
[Federal Register Volume 77, Number 244 (Wednesday, December 19, 2012)]
[Notices]
[Pages 75243-75250]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-30547]



[[Page 75243]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68434; File Numbers SR-OCC-2012-14 and AN-OCC-2012-01]


Self-Regulatory Organizations; Options Clearing Corporation; 
Order Approving Proposed Rule Change, as Modified by Amendment No. 1 
Thereto, and Notice of No Objection to Advance Notice, Modified by 
Amendment No. 1 Thereto, Relating to the Clearance and Settlement of 
Over-the-Counter Options

December 14, 2012.

I. Introduction

    On August 30, 2012, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2012-14 pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder 
\2\ (``Proposed Rule Change'') and as an Advance Notice (SR-OCC-2012-
01) pursuant to Section 806(e) of Title VIII of the Dodd-Frank Act 
(``Title VIII'' or ``Clearing Supervision Act'') \3\ (the Proposed Rule 
Change with the Advance Notice, the ``Proposal''). The Proposed Rule 
Change and Advance Notice were published for comment in the Federal 
Register on September 18, 2012 \4\ and September 27, 2012,\5\ 
respectively. On October 26, 2012, the Commission extended the time 
within which to act on the Proposal.\6\ The Commission received no 
comment letters. On November 30, 2012, OCC filed Amendment No. 1 to the 
Proposal.\7\ This Order approves the Proposed Rule Change and serves as 
notice of no objection to the Advance Notice.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 12 U.S.C. 5465(e).
    \4\ Securities Exchange Act Release No. 67835 (September 12, 
2012), 77 FR 57602 (September 18, 2012).
    \5\ Securities Exchange Act Release No. 67906 (September 21, 
2012), 77 FR 59431 (September 27, 2012).
    \6\ Notice of Designation of a Longer Period for Commission 
Action on Proposed Rule Change Relating to the Clearance and 
Settlement of Over-the-Counter Options, Release No. 34-68112 
(October 26, 2012); 77 FR 66497 (November 5, 2012); Notice of 
Extension of Review Period of Advance Notice to Establish the Legal 
and Operational Framework for Providing Central Clearing of OTC 
Index Options on the S&P 500 Index That Are Negotiated Bilaterally 
in the Over-The-Counter Market and Submitted to OCC for Clearance, 
Release No. 34-68111 (October 26, 2012), 77 FR 66196 (November 2, 
2012).
    \7\ In Amendment No. 1, OCC proposed to amend Article XVII of 
its By-laws to clarify that Section 6 of that Article, pertaining to 
OTC Index Options, are inoperative until further notice by OCC, as 
well as to amend Item 3 of the proposed rule change to clarify that 
the clearing of OTC Options will not occur until certain 
enhancements related to longer-tenor options have been approved and 
implemented.
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II. Description of the Proposal

    The purpose of this Proposal is to establish a legal and 
operational framework for OCC to provide central clearing of certain 
OTC index options on the S&P 500 Index (``OTC S&P 500 Index 
Options'').\8\ OCC will not commence clearing of OTC S&P 500 Index 
Options until a subsequent proposal concerning certain enhancements to 
OCC's risk modeling and risk management procedures (``Risk Management 
Proposal'') \9\ is approved by the Commission and implemented by 
OCC.\10\ OCC anticipates using the same legal and operational framework 
as contained in the Proposal for clearing additional OTC equity options 
or OTC equity index options in the future, subject to the requisite 
regulatory approvals.\11\
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    \8\ The proposed rule change replaces a previously proposed rule 
change which was withdrawn by OCC. See Securities Exchange Act 
Release No. 34-66090 (January 3, 2012), 77 FR 1107 (January 9, 2012) 
(SR-OCC-2011-19).
    \9\ OCC is in the process of implementing risk modeling 
enhancements with respect to longer-tenor options, including OTC S&P 
500 Index Options. The enhancements are part of OCC's ongoing 
efforts to test and improve its risk management operations with 
respect to all longer-tenor options that OCC currently clears. These 
procedures will be submitted for review in a separate proposed rule 
change and advance notice filing, and OCC represents that it will 
not commence clearing of OTC S&P 500 Index Options until such 
procedures have been approved and implemented. See also supra note 
7.
    \10\ Notice of Filing of Advance Notice Relating to the 
Clearance and Settlement of Over-the-Counter Options, Rel. No. 34-
67906 at 15 (Sept. 21, 2012), 77 FR 59431, 59434 (Sept. 27, 2012); 
Notice of Filing of Proposed Rule Change Relating to the Clearance 
and Settlement of Over-the-Counter Options, Rel. No. 34-67835 at 15 
(Sept. 12, 2012), 77 FR 57602, 57606 (Sept. 18, 2012). See also 
supra note 7.
    \11\ See supra notes 9 and 10 and accompanying text.
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OTC Options

    OCC has entered into a license agreement with Standard & Poor's 
Financial Services LLC (``S&P'') that allows OCC to clear OTC options 
on three equity indices published by the S&P: The S&P 500 Index, the 
S&P MidCap 400 Index, and the S&P SmallCap 600 Index. The Proposal 
would allow OCC to clear only OTC S&P 500 Index Options,\12\ and only 
subject to the filing and approval of the Risk Management Proposal, as 
discussed above.\13\ OTC S&P 500 Index Options are limited in tenor to 
between four months and five years and have minimum notional values of 
either 500,000 or 100,000 times the value of the S&P 500 Index.\14\ OCC 
may propose to clear OTC options on other indices and on individual 
equity securities in the future, subject to Commission approval of one 
or more additional rule filings. In establishing a legal and 
operational framework for the potential future clearing of OTC options 
referencing other equities or equity indices, the Proposal defines 
``OTC option'' and ``OTC index option'' (both of which terms include 
OTC S&P 500 Index Options) generically in order to simplify future 
amendments to provide for additional underlying interests. As noted 
above, however, the Proposal by its terms would permit only the 
clearing of OTC S&P 500 Index Options,\15\ and only after the 
Commission's approval and OCC's implementation of a subsequent Risk 
Management Proposal.\16\
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    \12\ See Proposed By-laws, Section 6, Interpretations and 
Policies .01, Proposed Rule Change and Advance Notice by OCC (SR-
OCC-2012-14), available at http://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_12_14.pdf.
    \13\ See supra notes 10 and 10 and accompanying text.
    \14\ See Proposed By-laws, Section 6, Interpretations and 
Policies .01, Proposed Rule Change and Advance Notice by OCC (SR-
OCC-2012-14), available at http://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_12_14.pdf.
    \15\ See id. See also supra notes 9 and 10 and accompanying 
text.
    \16\ See supra notes 10 and 10 and accompanying text.
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    OTC S&P 500 Index Options will be similar to exchange-traded 
standardized equity index options called ``FLEX Options.'' FLEX Options 
are put and call options traded on various options exchanges that allow 
for customization of certain terms. For example, FLEX index Options 
traded on the Chicago Board Options Exchange have six customizable 
terms: (1) Underlying index, (2) put or call, (3) expiration date, (4) 
exercise price, (5) American or European exercise style, and (6) method 
of calculating settlement value.\17\ OCC is the issuer and guarantor of 
FLEX Options and clears FLEX Options traded on multiple exchanges.
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    \17\ See CBOE Rule 24A.4, Terms of FLEX Options, available at 
http://www.cchwallstreet.com/CBOETools/PlatformViewer.asp?selectednode=chp%5F1%5F1%5F25%5F5&manual=%2FCBOE%2Frules%2Fcboe%2Drules%2F.
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    Similar to FLEX Options referencing the S&P 500 Index, OTC S&P 500 
Index Options will allow for customization of a limited number of 
variable terms with a specified range of values that may be assigned to 
each as agreed between the buyer and seller. Parties submitting 
transactions in OTC Options for clearing by OCC will be able to 
customize six

