[Federal Register Volume 79, Number 215 (Thursday, November 6, 2014)]
[Notices]
[Pages 66018-66022]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-26344]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-73482; File No. SR-OCC-2014-803]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection to Advance Notice Filing to Better Manage Risks
Concentration and Other Risks Associated With Accepting Deposits of
Common Stocks for Margin Purposes
October 31, 2014.
On July 16, 2014, the Options Clearing Corporation (``OCC'') filed
with
[[Page 66019]]
the Securities and Exchange Commission (``Commission'') advance notice
SR-OCC-2014-803 pursuant to Section 806(e)(1) of the Payment, Clearing,
and Settlement Supervision Act of 2010 (``Payment, Clearing and
Settlement Supervision Act'') \1\ and Rule 19b-4(n)(1) under the
Securities Exchange Act of 1934 (``Act'').\2\ The advance notice was
published for comment in the Federal Register on August 15, 2014.\3\ On
September 8, 2014, pursuant to Section 806(e)(1)(D) of the Payment,
Clearing and Settlement Supervision Act, the Commission required OCC to
provide additional information concerning this advance notice.\4\ The
Commission did not receive any comments on the advance notice
publication. This publication serves as a notice of no objection to the
changes proposed in the advance notice.
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\1\ 12 U.S.C. 5465(e)(1). The Financial Stability Oversight
Council designated OCC a systemically important financial market
utility on July 18, 2012. See Financial Stability Oversight Council
2012 Annual Report, Appendix A, http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. Therefore, OCC is
required to comply with the Payment, Clearing and Settlement
Supervision Act and file advance notices with the Commission. See 12
U.S.C. 5465(e).
\2\ 17 CFR 240.19b-4(n)(1).
\3\ Securities Exchange Act Release No. 72803 (August 11, 2014),
79 FR 48285 (August 15, 2014) (SR-OCC-2014-803). OCC also filed the
proposal contained in this advance notice as a proposed rule change
under Section 19(b)(1) of the Act and Rule 19b-4 thereunder, which
was published for comment in the Federal Register on August 5, 2014.
15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4. See Securities Exchange Act
Release No. 72717 (July 30, 2014), 79 FR 45523 (August 5, 2014) (SR-
OCC-2014-14). The Commission did not receive any comments on the
proposed rule change.
\4\ 12 U.S.C. 5465(e)(1)(D). The Commission received a response
with further information for consideration of the advance notice on
September 19, 2014, at which time a 60 day review period began
pursuant to Sections 806(e)(1)(E) and (G) of the Payment, Clearing
and Settlement Supervision Act. See 12 U.S.C. 5465(e)(1)(E) and 12
U.S.C. 5465(e)(1)(G).
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I. Description of the Advance Notice
According to OCC, the purpose of this change is to permit OCC to
better manage concentration risk and wrong-way risk associated with
accepting deposits of common stock for margin purposes. In order to
manage such risks, OCC is adding an Interpretation and Policy to Rule
604, which specifies the forms of margin assets accepted by OCC, that
will provide OCC with discretion with respect to giving value to assets
deposited by a single clearing member to satisfy its margin
requirement(s). In addition, OCC is making clarifying amendments to an
existing Interpretation and Policy under Rule 604 that gives OCC
discretion to not give value to a particular type of margin collateral
across all clearing members.
a. Background
OCC Rule 604 lists the types of assets that clearing members may
deposit with OCC to satisfy their margin requirement(s) as well as sets
forth eligibility criteria for such assets. According to OCC, common
stocks, including Exchange Traded Funds (``ETFs'') and Exchange Traded
Notes (``ETNs''), are the most common form of margin assets deposited
by clearing members and currently comprise 68% of the $60.6 billion in
clearing member margin deposits held by OCC (not including deposits in
lieu of margin). According to OCC, since 2009, OCC has used its System
for Theoretical Analysis and Numerical Simulations (``STANS''), which
is OCC's daily automated Monte Carlo simulation-based margining
methodology, to value common stocks deposited by clearing members as
margin.\5\ The value given to margin deposits depends on factors that
include the price volatility and the price correlation relationship of
common stock collateral to the balance of the cleared portfolio. The
approach used by STANS incentivizes clearing members who chose to meet
their margin obligations with deposits of common stocks to choose
common stocks that hedge their related open positions.
