Document ID: SEC-2022-0214-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: The Options Clearing Corp.
Posted Date: 2022-02-11T05:00Z

[Federal Register Volume 87, Number 29 (Friday, February 11, 2022)]
[Notices]
[Pages 8072-8080]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-02913]

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-94165; File No. SR-OCC-2022-001]

Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Concerning the Options 
Clearing Corporation's Margin Methodology for Incorporating Variations 
in Implied Volatility

February 7, 2022.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on January 24, 2022, the Options Clearing 
Corporation (``OCC'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by OCC. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    This proposed rule change would modify OCC's margin methodology, 
the System for Theoretical Analysis and Numerical Simulations 
(``STANS''), to simplify the methodology, control procyclicality in 
volatility modeling, provide natural offsets for volatility products 
with similar characteristics, and build the foundation for a single, 
consistent framework to model equity volatility products in margin and 
stress testing. Specifically, this proposed rule change would:

    (1) Implement a new model for incorporating variations in 
implied volatility within STANS for products based on the S&P 500 
Index (such index hereinafter referred to as ``S&P 500'' and such 
proposed model being the ``S&P 500 Implied Volatility Simulation 
Model'') to provide consistent and smooth simulated volatility 
scenarios;
    (2) implement a new model to calculate the theoretical values of 
futures on indexes designed to measure volatilities implied by 
prices of options on a particular underlying index (such indexes 
being ``volatility indexes''; futures contracts on such volatility 
indexes being ``volatility index futures''; and such proposed model 
being the ``Volatility Index Futures Model'') to provide consistent 
and stable coverage across all maturities; and
    (3) replace OCC's model to calculate the theoretical values of 
exchange-traded futures contracts based on the expected realized 
variance of an underlying interest (such contracts being ``variance 
futures,'' and such model being the ``Variance Futures Model'') with 
one that provides adequate margin coverage while providing offsets 
for hedged positions in the listed options market.

    The proposed changes to OCC's STANS Methodology document are 
contained in confidential Exhibit 5 of filing SR-OCC-2022-001. 
Amendments to the existing text are marked by underlining and material 
proposed to be deleted is marked by strikethrough text. The proposed 
changes are described in detail in Item 3 below. New sections 2.1.4 
(S&P 500 Implied Volatilities Scenarios) and 2.1.8 (Volatility Index 
Futures), and the replacement text for section 2.1.7 (Variance 
Futures), specific to the proposed models, are presented without 
marking. Existing Section 2.1.4 through 2.1.7 have been renumbered to 
reflect the addition of the new sections but are otherwise unchanged. 
The proposed rule change does not require any changes to the text of 
OCC's By-Laws or Rules. All terms with initial capitalization that are 
not otherwise defined herein have the same meaning as set forth in the 
OCC By-Laws and Rules.\3\
---------------------------------------------------------------------------

    \3\ OCC's By-Laws and Rules can be found on OCC's public 
website: https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
---------------------------------------------------------------------------

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

(1) Purpose
Background
STANS Overview
    STANS is OCC's proprietary risk management system for calculating 
Clearing Member margin requirements.\4\ The STANS methodology utilizes 
large-scale Monte Carlo simulations to forecast price and volatility 
movements in determining a Clearing Member's margin requirement.\5\ 
STANS margin requirements are calculated at the portfolio level of 
Clearing Member accounts with positions in marginable securities and 
consists of an estimate of two primary components: a base component and 
a concentration/dependence stress test add-on component. The base 
component is an estimate of a 99% expected shortfall \6\ over a two-day 
time horizon. The concentration/dependence stress test add-on is 
obtained by considering increases in the expected margin shortfall for 
an account that would occur due to (i) market movements that are 
especially large and/or in which certain risk factors would exhibit 
perfect or zero correlations rather than correlations otherwise 
estimated using historical data or (ii) extreme and adverse 
idiosyncratic movements for individual risk factors to which the 
account is particularly exposed. OCC uses the STANS methodology to 
measure the exposure of portfolios of options and futures cleared by 
OCC and cash instruments in margin collateral, including volatility 
index futures and variance futures.\7\
---------------------------------------------------------------------------

    \4\ See Exchange Act Release No. 91079 (Feb. 8, 2021), 86 FR 
9410 (Feb. 12, 2021) (File No. SR-OCC-2020-016). OCC makes its STANS 
Methodology description available to Clearing Members. An overview 
of the STANS methodology is on OCC's public website: https://www.theocc.com/Risk-Management/Margin-Methodology.
    \5\ See OCC Rule 601.
    \6\ The expected shortfall component is established as the 
estimated average of potential losses higher than the 99% value at 
risk threshold. The term ``value at risk'' or ``VaR'' refers to a 
statistical technique that, generally speaking, is used in risk 
management to measure the potential risk of loss for a given set of 
assets over a particular time horizon.
    \7\ Pursuant to OCC Rule 601(e)(1), OCC also calculates initial 
margin requirements for segregated futures accounts on a gross basis 
using the Standard Portfolio Analysis of Risk Margin Calculation 
System (``SPAN''). Commodity Futures Trading Commission (``CFTC'') 
Rule 39.13(g)(8), requires, in relevant part, that a derivatives 
clearing organization (``DCO'') collect initial margin for customer 
segregated futures accounts on a gross basis. While OCC uses SPAN to 
calculate initial margin requirements for segregated futures 
accounts on a gross basis, OCC believes that margin requirements 
calculated on a net basis (i.e., permitting offsets between 
different customers' positions held by a Clearing Member in a 
segregated futures account using STANS) affords OCC additional 
protections at the clearinghouse level against risks associated with 
liquidating a Clearing Member's segregated futures account. As a 
result, OCC calculates margin requirements for segregated futures 
accounts using both SPAN on a gross basis and STANS on a net basis, 
and if at any time OCC staff observes a segregated futures account 
where initial margin calculated pursuant to STANS on a net basis 
exceeds the initial margin calculated pursuant to SPAN on a gross 
basis, OCC collateralizes this risk exposure by applying an 
additional margin charge in the amount of such difference to the 
account. See Exchange Act Release No. 72331 (June 5, 2014), 79 FR 
33607 (June 11, 2014) (File No. SR-OCC-2014-13).

