
[Federal Register Volume 78, Number 206 (Thursday, October 24, 2013)]
[Notices]
[Pages 63548-63551]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-24918]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70719; File No. SR-OCC-2013-16]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing and Order Granting Accelerated Approval of Proposed 
Rule Change Amending OCC's By-Laws and Rules To Reflect Enhancements in 
OCC's System for Theoretical Analysis and Numerical Simulations as 
Applied to Longer-Tenor Options

October 18, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 10, 2013, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by OCC.\3\ The Commission is publishing this notice 
to solicit comments on the proposed rule change from interested persons 
and to approve the proposed rule change on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ OCC also filed the proposed change as an advance notice 
under Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act titled the Payment, Clearing, and 
Settlement Supervision Act of 2010 (``Payment, Clearing and 
Settlement Supervision Act''). 12 U.S.C. 5465(e)(1). The Commission 
issued a notice of no objection to the advance notice on October 17, 
2013. See Securities Exchange Act Release No. 70709 (October 17, 
2013) (SR-OCC-2013-803).
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The proposed rule change would 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 to reflect those enhancements 
in the description of OCC's margin model in OCC's Rules.

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

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

[[Page 63549]]

and C below, of the most significant aspects of such statements.

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

    The purpose of this proposed rule change 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 to 
reflect those enhancements in the description of OCC's margin model in 
OCC's Rules. OCC also proposes to make changes to the description of 
OCC's margin model to clarify that description.
    On August 30, 2012, OCC submitted a rule change with respect to 
OCC's proposal to clear certain over-the-counter options on the S&P 500 
Index (``OTC Options'').\4\ The OTC Options Rule Filing, as amended, 
added a statement appearing before Section 6 of Article XVII of OCC's 
By-Laws that ``THE BY-LAWS IN THIS SECTION (OTC INDEX OPTIONS) ARE 
INOPERATIVE UNTIL FURTHER NOTICE BY THE CORPORATION'' to clarify that 
OCC would not commence clearing OTC Options until the changes being 
made to OCC's margin model for longer-tenor options, as provided in 
this rule change, were put in place, notwithstanding whether the OTC 
Options Rule Filing had already been approved. OCC is now proposing to 
remove this statement from Section 6, which will allow OCC to commence 
clearing of OTC Options on the S&P 500 Index.
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    \4\ The proposal to clear OTC Options was approved on December 
14, 2012. See Securities Exchange Act Release No. 68434 (December 
14, 2012), 77 FR 75243 (December 19, 2012) (SR-OCC-2012-14).
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    Additional information concerning OCC's proposal to clear OTC 
Options is included in the OTC Options Rule Filing. As described in the 
OTC Options Rule Filing, 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.
Margin Enhancements for Longer-Tenor Options
    The proposed rule 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 
parameters \5\ and encouraging clearing members to have sufficient 
financial resources to meet their obligations to OCC.\6\ The proposed 
rule 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, the 
proposed rule change allows OCC to enhance its risk management 
procedures and controls related to longer-tenor options in accordance 
with the Commission's clearing agency standards.
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    \5\ 17 CFR 240.17Ad-22(b)(2).
    \6\ 17 CFR 240.17Ad-22(d)(2).
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    OCC 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
    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 improve the price discovery 
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 
reporting that is already done in the OTC markets.
Variations in Implied Volatility
    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. OCC's backtesting 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, it 
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. 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.
    A review of 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 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. 
These results are consistent with what would be expected given the 
strong negative correlation that exists between changes in implied 
volatility and market returns.
    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

[[Page 63550]]

