Document ID: SEC-2014-1873-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Options Clearing Corp.
Posted Date: 2014-11-06T05:00Z

[Federal Register Volume 79, Number 215 (Thursday, November 6, 2014)]
[Notices]
[Pages 66010-66013]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-26345]

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73483; File No. SR-OCC-2014-14]

Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change To Better Manage Risks 
Concentration and Other Risks Associated With Accepting Deposits of 
Common Stocks for Margin Purposes

October 31, 2014.
    On July 15, 2014, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange

[[Page 66011]]

Commission (``Commission'') the proposed rule change SR-OCC-2014-14 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 thereunder.\2\ The proposed rule change was 
published for comment in the Federal Register on August 5, 2014.\3\ The 
Commission did not receive any comments on the proposed rule change. 
This order approves the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 72717 (July 30, 2014), 
79 FR 45523 (August 5, 2014) (SR-OCC-2014-14). OCC also filed 
proposals contained in this proposed rule change as an advance 
notice under Section 806(e)(1) of the Payment, Clearing, and 
Settlement Supervision Act of 2010 (``Payment, Clearing and 
Settlement Supervision Act'') and Rule 19b-4(n)(1) of the Act, which 
was published for comment in the Federal Register on August 15, 
2014. 12 U.S.C. 5465(e)(1); 17 CFR 240.19b-4(n)(1). See Securities 
Exchange Act Release No. 72803 (August 11, 2014), 79 FR 48285 
(August 15, 2014) (SR-OCC-2014-803). The Commission did not receive 
any comments on the advance notice.
---------------------------------------------------------------------------

I. Description

    According to OCC, the purpose of this proposed rule change is to 
permit OCC to better manage concentration risk and wrong-way risk 
associated with accepting deposits of common stock for margin purposes. 
In order to manage such risks, OCC proposed to add an Interpretation 
and Policy to Rule 604, which specifies the forms of margin assets 
accepted by OCC, that will provide OCC with discretion with respect to 
giving value to assets deposited by a single clearing member to satisfy 
its margin requirement(s). In addition, OCC proposed to make clarifying 
amendments to an existing Interpretation and Policy under Rule 604 that 
gives OCC discretion to not give value to a particular type of margin 
collateral across all clearing members.

a. Background

    OCC Rule 604 lists the types of assets that clearing members may 
deposit with OCC to satisfy their margin requirement(s) as well as sets 
forth eligibility criteria for such assets. According to OCC, common 
stocks, including Exchange Traded Funds (``ETFs'') and Exchange Traded 
Notes (``ETNs''), are the most common form of margin assets deposited 
by clearing members and currently comprise 68% of the $60.6 billion in 
clearing member margin deposits held by OCC (not including deposits in 
lieu of margin). According to OCC, since 2009, OCC has used its System 
for Theoretical Analysis and Numerical Simulations (``STANS''), which 
is OCC's daily automated Monte Carlo simulation-based margining 
methodology, to value common stocks deposited by clearing members as 
margin.\4\ The value given to margin deposits depends on factors that 
include the price volatility and the price correlation relationship of 
common stock collateral to the balance of the cleared portfolio. The 
approach used by STANS incentivizes clearing members who chose to meet 
their margin obligations with deposits of common stocks to choose 
common stocks that hedge their related open positions.
---------------------------------------------------------------------------

    \4\ See Securities Exchange Act Release No. 58158 (July 15, 
2008), 73 FR 42646 (July 22, 2008) (SR-OCC-2007-20).
---------------------------------------------------------------------------

    According to OCC, notwithstanding the value STANS gives to deposits 
of common stocks, certain factors warrant OCC adjusting the value STANS 
gives to all clearing member margin deposits of a particular type of 
margin collateral. Such factors are set forth in Rule 604, 
Interpretation and Policy .14, and include the number of outstanding 
shares, number of outstanding shareholders and overall trading volume. 
OCC is proposing to add a new Interpretation and Policy to Rule 604 
(the ``Interpretation'') so that OCC has discretion to not give margin 
credit to a particular clearing member when such clearing member 
deposits a concentrated amount of any common stock and when a common 
stock, deposited as margin, presents ``wrong-way risk'' to OCC. In 
addition, the Interpretation will provide OCC discretion to grant 
margin credit to a clearing member when it deposits shares of common 
stock that serve as a hedge to the clearing member's related open 
positions and would otherwise be not be given margin credit.\5\
---------------------------------------------------------------------------

