
[Federal Register Volume 80, Number 37 (Wednesday, February 25, 2015)]
[Notices]
[Pages 10171-10173]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-03811]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74302; File No. SR-OCC-2014-23]


Self-Regulatory Organizations; the Options Clearing Corporation; 
Order Approving Proposed Rule Change To Clarify That OCC Would not 
Treat a Futures Transaction That Is an Exchange-for-Physical or Block 
Trade as a Non-Competitively Executed Trade if the Exchange on Which 
Such Trade Is Executed Has Provided OCC With Representations That it 
Has Policies or Procedures Requiring That Such Trades Be Executed at 
Reasonable Prices and That Such Price Is Validated by the Exchange

February 19, 2015.
    On December 19, 2014, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change File No. SR-OCC-2014-23 pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder.\2\ The proposed rule change was published for comment 
in the Federal Register on January 6, 2015.\3\ The Commission did not 
receive any comments on the proposed rule change. This order approves 
the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 73961(December 30, 
2014), 80 FR 568 (January 6, 2015) (SR-OCC-2014-23).
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I. Description

    OCC is modifying its By-Laws to add an interpretation and policy to 
Section 7 of Article XII of its By-Laws to clarify that OCC will not 
treat a futures transaction that is an exchange-for-physical (``EFP'') 
\4\ or block trade in futures (``Block Trade'') \5\ as a non-
competitively executed trade, and therefore subject to delayed 
novation, if the exchange on which the EFP or Block Trade is executed 
has provided OCC with representations that it has rules, policies or 
procedures requiring that such trades be executed at reasonable prices 
and that such prices are validated by the exchange.
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    \4\ According to OCC, an EFP is a transaction between two 
parties in which a futures contract on a commodity or security is 
exchanged for the actual physical good.
    \5\ According to OCC, a block trade is a trade involving a large 
number of shares being traded at an arranged price between parties, 
outside of the open markets, in order to lessen the impact of such a 
large trade being made public.
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Background

    According to OCC, under OCC's By-Laws, the novation of confirmed 
trades (i.e., transactions in options, futures, or other ``cleared 
contracts'' effected through an exchange and submitted to OCC for 
clearing) occurs at the ``commencement time'' for such transactions.\6\ 
The ``commencement time'' for most confirmed trades is when daily 
position reports are made available to clearing members.\7\ However, 
transactions in certain cleared products and certain types of 
transactions, including non-competitively executed EFPs and Block 
Trades, have delayed commencement times that are tailored to address 
risks specific to such products or transactions,\8\ including, but not 
limited to, those risks presented by off-market transactions.
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    \6\ Cleared Contracts and Commencement Time are defined terms 
set forth in Article 1, Section 1 of OCC's By-Laws.
    \7\ See OCC's By-Laws Article VI, Section 5. According to OCC, 
in a practical sense, however, most trades are novated upon proper 
submission to OCC for clearing since OCC's By-Laws, with limited 
exception, do not permit OCC to reject any confirmed trade due to 
the failure of the purchasing clearing member to pay any amount due 
to OCC at or before the settlement time. See also Securities 
Exchange Act Release No. 65990 (December 16, 2011), 76 FR 79731 
(December 22, 2011) (SR-OCC-2011-17).
    \8\ Id.
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    When OCC began clearing EFPs and Block Trades, it established that 
the commencement time for such transactions is expressly conditioned 
upon the receipt by OCC of variation payments due from purchasing and 
selling clearing members because EFPs and Block Trades could be 
executed away from the market and be executed at other than market 
prices. These factors were viewed as creating heightened exposure to 
OCC if a clearing member defaults on a trade executed at an off-market 
price and, as a result, Article XII, Section 7 of OCC's By-Laws 
establishes that the commencement time for an EFP or Block Trade is the 
time of the first variation payment after the trade is reported to OCC 
(typically 9:00 a.m. Central Time the following business day).\9\ OCC 
delays its novation of these non-competitively executed futures trades 
because OCC is bound to pay the first variation settlement amount to 
the counterparty once novation has occurred, and if the agreed-upon 
price at which the trade is entered differs from the competitive market 
price, there is an increased likelihood that OCC may

[[Page 10172]]

experience a loss if it is required to close out a defaulting 
purchaser's position. Accordingly, OCC does not novate, and thereby 
become a counterparty to, a non-competitively executed trade if OCC 
fails to receive the first variation payment when due.
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    \9\ See Securities Exchange Act Release No. 44727 (August 20, 
2001), 66 FR 45351 (August 28, 2001) (SR-OCC-2001-07).
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EFP and Block Trades Subject to Price Checks

