On July 11, 2024, the Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2024-009 (``Proposed Rule Change'') 
pursuant to Section 19(b) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder. The Proposed Rule 
Change would amend the OCC rules to more comprehensively describe its 
approach to backtesting, including underlying assumptions; establish a 
new category of backtesting regarding the maintenance of sufficient 
margin resources; implement a new margin add-on charge based on 
breaches of the new category of resource backtesting; and clarify 
governance and escalation criteria related to the updated backtesting 
framework. The Proposed Rule Change was published for public comment in 
the Federal Register on July 30, 2024.\3\ The Commission has received 
no comments regarding the Proposed Rule Change. This order approves the 
Proposed Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 100584 (July 24, 2024), 
89 FR 61211 (July 30, 2024) (File No. SR-OCC-2024-009) (``Notice of 
Filing'').
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II. Description of the Proposed Rule Change

    OCC is a central counterparty (``CCP''), which means that as part 
of its function as a clearing agency it interposes itself as the buyer 
to every seller and the seller to every buyer for certain financial 
transactions. As the CCP for the listed options markets in the U.S.,\4\ 
as well as for certain futures and stock loans, OCC is exposed to 
certain risks arising from providing settlement and clearing services 
to its Clearing Members.\5\ Because OCC is obligated to perform on the 
contracts it clears even where one of its Clearing Members defaults, 
one such risk to which OCC is exposed is credit risk in the form of 
exposure to its members' trading activities. OCC manages such credit 
risk, in part, by collecting collateral from its members in the form of 
margin. OCC evaluates the margin requirements it imposes on members by 
periodically comparing such requirements to the potential risk of loss 
arising out of a member default (i.e., backtesting).\6\ While 
backtesting does not directly establish a member's margin requirements, 
OCC maintains authority under its rules to collect additional margin if 
OCC identifies--through backtesting results or otherwise--issues with 
its margin coverage.\7\
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    \4\ OCC describes itself as ``the sole clearing agency for 
standardized equity options listed on a national securities exchange 
registered with the Commission (`listed options').'' See Securities 
Exchange Act Release No. 96533 (Dec. 19, 2022), 87 FR 79015 (Dec. 
23, 2022) (File No. SR-OCC-2022-012).
    \5\ Capitalized terms have the same meaning as provided in OCC's 
By-Laws and Rules, which can be found on OCC's public website: 
https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
    \6\ Under the rules applicable to OCC, backtesting means an ex-
post comparison of actual outcomes with expected outcomes derived 
from the use of margin models. 17 CFR 240.17ad-22(a) 
(``Backtesting'').
    \7\ See Notice of Filing, 89 FR at 61212.
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    OCC's current backtesting framework measures its Clearing Members' 
losses in excess of calculated margin requirements to evaluate the 
adequacy of OCC's model performance, improve margin methodology and 
risk assessment processes, and identify trends in exceedances that may 
indicate broader behavioral changes by market participants. However, 
OCC's current backtesting framework does not provide detailed 
descriptions of the backtesting process, nor does it require OCC to 
measure whether it has collected sufficient margin resources in the 
event of a Clearing Member default (a process often referred to as 
``resource sufficiency'' evaluation), or detail the underlying 
assumptions and governance process for the framework. To address these 
issues, the Proposed Rule Change would update OCC's current backtesting 
framework by:
     updating the current backtesting framework to more 
comprehensively describe material aspects of model backtesting;
     providing for a new category of backtesting--``Resource 
Backtesting''--that assesses the adequacy of OCC's margin resources to 
cover its credit exposure at the Clearing Member level; and
     detailing the underlying assumptions and reporting 
structure for the entire backtesting framework to provide for clearer 
governance procedures, including escalation criteria.
    Additionally, OCC lacks a mechanism with which to collect 
additional margin resources in instances where backtesting suggests 
that OCC may otherwise not have sufficient resources to cover its 
credit exposure during a Clearing Member's default. To that end, OCC 
proposes to implement a new add-on charge called the ``Resource 
Backtesting Margin Charge.'' Although this add-on would not be part of 
the backtesting framework, OCC would use the proposed Resource 
Backtesting category of backtesting to determine if additional margin 
in the form of the Resource Backtesting Margin Charge is necessary and 
in what amount. Specifically, OCC would apply the Resource Backtesting 
Margin Charge to Clearing Members who experience Resource Backtesting 
deficiencies that bring their margin coverage rates below a 99% 
coverage target. OCC also proposes to include in the backtesting 
framework governance procedures related to the Resource Backtesting 
Margin Charge.\8\
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    \8\ Under the Proposed Rule Change, OCC also would make 
conforming changes to its rules and internal policies and procedures 
to reflect these amendments and facilitate implementation, including 
consolidating internal procedures for all backtesting into a 
Backtesting Procedure and associated technical document, updating 
references and descriptions, and inserting headings. See Notice of 
Filing, 89 FR at 61219-20. OCC provided the new Backtesting 
Procedure as confidential Exhibit 3B, and the updated technical 
document as confidential Exhibit 3C to File No. SR-OCC-2024-009.
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A. OCC's Current Backtesting Framework

