[Federal Register Volume 90, Number 13 (Wednesday, January 22, 2025)]
[Notices]
[Pages 7720-7722]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2025-01414]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-102203; File Nos. SR-OCC-2024-016]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of Proposed Rule Change by The Options Clearing
Corporation Concerning Enhancements to the System for Theoretical
Analysis and Numerical Simulations (``STANS'') and OCC's Comprehensive
Stress Testing (``CST'') Methodology, To Better Capture the Risks
Associated With Short-Dated Options
January 15, 2025.
I. Introduction
On November 22, 2024, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2024-016, pursuant to Section 19(b) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
\2\ thereunder, to (i) align assumptions across models and (ii)
generate implied volatility shocks for options with a tenor of less
than one month that are consistent with observed market dynamics.\3\
The proposed rule change was published for public comment in the
Federal Register on December 6, 2024.\4\ The Commission has received no
comments regarding the proposed rule change. For the reasons discussed
below, the Commission is approving the proposed rule change
(hereinafter defined as ``Proposed Rule Change'').
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Notice of Filing infra note 4, at 89 FR 97131.
\4\ See Securities Exchange Act Release No. 101780 (Dec. 2,
2024), 89 FR 97131 (Dec. 6, 2024) (File No. SR-OCC-2024-016)
(``Notice of Filing'').
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II. Background
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 financial
transactions. As the CCP for the listed options markets and for certain
futures in the United States, OCC is exposed to the risk that one or
more of its Clearing Members may fail to make a payment or to deliver
securities. OCC addresses such risk exposure, in part, by requiring its
members to provide collateral, including both margin collateral and
Clearing Fund collateral. Margin is the collateral that CCPs collect to
cover potential changes in a member's positions over a set period of
time during normal market conditions. OCC's Clearing Fund is a
mutualized pool of financial resources to which each Clearing Member is
required to contribute to ensure that OCC maintains sufficient
qualifying liquid resources to manage its liquidity risk, and to
address the tail risk that the margin collateral OCC collects from each
Clearing Member might be insufficient to cover OCC's credit exposure to
a defaulting member in extreme but plausible market conditions.
OCC's methodology for calculating margin collateral requirements is
called the System for Theoretical Analysis and Numerical Simulations
(``STANS'').\5\ OCC's methodology for sizing and monitoring its
Clearing Fund is called the Comprehensive Stress Testing (``CST'')
methodology. OCC relies on STANS and the CST methodology to set
collateral requirements to cover the financial risk posed by the
positions OCC clears for its members. OCC states that the proportion of
such positions that comprise short-dated options (``SDOs'') \6\ has
increased over the past several years.\7\ In response to this
observation, OCC examined the risks posed by the increase in SDO
trading and identified opportunities to improve the performance of the
models comprising STANS and the CST methodology in covering the
financial risk posed by the increase in SDO trading observed by OCC.\8\
As described below, OCC proposes two changes to the models comprising
STANS and the CST methodology: one set of changes related to the day
count conventions \9\ and one set of changes related to the application
of volatility shocks to theoretical option prices.\10\
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\5\ 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.
\6\ SDOs are option contracts with a maturity of less than or
equal to one month to expiration. See Notice of Filing, 89 FR at
97132.
\7\ See Notice of Filing, 89 FR 97132 (citing Cboe, The Rise of
SPX & 0DTE Options (July 27, 2023), available at https://go.cboe.com/l/77532/2023-07-27/ffc83k).
\8\ See Notice of Filing, 89 FR 97132 (stating that
``opportunities exist to improve model performance for Clearing
Member portfolios dominated by SDOs'').
\9\ OCC uses the term ``day count convention'' to refer to a
standardized methodology for calculating the number of days between
two dates. See Notice of Filing, 89 FR 97132, note 13. Both calendar
and business day conventions are used by OCC in STANS and CST
calculations. Id.
\10\ The implied volatility of an option is a measure of the
expected future volatility of the option's underlying security at
expiration, which is reflected in the current option premium in the
market. See Notice of Filing, 89 FR 97132, note 12.
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[[Page 7721]]
Day count conventions. The models supporting STANS and CST rely on
two different day count conventions. Specifically, OCC's option price
smoothing process uses calendar day convention, and OCC's implied
volatility simulation uses trading day convention. OCC asserts that the
usage of two different day count conventions results in differences in
implied volatility, especially when non-trading days make up a large
portion of the time-to-expiration (e.g., on Fridays for options that
expire the following Monday),\11\ which is more pronounced in SDOs.\12\
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\11\ See Notice of Filing, 89 FR 97132.
\12\ OCC states that SDOs are more sensitive to day-count
convention alignment than contracts with longer expirations due to
the proportionally larger difference in time to expiry between the
trading day convention and calendar day convention for shorter dated
tenors. See Notice of Filing, 89 FR 97133.
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OCC proposes to address the misalignment of day count conventions
used in the models underlying both STANS and the CST methodology by
processing data through a series of conversions to ensure that the data
presented to the price smoothing and volatility simulation models is
consistent with the assumptions of those models. Specifically, OCC
would convert implied volatility data into a trading day convention
before feeding that data into OCC's implied volatility simulation
models. OCC would then convert the output of its implied volatility
simulation models back into a calendar day convention before feeding
those results into OCC's price smoothing process.
Volatility shocks. OCC's model for simulating theoretical prices
assumes that the implied volatility shocks of the one-month tenor
(``1M'') are sufficient to cover the implied volatility changes for SDO
tenors.\13\ As constructed, the models underlying both STANS and the
CST methodology impose the same volatility shocks applied to 1M options
to all options with tenors of less than one month. However, changes in
implied volatility for SDOs can be much larger than the changes
observed in 1M options.\14\
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\13\ The ``tenor'' of an option is the amount of time remaining
until its expiration or maturity. See Notice of Filing, 89 FR 97132,
note 14.
