
[Federal Register Volume 78, Number 131 (Tuesday, July 9, 2013)]
[Notices]
[Pages 41161-41163]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-16477]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69925; File No. SR-OCC-2013-803]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Advance Notice To Reflect Enhancements in OCC's 
System for Theoretical Analysis and Numerical Simulations as Applied to 
Longer-Tenor Options

July 3, 2013.
    Pursuant to Section 806(e)(1) of the Payment, Clearing, and 
Settlement Supervision Act of 2010 (``Clearing Supervision Act'') \1\ 
and Rule 19b-4(n)(1)(i) \2\ of the Securities Exchange Act of 1934 
(``Exchange Act'') notice is hereby given that on June 4, 2013, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') the advance notice described in 
Items I and II below, which Items have been substantially prepared by 
OCC.\3\ The Commission is publishing this notice to solicit comments on 
the advance notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ OCC is a designated financial market utility and is required 
to file advance notices with the Commission. See 12 U.S.C. 5465(e). 
OCC also filed the proposals contained in this advance notice as a 
proposed rule change under Section 19(b)(1) of the Exchange Act and 
Rule 19b-4 thereunder. 15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4. See 
SR-OCC-2013-08.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    OCC is proposing to provide for enhancements in OCC's margin model 
for longer-tenor options (i.e., those options with at least three years 
of residual tenor) and OCC intends to reflect those enhancements in the 
description of OCC's margin model in OCC's Rules through a 
corresponding proposed rule change.\4\
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    \4\ See supra note 3.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the advance notice and 
discussed any comments it received on the advance notice. The text of 
these statements may be examined at the places specified in Item IV 
below. OCC has prepared summaries, set forth in sections A, B, and C 
below, of the most significant aspects of such statements.\5\
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    \5\ The Commission has modified the text of the summaries 
prepared by the clearing agency.
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(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    The purpose of this advance notice is to provide for enhancements 
in OCC's margin model for longer-tenor options (i.e., those options 
with at least three years of residual tenor) and OCC intends to reflect 
those enhancements in the description of OCC's margin model in OCC's 
Rules through a corresponding proposed rule change.\6\
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    \6\ See supra note 3.
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1. Background
    On August 30, 2012, OCC submitted a rule change and advance notice 
with respect to OCC's proposal to clear certain over-the-counter 
options on the S&P 500 Index (``OTC Options Filings'').\7\ Additional 
information concerning OCC's proposal to clear OTC Options is included 
in the OTC Options Filings. As described in the OTC Options Filings, 
OCC intends to use its STANS margin system to calculate margin 
requirements for OTC Options on the same basis as for exchange-listed 
options cleared by OCC. However, OCC is proposing to implement 
enhancements to its risk models for all longer-tenor options (including 
OTC Options) in order to better reflect certain risks of longer-tenor 
options. The changes described herein would apply to all longer-tenor 
options cleared by OCC and would be implemented before OCC begins 
clearing OTC Options.
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    \7\ See Exchange Act Release No. 68434 (Dec. 14, 2012), 77 FR 
75243 (Dec. 19, 2012) (SR-OCC-2012-14 and AN-OCC-2012-01).
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2. Description of Current Proposed Changes
    OCC states that the proposed change includes daily OTC quotes, 
variations in implied volatility and valuation adjustments in the 
modeling of all longer-tenor options under STANS, thereby enhancing 
OCC's ability to set margin requirements through the use of risk-based 
models and encouraging clearing members to have sufficient financial 
resources to meet their obligations to OCC. OCC states that the 
proposed change would not affect OCC's safeguarding of securities and 
funds in its custody or control because though it may change margin 
requirements in respect of certain longer-tenor options, it does not 
change the manner in which margin assets are pledged. In addition, OCC 
states that the proposed change allows OCC to enhance its risk 
management procedures and controls related to longer-tenor options.
    OCC states that it calculates clearing-level margin using STANS, 
which determines the minimum expected liquidating value of each account 
using a large number of projected price scenarios created by large-
scale Monte Carlo simulations. OCC is proposing to implement 
enhancements to the STANS margin calculation methodology with respect 
to longer-tenor options and to amend Rule 601 to reflect these 
enhancements as well as to make certain clarifying changes in the 
description of STANS in Rule 601. The specific details of the 
calculations performed by STANS are maintained in OCC's proprietary 
procedures for the calculation of margin and coded into the computer 
systems used by OCC to calculate daily margin requirements.
    OCC has proposed at this time to clear only OTC Options on the S&P 
500 index and only such options with tenors of up to five years. 
However, OCC currently clears FLEX Options with tenors of up to fifteen 
years. While OCC believes that its current risk management practices 
are adequate for current clearing activity, OCC proposes to implement 
risk modeling enhancements with respect to all longer-tenor options.
Daily OTC Indicative Quotes
    OCC states that, in general, the market for listed longer-tenor 
options is less liquid than the market for other options, with less 
volume and therefore less price information. In order to supplement 
OCC's pricing data derived from the listed markets, and to improve the 
valuation process for longer-tenor options, OCC proposes to include in 
the daily dataset of market prices used by STANS to value each 
portfolio indicative daily quotations obtained through a third-party 
service provider that obtains these quotations through a daily poll of 
OTC derivatives dealers. A third-party service provider was selected to 
provide this data in lieu of having the data provided directly by the 
OTC derivatives dealers in order to avoid unnecessarily duplicating