    According to OCC, in the time since OCC adopted Article XII, 
Section 7 of its By-Laws, the Commodity Futures Trading Commission 
(``CFTC'') has adopted Regulation 1.73, which requires clearing futures 
commission merchants (``FCMs'') to establish certain risk controls, 
including risk based limits for bilaterally executed transactions and 
for Block Trades.\10\ In light of this requirement and other proposed 
regulatory developments that may affect EFPs and Block Trades,\11\ 
certain futures exchanges requested that OCC review its By-Laws 
regarding delayed novation of these trades to reassess the impact of 
the recently implemented rules, supported by policies and procedures, 
which require the exchanges' market participants to execute s EFPs and 
Block Trades at reasonable prices that are verified by the exchange. 
These rules, policies and procedures leverage risk controls implemented 
by FCMs, as applicable. OCC undertook such a review of its practices 
with respect to delayed novation of EFPs and Block Trades, and 
determined that it is appropriate to novate these trades when daily 
position reports are made available, provided that the exchange that 
submitted such trades to OCC represents to OCC that the exchange has in 
place rules, policies and procedures to verify the reasonableness of 
the transaction price of EFPs and Block Trades it submits to OCC for 
clearance and settlement, and that such price is validated by the 
exchange.
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    \10\ See 17 CFR 1.73. According to OCC, Regulation 1.73 requires 
FCMs to: (1) Establish risk-based limits in the proprietary account 
and in each customer account based on position size, order size, 
margin requirements, or similar factors; (2) screen orders for 
compliance with the risk-based limits; and (3) monitor for adherence 
to the risk based limits intra-day and overnight.
    \11\ According to OCC, the CFTC has proposed regulations 
requiring Designated Contract Markets (i.e., futures exchanges) to 
determine whether or not the price of a block trade is fair and 
reasonable considering: (1) The size of the block trade, (2) the 
price and size of other block trades in any relevant markets at the 
applicable time, and (3) the circumstances of the market or the 
parties to the block trade. See proposed CFTC Regulation 38.503. 75 
FR 80572, 80592. See also proposed Appendix B of part 38 of the 
CFTC's proposed regulations concerning Core Principle 9. 75 FR 
80572, 80630. The CFTC has also proposed to adopt similar 
regulations concerning EFP trades. See proposed CFTC Regulation 
38.505. 75 FR 80572, 80593.
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    OCC has determined that EFPs and Block Trades that are subject to 
price reasonability checks do not present the same settlement risks 
discussed above in relation to non-competitively executed EFPs and 
Block Trades. Specifically, should a clearing member that executed a 
reasonably priced EFP or Block Trades fail to pay its first variation 
payment to OCC on the trade, OCC anticipates it will liquidate the 
futures positions at the prevailing market price and obtain sufficient 
funds, or OCC will already have sufficient funds in its clearing fund, 
to pay or reimburse itself for the first variation settlement to the 
counterparty to the trade. This is the same risk management methodology 
OCC currently uses for other competitively executed trades in cleared 
contracts that OCC accepts for clearance and settlement on a daily 
basis.
    Accordingly, OCC is amending Article XII, Section 7, of its By-Laws 
by adding an interpretation and policy to exclude EFPs and Block Trades 
from the delayed novation and to provide for the treatment of these 
trades as competitively executed trades, provided that the s EFPs and 
Block Trades are reported by an exchange that represents to OCC that it 
performs a price reasonableness check on the trade, and that such price 
is validated by the exchange.

Verification of Exchange Rules, Policies and Procedures Related to 
Price Reasonableness