[[Page 75244]]

discrete terms: (1) Underlying index; \18\ (2) put or call; (3) 
exercise price; (4) expiration date; (5) American or European exercise 
style; and (6) method of calculating exercise settlement value on the 
expiration date.\19\ The variable terms and permitted values will be 
specified in the proposed Section 6 of Article XVII of the By-Laws.
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    \18\ Initially, pursuant to this Proposal, the S&P 500 Index 
will be the only permitted underlying index.
    \19\ The expiration date of an OTC option must fall on a 
business day. The method of determining the exercise settlement 
value of an OTC option on its expiration date may be either the 
opening settlement value or the closing settlement value of the 
underlying index (calculated by S&P using the opening or closing 
price, as applicable, in the primary market of each component 
security of the underlying index on the specified expiration date), 
in each case as reported to OCC by CBOE.
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Clearing of OTC Options

    OCC proposes to clear OTC S&P 500 Index Options subject to the same 
basic rules and procedures used for the clearance of listed index 
options, with such modifications to reflect the unique characteristics 
of OTC Options. Transactions in OTC options \20\ will not be executed 
through the facilities of any exchange, but will instead be entered 
into bilaterally and submitted to OCC for clearance through one or more 
providers of trade affirmation services.\21\ In addition, the proposed 
rules require that the counterparties to the OTC Options must be 
eligible contract participants (``ECPs''), as defined in Section 3a(65) 
of the Act,\22\ and Section 1a(18) of the Commodity Exchange Act,\23\ 
as amended (the ``CEA''). Because an OTC S&P 500 Index Option is a 
``security'' as defined in the Act, the proposed rules also require 
that the transactions be cleared through a clearing member of OCC that 
is registered with the Commission as a broker-dealer or one of the 
small number of clearing members that are ``non-U.S. securities firms'' 
as defined in OCC's By-Laws. OCC is not requiring clearing members to 
meet any different financial standards for clearing OTC Index Options, 
as defined in OCC's By-laws and Rules, than those to which they are 
presently subject. However, clearing members must be specifically 
approved by OCC to clear OTC Index Options pursuant to proposed new 
Interpretation and Policy .11 to Section 1 of Article V in order to 
ensure the operational readiness of such clearing members to clear OTC 
Index Options. Clearing members seeking to clear OTC Index Options will 
be required to submit a business expansion request and complete an 
operational review. The operational review is to consist of an initial 
meeting with the clearing member's staff to evaluate the staff's 
experience, confirming the staff's familiarity with current OCC systems 
and procedures, completion of an operational questionnaire, performing 
a high level review of the clearing member's systems and processing 
capabilities, and reviewing other pertinent operational information. 
Successful testing of messaging capability between the clearing member, 
the OTC Trade Source,\24\ and OCC is also necessary. These procedures 
will determine whether the firm is operationally ready to clear OTC 
Index Options.
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    \20\ As noted above, the Proposal by its terms would permit only 
the clearing of OTC S&P 500 Index Options, and only after the 
Commission's approval and OCC's implementation of a subsequent Risk 
Management Proposal. See supra notes 9, 10, and 14 and accompanying 
text. Also as discussed above, while OCC anticipates using the same 
legal and operational framework contained in the Proposal to clear 
additional OTC equity options or OTC equity index options in the 
future, OCC could only do so upon OCC's filing and the Commission's 
approval of one or more additional rule filings.
    \21\ See infra note 266 and accompanying text.
    \22\ 15 U.S.C. 78c(a)(65).
    \23\ 7 U.S.C. 1a(18).
    \24\ See infra note 266 and accompanying text.
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    Exercise of an OTC S&P 500 Index Option will be settled by payment 
of cash by the assigned writer and to the exercising holder through 
OCC's cash settlement system on the business day following exercise in 
exactly the same manner as is the case with exercise settlement of 
listed index options. As in the case of listed index options, the 
exercise-settlement amount will be equal to the difference between the 
current value of the underlying interest and the exercise price of the 
OTC Index Option, times the multiplier that determines the size of the 
OTC Index Option. In the case of OTC S&P 500 Index Options, the 
multiplier will be fixed at 1 (i.e., equal to the value of the S&P 500 
Index).
    OTC S&P 500 Index Options may be carried in a clearing member's 
firm account, in market-maker accounts or in its securities customers' 
account, as applicable. Although customer positions in OTC S&P 500 
Index Options will be carried in the securities customers' account (an 
omnibus account), OCC will use a ``customer ID'' to identify positions 
of individual customers based on information provided by clearing 
members.\25\ However, positions are not presently intended to be 
carried in individual customer sub-accounts, and positions in OTC S&P 
500 Index Options will be margined at OCC in the omnibus customers' 
account on the same basis as listed options. If a clearing member takes 
the other side of a transaction with its customer in an OTC S&P 500 
Index Option, the transaction will result in the creation of a long or 
short position (as applicable) in the clearing member's customers' 
account and the opposite short or long position in the clearing 
member's firm account. The positions could also be includable in the 
internal cross-margining account, subject to any necessary regulatory 
approvals.
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    \25\ Such customer IDs are necessary in order to allow OCC to 
comply with certain terms of OCC's license agreement with S&P. As 
described further below, customer IDs will be used for other 
purposes as well.
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    OCC has stated that OTC S&P 500 Index Options will be fungible with 
each other to the extent that there are OTC S&P 500 Index Options in 
the system with identical terms. However, OCC has stated that it will 
not treat OTC S&P 500 Index Options as fungible with index options 
listed on any exchange, even if an OTC S&P 500 Index Option has terms 
identical to the terms of the exchange-listed option.
    Clearing members that carry customer positions in cleared OTC S&P 
500 Index Options will be subject to all OCC rules governing OCC-
cleared options generally, as well as all applicable rules of the 
Commission and of any self-regulatory organization, including the 
Financial Industry Regulatory Authority (``FINRA''), of which they are 
a member. Section 8 of Article III of OCC's By-Laws provides that, 
subject to the By-Laws and Rules, ``the Board of Directors may suspend 
Clearing Members and may prescribe and impose penalties for the 
violation of the By-Laws or the Rules of the Corporation, and it may, 
by Rule or otherwise, establish all disciplinary procedures applicable 
to Clearing Members and their partners, officers, directors, and 
employees.'' As a condition to admission, Section 3(c) of Article V of 
the By-Laws provides that a clearing member must agree, among other 
things, to ``pay such fines as may be imposed on it in accordance with 
the By-Laws and Rules.'' OCC Rule 305 permits OCC to impose 
restrictions on the clearing activities of a clearing member if it 
finds that the financial or operational condition of the clearing 
member makes it necessary or advisable to do so for the protection of 
OCC, other clearing members, or the general public. OCC Rule 1201(a) 
provides that OCC ``may censure, suspend, expel or limit the 
activities, functions or operations of any Clearing Member for any 
violation of the By-Laws and Rules or its agreements with the 
Corporation.'' In addition to, or in lieu of, such actions, OCC is 
permitted under the same paragraph to impose fines. OCC Rule 1202(b) 
establishes procedures for