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\5\ See Securities Exchange Act Release No. 58158 (July 15,
2008), 73 FR 42646 (July 22, 2008) (SR-OCC-2007-20).
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According to OCC, notwithstanding the value STANS gives to deposits
of common stocks, certain factors warrant OCC adjusting the value STANS
gives to all clearing member margin deposits of a particular type of
margin collateral. Such factors are set forth in Rule 604,
Interpretation and Policy .14, and include the number of outstanding
shares, number of outstanding shareholders and overall trading volume.
OCC is proposing to add a new Interpretation and Policy to Rule 604
(the ``Interpretation'') so that OCC has discretion to not give margin
credit to a particular clearing member when such clearing member
deposits a concentrated amount of any common stock and when a common
stock, deposited as margin, presents ``wrong-way risk'' to OCC. In
addition, the Interpretation will provide OCC discretion to grant
margin credit to a clearing member when it deposits shares of common
stock that serve as a hedge to the clearing member's related open
positions and would otherwise be not be given margin credit.\6\
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\6\ According to OCC, consistent with the language contained in
existing Interpretation & Policy .14, the Interpretation provides
OCC with discretion in determining the amount of margin credit given
to deposits of common stock by an individual clearing member as such
determination would be based on positions held and common stock
deposits made by such clearing member on a given business day.
However, as discussed in the following two sections, OCC states that
it also has developed certain automated processes as well as
additional internal policies that describe how OCC presently intends
to exercise such discretion. According to OCC, these additional
internal policies are included in OCC's collateral risk management
policy, which will not be implemented until approval of this rule
change with changes thereto being subject to additional rule
filings.
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b. Concentrated Deposits of Common Stock
OCC has determined that in the event it is necessary to liquidate a
clearing member's positions (including the clearing member's margin
collateral), OCC may be exposed to risk arising from a large quantity
of a particular common stock deposited as margin by a clearing member.
Specifically, depending on the relationship between the average daily
trading volume of a particular security and the number of outstanding
shares of such security deposited by a clearing member as margin, it is
possible that the listed equities markets may not be able to quickly
absorb all of the common stock OCC seeks to sell, or OCC may not be
able to auction such securities, without an appreciable negative price
impact. This occurrence, referred to by OCC as ``concentration risk,''
is greatest when the number of shares being sold is large and the
average daily trading volume is low.
OCC's existing authority to not give value to otherwise eligible
forms of margin only provides OCC with the discretion to not give value
across all clearing member deposits of a particular common stock.
However, concentration risk may be a clearing member and account-
specific risk. In order to mitigate the concentration risk of a single
clearing member, OCC plans to implement automated processes to monitor
the composition of a clearing member's margin deposits. Such processes
will identify concentration risk at both an account level and across
all accounts of a clearing member. OCC is adding the Interpretation so
that OCC has discretion to limit the margin credit granted to an
individual clearing member that maintains a concentrated margin deposit
of otherwise eligible common stock.
According to OCC, for reasons stated above, OCC considers a common
stock's average daily trading volume and the number of shares a
clearing member deposited as margin to be the two most significant
factors when making a
[[Page 66020]]
decision to limit margin credit due to concentration risk. Accordingly,
OCC will not give margin credit to clearing member margin deposits of a
particular common stock in respect of a particular account when the
deposited amount of such common stock is in excess of two times the
average daily trade volume of such common stock over the most recent
three month period. OCC's systems will continually assess the
composition of clearing member margin deposits for each account
maintained by the clearing member, including intra-day collateral
substitutions in such accounts, to determine if a clearing member has a
margin deposit with a concentrated amount of common stock. With respect
to a given account, OCC's systems will automatically set appropriate
limits on the amount of a particular common stock for which a clearing
member may be given margin credit for any one of a its tier accounts.