    \5\ According to OCC, consistent with the language contained in 
existing Interpretation & Policy .14, the Interpretation provides 
OCC with discretion in determining the amount of margin credit given 
to deposits of common stock by an individual clearing member as such 
determination would be based on positions held and common stock 
deposits made by such clearing member on a given business day. 
However, as discussed in the following two sections, OCC also has 
developed certain automated processes as well as additional internal 
policies that describe how OCC presently intends to exercise such 
discretion. According to OCC, these additional internal policies are 
included in OCC's collateral risk management policy, which will not 
be implemented until approval of this rule change with changes 
thereto being subject to additional rule filings.
---------------------------------------------------------------------------

b. Concentrated Deposits of Common Stock

    OCC has determined that in the event it is necessary to liquidate a 
clearing member's positions (including the clearing member's margin 
collateral), OCC may be exposed to risk arising from a large quantity 
of a particular common stock deposited as margin by a clearing member. 
Specifically, depending on the relationship between the average daily 
trading volume of a particular security and the number of outstanding 
shares of such security deposited by a clearing member as margin, it is 
possible that the listed equities markets may not be able to quickly 
absorb all of the common stock OCC seeks to sell, or OCC may not be 
able to auction such securities, without an appreciable negative price 
impact. This occurrence, referred to by OCC as ``concentration risk,'' 
is greatest when the number of shares being sold is large and the 
average daily trading volume is low.
    OCC's existing authority to not give value to otherwise eligible 
forms of margin only provides OCC with the discretion to not give value 
across all clearing member deposits of a particular common stock. 
However, concentration risk may be a clearing member and account-
specific risk. In order to mitigate the concentration risk of a single 
clearing member, OCC plans to implement automated processes to monitor 
the composition of a clearing member's margin deposits. Such processes 
will identify concentration risk at both an account level and across 
all accounts of a clearing member. OCC proposed to add the 
Interpretation so that OCC has discretion to limit the margin credit 
granted to an individual clearing member that maintains a concentrated 
margin deposit of otherwise eligible common stock.
    According to OCC, for the reasons stated above, OCC considers a 
common stock's average daily trading volume and the number of shares a 
clearing member deposited as margin to be the two most significant 
factors when making a decision to limit margin credit due to 
concentration risk. Accordingly, OCC will not give margin credit to 
clearing member margin deposits of a particular common stock in respect 
of a particular account when the deposited amount of such common stock 
is in excess of two times the average daily trade volume of such common 
stock over the most recent three month period. OCC's systems will 
continually assess the composition of clearing member margin deposits 
for each account maintained by the clearing member, including intra-day 
collateral substitutions in such accounts, to determine if a clearing 
member has a margin deposit with a concentrated amount of common stock. 
With respect to a given account, OCC's systems will automatically set 
appropriate limits on the amount of a particular common stock for which 
a clearing member may be given margin credit for any one of its

[[Page 66012]]

tier accounts. In addition, and with respect to all of a clearing 
member's accounts, OCC will impose an add-on margin charge if, in 
aggregate, a clearing member deposits a concentrated amount of a 
particular common stock as margin across all of its accounts. The add-
on margin charge will operate to negate the margin credit given to the 
concentrated margin deposit, and will be collected, when applicable, as 
part of OCC's standard morning margin process. OCC will assess the add-
on margin charge across all of a clearing member's accounts on a pro-
rata basis (based on the amount of the particular common stock in each 
of a clearing member's accounts).\6\
---------------------------------------------------------------------------