[[Page 75245]]

taking any such disciplinary actions. The foregoing provisions are 
sufficient to permit OCC to fine or otherwise discipline a clearing 
member that fails to abide by OCC's By-Laws and Rules applicable to OTC 
options, or to prohibit such clearing member from continuing to clear 
such options.

MarkitSERV Trade Submission Mechanics

    The trade data for an OTC S&P 500 Index Option trade will be 
entered into the system of MarkitSERV or another trade confirmation/
affirmation vendor approved by OCC for this purpose (``OTC Trade 
Source'').\26\ While MarkitSERV will be the only OTC Trade Source at 
launch, OCC has stated that it will permit additional OTC Trade Sources 
in the future in response to sufficient market demand from OCC's 
clearing members and subject to the ability of any such OTC Trade 
Source to meet OCC's requirements for operational readiness and 
interoperability with OCC's systems, as well as requirements with 
respect to relevant business experience and reputation, adequate 
personnel and expertise, financial qualification, and such other 
factors as OCC deems relevant.
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    \26\ MarkitSERV, LLC is owned by Markit Group Limited, Markit 
Group Holdings Limited and The Depository Trust & Clearing 
Corporation. MarkitSERV Limited is a wholly-owned U.K. subsidiary of 
MarkitSERV, LLC. MarkitSERV, LLC and MarkitSERV Limited 
(collectively, ``MarkitSERV'') provide derivatives transaction 
processing, electronic confirmation, portfolio reconciliation 
services, and other related services for firms that conduct business 
in the over-the-counter derivatives markets through a variety of 
electronic systems, including the MarkitWire system. MarkitWire, 
owned by MarkitSERV Limited, is an OTC derivatives electronic 
confirmation/affirmation service offered by MarkitSERV as part of 
its post-trade processing suite of products. The role of MarkitSERV 
and MarkitWire in OCC's clearing of OTC options is described in 
further detail below.
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    MarkitSERV will provide an interface to OCC that allows OCC to 
receive messages containing details of transactions in OTC S&P 500 
Index Options submitted for clearing by clearing members with access to 
MarketWire and also allows OCC to transmit messages to MarkitWire 
participants identifying the status of submitted transactions. 
MarkitSERV will use a ``confirmation/affirmation'' procedure in which 
one party to the trade enters the trade data to the MarkitWire 
platform, which issues a confirmation to the counterparty to be 
affirmed, rejected, or requested to be revised. If the trade details 
are confirmed, the trade will then be submitted to OCC for clearance 
and MarkitSERV will affirm such submission to both parties. OCC will 
then validate the trade information for compliance with applicable 
requirements, such as the identification of an account of an eligible 
clearing member in which each side of the trade will be cleared, that 
the variable terms are within permissible ranges, and that minimum size 
requirements under OCC's license agreement with S&P are met.\27\ This 
validation will be completed by OCC immediately upon submission. OCC's 
clearing system will automatically accept the trade if it passes the 
validation process and will otherwise reject it. Once accepted, a trade 
is guaranteed by OCC.\28\ A trade that is rejected by OCC may be 
corrected and submitted as a new transaction. Parties may submit trades 
for clearance that were entered into bilaterally at any time in the 
past, provided that the eligibility for clearance will be determined as 
of the date the trade is submitted to OCC for clearance.\29\ Clearing 
members and customers with access to MarkitSERV will be able to 
determine whether a trade has been accepted or rejected both through 
MarkitSERV and, in the case of clearing members, through their 
interface with OCC's clearing system.
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    \27\ MarkitWire applications use product-specific templates to 
simplify deal entry and negotiations. The templates specify the data 
required for a given product and also the business validation rules 
for each field. MarkitSERV has included OCC's validation 
requirements for OTC options in its trade templates.
    \28\ Note, however, that OTC options for which the premium 
payment date communicated by MarkitSERV to OCC is prior to the 
business day on which the OTC option is submitted to OCC for 
clearing (``Backloaded OTC Option'') will not be accepted and 
guaranteed until the selling clearing member has met its initial 
morning cash settlement obligations to OCC on the following business 
day.
    \29\ OCC's license agreement with S&P imposes certain 
requirements relating to minimum time remaining to expiration of an 
OTC option.
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Proposed By-Law and Rule Changes \30\
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    \30\ As noted above, the Proposal by its terms would permit only 
the clearing of OTC S&P 500 Index Options, and only after the 
Commission's approval and OCC's implementation of a subsequent Risk 
Management Proposal. See supra notes 9, 10, and 12 and accompanying 
text. Also as discussed above, while OCC anticipates using the same 
legal and operational framework contained in the Proposal to clear 
additional OTC equity options or OTC equity index options in the 
future, OCC could only do so upon OCC's filing and the Commission's 
approval of one or more additional rule filings.
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    Article I of the By-Laws contains defined terms used throughout the 
By-Laws and Rules. OCC proposes to modify certain existing definitions 
and include certain new definitions in order to incorporate OTC options 
into existing rules and facilitate the creation of new provisions 
unique to OTC options. Throughout the By-Laws and Rules, OCC proposes 
to replace the term ``Exchange transaction,'' which is currently 
defined in Article I, in relevant part, as ``a transaction on or 
through the facilities of an Exchange for the purchase, writing or sale 
of a cleared contract'' with the term ``confirmed trade'' so as to make 
the relevant portions of the By-Laws and Rules applicable to 
transactions in OTC options as well as listed options. ``Confirmed 
trade'' is proposed to be defined in Article I to include transactions 
``effected on or through the facilities of an exchange'' or ``affirmed 
through the facilities of an OTC Trade Source'' in order to include 
transactions in both listed options and OTC options. The current 
definition of ``confirmed trade'' in OCC Rule 101 is proposed to be 
deleted as unnecessary given the new definition. OCC is also proposing 
to add an Interpretation and Policy to the new definition of 
``confirmed trade'' in order to avoid any ambiguity concerning how such 
terms should be interpreted in any such agreement.
    OCC proposes to add a new Interpretation and Policy .11 to Section 
1 of Article V of the By-Laws, providing the additional criteria that 
must be met by a clearing member in order to clear OTC index options. 
Among these new criteria are that clearing members seeking to clear OTC 
index options on underlying indices published by S&P must execute and 
maintain in effect a short-form license agreement in such form as 
specified from time to time by S&P.
    The Interpretations and Policies under Section 1, Article VI allow 
clearing members to adjust their positions with OCC for certain 
enumerated reasons. OCC proposes to amend the Interpretations and 
Policies to clarify that adjustment of positions in OTC options will be 
effected through a manual process (as opposed to the electronic process 
available to post-trade adjustments in listed options), to the extent 
permitted by OCC. For the same reason, OCC is proposing to amend OCC 
Rule 403 to prohibit clearing member trade assignment (``CMTA'') 
transactions in OTC options. Trade ``give-ups'' that are effected 
through the CMTA process in the case of listed options will, in the 
case of OTC options, be effected through MarkitSERV before the trades 
are submitted to OCC for clearing.
    Article XVII of the By-Laws governs index options in general and 
OCC is proposing amendments to Article XVII in order to set forth the 
terms applicable to the initial OTC options proposed to be cleared by 
OCC--options on the S&P