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

[[Page 8073]]

    The models in STANS currently incorporate a number of risk factors. 
A ``risk factor'' within OCC's margin system is defined as a product or 
attribute whose historical data is used to estimate and simulate the 
risk for an associated product. The majority of risk factors utilized 
in the STANS methodology are the returns on individual equity 
securities; however, a number of other risk factors may be considered, 
including, among other things, returns on implied volatility.
Current Implied Volatilities Scenarios Model
    Generally speaking, 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. Using the Black-Scholes options pricing model, 
the implied volatility is the standard deviation of the underlying 
asset price necessary to arrive at the market price of an option of a 
given strike, time to maturity, underlying asset price and the current 
discount interest rate. In effect, the implied volatility is 
responsible for that portion of the premium that cannot be explained by 
the current intrinsic value of the option (i.e., the difference between 
the price of the underlying and the exercise price of the option), 
discounted to reflect its time value. OCC considers variations in 
implied volatility within STANS to ensure that the anticipated cost of 
liquidating options positions in an account recognizes the possibility 
that the implied volatility could change during the two-business day 
liquidation time horizon and lead to corresponding changes in the 
market prices of the options.
    Using its current Implied Volatilities Scenarios Model,\8\ OCC 
models the variations in implied volatility used to re-price options 
within STANS for substantially all option contracts \9\ available to be 
cleared by OCC that have a residual tenor \10\ of less than three years 
(``Shorter Tenor Options'').\11\ To address variations in implied 
volatility, OCC models a volatility surface \12\ for Shorter Tenor 
Options by incorporating certain risk factors (i.e., implied volatility 
pivot points) based on a range of tenors and option deltas \13\ into 
the models in STANS. Currently, these implied volatility pivot points 
consist of three tenors of one month, three months and one year, and 
three deltas of 0.25, 0.5, and 0.75, resulting in nine implied 
volatility risk factors. These pivot points are chosen such that their 
combination allows the model to capture changes in level, skew (i.e., 
strike price), convexity, and term structure of the implied volatility 
surface. OCC uses a GARCH model \14\ to forecast the volatility for 
each implied volatility risk factor at the nine pivot points.\15\ For 
each Shorter Tenor Option in the account of a Clearing Member, changes 
in its implied volatility are simulated using forecasts obtained from 
daily implied volatility market data according to the corresponding 
pivot point and the price of the option is computed to determine the 
amount of profit or loss in the account under the particular STANS 
price simulation. Additionally, OCC uses simulated closing prices for 
the assets underlying the options in the account of a Clearing Member 
that are scheduled to expire within the liquidation time horizon of two 
business days to compute the options' intrinsic value and uses those 
values to help calculate the profit or loss in the account.\16\
---------------------------------------------------------------------------

    \8\ In December 2015, the Commission approved a proposed rule 
change and issued a Notice of No Objection to an advance notice 
filed by OCC to modify its margin methodology by more broadly 
incorporating variations in implied volatility within STANS. See 
Exchange Act Release No. 76781 (Dec. 28, 2015), 81 FR 135 (Jan. 4, 
2016) (File No. SR-OCC-2015-016); Exchange Act Release No. 76548 
(Dec. 3, 2015), 80 FR 76602 (Dec. 9, 2015) (File No. SR-OCC-2015-
804). Initially named the ``Implied Volatility Model,'' OCC re-
titled the model the ``Implied Volatilities Scenarios Model'' in 
2021 as part of the STANS Methodology's broader reorganization of 
OCC's Margin Methodology. See Exchange Act Release No. 90763 (Dec. 
21, 2020), 85 FR 85788, 85792 (Dec. 29, 2020) (File No. SR-OCC-2020-
016).
    \9\ OCC's Implied Volatilities Scenarios Model excludes (i) 
binary options, (ii) options on commodity futures, (iii) options on 
U.S. Treasury securities, and (iv) Asians and Cliquets.
    \10\ The ``tenor'' of an option is the amount of time remaining 
to its expiration.
    \11\ OCC currently incorporates variations in implied volatility 
as risk factors for certain options with residual tenors of at least 
three years (``Longer Tenor Options'') by a separate process. See 
Exchange Act Release No. 68434 (Dec. 14, 2012), 77 FR 57602 (Dec. 
19, 2012) (File No. SR-OCC-2012-14); Exchange Act Release No. 70709 
(Oct. 18, 2013), 78 FR 63267 (Oct. 23, 2013) (File No. SR-OCC-2013-
16). Because all Longer Tenor Options are S&P 500-based products, 
the proposed S&P 500 Implied Volatility Simulation Model would 
eliminate the separate process for Longer Tenor Options with a 
single methodology for all S&P 500 options.
    \12\ The term ``volatility surface'' refers to a three-
dimensional graphed surface that represents the implied volatility 
for possible tenors of the option and the implied volatility of the 
option over those tenors for the possible levels of ``moneyness'' of 
the option. The term ``moneyness'' refers to the relationship 
between the current market price of the underlying interest and the 
exercise price.
    \13\ The ``delta'' of an option represents the sensitivity of 
the option price with respect to the price of the underlying 
security.
    \14\ The acronym ``GARCH'' refers to an econometric model that 
can be used to estimate volatility based on historical data. See 
generally Tim Bollerslev, ``Generalized Autoregressive Conditional 
Heteroskedasticity,'' Journal of Econometrics, 31(3), 307-327 
(1986).
    \15\ STANS relies on 10,000 price simulation scenarios that are 
based generally on a historical data period of 500 business days, 
which are updated daily to keep model results from becoming stale.
    \16\ For such Shorter Tenor Options that are scheduled to expire 
on the open of the market rather than the close, OCC uses the 
relevant opening price for the underlying assets.
---------------------------------------------------------------------------

    In January 2019,\17\ OCC modified the Implied Volatilities 
Scenarios Model after OCC's analyses of the model demonstrated that the 
volatility changes forecasted by the GARCH model were extremely 
sensitive to sudden spikes in volatility, which at times resulted in 
overreactive margin requirements that OCC believed were unreasonable 
and procyclical.\18\ To reduce the oversensitivity of the Implied 
Volatilities Scenarios Model to large, sudden shocks in market 
volatility and therefore result in margin requirements that are more 
stable and that remain commensurate with the risks presented during 
periods of sudden, extreme volatility, OCC modified the Implied 
Volatilities Scenarios Model to use an exponentially weighted moving 
average \19\ of forecasted volatilities over a specified look-back 
period rather than using raw daily forecasted volatilities. The 
exponentially weighted moving average involves the selection of a look-
back period over which the data would be averaged and a decay factor 
(or weighting factor), which is a positive number between zero and one, 
that represents the weighting factor for the

[[Page 8074]]

most recent data point.\20\ The look-back period and decay factor are 
model parameters subject to monthly review, along with other model 
parameters that are reviewed by OCC's Model Risk Working Group 
(``MRWG'') \21\ in accordance with OCC's internal procedure for margin 
model parameter review and sensitivity analysis, and these parameters 
are subject to change upon approval of the MRWG.
---------------------------------------------------------------------------

    \17\ In December 2018, the Commission approved a proposed rule 
change and issued a Notice of No Objection to an advance notice 
filed by OCC to modify the Implied Volatilities Scenarios Model. See 
Exchange Act Release No. 84879 (Dec. 20, 2018), 83 FR 67392 (Dec. 
29, 2018) (File No. SR-OCC-2018-014); Exchange Act Release No. 84838 
(Dec. 19, 2018), 83 FR 66791 (Dec. 27, 2018) (File No. SR-OCC-2018-
804).
    \18\ A quality that is positively correlated with the overall 
state of the market is deemed to be ``procyclical.'' While margin 
requirements from risk-based margin models normally fluctuate with 
market volatility, a margin model can be procyclical if it 
overreacts to market conditions, such as generating drastic spikes 
in margin requirements in response to jumps in market volatility. 
Anti-procyclical features in a model are measures intended to 
prevent risk-based models from fluctuating too drastically in 
response to changing market conditions.
    \19\ An exponentially weighted moving average is a statistical 
method that averages data in a way that gives more weight to the 
most recent observations using an exponential scheme.
    \20\ The lower the number the more weight is attributed to the 
more recent data (e.g., if the value is set to one, the 
exponentially weighted moving average becomes a simple average).
    \21\ The MRWG is responsible for assisting OCC's Management 
Committee in overseeing OCC's model-related risk and includes 
representatives from OCC's Financial Risk Management department, 
Quantitative Risk Management department, Model Validation Group, and 
Enterprise Risk Management department.
---------------------------------------------------------------------------

