
[Federal Register Volume 79, Number 215 (Thursday, November 6, 2014)]
[Notices]
[Pages 66018-66022]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-26344]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73482; File No. SR-OCC-2014-803]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection to Advance Notice Filing to Better Manage Risks 
Concentration and Other Risks Associated With Accepting Deposits of 
Common Stocks for Margin Purposes

October 31, 2014.
    On July 16, 2014, the Options Clearing Corporation (``OCC'') filed 
with

[[Page 66019]]

the Securities and Exchange Commission (``Commission'') advance notice 
SR-OCC-2014-803 pursuant to Section 806(e)(1) of the Payment, Clearing, 
and Settlement Supervision Act of 2010 (``Payment, Clearing and 
Settlement Supervision Act'') \1\ and Rule 19b-4(n)(1) under the 
Securities Exchange Act of 1934 (``Act'').\2\ The advance notice was 
published for comment in the Federal Register on August 15, 2014.\3\ On 
September 8, 2014, pursuant to Section 806(e)(1)(D) of the Payment, 
Clearing and Settlement Supervision Act, the Commission required OCC to 
provide additional information concerning this advance notice.\4\ The 
Commission did not receive any comments on the advance notice 
publication. This publication serves as a notice of no objection to the 
changes proposed in the advance notice.
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    \1\ 12 U.S.C. 5465(e)(1). The Financial Stability Oversight 
Council designated OCC a systemically important financial market 
utility on July 18, 2012. See Financial Stability Oversight Council 
2012 Annual Report, Appendix A, http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. Therefore, OCC is 
required to comply with the Payment, Clearing and Settlement 
Supervision Act and file advance notices with the Commission. See 12 
U.S.C. 5465(e).
    \2\ 17 CFR 240.19b-4(n)(1).
    \3\ Securities Exchange Act Release No. 72803 (August 11, 2014), 
79 FR 48285 (August 15, 2014) (SR-OCC-2014-803). OCC also filed the 
proposal contained in this advance notice as a proposed rule change 
under Section 19(b)(1) of the Act and Rule 19b-4 thereunder, which 
was published for comment in the Federal Register on August 5, 2014. 
15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4. See Securities Exchange Act 
Release No. 72717 (July 30, 2014), 79 FR 45523 (August 5, 2014) (SR-
OCC-2014-14). The Commission did not receive any comments on the 
proposed rule change.
    \4\ 12 U.S.C. 5465(e)(1)(D). The Commission received a response 
with further information for consideration of the advance notice on 
September 19, 2014, at which time a 60 day review period began 
pursuant to Sections 806(e)(1)(E) and (G) of the Payment, Clearing 
and Settlement Supervision Act. See 12 U.S.C. 5465(e)(1)(E) and 12 
U.S.C. 5465(e)(1)(G).
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I. Description of the Advance Notice

