Document ID: SEC-2023-0880-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: The Options Clearing Corp.
Posted Date: 2023-08-16T04:00Z

[Federal Register Volume 88, Number 157 (Wednesday, August 16, 2023)]
[Notices]
[Pages 55775-55785]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-17529]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98101; File No. SR-OCC-2022-012]

Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change Concerning Collateral Haircuts and 
Standards for Clearing Banks and Letters of Credit

August 10, 2023.

I. Introduction

    On December 19, 2022, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
Proposed Rule Change SR-OCC-2022-012 (``Proposed Rule Change'') 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to amend OCC's 
rules, policies, and procedures regarding (i) the valuation of 
Government securities and government-sponsored enterprise (``GSE'') 
debt securities deposited as margin or Clearing Fund collateral; (ii) 
minimum standards for OCC's Clearing Bank relationships; and (iii) 
letters of credit as margin collateral.\3\ The Proposed Rule Change was 
published for public comment in the Federal Register on December 23, 
2022.\4\ The Commission received comments regarding the Proposed Rule 
Change.\5\ The

[[Page 55776]]

Commission designated a longer period within which to take action on 
the Proposed Rule Change on February 3, 2023, extending the period to 
March 23, 2023.\6\ The Commission instituted proceedings to determine 
whether to approve or disapprove the Proposed Rule Change on March 21, 
2023.\7\ The Commission designated a longer period for Commission 
action on the proceedings to determine whether to approve or disapprove 
the Proposed Rule Change on June 20, 2023.\8\ 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\ See Notice of Filing infra note 4, 87 FR at 79015.
    \4\ Securities Exchange Act Release No. 96533 (Dec. 19, 2022), 
87 FR 79015 (Dec. 23, 2022) (File No. SR-OCC-2022-012) (``Notice of 
Filing'').
    \5\ Comments on the proposed rule change are available at 
https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm.
    \6\ Securities Exchange Act Release No. 96797 (Feb. 3, 2023), 88 
FR 8505 (Feb. 9, 2023) (File No. SR-OCC-2022-012) (``Extension'').
    \7\ Securities Exchange Act Release No. 97178 (Mar. 21, 2023), 
88 FR 18205 (Mar. 27, 2023) (File No. SR-OCC-2022-012).
    \8\ Securities Exchange Act Release No. 97765 (June 20, 2023), 
88 FR 41441 (June 26, 2023) (File No. SR-OCC-2022-012).
---------------------------------------------------------------------------

II. Background 9
---------------------------------------------------------------------------

    \9\ 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.
---------------------------------------------------------------------------

    OCC is a central counterparty (``CCP''), which means it interposes 
itself as the buyer to every seller and seller to every buyer for 
financial transactions. As the CCP for the listed options markets in 
the U.S.,\10\ as well as for certain futures, OCC is exposed to certain 
risks arising from its relationships with its members as well as the 
banks that support OCC's clearance and settlement services. Such risks 
include credit risk because OCC is obligated to perform on the 
contracts it clears even where one of its members defaults. OCC manages 
credit risk by collecting collateral from members (i.e., margin and 
Clearing Fund resources) sufficient to cover OCC's credit exposure to 
Clearing Members under a wide range of stress scenarios. In doing so, 
OCC requires its Clearing Members to deposit collateral as margin to 
support obligations on short options, futures contracts, and other 
obligations arising within the members' accounts at OCC. OCC also 
requires its members to deposit collateral serving as Clearing Fund 
assets to protect OCC, should the margin of a defaulting member be 
insufficient to address the potential losses from the defaulting 
member's positions. OCC imposes a haircut to collateral to address the 
risk that such collateral may be worth less in the future than at the 
time it was pledged to OCC. With regard to risks posed by the banks 
that support OCC's clearance and settlement services, OCC maintains 
standards for third-party relationships, such as those with banks 
through which OCC conducts settlement (``Clearing Banks''), and banks 
that issue letters of credit that Clearing Members may deposit as 
margin collateral.
---------------------------------------------------------------------------

    \10\ OCC describes itself as ``the sole clearing agency for 
standardized equity options listed on a national securities exchange 
registered with the Commission (`listed options').'' See Notice of 
Filing supra note 4, 87 FR at 79015.
---------------------------------------------------------------------------

    As described in more detail below, OCC proposed to revise its 
rules, including certain policies,\11\ to make the following three 
changes related to the management of collateral haircuts and banking 
relationships:
---------------------------------------------------------------------------

    \11\ These policies include the Collateral Risk Management 
Policy (``CRM Policy''), Margin Policy, and System for Theoretical 
Analysis and Numerical Simulation (``STANS'') Methodology 
Description. Id.
---------------------------------------------------------------------------

    (1) Replace the current processes for applying haircuts to 
Government and GSE debt securities provided as collateral \12\ with a 
new process for applying fixed collateral haircuts that it would set 
and adjust from time to time, based on a process defined in OCC's CRM 
Policy;
---------------------------------------------------------------------------

    \12\ Generally, OCC defines, by rule, specific haircuts for 
Government and GSE debt securities. For margin collateral 
specifically, OCC currently also has authority to value such 
securities using Monte Carlo simulations as part of its STANS margin 
methodology (known as ``Collateral in Margin'' or ``CiM'').
---------------------------------------------------------------------------

    (2) Codify internal standards for Clearing Banks and letter-of-
credit issuers in OCC's Rules to provide transparency on minimum 
standards for banking relationships that are critical to OCC's 
clearance and settlement services; and
    (3) Authorize OCC to set more restrictive concentration limits for 
letters of credit than those limits currently codified in its Rules.
    Based on its impact analysis, OCC does not expect changes in 
collateral haircut valuation processes to have a significant impact on 
Clearing Members.\13\ OCC stated that the fixed haircut schedule under 
the proposed procedures-based approach initially would be the same as 
currently codified in the Rules.\14\ Regarding the additional minimum 
standards for Clearing Banks and letter-of-credit issuers, OCC 
indicated that the institutions currently approved as such already meet 
these proposed standards.\15\
---------------------------------------------------------------------------

    \13\ See Notice of Filing supra note 4, 87 FR at 79015. OCC 
provided its analysis in a confidential Exhibit 3 to File No. SR-
OCC-2022-012.
    \14\ See Notice of Filing supra note 4, 87 FR at 79015.
    \15\ Id.
---------------------------------------------------------------------------

A. Collateral Haircuts for Government Securities and GSE Debt 
Securities

    OCC proposed to eliminate the CiM treatment of Government 
securities and GSE debt securities, as well as to remove the fixed 
collateral haircuts schedule from its rules in favor of adopting rules 
that describe OCC's process for setting and adjusting fixed haircuts 
from time to time. OCC asserted that such a ``procedure-based 
approach'' would allow for more frequent valuation, thus reflecting 
current market conditions, including periods of stress.\16\ Under the 
current structure, OCC accepts Government securities from Clearing 
Members as contributions to the Clearing Fund.\17\ Additionally, OCC 
accepts both Government securities and GSE debt securities as margin 
collateral.\18\ Rule 604(b) specifies haircuts for Government 
securities \19\ and GSE debt securities \20\ that are contributed as 
margin collateral, while Rule 1002(a)(ii) \21\ specifies haircuts for 
Government securities that are contributed to the Clearing Fund.
---------------------------------------------------------------------------

    \16\ See Notice of Filing supra note 4, 87 FR at 79016-18.
    \17\ See OCC Rule 1002(a).
    \18\ See OCC Rule 604(b)(1), (2).
    \19\ ``Government securities shall be valued for margin purposes 
at 99.5% of the current market value for maturities of up to one 
year; 98% of the current market value for maturities in excess of 
one year through five years; 96.5% of the current market value for 
maturities in excess of five years through ten years; and 95% of the 
current market value for maturities in excess of ten years.'' See 
OCC Rule 604(b)(1).
    \20\ ``GSE debt securities shall be valued for margin purposes 
at (1) 99% of the current market value for maturities of up to one 
year; (2) 97% of the current market value for maturities in excess 
of one year through five years; (3) 95% of the current market value 
for maturities in excess of five years through ten years; and (4) 
93% of the current market value for maturities in excess of ten 
years.'' See OCC Rule 604(b)(2).
    \21\ ``For purposes of valuing Government securities for 
calculating contributions to the Clearing Fund, Government 
securities shall be valued at (1) 99.5% of the current market value 
for maturities less than one year; (2) 98% of the current market 
value for maturities between one and five years; (3) 96.5% of the 
current market value for maturities between five and ten years; and 
(4) 95% of the current market value for maturities in excess of ten 
years.'' See OCC Rule 1002(a)(ii).
---------------------------------------------------------------------------

