[Federal Register Volume 81, Number 53 (Friday, March 18, 2016)]
[Notices]
[Pages 14921-14927]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-06098]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-77358; File No. SR-OCC-2016-004]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Related to the Adoption of an
Options Exchange Risk Control Standards Policy
March 14, 2016.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on March 4, 2016, The Options Clearing Corporation (``OCC'') filed with
the Securities and Exchange Commission (``Commission'') the proposed
rule change as described in Items I and II below, which Items have been
prepared by OCC. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
This proposed rule change by OCC would adopt a new Options Exchange
Risk Control Standards Policy (``Policy''), which details OCC's policy
for addressing the potential risks arising from erroneous trades
executed on an options exchange (``Options Exchange'' or ``Options
Exchanges,'' as applicable) \3\ that has not demonstrated the existence
of certain risk controls (``Risk Controls'') that are consistent with a
set of principles-based risk control standards (``Risk Control
Standards'') developed by OCC in consultation with the exchanges. The
proposed rule change would also revise OCC's Schedule of Fees in
accordance with the proposed Policy to charge and collect from Clearing
Members \4\ a fee of two cents per each cleared options contract (per
side) (``Fee'') executed on an Options Exchange that did not
demonstrate sufficient Risk Controls designed to meet the proposed Risk
Control Standards. The text of the proposed Policy and related changes
to the OCC Schedule of Fees is attached as Exhibit 5. Material proposed
to be added is marked by underlining and material proposed to be
deleted is enclosed in bold brackets.
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\3\ Current Options Exchanges are: (i) BATS Options Market, (ii)
Box Options Exchange LLC, (iii) C2 Options Exchange, Inc., (iv)
Chicago Board Options Exchange, Inc., (v) EDGX Options Exchange,
(vi) International Securities Exchange, LLC, (vii) ISE Gemini LLC,
(viii) ISE Mercury, LLC, (ix) MIAX Options Exchange, (x) NASDAQ OMX
BX, Inc., (xi) NASDAQ OMX PHLX, LLC, (xii) NASDAQ Options Market,
(xiii) NYSE Amex Options, and (xiv) NYSE Arca Options.
\4\ See Article I, Section 1 of OCC's By-Laws.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of these
statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
(1) Purpose
Background
OCC proposes to adopt a new Options Exchange Risk Control Standards
Policy, which is designed to better protect OCC against risks related
to erroneous transactions that may occur on Options Exchanges that have
not implemented Risk Controls that are consistent with a defined set of
principles-based Risk Control Standards, which were developed by OCC in
consultation with the exchanges, and that are sent to OCC for a
guarantee. The proposed Policy would, among other things, impose an
additional Fee on cleared trades that are executed on an Options
Exchange that has not certified the existence of Risk Controls that
meet the Risk Control Standards in the following categories: (i)
``Price Reasonability Checks;'' (ii) ``Drill-Through Protections;''
(iii) ``Activity-Based Protections;'' and (iv) ``Kill-Switch
Protections'' (in each case discussed more thoroughly below) along with
OCC's review to determine if the Risk Controls are consistent with the
Risk Control Standards. The Policy would also require that any funds
collected from the Fee be retained as earnings and, as such, be
eligible for use for Clearing Member defaults under Article VIII,
Section 5(d) of OCC's By-Laws but prohibit such funds from being used
for any other purpose.
OCC believes that the implementation of Risk Controls that are
consistent with
[[Page 14922]]
the proposed principles-based Risk Control Standards at Options
Exchanges would guard against risks attendant to erroneous transactions
on such Options Exchanges and serve OCC, its Clearing Members, and the
financial markets OCC serves by helping to ensure the potential
significant financial impact and elevated risk of disruption resulting
from erroneous transactions is limited to the greatest extent possible.
As a systemically important financial market utility and the sole
clearing agency for the US listed options markets, OCC seeks to control
risks presented to it that might have the effect of disrupting routine
processes at OCC, and thus threatening the stability of the financial
system of the United States. As described in more detail below, there
have been numerous cases in the recent past where erroneous
transactions have occurred that could have caused substantial damage to
financial market entities and resultant damage to OCC. The options
market is not immune to the harmful effects of erroneous transactions,
and in fact OCC is more susceptible than other financial market
entities to the risks attendant thereto by virtue of: (i) Its role as a
guarantor of all options transactions that are novated, and (ii) its
lack of discretion to elect not to clear transactions executed on
Options Exchanges. OCC believes that Options Exchanges that apply the
Risk Control Standards to all transactions executed on such Options
Exchanges are better equipped to capture and eradicate erroneous and
potentially disruptive transactions at the Options Exchange level,
thereby reducing the likelihood that the risk inherent in such
erroneous and potentially disruptive trades is transferred to OCC, its
other Clearing Members, and the financial markets served by OCC.
