[Federal Register Volume 78, Number 205 (Wednesday, October 23, 2013)]
[Notices]
[Pages 63267-63268]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-24843]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70709; File No. SR-OCC-2013-803]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection to Advance Notice Filing To Reflect Enhancements
in OCC's System for Theoretical Analysis and Numerical Simulations as
Applied to Longer-Tenor Options
October 17, 2013.
On June 4, 2013, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') advance
notice SR-OCC-2013-803 (``Advance Notice'') pursuant to Section
806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of
2010 (``Clearing Supervision Act'' or ``Title VIII'') \1\ and Rule 19b-
4(n)(1)(i) under the Securities Exchange Act of 1934 (``Exchange
Act'').\2\ The Advance Notice was published for comment in the Federal
Register on July 9, 2013.\3\ The Commission did not receive any
comments on the Advance Notice publication. This publication serves as
a notice of no objection to the Advance Notice.
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\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i). OCC is a designated financial
market utility and is required to file advance notices with the
Commission. See 12 U.S.C. 5465(e). OCC also filed the proposal in
this Advance Notice as a proposed rule change under Section 19(b)(1)
of the Exchange Act and Rule 19b-4 thereunder, which was published
for comment in the Federal Register on June 14, 2013. 15 U.S.C.
78s(b)(1); 17 CFR 240.19b-4. See Release No. 69723 (June 10, 2013),
78 FR 36002 (June 14, 2013) (SR-OCC-2013-08). OCC withdrew the
proposed rule change on August 27, 2013. Prior to the date of
withdrawal, the Commission did not receive any comments on the
proposed rule change. On October 10, 2013, OCC re-filed the proposal
in this Advance Notice as a proposed rule change under Section
19(b)(1) of the Exchange Act and Rule 19b-4 thereunder.
\3\ Release No. 69925 (July 3, 2013), 78 FR 41161 (July 9, 2013)
(SR-OCC-2013-803) (``Notice'').
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I. Description of the Advance Notice
On December 14, 2012, the Commission issued an order approving a
proposed rule change and a notice of no objection to an advance notice,
collectively (``December 14, 2012 Action''), through which OCC proposed
to establish a legal and operational framework for OCC to clear certain
OTC index options on the S&P 500 Index (``OTC S&P 500 Index
Options'').\4\ OCC is prohibited from clearing OTC S&P 500 Index
Options until the Commission approves and OCC implements certain
enhancements to OCC's System for Theoretical Analysis and Numerical
Simulations (``STANS'') as applied to all options,\5\ including over-
the-counter (``OTC'') options that OCC is otherwise permitted to clear,
with at least three years of residual tenor (``Risk Management
Proposal'').\6\ This Advance Notice is the Risk Management Proposal. By
this Advance Notice, OCC is enhancing STANS by: (i) Including daily OTC
indicative quotations; (ii) introducing variations in implied
volatility; and (iii) introducing a valuation adjustment.
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\4\ Release No. 68434 (December 14, 2012), 77 FR 75243 (December
19, 2012) (SR-OCC-2012-14, AN-OCC-2012-01).
\5\ OCC represents that its Risk Management Proposal is part of
OCC's ongoing efforts to test and improve its risk management
operations with respect to all longer-tenor options that OCC
currently clears. See December 14, 2012 Action, supra note 4, 77 FR
at 75243. OCC states it intends to use its STANS margin system to
calculate margin requirements on the same basis as for exchange-
listed options cleared by OCC. See Notice, supra note 3, 78 FR at
41161.
\6\ Release No. 68434 (December 14, 2012), 77 FR 75243 (December
19, 2012) (SR-OCC-2012-14, AN-OCC-2012-01).
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STANS is a margin system that OCC uses to calculate clearing-level
margin.\7\ Through this Risk Management Proposal, OCC is enhancing
STANS in the following ways:
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\7\ According to OCC, STANS calculates margin by determining the
minimum expected liquidating value of each account using a large
number of projected price scenarios created by large-scale Monte
Carlo simulations. See Notice, supra note 3, 78 FR at 41161.
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(i) Daily OTC Indicative Quotations. According to OCC, STANS uses a
daily dataset of market prices to value each portfolio.\8\ OCC is
enhancing this daily dataset of market prices by including daily OTC
indicative quotations.\9\ OCC will obtain daily OTC indicative
quotations from a third-party service provider who obtains it through a
daily poll of OTC derivatives dealers.\10\
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\8\ See Notice, supra note 3, 78 FR at 41161.
\9\ Id.
\10\ OCC selected a third-party service provider rather than
having the OTC derivatives dealers provide the information directly
to OCC to avoid unnecessarily duplicating reporting that is already
being done in the OTC markets. See Notice, supra note 3, 78 FR at
41161-62.
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(ii) Variations in Implied Volatility. According to OCC, STANS
currently uses a two-day risk horizon which assumes that implied
volatilities of option contracts do not change during that period.\11\
OCC will introduce variations in implied volatility in the modeling of
all longer-tenor options under STANS.\12\ OCC plans to achieve this by
``incorporating, into the set of risk factors whose behavior is
included in the econometric models underlying STANS, time series of
proportional changes in implied volatilities for a range of tenors and
in-the-money and out-of-the-money amounts representative of the dataset
provided by OCC's third-party service provider.'' \13\
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\11\ See Notice, supra note 3, 78 FR at 41162.
\12\ Id.
\13\ Id.