(i) Removal of CiM Treatment
    OCC proposed to remove its authority to value Government securities 
and GSE debt securities using the STANS margin methodology, which 
currently is used to calculate haircuts applicable to margin 
collateral.\22\ As currently written, Interpretation and Policy 
(``I&P'') .06 to Rule 601 and Rule 604(f) grant OCC the authority to 
determine the collateral value of any Government securities or GSE debt 
securities pledged by Clearing Members as margin collateral either by: 
(1) the CiM method of including them in Monte Carlo simulations as part 
of OCC's STANS margin methodology; or

[[Page 55777]]

(2) applying the fixed haircuts that are specified in OCC Rule 604(b). 
OCC stated, however, that regulatory examination findings and OCC's 
model validation analyses have identified certain weaknesses, including 
that OCC may not adequately consider relevant stressed market 
conditions for Government securities and GSE debt securities deposited 
as margin and Clearing Fund collateral.\23\ OCC proposed to resolve 
such shortcomings by deleting I&P .06 to Rule 601 and Rule 604(f), and 
instead subjecting all Government securities and GSE debt securities 
pledged as margin collateral to a fixed haircut schedule set in 
accordance with a revised CRM Policy, discussed in more detail below.
---------------------------------------------------------------------------

    \22\ See Notice of Filing supra note 4, 87 FR at 79016.
    \23\ Id.
---------------------------------------------------------------------------

    OCC asserted that the resulting approach would be less 
procyclical.\24\ Under the proposed change, OCC would value all such 
deposits using a fixed haircut schedule.\25\ OCC stated that this 
change would prevent spikes in margin requirements during periods of 
heightened volatility that can occur under the current CiM 
approach.\26\ As stated in the Notice of Filing, while the proposed 
fixed haircut approach may be more conservative in periods of low 
market volatility, it would prevent spikes in margin requirements 
during periods of heightened volatility that may take place under the 
existing CiM approach.\27\ The proposed changes would result in an 
average impact of less than one percent of the value of Government 
securities and GSE debt securities.\28\ OCC stated that it intends to 
provide parallel reporting to its Clearing Members for a period of at 
least four consecutive weeks prior to implementing the change.\29\
---------------------------------------------------------------------------

    \24\ Id. The Commission has stated that procyclicality typically 
refers to changes in risk-management practices that are positively 
correlated with market, business, or credit cycle fluctuations that 
may cause or exacerbate financial stability. Standards for Covered 
Clearing Agencies, Securities Exchange Act Release No. 78961 (Sept. 
28, 2016), 81 FR 70786, 70816 n. 318 (Oct. 13, 2016). The Commission 
stated further that, while changes in collateral values tend to be 
procyclical, collateral arrangements can increase procyclicality if 
haircut levels fall during periods of low market stress and increase 
during periods of high market stress. Id.
    \25\ Additionally, OCC would shift its categorization of 
Government security and GSE debt security deposits currently valued 
using STANS from margin balances to collateral balances to align its 
reporting with the proposed haircut methodology. Specifically, the 
value of CiM-eligible Government securities and GSE debt securities 
would no longer be included in margin calculations, and thus would 
no longer be included on OCC's margin reports. Following 
implementation of the proposed changes, the value of the previously 
CiM-eligible Government securities and GSE debt securities would be 
found in OCC's collateral reports. See Notice of Filing supra note 
4, 87 FR at 79016 n.10.
    \26\ See Notice of Filing supra note 4, 87 FR at 79016.
    \27\ Id.
    \28\ Id. As noted below, OCC is proposing to replace the fixed 
haircut schedule in its rules that applies to Government securities 
deposited in the Clearing Fund. The change would result in a 
negligible impact to Clearing Fund collateral haircuts. Id. OCC 
provided supporting data as a confidential Exhibit 3 to File No. SR-
OCC-2022-012.
    \29\ See Notice of Filing supra note 4, 87 FR at 79016. See note 
25 supra regarding reporting changes that would be implemented in 
connection with the proposed change. Further, OCC's rules require it 
to provide reporting related to margin and Clearing Fund collateral 
each day. See OCC Rule 605 and OCC Rule 1007.
---------------------------------------------------------------------------

(ii) Removal of the Fixed Haircut Schedule From OCC's Rules
    OCC proposed to eliminate the fixed haircut schedules in its rules 
for Government securities and GSE debt securities used as margin 
collateral and Government securities deposited in the Clearing Fund, 
and instead to adopt new subsections that would grant OCC the authority 
to specify a schedule of haircuts from time to time based on changing 
market conditions. Specifically, OCC's proposal would delete the fixed 
collateral haircut schedule stated in Rule 604(b)(1)-(2) for Government 
securities and GSE debt securities used as margin collateral, and in 
Rule 1002(a)(ii) for Government securities deposited in the Clearing 
Fund.\30\ OCC proposed to adopt a new section (e) under Rule 604 and 
amend language in Rule 1002(a)(ii), to authorize OCC to determine the 
current value of these types of securities, and generally apply a 
schedule of haircuts that is specified from time to time upon prior 
notice to Clearing Members. OCC proposed to describe the new process 
for valuing such securities in its CRM Policy, as described in greater 
detail in Section II.A.iii. below. Additionally, the proposed changes 
to the CRM Policy would require OCC to communicate changes in haircut 
rates to Clearing Members at least one full day in advance, and to 
maintain the haircut schedule on OCC's public website.
---------------------------------------------------------------------------

    \30\ OCC does not accept GSE debt securities as Clearing Fund 
collateral.
---------------------------------------------------------------------------

    As noted above, OCC would publish a haircut schedule from time to 
time on its website, and such schedule would be determined based on the 
proposed methodology in the CRM Policy. The proposed changes to Rule 
604 would also authorize OCC to apply haircuts to Government securities 
and GSE debt securities that are more conservative than those defined 
in such haircut schedule, or, in unusual or unforeseen circumstances, 
to assign partial or no value to such securities. The proposed change 
would authorize OCC to take such action for its protection or the 
protection of Clearing Members or the general public with prior notice 
to Clearing Members.
    OCC also proposed changes to the CRM Policy that would provide 
additional detail regarding the authority to apply more conservative 
haircuts or reduce the value attributed to Government securities and 
GSE debt securities.\31\ Consistent with the proposed addition to Rule 
604, the CRM Policy would require OCC to communicate such actions to 
Clearing Members prior to implementation. Additionally, OCC proposed to 
add language to the CRM Policy to enumerate the factors that OCC would 
consider when determining if such action would be appropriate for its 
protection or the protection of Clearing Members or the general public, 
including (i) volatility and liquidity, (ii) elevated sovereign credit 
risk,\32\ and (iii) any other factors OCC determines are relevant.\33\
---------------------------------------------------------------------------

    \31\ The CRM Policy currently authorizes OCC to take additional 
mitigating actions in the form of reducing the value of such 
securities and review and approval of such actions by OCC's 
Management Committee and/or its delegates.
    \32\ OCC explained that while it already has authority under I&P 
.15 to Rule 604 to make disapprovals of collateral based on similar 
factors, the proposal is intended to enumerate sovereign credit risk 
as a factor in the CRM Policy for haircuts on Government securities. 
See Notice of Filing supra note 4, 87 FR at 79017, n.16.
    \33\ OCC also proposed to include ``any other factors the 
Corporation determines are relevant'' for consistency with I&P .15 
to OCC Rule 604 and because such a catch-all is designed to capture 
unforeseen circumstances that might not previously have been 
considered possible. Id.
---------------------------------------------------------------------------

(iii) A Procedures-Based Approach To Setting Collateral Haircuts
    As described above, OCC proposed to establish a new process for 
applying fixed collateral haircuts for Government securities and GSE 
debt securities that OCC would set and adjust from time to time. OCC 
proposed to define its new process, which it refers to as a 
``procedures-based approach,'' in the CRM Policy. The proposed 
procedures-based approach would replace the processes that OCC proposed 
removing from its rules (i.e., dynamic haircuts calculated by OCC's 
margin methodology and fixed haircuts defined by rule).
    The proposed procedures-based approach would rely on a financial 
model to set and assess the adequacy of collateral haircuts. In 
particular, the proposed amendments to the CRM Policy would provide 
that OCC's Pricing and Margins team within its Financial Risk 
Management (``FRM'') department

[[Page 55778]]

would monitor the adequacy of the haircuts using a Historical Value-at-
Risk approach (``H-VaR'') with multiple look-back periods (e.g., 2-
year, 5-year, and 10-year), updated at least monthly.\34\ Each look-
back period would comprise a synthetic time series of the greatest 
daily negative return observed for each combination of security type 
and maturity bucket (e.g., Government securities maturing in more than 
10 years). The longest look-back period under the proposed H-VaR 
approach would include defined periods of market stress.\35\ The CRM 
Policy would further require OCC to maintain haircuts at a level at 
least equal to a 99 percent confidence interval of the look-back period 
that provides for the most conservative haircuts. Changes to the 
haircut rate would be communicated to Clearing Members at least one 
full day in advance and the schedule would be maintained on OCC's 
public website.
---------------------------------------------------------------------------

