
[Federal Register Volume 80, Number 5 (Thursday, January 8, 2015)]
[Notices]
[Pages 1062-1065]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-00052]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73979; File No. SR-OCC-2014-809]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection to Advance Notice Concerning the Implementation 
of a Committed Master Repurchase Agreement Program as Part of OCC's 
Overall Liquidity Plan

January 2, 2015.
    On November 6, 2014, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-OCC-2014-809 (``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 December 9, 2014.\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). 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 Clearing Supervision Act and file 
advance notices with the Commission. See 12 U.S.C. 5465(e).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ Securities Exchange Act Release No. 73726 (December 3, 
2014), 79 FR 73116 (December 9, 2014) (SR-OCC-2014-809).
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I. Description of the Advance Notice

a. Background

    The purpose of the proposed change is to allow OCC to implement a 
committed master repurchase agreement program (``MRA Program'') in 
order to access an additional committed source of liquidity to meet its 
settlement obligations in a manner that does not increase the 
concentration of OCC's counterparty exposure, given OCC's existing 
affiliations between a number of commercial banking institutions and 
OCC's clearing members. According to OCC, the MRA Program will take the 
form of OCC entering into a committed master repurchase agreement and 
related confirmations (together, the ``Master Repurchase Agreement'') 
with one or more non-bank, non-clearing

[[Page 1063]]

member institutional investors.\4\ The program will be part of OCC's 
overall liquidity plan that is meant to provide OCC with access to 
diverse sources of liquidity, which includes committed credit 
facilities, securities lending and securities repurchase arrangements, 
and clearing member funding requirements that, under certain 
conditions, allow OCC to obtain funds from clearing members.\5\
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    \4\ OCC states that it will conduct a due diligence review with 
respect to each counterparty before entering into a master 
repurchase arrangement with it. Because the appropriate due 
diligence activities and financial criteria will vary for each type 
of counterparty, OCC will determine on a case-by-case basis the 
specific due diligence criteria it would implement. However, as the 
principal purpose of due diligence will be to obtain assurance that 
each counterparty has the financial ability to satisfy its 
obligations under the program, the review will encompass an 
assessment of the counterparty's financial statements (including 
external auditor reports thereon) and, as applicable, ratings and/or 
investment reports. Furthermore, OCC will identify key criteria 
relative to monitoring the financial stability of the counterparty 
on a going forward basis.
    \5\ See, e.g., Securities Exchange Act Release No. 72752 (August 
4, 2014), 79 FR 46490 (August 8, 2014) (SR-OCC-2014-17), Securities 
Exchange Act Release No. 71549 (February 12, 2014), 79 FR 03574 
(February 19, 2014) (SR-OCC-2014-801) and Securities Exchange Act 
Release No. 73257 (September 30, 2014), 79 FR 23698 (October 3, 
2014) (SR-OCC-2014-806).
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    Although the Master Repurchase Agreement would be based on the 
standard form of master repurchase agreement \6\ so that it will be 
more familiar to potential institutional investors, OCC would require 
the Master Repurchase Agreement to contain certain additional 
provisions tailored to ensure a reduction in concentration risk, 
certainty of funding, and operational effectiveness.
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    \6\ The standard form master repurchase agreement is published 
by the Securities Industry and Financial Markets Association and is 
commonly used in the repurchase market by institutional investors.
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b. The Proposed MRA Program