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

a. Background

    OCC Rule 604 lists the types of assets that clearing members may 
deposit with OCC to satisfy their margin requirement(s) as well as sets 
forth eligibility criteria for such assets. According to OCC, common 
stocks, including Exchange Traded Funds (``ETFs'') and Exchange Traded 
Notes (``ETNs''), are the most common form of margin assets deposited 
by clearing members and currently comprise 68% of the $60.6 billion in 
clearing member margin deposits held by OCC (not including deposits in 
lieu of margin). According to OCC, since 2009, OCC has used its System 
for Theoretical Analysis and Numerical Simulations (``STANS''), which 
is OCC's daily automated Monte Carlo simulation-based margining 
methodology, to value common stocks deposited by clearing members as 
margin.\5\ The value given to margin deposits depends on factors that 
include the price volatility and the price correlation relationship of 
common stock collateral to the balance of the cleared portfolio. The 
approach used by STANS incentivizes clearing members who chose to meet 
their margin obligations with deposits of common stocks to choose 
common stocks that hedge their related open positions.
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    \5\ See Securities Exchange Act Release No. 58158 (July 15, 
2008), 73 FR 42646 (July 22, 2008) (SR-OCC-2007-20).
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    According to OCC, notwithstanding the value STANS gives to deposits 
of common stocks, certain factors warrant OCC adjusting the value STANS 
gives to all clearing member margin deposits of a particular type of 
margin collateral. Such factors are set forth in Rule 604, 
Interpretation and Policy .14, and include the number of outstanding 
shares, number of outstanding shareholders and overall trading volume. 
OCC is proposing to add a new Interpretation and Policy to Rule 604 
(the ``Interpretation'') so that OCC has discretion to not give margin 
credit to a particular clearing member when such clearing member 
deposits a concentrated amount of any common stock and when a common 
stock, deposited as margin, presents ``wrong-way risk'' to OCC. In 
addition, the Interpretation will provide OCC discretion to grant 
margin credit to a clearing member when it deposits shares of common 
stock that serve as a hedge to the clearing member's related open 
positions and would otherwise be not be given margin credit.\6\
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    \6\ According to OCC, consistent with the language contained in 
existing Interpretation & Policy .14, the Interpretation provides 
OCC with discretion in determining the amount of margin credit given 
to deposits of common stock by an individual clearing member as such 
determination would be based on positions held and common stock 
deposits made by such clearing member on a given business day. 
However, as discussed in the following two sections, OCC states that 
it also has developed certain automated processes as well as 
additional internal policies that describe how OCC presently intends 
to exercise such discretion. According to OCC, these additional 
internal policies are included in OCC's collateral risk management 
policy, which will not be implemented until approval of this rule 
change with changes thereto being subject to additional rule 
filings.
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b. Concentrated Deposits of Common Stock

    OCC has determined that in the event it is necessary to liquidate a 
clearing member's positions (including the clearing member's margin 
collateral), OCC may be exposed to risk arising from a large quantity 
of a particular common stock deposited as margin by a clearing member. 
Specifically, depending on the relationship between the average daily 
trading volume of a particular security and the number of outstanding 
shares of such security deposited by a clearing member as margin, it is 
possible that the listed equities markets may not be able to quickly 
absorb all of the common stock OCC seeks to sell, or OCC may not be 
able to auction such securities, without an appreciable negative price 
impact. This occurrence, referred to by OCC as ``concentration risk,'' 
is greatest when the number of shares being sold is large and the 
average daily trading volume is low.
    OCC's existing authority to not give value to otherwise eligible 
forms of margin only provides OCC with the discretion to not give value 
across all clearing member deposits of a particular common stock. 
However, concentration risk may be a clearing member and account-
specific risk. In order to mitigate the concentration risk of a single 
clearing member, OCC plans to implement automated processes to monitor 
the composition of a clearing member's margin deposits. Such processes 
will identify concentration risk at both an account level and across 
all accounts of a clearing member. OCC is adding the Interpretation so 
that OCC has discretion to limit the margin credit granted to an 
individual clearing member that maintains a concentrated margin deposit 
of otherwise eligible common stock.
    According to OCC, for reasons stated above, OCC considers a common 
stock's average daily trading volume and the number of shares a 
clearing member deposited as margin to be the two most significant 
factors when making a

[[Page 66020]]