In addition, and with respect to all of a clearing member's accounts,
OCC will impose an add-on margin charge if, in aggregate, a clearing
member deposits a concentrated amount of a particular common stock as
margin across all of its accounts. The add-on margin charge will
operate to negate the margin credit given to the concentrated margin
deposit, and will be collected, when applicable, as part of OCC's
standard morning margin process. OCC will assess the add-on margin
charge across all of a clearing member's accounts on a pro-rata basis
(based on the amount of the particular common stock in each of a
clearing member's accounts).\7\
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\7\ According to OCC, since a 2-day limit is first checked at
each account, it is possible that a clearing member with multiple
accounts may have more than 2-days of a given common stock on
deposit in aggregate. To control this condition, a final check is
done on the aggregate amount of shares held by a clearing member
across all of its accounts. For example, if a particular clearing
member has three accounts each holding 2-days volume of a specific
common stock, the clearing member check would identify that the
member was holding six days of volume in aggregate. To mitigate this
risk, an add-on charge equal to the market value of four days of
volume would be applied to all accounts holding that security on a
pro-rata basis.
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According to OCC, OCC staff has been monitoring concentrated common
stock positions, assessing the impact of the proposed change described
in this filing and contacting clearing members affected by the proposed
change. OCC believes that clearing members will be able to comply with
the proposed change without making significant changes to their day-to-
day business operations. In December 2013, an information memo was
posted to inform all members of the upcoming change. According to OCC,
since January 2014, OCC staff has been in contact with any clearing
member that would be affected by the proposed change. On a weekly
basis, any clearing member that would see a reduction of 10% or more of
its collateral value is contacted and provided an explanation of the
policy and a list of concentrated positions observed in this analysis.
On a monthly basis, all clearing members exhibiting any concentration
risk are contacted to provide an explanation of the proposed policy and
a list of concentrated positions. In both cases, clearing members are
encouraged to proactively reduce concentrated positions to conform to
the proposed policy. As of June 2014, twenty-five members would be
affected. Implementation of the Interpretation would result in
disallowing $1.2 billion in collateral value and result in margin calls
for six members totaling $710 million. Moreover, in July 2014, OCC made
an automated report concerning concentrated margin deposits of common
stock available to all clearing members.
c. Wrong-Way Risk
OCC also will use the Interpretation to address the risk that the
common stock a clearing member has deposited as margin and which is
issued by the clearing member itself or an affiliate of the clearing
member will lose value in the event the clearing member providing such
margin defaults, which is known as ``wrong-way risk.'' According to
OCC, wrong-way risk occurs when a clearing member makes a deposit of
common stock issued by it or an affiliate and, in the event the
clearing member defaults, the clearing member's common stock margin
deposit will also be losing value at the same time because there is
likely to be a strong correlation between the clearing member's
creditworthiness and the value of such common stock. In order to
address wrong-way risk, the Interpretation will implement automated
systems that will not give margin credit to a clearing member that
deposits common stock issued by such clearing member or an affiliate as
margin collateral. OCC will define ``affiliate'' broadly in the
Interpretation to include any entity with direct or indirect equity
ownership of 10% of the clearing member, or any entity for which the
clearing member holds 10% of the direct or indirect equity
ownership.\8\
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\8\ This standard is based on the provisions of OCC Rule
215(a)(5).
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OCC has addressed the impact of the change designed to address
wrong-way risk. As of June 2014, there were 73 clearing members whose
parent or an affiliate has issued securities trading on U.S. exchanges.
As of June 2014, there are six clearing members that would be affected
by virtue of having made margin deposits of their own or an affiliate's
common stock. In total, these shares equaled $132 million and accounted
for less than one half of one percent of the total market value of
valued securities pledged as margin at OCC. In July 2014, OCC made
information available to each clearing member that indicates which of
its deposits of common stock would not receive margin credit under the
proposed change due to wrong-way risk considerations, as described
above.\9\
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\9\ OCC believes that by providing such information clearing
members will be better able to adjust their margin deposits at OCC
to conform to the proposed change if it is approved.