[[Page 75246]]

500 Index--and to differentiate OTC index options from other index 
options cleared by OCC. For example, certain amendments to the 
definitions are necessary because OTC options will be permitted to have 
a much wider range of expiration dates than exchange-traded options 
(other than FLEX Options). Additional definitional amendments ensure 
that OTC index options will constitute a separate class of options from 
other cash-settled index options even if both index options have the 
same terms and cover the same underlying interest.
    Section 3 of Article XVII provides for adjustment of the terms of 
outstanding index options as necessary to reflect possible changes in 
the underlying index--such as those creating a discontinuity in the 
level of the index--that could theoretically make an adjustment 
necessary to protect the legitimate expectations of holders and writers 
of options on the index. Pursuant to paragraph (g) of Section 3, most 
but not all such adjustments would be made, in the case of listed index 
options, by an adjustment panel consisting of representatives of the 
exchanges on which the options are traded. In the case of OTC options, 
any such adjustments will be made by OCC in its sole discretion. 
However, in exercising that discretion, OCC may take into consideration 
any adjustment made by the adjustment panel with respect to exchange-
traded options covering the same underlying index.
    OCC proposes to add a new Section 6 to Article XVII to set forth 
certain provisions unique to OTC index options, including the variable 
terms allowed for OTC index options and the general limitations on such 
variable terms. In general, all OTC index options must conform to the 
terms and limitations set forth in Section 6, and additional specific 
requirements applicable to specific OTC index options will either be 
set forth in the Interpretations and Policies under Section 6 or 
published separately on OCC's Web site. Section 6 also makes clear that 
although OTC index options are not fungible with exchange-traded index 
options, OTC index options of the same series (i.e., options having 
identical terms) will be fungible with each other. Interpretations and 
Policies .01 to Section 6 would provide that only the S&P 500 Index 
will have been approved by OCC as an underlying index for OTC Index 
Options and would specify the additional terms for an OTC S&P 500 Index 
Option.\31\
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    \31\ See supra note 12.
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    Unless another exemption from the registration requirements of the 
Securities Act of 1933 (``Securities Act'') \32\ is available, OCC 
intends to rely upon Rule 506 of Regulation D \33\ under the Securities 
Act, which is a safe harbor under the Securities Act exemption in 
Section 4(a)(2) \34\ for offerings by an issuer not involving a public 
offering.\35\ OCC represents that it intends to satisfy the conditions 
of Rule 506 of Regulation D as in effect at the time OCC relies upon 
the safe harbor. OTC Index Options will be available for purchase only 
by highly sophisticated investors that are both ``eligible contract 
participants,'' as defined in Section 3a(65) of the Act,\36\ and 
``accredited investors,'' as defined in Rule 501(a) under Regulation 
D.\37\ Accordingly, Section 6(f) of Article XVII will establish that 
clearing members will be deemed to have made a number of 
representations and warranties to OCC in connection with their 
activities in OTC options each time they affirm a confirmed trade 
entered into an OTC Trade Source. These representations and warranties 
include, among others, that (i) the offer and sale of the OTC Index 
Option are exempt from the registration requirements of the Securities 
Act; (ii) in the case where the transaction is effected for the account 
of a customer, the customer is an ECP, as defined in Section 3a(65) of 
the Act; (iii) unless OCC notifies clearing members that the OTC Index 
Options will no longer be offered and sold pursuant to Rule 506 of 
Regulation D under the Securities Act, the clearing member has not 
offered or sold the OTC Index Options to any person that is not an 
``accredited investor'', as defined in Rule 501(a) under Regulation D 
and has otherwise complied with applicable conditions to the exemption 
set forth in Rule 506; and (vi) unless OCC notifies clearing members 
that such restriction no longer applies, the clearing member has not 
offered or sold the OTC Index Options by any form of general 
solicitation or general advertising that, at the time of such 
activities, is or may be deemed to constitute general solicitation or 
general advertising, as described in Rule 502(c) of Regulation D.
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    \32\ 15 U.S.C. 77a et seq.
    \33\ 17 CFR 230.506.
    \34\ 15 U.S.C. 77d(a)(2).
    \35\ The OCC submitted a rulemaking petition requesting 
exemptions under the Securities Act, the Exchange Act, and the Trust 
Indenture Act. See SEC File No. 4-644 (submitted January 13, 2012), 
available at http://www.sec.gov/rules/petitions/2012/petn4-644.pdf. 
This Order does not address the relief requested under the 
rulemaking petition, nor does it represent a position on the 
availability of any exemption under the Securities Act.
    \36\ 15 U.S.C. 77c(a)(65).
    \37\ 17 CFR 230.501.
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    In addition, each clearing member would represent and warrant to 
OCC that the transaction has been effected by the clearing member in 
accordance with, the clearing member's participation in such 
transaction is in compliance with, and the clearing member will 
continue with respect to such transaction to comply with, all 
applicable laws and regulations including, without limitation, all 
applicable rules and regulations of the Commission, of FINRA, and any 
other regulatory or self-regulatory organization to which the clearing 
member is subject.
    Chapter IV of the OCC's Rules sets forth the requirements for 
reporting of confirmed trades to OCC, and OCC Rule 401 thereunder 
governs reporting of transactions in listed options by participant 
Exchanges. OCC is proposing to add new Rule 404 to govern the details 
of reporting of confirmed trades in OTC options by an OTC Trade Source.
    OCC has stated that positions in OTC options will generally be 
margined in the same manner as positions in listed options using STANS 
and pursuant to Chapter VI of the OCC's Rules. However, OCC proposes to 
amend its Rule 611 to establish different procedures for the 
segregation of long positions in OTC options for margining 
purposes.\38\ Long positions in listed options are held in a clearing 
member's customers' account or firm non-lien account and by default are 
deemed to be ``segregated,'' meaning that they are not subject to OCC's 
lien and are given no collateral value when determining the margin 
requirement in the account. Such positions may be unsegregated only 
when a clearing member instructs OCC to unsegregate a long position and 
represents to OCC that the long position is part of a spread 
transaction carried for