decision to limit margin credit due to concentration risk. Accordingly, 
OCC will not give margin credit to clearing member margin deposits of a 
particular common stock in respect of a particular account when the 
deposited amount of such common stock is in excess of two times the 
average daily trade volume of such common stock over the most recent 
three month period. OCC's systems will continually assess the 
composition of clearing member margin deposits for each account 
maintained by the clearing member, including intra-day collateral 
substitutions in such accounts, to determine if a clearing member has a 
margin deposit with a concentrated amount of common stock. With respect 
to a given account, OCC's systems will automatically set appropriate 
limits on the amount of a particular common stock for which a clearing 
member may be given margin credit for any one of a its tier accounts. 
In addition, and with respect to all of a clearing member's accounts, 
OCC will impose an add-on margin charge if, in aggregate, a clearing 
member deposits a concentrated amount of a particular common stock as 
margin across all of its accounts. The add-on margin charge will 
operate to negate the margin credit given to the concentrated margin 
deposit, and will be collected, when applicable, as part of OCC's 
standard morning margin process. OCC will assess the add-on margin 
charge across all of a clearing member's accounts on a pro-rata basis 
(based on the amount of the particular common stock in each of a 
clearing member's accounts).\7\
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    \7\ According to OCC, since a 2-day limit is first checked at 
each account, it is possible that a clearing member with multiple 
accounts may have more than 2-days of a given common stock on 
deposit in aggregate. To control this condition, a final check is 
done on the aggregate amount of shares held by a clearing member 
across all of its accounts. For example, if a particular clearing 
member has three accounts each holding 2-days volume of a specific 
common stock, the clearing member check would identify that the 
member was holding six days of volume in aggregate. To mitigate this 
risk, an add-on charge equal to the market value of four days of 
volume would be applied to all accounts holding that security on a 
pro-rata basis.
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    According to OCC, OCC staff has been monitoring concentrated common 
stock positions, assessing the impact of the proposed change described 
in this filing and contacting clearing members affected by the proposed 
change. OCC believes that clearing members will be able to comply with 
the proposed change without making significant changes to their day-to-
day business operations. In December 2013, an information memo was 
posted to inform all members of the upcoming change. According to OCC, 
since January 2014, OCC staff has been in contact with any clearing 
member that would be affected by the proposed change. On a weekly 
basis, any clearing member that would see a reduction of 10% or more of 
its collateral value is contacted and provided an explanation of the 
policy and a list of concentrated positions observed in this analysis. 
On a monthly basis, all clearing members exhibiting any concentration 
risk are contacted to provide an explanation of the proposed policy and 
a list of concentrated positions. In both cases, clearing members are 
encouraged to proactively reduce concentrated positions to conform to 
the proposed policy. As of June 2014, twenty-five members would be 
affected. Implementation of the Interpretation would result in 
disallowing $1.2 billion in collateral value and result in margin calls 
for six members totaling $710 million. Moreover, in July 2014, OCC made 
an automated report concerning concentrated margin deposits of common 
stock available to all clearing members.

c. Wrong-Way Risk

    OCC also will use the Interpretation to address the risk that the 
common stock a clearing member has deposited as margin and which is 
issued by the clearing member itself or an affiliate of the clearing 
member will lose value in the event the clearing member providing such 
margin defaults, which is known as ``wrong-way risk.'' According to 
OCC, wrong-way risk occurs when a clearing member makes a deposit of 
common stock issued by it or an affiliate and, in the event the 
clearing member defaults, the clearing member's common stock margin 
deposit will also be losing value at the same time because there is 
likely to be a strong correlation between the clearing member's 
creditworthiness and the value of such common stock. In order to 
address wrong-way risk, the Interpretation will implement automated 
systems that will not give margin credit to a clearing member that 
deposits common stock issued by such clearing member or an affiliate as 
margin collateral. OCC will define ``affiliate'' broadly in the 
Interpretation to include any entity with direct or indirect equity 
ownership of 10% of the clearing member, or any entity for which the 
clearing member holds 10% of the direct or indirect equity 
ownership.\8\
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    \8\ This standard is based on the provisions of OCC Rule 
215(a)(5).
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    OCC has addressed the impact of the change designed to address 
wrong-way risk. As of June 2014, there were 73 clearing members whose 
parent or an affiliate has issued securities trading on U.S. exchanges. 
As of June 2014, there are six clearing members that would be affected 
by virtue of having made margin deposits of their own or an affiliate's 
common stock. In total, these shares equaled $132 million and accounted 
for less than one half of one percent of the total market value of 
valued securities pledged as margin at OCC. In July 2014, OCC made 
information available to each clearing member that indicates which of 
its deposits of common stock would not receive margin credit under the 
proposed change due to wrong-way risk considerations, as described 
above.\9\
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    \9\ OCC believes that by providing such information clearing 
members will be better able to adjust their margin deposits at OCC 
to conform to the proposed change if it is approved.
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d. Deposits That Hedge Open Positions