    OCC conducts daily backtesting of collateral requirements generated 
by its margin methodology using standard predetermined parameters and 
assumptions. OCC uses such backtesting to update its credit risk 
management and margin methodology \9\ or to adjust model parameters. 
OCC relies on backtesting to evaluate the accuracy of its margin models 
by comparing the calculated margin coverage for each margin account 
against the realized profit and loss on the margined

[[Page 76172]]

portfolios. However, OCC's policies and procedures do not currently 
identify the categories of relevant assumptions, provide for how they 
are established or modified, or explain how assumptions may differ 
across different types of backtesting depending on the purpose of those 
backtesting variants.
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    \9\ OCC's margin methodology, adopted in 2006, is titled the 
System for Theoretical Analysis and Numerical Simulation 
(``STANS''). See Notice of Filing, 89 FR at 61212-13.
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    Currently, OCC conducts both backtesting of hypothetical portfolios 
(which OCC currently refers to as ``Model Backtesting'') and actual 
portfolios (which OCC currently refers to as ``Business 
Backtesting'').\10\ OCC's internal backtesting procedures address data 
acquisition, application of statistical tests, analyses initiated to 
address root causes of exceedances, reporting of results, annual 
methodology reviews, and issue escalation.
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    \10\ See generally Securities Exchange Act Release Nos. 73749 
(Dec. 5, 2014), 79 FR 73673 (Dec. 11, 2014) and 75290 (June 24, 
2015), 80 FR 37323 (June 30, 2015) (File No. SR-OCC-2014-810).
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    OCC's backtesting framework includes its Margin Policy.\11\ The 
Margin Policy requires that OCC's Financial Risk Management Department 
(``FRM'') continually evaluates the effectiveness of its margin models 
through daily backtesting of each margin account.\12\ The Margin Policy 
requires further that OCC's Quantitative Risk Management business unit 
(``QRM'') design backtests to focus on satisfying OCC's regulatory 
obligations, identifying potential opportunities to improve the margin 
methodology, and identifying trends in exceedances that may be 
indicative of behavioral changes by market participants. Acknowledging 
that problems may arise from both technical \13\ and model-related 
issues, the Margin Policy directs QRM to design backtests to find 
potential opportunities to improve OCC's risk-assessment processes. 
Under the current backtesting framework, FRM performs Business 
Backtesting to measure whether the losses observed for a constant set 
of positions over OCC's two-day margin period of risk were in excess of 
the total risk charges (i.e., aggregate of expected shortfall, stress 
test charges and add-on charges) required for the account. FRM is then 
directed to classify any observation in which losses are in excess as 
an exceedance.
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    \11\ OCC provided the Margin Policy as confidential Exhibit 5B 
to File No. SR-OCC-2024-009. OCC stated that, generally, ``the 
Margin Policy establishes a process for ongoing monitoring, review, 
testing and verification of OCC's risk-based margin system, 
including by requiring OCC to conduct daily backtesting, conduct 
analysis of exceedances, and report results at least monthly through 
OCC's governance process. . .'' See Notice of Filing, 89 FR at 
61212.
    \12\ See Notice of Filing, 89 FR at 61213.
    \13\ OCC indicated that such technical issues may arise from 
corporate actions and special dividends. Id.
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    With regard to governance, the current Margin Policy directs QRM to 
report identified problems and overall performance to FRM and the Model 
Risk Working Group (``MRWG''), which then determines whether the 
results require escalation to OCC's Management Committee (``MC''). The 
Margin Policy further requires routine reporting from QRM to the MRWG 
that accumulate daily backtesting results and detailed descriptions of 
the accounts that have incurred exceedances, trends, and causes of the 
exceedances. As with the escalation of identified problems and overall 
performance, the Margin Policy directs QRM to provide notable results 
from these reviews to the Chief Financial Risk Officer, who is the head 
of FRM, and the MRWG; and that the MRWG similarly determines whether 
escalation is warranted to the MC, which may decide what remedial 
actions may be taken. Under the current Margin Policy, QRM must also 
perform a monthly review of parameters and assumptions for Business 
Backtesting, and report such review to the MRWG to discuss and escalate 
issues as necessary.

