[Federal Register Volume 79, Number 215 (Thursday, November 6, 2014)]
[Notices]
[Pages 66010-66013]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-26345]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-73483; File No. SR-OCC-2014-14]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving Proposed Rule Change To Better Manage Risks
Concentration and Other Risks Associated With Accepting Deposits of
Common Stocks for Margin Purposes
October 31, 2014.
On July 15, 2014, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange
[[Page 66011]]
Commission (``Commission'') the proposed rule change SR-OCC-2014-14
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'')\1\ and Rule 19b-4 thereunder.\2\ The proposed rule change was
published for comment in the Federal Register on August 5, 2014.\3\ The
Commission did not receive any comments on 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. 72717 (July 30, 2014),
79 FR 45523 (August 5, 2014) (SR-OCC-2014-14). OCC also filed
proposals contained in this proposed rule change as an advance
notice under Section 806(e)(1) of the Payment, Clearing, and
Settlement Supervision Act of 2010 (``Payment, Clearing and
Settlement Supervision Act'') and Rule 19b-4(n)(1) of the Act, which
was published for comment in the Federal Register on August 15,
2014. 12 U.S.C. 5465(e)(1); 17 CFR 240.19b-4(n)(1). See Securities
Exchange Act Release No. 72803 (August 11, 2014), 79 FR 48285
(August 15, 2014) (SR-OCC-2014-803). The Commission did not receive
any comments on the advance notice.
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I. Description
According to OCC, the purpose of this proposed rule 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 proposed to add 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 proposed to make 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.\4\ 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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\4\ 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.\5\
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\5\ 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 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 proposed to add 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 the 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 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 its
[[Page 66012]]
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).\6\
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\6\ 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 rule change
described in this filing and contacting clearing members affected by
the proposed rule change. OCC believes that clearing members will be
able to comply with the proposed rule 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
rule 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 proposed to 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 proposed to 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.\7\
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\7\ 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.\8\
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\8\ 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 rule change if it is approved.
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d. Deposits That Hedge Open Positions
In addition to the above, OCC also proposed to 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'' \9\ for the particular common stock, taking into
account the hedging position.\10\ OCC believes that this policy will
further encourage clearing members to deposit margin collateral that
hedges their related open
[[Page 66013]]
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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\9\ 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.
\10\ 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 proposed to make certain clarifying changes in order to
accommodate the adoption of the Interpretation into its Rules.
Primarily, OCC proposed to add 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 proposed to remove 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 proposed to
renumber the Interpretations and Policies of Rule 604 in order to
accommodate the adoption of the Interpretation.
II. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act \11\ directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that the proposed rule change is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to such
organization.
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\11\ 15 U.S.C. 78s(b)(2)(C).
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The Commission finds that the proposed rule change is consistent
with Section 17A(b)(3)(F) of the Act,\12\ and Rule 17Ad-22(b)(2) of the
Act.\13\ Section 17A(b)(3)(F) of the Act \14\ requires a registered
clearing agency to have rules that are designed to, among other things,
promote the prompt and accurate clearance and settlement of securities
transactions, and 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. OCC's proposed rule change is consistent with this
rule because by implementing margin collateral requirements that
address concentration risk and wrong-way risk, OCC's proposed rule
change is consistent with promoting the prompt and accurate clearance
and settlement of securities transactions and assuring the safeguarding
of securities and funds which are in OCC's custody or control or for
which OCC is responsible. The proposed changes 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 proposed
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.
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\12\ 15 U.S.C. 78q-1(b)(3)(F).
\13\ 17 CFR 240.17Ad-22(b)(2).
\14\ 15 U.S.C. 78q-1(b)(3)(F).
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OCC's proposed rule change is consistent with Rule17Ad-22(b)(2) of
the Act.\15\ Rule 17Ad-22(b)(2) of the Act \16\ 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.\17\ 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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\15\ 17 CFR 240.17Ad-22(b)(2).
\16\ Id.
\17\ 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 \18\ 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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\18\ 17 CFR 240.17Ad-22(b)(2).
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act and, in
particular, with the requirements of Section 17A of the Act \19\ and
the rules and regulations thereunder.
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\19\ In approving this proposed rule change, the Commission has
considered the proposed rule's 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
Act,\20\ that the proposed rule change (SR-OCC-2014-14) be, and it
hereby is, approved, as of the date of this order or the date of a
notice by the Commission noticing, pursuant to Section 806(e)(1)(I) of
the Payment, Clearing and Settlement Supervision Act,\21\ 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,
whichever is later.
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\20\ 15 U.S.C. 78s(b)(2).
\21\ 12 U.S.C. 5465(e)(1)(I).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\22\
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\22\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-26345 Filed 11-5-14; 8:45 am]
BILLING CODE 8011-01-P