i. Standard Repurchase Agreement Terms
    According to OCC, the Master Repurchase Agreement generally will be 
structured like a typical repurchase arrangement, in order to help OCC 
attract interest from potential institutional investors willing to be 
counterparties to OCC. Under the Master Repurchase Agreement, the buyer 
(i.e., the institutional investor) on occasion would purchase from OCC 
United States government securities (``Eligible Securities'').\7\ OCC, 
as the seller, will transfer Eligible Securities to the buyer in 
exchange for a payment by the buyer to OCC in immediately available 
funds (``Purchase Price''). The buyer will simultaneously agree to 
transfer the purchased securities back to OCC at a specified later date 
or on OCC's demand (``Repurchase Date'') against the transfer of funds 
by OCC to the buyer in an amount equal to the outstanding Purchase 
Price plus the accrued and unpaid price differential (together, the 
``Repurchase Price''), which is the interest component of the 
Repurchase Price.
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    \7\ OCC would use U.S. government securities that are included 
in clearing fund contributions by clearing members and margin 
deposits of any clearing member that has been suspended by OCC for 
the repurchase arrangements. Article VIII, Section 5(e) of OCC's By-
Laws and OCC Rule 1104(b) authorize OCC to obtain funds from third 
parties through securities repurchases using these sources. The 
officers who may exercise this authority include the Executive 
Chairman and the President.
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    At all times while a transaction is outstanding, OCC will be 
required to maintain a specified amount of securities or cash margin 
with the buyer.\8\ The market value of the securities supporting each 
transaction will be determined daily, typically based on a price 
obtained from a generally recognized pricing source. If the market 
value of the purchased securities is determined to have fallen below 
OCC's required margin, OCC will be required to transfer to the buyer 
sufficient cash or additional securities reasonably acceptable to the 
buyer so that OCC's margin requirement is satisfied.\9\ If the market 
value of the purchased securities is determined to have risen to above 
OCC's required margin, OCC will be permitted to require the return of 
excess purchased securities from the buyer.
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    \8\ OCC expects that it would be required to maintain margin 
equal to 102% of the Repurchase Price which, according to OCC, is a 
standard rate for arrangements involving U.S. government securities.
    \9\ OCC expects that it would use clearing fund securities and 
securities posted as margin by defaulting clearing members.
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    As in a typical master repurchase agreement, an event of default 
will occur with respect to the buyer if the buyer fails to purchase 
securities on a purchase date, fails to transfer purchased securities 
on any applicable Repurchase Date, or fails to transfer any interest, 
dividends or distributions on purchased securities to OCC within a 
specified period after receiving notice of such failure. An event of 
default will occur with respect to OCC if OCC fails to transfer 
purchased securities on a purchase date or fails to repurchase 
purchased securities on an applicable Repurchase Date. The Master 
Repurchase Agreement also will provide for standard events of default 
for either party, including a party's failure to maintain required 
margin or an insolvency event with respect to one of the parties.
    Upon the occurrence of an event of default, the non-defaulting 
party, at its option, will have the right, among others, to accelerate 
the Repurchase Date of all outstanding transactions between the 
defaulting party and the non-defaulting party. For example, if OCC were 
the defaulting party with respect to a transaction and the buyer chose 
to terminate the transaction, OCC will be required to immediately 
transfer the Repurchase Price to the buyer. If the buyer were the 
defaulting party with respect to a transaction and OCC chose to 
terminate the transaction, the buyer will be required to deliver all 
purchased securities to OCC. If OCC or the buyer does not perform in a 
timely manner, the non-defaulting party will be permitted to buy or 
sell, or deem itself to have bought or sold, securities as needed to be 
made whole and the defaulting party will be required to pay the costs 
related to any covering transactions. Additionally, if OCC is required 
to obtain replacement securities as a result of an event of default, 
the buyer will be required to pay the excess of the price paid by OCC 
to obtain replacement securities over the Repurchase Price.
ii. Customized Features
    As part of the Master Repurchase Agreement, OCC will enter into an 
individualized master confirmation with each buyer and its agent which 
will set forth certain terms and conditions applicable to all 
transactions entered into under the Master Repurchase Agreement by that 
buyer. According to OCC, these required terms and conditions will be 
designed to promote OCC's goals of reduced concentration risk, 
certainty of funding and operational effectiveness. The terms of the 
master confirmations under each Master Repurchase Agreement may vary 
from one another, because a separate master confirmation will be 
negotiated for a given buyer at the time that buyer becomes a party to 
the Master Repurchase Agreement. OCC has identified the following as 
key standards that will need to be incorporated into each repurchase 
arrangement entered into under the program.\10\
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    \10\ OCC expects that the Master Repurchase Agreement also will 
include other, more routine, provisions such as the method for 
giving notices and basic due authorization representations by the 
parties.