    \6\ According to OCC, since a 2-day limit is first checked at 
each account, it is possible that a clearing member with multiple 
accounts may have more than 2-days of a given common stock on 
deposit in aggregate. To control this condition, a final check is 
done on the aggregate amount of shares held by a clearing member 
across all of its accounts. For example, if a particular clearing 
member has three accounts each holding 2-days volume of a specific 
common stock, the clearing member check would identify that the 
member was holding six days of volume in aggregate. To mitigate this 
risk, an add-on charge equal to the market value of four days of 
volume would be applied to all accounts holding that security on a 
pro-rata basis.
---------------------------------------------------------------------------

    According to OCC, OCC staff has been monitoring concentrated common 
stock positions, assessing the impact of the proposed rule change 
described in this filing and contacting clearing members affected by 
the proposed rule change. OCC believes that clearing members will be 
able to comply with the proposed rule change without making significant 
changes to their day-to-day business operations. In December 2013, an 
information memo was posted to inform all members of the upcoming 
change. According to OCC, since January 2014, OCC staff has been in 
contact with any clearing member that would be affected by the proposed 
rule change. On a weekly basis, any clearing member that would see a 
reduction of 10% or more of its collateral value is contacted and 
provided an explanation of the policy and a list of concentrated 
positions observed in this analysis. On a monthly basis, all clearing 
members exhibiting any concentration risk are contacted to provide an 
explanation of the proposed policy and a list of concentrated 
positions. In both cases, clearing members are encouraged to 
proactively reduce concentrated positions to conform to the proposed 
policy. As of June 2014, twenty-five members would be affected. 
Implementation of the Interpretation would result in disallowing $1.2 
billion in collateral value and result in margin calls for six members 
totaling $710 million. Moreover, in July 2014, OCC made an automated 
report concerning concentrated margin deposits of common stock 
available to all clearing members.

c. Wrong-Way Risk

    OCC also proposed to use the Interpretation to address the risk 
that the common stock a clearing member has deposited as margin and 
which is issued by the clearing member itself or an affiliate of the 
clearing member will lose value in the event the clearing member 
providing such margin defaults, which is known as ``wrong-way risk.'' 
According to OCC, wrong-way risk occurs when a clearing member makes a 
deposit of common stock issued by it or an affiliate and, in the event 
the clearing member defaults, the clearing member's common stock margin 
deposit will also be losing value at the same time because there is 
likely to be a strong correlation between the clearing member's 
creditworthiness and the value of such common stock. In order to 
address wrong-way risk, the Interpretation will implement automated 
systems that will not give margin credit to a clearing member that 
deposits common stock issued by such clearing member or an affiliate as 
margin collateral. OCC proposed to define ``affiliate'' broadly in the 
Interpretation to include any entity with direct or indirect equity 
ownership of 10% of the clearing member, or any entity for which the 
clearing member holds 10% of the direct or indirect equity 
ownership.\7\
---------------------------------------------------------------------------

    \7\ This standard is based on the provisions of OCC Rule 
215(a)(5).
---------------------------------------------------------------------------

    OCC has addressed the impact of the change designed to address 
wrong-way risk. As of June 2014, there were 73 clearing members whose 
parent or an affiliate has issued securities trading on U.S. exchanges. 
As of June 2014, there are six clearing members that would be affected 
by virtue of having made margin deposits of their own or an affiliate's 
common stock. In total, these shares equaled $132 million and accounted 
for less than one half of one percent of the total market value of 
valued securities pledged as margin at OCC. In July 2014, OCC made 
information available to each clearing member that indicates which of 
its deposits of common stock would not receive margin credit under the 
proposed change due to wrong-way risk considerations, as described 
above.\8\
---------------------------------------------------------------------------

    \8\ OCC believes that by providing such information clearing 
members will be better able to adjust their margin deposits at OCC 
to conform to the proposed rule change if it is approved.
---------------------------------------------------------------------------