Furthermore, and as discussed in more detail below, OCC believes this
proposal is complementary to efforts undertaken by the Commission to
strengthen critical market infrastructure and improve its resilience,
consistent with current Commission requirements \5\ and international
guidance,\6\ and in furtherance of remarks made by Chair White after
the latest in a series of prominent market disruptions to encourage
self-regulatory organizations to consider such complementary
efforts.\7\
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\5\ See Clearing Agency Standards, Securities Exchange Act
Release No. 68080 (October 22, 2012), 77 FR 66220 (November 2,
2012). More specifically, the Release states,
``The Commission notes however that under Section 17A(b)(3)(F)
of the Exchange Act, a clearing agency is charged with
responsibility to coordinate with persons engaged in the clearance
and settlement of securities transactions, not just other clearing
agencies. . . Further, the Commission notes that during the
clearance and settlement process, a registered clearing agency is
confronted with a variety of risks that must be identified and
understood if they are to be effectively controlled. To the extent
that these risks arise as a result of a registered clearing agency's
links with another entity involved in the clearance and settlement
process, Rule 17Ad- 22(d)(7) should help ensure that clearing
agencies have policies and procedures designed to identify those
risks.''
Id. at 66251.
\6\ See Principle 20 of the Committee on Payment and Settlement
Systems and Technical Committee of the International Organization of
Securities Commissions (``CPSS-IOSCO''), Principles for Financial
Market Infrastructures (April 16, 2012), available at http://www.bis.org/publ/cpss101a.pdf (``PFMI Report'').
\7\ See SEC Chair White Statement on Meeting with Leaders of
Exchanges, September 12, 2013. (``Today's meeting was very
constructive. I stressed the need for all market participants to
work collaboratively--together and with the Commission--to
strengthen critical market infrastructure and improve its resilience
when technology falls short.'') See also Chair White, Statement on
Nasdaq Trading Interruption, August 22, 2013. (``The continuous and
orderly functioning of the securities markets is critically
important to the health of our financial system and the confidence
of investors. Today's interruption in trading, while resolved before
the end of the day, was nonetheless serious and should reinforce our
collective commitment to addressing technological vulnerabilities of
exchanges and other market participants.'')
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Proposed Options Exchange Risk Control Standards Policy
Under the proposed Policy, if an Options Exchange does not submit a
signed certification sufficiently demonstrating that it has certain
Risk Controls in place that are consistent with the proposed Risk
Control Standards, OCC will charge and collect a fee \8\ in accordance
with its Schedule of Fees for each trade executed on such Options
Exchange until such time that the Options Exchange completes the
certification process, which is described in more detail below. Funds
collected through the imposition of the Fee are segregated for
recordkeeping purposes from other funds generated by clearing fees and
would not be available for a Clearing Member refund or Stockholder
Exchange dividend under OCC's approved Capital Plan. These funds would
be available for use by OCC, with unanimous approval by the Stockholder
Exchanges, in accordance with Article VIII, Section 5(d) of OCC's By-
Laws \9\ and as provided for in the Policy.
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\8\ OCC is proposing to collect a fee of two cents per each
cleared options contract (per side). Any changes to this fee would
be subject to a future rule filing with the Commission.
\9\ See Article VIII, Section 5(d). Under Article VIII, Section
5(d), usage of current or retained earnings may be considered after
the defaulting clearing member's margin has been exhausted, and it
may be used to reduce in whole or in part the pro rata contribution
otherwise made from the Clearing Fund to cover the loss. Id.
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Risk Control Standards
The proposed Options Exchange Risk Control Standards Policy details
each of the Risk Control Standards to which an Options Exchange must
attest so that the proposed Fee would not be applied to trades executed
on that Options Exchange. The proposed Risk Control Standards, which
were developed by OCC in consultation with the Options Exchanges, are
principle-based and designed to provide the flexibility for each
Options Exchange to develop specific Risk Controls that best suit its
own marketplace while still guarding against the types of risks
contemplated by the Policy. The proposed Risk Control Standards are
described below.
1. Price Reasonability Checks
Mandatory Price Reasonability Checks prevent limit orders,\10\
complex orders,\11\ and market maker quotes from being entered and
displayed on an Options Exchange if the price on such order or quote is
outside a defined threshold set in relation to the current market price
or National Best Bid or Offer (``NBBO''). For example,\12\ an Options
Exchange may set a Price Reasonability Check that would reject an order
that is priced at a certain percentage above the set parameter or a
quote entered by a market maker that is priced a certain dollar amount
higher than the set threshold.\13\ Options Exchanges' Price
Reasonability Checks would include:
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\10\ A limit order is an order placed on an Options Exchange to
buy or sell a specific amount of options contracts at a specified
price or better. (See, e.g., International Securities Exchange Rule
715(b).)
