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[Federal Register Volume 90, Number 13 (Wednesday, January 22, 2025)]
[Notices]
[Pages 7720-7722]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2025-01414]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-102203; File Nos. SR-OCC-2024-016]

Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of Proposed Rule Change by The Options Clearing 
Corporation Concerning Enhancements to the System for Theoretical 
Analysis and Numerical Simulations (``STANS'') and OCC's Comprehensive 
Stress Testing (``CST'') Methodology, To Better Capture the Risks 
Associated With Short-Dated Options

January 15, 2025.

I. Introduction

    On November 22, 2024, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2024-016, pursuant to Section 19(b) of the 
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
\2\ thereunder, to (i) align assumptions across models and (ii) 
generate implied volatility shocks for options with a tenor of less 
than one month that are consistent with observed market dynamics.\3\ 
The proposed rule change was published for public comment in the 
Federal Register on December 6, 2024.\4\ The Commission has received no 
comments regarding the proposed rule change. For the reasons discussed 
below, the Commission is approving the proposed rule change 
(hereinafter defined as ``Proposed Rule Change'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Notice of Filing infra note 4, at 89 FR 97131.
    \4\ See Securities Exchange Act Release No. 101780 (Dec. 2, 
2024), 89 FR 97131 (Dec. 6, 2024) (File No. SR-OCC-2024-016) 
(``Notice of Filing'').
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II. Background

    OCC is a central counterparty (``CCP''), which means that as part 
of its function as a clearing agency, it interposes itself as the buyer 
to every seller and the seller to every buyer for financial 
transactions. As the CCP for the listed options markets and for certain 
futures in the United States, OCC is exposed to the risk that one or 
more of its Clearing Members may fail to make a payment or to deliver 
securities. OCC addresses such risk exposure, in part, by requiring its 
members to provide collateral, including both margin collateral and 
Clearing Fund collateral. Margin is the collateral that CCPs collect to 
cover potential changes in a member's positions over a set period of 
time during normal market conditions. OCC's Clearing Fund is a 
mutualized pool of financial resources to which each Clearing Member is 
required to contribute to ensure that OCC maintains sufficient 
qualifying liquid resources to manage its liquidity risk, and to 
address the tail risk that the margin collateral OCC collects from each 
Clearing Member might be insufficient to cover OCC's credit exposure to 
a defaulting member in extreme but plausible market conditions.
    OCC's methodology for calculating margin collateral requirements is 
called the System for Theoretical Analysis and Numerical Simulations 
(``STANS'').\5\ OCC's methodology for sizing and monitoring its 
Clearing Fund is called the Comprehensive Stress Testing (``CST'') 
methodology. OCC relies on STANS and the CST methodology to set 
collateral requirements to cover the financial risk posed by the 
positions OCC clears for its members. OCC states that the proportion of 
such positions that comprise short-dated options (``SDOs'') \6\ has 
increased over the past several years.\7\ In response to this 
observation, OCC examined the risks posed by the increase in SDO 
trading and identified opportunities to improve the performance of the 
models comprising STANS and the CST methodology in covering the 
financial risk posed by the increase in SDO trading observed by OCC.\8\ 
As described below, OCC proposes two changes to the models comprising 
STANS and the CST methodology: one set of changes related to the day 
count conventions \9\ and one set of changes related to the application 
of volatility shocks to theoretical option prices.\10\
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    \5\ Capitalized terms used but not defined herein have the 
meanings specified in OCC's Rules and By-Laws, available at https://www.theocc.com/about/publications/bylaws.jsp.
    \6\ SDOs are option contracts with a maturity of less than or 
equal to one month to expiration. See Notice of Filing, 89 FR at 
97132.
    \7\ See Notice of Filing, 89 FR 97132 (citing Cboe, The Rise of 
SPX & 0DTE Options (July 27, 2023), available at https://go.cboe.com/l/77532/2023-07-27/ffc83k).
    \8\ See Notice of Filing, 89 FR 97132 (stating that 
``opportunities exist to improve model performance for Clearing 
Member portfolios dominated by SDOs'').
    \9\ OCC uses the term ``day count convention'' to refer to a 
standardized methodology for calculating the number of days between 
two dates. See Notice of Filing, 89 FR 97132, note 13. Both calendar 
and business day conventions are used by OCC in STANS and CST 
calculations. Id.
    \10\ The implied volatility of an option is a measure of the 
expected future volatility of the option's underlying security at 
expiration, which is reflected in the current option premium in the 
market. See Notice of Filing, 89 FR 97132, note 12.