    \34\ Upon implementation of the proposed changes, OCC 
anticipates that the collateral haircuts initially would be 
identical to those outlined in Rules 604(b) and 1002(a). See Notice 
of Filing supra note 4, 87 FR at 79017.
    \35\ The delineation of look-back periods, periods of stressed 
market volatility included in the longest-term look-back period, and 
the type and maturity buckets would be defined in procedures 
maintained by OCC's Pricing and Margins business unit.
---------------------------------------------------------------------------

(iv) Increased Frequency of Valuations
    OCC's proposed addition of Rule 604(e) and amendments to Rule 
1002(a)(ii) would resolve an inconsistency between its Rules, which 
require monthly reviews of collateral haircuts in relation to the 
Clearing Fund, and its CRM Policy, which requires daily review of all 
collateral haircuts, including both margin and Clearing Fund 
collateral. Specifically, under the proposal, OCC would determine the 
current market value for Government securities and GSE debt securities 
at such intervals as it may from time to time prescribe, at least 
daily, based on the quoted bid price supplied by a price source 
designated by OCC.\36\ The proposed change also would explicitly remove 
from the Rules the Risk Committee's authority for prescribing the 
interval at which haircuts are set. Rather, the Pricing and Margins 
business unit would continue to hold this authority, consistent with 
the current CRM Policy.
---------------------------------------------------------------------------

    \36\ Additionally, both the current and proposed language in the 
CRM Policy provide leeway for more frequent valuation, when 
warranted, and help to ensure that the designation of minimum 
valuation intervals would not be a limiting factor. See Notice of 
Filing supra note 4, 87 FR at 79017.
---------------------------------------------------------------------------

    Under the current CRM Policy, the Pricing and Margins business unit 
monitors haircuts daily for ``breaches'' (i.e., an erosion in value 
exceeding the relevant haircut) and adequacy, with any issues being 
promptly reported to appropriate decision-makers at OCC.\37\ Changes to 
OCC's Rules and the CRM Policy, including the minimum valuation 
interval, would remain subject to Risk Committee approval and the Risk 
Committee would retain oversight over OCC's risk management 
determinations.
---------------------------------------------------------------------------

    \37\ OCC believed that Pricing and Margins, as the business unit 
responsible for such monitoring, is well positioned to make the 
determination about more frequent valuation intervals consistent 
with the directive of the CRM Policy approved by the Risk Committee. 
See Notice of Filing supra note 4, 87 FR at 79018.
---------------------------------------------------------------------------

(v) Conforming Changes to OCC's Policies
    Based on the proposed changes to its Rules and policies, OCC also 
proposed conforming changes to its CRM Policy, Margin Policy, and STANS 
Methodology Description by:
     Establishing the CRM Policy as the relevant OCC policy 
governing OCC's process for valuing Government securities and GSE debt 
securities;
     Deleting descriptions that indicate that Government 
securities and GSE debt securities pledged as margin collateral may be 
valued using Monte Carlo simulations as part of OCC's STANS margin 
methodology; \38\
---------------------------------------------------------------------------

    \38\ The Margin Policy currently states that Government 
securities may be valued using the CiM approach. OCC did not propose 
to change the description of CiM generally, but rather would 
maintain it other than the removal of references suggesting that it 
applies to Government securities and GSE debt securities pledged as 
margin. See Notice of Filing supra note 4, 87 FR at 79018.
---------------------------------------------------------------------------

     Conforming capitalization of terms in the CRM Policy with 
OCC's By-Laws;
     Deleting certain portions of the STANS Methodology 
Description that exist to support the valuation of Government 
securities and GSE debt securities using Monte Carlo simulations;
     Removing Treasuries (i.e., Government securities) from 
OCC's model for generating yield curve distributions to form 
theoretical price distributions for U.S. Government securities and for 
modeling Treasury rates within STANS joint distribution of risk 
factors; \39\
---------------------------------------------------------------------------

    \39\ As described above, OCC would value such securities as 
described in the CRM Policy rather than pursuant to STANS.
---------------------------------------------------------------------------

     Revising the STANS Methodology Description to reflect the 
fact that the Liquidation Cost Add-on charge would no longer be 
assessed to Government security collateral deposits,\40\ while 
incorporating stressed market periods in the H-VaR approach for setting 
and adjusting the haircuts for collateral in the form of Government 
securities and GSE debt securities used in margin accounts and 
Government securities in the Clearing Fund, which is comparable to the 
approach for incorporating stressed markets into the Liquidation Cost 
Add-on.
---------------------------------------------------------------------------

    \40\ The Liquidation Cost charge is a margin add-on charge that 
is designed to estimate the cost to liquidate a portfolio based on 
the mid-points of the bid-ask spreads for the financial instruments 
within the portfolio, and would scale up such liquidation costs for 
large or concentrated positions that would likely be more expensive 
to close out. See Securities Exchange Act Release No. 86119 (June 
17, 2019), 84 FR 29267, 29268 (June 21, 2019) (File No. SR-OCC-2019-
004). The Liquidation Cost charge considers the cost of liquidating 
an underlying security, such as a Government security, during a 
period of market stress. Id. As described above, OCC now proposes to 
include defined periods of market stress in its collateral haircuts 
methodology under the CRM Policy. OCC indicated that the Liquidation 
Cost charge for such collateral is currently, and is expected to 
remain, immaterial, based on its analysis of the average daily 
Liquidation Cost charge across all accounts. See Notice of Filing 
supra note 4, 87 FR at 79018.
---------------------------------------------------------------------------

B. Minimum Standards for Clearing Banks and Letter-of-Credit Issuers

    OCC's proposal would update and codify existing internal minimum 
standards that OCC uses to establish relationships with Clearing Banks 
and letter-of-credit issuers. The core of these proposed minimum 
standards would be the same for both Clearing Banks and letter-of-
credit issuers, including requirements for, at a minimum, $500 million 
in Tier 1 Capital; \41\ maintaining certain Tier 1 Capital Ratios; and 
providing that non-U.S. entities must be domiciled in a country that 
has a sovereign rating considered to be ``low credit risk.'' OCC would 
reserve the right to set other such standards from time to time. OCC 
stated that these proposed changes would provide transparency on 
minimum standards for banking relationships that are critical to its 
clearance and settlement services. Details of proposed amendments to 
Rule 203 for Clearing Banks and the Interpretations and Policies for 
Rule 604 relating to letter-of-credit issuers are described below.
---------------------------------------------------------------------------

    \41\ Tier 1 Capital is the required regulatory capital that is 
permanently held by banks to absorb unexpected losses. See 
generally, Bank for International Settlements, Financial Stability 
Institute, ``Definition of capital in Basel III--Executive Summary'' 
(June 27, 2019), available at https://www.bis.org/fsi/fsisummaries/
defcap_b3.htm#:~:text=Regulatory%20capital%20under%20Basel%20III,the%
20components%20of%20regulatory%20capital; and The Federal Deposit 
Insurance Corporation (FDIC), ``Risk Management Manual of 
Examination Policies,'' Section 2.1 (Capital), available at https://www.fdic.gov/regulations/safety/manual/section2-1.pdf. Tier 1 
Capital includes common equity Tier 1 Capital, such as certain bank-
issued common stock instruments, and additional Tier 1 Capital. See 
12 CFR 217.20.

---------------------------------------------------------------------------

[[Page 55779]]

(i) Clearing Banks
    OCC indicated that Clearing Banks play a critical role in its 
clearance and settlement of options.\42\ As currently written, Rule 203 
requires that every Clearing Member establish and maintain a bank 
account at a Clearing Bank for each account maintained by it with OCC. 
However, the sole eligibility requirement for a Clearing Bank expressly 
delineated in current Rules is that the Clearing Bank be a bank or 
trust company that has entered into an agreement with OCC in respect of 
settlement of confirmed trades on behalf of Clearing Members.\43\ OCC's 
By-Laws and Rules are silent on the internal governance process for 
approving Clearing Bank relationships. Rather, the details as to the 
financial and operational capability requirements and the governance 
process for approving Clearing Banks are housed in OCC's internal 
procedures, which are not publicly available.\44\ OCC proposed to amend 
Rules 101 and 203 to clarify the term ``Clearing Bank'' and codify 
minimum capital and operational requirements and the governance process 
for approving its Clearing Banks.\45\ OCC believed that expressly 
listing these requirements in its By-Laws and Rules will provide 
Clearing Members and other market participants greater clarity and 
transparency concerning OCC's Clearing Bank relationships.\46\ 
Specifically, Rule 101 would amend the definition of ``Clearing Bank'' 
to reflect that such Clearing Bank relationships are approved by the 
Risk Committee, while leaving the rest of the definition intact. The 
proposed changes to Rule 203 would codify the following practices for 
Clearing Banks:
---------------------------------------------------------------------------