[[Page 75247]]

a single customer whose margin requirement on the corresponding short 
position has been reduced in recognition of the spread. OCC will then 
unsegregate the long position and so reduce OCC's margin requirement. 
However, in case of long positions in OTC options that are carried in a 
clearing member's customers' account and for which OCC has received a 
customer ID, OCC proposes that it will automatically unsegregate such 
long positions if OCC identifies a qualifying short position in OTC 
options carried under the same customer ID. Clearing members will not 
be required to give an affirmative instruction to OCC to unsegregate a 
long position in OTC options or make a separate representation 
regarding the spread transaction. Instead, by carrying a qualifying 
spread position in a customer account, clearing members are deemed to 
have represented to OCC that the customer's margin has been reduced in 
recognition of the spread. Based on discussion with its clearing 
members, OCC's understanding is that, in practice, broker-dealers 
reduce customers' margin requirements to reflect spread positions. 
Therefore, OCC has stated that it believes automatic recognition of 
such spreads by OCC together with the deemed representation will 
greatly increase operational efficiency while providing equal assurance 
that long positions in OTC options will be unsegregated only if an 
identified customer will receive the benefit of the reduced margin 
required for spread transactions.
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    \38\ Specifically, Proposed OCC Rule 611(d) provides:
    (d) In the case of a long position in OTC options carried in the 
securities customers' account of a Clearing Member and for which the 
Corporation has received a customer ID, to the extent permitted 
under all applicable laws and regulations (including the rules of 
the Financial Industry Regulatory Authority, Inc. and any other 
regulatory or self-regulatory organization to which the Clearing 
Member is subject), the Corporation shall automatically unsegregate 
such long position to the extent that the Corporation identifies a 
qualifying spread position where the short leg of the spread is 
carried under the same customer ID. The Clearing Member shall not 
carry a qualifying spread position for a customer unless the 
customer's margin requirement has been reduced in recognition of the 
spread, and the carrying of a qualifying spread position for the 
account of a customer shall constitute a representation to the 
Corporation that the customer's margin has been so reduced.
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    OCC Rule 1001 sets forth the amount of the contribution that each 
clearing member is required to make to the clearing fund. OCC proposes 
to amend OCC Rule 1001(c) so that, for purposes of calculating the 
daily average number of cleared contracts held by a clearing member in 
open positions with OCC during a calendar month (which number is used 
in turn to determine the clearing member's contribution to the clearing 
fund), open positions in OTC options will be adjusted as needed to 
account for any differences between the multiplier or unit of trading 
with respect to OTC options relative to non-OTC options covering the 
same underlying index or interest so that OTC options and non-OTC 
options are given comparable weight in the computation.\39\
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    \39\ For example, the index multiplier applicable to OTC index 
options on the S&P 500 Index will be fixed at 1. In comparison, the 
index multiplier applicable to listed index options is 100.
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    In general, the rules in Chapter XI governing the suspension of a 
clearing member will apply equally to clearing members that transact in 
OTC options. OCC Rule 1104 provides broad authority for OCC to 
liquidate a suspended clearing member's margin and clearing fund 
deposits ``in the most orderly manner practicable.'' OCC Rule 1106 
provides similarly worded authority to close out open positions in 
options and certain other cleared contacts carried by a suspended 
clearing member. In 2011, the Commission approved an OCC rule change 
providing OCC the express authority to use a private auction as one of 
the means by which OCC may close out open positions and liquidate 
margin and clearing fund deposits of a suspended clearing member.\40\ 
OCC has stated that it anticipates it will use this auction process for 
OTC options as well.
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    \40\ See Securities Exchange Act Release No. 34-65654 (October 
28, 2011), 76 FR 68238 (November 3, 2011) (SR-OCC-2011-08). OCC 
subsequently filed and obtained approval for a rule change to 
provide for detailed procedures for the conduct of such an auction. 
See Securities Exchange Act Release No. 34-67443 (July 16, 2012), 77 
FR 42784 (July 20, 2012) (SR-OCC-2012-11); Securities Exchange Act 
Release No. 34-67733 (August 27, 2012), 77 FR 53241 (August 31, 
2012) (approving SR-OCC-2012-11).
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    As an additional tool to ensure its ability to close out positions 
in OTC options promptly, OCC is proposing to amend OCC Rule 1106 to 
provide for an alternative auction procedure specifically applicable 
only to OTC index options and related positions hedging, or hedged by, 
OTC index options (``OTC Options Auction''). An OTC Options Auction 
would be used only in unusual circumstances where OCC determines it is 
not feasible to close out open positions in OTC index options through 
the other means provided in OCC's Rules and By-Laws.\41\ The amendments 
to OCC Rule 1106 summarize the OTC Options Auction procedures and 
incorporate by reference the detailed procedures contained in a 
document entitled ``OTC Options Auction Procedures,'' which will be 
posted on the OCC's Web site and otherwise made available to clearing 
members upon request of OCC.
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    \41\ OCC anticipates that it would propose to apply these 
procedures to other OTC derivatives that may be cleared by OCC in 
the future.
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    OCC Rule 1106(e)(2)(C) clarifies that, in the event that the 
liquidation of a clearing member results in a deficiency that would 
otherwise result in a proportionate charge against the clearing fund 
contributions of other clearing members, each OTC Index Option Member 
(as defined below) that failed to purchase or assume its share of an 
auction portfolio will be the first to absorb the deficiency, through a 
``Priority Charge'' against such clearing members' clearing fund 
contributions. The Priority Charge is a ``first loss'' mechanism, and 
is not intended to increase a clearing member's total maximum exposure 
to OCC.
    Under the OTC Options Auction procedures, all clearing members 
authorized to clear transactions in OTC index options (``OTC Index 
Option Members''), other than the defaulting clearing member, will be 
required to participate in the OTC Options Auction by submitting 
competitive bids for all or a portion of the defaulting clearing 
member's OTC index option portfolio. Each such participant will be 
subject to a minimum participation level based on the participant's 
proportionate share of the total ``risk margin'' requirement posted by 
all OTC Index Options Members in the previous month for all positions 
(not limited to OTC option positions) held in accounts eligible to hold 
OTC options positions (``OTC Eligible Accounts''), after removing the 
defaulting clearing member.\42\ This method of calculating the minimum 
participation level in the OTC Options Auction results in all OTC Index 
Option Members being required to participate in the OTC Options Auction 
based on their clearing activity related to all positions in OTC 
Eligible Accounts. Required participation ensures that the OTC Options 
Auction will have sufficient participants authorized to clear 
transactions in OTC index options and that the most active clearing 
members in OTC index options will submit bids for the largest 
percentage of the auction portfolio, increasing the likelihood of the 
acquisition of OTC index options positions by clearing members with 
appropriate financial strength, risk management capabilities, and 
trading expertise.
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    \42\ This minimum participation level will be multiplied by 1.15 
to calculate each participant's minimum bid size, such that the sum 
of all participants' bids will equal 115% of the auction portfolio, 
in order to increase the likelihood that the entire auction 
portfolio will be allocated to participants.
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    Each participant may submit bids at varying quantities and varying 
prices, so long as the participant's bids equal or exceed its minimum 
participation level. A participant may use bids from non-OTC Index 
Options Members and non-clearing members in order to meet its minimum 
participation level, subject to certain OCC requirements including that 
it guarantee the performance of such third parties. Each bid will 
indicate what percentage of the auction portfolio the participant is 
bidding on and the amount of the bid. Bids will be stated in terms of a 
price for the entire auction portfolio, and may be either positive or

