
[Federal Register Volume 78, Number 205 (Wednesday, October 23, 2013)]
[Notices]
[Pages 63267-63268]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-24843]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70709; File No. SR-OCC-2013-803]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection to Advance Notice Filing To Reflect Enhancements 
in OCC's System for Theoretical Analysis and Numerical Simulations as 
Applied to Longer-Tenor Options

October 17, 2013.
    On June 4, 2013, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') advance 
notice SR-OCC-2013-803 (``Advance Notice'') pursuant to Section 
806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of 
2010 (``Clearing Supervision Act'' or ``Title VIII'') \1\ and Rule 19b-
4(n)(1)(i) under the Securities Exchange Act of 1934 (``Exchange 
Act'').\2\ The Advance Notice was published for comment in the Federal 
Register on July 9, 2013.\3\ The Commission did not receive any 
comments on the Advance Notice publication. This publication serves as 
a notice of no objection to the Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i). 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 proposal in 
this Advance Notice as a proposed rule change under Section 19(b)(1) 
of the Exchange Act and Rule 19b-4 thereunder, which was published 
for comment in the Federal Register on June 14, 2013. 15 U.S.C. 
78s(b)(1); 17 CFR 240.19b-4. See Release No. 69723 (June 10, 2013), 
78 FR 36002 (June 14, 2013) (SR-OCC-2013-08). OCC withdrew the 
proposed rule change on August 27, 2013. Prior to the date of 
withdrawal, the Commission did not receive any comments on the 
proposed rule change. On October 10, 2013, OCC re-filed the proposal 
in this Advance Notice as a proposed rule change under Section 
19(b)(1) of the Exchange Act and Rule 19b-4 thereunder.
    \3\ Release No. 69925 (July 3, 2013), 78 FR 41161 (July 9, 2013) 
(SR-OCC-2013-803) (``Notice'').
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I. Description of the Advance Notice

    On December 14, 2012, the Commission issued an order approving a 
proposed rule change and a notice of no objection to an advance notice, 
collectively (``December 14, 2012 Action''), through which OCC proposed 
to establish a legal and operational framework for OCC to clear certain 
OTC index options on the S&P 500 Index (``OTC S&P 500 Index 
Options'').\4\ OCC is prohibited from clearing OTC S&P 500 Index 
Options until the Commission approves and OCC implements certain 
enhancements to OCC's System for Theoretical Analysis and Numerical 
Simulations (``STANS'') as applied to all options,\5\ including over-
the-counter (``OTC'') options that OCC is otherwise permitted to clear, 
with at least three years of residual tenor (``Risk Management 
Proposal'').\6\ This Advance Notice is the Risk Management Proposal. By 
this Advance Notice, OCC is enhancing STANS by: (i) Including daily OTC 
indicative quotations; (ii) introducing variations in implied 
volatility; and (iii) introducing a valuation adjustment.
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    \4\ Release No. 68434 (December 14, 2012), 77 FR 75243 (December 
19, 2012) (SR-OCC-2012-14, AN-OCC-2012-01).
    \5\ OCC represents that its Risk Management Proposal is 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. See December 14, 2012 Action, supra note 4, 77 FR 
at 75243. OCC states it intends to use its STANS margin system to 
calculate margin requirements on the same basis as for exchange-
listed options cleared by OCC. See Notice, supra note 3, 78 FR at 
41161.
    \6\ Release No. 68434 (December 14, 2012), 77 FR 75243 (December 
19, 2012) (SR-OCC-2012-14, AN-OCC-2012-01).
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    STANS is a margin system that OCC uses to calculate clearing-level 
margin.\7\ Through this Risk Management Proposal, OCC is enhancing 
STANS in the following ways:
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    \7\ According to OCC, STANS calculates margin by determining the 
minimum expected liquidating value of each account using a large 
number of projected price scenarios created by large-scale Monte 
Carlo simulations. See Notice, supra note 3, 78 FR at 41161.
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    (i) Daily OTC Indicative Quotations. According to OCC, STANS uses a 
daily dataset of market prices to value each portfolio.\8\ OCC is 
enhancing this daily dataset of market prices by including daily OTC 
indicative quotations.\9\ OCC will obtain daily OTC indicative 
quotations from a third-party service provider who obtains it through a 
daily poll of OTC derivatives dealers.\10\
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    \8\ See Notice, supra note 3, 78 FR at 41161.
    \9\ Id.
    \10\ OCC selected a third-party service provider rather than 
having the OTC derivatives dealers provide the information directly 
to OCC to avoid unnecessarily duplicating reporting that is already 
being done in the OTC markets. See Notice, supra note 3, 78 FR at 
41161-62.
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    (ii) Variations in Implied Volatility. According to OCC, STANS 
currently uses a two-day risk horizon which assumes that implied 
volatilities of option contracts do not change during that period.\11\ 
OCC will introduce variations in implied volatility in the modeling of 
all longer-tenor options under STANS.\12\ OCC plans to achieve this 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.'' \13\
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    \11\ See Notice, supra note 3, 78 FR at 41162.
    \12\ Id.
    \13\ Id.
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    (iii) Valuation Adjustment. OCC intends to enhance the portfolio 
net asset value that STANS uses, by introducing a valuation 
adjustment.\14\ According to OCC, the valuation adjustment will be 
``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.'' \15\
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    \14\ Id.
    \15\ Id.
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II. Discussion and Commission Findings