    \42\ See Notice of Filing supra note 4, 87 FR at 79018.
    \43\ See OCC Rule 101.C(1).
    \44\ These internal procedures include, for example, a Tier 1 
Capital requirement of $100 million for U.S. banks and $200 million 
for non-U.S. banks, and in effect align with standards for Clearing 
Banks codified in I&P .01 to OCC Rule 604 with respect to banks or 
trust companies that OCC may approve to issue letters of credit as 
margin collateral.
    \45\ See Notice of Filing supra note 4, 87 FR at 79018.
    \46\ Id.
---------------------------------------------------------------------------

     Provide in Rule 203(b) that the Risk Committee may approve 
a bank or trust company as a Clearing Bank if it meets the minimum 
requirements;
     Require under Rule 203(b)(1) that any Clearing Bank, 
whether domiciled in the U.S. or outside the U.S., maintain at least 
$500 million (U.S.) in Tier 1 Capital, rather than the existing $100 
million Tier 1 Capital requirement for letter-of-credit issuers 
currently required under I&P .01 to OCC Rule 604;
     Require under Rules 203(b)(2) and (4) that Clearing Banks 
maintain (i) common equity Tier 1 Capital (CET1) \47\ of 4.5%, (ii) 
minimum Tier 1 Capital of 6%, (iii) total risk-based capital of 8%, and 
(iv) a Liquidity Coverage Ratio of at least 100%, unless the Clearing 
Bank is not required to compute the Liquidity Coverage Ratio;
---------------------------------------------------------------------------

    \47\ See Rule 203(c). ``For purposes of this Rule, `Tier 1 
Capital,' `Common Equity Tier 1 Capital (CET1),' `total risk-based 
capital,' and `Liquidity Coverage Ratio' will mean those amounts or 
ratios reported by a bank or trust company to its regulatory 
authority.''
---------------------------------------------------------------------------

     Provide under Rule 203(b)(3) that non-U.S. Clearing Banks 
must be domiciled in a country that has a sovereign rating considered 
to be ``low credit risk'' (i.e., A- by Standard & Poor's, A3 by 
Moody's, A- by Fitch, or equivalent);
     Require under Rule 203(b)(5) that a Clearing Bank must 
execute an agreement with OCC, including that the Clearing Bank: (A) 
maintain the ability to utilize the Society for Worldwide Interbank 
Financial Telecommunication (``SWIFT''), (B) maintain access to the 
Federal Reserve Bank's Fedwire Funds Service, and (C) provide its 
quarterly and annual financial statements to OCC and promptly notify 
OCC of material changes to its operations, financial condition, and 
ownership;
     Allow under Rule 203(b)(5)(A) the use of such other 
messaging protocol, apart from SWIFT, as approved by the Risk 
Committee; \48\ and
---------------------------------------------------------------------------

    \48\ OCC stated that the Risk Committee may elect to temporarily 
accommodate a Clearing Bank that does not meet these requirements if 
it is actively implementing such capabilities. See Notice of Filing 
supra note 4, 87 FR at 79019.
---------------------------------------------------------------------------

     Add catchall language in Rule 203(b)(6) to provide that an 
institution must meet such other standards as OCC may determine from 
time to time.
    Language that forms the basis of Rule 203(b)(1)-(3) was taken, in 
part, from the previously codified standards for letter-of-credit 
issuers found in I&P .01 to Rule 604. OCC proposed to delete this rule 
text relating to letter-of-credit issuers and move the essential 
concepts to Rule 203(b)(1)-(3) concerning Clearing Banks. In doing so, 
OCC also proposed to adjust certain thresholds related to Tier 1 
Capital requirements and sovereign credit ratings. Most notably, the 
proposed change would increase the Tier 1 Capital minimum requirement 
from $100 million for U.S. institutions and $200 million for non-U.S. 
institutions to $500 million for all institutions serving as Clearing 
Banks or letter-of-credit issuers. Additionally, the proposed change 
would lower the sovereign credit risk threshold for institutions 
domiciled outside of the U.S. from countries rated as AAA to countries 
that have a rating considered to be low credit risk (A- by Standard & 
Poor's, A3 by Moody's, A- by Fitch, or equivalent). OCC then proposed 
to incorporate by reference minimum requirements for Clearing Banks in 
I&P .01 to Rule 604, which applies to letter-of-credit issuers, thus 
aligning standards for Clearing Banks and letter-of-credit issuers and 
erasing some distinctions between U.S. and non-U.S. institutions.
    OCC explained that the proposed changes in Rule 203(b) are meant to 
serve as the articulation of minimum standards for establishing 
relationships with Clearing Banks, and that OCC is not obligated to 
enter into any Clearing Bank relationship merely because a bank or 
trust company meets these enumerated standards.\49\ In proposing these 
changes, OCC believed that the Risk Committee is the appropriate 
governing body to approve such relationships because of the nature of 
the risks presented by OCC's Clearing Bank relationships, including the 
risk that OCC would need to borrow from or satisfy a loss using 
Clearing Fund assets in order to meet its liquidity needs as a result 
of the failure of a Clearing Bank to achieve daily settlement.\50\ 
Further, in reviewing its existing Clearing Banks, OCC found that a 
$500 million (U.S.) Tier 1 Capital standard was more representative of 
these institutions.\51\ In expanding the definition of ``low credit 
risk'' under the proposed Rule 203(b)(3), OCC stated that these ratings 
better reflect current understanding of countries considered to be 
``low credit risk,'' and that, for example, it would permit OCC to 
establish relationships with institutions from France with which OCC 
previously had relationships before France's sovereign credit rating 
fell below AAA.\52\
---------------------------------------------------------------------------

    \49\ See Notice of Filing supra note 4, 87 FR at 79019.
    \50\ See Notice of Filing supra note 4, 87 FR at 79018.
    \51\ Id.
    \52\ See Notice of Filing supra note 4, 87 FR at 79018-9.
---------------------------------------------------------------------------

(ii) Letter-of-Credit Issuers
    OCC proposed to revise Rule 604 regarding the acceptability of 
letters of credit as margin collateral. Under the proposal, OCC would 
align the minimum requirements for letter-of-credit issuers with some 
of those for OCC's other banking relationships, including the above-
proposed standards

[[Page 55780]]

for Clearing Banks.\53\ I&P .01 to OCC Rule 604 currently sets forth 
minimum standards for the types of U.S. and non-U.S. institutions that 
OCC may approve as an issuer of letters of credit, including minimum 
Tier 1 Capital requirements, and, for non-U.S. institutions, the 
ultimate sovereign credit rating for the country where the principal 
executive office is located, credit ratings for the institution's 
commercial paper or other short-term obligations, and standards that 
apply if there is no credit rating on the institution's commercial 
paper or other short-term obligations. OCC proposed to amend I&P .01 to 
Rule 604 in the following ways:
---------------------------------------------------------------------------

    \53\ See Notice of Filing supra note 4, 87 FR at 79015.
---------------------------------------------------------------------------

     Combine and restate, without substantive change, the 
description of which institutions OCC may approve as letter-of-credit 
issuers;
     Replace specific capital and sovereign credit rating 
requirements with reference to proposed Rule 203(b)(1)-(3) prescribing 
minimum standards for Clearing Banks; \54\
---------------------------------------------------------------------------

    \54\ OCC stated that in eliminating I&P .01(b)(3) concerning 
credit ratings, OCC would remove the subjective process for 
determining a ``AAA'' equivalent country based on consultation with 
entities experienced in international banking and finance matters 
satisfactory to the Risk Committee, in favor of the more objective 
standards. See Notice of Filing supra note 4, 87 FR at 79019.
---------------------------------------------------------------------------

     Remove external credit rating standards for a non-U.S. 
institution's commercial paper, other short-term obligations or long-
term obligations; \55\ and
---------------------------------------------------------------------------

    \55\ OCC stated that it has had to terminate several letter-of-
credit issuer relationships pursuant to these external credit rating 
standards even though the institutions otherwise met OCC's 
requirements and were not reporting elevated internal credit risk 
metrics. By deleting I&P .01(b)(4), OCC would make its Rules 
consistent with industry best practice, and instead would rely on 
its Watch Level and Internal Credit Rating surveillance processes 
under its Third-Party Risk Management Framework to determine 
creditworthiness of institutions. Id. Proposed I&P .01(c) to OCC's 
Rule 604 would provide OCC authority sufficient to determine 
additional standards for issuers of letters of credit.
---------------------------------------------------------------------------

     Add catchall language to provide that an institution must 
meet such other standards as OCC may determine from time to time.
    Additionally, OCC proposed conforming changes to better align I&P 
.03 and .09 to Rule 604, requiring that all letters of credit must be 
payable at an issuer's domestic branch.\56\ Currently, I&P .03 requires 
any letter of credit issued by a non-U.S. institution be payable at a 
Federal or State branch or agency thereof, while I&P .09 provides that 
a letter of credit may be issued by a Non-U.S. branch of a U.S. 
institution, as long as it otherwise conforms with Rule 604 and the 
Interpretations and Policies thereunder and is payable at a U.S. office 
of such institution. OCC's proposal would eliminate the text of I&P .09 
in its entirety, and instead amend the text of I&P .03 to require 
letters of credit used as margin collateral to be payable at an 
issuer's ``domestic branch,'' \57\ or at the issuer's Federal or State 
branch or agency.\58\ The amended I&P .03 would apply to U.S. and Non-
U.S. institutions alike.
---------------------------------------------------------------------------