[[Page 75248]]

negative. (Negative bids imply an auction portfolio that has a negative 
net asset value and indicate how much OCC would be required to pay the 
participant to assume the relevant percentage of the auction 
portfolio.) OCC will rank the submitted bids from best to worst and the 
auction portfolio will be allocated among the bidding participants 
accordingly until the auction portfolio is exhausted. The bid price 
that is sufficient to clear the entire auction portfolio will become 
the single price to be used for all winning bids, even if a 
participant's stated bid was better.
    In order to provide a strong incentive to ensure competitive 
bidding by the OTC Index Option Members required to participate in an 
OTC Options Auction, OTC Index Options Members who fail to win their 
minimum participation in the auction will be subject to a potential 
priority charge against its clearing fund contribution. If all OTC 
Options Auction participants submit bids such that each receives an 
allocation of OTC index options positions equal to its minimum 
participation level, no priority charge will be made regardless of 
whether or not there is a liquidation shortfall. If a liquidation 
shortfall remains after any priority charges, or if no priority charges 
were required, OCC will then make a proportionate charge against the 
clearing fund contributions of all clearing members, including those 
that participated in the OTC Options Auction, in the usual manner 
pursuant to Section 5 of Article VIII of OCC's By-Laws.
    In order to protect the estate of the suspended clearing member, 
OCC reserves some discretion in supervising the auction. In the event 
that the bid price that clears the entire auction portfolio is 
determined by OCC to be an outlier bid, OCC may choose as the winning 
bid a price that clears at least 80% of the auction portfolio. The 
remaining auction portfolio will then be re-auctioned as described 
above.

Impact of Clearing OTC Options on Other OCC-Cleared Products

    An OTC option may have economic characteristics that are 
substantially similar or identical to the characteristics of options in 
series of listed options that OCC clears. While it is possible that in 
any given instance a market participant may elect to enter into an OTC 
S&P 500 Index Option in lieu of an economically similar listed product, 
OCC has stated that it does not believe that its clearing of OTC 
options will adversely affect the efficiency or liquidity of the listed 
markets. According to OCC, the OTC options markets accommodate a 
variety of commercial and other needs of market participants, including 
the ability to customize the terms of transactions. While the 
availability of an OCC guarantee for OTC transactions in which the 
parties would otherwise be exposed to each other's creditworthiness may 
cause transactions that currently occur in the non-cleared OTC markets 
to migrate to the cleared-OTC markets, OCC does not believe it will 
cause significant migration from the listed markets to the cleared-OTC 
options markets. OCC has stated that the limitation of the OTC options 
markets to ECPs as well as the significant minimum transaction size and 
tenor requirements that are applicable to OTC options under the S&P 
License Agreement will limit their use appropriately and should help to 
ensure that there is no substantial migration from the listed markets 
to the OTC markets for this product. OCC has stated that the existing 
bilateral OTC options markets have existed for years alongside the 
listed options markets, and OCC believes that dealers in such bilateral 
options often use the listed markets to hedge positions taken in such 
bilateral options and other OTC derivatives.

III. Analysis of the Proposed Rule Change

    Section 19(b)(2)(B) of the Act \43\ directs the Commission to 
approve a proposed rule change of a SRO if the Commission finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires, among other 
things, that the rules of the clearing agency be designed to promote 
the prompt and accurate clearance and settlement of securities 
transactions and, to the extent applicable, derivative agreements, 
contracts, and transactions, 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, to remove impediments to and perfect the 
mechanism of a national system for the prompt and accurate clearance 
and settlement of securities transactions and, in general, to protect 
investors and the public interest.\44\
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    \43\ 15 U.S.C. 78s(b)(2)(B).
    \44\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Proposal contains provisions requiring clearing members to make 
representations necessary to ensure that OTC S&P 500 Index Options 
trades submitted to OCC for clearing involve only parties that are 
ECPs, were transacted in accordance with the conditions of Regulation D 
under the Securities Act, and are in compliance with other regulatory 
requirements. Consistent with the objective of OCC's safeguarding 
securities and funds within its control, such provisions help to ensure 
that OCC avoids clearing trades that are not in compliance with 
regulatory requirements.
    The Proposal, as an initial step toward enabling OCC to provide 
central clearing for OTC S&P 500 Index Options, is consistent with the 
objective under Section 17A(b)(3)(A) of the Exchange Act of removing 
impediments to and perfecting the mechanism of a national system for 
the prompt and accurate clearance and settlement of securities 
transactions. Clearing OTC options using the existing market 
infrastructure at OCC will allow market participants to retain the 
benefits of the features of OTC options on the S&P 500 Index, such as 
expiration dates and strike prices that can be customized to match 
market participants' unique needs, while reducing less favorable 
aspects such as counterparty risk. Clearing OTC S&P 500 Index Options 
may also allow for capital and market efficiencies because it extends 
the use of existing market infrastructure at OCC into a related new 
product category, and eliminates the need for individual counterparties 
to bilaterally exchange option premiums and collect and maintain margin 
on a daily basis. As such, cleared OTC S&P 500 Index Options should 
represent a safer and more efficient use of capital than their 
uncleared counterpart.
    Additionally, clearing OTC S&P 500 Index Options should benefit the 
markets and regulators by centralizing and allowing for access to 
information about the OTC markets that has otherwise been unavailable.
    The Proposal is consistent with the protection of customers and the 
public interest. Only OTC S&P 500 Index Options between counterparties 
that are ECPs and that meet the notional minimums and other OCC 
requirements, as well as the conditions of Rule 506 of Regulation D 
under the Securities Act and other regulatory requirements, will be 
eligible for clearing by OCC. In addition, customers are expected 
benefit from substituting their credit exposure to a clearing member 
with exposure to OCC itself.
    Although customer positions in OTC S&P 500 Index Options will be 
carried in an omnibus account, OCC will use a ``customer ID'' to 
identify OTC S&P 500 Index Options positions of individual customers 
based on information provided by the clearing member. This should allow 
customers holding OTC