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[[Page 7721]]

    Day count conventions. The models supporting STANS and CST rely on 
two different day count conventions. Specifically, OCC's option price 
smoothing process uses calendar day convention, and OCC's implied 
volatility simulation uses trading day convention. OCC asserts that the 
usage of two different day count conventions results in differences in 
implied volatility, especially when non-trading days make up a large 
portion of the time-to-expiration (e.g., on Fridays for options that 
expire the following Monday),\11\ which is more pronounced in SDOs.\12\
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    \11\ See Notice of Filing, 89 FR 97132.
    \12\ OCC states that SDOs are more sensitive to day-count 
convention alignment than contracts with longer expirations due to 
the proportionally larger difference in time to expiry between the 
trading day convention and calendar day convention for shorter dated 
tenors. See Notice of Filing, 89 FR 97133.
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    OCC proposes to address the misalignment of day count conventions 
used in the models underlying both STANS and the CST methodology by 
processing data through a series of conversions to ensure that the data 
presented to the price smoothing and volatility simulation models is 
consistent with the assumptions of those models. Specifically, OCC 
would convert implied volatility data into a trading day convention 
before feeding that data into OCC's implied volatility simulation 
models. OCC would then convert the output of its implied volatility 
simulation models back into a calendar day convention before feeding 
those results into OCC's price smoothing process.
    Volatility shocks. OCC's model for simulating theoretical prices 
assumes that the implied volatility shocks of the one-month tenor 
(``1M'') are sufficient to cover the implied volatility changes for SDO 
tenors.\13\ As constructed, the models underlying both STANS and the 
CST methodology impose the same volatility shocks applied to 1M options 
to all options with tenors of less than one month. However, changes in 
implied volatility for SDOs can be much larger than the changes 
observed in 1M options.\14\
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    \13\ The ``tenor'' of an option is the amount of time remaining 
until its expiration or maturity. See Notice of Filing, 89 FR 97132, 
note 14.
    \14\ OCC has observed that the day-over-day at the money implied 
volatility changes for the options with a one-week tenor are 
approximately twice that of the 1M tenor on certain risk factors 
such as SPX, RUT, QQQ, AAPL, and TSLA. See Notice of Filing, 89 FR 
97132, note 15.
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    OCC proposes to estimate implied volatility shocks specific to 
options with a shorter tenor than 1M options rather than imposing the 
same shock on all options with one month or less to maturity. Within 
STANS, OCC proposes to derive the shocks for SDOs from the shock 
applied to 1M options. Specifically, OCC would derive the shocks for 
such options through the application of a square-root decay to the 1M 
option volality.\15\ Within the CST methodology, OCC proposes to extend 
its existing processes for establishing implied volatility shocks to 
specific maturities that are less than one month (i.e., two weeks, one 
week) and to rely on linear interpolation to establish shocks for even 
shorter maturities (i.e., down to three days).
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    \15\ See Notice of Filing, 89 FR 97135.
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    OCC summarized the potential impacts of the proposed changes to 
both margin and Clearing Fund requirements based on data from July 2023 
to September 2024.\16\ For margin, OCC observed that the proposed 
changes would have caused an increase in average daily margin 
requirements of 0.58 percent with the daily impacts ranging from a 0.81 
percent decrease to a 3.21 percent increase.\17\ For the Clearing Fund, 
OCC observed that the proposed changes would have caused the total 
Clearing Fund to decrease by 0.14 percent.\18\
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    \16\ See Notice of Filing, 89 FR 97136.
    \17\ Id.
    \18\ Id.
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Exchange 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 Exchange Act and the rules and regulations 
thereunder applicable to such organization.\19\ Under the Commission's 
Rules of Practice, the ``burden to demonstrate that a proposed rule 
change is consistent with the Exchange Act and the rules and 
regulations issued thereunder . . . is on the self-regulatory 
organization [`SRO'] that proposed the rule change.'' \20\
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    \19\ 15 U.S.C. 78s(b)(2)(C).
    \20\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR 
201.700(b)(3).
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    The description of a proposed rule change, its purpose and 
operation, its effect, and a legal analysis of its consistency with 
applicable requirements must all be sufficiently detailed and specific 
to support an affirmative Commission finding,\21\ and any failure of an 
SRO to provide this information may result in the Commission not having 
a sufficient basis to make an affirmative finding that a proposed rule 
change is consistent with the Exchange Act and the applicable rules and 
regulations.\22\ Moreover, ``unquestioning reliance'' on an SRO's 
representations in a proposed rule change is not sufficient to justify 
Commission approval of a proposed rule change.\23\
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    \21\ Id.
    \22\ Id.
    \23\ Susquehanna Int'l Group, LLP v. Securities and Exchange 
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017).
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    After carefully considering the Proposed Rule Change, the 
Commission finds that the Proposed Rule Change is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to OCC. More specifically, the Commission finds 
that the Proposed Rule Change is consistent with Exchange Act Rules 
17Ad-22(e)(4) \24\ and 17Ad-22(e)(6),\25\ and with Section 17A(b)(3)(F) 
of the Exchange Act,\26\ as described in detail below.
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    \24\ 17 CFR 240.17Ad-22(e)(4).
    \25\ 17 CFR 240.17Ad-22(e)(6).
    \26\ 15 U.S.C. 78q-1(b)(3)(F).
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A. Consistency With Rules 17Ad-22(e)(4) and (6) Under the Exchange Act