\11\ A complex order is an order involving the execution of two
or more different options series in the same underlying security
occurring at or near the same time. (See, e.g., Chicago Board
Options Exchange Rule 6.53C(a)(1).)
\12\ Examples herein are illustrative only, and the specifics of
such examples are not necessarily required for an Options Exchange
to certify having specific Risk Controls sufficient to meet the Risk
Control Standards.
\13\ By way of example, assume the market is $1.00 bid at $1.10.
An Options Exchange Price Reasonability Check could reject orders
greater than 5 cents above the offer or below the bid. Accordingly,
if a broker wanted to buy an option for $1.10, but inadvertently
``fat fingers'' the limit price for $11.00 on the order, the Options
Exchange would reject the order prior to execution because the limit
on the order is greater than the Price Reasonability Check limit.
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(i) Mandatory limit order, complex order and quote Price
Reasonability Checks;
(ii) Application to all trading sessions, including market
openings; and
(iii) If the checks do not prevent the display and execution of
quotes, the Options Exchange would have other means by which it
mitigates the risks associated with the display and
[[Page 14923]]
execution of quotes outside the specific threshold.
Trades executed on an Options Exchange that occur at prices that
were input erroneously and are substantially removed from other trades
executed in the same product have the potential to result in large
trading losses. In 2013, a trading firm's internal algorithm used to
satisfy market demand for equity options inadvertently produced orders
with inaccurate price limits and sent those orders to Options Exchanges
(``2013 Trading Firm Error''). Though many of the erroneous trades were
later canceled, it has been estimated that the trading firm could have
faced approximately $500 million in losses.\14\ If these potential
losses were realized and if the OCC Clearing Member clearing and
settling those trades was unable to honor them, OCC and its remaining
Clearing Members would have been exposed to significant losses and a
potential disruption to the operations of OCC.
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\14\ See In the Matter of Goldman, Sachs & Co., Order
Instituting Administrative and Cease- and-Desist Proceedings,
Pursuant to Sections 15(9b) and 21C of the Securities Exchange Act
of 1934, Making Findings, and Imposing Remedial Sanctions and a
Cease-and-Desist Order (June 30, 2015) (Release No. 34-75331).
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2. Drill-Through Protections
Drill-Through Protections are closely related to Price
Reasonability Checks and would require all orders, including market
orders,\15\ limit orders, and complex orders, to be executed within
pre-determined price increments of the NBBO. Drill-Through Protections
also restrict orders from immediately trading up or down an unlimited
number of price intervals and allow market liquidity to be refreshed
prior to the execution of further trades.\16\ Options Exchanges' Drill-
Through Protections would include:
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\15\ A market order is an order to buy or sell a stated number
of options contracts at the best price obtainable when the order
reaches the Options Exchange in which the order was sent to. (See,
e.g., Chicago Board Options Exchange Rule 6.53).
\16\ By way of example, assume the market is $1.00 bid at $1.10
and the size, or liquidity provided on the bid, or offered on the
ask, is 100 contracts by 100 contracts. Assume an order is entered
as a market order to buy 1000 contracts and the Drill-Through
Protection is set at 5 cents and 500 milliseconds (or half a
second). The Drill-Through Protection would allow the order to trade
up to the price limit set, or $1.15. At $1.15, the order would be
halted by the Options Exchange and either routed to another Options
Exchange or manually executed. Also, after executing 100 contracts
for $1.10, the Drill-Through Protection would temporarily halt the
order for 500 milliseconds (or half a second) to allow market makers
to refresh their market and size.
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(i) Mandatory Drill-Through Protections with reasonably
quantifiable limits;
(ii) Application to all orders; and
(iii) Application to all trading sessions, including market
openings.
Options orders that are large in size may, due to the available
contra orders, be partially executed at reasonable prices with the
remainder of the same order executed at prices that are far from the
NBBO, and thus have the potential to result in large trading losses.
For example, in 2012, a trading firm erroneously sent more than 4
million orders to equity exchanges over a period of forty-five minutes,
creating a loss of over $450 million that nearly resulted in the
trading firm's insolvency (``2012 Trading Firm Error'' and collectively
with the 2013 Trading Firm Error, the ``Trading Firm Errors'').\17\ If
the trading firm was unable to absorb the loss and honor the trades,
the clearing agency and its surviving Clearing Members would have been
exposed to significant losses and a potential disruption to their
operations. While detailed facts surrounding the incident are not
publicly known, Drill-Through Protections could have helped limit the
losses by preventing execution of orders that would have traded through
a large number of price increments in a short period of time.