    The current Implied Volatilities Scenarios Model is subject to 
certain limitations and issues, which would be addressed by the 
proposed changes described herein. While the overlay of an 
exponentially weighted moving average reduces and delays the impact of 
large implied volatility spikes, it does so in an artificial way that 
does not target the primary issues that OCC identified with the GARCH 
model. Consequently, the 2019 modifications were intended to be a 
temporary solution.
    The current model uses the ``nearest neighbor'' method to switch 
pivot points in the implied volatility surface, which introduces 
discontinuity in the implied volatility curve for a given tenor. In 
addition, the implied volatility scenarios for call and put options 
with the same tenor and strike price are not equal. These issues 
introduce inconsistencies in implied volatility scenarios.\22\ Due to 
the use of arithmetic implied volatility returns in the current 
model,\23\ it can produce near zero implied volatility, which is 
unrealistic, in a few simulated scenarios.
---------------------------------------------------------------------------

    \22\ The inconsistency arises from the assumption that call 
deltas are equivalent to put deltas plus one, which is not well 
justified.
    \23\ The arithmetic return of an implied volatility over a 
single period of any length of time is calculated by dividing the 
difference between final value and initial value by the initial 
value.
---------------------------------------------------------------------------

    In addition, the current model does not impose constraints on the 
nine pivot points to ensure that simulated surfaces are arbitrage-free 
because the pivots are not modeled consistently. As a result, the 
simulated implied volatility surfaces often allow arbitrages across 
options. Because of the potential for arbitrage, the implied 
volatilities are not adequate inputs to price variance futures and 
volatility index futures accurately, both of which assume an arbitrage-
free condition.\24\ Furthermore, the current Implied Volatilities 
Scenarios Model may not provide natural offsetting of risks in accounts 
that contain combinations of S&P 500 options, variance futures, and/or 
volatility index futures because the copula utilized in the current 
model indirectly captures the correlation effect between S&P 500 
options and volatility index futures or variance futures.
---------------------------------------------------------------------------

    \24\ Currently, the S&P 500 underlying price scenario generated 
from the Variance Futures Model is used as input data for variance 
futures. For volatility index futures, synthetic VIX futures time 
series generated by the Synthetic Futures Model are used as input 
data to calibrate model parameters, as discussed below.
---------------------------------------------------------------------------

Current Synthetic Futures Model
    Volatility indexes are indexes designed to measure the volatility 
that is implied by the prices of options on a particular reference 
index or asset. For example, Cboe's Volatility Index (``VIX'') is an 
index designed to measure the 30-day expected volatility of the S&P 
500. Volatility index futures can consequently be viewed as an 
indication of the market's future expectations of the volatility of a 
given volatility index's underlying reference index (e.g., in the case 
of the VIX, providing a snapshot of the expected market volatility of 
the S&P 500 over the term of the options making up the index). OCC 
clears futures contracts on such volatility indexes.
    OCC currently uses the Synthetic Futures Model to calculate the 
theoretical value of volatility index futures, among other 
products,\25\ for purposes of calculating margin for Clearing Member 
portfolios. OCC's current approach for projecting the potential final 
settlement prices of volatility index futures models the price 
distributions of ``synthetic'' futures on a daily basis based on the 
historical returns of futures contracts with approximately the same 
tenor.\26\ The Synthetic Futures Model uses synthetic time series of 
500 daily proportional returns created from historical futures. Once 
futures mature, the synthetic time series roll from the nearer-term 
futures to the next further out futures on the day subsequent to the 
front-month maturity date. Thus, the front-month synthetic always 
contains returns of the front contract; the second synthetic 
corresponds to the next month out, and so on. While synthetic time 
series contain returns from different contracts, a return on any given 
date is constructed from prices of the same contract (e.g., as the 
front-month futures contract ``rolls'' from the current month to the 
subsequent month, returns on the roll date are constructed by using the 
same contract and not by calculating returns across months). The 
econometric model currently used in STANS for purposes of modeling 
proportionate returns of the synthetic futures is an asymmetric 
GARCH(1,1) with an asymmetric Standardized Normal Reciprocal Inverse 
Gaussian (or ``NRIG'')-distributed logarithmic returns.\27\ The 
correlation between S&P 500 options and VIX futures are controlled by a 
copula.
---------------------------------------------------------------------------

    \25\ OCC also applies the Synthetic Futures Model to (i) futures 
on the American Interbank Offered Rate (``AMERIBOR'') disseminated 
by the American Financial Exchange, LLC, which is a transaction-
based interest rate benchmark that represents market-based borrowing 
costs; (ii) futures products linked to indexes comprised of 
continuous yield based on the most recently issued (i.e., ``on-the-
run'') U.S. Treasury notes listed by Small Exchange Inc. (``Small 
Treasury Yield Index Futures''); and (iii) futures products linked 
to Light Sweet Crude Oil (WTI) listed by Small Exchange (``Small 
Crude Oil Futures''). See Exchange Act Release No. 89392 (July 24, 
2020), 85 FR 45938 (July 30, 2020) (File No. SR-OCC-2020-007) 
(AMERIBOR futures); Exchange Act Release No. 90139 (Oct. 8, 2020), 
85 FR 65886 (Oct. 16, 2020) (File No. SR-OCC-2020-012) (Small 
Treasury Yield Index Futures); Exchange Act Release No. 91833 (May 
10, 2021), 86 FR 26586 (May 14, 2021) (File No. SR-OCC-2021-005) 
(Small Crude Oil Futures). Notwithstanding the proposed charges 
herein, OCC would continue to use the current Synthetic Futures 
Model to model prices for interest rate futures on AMERIBOR, Small 
Treasury Yield Index Futures and Small Crude Oil Futures.
    \26\ A ``synthetic'' futures time series relates to a uniform 
substitute for a time series of daily settlement prices for actual 
futures contracts, which persists over many expiration cycles and 
thus can be used as a basis for econometric analysis. One feature of 
futures contracts is that each contract may have a different 
expiration date, and at any one point in time there may be a variety 
of futures contracts on the same underlying interest, all with 
varying dates of expiration, so that there is no one continuous time 
series for those futures. Synthetic futures can be used to generate 
a continuous time series of futures contract prices across multiple 
expirations. These synthetic futures price return histories are 
inputted into the existing Copula simulation process in STANS 
alongside the underlying interests of OCC's other cleared and cross-
margin products and collateral. The purpose of this use of synthetic 
futures is to allow the margin system to better approximate 
correlations between futures contracts of different tenors by 
creating more price data points and their margin offsets.
    \27\ See Exchange Act Release No. 85873 (May 16, 2019), 84 FR 
23620 (May 22, 2019) (File No. SR-OCC-2019-002); Exchange Act 
Release No. 85870 (May 15, 2019), 84 FR 23096 (May 21, 2019) (File 
No. SR-OCC-2019-801).
---------------------------------------------------------------------------