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d. Deposits That Hedge Open Positions
In addition to the above, OCC also will include language in the
Interpretation so that it has discretion to give margin credit to
common stock deposited as margin that would otherwise not be given
margin credit in circumstances when such common stock acts as a hedge
(i.e., the member holds an equivalent short position in cleared
contracts on the same underlying security). This condition will be
checked in both the account and clearing member level. For example, if
a clearing member deposits the common stock of an affiliate as margin
collateral, which, pursuant to the above, would ordinarily not be given
value for the purposes of granting margin credit, OCC may nevertheless
give value to such common stock for the purposes of granting margin
credit to the extent such common stock acts as a hedge against open
positions of the clearing member. In this case, a decline in the value
of the margin deposit would be wholly or partially offset by an
increase in the value in the open position. Moreover, in such a
situation, OCC will systematically limit the margin credit granted to
the lesser of a multiple of the daily trading volume or the ``delta
equivalent position'' \10\ for the particular
[[Page 66021]]
common stock, taking into account the hedging position.\11\ OCC
believes that this policy will further encourage clearing members to
deposit margin collateral that hedges their related open positions and
is in line with the valuation methods within STANS. This policy will
also facilitate OCC's management of its and its participants' credit
exposure as well as the liquidation of a clearing member's portfolio
should the need arise.
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\10\ According to OCC, the ``delta equivalent position'' is the
equivalent number of underlying shares represented by the
aggregation of cleared products on that same underlying instrument.
This value is calculated using the ``delta'' of the option or
futures contract, which is the ratio between the theoretical change
in the price of the options or futures contract to the corresponding
change in the price of an underlying asset. Thus, delta measures the
sensitivity of an options or futures contract price to changes in
the price of the underlying asset. For example, a delta of +0.7
means that for every $1 increase in the price of the underlying
stock, the price of a call option will increase by $0.70. Delta for
an option or future can be expressed in shares of the underlying
asset. For example, a standard put option with a delta of -.45 would
have a delta of -45 shares, because the unit of trading is 100
shares.
\11\ Assume, for example, an average daily trade volume of 250
shares, a threshold of 2 times the average daily trade volume, and a
delta of -300 shares for the options on a particular security in a
particular account. A position of 700 shares that did not hedge any
short options or futures would receive credit for only 500 shares
(i.e., 2 times the average daily trade volume). If the net long
position in the account, when combined with the delta of short
option and futures position, were only 400, credit would be given
for the entire 700 shares since the delta equivalent position is
below the 500 share threshold. However, if the option delta were
+300, the net long position would be 1000, and credit would only be
given for 500 shares because the delta equivalent position would
exceed the 500 share threshold.
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e. Other Proposed Changes
OCC also will make certain clarifying changes in order to
accommodate the adoption of the Interpretation into its Rules.
Primarily, OCC is adding language to OCC Rule 604, Interpretation and
Policy .14, to clarify that such Interpretation and Policy concerns
OCC's authority to not give value to certain margin deposits for all
clearing members (whereas the Interpretation applies to particular
clearing member(s)). In addition, OCC is removing language from OCC
Rule 604, Interpretation and Policy .14, to improve readability as well
as to remove ``factors'' concerning number of shares and affiliates
since OCC's authority with respect to such factors will be more clearly
described in the Interpretation. Finally, OCC is renumbering the
Interpretations and Policies of Rule 604 in order to accommodate the
adoption of the Interpretation.
II. Discussion and Commission Findings
Although the Payment, Clearing and Settlement Supervision Act does
not specify a standard of review for an advance notice, the Commission
believes its stated purpose is instructive.\12\ The stated purpose 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
(``FMU'') and strengthening the liquidity of systemically important
FMUs.\13\
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\12\ See 12 U.S.C. 5461(b).
\13\ Id.
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Section 805(a)(2) of the Payment, Clearing and Settlement
Supervision Act \14\ 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 financial regulator. Section 805(b) of the Payment,
Clearing and Settlement Supervision Act \15\ states that the objectives
and principles for the risk management standards prescribed under
Section 805(a) shall be to:
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\14\ 12 U.S.C. 5464(a)(2).
\15\ 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 Payment, Clearing and Settlement Supervision Act \16\
and the Act (``Clearing Agency Standards'').\17\ The Clearing Agency
Standards became effective on January 2, 2013 and establish, among
other things, minimum requirements regarding how registered clearing
agencies must maintain effective risk management procedures and
controls.\18\ Therefore, it is appropriate for the Commission to review
advance notices against these Clearing Agency Standards and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Payment, Clearing and Settlement
Supervision Act.\19\
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\16\ 12 U.S.C. 5464(a)(2).