    \56\ See Notice of Filing supra note 4, 87 FR at 79020.
    \57\ As that term is defined in the Federal Deposit Insurance 
Act. See 12 U.S.C. 1813(o).
    \58\ As those terms are defined in I&P .01 by reference to the 
International Banking Act of 1978.
---------------------------------------------------------------------------

C. Letter-of-Credit Concentration Limits

    Lastly, the proposal would allow OCC to set more restrictive 
concentration limits for accepting letters of credit, while retaining 
the currently codified concentration limits as thresholds.\59\ As 
currently written, I&P .02 to Rule 604 provides that ``[n]o more than 
50% of a Clearing Member's margin on deposit at any given time may 
include letters of credit in the aggregate, and no more than 20% may 
include letters of credit issued by any one institution.'' In addition, 
I&P .04 to Rule 604 limits the total amount of letters of credit issued 
for the account of any one Clearing Member by a U.S. or non-U.S. 
institution to a maximum of 15% of such institution's Tier 1 Capital. 
OCC proposed to retain these provisions, while simultaneously deleting 
the current text of I&P .09 to Rule 604, as described above, and 
replacing it with language that grants OCC the authority to specify, 
from time to time, more restrictive limits for the amount of letters of 
credit a Clearing Member may deposit in the aggregate or from any one 
institution.\60\ Such determinations would be made based on market 
conditions, the financial condition of approved issuers, and any other 
factors OCC determines are relevant. Any such restrictive limit would 
apply to all Clearing Members.
---------------------------------------------------------------------------

    \59\ See Notice of Filing supra note 4, 87 FR at 79015.
    \60\ Id. at 79020.
---------------------------------------------------------------------------

    Under the proposal, the CRM Policy would explicitly state that the 
responsibility of setting and adjusting more conservative concentration 
limits for letters of credit would lie with the Credit and Liquidity 
Risk Working Group (``CLRWG''), which is a cross-functional group that 
comprises representatives from relevant OCC business units including 
Pricing and Margins, Collateral Services, and Credit Risk Management. 
Similar to determinations surrounding collateral haircuts, the CRM 
Policy would provide that OCC will maintain the concentration limits on 
its website and will provide prior notice of any changes to the limits. 
OCC would retain the current requirements under the CRM Policy and the 
Model Risk Management Policy regarding the CLRWG's, at a minimum, 
annual review of the CRM Policy, including concentration limits, and 
the requirement that any changes to the CRM Policy resulting from the 
review be presented the Management Committee and, if approved, then the 
Risk Committee.
    OCC stated that the anticipated impact of more restrictive 
concentration limits is low, considering that the use of letters of 
credit as margin collateral is currently low.\61\ OCC explained that 
while utilization of letters of credit is low, it plans to continue to 
support letters of credit based on their acceptability as collateral 
under Commodity Futures Trading Commission regulations.\62\
---------------------------------------------------------------------------

    \61\ Id.
    \62\ Id.
---------------------------------------------------------------------------

    The final proposed change would amend I&P .08 to Rule 604, which 
currently provides that OCC will not accept a letter of credit issued 
pursuant to Rule 604(c) for the account of a Clearing Member in which 
the issuing institution, a parent, or an affiliate has an equity 
interest in the amount of 20 percent or more of such Clearing Member's 
total capital. The Proposed Rule Change would eliminate the reference 
to 20 percent, thus resulting in a total prohibition on accepting 
letters of credit for the account of a Clearing Member in which the 
issuing institution, a parent, or an affiliate has any equity interest 
in such Clearing Member's total capital.

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.\63\ After carefully 
considering the Proposed Rule Change and the comment letters received, 
the Commission finds that the proposal is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to OCC. More specifically, the Commission

[[Page 55781]]

finds that the proposal is consistent with Section 17A(b)(3)(F) and (I) 
of the Exchange Act,\64\ and Rule 17Ad-22(e)(5),\65\ Rule 17Ad-
22(e)(9),\66\ Rule 17Ad-22(e)(22),\67\ and Rule 17Ad-22(e)(23) \68\ 
thereunder, as described in detail below.
---------------------------------------------------------------------------

    \63\ 15 U.S.C. 78s(b)(2)(C).
    \64\ 15 U.S.C. 78q-1(b)(3)(F) and 15 U.S.C. 78q-1(b)(3)(I).
    \65\ 17 CFR 240.17Ad-22(e)(5).
    \66\ 17 CFR 240.17Ad-22(e)(9).
    \67\ 17 CFR 240.17Ad-22(e)(22).
    \68\ 17 CFR 240.17Ad-22(e)(23).
---------------------------------------------------------------------------

A. Consistency With Section 17A(b)(3)(F) of the Exchange Act

    Section 17A(b)(3)(F) \69\ of the Exchange Act requires, among other 
things, that the rules of a clearing agency be designed to promote the 
prompt and accurate clearance and settlement of securities transactions 
and derivative agreements, contracts, and 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.
---------------------------------------------------------------------------

    \69\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    Based on its review of the record, and for the reasons described 
below, the Commission believes that the proposed changes to OCC's rules 
and procedures regarding collateral haircuts and concentration limits 
for letters of credit are consistent with promoting the prompt and 
accurate clearance and settlement of securities and derivatives 
transactions. As stated above, OCC is exposed to credit risk stemming 
from its relationships with Clearing Members during the course of 
fulfilling its core clearing services. One of the ways OCC manages this 
credit risk is by collecting high-quality collateral for margin 
accounts and the Clearing Fund, while recognizing that this collateral 
may decrease in value at a future date. The Commission continues to 
believe that a clearing agency generally should reduce the need for 
procyclical adjustments by establishing stable and conservative 
haircuts that are calibrated to include periods of stressed market 
conditions, to the extent practicable and prudent.\70\ Procyclical 
adjustments (i.e., lower haircuts during periods of low stress followed 
by increased haircuts during times of high market stress) could 
exacerbate market stress and contribute to driving down asset prices 
further, resulting in additional collateral requirements.\71\ The 
imposition of more conservative haircuts during normal market 
conditions, therefore, would reduce the amount by which haircuts must 
be adjusted during times of market stress. Based on the data provided 
by OCC, the proposed replacement of OCC's current process for setting 
collateral haircuts with the proposed H-VaR approach would yield more 
conservative haircuts during times of low market stress, which, in 
turn, would help reduce spikes in collateral haircuts during heightened 
market volatility. As noted above, reducing such spikes would reduce 
the potential for driving down asset prices that could result in the 
imposition of additional collateral requirements on market participants 
already faced with increased market stress.
---------------------------------------------------------------------------

    \70\ See Standards for Covered Clearing Agencies supra note 24, 
81 FR at 70816-17.
    \71\ See Committee on Payment and Settlement Systems, Principles 
for Financial Market Infrastructures, section 3.5.6 (Apr. 2012); 
available at https://www.bis.org/publ/cpss101a.pdf.
---------------------------------------------------------------------------

    The proposed approach also would attempt to address the weaknesses 
identified in the CiM model in response to regulatory and internal 
examinations by, for example, incorporating periods of market stress 
into the look-back period for the model under the proposed H-VaR 
approach. Further, the proposed changes would add flexibility for OCC 
to more frequently value collateral haircuts during time of 
deteriorating market or other conditions while preserving notice 
requirements to ensure that Clearing Members are aware of risk 
management changes. Similarly, the proposed changes related to letters 
of credit (e.g., limits not linked to a specific domicile in order to 
impose the same requirements on both U.S. and non-U.S. issuers, 
concentration limits, and a prohibition on affiliated issuers) would 
support OCC's ability to manage risks posed by the collateral it 
accepts from participants.
    Based on its review of the record, and for the reasons described 
below, the Commission believes that OCC's proposed changes to rules and 
procedures regarding minimum standards for Clearing Banks and letter-
of-credit issuers are consistent with assuring the safeguarding of 
securities and funds which are in its custody or control or for which 
it is responsible. The quality of acceptable custodians is crucial to 
safeguarding these types of securities and funds, and one of the key 
ways to measure this quality is by establishing minimum qualifying 
standards. OCC's proposed Rule amendments would set more stringent Tier 
1 Capital requirements for both Clearing Banks and letter-of-credit 
issuers, while amending the sovereign credit ratings to reflect current 
understanding, and requiring Clearing Banks to maintain the ability to 
use SWIFT, a generally accepted and secure communication method, as a 
primary messaging protocol. Although the proposal would remove from 
OCC's Rules the external credit rating standards for a non-U.S. 
institution's commercial paper and related obligations, the ability of 
these institutions to meet their financial and other obligations to OCC 
would still be considered under the Third-Party-Risk Management 
Framework (``TPRMF''), along with other risk factors.\72\ Additionally, 
the proposed changes to the minimum standards for Clearing Banks and 
letter-of-credit issuers, when viewed as a whole, serve to strengthen 
OCC's process for accepting letters of credit, which comprise a 
fraction of margin,\73\ come with many related restrictions, and pose 
minimal risk to OCC. Moreover, the proposal would provide clarity by 
aligning minimum standards for Clearing Banks and letter-of-credit 
issuers, and would make clear that these rule changes are meant to 
serve as the articulation of minimum standards for establishing 
relationships, and OCC would not be obligated to enter into any such 
relationship merely because an institution meets these enumerated 
standards. The Commission believes that aligning and codifying such 
standards in OCC's rules facilitate OCC's maintenance of banking and 
letter-of-credit issuer relationships that support its ability to 
safeguard securities and funds for which it is responsible or that are 
in its custody or control.
---------------------------------------------------------------------------