B. Proposed Updates to the Backtesting Framework

    OCC's current backtesting framework does not specify certain 
materials aspects of OCC's backtesting processes, namely, a 
comprehensive description of the different types of backtesting OCC 
performs and their respective purposes, and how OCC establishes and 
modifies its assumptions for backtesting. Importantly, the current 
framework does not require OCC to conduct backtesting to measure margin 
resource sufficiency, but rather, is designed to identify technical and 
model-based issues as described above. OCC's current backtesting 
framework also lacks detailed guidance around governance, specifically 
the reporting process and escalation criteria and thresholds, which 
could lead to inconsistencies in the escalation of similar backtesting 
exceedances or deficiencies, and reviews of backtesting assumptions.
    To help mitigate these issues, OCC proposes to:
     more comprehensively describe material aspects of its 
model backtesting framework, including the purpose and scope of the 
backtesting OCC performs;
     introduce a new category of backtesting, Resource 
Backtesting, to measure whether OCC's margin resources adequately cover 
its credit exposure at the Clearing Member level;
     list the assumptions underlying OCC's backtesting and the 
process for reviewing and modifying those assumptions; and
     outline in more detail the backtesting reporting process, 
including which decision-makers are involved and escalation criteria 
for exceedances or deficiencies and reviews.
1. Model Backtesting
    Under the Proposed Rule Change, OCC would consolidate discussion of 
its two current ``Model'' and ``Business'' backtesting programs under 
the heading of Model Backtesting, without changing its current process 
for conducting daily backtesting of hypothetical and actual portfolios 
to evaluate the performance of its margin methodology. OCC proposes to 
add descriptions in the Margin Policy to explain that FRM conducts 
Model Backtesting of hypothetical portfolios to target specific aspects 
of the models that may be masked by the backtesting of actual 
portfolios, because margin accounts may have thousands of positions in 
many diverse products. Under the Proposed Rule Change, the Margin 
Policy would include additional details consistent with OCC's current 
backtesting practices. Such details would include that OCC would 
conduct Model Backtesting (i) over a set liquidation horizon; (ii) at 
the marginable account level; \14\ and (iii) at a 99 percent confidence 
level. The Margin Policy would add a definition of ``exceedance'' to 
mean a daily outcome in which the loss in portfolio value over the 
applicable time horizon is larger in magnitude than what the daily 
STANS model predicted at the start of that time horizon.
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    \14\ See Notice of Filing, 89 FR at 61214 (``OCC conducts Model 
Backtesting at this level because Model Backtesting exceedances 
potentially indicate issues that could be actively impacting OCC's 
margin requirements for the margin accounts. In addition, 
backtesting at this level is consistent with OCC's obligations in 
its capacity as a derivatives clearing organization (`DCO') 
registered with the Commodity Futures Trading Commission.'')
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    OCC would continue to limit the purpose of Model Backtesting to 
assessing the performance of OCC's margin models in calculating margin 
requirements, as opposed to assessing the performance of other aspects 
of OCC's credit risk management. Consistent with this intent, the 
Margin Policy would state that OCC would continue to exclude collateral 
from Model Backtesting that is not modeled by STANS, such as collateral 
that is valued using the more traditional method of fixed collateral 
haircuts outside of the STANS margin methodology, or collateral that 
does not capture changes in market risk factors, such as add-ons that 
are unrelated to

[[Page 76173]]