    Before permitting an exchange to submit EFPs and Block Trades that 
will not be subject to delayed novation, OCC will require an exchange 
to provide OCC with a certification that the exchange has rules, 
policies or procedures as they relate to verifying the reasonableness 
of the price of the EFP and Block Trade. Specifically, OCC will require 
an exchange to certify that its rules, policies or procedures provide 
that the price at which a EFP or Block Trade is executed must be fair 
and reasonable in light of: (i) The size of the EFP or Block Trade; 
(ii) the prices and sizes of other transactions in the same contract at 
the relevant time; and (iii) the prices and sizes of transactions in 
other relevant markets, including, without limitation, the underlying 
cash market or related futures markets, at the relevant time.\12\ An 
exchange will also have to certify that its rules, policies or 
procedures require one or both parties to an EFP or Block Trade to 
report the trade details of the trade to the exchange within a 
reasonable period of time (i.e., within 10 minutes of the time of 
execution or, if the EFP or Block Trade is executed outside of regular 
trading hours, within 15 minutes of the commencement of trading on the 
next business day). OCC believes that it is appropriate to rely on 
price reasonableness checks performed by exchanges trading futures 
because they are self-regulatory organizations subject to regulatory 
oversight, including routine examinations. Moreover, OCC will presume 
that all EFPs and Block Trades submitted by an exchange that represents 
that it has price reasonableness rules, policies or procedures in place 
will submit to OCC EFPs and Block Trades that have undergone a price 
reasonableness check.
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    \12\ For example, according to OCC, OneChicago LLC (``OCX'') 
Rule 417 governs EFP and Block Trades executed on OCX and provides 
that such trades be executed on a designated trading platform that 
will automatically verify that EFPs and Block Trades were executed 
at competitive prices by price verification software for price 
reasonableness.
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    In addition to exchanges implementing rules, policies or procedures 
regarding the price reasonableness checks for EFPs and Block Trades, 
exchanges may continue to use their existing authority to notify OCC 
pursuant to Article VI, Section 7(c) of OCC's By-Laws, to disregard any 
EFP or Block Trade submitted to OCC that was executed at an 
unreasonable price. The notification will be delivered to OCC along 
with other trades ``busted'' by an exchange, in accordance with an 
operational process that currently occurs every day before daily 
position reports are distributed. Such trades could not be properly 
cleared under amended Article XII, Section 7, but instead would fall 
within the non-competitively executed category and therefore be subject 
to delayed novation. Taken together, OCC believes that these measures 
appropriately protect OCC in the event OCC receives a EFP or Block 
Trade at an unreasonable price. Moreover, OCC and the exchanges will 
continue to maintain an ongoing dialogue about operational matters, 
which OCC will use to confirm the continued application of price 
reasonableness controls.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \13\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that the proposed rule change is consistent with the requirements 
of the Act and the

[[Page 10173]]

rules and regulations thereunder applicable to such organization.
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    \13\ 15 U.S.C. 78s(b)(2)(C).
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    The Commission finds that the proposed rule change is consistent 
with Section 17A(b)(3)(F) of the Act \14\ which requires the rules of a 
clearing agency to, among other things, assure the safeguarding of 
securities and funds which are in the custody or control of the 
clearing agency or for which it is responsible. OCC is amending Article 
XII, Section 7, to include a new policy and interpretation setting 
forth the specific criteria a futures exchange must meet in order for 
EFPs and Block Trades to not be subject to the delayed novation times 
set forth in Article XII of OCC's By-Laws. Specifically the exchange 
must provide OCC with a certification that the exchange has rules, 
policies or procedures as they relate to verifying the reasonableness 
of the price of the EFP and Block Trade. OCC's proposal, as approved, 
does not affect the novation time for any securities transactions.
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    \14\ 15 U.S.C. 78q-1(b)(3)(F).
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    OCC has determined that EFPs and Block Trades that are subject to 
price reasonability checks do not present the same settlement risks as 
those executed on exchanges without price reasonability checks, and as 
such has determined that OCC's requirement that exchanges certify price 
reasonableness policies and procedures are sufficiently appropriate to 
mitigate the risks associated with non-competitively executed trades. 
In addition, in the event a clearing member fails to its first 
variation payment to OCC on an EFP or Block Trade that was executed on 
an exchange with price reasonability checks, OCC will employ the same 
risk management methodology used for all other competitively executed 
trades accept for clearing at OCC, which should in turn reduce 
settlement risks that could expose OCC to loss if it is required to 
close out a defaulting purchaser's EFP or Block Trade position. 
Combining OCC's price reasonableness requirements for exchanges and 
OCC's ability to liquidate futures positions or use its clearing fund 
to management risks associated with non-payment of premiums for those 
trades accepted for clearance and settlement, OCC should have 
sufficient risk management controls in place in to assure the 
safeguarding of securities and funds which are in the custody of 
control of OCC or for which it is responsible.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act \15\ and the 
rules and regulations thereunder.
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    \15\ 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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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change File No. SR-OCC-2014-23 be, and 
it hereby is, approved.
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    \16\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2015-03811 Filed 2-24-15; 8:45 am]
BILLING CODE 8011-01-P