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[[Page 1064]]

Counterparties
    OCC only will enter into repurchase arrangements with non-bank 
institutional investors, such as pension funds or insurance companies 
that are not OCC clearing members or banks affiliated with any OCC 
clearing member. OCC believes this requirement will allow OCC to access 
stable, reliable sources of funding, without increasing the 
concentration of its exposure to counterparties that are affiliated 
banks, broker/dealers and futures commission merchants. OCC believes 
that this reduction in concentration risk is a key advantage of this 
proposed program.
Commitment to Fund and Funding Accounts
    OCC will seek funding commitments from one or more potential 
counterparties that will equal $1 billion in the aggregate,\11\ with 
each commitment extending for 364 days or more. Each counterparty will 
be obligated to enter into transactions under the Master Repurchase 
Agreement up to its committed amount so long as no default had occurred 
and OCC transferred sufficient Eligible Securities. Each counterparty 
will be obligated to enter into transactions even if OCC had 
experienced a material adverse change, such as the failure of a 
clearing member. According to OCC, this commitment to provide funding 
will be a key departure from ordinary repurchase arrangements and a key 
requirement for OCC. Each commitment will be supported by an agreement 
by the counterparty to maintain cash and investments acceptable to OCC 
that must be readily converted into cash in a designated account into 
which OCC has visibility. OCC believes that the creation of a funding 
account is important because it will help OCC ensure that the committed 
funds will be available each day. OCC also believes that it will 
facilitate prompt funding by counterparties that are not commercial 
banks and therefore are not in the business of daily funding.
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    \11\ The $1 billion in commitments could be spread across 
multiple counterparties, but $1 billion represents the proposed 
aggregate size of the program.
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Funding Mechanics
    According to OCC, funding mechanics will be targeted so that OCC 
will receive the Purchase Price in immediately available funds within 
60 minutes of its request for funds and delivery of Eligible Securities 
and, if needed, prior to OCC's regular daily settlement time.\12\ OCC 
believes that these targeted funding mechanics will allow OCC to 
receive needed liquidity in time to satisfy settlement obligations, 
even in the event of a default by a clearing member or a market 
disruption. The funding mechanism may be, for example, delivery versus 
payment/receive versus payment or another method acceptable to OCC that 
both satisfies the objectives of the MRA Program and presents limited 
operational risks.
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    \12\ According to OCC, this would include OCC's regular daily 
settlement time and any extended settlement time implemented by OCC 
in an emergency situation under OCC Rule 505.
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No Rehypothecation
    Under the terms of each master confirmation, the buyer would not be 
permitted to grant any third party an interest in purchased securities, 
the custody account at the custodian where purchased securities are 
held, or any cash held in OCC's account. As a result, OCC states that 
the buyer would be prohibited from rehypothecating purchased 
securities, the purchased securities should never leave the account, 
and there should be no third-party claims against the purchased 
securities. OCC believes that the prohibition on rehypothecation also 
would reduce the risk that a third party could interfere with the 
buyer's transfer of the purchased securities on the Repurchase Date. 
Further, according to OCC, the custodian would agree to provide OCC 
with daily information about each buyer's account. OCC believes that 
this visibility would allow OCC to act quickly in the event a buyer 
violates any requirements.
Early Termination Rights
    Under the Master Repurchase Agreement, OCC would have the ability 
to terminate any transaction upon written notice to the buyer, but a 
buyer only would be able to terminate a transaction upon the occurrence 
of an event of default with respect to OCC.\13\ OCC has stated that 
this optional early termination right is important because its 
liquidity needs may change unexpectedly over time and as a result OCC 
may not want to keep a transaction outstanding as long as originally 
planned.
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    \13\ According to OCC, a notice of termination by OCC would 
specify a new Repurchase Date prior to the originally agreed upon 
Repurchase Date. Upon the early termination of a transaction, the 
buyer would be required to return all purchased securities to OCC, 
and OCC would be required to pay the Repurchase Price.
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Substitution
    Under the Master Repurchase Agreement, OCC would have the ability 
to substitute any Eligible Securities for purchased securities in its 
discretion by a specified time, so long as the Eligible Securities 
satisfy any applicable criteria contained in the Master Repurchase 
Agreement and the transfer of the Eligible Securities would not create 
a margin deficit, as described above.\14\ OCC believes that this 
substitution right is important because it must be able to manage 
clearing member requests to return excess or substitute Eligible 
Securities in accordance with established operational procedures.
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    \14\ In addition to its substitution rights, OCC could cause the 
return of purchased securities by exercising its optional early 
termination rights under the Master Repurchase Agreement. If OCC 
were to terminate part or all of a transaction, the buyer would be 
required to return purchased securities to OCC against payment of 
the corresponding Repurchase Price.
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Events of Default
    In addition to the standard events of default for a failure to 
purchase or transfer securities on the applicable Purchase Date or 
Repurchase Date, OCC would require that the Master Repurchase Agreement 
not contain any additional events of default that would restrict OCC's 
access to funding and that it contain an additional default remedy. OCC 
would require that it would not be an event of default if OCC suffers a 
``material adverse change.'' \15\ According to OCC, this provision 
provides it with certainty of funding, even in difficult market 
conditions.
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    \15\ According to OCC, a ``material adverse change'' is 
typically defined as a change that would have a materially adverse 
effect on the business or financial condition of a company.
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    Upon the occurrence of an event of default, in addition to the non-
defaulting party's right to accelerate the Repurchase Date of all 
outstanding transactions or to buy or sell securities as needed to be 
made whole, the non-defaulting party may elect to take the actions 
specified in the ``mini close-out'' provision of the Master Repurchase 
Agreement, rather than declaring an event of default.\16\ Therefore, if 
the buyer fails to deliver purchased securities on any Repurchase Date, 
OCC believes that it would have remedies that allow it to mitigate risk 
with respect to a particular transaction, without declaring an event of 
default with

