Document ID: SEC-2020-1204-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: The Options Clearing Corp.
Posted Date: 2020-07-30T04:00Z

[Federal Register Volume 85, Number 147 (Thursday, July 30, 2020)]
[Notices]
[Pages 45943-45946]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16467]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-89393; File No. SR-OCC-2020-008]

Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Enhance OCC's Stock Loan 
Close-Out Process

July 24, 2020.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that on July 14, 2020, 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 primarily by OCC. The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The proposed rule change would amend OCC Rules 2211 and 2211A, 
which concern the close-out of a defaulting Hedge Clearing Member's or 
Market Loan Clearing Member's (each a ``defaulting Clearing Member'') 
stock loan positions, respectively, to require Lending Clearing Members 
or Borrowing Clearing Members (each a ``non-defaulting Clearing 
Member'') whom OCC instructs to buy-in or sell-out securities to 
execute such transactions and provide OCC notice of such action by the 
settlement time for a Clearing Member's obligations to OCC on the 
business day after OCC gives the instruction.\3\ In addition, OCC 
proposes to amend Rules 2211 and 2211A to provide that if a non-
defaulting Clearing Member so instructed does not execute the trades 
and provide notice by that time, OCC will terminate the Stock Loan and 
effect settlement based upon the Marking Price at the close of business 
on the day that OCC provided the instruction. OCC submitted the 
proposed amendments to OCC's Rules in Exhibit 5. Material proposed to 
be added to OCC's Rules as currently in effect is marked by underlining 
and material proposed to be deleted is marked with strikethrough text. 
All terms with initial capitalization that are not otherwise defined 
herein have the same meaning as set forth in the By-Laws and Rules.\4\
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    \3\ ``Buy-in'' refers to a non-defaulting lender purchasing 
replacement stock. ``Sell-out'' refers to a non-defaulting borrower 
selling the loaned securities in order to recoup its collateral.
    \4\ OCC's By-Laws and Rules can be found on OCC's public 
website: http://optionsclearing.com/about/publications/bylaws.jsp.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

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

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

(1) Purpose
    OCC proposes amendments to OCC Rules 2211 and 2211A designed to 
ensure that OCC has authority and operational capacity to take timely 
action to contain losses and liquidity demands and continue to meet its 
obligations in the event of a Clearing Member default by more closely 
aligning the close-out of stock loan positions through buy-in and sell-
out transactions with the timing of an auction of a defaulting Clearing 
Member's other positions and to ensure that the close-out of a 
defaulting Clearing Member's stock loan positions by buy-in or sell-out 
transactions occurs within OCC's two-day liquidation assumption. The 
proposed amendments to the Rules are discussed in more detail below.
Background
    OCC operates two programs in which it acts as a central 
counterparty for stock loan transactions: (1) The Stock Loan/Hedge 
Program and (2) Market Loan Program (collectively, the ``Stock Loan 
Programs''). Stock Loan/Hedge Program transactions are initiated 
directly between Clearing Members on a bilateral basis (i.e., ``broker-
to-broker'' model) and Market Loan Program transactions are initiated 
on either a broker-to-broker basis or anonymously through the matching 
of bids and offers (i.e., ``market'' model). Both programs rely on The 
Depository Trust Company (``DTC'') to facilitate the settlement of 
equity securities and cash collateral between members.
    Under the Stock Loan Programs, OCC novates the transaction and 
becomes the

[[Page 45944]]

