[Federal Register Volume 83, Number 43 (Monday, March 5, 2018)]
[Notices]
[Pages 9345-9347]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-04338]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-82785; File No. SR-OCC-2017-011]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving Proposed Rule Change Related to The Options Clearing
Corporation's Model Risk Management Policy
February 27, 2018.
I. Introduction
On December 28, 2017, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities and Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change (SR-
OCC-2017-011) to formalize and update OCC's Model Risk Management
Policy (``MRM Policy''). The proposed rule change was published for
comment in the Federal Register on January 16, 2018.\3\ The Commission
did not receive any comments regarding the proposed rule change. For
the reasons discussed below, the Commission is approving the proposed
rule change.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 82473 (Jan. 9, 2018), 83
FR 2271 (Jan. 16, 2018) (SR-OCC-2017-011) (``Notice'').
---------------------------------------------------------------------------
II. Description of the Proposed Rule Change \4\
---------------------------------------------------------------------------
\4\ All terms with initial capitalization that are not otherwise
defined herein have the same meaning as set forth in the OCC By-Laws
and Rules.
---------------------------------------------------------------------------
OCC uses quantitative methods to make estimates, forecasts, and
projections.\5\ Specifically, OCC employs such methods in the context
of its credit risk models, margin system and related models, and
liquidity risk models.\6\ OCC refers to the use of such quantitative
methods in this context as Risk Models.\7\ OCC's use of models
inherently exposes OCC to model risk.\8\ Such risk includes the
consequences of decisions based on incorrect or misused model
outputs.\9\ The proposed MRM Policy will apply to all Risk Models that
OCC uses to determine, quantify, or measure actual or potential risk
exposures or risk mitigating actions.\10\
---------------------------------------------------------------------------
\5\ Notice, 83 FR at 2271, n. 6.
\6\ Id.
\7\ Id.
\8\ Notice, 83 FR at 2271.
\9\ Notice, 83 FR at 2271, n. 5.
\10\ Notice, 83 FR at 2271.
---------------------------------------------------------------------------
The MRM Policy details the general framework for OCC's model risk
management practices, including describing and outlining the roles and
responsibilities of OCC's Quantitative Risk Management department
(``QRM''), Model Validation Group (``MVG''), and Model Risk Working
Group (``MRWG'').\11\ The MRM Policy also addresses the roles of OCC's
Legal department, Management Committee (``MC'') and Board Risk
Committee (``RC'') in the review and approval of OCC's Risk Models.\12\
The proposed rule change would formalize and update OCC's MRM Policy.
---------------------------------------------------------------------------
\11\ Id.
\12\ Notice, 83 FR at 2272.
---------------------------------------------------------------------------
Under the MRM Policy, QRM will be responsible for developing,
implementing, and monitoring OCC's Risk Models.\13\ Regarding model
development, QRM will maintain documentation of the design, theory, and
logic of each Risk Model, including a description of the model, its
intended purpose, assumptions, supporting data, limitations, and other
details.\14\ As part of model implementation, QRM will review,
evaluate, and propose model changes, including model decommissioning,
make recommendations to the MRWG for approval of changes, and seek
review by the Legal department regarding the regulatory filing
requirements related to
[[Page 9346]]
proposed model changes.\15\ The MC will review, and as appropriate,
recommend model change proposals to the RC for review and, if
appropriate, to OCC's Board for final approval.\16\ Finally, QRM will
monitor the use and performance of Risk Models, and will report its
findings to the MRWG for potential escalation to the MC or RC as
necessary.\17\
---------------------------------------------------------------------------
\13\ Notice, 83 FR at 2272-73.
\14\ Notice, 83 FR at 2272.
\15\ Id.
\16\ Notice, 83 FR at 2273.
\17\ Id.
---------------------------------------------------------------------------
Under the MRM Policy, MVG will be responsible for maintaining an
inventory of OCC's Risk Models, and validating such models no less than
annually.\18\ Each model validation must include a review of the
model's performance, parameters, and assumptions.\19\ Such validations
must be independent, which is defined by the MRM Policy as an
evaluation performed by a qualified person who is free from influence
from the persons responsible for the development or operation of the
models being validated.\20\ Under the proposed MRM Policy, the MRWG is
responsible for assisting the MC to oversee and govern OCC's model-
related risk issues.\21\ Specifically, the MRM Policy requires MRWG to
provide, among other things, adequate support and legal expertise as it
relates to model risk.\22\
---------------------------------------------------------------------------
\18\ Id.
