
[Federal Register Volume 80, Number 44 (Friday, March 6, 2015)]
[Notices]
[Pages 12215-12221]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-05117]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74387; File No. SR-OCC-2014-813]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection to Advance Notice Filing, as Modified by 
Amendment No. 1, Concerning a Proposed Capital Plan for Raising 
Additional Capital That Would Support The Options Clearing 
Corporation's Function as a Systemically Important Financial Market 
Utility

February 26, 2015.
    On December 29, 2014, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
advance notice File No. SR-OCC-2014-813 pursuant to Section 
806(e)(1)(A) of the Payment, Clearing, and Settlement Supervision Act 
of 2010 (``Payment, Clearing and Settlement Supervision Act'') \1\ and 
Rule 19b-4(n)(1)(i) under the Securities Exchange Act of 1934 
(``Act'').\2\ On January 14, 2015, OCC filed Amendment No. 1 to the 
advance notice.\3\ The advance notice was published for comment in the 
Federal Register on February 9, 2015.\4\ The Commission received eight 
comment letters on OCC's proposal.\5\ This publication serves as a 
notice of no objection to proposal discussed in the advance notice.
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    \1\ 12 U.S.C. 5465(e)(1)(A). 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.
    \2\ 17 CFR 240.19b-4(n)(1)(i). As the Commission noted in the 
notice of filing of the advance notice, as modified by Amendment No. 
1, OCC stated that the purpose of this proposal is, in part, to 
facilitate compliance with proposed Commission rules and address 
Principle 15 of the Principles for Financial Market Infrastructures 
(``PMFIs''). The proposed Commission rules are pending. See 
Securities Exchange Act Release No. 71699 (March 12, 2014), 79 FR 
29508 (May 22, 2014) (S7-03-14). Therefore, the Commission has 
evaluated this advance notice under the Payment, Clearing and 
Settlement Supervision Act and the rules currently in force 
thereunder. See Securities Exchange Act Release No. 74202 (February 
4, 2015), 80 FR 7056 (February 9, 2015) (SR-OCC-2014-813) at note 3.
    \3\ According to OCC, OCC filed Amendment No. 1 to: (i) Update 
OCC's plan for raising additional capital (``Capital Plan'') in 
connection with negotiations between OCC and the options exchanges 
that own equity in OCC (``Stockholder Exchanges'' or 
``stockholders'') and that would contribute additional capital under 
the Capital Plan, (ii) correct typographical errors, and (iii) 
update the Term Sheet included as an exhibit, which summarizes 
material features of the Capital Plan.
    \4\ Securities Exchange Act Release No. 74202 (February 4, 
2015), 80 FR 7056 (February 9, 2015) (SR-OCC-2014-813). In 
conjunction with this advance notice, OCC filed a corresponding 
proposed rule change seeking approval of changes to its By-Laws, 
Certificate of Incorporation and relevant agreements, including its 
Stockholders Agreement, necessary to implement the Capital Plan. 
This proposed rule change was published in the Federal Register on 
January 30, 2015. Securities Exchange Act Release No. 74136 (January 
26, 2015), 80 FR 5171 (January 30, 2015) (SR-OCC-2015-02).
    \5\ See Letter from Eric Swanson, General Counsel & Secretary, 
BATS Global Markets, Inc., (February 19, 2015) (``BATS Letter''); 
Letter from Tony McCormick, Chief Executive Officer, BOX Options 
Exchange, (February 19, 2015) (``BOX Letter''); Letter from Howard 
L. Kramer on behalf of Belvedere Trading, CTC Trading Group, IMC 
Financial Markets, Integral Derivatives, Susquehanna Investment 
Group, and Wolverine Trading, (February 20, 2015) (``MM Letter''); 
Letter from Ellen Greene, Managing Director, Financial Services 
Operations, SIFMA, (February 20, 2015) (``SIFMA Letter''); Letter 
from James E. Brown, General Counsel, OCC, (February 23, 2015) 
(responding to BATS Letter and BOX Letter) (``OCC Letter I''); 
Letter from James E. Brown, General Counsel, OCC, (February 23, 
2015) (responding to MM Letter) (``OCC Letter II''); Letter from 
Barbara J. Comly, Executive Vice President, General Counsel & 
Corporate Secretary, Miami International Securities Exchange, LLC 
(February 24, 2015) (``MIAX Letter''); Letter from James E. Brown, 
General Counsel, OCC, (February 24, 2015) (responding to SIFMA 
Letter) (``OCC Letter III''). Since the proposal was filed as both 
an advance notice and proposed rule change, the Commission 
considered all comments received on the proposal, regardless of 
whether the comments were submitted to the proposed rule change or 
advance notice. In its assessment of the advance notice, the 
Commission assessed whether the issues raised by the commenters 
relate to the level or nature of risks presented to OCC by the 
Capital Plan. See comments on the advance notice (File No. SR-OCC-
2014-813), http://www.sec.gov/comments/sr-occ-2014-813/occ2014813.shtml and comments on the proposed rule change (File No. 
SR-OCC-2015-02), http://www.sec.gov/comments/sr-occ-2015-02/occ201502.shtml.
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I. Description of the Advance Notice