[[Page 75249]]

S&P 500 Index Options to benefit from additional capital efficiencies 
resulting from OCC's ability to unsegregate and offset long positions 
in OTC S&P 500 Index Options with qualifying short spread positions 
belonging to the same customer without compromising customer 
protections.\45\
---------------------------------------------------------------------------

    \45\ See supra 38 and accompanying text.
---------------------------------------------------------------------------

    Finally, the Proposal is in the public interest in that it 
represents an initial step in enabling OCC to provide central clearing 
for OTC S&P 500 Index Options, which ultimately should help to reduce 
systemic risk. Allowing for the substitution of OCC as the buyer for 
every seller and the seller for every buyer should reduce bilateral 
credit risk, replacing it with the credit risk of the more robustly 
risk-managed central counterparty. Thus, clearing OTC S&P 500 Index 
Options could potentially decrease risk to end-users of such products 
and, as a result, decrease systemic risk overall.
    The Proposal is designed to bring about the clearing of options in 
sizes that are not already traded in the listed (cleared) markets. 
While the availability of an OCC guarantee for OTC transactions in 
which the parties would otherwise be exposed to each other's credit 
risk could cause transactions that currently occur in the listed 
markets to migrate to less transparent cleared-OTC markets, OCC has 
indicated that it does not believe this will be the case for OTC S&P 
500 Index Options. The limitation to ECPs, as well as the significant 
minimum transaction size and tenor requirements established as part of 
OCC's license with S&P, are intended to minimize and should limit 
migration of index options referencing the S&P 500 Index from the 
listed to the OTC markets. OTC S&P 500 Index Options will have a 
minimum notional value of $500,000 times the value of the S&P 500 Index 
for initial maturities greater than four months but less than or equal 
to nine months, and a minimum notional value of at least $100,000 times 
the value of the S&P 500 Index for initial maturities greater than nine 
months but less than three years after the date the trade was 
originally executed.\46\ The Commission expects to monitor the clearing 
of OTC S&P 500 Index Options and the trading of equivalent options on 
listed markets to consider the possible impact the clearing of OTC S&P 
500 Index Options may have on the listed markets.
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    \46\ The value of the S&P 500 Index has hovered around 1,400 
points in recent months; therefore, the current notional values of 
such minimum transaction amounts are approximately $700,000,000 and 
$140,000,000, respectively.
---------------------------------------------------------------------------

    OCC has stated, and the Commission notes, that the existing 
bilateral OTC options markets have existed for years alongside the 
listed options markets and believes that dealers in bilateral options 
often use the listed markets to hedge positions taken in bilateral 
options and other OTC derivatives.
    The Commission believes OCC's clearing of OTC S&P 500 Index Options 
can lead to greater efficiency. Increases in efficiency may be achieved 
through lower transaction costs and appropriately risk-based margin 
reductions for clearing members and customers. Clearing of OTC S&P 500 
Index Options will increase the volume of transactions cleared at OCC 
and should thereby reduce transaction costs.
    Another improvement in efficiency will come from margin offsets, 
which will free up costly capital for other uses. In particular, in 
clearing OTC S&P 500 Index Options, clearing members would be expected 
to gain margin efficiencies by (i) clearing in the same account both 
OTC contracts and the hedges to those positions that are traded on the 
listed markets; and (ii) netting positions and/or obtaining margin 
offsets among OTC positions in the same account that would otherwise be 
spread across multiple accounts and OTC counterparties. Customers may 
gain margin efficiencies from OCC's ability to identify unsegregated 
long and short positions associated with the same customer ID. By 
moving OTC S&P 500 Index Options to OCC for clearing, OCC clearing 
members and their customers trading these products may be expected to 
benefit from reduced counterparty credit risk by introducing OCC as 
central counterparty.
    Finally, central clearing of OTC derivatives will bring more 
transparency for regulators concerning a market that is presently more 
asymmetric in terms of information available to regulators than the 
exchange-traded derivatives market. The Commission believes that the 
introduction of OTC S&P 500 Index Options for clearing by OCC should 
result in OCC and the Commission having more complete information 
regarding options market activity and clearing member positions 
overall. This should assist OCC in its risk management practices and 
the Commission in its supervisory and other regulatory efforts.
    The impact of OCC's clearing of OTC S&P 500 Index Options on 
capital formation is not as direct as it is on efficiency and 
competition. Derivative contracts are risk management products used to 
hedge different risks, a practice that supports the investments that 
lead to capital formation. However, it is unclear whether the effects 
of the Proposal would be large enough to affect capital formation.

IV. Analysis of the Advance Notice

Standard of Review

    A registered clearing agency that has been designated as a 
systemically important financial market utility (``FMU'') by the 
Financial Stability Oversight Council (``FSOC'') \47\ must provide 
advance notice of all changes to its rules, procedures or operations 
that could, as defined in the rules of the supervisory agency, 
materially affect the nature or level of risk presented by the clearing 
agency.\48\ Absent an extension or request for additional information, 
as discussed in greater detail below, the Commission is required to 
notify the clearing agency of any objection regarding the proposed 
change within the 60 day time frame established by Title VIII.\49\ A 
designated clearing agency may not implement a change to which its 
supervisory agency has objected; \50\ however, the clearing agency is 
explicitly permitted to implement a change if it has not received an 
objection from its supervisory agency within the same 60 day time 
period.\51\
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    \47\ On July 18, 2012, the FSOC designated OCC as a systemically 
important FMU. See Financial Stability Oversight Council, 2012 
Annual Report 145 (2012).
    \48\ 12 U.S.C. 5465(e). See also, Process for Submissions for 
Review of Security-Based Swaps for Mandatory Clearing and Notice 
Filing Requirements for Clearing Agencies; Technical Amendments to 
Rule 19b-4 and Form 19b-4 Applicable to All Self-Regulatory 
Organizations, Rel. No. 34-63557 (December 15, 2010), 75 FR 82490 
(December 30, 2010) (Proposing Release); Rel. No. 34-67286 (June 28, 
2012), 77 FR 41602 (July 13, 2012) (Adopting Release).
    \49\ 12 U.S.C. 5465(e)(1)(E).
    \50\ 12 U.S.C. 5465(e)(1)(F).
    \51\ 12 U.S.C. 5465(e)(1)(G).
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    Although Title VIII does not specify a standard that the Commission 
must apply to determine whether to object to an advance notice, the 
Commission believes that the purpose of Title VIII, stated under 
Section 802(b),\52\ is relevant to the review of advance notices.
---------------------------------------------------------------------------