    The current synthetic modeling approach suffers from limitations 
and issues similar to the current Implied Volatilities Scenarios Model. 
For one, the current synthetic model relies on the GARCH variance 
forecast, which, as described above, is prone to volatility shocks. To 
address this, the Synthetic Futures Model employs an anti-procyclical 
floor for variance

[[Page 8075]]

estimates.\28\ Secondly, the current synthetic model makes the rolling 
volatility futures contracts take on different variances from 
calibration at futures roll dates, which could translate to jumps in 
margin.
---------------------------------------------------------------------------

    \28\ In order to incorporate a variance level implied by a 
longer time series of data, OCC calculates a floor for variance 
estimates based on the underlying index (e.g., VIX) which is 
expected to have a longer history that is more reflective of the 
long-run variance level that cannot be otherwise captured using the 
synthetic futures data. The floor therefore reduces the impact of a 
sudden increase in margin requirements from a low level and 
therefore mitigates procyclicality in the model.
---------------------------------------------------------------------------

Current Model for Variance Futures
    Variance futures are commodity futures for which the underlying 
interest is a variance.\29\ Variance futures differ from volatility 
index futures in that the underlying variance is calculated using only 
historical daily closing values of the reference variable while an 
underlying volatility index represents the implied volatility component 
of bid and ask premium quotations for options on a reference variable. 
When a variance futures contract is listed, it defines the initial 
variance strike. This initial variance strike represents the estimated 
future variance at contract expiration. The final settlement value is 
determined based on a standardized formula for calculating the realized 
variance of the S&P 500 measured from the time of initial listing until 
expiration of the contract. At maturity, the buyer of the contract pays 
the amount of predefined strike to the seller and the seller pays the 
realized variances. Therefore, the buyer profits if the realized 
variance at maturity exceeds the predefined variance strike. S&P 500 
variance futures are exchange-traded futures contracts based on the 
realized variance of the S&P 500.
---------------------------------------------------------------------------

    \29\ A variance is a statistical measure of the variability of 
price returns relative to an average (mean) price return. 
Accordingly, OCC believes that an underlying variance is a 
``commodity'' within the definition of Section 1a(4) of the 
Commodity Exchange Act (``CEA''), which defines ``commodity'' to 
include ``all . . . rights, and interests in which contracts for 
future delivery are presently or in the future dealt in.'' 7 U.S.C. 
1a(9). OCC believes a variance is neither a ``security'' nor a 
``narrow-based security index'' as defined in Section 3(a)(10) and 
Section 3(a)(55)(A) of the Exchange Act, respectively, and therefore 
is within the exclusive jurisdiction of the CFTC. OCC clears this 
product in its capacity as a DCO registered under Section 5b of the 
CEA. See Exchange Act Release No. 49925 (June 28, 2004), 69 FR 40447 
(July 2, 2004) (File No. SR-OCC-2004-08).
---------------------------------------------------------------------------

    OCC uses the current Variance Futures Model to calculate the 
theoretical value of variance futures for purposes of calculating 
margin for Clearing Member portfolios. OCC's current Variance Futures 
Model was introduced in 2007 and is an econometric model designed to 
capture long- and short-term conditional variance of the underlying S&P 
500 to generate variance futures prices. OCC's current approach to 
modeling variance futures has several disadvantages. OCC currently 
models variance futures by simulating a final settlement price rather 
than a near-term variance futures price. This approach is not 
consistent with OCC's two-day liquidation horizon. In addition, the 
current Variance Futures Model is based on an econometric model that 
assumes the S&P 500 return variance can be described by the GARCH(1,1) 
model and that the long-term variation follows and Ornstein-Uhlenbeck 
process.\30\ As with the use of GARCH for the Implied Volatilities 
Scenarios Model, this approach has several limitations, including (1) 
the current approach does not provide appropriate risk offsets with 
other instruments closely related to the S&P 500 implied volatility, 
such as VIX futures; and (2) the margin rates it generates are too 
conservative for short positions and too aggressive for long positions, 
which causes model backtesting to fail.
---------------------------------------------------------------------------

    \30\ See Uhlenbeck, G. E. and L.S. Ornstein, ``On the Theory of 
Brownian Motion,'' Physical Review, 36, 823-841 (1930) (explaining 
the Gaussian Ornstein-Uhlenbeck process).
---------------------------------------------------------------------------

Proposed Change
    OCC is proposing to replace the Implied Volatilities Scenarios 
Model for S&P 500-based products, the Synthetic Futures Model for 
volatility index-based products, and the Variance Future Model for 
variance futures with new models that would simplify the STANS 
methodology, control procyclicality in volatility modeling, provide 
natural offsets for volatility products with similar characteristics, 
and build the foundation for a single, consistent framework to model 
equity volatility products in margin and stress testing.
Proposed Changes to the Implied Volatilities Scenarios Model for S&P 
500-Based Products
    OCC proposes to replace the current Implied Volatilities Scenarios 
Model with the proposed S&P 500 Implied Volatility Simulation Model for 
the S&P 500 product group.\31\ The purpose of the proposed S&P 500 
Implied Volatility Simulation Model is to establish a consistent and 
robust framework for implied volatility simulation, provide appropriate 
control for procyclicality in S&P 500 implied volatility modeling, and 
provide natural offsets for volatility products with similar 
characteristics to S&P 500 implied volatility (e.g., VIX futures and 
options). The output of the S&P 500 Implied Volatility Simulation Model 
would be used by OCC's options pricing model, as well as the proposed 
Volatility Index Futures Model and Variance Futures Model.
---------------------------------------------------------------------------

    \31\ The S&P 500 Implied Volatility Model has been designed to 
model implied volatility dynamics for options written on the S&P 500 
and related indexes, such as S&P 500 index options (``SPX'') and S&P 
500 Exchange Traded Funds (``SPY'') options, options on S&P 500 
futures, and related implied volatility derivatives such as VIX 
futures and Miax's SPIKES Volatility Index (``SPIKES''). While OCC 
would continue to use the current Implied Volatilities Scenarios 
Model for the products other than S&P 500-based products to which 
the model currently applies, the S&P 500 Implied Volatility 
Simulation Model is intended to provide a foundation upon which OCC 
can build a single consistent framework to model single-name and 
index/futures equity volatility products for margin and stress 
testing.
---------------------------------------------------------------------------