\19\ Id.
\20\ Notice, 83 FR at 2273, n. 15.
\21\ Notice, 83 FR at 2273.
\22\ Id.
---------------------------------------------------------------------------
Additionally, the MRM Policy provides arrangements governing
updates and exceptions to, as well as violations of, the MRM
Policy.\23\ Specifically, updates to the MRM Policy may be approved by
the RC upon recommendation from the MC. Exceptions to the MRM Policy
require written approval from OCC's Office of the Executive
Chairman.\24\ Finally, all violations of the MRM Policy must be
reported to OCC's Chief Compliance Officer.\25\
---------------------------------------------------------------------------
\23\ Notice, 83 FR at 2273-74.
\24\ Notice, 83 FR at 2274.
\25\ Id. Violations involving the Chief Compliance Officer must
be reported to the head of Internal Audit or a member of the Office
of the Executive Chairman.
---------------------------------------------------------------------------
III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act directs the Commission to approve a
proposed rule change of a self-regulatory organization if it finds that
such proposed rule change is consistent with the requirements of the
Act and the rules and regulations thereunder applicable to such
organization.\26\ After carefully considering the proposed rule change,
the Commission finds the proposal is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to OCC.
More specifically, the Commission finds that the proposal is consistent
with Section 17A(b)(3)(F) of the Act \27\ and Rules 17Ad-22(e)(2) \28\
17Ad-22(e)(4)(vii),\29\ 17Ad-22(e)(6)(vii),\30\ and 17Ad-22(e)(7)(vii)
\31\ thereunder.
---------------------------------------------------------------------------
\26\ 15 U.S.C. 78s(b)(2)(C).
\27\ 15 U.S.C. 78q-1(b)(3)(F).
\28\ 17 CFR 240.17Ad-22(e)(2).
\29\ 17 CFR 240.17Ad-22(e)(4)(vii).
\30\ 17 CFR 240.17Ad-22(e)(6)(vii).
\31\ 17 CFR 240.17Ad-22(e)(7)(vii).
---------------------------------------------------------------------------
A. Consistency With Section 17A(b)(3)(F) of the Act
Section 17A(b)(3)(F) of the Act requires that the rules of a
registered clearing agency be designed to, among other things, assure
the safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible.\32\
---------------------------------------------------------------------------
\32\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
As described above, the MRM Policy is designed to reduce the model
risk inherent in OCC's use of credit risk models, margin models, and
liquidity risk models. Such model risk includes the consequences of
decisions based on incorrect or misused model outputs. The Commission
believes that decisions based on incorrect or misused model outputs
could lead OCC to suffer credit losses or liquidity shortfalls arising
out of the default of a clearing member, and that such losses or
shortfalls could negatively affect the securities and funds that have
been posted by non-defaulting clearing members and are within OCC's
custody or control. For example, if an OCC risk model were to
underestimate the risks posed by a clearing member's positions, the
default of such a clearing member could cause OCC to face losses in
excess of the collateral collected from the defaulting clearing member.
Where OCC faces losses in excess of a defaulter's collateral, it may be
forced to cover such losses with the securities and funds posted as
collateral by non-defaulting clearing members.
The Commission believes that measures that reduce model risk may
allow OCC to better manage its credit and liquidity risk exposures by
more accurately estimating the collateral OCC must collect from its
clearing members to cover those risks. Such increased accuracy may, in
turn, help OCC avoid credit losses or liquidity shortfalls in excess of
collateral posted by a clearing member in the event of a default, and,
thus, avoid the need to use non-defaulting clearing members' collateral
to cover such losses or shortfalls. Therefore, because the
formalization of the MRM Policy would incorporate into OCC's rules
measures intended to reduce the likelihood that OCC would have to use
non-defaulting clearing members' collateral to manage a clearing member
default, the Commission finds that proposal is consistent with Section
17A(b)(3)(F) of the Act.\33\
---------------------------------------------------------------------------
\33\ Id.
---------------------------------------------------------------------------
B. Consistency With Rule 17Ad-22(e)(2)
Rule 17Ad-22(e)(2) under the Act requires, among other things, that
a covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to provide for
governance arrangements that are clear and transparent and specify
clear and direct lines of responsibility.\34\
---------------------------------------------------------------------------
\34\ 17 CFR 240.17Ad-22(e)(2)(i) and (v).