    Although Title VIII does not specify a standard of review for an 
advance notice, the Commission believes that the stated purpose of 
Title VIII is instructive.\16\ The stated purpose of Title VIII is to 
mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically-important financial market utilities 
(``FMUs'') and strengthening the liquidity of systemically important 
FMUs.\17\
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    \16\ See 12 U.S.C. 5461(b).
    \17\ Id.
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    Section 805(a)(2) of the Clearing Supervision Act \18\ authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing, and settlement activities of designated clearing entities and 
financial institutions engaged in designated activities for which it is 
the supervisory agency or the appropriate

[[Page 63268]]

financial regulator. Section 805(b) of the Clearing Supervision Act 
\19\ states that the objectives and principles for the risk management 
standards prescribed under Section 805(a) shall be to:
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    \18\ 12 U.S.C. 5464(a)(2).
    \19\ 12 U.S.C. 5464(b).
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     Promote robust risk management;
     Promote safety and soundness;
     Reduce systemic risks; and
     Support the stability of the broader financial system.
    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act \20\ (``Clearing Agency 
Standards'').\21\ The Clearing Agency Standards became effective on 
January 2, 2013 and require registered clearing agencies that perform 
central counterparty (``CCP'') services to establish, implement, 
maintain, and enforce written policies and procedures that are 
reasonably designed to meet certain minimum requirements for their 
operations and risk management practices on an ongoing basis.\22\ As 
such, it is appropriate for the Commission to review advance notices 
against these risk management standards that the Commission promulgated 
under Section 805(a) of the Clearing Supervision Act \23\ and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act.\24\
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    \20\ 12 U.S.C. 5464(a)(2).
    \21\ Exchange Act Release No. 68080 (October 22, 2012), 77 FR 
66220 (November 2, 2012) (S7-08-11).
    \22\ The Clearing Agency Standards are substantially similar to 
the risk management standards established by the Board of Governors 
of the Federal Reserve System (``Federal Reserve'') governing the 
operations of designated DFMUs that are not clearing entities and 
financial institutions engaged in designated activities for which 
the Commission or the Commodity Futures Trading Commission is the 
Supervisory Agency. See Financial Market Utilities, 77 FR 45907 
(August 2, 2012).
    \23\ 12 U.S.C. 5464(a).
    \24\ 12 U.S.C. 5464(b).
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    OCC's Risk Management Proposal, as described above, is designed to 
enhance OCC's margin calculation requirements for longer-tenor options. 
Consistent with Section 805(b) of the Clearing Supervision Act,\25\ the 
Division believes that OCC's Risk Management Proposal should help 
promote robust risk management and mitigate systemic risk by 
introducing variations in implied volatility in the modeling of all 
Longer-Tenor Options, and introducing a valuation adjustment in STANS 
to address OCC's increased exposure to Longer-Tenor Options that may 
possess characteristics that are more illiquid than other options that 
are cleared by OCC. The Risk Management proposal may also improve 
liquidity in the market for Longer-Tenor Options, which may improve 
price discovery in this market.
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    \25\ See 12 U.S.C. 5464(b).
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    Commission Rule 17Ad-22(b)(2),\26\ adopted as part of the Clearing 
Agency Standards,\27\ requires that a registered clearing agency 
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;'' 
and ``use risk-based models and parameters to set margin 
requirements.'' Furthermore, Commission Rule 17Ad-22(b)(3),\28\ also 
adopted as part of the Clearing Agency Standards,\29\ requires, in 
relevant part, a central counterparty to establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to maintain sufficient financial resources to withstand, at a 
minimum, a default by the participant family to which it has the 
largest exposure in extreme but plausible market conditions. The 
proposed enhancements to STANS, as described in the Risk Management 
Proposal, should help OCC to more accurately set margin requirements 
for Longer-Tenor Options, which OCC will use to limit its credit 
exposures to participants under both normal and stressed market 
conditions and should help OCC maintain sufficient financial resources 
to withstand a default by the participant family to which it has the 
largest exposure in extreme but plausible market conditions.
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    \26\ 17 CFR 240.17Ad-22(b)(2).
    \27\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (November 
2, 2012).
    \28\ 17 CFR 240.17Ad-22(b)(3).
    \29\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (November 
2, 2012).
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\30\ that the Commission DOES NOT OBJECT to 
advance notice proposal (SR-OCC-2013-803) and that OCC is AUTHORIZED to 
implement the proposal as of the date of this notice or the date of an 
order by the Commission approving a proposed rule change that reflects 
rule changes that are consistent with this advance notice proposal (SR-
OCC-2013-803), whichever is later.
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    \30\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-24843 Filed 10-22-13; 8:45 am]
BILLING CODE 8011-01-P