lender to the Borrowing Clearing Member and the borrower to the Lending 
Clearing Member upon receiving reports from DTC showing completed Stock 
Loans, provided that OCC has not rejected such transactions.\5\ As the 
principal counterparty to the Borrowing and Lending Clearing Members, 
OCC guarantees the return of the full value of cash collateral to a 
Borrowing Clearing Member and guarantees the return of the Loaned Stock 
(or value of that Loaned Stock) to the Lending Clearing Member.\6\ 
After novation, as part of the guaranty, OCC makes Mark-to-Market 
Payments for all cleared Stock Loans on a daily basis to collateralize 
all loans to the negotiated levels. Settlements generally are combined 
and netted against other OCC settlement obligations in a Clearing 
Member's account, including trade premiums and margin deficits. 
Clearing Member open positions in the Stock Loan Programs are factored 
into the Clearing Member's overall Margin \7\ and Clearing Fund 
contribution requirements.\8\
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    \5\ See OCC Rules 2202(b) and 2202A(b). OCC receives DTC 
confirmation upon settlement of delivery versus payment. See 
generally DTC Settlement Services Guide, available at http://
www.dtcc.com/~/media/Files/Downloads/legal/service-guides/
Settlement.pdf (discussing the operation of the ``Option Exercise & 
Assignment Loan Program'').
    \6\ Under the Market Loan Program, OCC also provides a limited 
guaranty of dividend and rebate payments.
    \7\ See OCC Rules 601 and 2203.
    \8\ See OCC Rule 1001.
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    In the event a Clearing Member defaults, OCC closes the defaulting 
Clearing Member's positions, liquidates collateral, and deposits any 
proceeds into a Liquidating Settlement Account. The close-out of 
positions other than stock loan positions would typically be effected 
by an auction that would occur on the morning prior to market opening 
on the day after a default occurs.\9\ In contrast, OCC's Rules allow 
OCC to close stock loan positions by instructing the non-defaulting 
Clearing Members who are parties to the defaulting Clearing Member's 
loans to sell-out or buy-in securities as applicable.\10\ A non-
defaulting Clearing Member is required to provide OCC with evidence of 
the execution price at which each transaction occurred. This execution 
price is used as the settlement price to facilitate the final mark 
between the non-defaulting Clearing Member and the Liquidating 
Settlement Account. Currently, non-defaulting Clearing Members are 
required to buy-in or sell-out the relevant securities by the close of 
business on the stock loan business day after OCC's instruction.\11\ If 
a non-defaulting Clearing Member fails to execute such buy-in or sell-
out, OCC would terminate the stock loan position and mark the 
transaction based upon the Marking Price at close of business on the 
business day after OCC's instruction.\12\
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    \9\ While this timing describes the typical scenario, the timing 
of an auction is not set by regulation or OCC's By-Laws or Rules, 
which allows for an auction on an accelerated timeline, if needed. 
In addition, OCC's Rules also allow for the close-out of a 
defaulting Clearing Member's portfolio by open market transactions 
and hedging transactions to reduce the risks to OCC associated with 
holding open positions. See OCC Rule 1106.
    \10\ OCC may also effect the close-out of stock loan positions 
by re-matching Matched-Book Positions, an auction, or in such other 
manner as OCC determines to be the most orderly manner practicable 
under the circumstances. OCC Rules 2210(b) and 2210A(b).
    \11\ See OCC Rules 2211 (Suspension of Hedge Clearing Members--
Buy-In and Sell-Out Procedures) and 2211A (Suspension of Market Loan 
Clearing Members--Buy-In and Sell-Out Procedures).
    \12\ Id.
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    The buy-in/sell-out process for stock loan positions has 
significant benefits as it distributes the liquidity demands across 