    \72\ The TPRMF is an OCC rule that requires OCC to evaluate 
financial institutions such as Clearing Banks and other liquidity 
providers when they on-board or off-board with OCC, and to 
continuously monitor such institutions for so long as they maintain 
a relationship with OCC. It requires OCC to evaluate such financial 
institutions across a variety of factors, several of which assess 
the ability of the institution to meet its financial and other 
obligations to OCC, such as the financial, operational, legal, and 
regulatory risks faced by the institution. See Securities Exchange 
Act Release No. 90797 (Dec. 23, 2020), 85 FR 86592 (Dec. 30, 2020) 
(File No. SR-OCC-2020-014) (approving adoption of OCC's TPRMF). The 
TPRMF also provides for Watch List processes and internal escalation 
procedures in instances of an institution's deteriorating financial 
or operational ability to timely meet its future obligations to OCC, 
including assessing the institution's operational difficulties, late 
financial reports, and risk management issues. OCC, ``Third-Party 
Risk Management Framework'' (Dec. 22, 2022), available at https://www.theocc.com/getmedia/68a1ea2d-ddae-4a93-a309-100bf70a0f28/Third-Party-Risk-Management-Framework.pdf.
    \73\ As of Dec. 31, 2022, OCC reported that bank letters of 
credit accounted for only $130 million out of $152.7 billion of 
margin at OCC. See OCC 2022 Financials, at 10, available at https://www.theocc.com/company-information/documents-and-archives/annual-reports.
---------------------------------------------------------------------------

    The Commission received comments stating that the proposal to 
calculate collateral haircuts using the H-VaR model, rather than the 
current CiM methodology, would ignore long-tail

[[Page 55782]]

risks \74\ and historical periods of significant market stress.\75\ 
Commenters also stated that fixed collateral haircuts do not accurately 
reflect the potential fluctuations in asset values, including during 
times of market stress.\76\ The Commission has reviewed the proposed H-
VaR methodology, including confidential policies, procedures, and 
related materials.\77\ The H-VaR model would reflect asset value 
fluctuations during times of market stress because it specifically 
includes such periods in the defined lookback periods. With regard to 
long-tail risk, the proposed rules would require OCC to maintain 
haircuts at a level at least equal to a 99 percent confidence interval 
of the look-back period that provides for most conservative 
haircuts.\78\ Further, the Commission notes that regulatory and 
internal examinations showed that the CiM method has previously 
resulted in inaccuracies in sizing haircuts, and concludes that the use 
of the H-VaR model in place of the CiM method would improve accuracy of 
collateral haircuts. Additionally, fixed collateral haircuts are not a 
fundamentally new approach for OCC. For example, OCC's Rule 1002 
currently applies fixed haircuts to Government securities in the 
Clearing Fund, and such haircuts are currently subject to review and 
recalculation based, in part, on market fluctuations.\79\ Based on its 
review of the record and having considered the comments described 
above, the Commission believes that the proposed H-VaR methodology and 
the continued use of fixed collateral haircuts is consistent with the 
Exchange Act and the relevant rules thereunder.\80\
---------------------------------------------------------------------------

    \74\ The commenters did not elaborate on what was meant by 
``long tail risk.'' See, e.g., Letter from Jean Garcia-Gomez (Feb. 
12, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-325181.htm. Given the related comments and context, 
the Commission believes this to refer to the risk of loss due to an 
event that has an extremely low probability of occurring (i.e., an 
event that is far out in the tail of a distribution of possible 
events).
    \75\ See, e.g., id. Commenters raised additional concerns 
regarding sovereign credit ratings, and OCC's redaction of certain 
exhibits to the filing. See, e.g., id. Regarding OCC's redaction of 
certain exhibits, the Commission notes that OCC asserted that 
Exhibits 3A-3C and 5B-5D to the filing, which contain internal 
policies and procedures, internal statistical calculations and 
descriptions, and confidential regulatory findings, were entitled to 
confidential treatment because they contained commercial and 
financial information that is not customarily released to the public 
and is treated as the private information of OCC. Under Section 
23(a)(3) of the Exchange Act, the Commission is not required to make 
public statements filed with the Commission in connection with a 
proposed rule change of a self-regulatory organization if the 
Commission could withhold the statements from the public in 
accordance with the Freedom of Information Act (``FOIA''), 5 U.S.C. 
552. 15 U.S.C. 78w(a)(3). The Commission has reviewed the documents 
for which OCC requests confidential treatment and concludes that 
they could be withheld from the public under the FOIA. FOIA 
Exemption 4 protects confidential commercial or financial 
information. 5 U.S.C. 552(b)(4). Under Exemption 4, information is 
confidential if it ``is both customarily and actually treated as 
private by its owner and provided to government under an assurance 
of privacy.'' Food Marketing Institute v. Argus Leader Media, 139 S. 
Ct. 2356, 2366 (2019). In its requests for confidential treatment, 
OCC stated that it has not disclosed the confidential exhibits to 
the public, and the information is the type that would not 
customarily be disclosed to the public. In addition, by requesting 
confidential treatment, OCC had an assurance of privacy because the 
Commission generally protects information that can be withheld under 
Exemption 4. Thus, the Commission has determined to accord 
confidential treatment to the confidential exhibits.
    \76\ Comments on the Proposed Rule Change are available at 
https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm. See, 
e.g., Letter from Jean Garcia-Gomez (Feb. 12, 2023), available at 
https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-325181.htm.
    \77\ See Notice of Filing supra note 4, 87 FR at 79016-79018. 
OCC provided its policies, procedures, and related documents in 
confidential Exhibits 3A-3C, and 5B-5D to File No. SR-OCC-2022-012. 
Such documents included changes to both high-level policies and 
detailed technical documentation, as well as an analysis of the 
impact that changes in the haircut methodology would have on the 
value of collateral posted by members.
    \78\ See Notice of Filing supra note 4, 87 FR at 79017.
    \79\ Id.
    \80\ Commenters also raised a concern that the proposed rule 
change would ``cut margin requirements.'' See, e.g., letter from 
Daniel Lambden (Feb. 25, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-326082.htm. Such comments are 
not relevant to the filing because OCC did not propose changes to 
how it calculates margin requirements.
---------------------------------------------------------------------------

    The Commission also received comments stating that lowering or 
eliminating sovereign credit rating requirements for non-U.S. Clearing 
Banks and letter-of-credit issuers increases the risk taken on by 
OCC.\81\ The Commission has considered the materials submitted by OCC 
with regard to the Proposed Rule Change.\82\ OCC's rules do not 
currently prescribe acceptable sovereign credit rating for the domicile 
of any non-U.S. Clearing Bank. OCC is not proposing to weaken minimum 
standards, but rather to codify the current requirement to allow only 
those Clearing Banks domiciled in the U.S. or in locations with 
sovereign rating considered to be low credit risk. The Commission 
believes the proposed standards (i.e., A- by Standard & Poor's, A3 by 
Moody's, A- by Fitch, or equivalent, which would include institutions 
domiciled in countries such as France) represents a reasonable choice 
by OCC to identify sovereigns with low credit risk.\83\ The Commission 
recognizes that the proposal would change the acceptable ratings for 
letter-of-credit issuers; however, the proposed standard would still 
require that such banks be domiciled in the United States or in 
locations with sovereign ratings considered to be low credit risk, as 
noted above. Moreover, the removal of external credit rating standards 
for a non-U.S. institution's commercial paper and related obligations 
from OCC's Rules does not mean that creditworthiness will not be 
considered at all. Rather, the proposal calls for an evaluation of 
credit risk as part of a broader review of factors, such as financial, 
operational, legal, and regulatory risks, with regard to Clearing Banks 
and liquidity providers, such as letters of credit issuers under the 
TPRMF.\84\ The sovereign credit rating requirements are part of a 
broader set of minimum standards for Clearing Banks and letter-of-
credit issuers, including the Tier 1 Capital that OCC proposes to 
increase, thus providing further safeguards that mitigate or eliminate 
the additional risk to OCC. Based on its review of the record and 
having considered the comments described above, the Commission believes 
that the proposed sovereign credit rating requirements are consistent 
with the Exchange Act and the relevant rules thereunder.
---------------------------------------------------------------------------