Proposed S&P 500 Implied Volatility Simulation Model Description
    The proposed S&P 500 Implied Volatility Simulation Model is a Monte 
Carlo simulation model that captures the risk dynamics in S&P 500 
implied volatility surface including its term structure and skew. This 
proposed model aims to provide enhanced treatment for simulating the 
dynamics of S&P 500 options and replace the nine-pivot approach in 
STANS, to provide appropriate control for procyclicality in S&P 500 
implied volatility modeling, and to provide natural offsets for 
volatility products with similar characteristics of S&P 500 implied 
volatility (e.g., VIX futures and options).
    The proposed approach would model the implied volatility surface in 
the space of standardized log-moneyness and tenor. Based on the 
approximation of the Bergomi-Guyon expansion,\32\ the dynamics of S&P 
500 implied volatility surface would be characterized by an affine 
model. In the model, the dynamics of S&P 500 at-the-money (``ATM'') 
implied volatility would be specified precisely in the form of 
stochastic differential equations \33\ for a fixed number of key 
tenors. The changes of S&P 500 ATM implied volatility across different 
tenors would be characterized by the volatility-of-volatility of the 
anchor tenor with a power law decay term structure and a residual term-
specific random process. The power law decay parameter would be modeled 
as a function of S&P 500

[[Page 8076]]

1-month ATM implied volatility. For any arbitrary tenors within the key 
tenor range, the term-specific correlation structure would be given by 
a linear interpolation across the nearest two key tenors. For any 
arbitrary tenors outside the key tenor range, the term-specific 
correlation structure would be determined by the shortest or longest 
key tenor, respectively.
---------------------------------------------------------------------------

    \32\ See Bergomi, Lorenzo, and Julien Guyon, ``Stochastic 
volatility's orderly smiles,'' Risk 25.5 (2012): 60.
    \33\ A stochastic differential equation is a differential 
equation in which one or more of the terms is a stochastic process, 
resulting in a solution which is also a stochastic process.
---------------------------------------------------------------------------

    OCC assumes changes of skew (i.e., skew shock) evolve 
proportionally across different standardized log-moneyness and also 
follow a power law decay term structure. OCC would model the S&P 500 1-
month implied volatility skew shock via a linear regression approach 
conditional on the changes of S&P 500 1-month ATM implied volatility 
and an idiosyncratic term.
    OCC would generate the simulated scenarios of S&P 500 implied 
volatility surface by first applying shocks across term structure and 
then skew shock across moneyness to the initial S&P 500 implied 
volatility surface (obtained through OCC's smoothing algorithm).\34\ 
Along with other risk factors in STANS, the standard uniform draws of 
the S&P 500 1-month ATM implied volatility risk factor is generated 
from Copula. First, the log-return scenarios of S&P 500 1-month ATM 
implied volatility would be simulated from a Hansen's skewed t 
distribution with pre-determined degrees-of-freedom and skewness 
parameters. The forecasted volatility-of-volatility for S&P 500 1-month 
ATM implied volatility would be estimated based on the 30-day VVIX, 
Cboe's option-implied volatility-of-volatility index. An equal-weighted 
look-back moving average would be applied to smooth the daily 30-day 
VVIX. To control for procyclicality, a dynamic scaling factor would be 
applied to the smoothed 30-day VVIX. The log-return scenarios of S&P 
500 ATM implied volatility for a given listed tenor would be generated 
based on the log-return scenarios of the 1-month ATM implied volatility 
with a power law decay and the term-specific residuals for tenors 
longer than 1 month. The random variables for the term-specific 
residual diffusion process would be drawn from a multivariate Student's 
t distribution with common degrees-of-freedom.
---------------------------------------------------------------------------

    \34\ The smoothing algorithm is the process that OCC uses to 
estimate fair values for plain vanilla listed options based on 
closing bid and ask price quotes. See Exchange Act Release No. 86731 
(Aug. 22, 2019), 84 FR 45188, 45189 (Aug. 28, 2019) (File No. SR-
OCC-2019-005).
---------------------------------------------------------------------------

    Secondly, OCC would simulate the S&P 500 1-month implied volatility 
skew shock conditional on the log-return scenarios of S&P 500 1-month 
ATM implied volatility and an idiosyncratic term. OCC would generate 
the skew shock scenarios for listed options with arbitrary tenors and 
standardized log-moneyness by applying the power law decay and scaling 
by the stylized standardized log-moneyness scenarios. Finally, OCC 
would add the skew shock scenario to the shocked S&P 500 ATM implied 
volatility scenario to obtain the final S&P 500 implied volatility 
scenario for an arbitrary tenor and standardized log-moneyness. OCC 
would use the simulated S&P 500 implied volatility scenarios to 
generate option prices used in margin estimation and stress testing.
Proposed S&P 500 Implied Volatility Simulation Model Performance
    The proposed S&P 500 Implied Volatility Simulation Model simplifies 
the STANS methodology by minimizing the number of implied volatility 
risk factors. Under the current model, the nine implied volatility 
pivots used to simulate volatility scenarios have significantly 
increased the dimension of the Student's t copula by adding nine risk 
factors to every index or security that has listed options. The 
proposed S&P 500 Implied Volatility Simulation Model would employ a 
simpler approach to model the S&P 500 implied volatility surface so 
that key risk factors driving the implied volatility surface are 
explicitly modeled within the model itself. By modeling the implied 
volatility surface directly, instead of using the nine-pivot approach, 
the simulated implied volatility surface would be smooth and continuous 
in both term structure and moneyness dimensions. In addition, put and 
call options with the same tenors and strike prices would have the same 
implied volatility scenarios under the proposed model. Thus, the S&P 
500 Implied Volatility Simulation Model would address issues with the 
current model's implied volatility surface and scenarios as discussed 
above.
    To compensate for the procyclicality in the GARCH process, the 
current model employs an exponentially weighted moving average overlay 
to reduce and delay the impact of large implied volatility spikes. In 
the proposed S&P 500 Implied Volatility Simulation Model, the 
forecasted variance of the S&P 500 1-Month ATM implied volatility would 
be simulated using the smoothed 30-day VVIX, which is a proxy of the 
option-implied volatility-of-volatility, scaled by a dynamic factor to 
control for procyclicality. OCC believes the proposed model would be a 
better and sounder method to produce consistent and smooth simulated 
implied volatility scenarios in both term structure and skew dimensions 
for S&P 500 and to control the procyclicality in margin requirements. 
As borne out by observations on the performance of the proposed model 
discussed below, OCC believes that these proposed changes also reduce 
the oversensitivity observed with the GARCH process under the current 
Implied Volatilities Scenarios Model to large, sudden shocks in market 
volatility and produce margin requirements that are more stable and 
that remain commensurate with the risks presented during stressed 
periods.
    Based on its analysis of the S&P 500 Implied Volatility Simulation 
Model's performance, OCC concludes that the proposed model accurately 
recovers the correlation structure of the S&P 500 ATM implied 
volatilities as well as the VIX futures across different tenors, which 
benefits margin coverage of portfolios containing S&P 500 options, VIX 
futures, and S&P 500 options and VIX futures. Moreover, the proposed 
model provides adequate margin coverages for both upward and downward 
movements of implied volatility over the margin risk horizon. The 
margin coverage is stable across time and low, medium, and high 
volatility market conditions. The model parameters would periodically 
be recalibrated to incorporate more recent data and backtesting 
performance.
    In addition, the implied volatility scenarios generated by the 
proposed model observed fewer arbitrage violations and tighter 
consistency between VIX and S&P 500 option price scenarios.\35\ The 
proposed methodology's mitigation of arbitrage is sufficient to allow 
OCC to use S&P 500 Implied Volatility Simulation model in pricing 
volatility index futures and variance futures, which assume an 
arbitrage-free condition. In this way, the proposed changes support 
enhanced margin offsetting between S&P 500 options, VIX futures, and 
S&P 500 variance futures, which is naturally captured by the proposed 
models.
---------------------------------------------------------------------------