[[Page 1065]]

respect to all transactions under the Master Repurchase Agreement.
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    \16\ For example, if the buyer fails to transfer purchased 
securities on the applicable Repurchase Date, rather than declaring 
an event of default, OCC may (1) if OCC has already paid the 
Repurchase Price, require the buyer to repay the Repurchase Price, 
(2) if there is a margin excess, require the buyer to pay cash or 
delivered purchased securities in an amount equal to the margin 
excess, or (3) declare that the applicable transaction, and only 
that transaction, will be immediately terminated, and apply default 
remedies under the Master Repurchase Agreement to only that 
transaction.
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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.\17\ 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.\18\
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    \17\ See 12 U.S.C. 5461(b).
    \18\ Id.
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    Section 805(a)(2) of the Clearing Supervision Act \19\ 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 Clearing Supervision Act \20\ states that the objectives 
and principles for the risk management standards prescribed under 
Section 805(a) shall be to:
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    \19\ 12 U.S.C. 5464(a)(2).
    \20\ 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 (``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 Clearing Agency Standards, and the objectives and 
principles of these risk management standards as described in Section 
805(b) of the Clearing Supervision Act.\23\
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    \21\ 17 CFR 240.17Ad-22.
    \22\ The Clearing Agency Standards are substantially similar to 
the risk management standards established by the Board of Governors 
of the Federal Reserve System governing the operations of designated 
FMUs 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(b).
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    The Commission believes that the proposal in this Advance Notice is 
designed to further the objectives and principles of Section 805(b) of 
the Clearing Supervision Act.\24\ As a systemically-important FMU, it 
is imperative that OCC have adequate resources to be able to satisfy 
its counterparty settlement obligations. The MRA Program provides OCC 
with a committed liquidity resource that does not increase the 
concentration of OCC's counterparty exposure because the counterparties 
will not include OCC's clearing members nor affiliated commercial 
banking institutions. Accordingly, the Commission believes that the 
proposal should promote robust risk management, promote safety and 
soundness in the marketplace, reduce systemic risks, and support the 
stability of the broader financial system by giving OCC access to 
additional committed liquidity that will help OCC meet its settlement 
obligations in a timely manner, while also limiting the exposure that 
OCC has to its counterparties.
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    \24\ 12 U.S.C 5464(b).
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    Exchange Act Rule 17Ad-22(b)(3),\25\ adopted as part of the 
Clearing Agency Standards, requires that a non-security-based swap 
registered clearing agency that performs CCP services establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to withstand, at a minimum, a default by the 
participant family to which it has the largest exposure in extreme but 
plausible market conditions. As a part of OCC's overall liquidity plan, 
the Commission believes that the MRA Program will contribute additional 
liquid financial resources that should enhance OCC's ability to meet 
any potential settlement demands arising out of a default of a clearing 
member or clearing member family, including one to which it has the 
largest exposure.
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    \25\ 17 CFR 240.17Ad-22(b)(3).
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\26\ that the Commission does not object to 
advance notice proposal (SR-OCC-2014-809) and that OCC is authorized to 
implement the proposal as of the date of this notice.
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    \26\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2015-00052 Filed 1-7-15; 8:45 am]
BILLING CODE 8011-01-P