    \81\ See note 75, supra.
    \82\ See Notice of Filing supra note 4, 87 FR at 79018-79020. 
OCC provided its policies, procedures, and related documents in 
confidential Exhibits 3A-3C, and 5B-5D to File No. SR-OCC-2022-012. 
Such documents include changes to policy governing OCC's management 
of risk presented by letters of credit.
    \83\ OCC acknowledged that the sovereign credit rating 
requirement historically applied to letter-of-credit issuers is 
different than what is currently applied to its Clearing Banks, and 
that OCC would change the sovereign credit rating requirement for 
letter-of-credit issuers to conform to that for the Clearing Banks. 
See Notice of Filing supra note 4, 87 FR at 79018-79019.
    \84\ See note 72, supra.
---------------------------------------------------------------------------

    The Commission received further comments stating that the proposed 
changes would reduce or remove external audit, supervision, and credit 
ratings, contrary to recommendations made in a 2015 paper from the Bank 
of International Settlements (``BIS'').\85\ These comments are not 
relevant to the proposal being considered here. The Proposed Rule 
Change is unrelated to and does not address external audit or 
supervision and, contrary to commenters' assertions, it would not 
remove the consideration of credit ratings. Where the proposal 
addresses credit ratings, it does so in the limited context of 
sovereign credit ratings

[[Page 55783]]

considered to be of low credit risk, transferring the rules regarding 
consideration of creditworthiness of Clearing Banks and liquidity 
providers from the OCC rulebook to the TPRMF, and as part of a broader 
set of minimum requirements for Clearing Banks and letter-of-credit 
issuers. The BIS paper discusses, among other things, how interactions 
among internal lines of defense and external controls can enhance 
governance at financial institutions.\86\ These issues are not relevant 
to the Proposed Rule Change. Further, unlike the commenters suggest, 
the BIS paper does not discuss credit ratings at all. Additionally, 
even though the proposal would adjust the required sovereign credit 
rating, and transfer the rules regarding consideration of 
creditworthiness of Clearing Banks and liquidity providers from the OCC 
rulebook to the TPRMF, it would still only allow for countries with low 
credit risk and institutions that are able to meet obligations to OCC, 
and these requirements are part of a larger set of minimum standards, 
such as more stringent Tier 1 Capital requirements and the requirement 
for Clearing Banks to maintain the ability to use SWIFT, that serve to 
enhance OCC's banking and letter-of-credit relationships. As such, 
after having considered the comments relating to the BIS paper, the 
Commission continues to believe that the proposal is consistent with 
the Exchange Act and the relevant rules thereunder.
---------------------------------------------------------------------------

    \85\ Isabella Arndorfer, Bank of International Settlements, and 
Andrea Minto, Utrecht University, Occasional Paper No. 11, ``The 
`four lines of defence model' for financial institutions,'' 
Financial Stability Institute ((Dec. 23, 2015), available at https://www.bis.org/fsi/fsipapers11.pdf. (``BIS paper'').
    \86\ Id.
---------------------------------------------------------------------------

    Therefore, the Commission finds that, taken together, the proposed 
changes described above are consistent with the requirements of Section 
17A(b)(3)(F) of the Exchange Act.\87\
---------------------------------------------------------------------------

    \87\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

B. Consistency With Section 17A(b)(3)(I) of the Exchange Act

    Section 17A(b)(3)(I) of the Exchange Act requires that the rules of 
a clearing agency do not impose any burden on competition not necessary 
or appropriate in furtherance of the purposes of the Exchange Act.\88\
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    In response to the Notice of Filing,\89\ the Commission received a 
comment \90\ opposing the proposal stating that the ``increase to the 
current Tier 1 Capital requirement will have a negative effect by 
eliminating [Lakeside Bank] as a member Clearing Bank'' and that such 
elimination ``will reduce competition.'' \91\ The commenter, Lakeside, 
states further that large Clearing Banks ``tend to not provide service 
for small and mid-sized Clearing Brokers,'' which appears to suggest 
that the proposed change could reduce direct access to clearing for 
OCC's current membership.\92\ Finally, the commenter states that the 
``proposed Tier 1 Capital rule change to $500 million is arbitrary and 
capricious and not explained other than the OCC's belief the new 
requirement reduces the risk of a Clearing Banks failure to achieve 
their daily settlement obligations.'' \93\
---------------------------------------------------------------------------

    \89\ See Notice of Filing supra note 4, 87 FR at 79015.
    \90\ Letter from Lakeside Bank dated January 26, 2023 
(``Lakeside Ltr''), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm. See also Letter from Lakeside Bank 
dated March 15, 2023 (``Lakeside Ltr 2''), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-328270.htm. 
Lakeside Ltr 2 did not present novel comments.
    \91\ Lakeside Ltr at 1.
    \92\ Id. The Commission also received a comment stating that the 
proposed increase to capital requirements would impact smaller 
members. Letter from Kevin Lau (Feb. 14, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-325669.htm.
    \93\ Lakeside Ltr at 2.
---------------------------------------------------------------------------

    In a subsequent comment letter, OCC responded to the concerns 
raised by Lakeside.\94\ OCC stated that its proposal would not impose a 
burden on competition \95\ because Clearing Members of various sizes 
``currently have established relationships with OCC-approved Clearing 
Banks that meet the proposed standards.'' \96\ Further, OCC stated that 
``Lakeside Bank does not currently provide settlement banking services 
as a Clearing Bank for any OCC Clearing Member.'' \97\ Moreover, OCC 
stated that its ``current rules do not obligate OCC to enter into a 
Clearing Bank relationship with a bank simply because the bank meets 
its present standards.'' \98\ OCC stated that obligating it to enter 
into Clearing Bank relationships simply because an institution meets 
the minimum standards and without further due diligence ``would not be 
consistent with sound third-party risk management practices.'' \99\ On 
the contrary, ``OCC believes that strengthening OCC standards for 
entering into Clearing Bank arrangements is necessary and appropriate 
to ensure the overall safety and soundness of the markets OCC serves.'' 
\100\ OCC stated further that it ``determined the proposed Tier 1 
Capital requirement to align with the Tier 1 Capital held by the 
Clearing Banks that have demonstrated records of performance, including 
the resources to devote to and meet OCC's operational expectations for 
providing such critical services.'' \101\
---------------------------------------------------------------------------

    \94\ Letter from Megan Cohen, Managing Director, OCC, to Vanessa 
Countryman, Secretary, Commission, dated February 2, 2023 (``OCC 
Ltr''), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm.
    \95\ The Exchange Act requires that the rules of the clearing 
agency do not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Exchange Act. See 
15 U.S.C. 78q-1(b)(3)(I).
    \96\ OCC Ltr at 3.
    \97\ Id. at 1.
    \98\ Id. at 2.
    \99\ Id. at 2.
    \100\ Id. at 3. As OCC additionally explained, ``If a Clearing 
Bank is unable to timely make incoming payments on behalf of one or 
more Clearing Members, OCC may face liquidity challenges requiring 
it to draw on resources that could impose unexpected costs or other 
adverse consequences for its Clearing Members and, ultimately, 
market participants.'' Id.
    \101\ Id.
---------------------------------------------------------------------------

    Based on the information provided, the Commission believes that the 
proposal would not impose a burden on competition that is not necessary 
or appropriate in furtherance of the purposes of the Exchange Act. All 
of OCC's current members maintain relationships with Clearing Banks 
that meet the proposed standards. The Commission did not receive 
comments raising concerns from current or prospective OCC participants. 
With regard to monitoring, managing, and limiting the credit and 
liquidity risk arising from commercial settlement banks, the Commission 
has provided guidance that a clearing agency generally should consider 
establishing and monitoring adherence to strict criteria for its 
settlement banks that take account of, among other things, their 
capitalization.\102\ The Commission believes, therefore, that 
strengthening capital requirements for settlement banks, such as OCC's 
Clearing Banks, can serve an important risk management purpose. The 
Commission acknowledges the concerns raised by Lakeside with regard to 
competition among settlement banks and access to central clearing at 
OCC.\103\ As noted above, the proposal does not limit access to current 
OCC members, and, even if the proposed changes were not approved, OCC's 
current rules would not necessarily obligate OCC to

[[Page 55784]]

maintain a Clearing Bank relationship with Lakeside or a similar 
institution.
---------------------------------------------------------------------------

    \102\ See Standards for Covered Clearing Agencies supra note 24, 
81 FR at 70826.
    \103\ Lakeside also raised concerns regarding potential future 
rule changes at the Chicago Mercantile Exchange (``CME'') and the 
Depository Trust and Clearing Corporation (``DTCC''). See Lakeside 
Ltr at 2. Such concerns are not ripe for consideration here because 
(1) CME is not currently registered as a clearing agency with the 
Commission, and (2) there are no proposed changes related to this 
matter pending with the Commission from the Depository Trust 
Company, Fixed Income Clearing Corporation, or National Securities 
Clearing Corporation (i.e., the three registered clearing agencies 
whose parent is DTCC).
---------------------------------------------------------------------------