changes in market risk factors (e.g., when a Clearing Member's 
operational or financial condition presents elevated risks). The 
collateral that is not modelled by STANS instead would be accounted for 
under the new backtesting category of Resource Backtesting, as 
described in Section II.B.2. below.\15\
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    \15\ Notwithstanding the inclusion of such collateral in 
Resource Backtesting rather than in Model Backtesting, OCC also 
would have the authority under the proposed Margin Policy to 
maintain variations of Model Backtesting for diagnostic or 
informational purposes that include such add-ons. See Notice of 
Filing, 89 FR at 61214.
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2. Resource Backtesting
    In addition to formalizing the process of performing daily Model 
Backtesting in the Margin Policy, OCC would add a new category of 
backtesting, called Resource Backtesting, to evaluate whether OCC's 
financial resources are sufficient to cover its credit exposures during 
a Clearing Member default. Pursuant to the proposed Margin Policy, FRM 
would be required to conduct Resource Backtesting using actual 
portfolios at the Clearing Member level to evaluate whether OCC 
maintains sufficient financial resources to cover its credit exposure 
to the liquidation portfolio of each Clearing Member from the last 
deposit of margin assets until the end of the liquidation horizon 
following the Clearing Member's default. Since Resource Backtesting 
would be designed to determine whether the liquidating value of a 
Clearing Member's portfolios would be positive or negative at the end 
of OCC's liquidation horizon, it would take into account observed 
intraday position changes from the time of the last good margin 
collection until the assumed point of default.
    The proposed Margin Policy would set the coverage target for 
Resource Backtesting at 99 percent, meaning that any Resource 
Backtesting deficiencies should be no more than one percent in the 
rolling 12-month lookback period for each Clearing Member. The proposed 
changes to the Margin Policy would define a ``deficiency'' as a daily 
result where the prefunded financial resources collected from the 
Clearing Member would have been insufficient to cover the potential 
loss in case of its default (i.e., a negative liquidating value of the 
Clearing Member's portfolios).
    While OCC conducts Model Backtesting at the account level, OCC 
would consider resources and exposures across a given member's account 
for Resource Backtesting. Because OCC's By-Laws and Rules provide for 
different types of liens over different types of accounts, OCC would 
consider the liens on a particular account when netting deficits and 
surpluses across account types to ensure that surpluses in an account 
over which OCC maintains a restricted lien do not offset losses in 
another account for purposes of Resource Backtesting.
    In contrast with Model Backtesting, OCC would include collateral 
that is not modelled by STANS in Resource Backtesting. The margin 
resources that would be considered by Resource Backtesting would be 
limited to a member's margin requirements; accordingly, any excess 
margin collateral would be excluded. OCC would continue to exclude 
Clearing Fund deposits from all margin backtesting.
3. Backtesting Assumptions and Reporting
    The proposed Margin Policy would explicitly list certain 
assumptions that inform OCC's backtesting practices: the timing of 
default, liquidation horizon, available resources, confidence level, 
lookback period, and the backtesting portfolio.\16\ The proposed 
changes to the Margin Policy would define OCC's process for evaluating 
and changing such assumptions. Specifically, changes to backtesting 
assumptions would require escalation by MRWG and the MC, with ultimate 
approval by the Risk Committee (``RC''). Under the proposed changes to 
the Margin Policy, changes to backtesting assumptions that would result 
in or arise from changes to OCC's margin methodology, in such a way as 
to require a rule change proposal to be filed with the Commission, 
would continue to require the approval of OCC's Board of Directors.
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    \16\ Although the type of assumptions would be listed in the 
Margin Policy, OCC would maintain the specific assumptions in its 
underlying documentation.
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    As proposed, the Margin Policy would provide that, at least 
monthly,\17\ FRM will review the results of backtesting to identify any 
Model Backtesting exceedances or Resource Backtesting deficiencies and 
present a detailed analysis of such information, as well as a review of 
backtesting assumptions, to the MRWG to determine whether OCC's 
backtesting practices are appropriate for measuring the adequacy of 
margin requirements. The proposed changes to the Margin Policy state 
that escalation criteria for backtesting results would include (i) 
thresholds related to the size and number of exceedances for Model 
Backtesting of actual portfolios; (ii) thresholds related to 
statistical tests for Model Backtesting of hypothetical portfolios; and 
(iii) thresholds related to the size of an individual Clearing Member's 
Resource Backtesting deficiency and the coverage rate across all 
Clearing Members in the aggregate. Further, escalation criteria for 
backtesting assumptions would include (i) market conditions, (ii) 
changes to OCC's risk methodologies, and (iii) unusual exceedances.\18\ 
Under the proposed Margin Policy, FRM would prepare and present to MRWG 
a review of the backtesting assumptions more frequently than monthly in 
the event of triggers related to high market volatility, low market 
liquidity, and significant increases or decreases in position size or 
concentration risk.
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    \17\ The monthly reviews are part of the current backtesting 
framework, as described in Section II.A. above. The Proposed Rule 
Change does not seek to change this monthly cadence.
    \18\ OCC's internal procedures would include further detail 
regarding escalation criteria for backtesting results and 
assumptions.
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    The amended Margin Policy would provide that, annually, QRM will 
present to MRWG a backtesting framework evaluation, including QRM's 
recommendations regarding whether OCC should change any of its 
assumptions or exceedance escalation criteria. The Margin Policy would 
require that changes to the escalation criteria must be approved by the 
governing body to which the escalation must be made. That is, the MRWG 
would be authorized to approve changes to the criteria for escalation 
to the MRWG, and the MC would be authorized to approve changes to the 
escalation criteria to the MC. The MRWG also would be responsible for 
determining whether to escalate any changes to backtesting assumptions 
or the escalation criteria to the MC or RC for consideration. On an 
annual basis, the MC would report to the RC the results of the annual 
Backtesting Framework evaluation, including any changes it believes 
should be made to OCC's backtesting assumptions or the escalation 
criteria to the RC. The RC would be authorized to approve such 
assumption changes and escalation criteria to the RC for 
implementation, as proposed in the Margin Policy.

C. Establishing the Resource Backtesting Margin Charge

    In addition to the Model Backtesting and Resource Backtesting 
amendments described above, OCC proposes to implement a margin add-on 
charge to help ensure it has sufficient financial resources as a method 
of managing its credit risk exposure. OCC determined that the proposed 
Resource Backtesting would identify deficiencies showing whether its 
Clearing Members fall below