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(iii) Valuation Adjustment. OCC intends to enhance the portfolio
net asset value that STANS uses, by introducing a valuation
adjustment.\14\ According to OCC, the valuation adjustment will be
``based upon the aggregate sensitivity of any longer-tenor options in a
portfolio to the overall level of implied volatilities at three years
and five years and to the relationship between implied volatility and
exercise prices at both the three- and five-year tenors in order to
allow for the anticipated market impact of unwinding a portfolio of
longer-tenor options, as well as for any differences in the quality of
data in OCC's third party service provider's dataset, given that month-
end data may be subjected to more extensive validation by the service
provider than daily data.'' \15\
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\14\ Id.
\15\ Id.
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II. Discussion and Commission Findings
Although Title VIII does not specify a standard of review for an
advance notice, the Commission believes that the stated purpose of
Title VIII is instructive.\16\ The stated purpose of Title VIII is 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
(``FMUs'') and strengthening the liquidity of systemically important
FMUs.\17\
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\16\ See 12 U.S.C. 5461(b).
\17\ Id.
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Section 805(a)(2) of the Clearing Supervision Act \18\ authorizes
the Commission to prescribe risk management standards for the payment,
clearing, and settlement activities of designated clearing entities and
financial institutions engaged in designated activities for which it is
the supervisory agency or the appropriate
[[Page 63268]]
financial regulator. Section 805(b) of the Clearing Supervision Act
\19\ states that the objectives and principles for the risk management
standards prescribed under Section 805(a) shall be to:
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\18\ 12 U.S.C. 5464(a)(2).
\19\ 12 U.S.C. 5464(b).
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Promote robust risk management;
Promote safety and soundness;
Reduce systemic risks; and
Support the stability of the broader financial system.
The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act \20\ (``Clearing Agency
Standards'').\21\ The Clearing Agency Standards became effective on
January 2, 2013 and require registered clearing agencies that perform
central counterparty (``CCP'') services to establish, implement,
maintain, and enforce written policies and procedures that are
reasonably designed to meet certain minimum requirements for their
operations and risk management practices on an ongoing basis.\22\ As
such, it is appropriate for the Commission to review advance notices
against these risk management standards that the Commission promulgated
under Section 805(a) of the Clearing Supervision Act \23\ and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Clearing Supervision Act.\24\
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\20\ 12 U.S.C. 5464(a)(2).
\21\ Exchange Act Release No. 68080 (October 22, 2012), 77 FR
66220 (November 2, 2012) (S7-08-11).
\22\ The Clearing Agency Standards are substantially similar to
the risk management standards established by the Board of Governors
of the Federal Reserve System (``Federal Reserve'') governing the
operations of designated DFMUs that are not clearing entities and
financial institutions engaged in designated activities for which
the Commission or the Commodity Futures Trading Commission is the
Supervisory Agency. See Financial Market Utilities, 77 FR 45907
(August 2, 2012).
\23\ 12 U.S.C. 5464(a).
\24\ 12 U.S.C. 5464(b).
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OCC's Risk Management Proposal, as described above, is designed to
enhance OCC's margin calculation requirements for longer-tenor options.
Consistent with Section 805(b) of the Clearing Supervision Act,\25\ the
Division believes that OCC's Risk Management Proposal should help
promote robust risk management and mitigate systemic risk by
introducing variations in implied volatility in the modeling of all
Longer-Tenor Options, and introducing a valuation adjustment in STANS
to address OCC's increased exposure to Longer-Tenor Options that may
possess characteristics that are more illiquid than other options that
are cleared by OCC. The Risk Management proposal may also improve
liquidity in the market for Longer-Tenor Options, which may improve
price discovery in this market.
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\25\ See 12 U.S.C. 5464(b).
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Commission Rule 17Ad-22(b)(2),\26\ adopted as part of the Clearing
Agency Standards,\27\ requires that a registered clearing agency
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to ``use margin requirements to limit
its credit exposures to participants under normal market conditions;''
and ``use risk-based models and parameters to set margin
requirements.'' Furthermore, Commission Rule 17Ad-22(b)(3),\28\ also
adopted as part of the Clearing Agency Standards,\29\ requires, in
relevant part, a central counterparty to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to maintain sufficient financial resources to withstand, at a
minimum, a default by the participant family to which it has the
largest exposure in extreme but plausible market conditions. The
proposed enhancements to STANS, as described in the Risk Management
Proposal, should help OCC to more accurately set margin requirements
for Longer-Tenor Options, which OCC will use to limit its credit
exposures to participants under both normal and stressed market
conditions and should help OCC maintain sufficient financial resources
to withstand a default by the participant family to which it has the
largest exposure in extreme but plausible market conditions.
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\26\ 17 CFR 240.17Ad-22(b)(2).
\27\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (November
2, 2012).
\28\ 17 CFR 240.17Ad-22(b)(3).
\29\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (November
2, 2012).
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III. Conclusion
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Clearing Supervision Act,\30\ that the Commission DOES NOT OBJECT to
advance notice proposal (SR-OCC-2013-803) and that OCC is AUTHORIZED to
implement the proposal as of the date of this notice or the date of an
order by the Commission approving a proposed rule change that reflects
rule changes that are consistent with this advance notice proposal (SR-
OCC-2013-803), whichever is later.
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\30\ 12 U.S.C. 5465(e)(1)(I).
By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-24843 Filed 10-22-13; 8:45 am]
BILLING CODE 8011-01-P