d. Deposits That Hedge Open Positions

    In addition to the above, OCC also proposed to include language in 
the Interpretation so that it has discretion to give margin credit to 
common stock deposited as margin that would otherwise not be given 
margin credit in circumstances when such common stock acts as a hedge 
(i.e., the member holds an equivalent short position in cleared 
contracts on the same underlying security). This condition will be 
checked in both the account and clearing member level. For example, if 
a clearing member deposits the common stock of an affiliate as margin 
collateral, which, pursuant to the above, would ordinarily not be given 
value for the purposes of granting margin credit, OCC may nevertheless 
give value to such common stock for the purposes of granting margin 
credit to the extent such common stock acts as a hedge against open 
positions of the clearing member. In this case, a decline in the value 
of the margin deposit would be wholly or partially offset by an 
increase in the value in the open position. Moreover, in such a 
situation, OCC will systematically limit the margin credit granted to 
the lesser of a multiple of the daily trading volume or the ``delta 
equivalent position'' \9\ for the particular common stock, taking into 
account the hedging position.\10\ OCC believes that this policy will 
further encourage clearing members to deposit margin collateral that 
hedges their related open

[[Page 66013]]

positions and is in line with the valuation methods within STANS. This 
policy will also facilitate OCC's management of its and its 
participants' credit exposure as well as the liquidation of a clearing 
member's portfolio should the need arise.
---------------------------------------------------------------------------

    \9\ According to OCC, the ``delta equivalent position'' is the 
equivalent number of underlying shares represented by the 
aggregation of cleared products on that same underlying instrument. 
This value is calculated using the ``delta'' of the option or 
futures contract, which is the ratio between the theoretical change 
in the price of the options or futures contract to the corresponding 
change in the price of an underlying asset. Thus, delta measures the 
sensitivity of an options or futures contract price to changes in 
the price of the underlying asset. For example, a delta of +0.7 
means that for every $1 increase in the price of the underlying 
stock, the price of a call option will increase by $0.70. Delta for 
an option or future can be expressed in shares of the underlying 
asset. For example, a standard put option with a delta of-.45 would 
have a delta of-45 shares, because the unit of trading is 100 
shares.
    \10\ Assume, for example, an average daily trade volume of 250 
shares, a threshold of 2 times the average daily trade volume, and a 
delta of -300 shares for the options on a particular security in a 
particular account. A position of 700 shares that did not hedge any 
short options or futures would receive credit for only 500 shares 
(i.e., 2 times the average daily trade volume). If the net long 
position in the account, when combined with the delta of short 
option and futures position, were only 400, credit would be given 
for the entire 700 shares since the delta equivalent position is 
below the 500 share threshold. However, if the option delta were 
+300, the net long position would be 1000, and credit would only be 
given for 500 shares because the delta equivalent position would 
exceed the 500 share threshold.
---------------------------------------------------------------------------

e. Other Proposed Changes

    OCC also proposed to make certain clarifying changes in order to 
accommodate the adoption of the Interpretation into its Rules. 
Primarily, OCC proposed to add language to OCC Rule 604, Interpretation 
and Policy .14, to clarify that such Interpretation and Policy concerns 
OCC's authority to not give value to certain margin deposits for all 
clearing members (whereas the Interpretation applies to particular 
clearing member(s)). In addition, OCC proposed to remove language from 
OCC Rule 604, Interpretation and Policy .14, to improve readability as 
well as to remove ``factors'' concerning number of shares and 
affiliates since OCC's authority with respect to such factors will be 
more clearly described in the Interpretation. Finally, OCC proposed to 
renumber the Interpretations and Policies of Rule 604 in order to 
accommodate the adoption of the Interpretation.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \11\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that the proposed rule change is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to such 
organization.
---------------------------------------------------------------------------

    \11\ 15 U.S.C. 78s(b)(2)(C).
---------------------------------------------------------------------------

    The Commission finds that the proposed rule change is consistent 
with Section 17A(b)(3)(F) of the Act,\12\ and Rule 17Ad-22(b)(2) of the 
Act.\13\ Section 17A(b)(3)(F) of the Act \14\ requires a registered 
clearing agency to have rules that are designed to, among other things, 
promote the prompt and accurate clearance and settlement of securities 
transactions, and to assure the safeguarding of securities and funds 
which are in the custody or control of the clearing agency or for which 
it is responsible. OCC's proposed rule change is consistent with this 
rule because by implementing margin collateral requirements that 
address concentration risk and wrong-way risk, OCC's proposed rule 
change is consistent with promoting the prompt and accurate clearance 
and settlement of securities transactions and assuring the safeguarding 
of securities and funds which are in OCC's custody or control or for 
which OCC is responsible. The proposed changes are designed to reduce 
the risk that clearing member margin assets would be insufficient 
should OCC need to use such assets to close-out positions of a 
defaulted clearing member. The changes are also designed to facilitate 
OCC to timely meet its settlement obligations because the proposed 
change will diminish the likelihood that a large percentage of the 
value of a defaulting clearing member's margin assets would not be 
available to OCC to cover losses in the event of a clearing member 
default.
---------------------------------------------------------------------------