[[Page 76174]]

the 99 percent coverage threshold described above.\19\ To address such 
deficiencies, OCC proposes to adopt a new margin charge to increase the 
likelihood that OCC's margin resources would be sufficient to cover 
fully its potential future exposure to each participant.\20\
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    \19\ See Notice of Filing, 89 FR at 61217. (``[. . .B]ased on 
2023 historical data, approximately 25% of Clearing Members would 
have fallen below the Resource Backtesting coverage target.)
    \20\ OCC represented that the Resource Backtesting Margin Charge 
is modeled on the implementation of similar add-ons by other 
clearing agencies to collect additional financial resources when a 
Clearing Member's margin coverage falls below the agency's coverage 
target. See Notice of Filing, 89 FR at 61217, citing Securities 
Exchange Act Release No. 79167 (Oct. 26, 2016), 81 FR 75883, 75884 
(Nov. 1, 2016) (SR-FICC-2016-006; SR-NSCC-2016-004).
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    To implement the Resource Backtesting Margin Charge, OCC proposes 
to add subsection (h) to its Rule 601 and amend its Margin Policy.\21\ 
Under the Proposed Rule Change, Rule 601(h)(1) would provide that OCC 
may require a Clearing Member to deposit additional margin assets to 
mitigate OCC's exposures that may not otherwise be covered by 
calculated margin requirements in accordance with Rule 601 and OCC's 
policies and procedures. Additionally, Rule 601(h)(1) would state that 
OCC may assess this charge as part of a Clearing Member's daily margin 
requirement, as needed, to enable OCC to achieve its Resource 
Backtesting coverage rate. As proposed, Rule 601(h)(1) would state that 
this add-on may apply to Clearing Members that have a 12-month trailing 
Resource Backtesting coverage rate below OCC's 99 percent backtesting 
coverage target.
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    \21\ Implementation of the proposed charge would also require 
revisions to OCC's internal documentation, including the Backtesting 
Procedure and associated technical document, which OCC provided as 
confidential Exhibits 3B and 3C, respectively, to File No. SR-OCC-
2024-009.
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    Rule 601(h)(2) would provide that, generally, the Resource 
Backtesting Margin Charge will be equal to the third-largest Resource 
Backtesting deficiency during the previous 12 months, rounded up to the 
nearest $1,000. Rule 601(h)(2) also would grant OCC the discretion to 
adjust the Resource Backtesting Margin Charge if it determines that 
circumstances particular to a Clearing Member's clearance and 
settlement activity and/or market volatility warrant a different 
approach to determining or applying such charge in a manner consistent 
with achieving OCC's Resource Backtesting coverage target.
    Under proposed Rule 601(h)(3), in calculating a Clearing Member's 
Resource Backtesting coverage for purposes of the Resource Backtesting 
Margin Charge and in calculating the third-largest Resource Backtesting 
deficiency, OCC will not include amounts already collected as a 
Resource Backtesting Margin Charge from that Clearing Member.
    Lastly, under the proposal, Rule 601(h)(4) would provide that for 
the purposes of this rule, ``Resource Backtesting'' means backtesting 
pursuant to OCC's policies and procedures that is designed to evaluate, 
with a high degree of confidence, whether OCC maintains sufficient 
financial resources to cover its credit exposure to the liquidation 
portfolio of each Clearing Member from the last margin collection until 
the end of the liquidation horizon following the Clearing Member's 
default.
    In addition to new Rule 601(h), OCC proposes amendments to its 
Margin Policy governing how the Resource Backtesting Margin Charge 
would be applied, calculated and, in certain circumstances, adjusted. 
OCC states that the Resource Backtesting Margin Charge would apply to 
any Clearing Member whose 12-month trailing Resource Backtesting falls 
below the 99 percent coverage target, using three or more confirmed 
Resource Backtesting deficiencies over the previous 12 months.\22\ At 
least once per month, and more often in circumstances described below, 
OCC would review and determine which Clearing Member may be subject to 
the Resource Backtesting Margin Charge, or which Clearing Member's 
existing Resource Backtesting Margin Charge is subject to change, based 
on the trailing 12-month Resource Backtesting coverage rate. The 
Resource Backtesting Margin Charge would be applied daily to the 
accounts of Clearing Members that contributed to the deficiencies. If 
in the subsequent month an affected Clearing Member's trailing 12-month 
coverage rises above 99 percent, the Resource Backtesting Margin Charge 
would be removed.
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    \22\ See Notice of Filing, 89 FR at 61217-18.
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    The Resource Backtesting Margin Charge would be calculated as the 
equivalent of a member's third largest Resource Backtesting deficiency 
in the rolling 12-month lookback period rounded up to the nearest 
$1,000, subject to adjustment described below. The Resource Backtesting 
Margin Charge generally would be allocated proportionally to the 
Clearing Member's accounts contributing to the third-largest Resource 
Backtesting deficiency, with the goal of restoring the Clearing 
Member's margin coverage to the 99 percent target. If applying and 
allocating the Margin Resource Backtesting Margin Charge would not 
bring the Clearing Member above this coverage target based on the third 
largest deficiency,\23\ the proposed rules would allow OCC to increase 
the add-on for a particular account in an amount necessary to meet the 
coverage target. For purposes of application, calculation, or 
adjustment, OCC would not take into account any Resource Backtesting 
Margin Charge(s) already in effect, but would take into account the 
number and size of deficiencies subsequent to the Resource Backtesting 
Margin Charge(s) already applied.\24\
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    \23\ This may occur when the account driving the third largest 
deficiency, such as a customer account, is experiencing losses that 
cannot be offset by funds is a different type of account, such as a 
firm account. See Notice of Filing, 89 FR at 61218, n. 55 and 
accompanying text.
    \24\ See Notice of Filing, 89 FR at 61217. Additionally, OCC 
would test the sufficiency of the Resource Backtesting Margin Charge 
against a Resource Backtesting variant that includes that charge as 
a financial resource for purposes of: (i) confirming that the 
charge, as allocated proportionally to the accounts contributing to 
the third-largest Resource Backtesting deficiency, would be 
sufficient to achieve the 99 percent coverage target, and (ii) 
increasing the Resource Backtesting Margin Charge for a particular 
account that may be contributing a proportionally greater amount to 
other Resource Backtesting deficiencies if the coverage target is 
not met. Id., at 61218-19.
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    OCC proposes to amend the Margin Policy further to outline the 
governance around the calculation of and adjustment to the Resource 
Backtesting Margin Charge, as defined in proposed Rule 601(h)(2). As 
proposed, the Margin Policy would require FRM to review the Resource 
Backtesting results at least monthly \25\ to determine whether a 
Clearing Member should be assessed a Resource Backtesting Margin Charge 
and, if so, the amount of the add-on. Imposing a Resource Backtesting 
Margin Charge on a Clearing Member would require an FRM Officer's 
approval, which the FRM Officer would grant unless an adjustment to the 
charge is necessary. Any adjustment to increase the charge would 
require approval by an FRM Officer, while any adjustment to reduce the 
charge would require escalation to and approval by the MRWG.\26\ Under 
the Proposed Rule Change, the MRWG may authorize such adjustment under 
certain circumstances, including, but not limited to, differences in 
magnitude of the deficiencies observed over the last 12-month period, 
variability in the Clearing Member's