---------------------------------------------------------------------------
As described above, the MRM Policy provides for arrangements
governing updates and exceptions to, as well as violations of, the MRM
Policy. Such arrangements provide clarity to OCC staff regarding the
operation of the MRM Policy generally, and provide for unforeseen
circumstances requiring changes to OCC's practices. Because
formalization of the MRM Policy would incorporate into OCC's rules a
policy intended to provide such clarity, the Commission finds that the
proposal is consistent with Rule 17Ad-22(e)(2)(i).\35\
---------------------------------------------------------------------------
\35\ 17 CFR 240.17Ad-22(e)(2)(i).
---------------------------------------------------------------------------
As described above, the MRM Policy outlines the roles and
responsibilities of departments, a working group, and management and
board committees within the framework of OCC's model risk management
practices. The MRM Policy states that the Board has final authority to
approve changes to OCC's Risk Models. The MRM Policy also describes the
escalation path for issues arising out of routine performance
monitoring. The Commission believes that this aspect of the MRM Policy,
which defines approval authority and escalation processes within OCC's
governance structure, supports the specification of clear and direct
lines of responsibility, and, therefore, is consistent with Rule 17Ad-
22(e)(2)(v).\36\
---------------------------------------------------------------------------
\36\ 17 CFR 240.17Ad-22(e)(2)(v).
---------------------------------------------------------------------------
C. Consistency With Rules 17Ad-22(e)(4)(vii), (e)(6)(vii) and 17Ad-
22(e)(7)(vii)
Rules 17Ad-22(e)(4)(vii), (e)(6)(vii) and (e)(7)(vii) under the Act
require a covered clearing agency to establish, implement, maintain,
and enforce written policies and procedures
[[Page 9347]]
reasonably designed to, among other things, require the performance of
a model validation for its credit risk models, margin system and
related models, and liquidity risk models not less than annually, or
more frequently as may be contemplated by the covered clearing agency's
risk management framework established pursuant to Rule 17Ad-22(e)(3)
under the Act.\37\
---------------------------------------------------------------------------
\37\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii) and (e)(7)(vii).
The requirements of Rule 17Ad-22(e)(4) pertain to the effective
identification, measurement, monitoring, and management of credit
exposures. 17 CFR 240.17Ad-22(e)(4). The requirements of Rule 17Ad-
22(e)(6), which apply to a covered clearing agency that performs
central counterparty services, pertain to the covering of a covered
clearing agency's credit exposures to its participants. 17 CFR
240.17Ad-22(e)(6). The requirements of Rule 17Ad-22(e)(7) pertain to
the effective measurement, monitoring, and management of liquidity
risk. 17 CFR 240.17Ad-22(e)(7).
Rule 17Ad-22 defines model validation to mean an evaluation of
the performance of each material risk management model used by a
covered clearing agency (and the related parameters and assumptions
associated with such models), including initial margin models,
liquidity risk models, and models used to generate clearing or
guaranty fund requirements, performed by a qualified person who is
free from influence from the persons responsible for the development
or operation of the models or policies being validated. 17 CFR
240.17Ad-22(a)(9).
---------------------------------------------------------------------------
As described above, the MRM Policy provides for the annual
validation of OCC's Risk Models, which include credit risk, margin, and
liquidity risk models. Under the MRM Policy, a model validation must
include a review of the model's performance, parameters, and
assumptions. Further, the MRM Policy clarifies that each model
validation must be performed by a qualified person who is free from
influence from the persons responsible for the development or operation
of the models being validated. Therefore, because the Commission
believes that the MRM Policy requires the annual validations of the
performance, parameters, and assumptions of OCC's credit risk, margin,
and liquidity risk models, the Commission finds that the proposed rule
change is consistent with Rules 17Ad-22(e)(4)(vii), (e)(6)(vii), and
(e)(7)(vii).
IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act,
and in particular, with the requirements of Section 17A of the Act \38\
and the rules and regulations thereunder.
---------------------------------------------------------------------------
\38\ 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).
---------------------------------------------------------------------------
It is therefore ordered pursuant to Section 19(b)(2) of the Act
\39\ that the proposed rule change (SR-OCC-2017-011) be, and hereby is,
approved.
---------------------------------------------------------------------------
\39\ 15 U.S.C. 78s(b)(2).
For the Commission by the Division of Trading and Markets,
pursuant to delegated authority.\40\
---------------------------------------------------------------------------
\40\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-04338 Filed 3-2-18; 8:45 am]
BILLING CODE 8011-01-P