other variables influencing prices of cleared contracts and modeled 
collateral. Accordingly, the references to ``underlying interests'' are 
proposed to be deleted.
Valuation Adjustment
    While historically OCC has not cleared a significant volume of 
longer-tenor options, OCC anticipates that there will be growth in 
volume of longer-tenor options, including OTC Options, being cleared 
with three to five year tenors. 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, new language would be added 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. 
This change is not intended to be substantive and simply clarifies the 
description in Rule 601.
Effect on Clearing Members
    The proposed rule 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 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.
    The proposed rule change is consistent with the purposes and 
requirements of Section 17A(b)(3)(F) of the Exchange Act [sic] (the 
``Act'') \7\ because amending OCC's margin rules to accommodate longer-
tenor options will promote the prompt and accurate clearance and 
settlement of securities transactions and facilitate the safeguarding 
of funds and securities within OCC's custody and control. In addition, 
and in accordance with Rule 17Ad-22(b)(2), the proposed rule change 
will allow OCC to use risk-based models to set clearing member margin 
requirements that will limit OCC's exposure to its clearing members 
under normal market conditions.\8\ The proposed rule change is not 
inconsistent with any rules of OCC, including any other rules proposed 
to be amended.
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    \7\ 15 U.S.C. 78q-1(b)(3)(F).
    \8\ 17 CFR 240.17Ad-22(b)(2).
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(B) Clearing Agency's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose a 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. With respect to a burden on 
competition among clearing agencies, OCC does not believe that the 
proposed rule change would have any impact because OCC is the only 
registered clearing agency that issues options and provides central 
counterparty services to the options markets.
    OCC does not believe that enhancing OCC's margin model for longer-
tenor options would inhibit access to any of OCC's services or 
disadvantage or favor any user of OCC's services in relationship to any 
other such user because the model enhancements would apply equally to 
all clearing members clearing longer-tenor options. Moreover, OCC 
believes that the proposed rule change would also promote competition 
among participants in the longer-tenor options markets. The rule change 
would enhance OCC's ability to manage risk within OCC's existing 
structure, and improve OCC's ability to reduce systemic risk to the 
longer-tenor options market in general as well as reduce inter-dealer 
counterparty risk in the OTC Options market, allowing for increased 
participation in this market.
    For the foregoing reasons, OCC believes that the proposed rule 
change is in the public interest, would be consistent with the 
requirements of the Act applicable to clearing agencies, and would not 
impose a burden on competition that is unnecessary or inappropriate in 
furtherance of the purposes of the Act because the changes would 
enhance OCC's margin methodology for longer-tenor options in ways that 
help to promote the purposes of the Act and Rule 17Ad-22 thereunder as 
described above.\9\
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    \9\ 17 CFR 240.17Ad-22.
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(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants, or Others

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change and none have been received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-OCC-2013-16 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-2013-16. 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 proposed rule change that are 
filed with the Commission, and all written communications relating to 
the

[[Page 63551]]

proposed rule change between the Commission and any person, other than 
those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for 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-2013-16 and should be 
submitted on or before November 14, 2013.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    Section 19(b)(2)(C) of the Act \10\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and rules and regulations thereunder applicable 
to such organization. After a careful review, the Commission finds that 
the proposed rule change is consistent with the requirements of the 
Act, particularly with the requirements of Section 17A of the Act,\11\ 
and the rules and regulations thereunder.\12\
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    \10\ 15 U.S.C. 78s(b)(2)(C).
    \11\ 15 U.S.C. 78q-1.
    \12\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    Section 17A(b)(3)(F) of the Act \13\ requires the rules of a 
clearing agency to be designed to, among other things, promote the 
prompt and accurate clearance and settlement of securities transactions 
and to assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible. The Commission finds that OCC's proposed rule change is 
consistent with these requirements because it amends OCC's margin rules 
to accommodate longer-tenor options and also includes a non-substantive 
change to clarify a pricing model reference in OCC Rule 601.
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    \13\ 12 U.S.C. 78q-1(b)(3)(F).
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    Rule 17Ad-22(b)(2) of the Act,\14\ requires, in part, that a 
registered clearing agency that performs central counterparty services 
shall 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. The 
proposed change is consistent with this rule because it is designed to 
enhance STANS, which is a risk-based model OCC uses to set margin 
requirements to limit OCC's credit exposures to participants under 
normal market conditions.
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    \14\ 17 CFR 240.17Ad-22(b)(2).
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    Rule 17Ad-22(b)(3) of the Act \15\ requires, in part, that a 
registered clearing agency that performs central counterparty services 
shall 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. This proposed change is consistent with this rule 
because it is designed to enhance STANS, which OCC uses to set margin 
requirements for longer-tenor options and should therefore 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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    \15\ 17 CFR 240.17Ad-22(b)(3).
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    The Commission finds that, pursuant to Section 19(b)(2)(C)(iii) of 
the Act,\16\ there is good cause to approve the proposed rule change 
earlier than 30 days after the date of publication of the notice in the 
Federal Register. Approval of the proposal will allow OCC to 
immediately implement enhancements in its margin model for longer tenor 
options cleared by OCC, which should in turn facilitate the reduction 
in risk in the clearance and settlement of these securities.
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    \16\ 15 U.S.C. 78s(b)(2)(C)(iii).
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V. Conclusion

    On the basis of the foregoing, the Commission finds the proposed 
rule change consistent with the requirements of the Act, particularly 
with the requirements of Section 17A of the Exchange Act,\17\ and the 
rules and regulations thereunder.
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    \17\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-OCC-2013-16) be, and it 
hereby is, approved on an accelerated basis.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-24918 Filed 10-23-13; 8:45 am]
BILLING CODE 8011-01-P