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\17\ See http://www.reuters.com/article/2012/10/17/us-knightcapital-results-idUSBRE89G0HI20121017.
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3. Activity-Based Protections
Activity-Based Protections extend an Options Exchange's Risk
Controls to factors beyond price and are most commonly designed to
address risks associated with a high frequency of trades in a short
period of time. Activity-Based Protections may address the maximum
number of contracts that may be entered as one order, the maximum
number of contacts that may be entered or executed by one firm over a
certain period of time, and the maximum number of messages that may be
entered over a certain period of time. Options Exchanges' Activity-
Based Protections would include:
(i) Application to all traded products available on the Options
Exchange;
(ii) Mandatory use of available Activity-Based Protections by its
members where the use of such protections is consistent with sound risk
management practice; and
(iii) Maximum number of contracts or orders that may be executed
over a certain period of time.
Options Exchanges that don't have Activity-Based Protections have a
greater likelihood of facilitating erroneous trades by not imposing
limits based on factors other than price. Trading errors that result in
a large number of orders or quotes could magnify the trading losses
that result from the error and could cause the default of a Clearing
Member if the Clearing Member cannot meet its obligations due to such
losses. For example, Activity-Based Protections could have limited the
loss associated with the 2013 Trading Firm Error mentioned above.
4. Kill-Switch Protections
Kill-Switch Protections provide Options Exchanges, and their market
participants, with the ability to cancel existing orders and quotes
and/or block new orders and quotes on an exchange-wide or more tailored
basis (e.g., symbol specific, by Clearing Member, etc.) with a single
message to the Options Exchange after established trigger events are
detected. A trigger event may include a situation where a market
participant is disconnected from an Options Exchange due to an
abnormally large order or manual errors in the system by a market
participant causing multiple erroneous trades to occur. Kill-Switch
Protections are considered a last line of defense, applicable where,
for example, a severe trading problem occurs or an Options Exchange
market participant loses connectivity to the Options Exchange. Options
Exchanges' Kill-Switch Protections would include:
(i) The availability, and required use in the case of Options
Exchange market makers, of ``heartbeat monitoring,'' a function that
periodically sends an electronic signal between the Options Exchange
and the market participant that subsequently cancels all quotes and/or
orders if the market participant does not respond to the signal in a
certain period of time;
(ii) The ability for participants of the Options Exchange to
``cancel-on-disconnect;''
(iii) The ability to cancel all quotes and/or orders with a single
message to the Options Exchange, with the availability of backup
alternative messaging systems; and
(iv) Restricted automated reentry to trading after the activation
of a kill-switch.
Trades executed on Options Exchanges without Kill-Switch
Protections increase the risk that trading malfunctions or other
harmful events could lead to erroneous trades being executed on an
Options Exchange and sent to OCC for clearance and settlement. If the
Clearing Member for these trades was not able to absorb losses
associated with them, it could potentially expose OCC and its surviving
Clearing Members to
[[Page 14924]]
significant losses and a disruption of operations. For example, the
potential severity of the 2012 Trading Firm Error could have been
substantially limited if a Kill-Switch Protection temporarily
restricted the trading firm's ability to trade.
Certification Process \18\
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\18\ OCC intends to begin the collection of certifications from
the Options Exchanges after appropriate regulatory approval has been
obtained.
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OCC has developed, in conjunction with the Options Exchanges, the
following process to evaluate each Options Exchange's Risk Controls.
Under the proposal, each Options Exchange would certify to OCC that the
Options Exchange implemented Risk Controls consistent with the Risk
Control Standards using a form provided by OCC and signed by an
executive officer of the Options Exchange.\19\ Provided regulatory
approval is received, Options Exchanges that submit documentation would
receive a determination from OCC regarding their Risk Controls by a
date no sooner than June 30 of each year (``Evaluation Completion
Date'').\20\
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\19\ The signed certification signed by an executive officer of
the Options Exchange will attest to the validity, efficacy and
implementation of Risk Controls satisfying each of the above
described Risk Control Standards. As part of the certification, the
executive officer of the Options Exchange will certify that the
Options Exchange has met the Risk Control Standards as described in
this proposed rule change as approved by the Commission.
\20\ OCC notes that the implementation of the Policy and
resulting Evaluation Completion Date for 2016 are subject to
regulatory approval of the proposed rule change. After receiving
regulatory approval, OCC will notify Options Exchanges, its Clearing
Members, and market participants of the Evaluation Completion Date
for 2016 by issuing an Information Memo on its public Web site. The
Evaluation Completion Date for 2016 will be set for a date not
sooner than 30 days after issuing the Information Memo (which may be
later than June 30, 2016).