    Pursuant to this advance notice, OCC is implementing a Capital Plan 
under which the Stockholder Exchanges will make an additional capital 
contribution and commit to replenishment capital (``Replenishment 
Capital'') in circumstances discussed below, and will receive, among 
other things, the right to receive dividends from OCC. In addition to 
the additional capital contribution and Replenishment Capital, the main 
features of the Capital Plan include: (i) A policy establishing OCC's 
clearing fees at a level that would be sufficient to cover OCC's 
estimated operating expenses plus a ``business risk buffer'' as 
described below (``Fee Policy''), (ii) a policy establishing the amount 
of the annual refund to clearing members of OCC's fees (``Refund 
Policy''), and (iii) a policy for calculating the amount of dividends 
to be paid to the options exchanges owning equity in OCC (``Dividend 
Policy''). OCC stated that it intends to implement the Capital Plan on 
or about February 27, 2015, subject to all necessary regulatory 
approvals.\6\
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    \6\ OCC filed a proposed rule change seeking approval of changes 
to its By-Laws, Certificate of Incorporation and relevant 
agreements, including its Stockholders Agreement, necessary to 
implement the Capital Plan. See supra note 4.
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    OCC states in its proposal that it is implementing this Capital 
Plan, in part, to increase significantly OCC's capital in connection 
with its increased responsibilities as a systemically important 
financial market utility. OCC's proposal includes an infusion of 
substantial additional equity capital by the Stockholder Exchanges to 
be made prior to February 27, 2015, subject to regulatory approval, 
that when added to retained earnings accumulated by OCC in 2014 will 
significantly increase OCC's capital levels as compared to historical 
levels. Additionally, the proposed change includes the Replenishment 
Capital commitment, which will provide OCC with access to additional 
equity contributed by the Stockholder Exchanges should OCC's equity 
fall close to or below the amount that OCC determines to be appropriate 
to support its business and manage business risk.

A. Background

    OCC is a clearing agency registered with the Commission and is also 
a derivatives clearing organization (``DCO'') regulated in its capacity 
as such by the Commodity Futures Trading Commission (``CFTC''). OCC is 
a Delaware business corporation and is owned equally by the Stockholder 
Exchanges, five national securities exchanges for which OCC provides 
clearing services.\7\ In addition, OCC provides clearing services for 
seven other national securities exchanges that trade options (``Non-
Stockholder Exchanges''). In its capacity as a DCO, OCC provides 
clearing services to four futures exchanges. OCC also has been 
designated systemically important by the Financial Stability Oversight 
Council pursuant to the Payment, Clearing and Settlement Supervision

[[Page 12216]]