multiple counterparties, each of whom effectively act as independent 
liquidating agents. The buy-in/sell-out process also aligns the 
liquidity demands necessary to facilitate an unwind with the Clearing 
Member receiving proceeds from the origination of the loan and 
currently in possession of the collateral. However, the difference in 
timing between an auction and the buy-in/sell-out process presents 
credit and liquidity risks for OCC. Specifically, because OCC's 
portfolio-based margin methodology combines stock loan positions with 
options, futures, and margin collateral when determining margin 
requirements, the difference in timing could expose OCC to increased 
credit and liquidity risk should the price of the stock loan positions 
move unfavorably between the time of auction and determination of the 
final settlement price for remaining buy-in/sell-out transactions and 
should that price differential exceed the amount of margin on deposit 
for such positions.
Enhancement to Stock Loan Programs Close-Out Rules
    In response to these concerns, OCC proposes to amend OCC Rules 2211 
and 2211A to require buy-in or sell-out transactions to be complete by 
the settlement time for a Clearing Member's obligations to OCC, defined 
in Article I of the By-Laws,\13\ on the stock loan business day after 
OCC gives non-defaulting Clearing Members the buy-in/sell-out 
instruction. If a non-defaulting Clearing Member does not execute the 
trades and provide notice by that time, OCC would terminate the Stock 
Loan and effect settlement based upon the Marking Price at the close of 
business the previous business day (i.e., the day that OCC provided the 
instruction). This Marking Price (i.e., closing price) would be the 
last settlement price captured in OCC's systems prior to the time by 
which the non-defaulting Clearing Member was supposed to have taken 
such actions.
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    \13\ By-Law Article I, Section 1.S.(16) defines ``settlement 
time'' with respect of a Clearing Member's obligations to OCC to 
mean 9:00 a.m. Central Time.
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    This proposed enhancement is designed to mitigate the risks 
associated with the difference in timing between close-out of stock 
loan positions and an auction for the remainder of defaulting Clearing 
Member's portfolio. In the typical case, an auction to close positions 
for other products would occur on the morning prior to market opening 
on the day after a default event occurs. Accelerating the deadline for 
buy-in or sell-out transactions to that morning--rather than the end of 
the stock loan business day--would reduce credit and liquidity risks by 
aligning liquidation timing across products more closely.
    The proposed enhancement also is designed to ensure that the close-
out process for the Stock Loan Programs would occur in a manner 
consistent with OCC's two-day liquidation assumption (which is 
applicable to all products without differentiation). At the earliest, a 
defaulting Clearing Member would have made its last margin payment at 
the settlement time on the business day prior to default. When that 
Clearing Member fails to make its margin or mark-to-market payments the 
next morning, OCC would suspend it and typically would issue the buy-
in/sell-out instruction to non-defaulting Clearing Members. The 
proposed requirement that non-defaulting Clearing Members execute buy-
in and sell-out transactions by the settlement time on the business day 
after default ensures that close-out occurs in a manner consistent with 
the two-day liquidation assumption.
    OCC considered requiring non-defaulting Clearing Members to execute 
buy-in or sell-out transactions by the end of the business day on the 
same day as OCC's instruction but believes extending the process to the 
following morning is the better option. In discussion with several 
Clearing Members, they expressed a preference for setting the deadline 
at 9:00 a.m. Central Time the following business day because doing so 
would allow a non-defaulting Clearing Member the