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Under the Policy, OCC would evaluate each Options Exchange's Risk
Controls and the Risk Controls' compliance with the Risk Control
Standards by the Evaluation Completion Date based on a review of its
certification and supporting materials, which will include, but will
not be limited to, proposed rule changes filed with the Commission,
approved Options Exchange rules, information circulars, and/or written
procedures, if any, in each case consistent with the date of receipt of
the certification. If OCC is unable to determine that an Options
Exchange has Risk Controls sufficient to meet Risk Control Standards,
OCC would furnish the Options Exchange with a concise written statement
of the reason(s) as soon as reasonably practicable. The Options
Exchange may, within 30 days of receipt of the written statement
providing the reason OCC was unable to find the Options Exchange
maintained sufficient Risk Controls to meet the proposed Risk Control
Standards, present further evidence of such sufficient Risk Controls to
OCC. OCC would then conduct a second review and make a recommendation
to OCC's Risk Committee \21\ whether the Options Exchange has
sufficient Risk Controls within 30 days of receiving the evidence of
such Risk Controls from the Options Exchange. OCC's Risk Committee
would, within 30 days of receipt of the recommendation, review the
recommendation and the Options Exchange's supporting materials, as
appropriate, to determine whether the Options Exchange has Risk
Controls sufficient to meet the Risk Control Standards (``Risk
Committee Review''). OCC would furnish the Options Exchange with a
concise written statement of the Risk Committee determination and the
reason for such determination as soon as reasonably practicable
following the Risk Committee Review.
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\21\ OCC's Risk Committee is chaired by a public Director and it
does not currently have an Options Exchange representative. In the
event OCC's Risk Committee has an exchange representative at some
time in the future, such representative would be recused from a
decision on the appeal of a determination of an Options Exchange's
compliance with the Risk Control Standards.
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Pursuant to the proposed Policy, on June 30 of each year (with the
potential exception of 2016, as noted above),\22\ OCC would post a
notice to its Web site to which Clearing Members (but not the general
public) have access advising Clearing Members, with respect to each
Options Exchange, whether: (1) The Options Exchange has implemented
sufficient Risk Controls to meet the Risk Control Standards; (2) OCC
was unable to determine the Options Exchange has sufficient Risk
Controls that meet the Risk Control Standards; or (3) a certification
has not been submitted by the Options Exchange.\23\
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\22\ See supra note 19.
\23\ For annual certifications commencing in 2017 and
thereafter, beginning June 30 of the calendar year for which the
certification is being made, OCC would post a notice to its Web site
to which Clearing Members (but not the general public) have access
advising members, with respect to each Options Exchange, whether:
(i) OCC has determined the Options Exchange has sufficient Risk
Controls that meet the Risk Control Standards; (ii) OCC was unable
to determine the Options Exchange has sufficient Risk Controls that
meet the Risk Control Standards; or (iii) a certification has not
been submitted by the Options Exchange. In addition, OCC will
continue to keep a record posted of the history of each Options
Exchange's compliance submission status, and any changes made to
that status, with the Risk Control Standards on the same OCC Web
site to which Clearing Members (but not the general public) have
access in order for Clearing Members to properly keep internal
records.
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Collection of Proposed Fee
Beginning on the first business day that is at least 60 days after
OCC posts such notice, OCC would charge and collect the Fee in
accordance with the Policy for trades executed on an Options Exchange
that was determined not to have sufficient Risk Controls to satisfy the
Policy.\24\ In the event the Fee is charged, it would continue to be
charged to and collected from Clearing Members,\25\ and the notice
would remain posted on OCC's Web site to which Clearing Members (but
not the general public) have access, until the Options Exchange has
demonstrated it has Risk Controls that satisfy the Policy.\26\ OCC
believes that implementing this Fee may incentivize Options Exchanges
to maintain Risk Controls that are consistent with the proposed Risk
Control Standards, thereby reducing the likelihood that erroneous
trades are submitted to OCC and the attendant risk identified above
comes to fruition.\27\ However, the primary reason for the Fee is to
provide additional funds for OCC to manage the elevated risk that would
be presented to OCC absent the Risk Control Standards and for which OCC
has no reasonable means to predict, measure, or consider otherwise. OCC
believes the Fee is reasonable, as it represents less than half but
more than a third of a premium over the base rate of five cents per
contract, and, since clearing fees represent two percent or less of the
total execution cost, should not materially impact a Clearing Member
that chooses to execute a transaction on an Options Exchange that has
not certified its Risk Control Standards.
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\24\ Exhibit 5A contains an updated Schedule of Fees reflecting
the Fee. As proposed, the Fee will be applied to all trades executed
on an Options Exchange that has not completed the certification
process.
\25\ The Accounting and Finance Department is responsible for
the collection of the Fee and segregation of those funds from other
monies collected by OCC.