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

[[Page 66021]]

common stock, taking into account the hedging position.\11\ OCC 
believes that this policy will further encourage clearing members to 
deposit margin collateral that hedges their related open positions and 
is in line with the valuation methods within STANS. This policy will 
also facilitate OCC's management of its and its participants' credit 
exposure as well as the liquidation of a clearing member's portfolio 
should the need arise.
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    \10\ According to OCC, the ``delta equivalent position'' is the 
equivalent number of underlying shares represented by the 
aggregation of cleared products on that same underlying instrument. 
This value is calculated using the ``delta'' of the option or 
futures contract, which is the ratio between the theoretical change 
in the price of the options or futures contract to the corresponding 
change in the price of an underlying asset. Thus, delta measures the 
sensitivity of an options or futures contract price to changes in 
the price of the underlying asset. For example, a delta of +0.7 
means that for every $1 increase in the price of the underlying 
stock, the price of a call option will increase by $0.70. Delta for 
an option or future can be expressed in shares of the underlying 
asset. For example, a standard put option with a delta of -.45 would 
have a delta of -45 shares, because the unit of trading is 100 
shares.
    \11\ Assume, for example, an average daily trade volume of 250 
shares, a threshold of 2 times the average daily trade volume, and a 
delta of -300 shares for the options on a particular security in a 
particular account. A position of 700 shares that did not hedge any 
short options or futures would receive credit for only 500 shares 
(i.e., 2 times the average daily trade volume). If the net long 
position in the account, when combined with the delta of short 
option and futures position, were only 400, credit would be given 
for the entire 700 shares since the delta equivalent position is 
below the 500 share threshold. However, if the option delta were 
+300, the net long position would be 1000, and credit would only be 
given for 500 shares because the delta equivalent position would 
exceed the 500 share threshold.
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e. Other Proposed Changes