[[Page 45945]]

opportunity to trade at market opening. OCC believes allowing non-
defaulting Clearing Members to trade at market opening the following 
morning would provide additional time to execute the buy-in and sell-
out method in a manner consistent with OCC's two-day liquidation 
assumption.\14\ OCC also presented the proposed change at a meeting of 
its Financial Risk Advisory Council (``FRAC''), a working group 
comprised of exchanges, Clearing Members and other market 
participants.\15\ No participant objected to OCC's proposal to 
accelerate the close-out timing. While questions were raised about the 
proposal to use the Marking Price at the close of business the day 
prior in the event a Clearing Member fails to act by the settlement 
time the next day, OCC believes using the last Marking Price available 
in its system prior to the time by which a Clearing Member is obligated 
to take action is superior because OCC's automated systems are designed 
to determine the Marking Price based on closing securities prices. The 
manual processes that OCC would need to institute to pull pricing 
information other than closing prices would make the stock loan close-
out process more susceptible to delay and errors.
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    \14\ OCC is considering a proposal to move its settlement time 
from 9:00 a.m. settlement time earlier in the day, in which case the 
deadline for a non-defaulting Clearing Member instructed to buy-in 
or sell-out would change to the new settlement time.
    \15\ OCC submitted the relevant portions of the presentation 
provided at the April 16, 2019 FRAC meeting in confidential Exhibit 
3.
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Implementation Timeframe
    OCC expects to implement the proposed changes within thirty (30) 
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 one (1) weeks prior to 
implementation.
(2) Statutory Basis
    OCC believes the proposed rule change is consistent with Section 
17A of the Exchange Act and the rules and regulations thereunder. In 
particular OCC believes that the proposed rule change is consistent 
with Section 17A(b)(3)(F) \16\ of the Exchange Act and Rule 17Ad-
22(e)(13) \17\ and (e)(23) \18\ thereunder for the reasons described 
below.
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    \16\ 15 U.S.C. 78q-1(b)(3)(F).
    \17\ 17 CFR 240.17Ad-22(e)(13).
    \18\ 15 U.S.C. 78q-1(b)(3)(F).
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    Section 17A(b)(3)(F) of the Exchange Act,\19\ requires, among other 
things, that the rules of a clearing agency be designed to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible. The 
proposed rule change would help mitigate the potential credit and 
liquidity risks associated with the difference in timing between the 
close-out of a defaulting Clearing Member's stock loan positions by 
buy-in or sell-out transactions and the close-out of the remainder of 
its portfolio by auction. Furthermore, the proposed rule change would 
ensure that the close-out of stock loan positions is consistent with 
the two-day liquidation assumption upon which OCC's margin calculations 
rely. Therefore, OCC believes that the proposed rule change is 
consistent Section 17A(b)(3)(F) because it helps safeguard against the 
possibility that OCC would need to charge the Clearing Fund 
contributions of non-defaulting Clearing Members to meet settlement 
obligations in the event of a member default.
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    \19\ 15 U.S.C. 78q-1(b)(3)(F).
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    Rule 17Ad-22(e)(13) requires covered clearing agencies to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, in part, ensure the covered clearing 
agency has the authority and operational capacity to take timely action 
to contain losses and liquidity demands and continue to meet its 
obligations in the event of a Clearing Member default.\20\ By more 
closely aligning the close-out of stock loan positions with the close-
out of other positions, these proposed changes to OCC's default 
management processes would help mitigate credit and liquidity risks 
should the price of the stock loan positions move unfavorably between 
the time of auction and determination of the final settlement price for 
remaining buy-in/sell-out transactions and should that price 
differential exceed the amount of margin on deposit for such positions. 
In addition, the proposed change would give OCC the authority and 
operational capacity to take timely action to contain credit losses by 
authorizing OCC to cash-settle positions within OCC's two-day 
liquidation time horizon should a non-defaulting Clearing Member fail 
to report buy-in or sell-out transactions as instructed. Hence, OCC 
believes the proposed rule change is reasonably designed to ensure that 
OCC's default management processes contain losses and liquidity demands 
and continue to meet settlement demands in the event of a Clearing 
Member default.
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    \20\ 17 CFR 240.17Ad-22(e)(13).
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    Rule 17Ad-22(e)(23) requires covered clearing agencies to maintain 
written policies and procedures reasonably designed to, among other 
things, provide for publicly disclosing all relevant rules and material 
procedures, including key aspects of its default rules and 
procedures.\21\ The proposed rule changes would amend OCC's Rules, 
which are available on OCC's websites, to provide for the new deadline 
for non-defaulting Clearing Members to buy-in or sell-out if so 
instructed by OCC in the event of a Clearing Member default, as well as 
how OCC would close out a stock loan position if a non-defaulting 
Clearing Member failed to do so. Therefore, OCC believes the proposed 
changes would disclose default rules and procedures to the public and 
to Clearing Members so that they can understand their obligations in 
the event of a Clearing Member default.
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    \21\ 17 CFR 240.17Ad-22(e)(23).
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(B) Clearing Agency's Statement on Burden on Competition

    Section 17A(b)(3)(I) of the Exchange Act requires that the rules of 
a clearing agency not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Exchange Act.\22\ OCC 
does not believe that the proposed rule change would have any impact or 
impose any burden on competition. The proposed rules are generally 
designed to align the timeframe for buy-in or sell-out of stock loan 
positions more closely with the close-out of the defaulting Clearing 
Member's other positions by auction and to ensure the close-out of 
stock loan positions is consistent with OCC's two-day liquidation 
assumption. The new deadline for buy-in and sell-out transactions, as 
well as the rules governing the determination of the Marking Price when 
a Clearing Member fails to buy-in or sell-out as directed, would be 
equally applicable to all Clearing Members in OCC's Stock Loan 
Programs. Accordingly, OCC does not believe that the proposed rule 
change would have any impact or impose a burden on competition.
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    \22\ 15 U.S.C. 78q-1(b)(3)(I).
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(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.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Exchange 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 rule-comments@sec.gov. Please include 
File Number SR-OCC-2020-008 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-2020-008. 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/about/publications/bylaws.jsp.
    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-2020-008 and 
should be submitted on or before August 20, 2020.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-16467 Filed 7-29-20; 8:45 am]
BILLING CODE P