\26\ The National Operations Group is responsible for
operationally updating each Options Exchange's certification status,
and associated Fee date, as applicable, within the OCC system.
\27\ OCC notes, however, that an Options Exchange that does not
maintain Risk Controls consistent with the Risk Control Standards is
not prevented from submitting transactions to OCC.
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OCC believes ensuring that funds collected through imposition of
the Fee are available for use as current or retained earnings in
accordance with Article VIII Section 5(d) of OCC's By-Laws is an
integral component of the proposed rule change, as it provides OCC with
increased financial means to cover potential losses stemming from a
[[Page 14925]]
default caused by erroneous trades that would be presented to OCC
absent the Risk Controls and for which OCC has no reasonable means to
predict, measure, or consider.
Exception and Escalation Processes
The proposed Policy also provides that, on rare occasion, OCC may
grant exceptions to the Policy in order to appropriately address
immediate business issues and provides for an escalation process to
report breaches of the Policy.
Commission Rules and Statements on Critical Market Infrastructure
Exchange Act Rule 15c3-5 (``Market Access Rule'') \28\ and
Regulation Systems Compliance and Integrity (``Regulation SCI,''
collectively with ``Market Access Rule,'' ``Market Integrity Rules'')
\29\ provide some requirements for the resiliency of critical market
infrastructures. The Market Access Rule, which was adopted in November,
2010, generally prohibits broker-dealers from providing ``unfiltered''
or ``naked access'' to the securities markets through an exchange or
automated trading system. To comply, broker-dealers must establish and
maintain a system of risk management controls and supervisory
procedures that are reasonably designed to systematically limit the
financial, regulatory, and other risks related to the business activity
of any customer utilizing the broker-dealer for access to the national
market system. OCC believes that the Risk Control Standards
contemplated by the Policy are in no way designed to interfere with,
contradict, or undermine the Market Access Rule and are in fact
designed to be complementary to the Market Access Rule. The proposed
Risk Control Standards, which are based upon calculated prices of
orders, bids, and offers, and activity of each Options Exchange
participant, as described in more detail above, would provide an
additional layer of protections at the Options Exchange level to guard
against the risks associated with erroneous trades and would thereby
complement the Market Access Rule, which is primarily aimed at
controlling access to the marketplace at the firm level. While the
Market Access Rule has no doubt contributed to a more resilient market
infrastructure, OCC believes there remain gaps in critical market
infrastructure with respect to erroneous transactions that should be
addressed; in fact, each of the Trading Firm Errors discussed above
occurred while the Market Access Rule was in place.
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\28\ See 17 CFR 240.15c3-5.
\29\ See Securities Exchange Act Release No. 73639 (November 19,
2014), 79 FR 72252 (December 5, 2014) (Reg SCI Adopting Release).
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In addition, OCC believes that the Risk Control Standards
complement Regulation SCI. Regulation SCI is focused on the need for
market participants to bolster the operational integrity of automated
systems, whereas the Risk Control Standards are designed to adopt more
granular controls around the actual entry of an order that occurs
outside the four walls of OCC before a trade is settled or cleared by
OCC. As such, OCC believes the Risk Control Standards set specific
standards to better further the intent of Regulation SCI. Regulation
SCI mandates that an applicable entity have reasonable policies,
procedures, and controls in place to ensure the integrity of its
systems, but the rule doesn't necessarily prescribe what those controls
should be. As proposed, the Risk Control Standards complement the
objectives of Regulation SCI by applying specific risk controls related
to the execution of trades on Options Exchanges. Because the Risk
Control Standards would act to further the intentions of the Market
Integrity Rules, rather than undermine or act contrary to them, OCC
believes the implementation of the Risk Controls by Options Exchanges
consistent with the proposed Risk Control Standards would promote
market resiliency when working alongside these Market Integrity Rules.
Finally, OCC believes the proposed Risk Control Standards are
consistent with Commission rules requiring clearing agencies to
establish and enforce written policies reasonably designed to evaluate
the potential sources of risks that can arise when the clearing agency
establishes links to clear and settle trades, and to ensure that these
risks are managed prudently on an ongoing basis.\30\
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\30\ See 17 CFR 240.17Ad-22(d)(7). OCC notes that these links
are not limited in scope to linkages between clearing agencies. See
supra note 5 at 66250-66251.
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OCC also notes that the proposed Risk Control Standards are
principle-based in nature and do not prescribe any specific method for
satisfying the standards, which would allow each Options Exchange to
develop specific Risk Controls that are best suited for its
marketplace. Moreover, the adoption of any Risk Control that would be
deemed to be a ``rule of an exchange'' \31\ under the Securities
Exchange Act of 1934, as amended (the ``Act''), would be subject to the
rule filing requirements of Section 19(b) of the Act \32\ and thereby
subject to review by the Commission before it could be implemented by
the Options Exchange.\33\
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\31\ See 15 U.S.C. 78c(a)(27).