    \35\ OCC believes that the proposed model's improvements to the 
number of arbitrage violations is explained by two factors: (i) 
Replacing the current model's approximate delta-based function for 
the volatility curve--which leads to arbitrage prices between call 
and put options of the same strike and expiration--with the proposed 
model's standardized log-moneyness approach, and (ii) replacing the 
current model's nine pivot points method with a methodology that 
produces an implied volatility surface that is continuous in strike 
and time space.
---------------------------------------------------------------------------

    OCC has performed backtesting of the current models and proposed 
models, including the proposed Volatility Index Futures Model, to 
compare and evaluate

[[Page 8077]]

the performance of each model from a margin coverage perspective. 
Overall, the proposed models, when tested along with other models in 
STANS, provided adequate margin coverage under different market 
conditions over the backtesting period. Moreover, compared to the 
current models, the margin coverage from the proposed model is more 
stable and less procyclical, especially under stressed market 
conditions.
Proposed Changes to the Synthetic Futures Model for Volatility Index-
Based Products
    OCC proposes to use the Volatility Index Futures Model, rather than 
the current Synthetic Futures Model, to derive the theoretical fair 
values of volatility index futures.\36\ OCC would also use the 
Volatility Index Futures Model to calculate the implied forward price 
for options on volatility indexes, including options on VIX and 
SPIKES.\37\ The purpose of the proposed change is to replace the 
current method for pricing volatility index futures with an industry-
standard method based on Cboe's option replication formula augmented 
with a convexity correction. As discussed below, OCC believes that the 
proposed model will produce more accurate and stable results than the 
current Synthetic Futures Model, which suffers from the limitations 
discussed above, including that (i) the Synthetic Futures Model 
produces results that are not strongly correlated with S&P 500 option 
prices and volatility and are more susceptible to volatility shocks due 
to the sensitivity of the GARCH process; and (ii) the Synthetic Futures 
Model depends on the historical calibration for various parameters, 
which can create artifacts due to the roll dates of VIX futures.
---------------------------------------------------------------------------

    \36\ In addition to the VIX index, Cboe calculates several other 
volatility indexes including the Cboe Short Term Volatility Index 
(VXST), which reflects the 9-day expected volatility of the S&P 500, 
as well as the Cboe Nasdaq-100 Volatility Index (VXN), Cboe DJIA 
Volatility Index (VXD), Cboe Russell 2000 Volatility Index (RVX) and 
Cboe S&P 500 3-Month Volatility Index (VXV) and the Cboe S&P 500 6-
Month Volatility Index (VXMT). The Volatility Index Futures Model 
may apply to futures contracts written on these and other volatility 
indexes if and when such futures contracts are listed, depending on 
OCC's assessment of whether those futures contracts meet the model 
assumptions and subject to OCC obtaining all necessary regulatory 
approval to apply the Volatility Index Futures Model to such futures 
contracts.
    \37\ OCC calculates the implied forward price for options on 
indexes using the basis futures price. See Exchange Act Release No. 
86296 (July 3, 2019), 84 FR 32821 (July 9, 2019) (File No. SR-OCC-
2019-005) (enhancing OCC's smoothing algorithm).
---------------------------------------------------------------------------

Proposed Volatility Index Futures Model Description
    The proposed Volatility Index Futures Model would alleviate the 
issues observed with the current Synthetic Futures Model by adopting a 
parameter-free approach based on the replication of log-contract, which 
measures the expected realized volatility using S&P 500 options, as 
discussed in Cboe's VIX white paper.\38\ The proposed model would 
derive the theoretical fair value of volatility index futures via 
replication through a portfolio of vanilla S&P 500 options \39\ using 
the proposed S&P 500 Implied Volatility Simulation Model and convexity 
adjustments, which reflect the concavity of the square root function 
used to convert variance into volatility. A basis adjustment would be 
computed to reflect the difference between the market price and the 
theoretical value at the base level and then applied to the simulated 
volatility index futures prices at the scenario level to align the 
simulation to the market. The output from the Volatility Index Futures 
Model would be an input to the options pricing model, which treats the 
volatility index Futures as the underlying of the options contract. By 
providing a direct link between the volatility index futures price and 
the underlying S&P 500 options price, OCC believes that the Volatility 
Index Futures Model would result in more sensible margin charges 
compared to the current model.
---------------------------------------------------------------------------

    \38\ See Cboe, VIX White Paper (2021), available at https://cdn.cboe.com/resources/vix/vixwhite.pdf.
    \39\ In some cases with limited listed strikes, additional 
strikes will be interpolated or extrapolated to provide more robust 
results.
---------------------------------------------------------------------------

Proposed Volatility Index Futures Model Performance
    Based on its analysis of the Volatility Index Futures Model's 
performance,\40\ OCC has concluded the proposed model would provide 
more consistent and better-behaved margin coverage across the term 
structure when compared to the current Synthetic Futures Model. The 
Volatility Index Futures Model demonstrates desirable anti-
procyclicality properties, providing adequate margin coverage during 
periods of high volatility without being too conservative in periods of 
low volatility. Furthermore, the propose model generates adequate 
margin coverage for short-term futures which is manifested in the 
pronounced Samuelson effect.\41\ OCC believes three reasons account for 
the improved performance of the Volatility Index Futures Model: (1) The 
proposed model provides a direct link between the futures price and the 
underlying option prices via replication; (2) the margin coverage of 
VIX futures is closely coupled with the S&P 500 Implied Volatility 
Simulation Model with procyclicality control, whereas the Synthetic 
Futures Model relies on the GARCH variance forecast process, which is 
prone to overreaction to shocks; and (3) unlike the Synthetic Futures 
Model, the Volatility Index Futures Model is not subject to the 
calibration artifact due to the 500-day lookback window, nor does it 
require the rolling VIX futures contracts to take on different 
variances from calibration at futures roll dates, which translate to 
discontinuities in margin under the current method.
---------------------------------------------------------------------------

    \40\ See Confidential Exhibit 3 to File No. SR-OCC-2022-001.
    \41\ The Samuelson effect refers to a decrease in volatility 
with increasing time to maturity.
---------------------------------------------------------------------------