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

II. Discussion and Commission Findings

    Although the Payment, Clearing and Settlement Supervision Act does 
not specify a standard of review for an advance notice, the Commission 
believes its stated purpose is instructive.\12\ The stated purpose 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 
(``FMU'') and strengthening the liquidity of systemically important 
FMUs.\13\
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    \12\ See 12 U.S.C. 5461(b).
    \13\ Id.
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    Section 805(a)(2) of the Payment, Clearing and Settlement 
Supervision Act \14\ 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 financial regulator. Section 805(b) of the Payment, 
Clearing and Settlement Supervision Act \15\ states that the objectives 
and principles for the risk management standards prescribed under 
Section 805(a) shall be to:
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    \14\ 12 U.S.C. 5464(a)(2).
    \15\ 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 Payment, Clearing and Settlement Supervision Act \16\ 
and the Act (``Clearing Agency Standards'').\17\ The Clearing Agency 
Standards became effective on January 2, 2013 and establish, among 
other things, minimum requirements regarding how registered clearing 
agencies must maintain effective risk management procedures and 
controls.\18\ Therefore, it is appropriate for the Commission to review 
advance notices against these Clearing Agency Standards and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Payment, Clearing and Settlement 
Supervision Act.\19\
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    \16\ 12 U.S.C. 5464(a)(2).
    \17\ See Rule 17Ad-22 of the Act. 17 CFR 240.17Ad-22. Securities 
Exchange Act Release No. 68080 (October 22, 2012), 77 FR 66220 
(November 2, 2012) (S7-08-11).
    \18\ See Securities Exchange Act Release No. 68080 (October 22, 
2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
    \19\ 12 U.S.C. 5464(b).
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    The proposal in this advance notice is consistent with Clearing 
Agency Standards, Rule17Ad-22(b)(2) of the Act.\20\ Rule 17Ad-22(b)(2) 
of the Act \21\ requires a registered clearing agency that performs 
central counterparty services to, among other things, establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to use margin requirements to limit its credit 
exposures to participants under normal market conditions. This proposal 
is consistent with this rule because it is reasonably designed to 
permit OCC to use margin requirements to limit its credit exposures to 
clearing members under normal market conditions in two ways. First, it 
is reasonably designed to limit OCC's credit exposures to clearing 
members whose collateral portfolios could present concentration risk. 
Specifically, it addresses concentration risk by particular clearing 
member and by particular account by giving OCC discretion to disapprove 
as margin collateral certain securities, based on the number of shares 
deposited, by particular clearing member and by particular account, 
while also considering deposits that hedge open positions. It also 
clarifies that OCC's existing authority to not give value to certain 
margin deposits applies to all clearing members, as opposed to 
particular clearing members.\22\ Second, it is reasonably designed to 
limit OCC's credit exposures to clearing members whose collateral 
portfolios could present wrong-way risk. Specifically, it addresses 
wrong-way risk presented by clearing members who deposit as margin 
securities that are issued by the clearing member itself or by an 
affiliate of the clearing member. It addresses this type of wrong-way 
risk by giving OCC discretion to disapprove as margin collateral, with 
respect to a particular clearing member, any security issued by such 
clearing member or by an affiliate of such clearing member, while also 
considering deposits that hedge open positions.
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    \20\ 17 CFR 240.17Ad-22(b)(2).
    \21\ Id.
    \22\ See Rule 604, Interpretation and Policy .15 (providing OCC 
discretion to disapprove as margin collateral securities that meet 
certain factors, including trading volume, number of outstanding 
shareholder, number of outstanding shares, volatility and 
liquidity).
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    Rule 17Ad-22(b)(2) of the Act \23\ also requires a registered 
clearing agency that performs central counterparty services to, among 
other things, establish, implement, maintain and enforce written 
policies and procedures reasonably designed to use risk-based models 
and parameters to set margin requirements. This proposal is consistent 
with this rule because it permits OCC to use risk-based models and 
parameters to set margin requirements in a way that takes into account 
concentration risk and wrong-way risk, as described above.
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    \23\ 17 CFR 240.17Ad-22(b)(2).
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    The proposal in this advance notice meets the objectives and 
principles described in Section 805(b) of the Payment, Clearing and 
Settlement Supervision Act.\24\ The changes to

[[Page 66022]]

OCC's margin policy, as described above, are designed to reduce the 
risk that clearing member margin assets would be insufficient should 
OCC need to use such assets to close-out positions of a defaulted 
clearing member. The changes are also designed to facilitate OCC to 
timely meet its settlement obligations because the change will diminish 
the likelihood that a large percentage of the value of a defaulting 
clearing member's margin assets would not be available to OCC to cover 
losses in the event of a clearing member default. Therefore, the 
proposal (i) promotes robust risk management (including risk management 
of concentration risk and wrong-way risk), (ii) promotes safety and 
soundness, (iii) reduces systemic risks (including those caused by 
concentration risk and wrong-way risk), and (iv) supports the stability 
of the broader financial system.
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    \24\ 12 U.S.C 5464(b); See also 12 U.S.C. 5464(a).
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Payment, Clearing and Settlement Supervision Act,\25\ that the 
Commission DOES NOT OBJECT to the proposal in OCC's advance notice (SR-
OCC-2014-803) and OCC is AUTHORIZED to implement the proposal 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 the proposal in this advance notice (SR-OCC-2014-14), whichever is 
later.
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    \25\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2014-26344 Filed 11-5-14; 8:45 am]
BILLING CODE 8011-01-P