[[Page 76175]]

activity since the observed deficiencies, cyclicality of observed 
deficiencies, and/or market volatility. Under the Proposed Rule Change, 
if OCC implements changes to its margin methodology that affect 
Clearing Members' margin requirements, FRM would reevaluate Resource 
Backtesting coverage within the 12-month lookback period based on the 
margin resources OCC would have collected under the revised methodology 
to determine whether a Resource Backtesting Margin Charge for a 
particular Clearing Member is required and, if so, in what amount.\27\
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    \25\ This review and determination would be conducted at least 
monthly but could be done on an intramonth basis based on the daily 
backtesting results reviewed by FRM.
    \26\ Such adjustments are distinct from the routine process of 
setting the charge on a monthly basis.
    \27\ OCC stated that such a reevaluation is designed to avoid 
double-margining Clearing Members if and/or when OCC would begin to 
collect additional margin resources after a margin methodology 
change. See Notice of Filing, 89 FR at 61219.
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Exchange Act directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to such organization.\28\ Under the Commission's 
Rules of Practice, the ``burden to demonstrate that a proposed rule 
change is consistent with the Exchange Act and the rules and 
regulations issued thereunder . . . is on the self-regulatory 
organization [`SRO'] that proposed the rule change.'' \29\
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    \28\ 15 U.S.C. 78s(b)(2)(C).
    \29\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR 
201.700(b)(3).
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    The description of a proposed rule change, its purpose and 
operation, its effect, and a legal analysis of its consistency with 
applicable requirements must all be sufficiently detailed and specific 
to support an affirmative Commission finding,\30\ and any failure of an 
SRO to provide this information may result in the Commission not having 
a sufficient basis to make an affirmative finding that a proposed rule 
change is consistent with the Exchange Act and the applicable rules and 
regulations.\31\ Moreover, ``unquestioning reliance'' on an SRO's 
representations in a proposed rule change is not sufficient to justify 
Commission approval of a proposed rule change.\32\
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    \30\ Id.
    \31\ Id.
    \32\ Susquehanna Int'l Group, LLP v. Securities and Exchange 
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (``Susquehanna'').
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    After carefully considering the Proposed Rule Change, the 
Commission finds that the proposal is consistent with the requirements 
of the Exchange Act and the rules and regulations thereunder applicable 
to OCC. More specifically, the Commission finds that the proposal is 
consistent with Section 17A(b)(3)(F) of the Exchange Act,\33\ and Rules 
17Ad-22(e)(6),\34\ 17Ad-22(e)(4),\35\ and 17Ad-22(e)(2) \36\ 
thereunder, as described below.
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    \33\ 15 U.S.C. 78q-1(b)(3)(F).
    \34\ 17 CFR 240.17Ad-22(e)(6).
    \35\ 17 CFR 240.17Ad-22(e)(4).
    \36\ 17 CFR 240.17Ad-22(e)(2).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act