    For VIX futures portfolios \42\ hedged with S&P 500 options, the 
proposed models provide more efficient margin coverage.\43\ The 
improvement in margin coverage can be attributed to the direct coupling 
between VIX futures and S&P 500 options, which gives rise to risk-
offsetting effect from the volatility. This result demonstrates that 
the replication method in conjunction with the S&P 500 Implied 
Volatility Simulation Model is better able to capture the correlations 
between VIX futures and S&P 500 options and produce cross-hedging 
benefits for Clearing Members.
---------------------------------------------------------------------------

    \42\ VIX futures are commonly incorporated into a large S&P 500 
portfolio as hedging instruments for volatility risk. For example, 
one could gain pure exposure to underlying spot movements of the S&P 
500 by buying/selling VIX futures to hedge the vega risk (i.e., risk 
of changes in implied volatility) of S&P 500 options.
    \43\ See Confidential Exhibit 3 to File No. SR-OCC-2022-001.
---------------------------------------------------------------------------

Proposed Changes to the Variance Futures Model
    OCC proposes to replace the current Variance Futures Model in its 
entirety. As discussed above, OCC uses the current Variance Futures 
Model to derive the theoretical fair values of variance futures for 
calculating margin and clearing fund requirements based on Clearing 
Member portfolios. Like the proposed Volatility Index Futures Model, 
the proposed Variance Futures Model would employ an industry-standard 
fundamental replication technique using the log-contract to price 
variance futures.\44\ OCC expects that this approach would not only 
provide more

[[Page 8078]]

accurate prices, but also offer natural risk offsets with the options 
of the same underlying security. In addition, the proposed Variance 
Futures Model would no longer be reliant on a GARCH variance forecast 
process, thereby addressing the sensitivity and procyclicality of that 
process to volatility shocks observed with the current model. 
Furthermore, the proposed method would simulate a near-term variance 
futures price rather than a final settlement price, consistent with 
OCC's two-day liquidation assumption.
---------------------------------------------------------------------------

    \44\ This approach is based on Cboe's published method for 
pricing S&P 500 variance futures. See Cboe, S&P 500 Variance Futures 
Contract Specification (Dec. 10, 2012), available at http://www.cboe.com/products/futures/va-s-p-500-variance-futures/contract-specifications.
---------------------------------------------------------------------------

Proposed Variance Futures Model Description
    The theoretical variances produced by the proposed Variance Futures 
Models would be comprised of two components. The first component, as 
under the current Variance Futures Model, would be the realized 
variance calculated by the realized daily returns of S&P 500 option 
prices.\45\ The second component captures the unrealized variance, 
which OCC would approximate using a portfolio of out of the money 
(``OTM'') call and put European options. The proposed model would 
calculate the implied component of variance futures via replication 
through a portfolio of OTM option prices generated using the proposed 
S&P 500 Implied Volatility Simulation Model.
---------------------------------------------------------------------------

    \45\ Additional strikes may be interpolated or extrapolated from 
listed strikes to provide more robust results.
---------------------------------------------------------------------------

Proposed Variance Futures Model Performance
    Based on its analysis of the current and proposed Variance Futures 
Model,\46\ the proposed model shows significant improvement in margin 
coverage. The proposed model naturally captures the correlations 
between S&P 500 options, variance futures, and VIX. Compared to the 
current model, the proposed model provides adequate long and short 
coverage for periods of high volatility and reasonable levels for 
periods of low volatility. In particular, the proposed model 
significantly reduces long-side coverage exceedances. The proposed 
model produces higher correlation for neighboring variance futures and 
adequate coverage without being overly conservative on the short side. 
OCC expects that any changes to the overall margins of Clearing Member 
accounts would be limited; over the twelve-month period between May 
2019 and April 2020, only four margin accounts held variance futures 
positions and the total risk from variance futures positions was less 
than one percent of the total risk of all the positions for each of 
those accounts.
---------------------------------------------------------------------------

    \46\ See Confidential Exhibit 3 to File No. SR-OCC-2022-001.
---------------------------------------------------------------------------

Implementation Timeframe
    OCC expects to operate the proposed model in parallel with the 
current model for a period of at least thirty (30) days before 
implementing the proposed model into production to give Clearing 
Members an opportunity to understand the practical effects of the 
proposed changes. OCC further expects to implement the proposed changes 
within sixty (60) days after the date that OCC receives all necessary 
regulatory approvals for the proposed changes. OCC will announce the 
implementation date of the proposed change by an Information Memorandum 
posted to its public website at least 2 weeks prior to implementation.
(2) Statutory Basis
    OCC believes that the proposed rule change is consistent with 
Section 17A of the Exchange Act \47\ and the rules and regulations 
thereunder applicable to OCC. Section 17A(b)(3)(F) of the Act \48\ 
requires, in part, that the rules of a clearing agency be designed to 
promote the prompt and accurate clearance and settlement of securities 
transactions, and in general, to protect investors and the public 
interest. As described above, the volatility changes forecasted by 
OCC's current Implied Volatilities Scenarios Model are sensitive to 
large, sudden spikes in volatility, which can at times result in 
overreactive margin requirements that OCC believes are unreasonable and 
procyclical (for the reasons set forth above). Such sudden, 
unreasonable increases in margin requirements may stress certain 
Clearing Members' ability to obtain liquidity to meet those 
requirements, particularly in periods of extreme volatility, and could 
result in a Clearing Member being delayed in meeting, or ultimately 
failing to meet, its daily settlement obligations to OCC. A Clearing 
Member's failure to meet its daily settlement obligations could, in 
turn, cause the suspension of such Clearing Member and the liquidation 
of its portfolio, which could harm investors. While the current Implied 
Volatilities Scenarios Model addresses this issue with an exponentially 
weighted moving average that reduces and delays the impact of large 
implied volatility spikes, it does so in an artificial way that does 
not target the primary issues with the GARCH process that OCC has 
identified. By modeling implied volatility in a more direct, coherent 
manner, the proposed S&P 500 Implied Volatility Simulation Model would 
therefore reduce the likelihood that OCC's models would produce 
extreme, overreactive margin requirements that could strain the ability 
of certain Clearing Members to meet their daily margin requirements at 
OCC by controlling procyclicality in OCC's margin methodology and 
ensuring more stable and appropriate changes in margin requirements 
across volatile market periods while continuing to capture changes in 
implied volatility and produce margin requirements that are 
commensurate with the risks presented. The proposed model would be used 
by OCC to calculate margin requirements designed to limit its credit 
exposures to participants, and OCC uses the margin it collects from a 
defaulting Clearing Member to protect other Clearing Members and their 
customers from losses as a result of the default and ensure that OCC is 
able to continue the prompt and accurate clearance and settlement of 
its cleared products. As a result, OCC believes the S&P 500 Implied 
Volatility Simulation Model is designed to promote the prompt and 
accurate clearance and settlement of securities transactions, and, 
thereby, to protect investors and the public interest in accordance 
with Section 17A(b)(3)(F) of the Exchange Act.\49\
---------------------------------------------------------------------------