[[Page 41162]]

reporting that is already done in the OTC markets.
Variations in Implied Volatility
    OCC states that, to date, the STANS methodology has assumed that 
implied volatilities of option contracts do not change during the two-
day risk horizon used by OCC in the STANS methodology. According to 
OCC, back testing of its margin models has identified few instances in 
which this assumption would have, as a result of sudden changes in 
implied volatility, resulted in margin deposits insufficient to 
liquidate clearing member accounts without loss. However, as OCC 
expects to begin clearing more substantial volumes of longer-tenor 
options, including OTC Options, OCC believes that implied volatility 
shocks may become more relevant due to the greater sensitivity of 
longer-tenor options to implied volatility. OCC therefore proposes to 
introduce variations in implied volatility in the modeling of all 
longer-tenor options under STANS. OCC states that this will be achieved 
by incorporating, into the set of risk factors whose behavior is 
included in the econometric models underlying STANS, time series of 
proportional changes in implied volatilities for a range of tenors and 
in-the-money and out-of-the-money amounts representative of the dataset 
provided by OCC's third-party service provider.
    OCC states that it has reviewed individual S&P 500 Index put and 
call options positions with varying in-the-money amounts and with four 
to nine years of residual tenor and that such review indicates that the 
inclusion of modeled implied volatilities tends to result in less 
margin being held against short call positions and more margin being 
held against short put positions. OCC states that these results are 
consistent with what would be expected given the strong negative 
correlation that exists between changes in implied volatility and 
market returns.
    OCC states that the description of the Monte Carlo simulations 
performed within STANS in Rule 601 references revaluations of assets 
and liabilities in an account under numerous price scenarios for 
``underlying interests.'' In order to accommodate the proposed implied 
volatility enhancements, OCC is proposing to amend this portion of Rule 
601 to provide that the scenarios used may also involve projected 
levels of other variables influencing prices of cleared contracts and 
modeled collateral. Accordingly, the references to ``underlying 
interests'' are proposed to be deleted.
Valuation Adjustment
    OCC states that historically it has not cleared a significant 
volume of longer-tenor options, but that it anticipates that there will 
be growth in the volume of longer-tenor options, including OTC Options, 
being cleared with three to five year tenors. According to OCC, longer-
tenor options may represent a larger portion of any clearing member's 
portfolio in the future, and OCC has therefore identified a need to 
model anticipated changes in the value of longer-tenor options on a 
portfolio basis in order to address OCC's exposure to longer-tenor 
options that may have illiquid characteristics. OCC proposes to 
introduce a valuation adjustment into the portfolio net asset value 
used by STANS based upon the aggregate sensitivity of any longer-tenor 
options in a portfolio to the overall level of implied volatilities at 
three years and five years and to the relationship between implied 
volatility and exercise prices at both the three- and five-year tenors 
in order to allow for the anticipated market impact of unwinding a 
portfolio of longer-tenor options, as well as for any differences in 
the quality of data in OCC's third party service provider's dataset, 
given that month-end data may be subjected to more extensive validation 
by the service provider than daily data. In order to accommodate the 
planned valuation adjustment for longer-tenor options, OCC proposes to 
add language to Rule 601 to indicate that the projected portfolio 
values under the Monte Carlo simulations may be adjusted to account for 
bid-ask spreads, illiquidity, or other factors.
Clarification of Pricing Model Reference in Rule 601
    Rule 601 currently refers to the use of ``options pricing models'' 
to predict the impact of changes in values on positions in OCC-cleared 
contracts. OCC is proposing to amend this description to reflect that 
OCC currently uses non-options related models to price certain 
instruments, such as futures contracts and U.S. Treasury securities. 
OCC states that this change is not intended to be substantive and 
simply clarifies the description in Rule 601.
Effect on Clearing Members
    OCC states that the proposed change will affect clearing members 
who engage in transactions in longer-tenor options, and indirectly 
their customers, by enhancing the STANS margin calculation methodology 
for these options. The STANS enhancements could increase margin 
requirements with respect to these positions. However, OCC states that 
it does not believe that the enhancements will result in significantly 
increased margin requirements for any particular clearing member, and 
therefore is not aware of any significant problems that clearing 
members are likely to have in complying with the proposed rule change.
    OCC states that the proposed rule change is consistent with the 
purposes and requirements of Section 17A(b)(3)(F) of the Exchange Act 
\8\ and the rules and regulations thereunder, including Rule 17Ad-
22(b)(2) \9\ and Rule 17Ad-22(d)(2) \10\ because by providing 
additional clarity to clearing members and others concerning the 
current calculation of margin requirements under OCC's Rules, while 
also enhancing the calculation of margin with respect to longer-tenor 
options, the proposed modifications would help remove impediments to 
and perfect the mechanism of a national system for the prompt and 
accurate clearance and settlement of securities transactions, ensure 
that OCC's rules are reasonably designed to have participation 
requirements that are objective and publicly disclosed and permit fair 
and open access, and provide for a well-founded, transparent, and 
enforceable legal framework. OCC states that the proposed rule change 
is not inconsistent with any rules of OCC, including any other rules 
proposed to be amended.
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    \8\ 15 USC 78q-1(b)(3)(F).
    \9\ 17 CFR 240.17Ad-22(b)(2).
    \10\ 17 CFR 240.17Ad-22(d)(2).
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(B) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants, or Others