    \12\ 15 U.S.C. 78q-1(b)(3)(F).
    \13\ 17 CFR 240.17Ad-22(b)(2).
    \14\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    OCC's proposed rule change is consistent with Rule17Ad-22(b)(2) of 
the Act.\15\ Rule 17Ad-22(b)(2) of the Act \16\ requires a registered 
clearing agency that performs central counterparty services to, among 
other things, establish, implement, maintain and enforce written 
policies and procedures reasonably designed to use margin requirements 
to limit its credit exposures to participants under normal market 
conditions. This proposal is consistent with this rule because it is 
reasonably designed to permit OCC to use margin requirements to limit 
its credit exposures to clearing members under normal market conditions 
in two ways. First, it is reasonably designed to limit OCC's credit 
exposures to clearing members whose collateral portfolios could present 
concentration risk. Specifically, it addresses concentration risk by 
particular clearing member and by particular account by giving OCC 
discretion to disapprove as margin collateral certain securities, based 
on the number of shares deposited, by particular clearing member and by 
particular account, while also considering deposits that hedge open 
positions. It also clarifies that OCC's existing authority to not give 
value to certain margin deposits applies to all clearing members, as 
opposed to particular clearing members.\17\ Second, it is reasonably 
designed to limit OCC's credit exposures to clearing members whose 
collateral portfolios could present wrong-way risk. Specifically, it 
addresses wrong-way risk presented by clearing members who deposit as 
margin securities that are issued by the clearing member itself or by 
an affiliate of the clearing member. It addresses this type of wrong-
way risk by giving OCC discretion to disapprove as margin collateral, 
with respect to a particular clearing member, any security issued by 
such clearing member or by an affiliate of such clearing member, while 
also considering deposits that hedge open positions.
---------------------------------------------------------------------------

    \15\ 17 CFR 240.17Ad-22(b)(2).
    \16\ Id.
    \17\ See Rule 604, Interpretation and Policy .15 (providing OCC 
discretion to disapprove as margin collateral securities that meet 
certain factors, including trading volume, number of outstanding 
shareholder, number of outstanding shares, volatility and 
liquidity).
---------------------------------------------------------------------------

    Rule 17Ad-22(b)(2) of the Act \18\ also requires a registered 
clearing agency that performs central counterparty services to, among 
other things, establish, implement, maintain and enforce written 
policies and procedures reasonably designed to use risk-based models 
and parameters to set margin requirements. This proposal is consistent 
with this rule because it permits OCC to use risk-based models and 
parameters to set margin requirements in a way that takes into account 
concentration risk and wrong-way risk, as described above.
---------------------------------------------------------------------------

    \18\ 17 CFR 240.17Ad-22(b)(2).
---------------------------------------------------------------------------

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and, in 
particular, with the requirements of Section 17A of the Act \19\ and 
the rules and regulations thereunder.
---------------------------------------------------------------------------

    \19\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-OCC-2014-14) be, and it 
hereby is, approved, as of the date of this order or the date of a 
notice by the Commission noticing, pursuant to Section 806(e)(1)(I) of 
the Payment, Clearing and Settlement Supervision Act,\21\ that the 
Commission does not object to the proposal in OCC's advance notice (SR-
OCC-2014-803) and OCC is authorized to implement the proposal, 
whichever is later.
---------------------------------------------------------------------------

    \20\ 15 U.S.C. 78s(b)(2).
    \21\ 12 U.S.C. 5465(e)(1)(I).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\22\
---------------------------------------------------------------------------

    \22\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-26345 Filed 11-5-14; 8:45 am]
BILLING CODE 8011-01-P