    \47\ 15 U.S.C. 78q-1.
    \48\ 15 U.S.C. 78q-1(b)(3)(F).
    \49\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    In addition, OCC believes the proposed changes to establish the 
Volatility Index Futures Model and replace the Variance Futures Model 
are consistent with Section 17A(b)(3)(F) of the Act.\50\ Both the 
Volatility Index Futures Model and the Variance Futures Model exhibit 
procyclicality issues as a result of their reliance on the GARCH 
variance forecast process, which is prone to volatility shocks. The 
proposed Volatility Index Futures Model and Variance Futures Model 
would address these issues by adopting a fundamental replication 
technique using the log-contract to price volatility index futures and 
variance futures. In addition to providing a consistent modeling 
approach to modeling equity volatility products that provides accurate 
prices, this approach also offers natural risk offsets with the options 
of the same underlying security. This model is also expected to 
alleviate concerns around high margin requirements for S&P 500 variance 
futures generated by current STANS systems. As discussed above, 
collecting margins that are commensurate with risk helps to avoid

[[Page 8079]]

collection of excessive margin that may stress certain Clearing 
Members' ability to obtain liquidity to meet those requirements, 
particularly in periods of extreme volatility, and could result in 
Clearing Member defaults that could harm investors and other Clearing 
Members. These changes would also provide natural offsets between S&P 
500 options, volatility index Futures and variance futures. The 
proposed models would be used by OCC to calculate margin requirements 
designed to limit its credit exposures to participants. OCC uses the 
margin it collects from a defaulting Clearing Member to protect other 
Clearing Members from losses as a result of the default and ensure that 
OCC is able to continue the prompt and accurate clearance and 
settlement of its cleared products. Accordingly, OCC believes these 
proposed rule changes are designed to promote the prompt and accurate 
clearance and settlement of securities and derivatives transactions and 
to protect investors and the public interest in accordance in 
accordance with Section 17A(b)(3)(F) of the Exchange Act.\51\
---------------------------------------------------------------------------

    \50\ Id.
    \51\ Id.
---------------------------------------------------------------------------

    OCC also believes that the proposed changes are consistent with 
Rule 17Ad-22(e)(6).\52\ In particular, paragraphs (i), (iii), and (v) 
of Rule 17Ad-22(e)(6) \53\ require a covered clearing agency that 
provides central counterparty services to establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to cover its credit exposures to its participants by 
establishing a risk-based margin system that (1) considers, and 
produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market; (2) 
calculates margin sufficient to cover its potential future exposure to 
participants in the interval between the last margin collection and the 
close out of positions following a participant default; and (3) uses an 
appropriate method for measuring credit exposure that accounts for 
relevant product risk factors and portfolio effects across products. As 
noted above, OCC's current models for implied volatility and pricing 
volatility index futures and variance futures demonstrate sensitivity 
to sudden spikes in volatility, which can at times result in 
overreactive margin requirements that OCC believes are unreasonable and 
procyclical. The proposed changes are designed to reduce the 
oversensitivity of the model and produce margin requirements that are 
commensurate with the risks presented during periods of sudden, extreme 
volatility. The proposed changes are designed to reduce procyclicality 
in OCC's margin methodology and ensure more stable changes in margin 
requirements across volatile market periods while continuing to capture 
changes in implied volatility and produce margin requirements that are 
commensurate with the risks presented by OCC's cleared options. As a 
result, OCC believes that the proposed changes are reasonably designed 
to consider, and produce margin levels commensurate with, the risk 
presented by the implied volatility of OCC's cleared options, as well 
as the risk presented by volatility index futures and variance futures; 
calculate margin sufficient to cover its potential future exposure to 
participants in the interval between the last margin collection and the 
close out of positions following a participant default; and use an 
appropriate method for measuring credit exposure that accounts for this 
product risk factor (i.e., implied volatility) and for these products 
(i.e., volatility index futures and variance futures) in a manner 
consistent with Rules 17Ad-22(e)(6)(i), (iii) and (v).\54\
---------------------------------------------------------------------------

    \52\ 17 CFR 240.17Ad-2(e)(6).
    \53\ 17 CFR 240.17Ad-2(e)(6)(i), (iii), (v).
    \54\ Id.
---------------------------------------------------------------------------

(B) Clearing Agency's Statement on Burden on Competition

    Section 17A(b)(3)(I) 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 Act.\55\ The proposed S&P 500 Implied 
Volatility Simulation Model would be used to incorporate variations in 
implied volatility within STANS for S&P 500-based products for all 
Clearing Members. The Volatility Index Futures Model and Variance 
Futures Model would be used to calculate the theoretical values of 
volatility index futures and variance futures, respectively, for all 
Clearing Members. Accordingly, OCC does not believe that the proposed 
rule change would unfairly inhibit access to OCC's services.
---------------------------------------------------------------------------

    \55\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    While the proposed rule change may impact different accounts to a 
greater or lesser degree depending on the composition of positions in 
each account, OCC does not believe that the proposed rule change would 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act. As discussed above, 
OCC is obligated under the Exchange Act and the regulations thereunder 
to establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover 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.\56\ Overall, the impact analysis shows that at 
the account level, margin coverage generated by the proposed models is 
comparable to that generated using OCC's existing models for accounts 
dominated by S&P 500 options. While margin charges resulting from the 
proposed changes may be higher or lower than under the current models 
due to compositions of positions in each account, OCC believes that 
margin coverage under the proposed models will be more commensurate 
with the risks presented by its members' activity because the proposed 
models employ a more consistent and sounder approach to modeling 
implied volatility, as discussed above. For accounts dominated by 
volatility index futures and variance futures, the proposed models are, 
in general, expected to produce more accurate margin requirement 
because by using S&P 500 options to calculate the price for such 
products, the proposed models provide natural offsets for volatility 
products with similar characteristics. In addition, the proposed models 
are expected to produce margin requirements that are more stable across 
time, especially during stressed market conditions--thereby addressing 
known issues with the current GARCH-based models. As such, OCC believes 
the proposed changes would result in margin requirements commensurate 
with the vega risk presented by Clearing Members' portfolios, 
consistent with OCC's obligations under the Exchange Act and 
regulations thereunder. Accordingly, OCC believes that the proposed 
rule change would not impose any burden or impact on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.
---------------------------------------------------------------------------

    \56\ See 17 CFR 240.17Ad-2(e)(6)(i).
---------------------------------------------------------------------------

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants or Others

    Written comments on the proposed rule change were not and are not 
intended to be solicited with respect to the proposed rule change and 
none have been received.

[[Page 8080]]

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.
    OCC shall post notice on its website of proposed changes that are 
implemented. The proposal shall not take effect until all regulatory 
actions required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-OCC-2022-001 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

    All submissions should refer to File Number SR-OCC-2022-001. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for website viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of such filing also will be available for inspection 
and copying at the principal office of OCC and on OCC's website at 
https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly.
    All submissions should refer to File Number SR-OCC-2022-001 and 
should be submitted on or before March 4, 2022.
---------------------------------------------------------------------------

    \57\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\57\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-02913 Filed 2-10-22; 8:45 am]
BILLING CODE 8011-01-P