\32\ 15 U.S.C. 78(s)(b).
\33\ Certain Options Exchanges have already filed proposed rule
changes, and received approval for such rule changes, with the
Commission to implement risk controls that are designed to guard
against the same types of risks contemplated by the Risk Control
Standards. See, e.g. Securities Exchange Act Release No. 76123
(October 16, 2015), 80 FR 62591 (October 16, 2015) (SR-NASDAQ-2015-
096) (Order Approving Proposed Rule Change to Adopt a Kill Switch
for NOM). See also Securities Exchange Act Release No. 77092
(February 9, 2016), 81 FR 7873 (February 16, 2016) (SR-BOX-2016-03)
(Notice of Filing and Immediate Effectiveness of a Proposed Rule
Change to Add Rule 7310 (Drill-through Protection) to Implement a
New Price Protection Feature).
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Anticipated Risk Mitigation
As discussed above and throughout the rule proposal, OCC believes
that charging an additional fee for trades executed on Options
Exchanges that have not implemented Risk Controls consistent with the
proposed Risk Control Standards would mitigate potential risks to OCC,
its Clearing Members, and the financial markets OCC serves, and
mitigate any threat to the stability of the financial system of the
United States. OCC believes the potential harm from the recent market
disruptions described above would have been limited if Risk Control
Standards were in place on the exchanges on which they occurred. As
discussed above, OCC believes that market disruptions of this nature
present additional risk to OCC for which it has no other means to
reasonably predict, measure, or consider, and as a result presents
otherwise uncovered risk to OCC's Clearing Members and the financial
markets OCC serves and, if left unchecked, could threaten the stability
of the financial system of the United States. The imposition of the
proposed Fee would provide additional financial resources to help OCC
mitigate such risks.
(2) Statutory Basis
OCC believes that the proposed rule change is consistent with
Section 17A(b)(3)(F) of the Act \34\ as it would help to promote the
prompt and accurate clearance and settlement of securities transactions
and assure the safeguarding of securities and funds which are in the
custody and control of OCC or for which it is responsible. Absent the
certification of Risk Controls consistent with the Risk Control
Standards at Options Exchanges from which OCC has no authority or
discretion to elect not to clear options transactions, OCC has no
assurance that reasonable controls are in place at
[[Page 14926]]
Options Exchanges to help mitigate the potential risks that may arise,
for example, due to operational errors outside of OCC, that OCC has no
ability to predict, measure, or consider. This otherwise uncovered risk
increases the likelihood that an OCC Clearing Member would experience a
default that would cause OCC to use the funds of other Clearing Members
that are in its custody and control (Clearing Fund deposits).
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\34\ 15 U.S.C. 78q-1(b)(3)(F).
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While the Market Integrity Rules help to build a safe and reliable
market structure environment, they do not provide absolute protections
to OCC, its Clearing Members, and the financial markets OCC serves from
risks attendant to the clearance of erroneous transactions that are
nevertheless executed on Options Exchanges. OCC notes that the Trading
Firm Errors described above occurred after the adoption of the Market
Access Rule, and Regulation SCI does not mandate the implementation of
Risk Control Standards as contemplated by the Policy. In the event an
Options Exchange has not implemented Risk Controls designed to meet the
proposed Risk Control Standards, imposition of the Fee would provide
OCC with additional financial resources, which are derived from fees
associated with the execution of transactions that are driving such
risks, that would facilitate OCC's ability to promptly fulfill its
settlement obligations and contribute to the safeguarding of funds in
OCC's custody and control by reducing the likelihood an erroneous trade
that causes an OCC Clearing Member to default would exhaust the
financial resources of the defaulting Clearing Member available to OCC
so that OCC is required to use mutualized resources deposited by non-
defaulting Clearing Members with OCC as Clearing Fund.
OCC also believes the proposed increase to fees for transactions
executed on an Options Exchange that does not implement sufficient Risk
Controls to meet the Risk Control Standards is an equitable allocation
of reasonable fees among its participants, as required by Section
17A(b)(3)(D) of the Act.\35\ The proposed Fee would be charged only to
Clearing Members that execute trades on Options Exchanges that have not
implemented Risk Controls designed to meet the proposed Risk Control
Standards. The transactions executed on these Options Exchanges
generate risk for OCC by increasing the likelihood that a guaranteed
erroneous trade would exhaust OCC's financial resources available in
the event of a Clearing Member default and that OCC would use
mutualized resources deposited by non-defaulting Clearing Members to
cover at least part of the loss. The two cent charge will better enable
OCC to allocate fees to transactions that are driving that risk.