\17\ See Rule 17Ad-22 of the Act. 17 CFR 240.17Ad-22. Securities
Exchange Act Release No. 68080 (October 22, 2012), 77 FR 66220
(November 2, 2012) (S7-08-11).
\18\ See Securities Exchange Act Release No. 68080 (October 22,
2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
\19\ 12 U.S.C. 5464(b).
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The proposal in this advance notice is consistent with Clearing
Agency Standards, Rule17Ad-22(b)(2) of the Act.\20\ Rule 17Ad-22(b)(2)
of the Act \21\ requires a registered clearing agency that performs
central counterparty services to, among other things, 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. This proposal
is consistent with this rule because it is reasonably designed to
permit OCC to use margin requirements to limit its credit exposures to
clearing members under normal market conditions in two ways. First, it
is reasonably designed to limit OCC's credit exposures to clearing
members whose collateral portfolios could present concentration risk.
Specifically, it addresses concentration risk by particular clearing
member and by particular account by giving OCC discretion to disapprove
as margin collateral certain securities, based on the number of shares
deposited, by particular clearing member and by particular account,
while also considering deposits that hedge open positions. It also
clarifies that OCC's existing authority to not give value to certain
margin deposits applies to all clearing members, as opposed to
particular clearing members.\22\ Second, it is reasonably designed to
limit OCC's credit exposures to clearing members whose collateral
portfolios could present wrong-way risk. Specifically, it addresses
wrong-way risk presented by clearing members who deposit as margin
securities that are issued by the clearing member itself or by an
affiliate of the clearing member. It addresses this type of wrong-way
risk by giving OCC discretion to disapprove as margin collateral, with
respect to a particular clearing member, any security issued by such
clearing member or by an affiliate of such clearing member, while also
considering deposits that hedge open positions.
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\20\ 17 CFR 240.17Ad-22(b)(2).
\21\ Id.
\22\ See Rule 604, Interpretation and Policy .15 (providing OCC
discretion to disapprove as margin collateral securities that meet
certain factors, including trading volume, number of outstanding
shareholder, number of outstanding shares, volatility and
liquidity).
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Rule 17Ad-22(b)(2) of the Act \23\ also requires a registered
clearing agency that performs central counterparty services to, among
other things, establish, implement, maintain and enforce written
policies and procedures reasonably designed to use risk-based models
and parameters to set margin requirements. This proposal is consistent
with this rule because it permits OCC to use risk-based models and
parameters to set margin requirements in a way that takes into account
concentration risk and wrong-way risk, as described above.
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\23\ 17 CFR 240.17Ad-22(b)(2).
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The proposal in this advance notice meets the objectives and
principles described in Section 805(b) of the Payment, Clearing and
Settlement Supervision Act.\24\ The changes to
[[Page 66022]]
OCC's margin policy, as described above, are designed to reduce the
risk that clearing member margin assets would be insufficient should
OCC need to use such assets to close-out positions of a defaulted
clearing member. The changes are also designed to facilitate OCC to
timely meet its settlement obligations because the change will diminish
the likelihood that a large percentage of the value of a defaulting
clearing member's margin assets would not be available to OCC to cover
losses in the event of a clearing member default. Therefore, the
proposal (i) promotes robust risk management (including risk management
of concentration risk and wrong-way risk), (ii) promotes safety and
soundness, (iii) reduces systemic risks (including those caused by
concentration risk and wrong-way risk), and (iv) supports the stability
of the broader financial system.
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\24\ 12 U.S.C 5464(b); See also 12 U.S.C. 5464(a).
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III. Conclusion
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Payment, Clearing and Settlement Supervision Act,\25\ that the
Commission DOES NOT OBJECT to the proposal in OCC's advance notice (SR-
OCC-2014-803) and 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 the proposal in this advance notice (SR-OCC-2014-14), whichever is
later.
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\25\ 12 U.S.C. 5465(e)(1)(I).
By the Commission.
Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2014-26344 Filed 11-5-14; 8:45 am]
BILLING CODE 8011-01-P