    Section 17A(b)(3)(F) of the Exchange Act requires, among other 
things, that a clearing agency's rules are designed to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible.\37\ 
Based on its review of the record, and for the reasons described below, 
the changes described above are consistent with assuring the 
safeguarding of securities and funds which are in OCC's custody or 
control or for which it is responsible.
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    \37\ 15 U.S.C. 78q-1(b)(3)(F).
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    As discussed above, OCC's backtesting framework is used, in part, 
to monitor whether STANS-calculated margin requirements are adequate, 
as well as to evaluate the adequacy of credit risk assessment 
procedures. As described above, OCC proposes to improve its current 
backtesting by, among other things, clearly defining terms and 
parameters. However, the current backtesting focuses on the 
identification of technical or model-related issues, rather than on the 
sufficiency of OCC's resources to cover its credit exposure during a 
Clearing Member's default.
    To address the gap in its current backtesting, OCC proposes to 
implement a new category of backtesting, Resource Backtesting, that 
would measure whether OCC maintains sufficient financial resources to 
cover its credit exposure to the liquidation portfolio of each Clearing 
Member from the last deposit of margin assets until the end of the 
liquidation horizon following the Clearing Member's default. Based on 
the information OCC provided to the Commission,\38\ the proposed 
Resource Backtesting would reveal that OCC does not always meet its 
coverage target at the member level.
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    \38\ OCC provided impact data as confidential Exhibit 3A to File 
No. SR-OCC-2024-009.
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    To address the gap in coverage, which suggests OCC may not be 
holding sufficient margin collateral, OCC also proposes to implement a 
new margin add-on, the Resource Backtesting Margin Charge, that is 
designed to increase the likelihood that OCC collects margin sufficient 
to cover its potential future exposure to each participant in the 
interval between the last margin collection and the close-out of 
positions following a participant default. Working in tandem, the 
proposed backtesting category and add-on would support OCC's efforts to 
collect sufficient margin resources to maintain a 99 percent coverage.
    Improving OCC's current backtesting processes as well as adoption 
of the proposed Resource Backtesting and Resource Backtesting Margin 
Charge add-on would increase the likelihood that OCC collects 
sufficient margin collateral to mitigate OCC's credit exposure to a 
Clearing Member default. Increasing the likelihood that OCC collects 
sufficient margin collateral to address a member default would, in 
turn, assure the safeguarding of non-defaulting Clearing Members' 
collateral by reducing the likelihood that OCC would be forced to 
charge losses to the Clearing Fund.
    Accordingly, the changes proposed to the backtesting framework are 
consistent with the requirements of Section 17A(b)(3)(F) of the 
Exchange Act.\39\
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    \39\ Id.
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B. Consistency With Rule 17Ad-22(e)(6)(vi)(A) Under the Exchange Act

    Rule 17Ad-22(e)(6)(vi)(A) under the Exchange Act requires that a 
covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to cover, if the 
covered clearing agency provides central counterparty services, its 
credit exposures to its participants by establishing a risk-based 
margin system that, at a minimum is monitored by management on an 
ongoing basis and regularly reviewed, tested, and verified by 
conducting backtests of its margin model at least once each day using 
standard predetermined parameters and assumptions.\40\ In adopting Rule 
17Ad-22(e)(6), the Commission provided guidance that a covered clearing 
agency generally should consider in establishing and maintaining 
policies and procedures for margin, including whether the covered 
clearing agency analyzes and monitors its model performance and overall 
margin coverage by conducting rigorous daily backtesting and at least 
monthly, and more frequent when appropriate, sensitivity analysis; as 
well as whether, in conducting sensitivity analysis of the model's 
coverage, the covered clearing agency has taken into account a wide

[[Page 76176]]