    Therefore, the Commission finds that the proposed changes described 
above are consistent with the requirements of Section 17A(b)(3)(I) of 
the Exchange Act.\104\
---------------------------------------------------------------------------

    \104\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(5) Under the Exchange Act

    Rule 17Ad-22(e)(5) \105\ under the Exchange Act requires each 
covered clearing agency to establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to set and enforce 
appropriately conservative haircuts and concentration limits if the 
covered clearing agency requires collateral to manage its or its 
participants' credit exposures; and require a review of the sufficiency 
of its collateral haircuts and concentration limits to be performed not 
less than annually. In adopting Rule 17Ad-22(e)(5), the Commission 
provided guidance that ``to reduce the need for procyclical 
adjustments, a covered clearing agency generally should consider 
establishing stable and conservative haircuts that are calibrated to 
include periods of stressed market conditions, to the extent practical 
and prudent.'' \106\
---------------------------------------------------------------------------

    \105\ 17 CFR 240.17Ad-22(e)(5).
    \106\ See Standards for Covered Clearing Agencies supra note 24, 
81 FR at 70816-17.
---------------------------------------------------------------------------

    Based on the information and data provided by OCC, the Commission 
believes that OCC's proposed H-VaR approach would help reduce spikes 
during heightened market volatility by yielding more conservative 
haircuts during normal market conditions. The proposed approach also 
would attempt to address the weaknesses identified in the CiM model in 
response to regulatory and internal examinations by, for example, 
incorporating periods of market stress into the look-back period for 
the model. Additionally, OCC's proposal to amend its internal CRM 
Policy to list specific factors, such as volatility and liquidity, and 
elevated sovereign credit risk when determining the value of GSE debt 
securities and Government securities used as margin or Clearing Fund 
collateral, would provide guideposts to set and enforce appropriately 
conservative haircuts. OCC's proposed changes also would grant it new 
authority to set and adjust more restrictive concentration limits for 
accepting letters of credit, as well as expressly list the factors for 
making such determinations, and establish a prohibition on accepting 
letters of credit for the account of a Clearing Member where the 
issuing institution, a parent, or an affiliate has any equity interest 
in such Clearing Member's total capital. Thus, the Commission believes 
that OCC's proposed changes to letter-of-credit concentration limits, 
when reviewed in combination with the proposed minimum standards for 
Clearing Banks and letter-of-credit issuers, would be appropriately 
conservative and may help eliminate wrong-way risk found in some 
Clearing Members' relationships with such issuers.\107\ Finally, the 
Commission believes that reviews at regular intervals of collateral 
haircuts and concentration limits proposed in the CRM Policy and Rules 
would be consistent with the requirement for, at a minimum, an annual 
review.
---------------------------------------------------------------------------

    \107\ Wrong-way risk can be either general or specific. General 
wrong-way risk arises at a central counterparty (``CCP'') when the 
potential losses of either a participant's portfolio or a 
participant's collateral is correlated with the default probability 
of that participant. Specific wrong-way risk arises at a CCP when an 
exposure to a participant is highly likely to increase when the 
creditworthiness of that participant is deteriorating. See Standards 
for Covered Clearing Agencies supra note 24, 81 FR at 70816, n.317.
---------------------------------------------------------------------------

    Accordingly, the Commission finds that the proposed changes are 
consistent with Rule 17Ad-22(e)(5) \108\ under the Exchange Act.
---------------------------------------------------------------------------

    \108\ 17 CFR 240.17Ad-22(e)(5).
---------------------------------------------------------------------------

D. Consistency With Rule 17Ad-22(e)(9) Under the Exchange Act

    Rule 17Ad-22(e)(9) \109\ under the Exchange Act requires each 
covered clearing agency to establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to, among other 
things, minimize and manage credit and liquidity risk arising from 
conducting its money settlements in commercial bank money if central 
bank money is not used by the covered clearing agency. The Commission 
believes that including OCC's minimum standards for Clearing Banks in 
its rules would support OCC's ability to monitor its relationships with 
Clearing Banks and manage the financial and operational risks inherent 
in such relationships. The Commission also believes that the 
requirements for Clearing Banks, taken as a whole, as well as the 
mandatory approval of any new Clearing Bank by the Risk Committee prior 
to onboarding, would help reduce credit and liquidity risk arising from 
conducting its money settlements in commercial bank money. Accordingly, 
the Commission finds that the proposed changes are consistent with Rule 
17Ad-22(e)(9) \110\ under the Exchange Act.
---------------------------------------------------------------------------

    \109\ 17 CFR 240.17Ad-22(e)(9).
    \110\ Id.
---------------------------------------------------------------------------

E. Consistency With Rule 17Ad-22(e)(22) Under the Exchange Act

    Rule 17Ad-22(e)(22) \111\ under the Exchange Act requires each 
covered clearing agency to establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to use, or at a 
minimum accommodate, relevant internationally accepted communication 
procedures and standards in order to facilitate efficient payment, 
clearing, and settlement. As described above, OCC proposed codifying 
its requirement that its Clearing Banks maintain the ability to utilize 
SWIFT, whenever possible. The proposed change would codify the process 
that OCC proposed in 2017.\112\ Previously, the Commission did not to 
object to the process, in part, based on the belief that the proposal 
to expand the usage of SWIFT as a standard for OCC's Clearing Banks is 
consistent with Rule 17Ad-22(e)(22).\113\ The Commission believes that 
codifying the requirement would further support OCC's existing process 
and use of SWIFT to facilitate efficient payment, clearing, and 
settlement. Accordingly, the Commission finds that the proposed changes 
are consistent with Rule 17Ad-22(e)(22) \114\ under the Exchange Act.
---------------------------------------------------------------------------

    \111\ 17 CFR 240.17Ad-22(e)(22).
    \112\ See Securities Exchange Act Release No. 82055 (Nov. 13, 
2017), 82 FR 54448 (Nov. 17, 2017) (File No. SR-OCC-2017-805).
    \113\ See Securities Exchange Act Release No. 82221 (Dec. 5, 
2017), 82 FR 58230, 58232 (Dec. 11, 2017) (File No. SR-OCC-2017-
805).
    \114\ 17 CFR 240.17Ad-22(e)(22).
---------------------------------------------------------------------------

F. Consistency With Rule 17Ad-22(e)(23) Under the Exchange Act

    Rule 17Ad-22(e)(23)(i) and (ii) \115\ under the Exchange Act 
requires each covered clearing agency to establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to, among other things, publicly disclose all relevant rules 
and material procedures; and provide sufficient information to enable 
participants to identify and evaluate the risks, fees, and other 
material costs they incur by participating in the covered clearing 
agency. Based on its review of the record, and for the reasons 
described below, the Commission finds that the proposed changes, taken 
together, are consistent with the requirements of Rule 17Ad-
22(e)(23)(i) and (ii).\116\
---------------------------------------------------------------------------

    \115\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
    \116\ Id.
---------------------------------------------------------------------------

    By adopting rules that require OCC to provide prior notice through 
public

[[Page 55785]]

disclosures on its website relating to information on collateral 
haircuts for Government securities and GSE debt securities, and 
concentration limits for letters of credit, the Commission believes 
that OCC's rules would support the communication of information that 
Clearing Members may use to identify and evaluate the haircuts and 
concentration limits resulting from OCC's valuation processes. 
Additionally, the Commission believes that codifying minimum standards 
for Clearing Banks and letter-of-credit issuers in OCC's public rules 
would provide increased clarity and transparency to Clearing Members 
and market participants, while preserving OCC's flexibility and 
authority in disapproving specific relationships based on individual 
facts and circumstances. As such, the Commission believes that the 
proposed rule and policy revisions are consistent with publicly 
disclosing all relevant rules and material procedures; and providing 
sufficient information to enable participants to identify and evaluate 
the risks, fees, and other material costs incurred with participation 
in the covered clearing agency.
    The Commission finds, therefore, that OCC's proposals, described 
above, are consistent with the requirements of Rule 17Ad-22(e)(23)(i) 
and (ii) under the Exchange Act.\117\
---------------------------------------------------------------------------

    \117\ Id.
---------------------------------------------------------------------------

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 \118\ and the rules and regulations thereunder.
---------------------------------------------------------------------------

    \118\ In approving this Proposed Rule Change, the Commission has 
considered the proposed rules' 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 
Exchange Act,\119\ that the Proposed Rule Change (SR-OCC-2022-012), be, 
and hereby is, approved.
---------------------------------------------------------------------------

    \119\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\120\
---------------------------------------------------------------------------

    \120\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-17529 Filed 8-15-23; 8:45 am]
BILLING CODE 8011-01-P