    Rule 17Ad-22(e)(4) under the Exchange Act requires that a covered 
clearing agency establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to effectively identify, 
measure, monitor, and manage its credit risk exposures to participants 
and those arising from payment clearing, and settlement processes by, 
in part, testing the sufficiency of its financial resources available 
to meet the minimum standards under Rules 17Ad-22(e)(4)(i) through 
(iii), as applicable.\27\ Rule 17Ad-22(e)(6) under the Exchange Act 
requires that a covered clearing agency establish, implement, maintain, 
and enforce written policies and procedures reasonably designed to 
cover, if the covered clearing agency provides central counterparty 
services, its credit exposures to its participants by establishing a 
risk-based margin system that, among other things, considers, and 
produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market.\28\ Based 
on the review of the record, and for the reasons described below, OCC's 
proposed update to STANS and the CST methodology in the manner 
described above is consistent with Rules 17Ad-22(e)(4) and (6).
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    \27\ 17 CFR 240.17Ad-22(e)(4)(vi).
    \28\ 17 CFR 240.17Ad-22(e)(6)(i).
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    As described above, OCC proposes changes to both its margin 
methodology (STANS) and stress testing (CST) methodology. The proposed 
changes

[[Page 7722]]

would resolve inconsistent model assumptions by aligning the day count 
convention across models. The proposed changes would also provide for 
implied volatility shocks to options with tenors of less than one month 
that are consistent with historical evidence, rather than simply 
applying the shocks generated for 1M options. Each of the proposed 
changes is designed to more accurately reflect the particular 
attributes of the options OCC clears. In the context of STANS, 
therefore, the proposed changes would support the production of 
margining requirements consistent with such attributes. In the context 
of OCC's CST methodology, the changes would provide a more accurate 
basis on which to test the sufficiency of OCC's financial resources.
    Accordingly, the Proposed Rule Change is consistent with Rules 
17Ad-22(e)(4) and (6) under the Exchange Act.\29\
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    \29\ 17 CFR 240.17Ad-22(e)(4) and 17 CFR 240.17Ad-22(e)(6).
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B. Consistency With Section 17A(b)(3)(F) of the Exchange Act

    Section 17A(b)(3)(F) of the Exchange Act requires, among other 
things, that the rules of a clearing agency be designed 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.\30\ As 
discussed above, the proposed changes would improve the performance of 
the models comprising STANS and the CST methodology by, among other 
things, supporting the production of margining requirements consistent 
with the particular attributes of the products that OCC clears and 
providing a more accurate basis on which to test the sufficiency of 
OCC's financial resources. These changes will, in turn, help ensure 
that OCC collects appropriate Clearing Fund collateral and reduce the 
likelihood that OCC would need to utilitze Clearing Fund collateral of 
non-defaulting clearing members in the event of a default. For these 
reasons, OCC's proposed update to its Margin Policy in the manner 
described above is consistent with the safeguarding of securities and 
funds which are in OCC's custody or control or for which it is 
responsible. Accordingly, the Proposed Rule Change is consistent with 
the requirements of Section 17A(b)(3)(F) of the Exchange Act.\31\
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    \30\ 15 U.S.C. 78q-1(b)(3)(F).
    \31\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the 
Exchange Act, and in particular, the requirements of Section 17A of the 
Exchange Act \32\ and the rules and regulations thereunder.
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    \32\ In approving the Proposed Rule Change, the Commission has 
considered the proposed rules' 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 
Exchange Act,\33\ that the Proposed Rule Change (SR-OCC-2024-016) be, 
and hereby is, approved.
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    \33\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2025-01414 Filed 1-21-25; 8:45 am]
BILLING CODE 8011-01-P
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