    Written comments were not and are not intended to be solicited by 
OCC with respect to the advance notice and none have been received.

(C) Advance Notices Filed Pursuant to Section 806(e) of the Clearing 
Supervision Act

    OCC is filing this proposed change as an advance notice pursuant to 
Section 806(e)(2) of the Clearing Supervision Act because the proposed 
change could be deemed to materially affect the nature or level of 
risks presented by OCC. However, OCC believes that the Rule changes and 
changes in OCC's system for calculating margin on longer-tenor options 
will represent enhancements to OCC's ability to manage the risks 
presented to it, particularly as OCC begins clearing OTC Options.

[[Page 41163]]

    According to OCC, OTC Options are nearly identical to listed FLEX 
options on the S&P 500 that OCC has cleared for many years. OTC Options 
have the same degree of customization as FLEX options except that OTC 
Options are limited to a maximum tenor of five years whereas FLEX 
options can have tenors of up to fifteen years. In this respect, OCC 
states that OTC Options pose less of a challenge from a risk management 
perspective than do FLEX options. However, OCC believes, based on 
activity in the existing OTC markets for uncleared, bilateral options, 
that there may be greater open interest in OTC Options with tenors 
exceeding three years as compared to FLEX options, in which open 
interest is more concentrated in shorter term options. In addition, it 
is inherent in the nature of the OTC option markets that there are no 
market makers with affirmative duties to create liquidity by standing 
ready to buy and sell OTC Options in response to market interest as in 
the listed options markets, including the FLEX options market.
    In order to address the potentially greater open interest in 
longer-tenor options, OCC is proposing to supplement its existing risk 
management procedures by enhancing its STANS margining system by:
    (i) including in the daily dataset of market prices used by STANS 
to value each portfolio indicative daily quotations obtained through a 
third-party service provider that obtains these quotations through a 
daily poll of OTC derivatives dealers;
    (ii) incorporating, into the set of risk factors whose behavior is 
included in the econometric models underlying STANS, time series of 
proportional changes in implied volatilities, for a range of tenors and 
in-the-money and out-of-the-money amounts representative of the 
foregoing dataset; and
    (iii) introducing a valuation adjustment into the portfolio net 
asset value used by STANS, based upon the aggregate sensitivity of any 
longer-tenor options in a portfolio to the overall level of implied 
volatilities at three years and five years and to the relationship 
between implied volatility and exercise prices at both the three- and 
five-year tenors in order to allow for the market impact of unwinding a 
portfolio of longer-tenor options, as well as for any differences in 
the quality of data provided by OCC's third party service provider's 
dataset, given that month-end data may be subjected to more extensive 
validation by the service provider than daily data.
    These proposed changes are described in more detail above. As noted 
above, OCC will not commence clearing of OTC Options unless and until 
the Commission has approved the modeling enhancements described herein.

III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    OCC may implement the proposed change pursuant to Section 
806(e)(1)(G) of the Clearing Supervision Act \11\ if it has not 
received an objection to the proposed change within 60 days of the 
later of (i) the date that the Commission received the advance notice 
or (ii) the date the Commission receives any further information it 
requested for consideration of the notice. The clearing agency shall 
not implement the proposed change if the Commission has any objection 
to the proposed change.
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    \11\ 12 U.S.C. 5465(e)(1)(G).
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    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date of receipt of the advance notice, or the date the 
Commission receives any further information it requested, if the 
Commission notifies the clearing agency in writing that it does not 
object to the proposed change and authorizes the clearing agency to 
implement the proposed change on an earlier date, subject to any 
conditions imposed by the Commission.
    The clearing agency shall post notice on its Web site of proposed 
changes that are implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.\12\
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    \12\ OCC also filed the proposals contained in this advance 
notice as a proposed rule change under Section 19(b)(1) of the 
Exchange Act and Rule 19b-4 thereunder. See supra note 3.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-OCC-2013-803 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-OCC-2013-803. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the advance notice that are filed 
with the Commission, and all written communications relating to the 
advance notice between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE., Washington, 
DC 20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of OCC and on OCC's Web site 
(http://www.theocc.com/about/publications/bylaws.jsp). All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-OCC-2013-803 and should be 
submitted on or before July 30, 2013.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-16477 Filed 7-8-13; 8:45 am]
BILLING CODE 8011-01-P