Act, and the Commission is OCC's ``Supervisory Agency'' under Section 
803(8) of the Payment, Clearing and Settlement Supervision Act.\8\
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    \7\ The Stockholder Exchanges are: Chicago Board Options 
Exchange, Incorporated; International Securities Exchange, LLC; 
NASDAQ OMX PHLX LLC; NYSE MKT LLC; and NYSE Arca, Inc.
    \8\ 12 U.S.C. 5462(8).
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    According to OCC, it has devoted substantial efforts during the 
past year to: (1) Develop a 5-year forward looking model of expenses; 
(2) quantify maximum recovery and wind-down costs under OCC's recovery 
and wind-down plan; (3) assess and quantify OCC's operational and 
business risks; (4) model projected capital accumulation taking into 
account varying assumptions concerning business conditions, fee levels, 
buffer margin levels and refunds; and (5) develop an effective 
mechanism that provides OCC access to replenishment capital in the 
event of losses. Incorporating the results of those efforts, the 
Capital Plan is intended to provide OCC with the means to increase its 
stockholder equity.

B. OCC's Projected Capital Requirement

    According to OCC, using the methods described in detail below, OCC 
will annually determine a target capital requirement consisting of (i) 
a baseline capital requirement equal to the greatest of (x) six months 
operating expenses for the following year, (y) the maximum cost of the 
recovery scenario from OCC's recovery and wind-down plan, and (z) the 
cost to OCC of winding down operations as set forth in the recovery and 
wind-down plan (``Baseline Capital Requirement''), plus (ii) a target 
capital buffer linked to plausible loss scenarios from operational 
risk, business risk and pension risk (``Target Capital Buffer'') 
(collectively, ``Target Capital Requirement''). OCC determined that the 
appropriate Target Capital Requirement is $247 million, reflecting a 
Baseline Capital Requirement of $117 million, which is equal to six 
months of projected operating expenses, plus a Target Capital Buffer of 
$130 million. This Target Capital Buffer would provide a significant 
capital cushion to offset potential business losses.
    According to OCC, it had total shareholders' equity of 
approximately $25 million as of December 31, 2013,\9\ meaning that OCC 
proposes to add additional capital of $222 million to meet its 2015 
Target Capital Requirement. OCC determined that a viable plan for 
Replenishment Capital should provide for a replenishment capital amount 
which would give OCC access to additional capital as needed up to a 
maximum of the Baseline Capital Requirement (``Replenishment Capital 
Amount'').\10\ Therefore, OCC's Capital Plan will include the following 
in order to provide OCC in 2015 with ready access to approximately $364 
million in equity capital:
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    \9\ See OCC 2013 Annual Report, Financial Statements, Statements 
of Financial Condition, available on OCC's Web site, http://optionsclearing.com/components/docs/about/annual-reports/occ_2013_annual_report.pdf.
    \10\ The obligation to provide Replenishment Capital will be 
capped at $200 million, which OCC projects will account for 
increases in its capital requirements for the foreseeable future.

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------------------------------------------------------------------------
Baseline Capital Requirement............................    $117,000,000
Target Capital Buffer...................................    $130,000,000
Target Capital Requirement..............................    $247,000,000
Replenishment Capital Amount............................    $117,000,000
                                                         ---------------
    Total OCC Capital Resources.........................    $364,000,000
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C. Procedures Followed in Order To Determine Capital Requirement