\14\ OCC has observed that the day-over-day at the money implied
volatility changes for the options with a one-week tenor are
approximately twice that of the 1M tenor on certain risk factors
such as SPX, RUT, QQQ, AAPL, and TSLA. See Notice of Filing, 89 FR
97132, note 15.
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OCC proposes to estimate implied volatility shocks specific to
options with a shorter tenor than 1M options rather than imposing the
same shock on all options with one month or less to maturity. Within
STANS, OCC proposes to derive the shocks for SDOs from the shock
applied to 1M options. Specifically, OCC would derive the shocks for
such options through the application of a square-root decay to the 1M
option volality.\15\ Within the CST methodology, OCC proposes to extend
its existing processes for establishing implied volatility shocks to
specific maturities that are less than one month (i.e., two weeks, one
week) and to rely on linear interpolation to establish shocks for even
shorter maturities (i.e., down to three days).
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\15\ See Notice of Filing, 89 FR 97135.
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OCC summarized the potential impacts of the proposed changes to
both margin and Clearing Fund requirements based on data from July 2023
to September 2024.\16\ For margin, OCC observed that the proposed
changes would have caused an increase in average daily margin
requirements of 0.58 percent with the daily impacts ranging from a 0.81
percent decrease to a 3.21 percent increase.\17\ For the Clearing Fund,
OCC observed that the proposed changes would have caused the total
Clearing Fund to decrease by 0.14 percent.\18\
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\16\ See Notice of Filing, 89 FR 97136.
\17\ Id.
\18\ Id.
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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.\19\ 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.'' \20\
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\19\ 15 U.S.C. 78s(b)(2)(C).
\20\ 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,\21\ 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.\22\ 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.\23\
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\21\ Id.
\22\ Id.
\23\ Susquehanna Int'l Group, LLP v. Securities and Exchange
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017).
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After carefully considering the Proposed Rule Change, the
Commission finds that the Proposed Rule Change 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 Proposed Rule Change is consistent with Exchange Act Rules
17Ad-22(e)(4) \24\ and 17Ad-22(e)(6),\25\ and with Section 17A(b)(3)(F)
of the Exchange Act,\26\ as described in detail below.
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\24\ 17 CFR 240.17Ad-22(e)(4).
\25\ 17 CFR 240.17Ad-22(e)(6).
\26\ 15 U.S.C. 78q-1(b)(3)(F).
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A. Consistency With Rules 17Ad-22(e)(4) and (6) Under the Exchange Act
Rule 17Ad-22(e)(4) 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 risk exposures to participants
and those arising from payment clearing, and settlement processes by,
in part, testing the sufficiency of its financial resources available
to meet the minimum standards under Rules 17Ad-22(e)(4)(i) through
(iii), as applicable.\27\ Rule 17Ad-22(e)(6) 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, among other things, considers, and
produces margin levels commensurate with, the risks and particular
attributes of each relevant product, portfolio, and market.\28\ Based
on the review of the record, and for the reasons described below, OCC's
proposed update to STANS and the CST methodology in the manner
described above is consistent with Rules 17Ad-22(e)(4) and (6).
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\27\ 17 CFR 240.17Ad-22(e)(4)(vi).
\28\ 17 CFR 240.17Ad-22(e)(6)(i).
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As described above, OCC proposes changes to both its margin
methodology (STANS) and stress testing (CST) methodology. The proposed
changes
[[Page 7722]]
would resolve inconsistent model assumptions by aligning the day count
convention across models. The proposed changes would also provide for
implied volatility shocks to options with tenors of less than one month
that are consistent with historical evidence, rather than simply
applying the shocks generated for 1M options. Each of the proposed
changes is designed to more accurately reflect the particular
attributes of the options OCC clears. In the context of STANS,
therefore, the proposed changes would support the production of
margining requirements consistent with such attributes. In the context
of OCC's CST methodology, the changes would provide a more accurate
basis on which to test the sufficiency of OCC's financial resources.
Accordingly, the Proposed Rule Change is consistent with Rules
17Ad-22(e)(4) and (6) under the Exchange Act.\29\
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\29\ 17 CFR 240.17Ad-22(e)(4) and 17 CFR 240.17Ad-22(e)(6).
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B. 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 the rules of a clearing agency be 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.\30\ As
discussed above, the proposed changes would improve the performance of
the models comprising STANS and the CST methodology by, among other
things, supporting the production of margining requirements consistent
with the particular attributes of the products that OCC clears and
providing a more accurate basis on which to test the sufficiency of
OCC's financial resources. These changes will, in turn, help ensure
that OCC collects appropriate Clearing Fund collateral and reduce the
likelihood that OCC would need to utilitze Clearing Fund collateral of
non-defaulting clearing members in the event of a default. For these
reasons, OCC's proposed update to its Margin Policy in the manner
described above is consistent with the safeguarding of securities and
funds which are in OCC's custody or control or for which it is
responsible. Accordingly, the Proposed Rule Change is consistent with
the requirements of Section 17A(b)(3)(F) of the Exchange Act.\31\
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\30\ 15 U.S.C. 78q-1(b)(3)(F).
\31\ 15 U.S.C. 78q-1(b)(3)(F).
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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 \32\ and the rules and regulations thereunder.
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\32\ In approving the 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,\33\ that the Proposed Rule Change (SR-OCC-2024-016) be,
and hereby is, approved.
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\33\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\34\
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\34\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2025-01414 Filed 1-21-25; 8:45 am]
BILLING CODE 8011-01-P