range of parameters and assumptions that reflect possible market 
conditions.\41\
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    \40\ 17 CFR 240.17Ad-22(e)(6)(vi)(A).
    \41\ Securities Exchange Act Release No. 78961 (Sept. 28, 2016), 
81 FR 70786, 70819 (Oct. 13, 2016) (File No. S7-03-14) (``Standards 
for Covered Clearing Agencies'').
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    As described above, OCC's Proposed Rule Change is designed to 
improve the level of detail about the material aspects of OCC's 
backtesting framework included in the overall framework, including how 
OCC establishes and modifies its assumptions for backtesting. OCC's 
proposal also is designed to establish a process for assessing the 
adequacy of OCC's margin resources to cover its credit exposure at the 
Clearing Member level, and would detail the assumptions underlying 
OCC's margin backtesting framework and the process for reviewing and 
modifying those assumptions.
    As described above, OCC proposes to codify in the framework its 
current backtesting procedures, including incorporating definitions, 
detailing coverage level measurements of actual and hypothetical 
portfolios, and establishing which types of collateral would be 
reviewed. Further, OCC's proposal would consolidate its current 
backtests under one heading (Model Backtesting) that would be governed 
by a single set of rules and internal procedures. The proposed 
revisions would improve clarity and consistency across OCC's current 
backtesting framework. Likewise, OCC proposes adding to the framework a 
new category of backtesting, Resource Backtesting, as well as related 
definitions and descriptions of material aspects of how this new 
resource sufficiency measurement would apply at a Clearing Member 
level. The proposed rules would also address how OCC would consider 
different types of accounts and liens when netting, and would provide 
OCC with more accurate insights into the collected margin levels of its 
Clearing Members, that could, in turn, affect OCC's credit exposures. 
OCC's proposal to specifically list the assumptions on which Model 
Backtesting and Resource Backtesting would rest, and how these 
assumptions would be reviewed and, if necessary, escalated according to 
set criteria, would standardize these assumptions and parameters, 
incorporates the Commission's guidance provided in the adopting 
release,\42\ and provide OCC's management with clear guidelines to 
continue its monitoring on an ongoing basis.
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    \42\ Id.
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    Accordingly, the proposed changes to OCC's backtesting framework 
are consistent with the requirements of Rule 17Ad-22(e)(6)(vi)(A) under 
the Exchange Act.\43\
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    \43\ 17 CFR 240.17Ad-22(e)(6)(vi)(A).
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C. Consistency With Rule 17Ad-22(e)(4)(i) Under the Exchange Act

    Rule 17Ad-22(e)(4)(i) under the Exchange Act requires that a 
covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to effectively 
identify, measure, monitor, and manage its credit exposures to 
participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence.\44\ In adopting Rule 17Ad-22(e)(4), the 
Commission provided guidance that a covered clearing agency generally 
should consider in establishing and maintaining policies and procedures 
that address credit risk, including whether, if providing central 
counterparty services, the covered clearing agency has covered its 
current and potential future exposures to each participant fully with a 
high degree of confidence using margin and other prefunded financial 
resources.\45\
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    \44\ 17 CFR 240.17Ad-22(e)(4)(i).
    \45\ See Standards for Covered Clearing Agencies, 81 FR at 
70814-15.
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    As described above, OCC proposes to adopt the Resource Backtesting 
Margin Charge to address coverage gaps identified by the proposed 
Resource Backtesting. The proposed Resource Backtesting Margin Charge 
would be applied daily based on an at-least monthly assessment of a 
Clearing Member's 12-month trailing deficiencies to the extent they 
fall below OCC's 99 percent coverage rate. Collecting additional margin 
based on such deficiencies would reduce the likelihood of future margin 
deficiencies for each member. This, in turn, would increase the 
likelihood that OCC would maintain sufficient financial resources to 
cover its credit exposure to each participant fully with a high degree 
of confidence.
    Accordingly, the proposed adoption of the Resource Backtesting 
Margin Charge is consistent with the requirements of Rule 17Ad-
22(e)(4)(i) under the Exchange Act.\46\
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    \46\ Id.
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D. Consistency With Rule 17Ad-22(e)(2)(v) Under the Exchange Act

    Rule 17Ad-22(e)(2)(v) under the Exchange Act requires that a 
covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to provide for 
governance arrangements that specify clear and direct lines of 
responsibility.\47\
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    \47\ 17 CFR 240.17Ad-22(e)(2)(v).
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    OCC's backtesting framework documentation lacks explicit guidance 
around the reporting process as well as escalation criteria and 
thresholds, which could lead to inconsistencies in the escalation of 
similar backtesting exceedances or deficiencies, and inconsistencies in 
reviews of backtesting assumptions. The Proposed Rule Change would list 
the escalation criteria considered during reviews of backtesting 
results and assumptions and would clearly specify which business units, 
working groups, and committees would be involved in such reviews, as 
well as each group's respective authorities and obligations. The 
Proposed Rule Change also would describe OCC's reporting process and 
timelines for review of backtesting results, assumptions, and 
parameters. Adding such detail to OCC's rules would more clearly 
specify the lines of responsibly governing OCC's backtesting framework.
    Accordingly, the proposed changes to further detail OCC's processes 
for governing its backtesting framework are consistent with the 
requirements of Rule 17Ad-22(e)(2)(v) under the Exchange Act.\48\
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    \48\ Id.
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the 
Exchange Act, and in particular, the requirements of Section 17A of the 
Exchange Act \49\ and the rules and regulations thereunder.
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    \49\ In approving this Proposed Rule Change, the Commission has 
considered the proposed rules' impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\50\ that the proposed rule change (SR-OCC-2024-009), 
hereby is, approved.
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    \50\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\51\
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    \51\ 17 CFR 200.30-3(a)(12).
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Vanessa A. Countryman,
Secretary.
[FR Doc. 2024-21035 Filed 9-16-24; 8:45 am]
BILLING CODE 8011-01-P