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\35\ 15 U.S.C. 78q-1(b)(3)(D).
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Finally, OCC believes the proposed rule change is consistent with
Rule 17Ad-22(d)(7),\36\ which requires OCC to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to ensure that risks that arise when OCC establishes links are
managed prudently on an ongoing basis. Though the primary type of link
arrangement contemplated by Rule 17Ad-22(d)(7) is between clearing
agencies, the Commission declined to explicitly restrict application of
Rule 17Ad-22(d)(7) to links between clearing agencies, noting that
``during the clearance and settlement process, a registered clearing
agency is confronted with a variety of risks that must be identified
and understood if they are to be effectively controlled. To the extent
that these risks arise as a result of a registered clearing agency's
links with another entity involved with the clearance and settlement
process, Rule 17Ad-22(d)(7) should help ensure that clearing agencies
have policies and procedures designed to identify those risks.'' \37\
OCC believes this proposed rule change is the product of thorough
evaluation of risks presented to OCC arising from links with another
entity involved with the clearance and settlement process.\38\ Finally,
the proposed rule change is not inconsistent with any existing OCC By-
Laws or Rules, including those proposed to be amended.\39\
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\36\ 17 CFR 240.17Ad-22(d)(7).
\37\ See supra note 5.
\38\ The Commission's proposed Standards for Covered Clearing
Agencies would also require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify, monitor, and manage risks related
to any link the covered clearing agency establishes with among other
things, trading markets. See Proposed Rule 17Ad-22(e)(20), Standards
for Covered Clearing Agencies, Proposed Rule, Securities Exchange
Act Release No. 71699 (March 12, 2014), 79 FR 29507 (May 22, 2014).
\39\ OCC also notes that many of the Risk Controls require
regulatory approval prior to implementation on the Options
Exchanges. As such, OCC does not believe that any of the Risk
Controls will be in conflict with any other rules of the exchanges.
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(B) Clearing Agency's Statement on Burden on Competition
OCC believes the proposed rule change may impose a burden on
competition amongst Options Exchanges, as Options Exchanges that do not
implement sufficient Risk Control Standards to meet the Risk Control
Standards will have the Fee added to the cost of transacting on such
Options Exchange. OCC believes that the burden on competition is
necessary and appropriate in furtherance of the Act because, as
discussed above, imposition of the Fee would provide OCC with a means
to accrue funds to help cover additional risk that OCC has no other
means to predict, measure, or consider, and as a result presents
otherwise uncovered risk to OCC's Clearing Members and the financial
markets OCC serves and, if left unchecked, could threaten the stability
of the financial system of the United States. The additional risk to
OCC, its Clearing Members, and the financial markets it serves that
results from the increased likelihood that an erroneous transaction
will cause an OCC Clearing Member to default and cause OCC to cover the
loss in part through mutualized resources available in its Clearing
Fund must be addressed by OCC in furtherance of Sections 17A(b)(3)(F)
\40\ and 17A(b)(3)(D) \41\ of the Act and Rule 17Ad-22(d)(7)
thereunder,\42\ as described above.
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\40\ 15 U.S.C. 78q-1(b)(3)(F).
\41\ 15 U.S.C. 78q-1(b)(3)(D).
\42\ 17 CFR 240.17Ad-22(d)(7).
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While the proposed Fee would be charged to Clearing Members that
execute on Options Exchanges that do not implement sufficient Risk
Controls to meet the Risk Control Standards, OCC does not believe that
this charge results in a burden on competition between Clearing
Members. OCC believes that differential fees are not, in and of
themselves, burdens on competition amongst industry participants that
pay those fees; in fact, OCC's current fee structure applies
differential fees for Clearing Members based on the number of contracts
within a trade. Furthermore, while the Fee is important for OCC to
properly manage risks attendant with the provision of clearing services
in a market that does not have Risk Control Standards, it represents an
incremental increase--less than half but more than a third of a premium
over the base rate of five cents per contract of what is an
infinitesimal component--approximately two percent--of the total
execution costs for an options contract.
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments on the proposed rule change were not and are not
intended to be solicited with respect to
[[Page 14927]]
the proposed rule change and none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self- regulatory organization consents, the Commission will:
(A) By order approve or disapprove the proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-OCC-2016-004 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-OCC-2016-004. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of such filings also will be available
for inspection and copying at the principal office of OCC and on OCC's
Web site at http://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_16_004.pdf.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly.
All submissions should refer to File Number SR-OCC-2016-004 and
should be submitted on orbefore April 8, 2016.
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\43\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\43\
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-06098 Filed 3-17-16; 8:45 am]
BILLING CODE 8011-01-P