    \52\ 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    The stated purpose of Title VIII is to mitigate systemic risk in 
the financial system and promote financial stability, by (among other 
things) authorizing the Federal Reserve Board to promote uniform risk 
management standards for systemically important FMUs, and providing an 
enhanced role for the Federal Reserve Board in the supervising of risk 
management standards for systemically important

[[Page 75250]]

FMUs.\53\ Therefore, the Commission believes that when reviewing 
advance notices related for FMUs, the consistency of an advance notice 
with Title VIII may be judged principally by reference to the 
consistency of the advance notice with applicable rules of the Federal 
Reserve Board governing payment, clearing, and settlement activity of 
the designated FMU.\54\
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    \53\ 12 U.S.C. 5461(b).
    \54\ See Financial Market Utilities, 77 FR 45907 (Aug. 2, 2012).
---------------------------------------------------------------------------

    Section 805(a) requires the Federal Reserve Board and authorizes 
the Commission to prescribe standards for the payment, clearing, and 
settlement activities of FMUs designated as systemically important, in 
consultation with the supervisory agencies. Section 805(b) of the 
Clearing Supervision Act \55\ requires that the objectives and 
principles for the risk management standards prescribed under Section 
805(a) shall be to:
---------------------------------------------------------------------------

    \55\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     Promote robust risk management and safety and soundness;
     Reduce systemic risks; and
     Support the stability of the broader financial system.
    The relevant rules of the Federal Reserve Board prescribing risk 
management standards for designated FMUs by their terms do not apply to 
designated FMUs that are clearing agencies registered with the 
Commission.\56\ Therefore, the Commission believes that the objectives 
and principles by which the Federal Reserve Board is authorized to 
promulgate such rules, as expressed in Section 805(b) of Title 
VIII,\57\ are the appropriate standards at this time by which to 
evaluate advance notices.\58\ Accordingly, the analysis set forth below 
is organized by reference to the stated objectives and principles in 
Section 805(b).
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    \56\ 12 CFR 234.1(b).
    \57\ 12 U.S.C. 5464(b).
    \58\ The risk management standards that have been adopted by the 
Commission in Rule 17Ad-22 are substantially similar to those of the 
Federal Reserve Board applicable to designated FMUs other than those 
designated clearing organizations registered with the CFTC or 
clearing agencies registered with the Commission. See Clearing 
Agency Standards, Exchange Act Release No. 68080 (Oct. 22, 2012), 77 
FR 66220 (November 2, 2012). To the extent such Commission standards 
are in effect at the time advance notices are reviewed in the 
future, the analysis of clearing agency rule filings under the 
Exchange Act would incorporate such standards directly.
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Promote Robust Risk Management and Safety and Soundness

    By establishing the legal and operational framework for central 
clearing of OTC S&P 500 Index Options, the Proposal paves the way for 
shifting counterparty credit risk stemming from the over-the-counter 
trading of these products between bilateral counterparties to OCC. As a 
central counterparty that collects margin and mutualizes the risk of 
loss among its members in the event of a member default, OCC is 
generally expected to be better situated to manage the risks associated 
with OTC S&P 500 Index Options than the original bilateral 
counterparties. By laying the groundwork for OCC's clearing of OTC S&P 
500 Index Options, the Proposal is consistent with the objective of 
promoting safety and soundness.
    With regard to the credit risk that OCC would face once it begins 
to clear OTC S&P 500 Index Options, changes in membership or additional 
trading in OTC S&P 500 Index Options that results from the OTC S&P 500 
Index Options being available for clearing (i.e., is not listed traffic 
that is migrating to OCC) could increase OCC's total exposure to its 
members and hence credit risk to OCC. On the other hand, credit risk to 
OCC could decrease because, by clearing OTC S&P 500 Index Options, OCC 
would have better visibility into the OTC S&P 500 Index Options 
positions of its members and thereby be better able to monitor its 
members' financial conditions, thus improving its own credit risk 
management. OCC's financial risks are managed through a set of 
financial safeguards, including strict membership rules, the collection 
of high-quality collateral, and additional assessment powers that 
protect OCC in the event of a default by a member.

Reduce Systemic Risks

    As discussed above, the Proposal would allow OCC to lay the 
groundwork for clearing OTC S&P 500 Index Options. Substitution of a 
central counterparty as a buyer to each seller and seller to each buyer 
is expected to reduce counterparty risk inherent in the markets for OTC 
derivatives, including OTC options. To the extent the Proposal 
eventually leads to eliminating bilateral credit risk in OTC S&P 500 
Index Options and replacing it with the credit risk of OCC, the more 
robustly risk-managed central counterparty, the Proposal should 
decrease risk to end-users of such products and, as a result, should 
reduce systemic risk overall.

Support the Stability of the Broader Financial System

    OCC is the only central counterparty currently clearing exchange-
listed options; any prolonged interruption to these services likely 
would prevent the exchanges from trading until they were restored. As 
such, OCC plays a primary role in the trading and clearing of options 
in the United States. OCC also maintains relationships with financial 
market utilities, settlement banks, clearing members, credit facility 
lenders, custodians, exchanges, cross-margining entities, and pricing 
vendors.
    OTC options directly indexed to the S&P 500 amounted to more than 
$1.1 trillion as of 2010,\59\ representing a market with a significant 
trading volume that currently does not reap any of the risk mitigation 
benefits of central clearing. The Commission believes that, by 
establishing the legal and operational framework for clearing OTC S&P 
500 Index Options, the Proposal will pave the way for systemic risk 
reducing benefits and thus support the stability of the broader 
financial system.
---------------------------------------------------------------------------

    \59\ See Nina Mehta, Nandini Sukumar, and Jeff Kearns, Over-The-
Counter S&P 500 Index Options Will Shift to Clearinghouse in 2011, 
Sept. 20, 2010, http://www.bloomberg.com/news/2010-09-20/over-the-counter-s-p-500-index-options-will-shift-to-clearinghouse-in-2011.html.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\60\ that the Proposed Rule Change (File No. SR-OCC-2012-14), as 
Modified by Amendment No. 1 Thereto, be and hereby is approved as of 
the date of this order, provided that OCC will not commence clearing of 
OTC S&P 500 Index Options until the Risk Management Proposal referenced 
above is filed by OCC, approved by the Commission, and implemented by 
OCC.
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    \60\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\61\ that the Commission does not object to 
proposed rule change (File No. AN-OCC-2012-01), as Modified by 
Amendment No. 1 Thereto, provided that OCC will not commence clearing 
of OTC S&P 500 Index Options until the Risk Management Proposal 
referenced above is filed by OCC, approved by the Commission, and 
implemented by OCC.
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    \61\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-30547 Filed 12-18-12; 8:45 am]
BILLING CODE 8011-01-P