    According to OCC, various measures were used in determining the 
appropriate level of capital. An outside consultant conducted a 
``bottom-up'' analysis of OCC's risks and quantified the appropriate 
amount of capital to be held against each risk. The analysis was 
comprehensive across risk types, including credit, market, pension, 
operation, and business risk. Based on internal operational risk 
scenarios and loss modeling at or above the 99% confidence level, OCC's 
operational risk was quantified at $226 million and pension risk at $21 
million, resulting in the total Target Capital Requirement of $247 
million. Business risk was addressed by taking into consideration that 
OCC has the ability to fully offset potential revenue volatility and 
manage business risk to zero by adjusting the levels at which fees and 
refunds are set and by adopting a Business Risk Buffer of 25% when 
setting fees. Other risks, such as counterparty risk and on-balance 
sheet credit and market risk, were considered to be immaterial for 
purposes of requiring additional capital based on means available to 
OCC to address those risks that did not require use of OCC's capital. 
As discussed in more detail below in the context of OCC's Fee Policy, 
the Business Risk Buffer of 25% is achieved by setting OCC's fees at a 
level intended to achieve target annual revenue that will result in a 
25% buffer for the year after paying all operating expenses.
    Additionally, OCC determined that its maximum recovery costs would 
be $100 million and projected wind-down costs would be $73 million. OCC 
projected its expenses for 2015 will be $234 million, so that six 
months projected expenses are $234 million/2 = $117 million. The 
greater of recovery or wind-down costs and six months of operating 
expenses is therefore $117 million, and OCC's Baseline Capital 
Requirement (minimum regulatory requirement) is therefore $117 million. 
According to OCC, it then computed the appropriate amount of a Target 
Capital Buffer from operational risk, business risk, and pension risk, 
resulting in a determination that the current Target Capital Buffer 
should be $130 million. Thus, the Target Capital Requirement is $117 
million + $130 million = $247 million.

D. Overview of, and Basis for, OCC's Proposal To Acquire Additional 
Equity Capital

    According to OCC, in order to meet its Target Capital Requirement, 
and after consideration of alternatives, OCC's Board of Directors 
approved a proposal from OCC's Stockholder Exchanges pursuant to which 
OCC would meet its Target Capital Requirement of $247 million in early 
2015 as follows:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Shareholders' Equity as of 1/1/2014..................        $25,000,000
Shareholders Equity Accumulated Through Retained             $72,000,000
 Earnings \11\.......................................
Additional Contribution from Stockholder Exchanges...       $150,000,000
                                                      ------------------
Target Capital Requirement...........................       $247,000,000
Replenishment Capital Amount.........................       $117,000,000
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    Total OCC Capital Resources......................       $364,000,000
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    The additional contribution of the Stockholder Exchanges will be 
made in respect of their Class B Common Stock on a pro rata basis. The 
Stockholder Exchanges will also commit to provide additional equity 
capital up to the Replenishment Capital Amount, which is currently $117 
million, in the event Replenishment Capital is needed. While the 
Replenishment Capital Amount will increase as the Baseline Capital 
Requirement increases, under OCC's proposal, it would be capped at a 
total of $200 million, which could be outstanding at any point in time. 
OCC estimates that the Baseline Capital Requirement will not exceed 
this amount before 2022. When the limit is

[[Page 12217]]

being approached, OCC will revise the Capital Plan as needed to address 
future needs. In consideration for their capital contributions and 
replenishment commitments, the Stockholder Exchanges will receive 
dividends as described in the Dividend Policy discussed below for so 
long as they remain stockholders, and maintain their contributed 
capital and commitment to replenish capital up to the Replenishment 
Capital Amount, subject to the $200 million cap.
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    \11\ According to OCC, ``the $72 million is after giving effect 
to the approximately $40 million refund'' expected to be made for 
2014. Securities Exchange Act Release No. 74202 (February 4, 2015), 
80 FR 7056, 7058 at note 15 (February 9, 2015) (SR-OCC-2014-813).
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E. Fee, Refund, and Dividend Policies

    Upon reaching the Target Capital Requirement, the Capital Plan 
requires OCC to set its fees at a level that utilizes a Business Risk 
Buffer of 25%. The purpose of this Business Risk Buffer is to ensure 
that OCC accumulates sufficient capital to cover unexpected 
fluctuations in operating expenses, business capital needs, and 
regulatory capital requirements. Furthermore, the Capital Plan requires 
OCC to maintain Fee, Refund, and Dividend Policies, described in more 
detail below, which are designed to ensure that OCC's shareholders' 
equity remains well above the Baseline Capital Requirement.
    The required Business Risk Buffer of 25% is below OCC's 10-year 
historical pre-refund average buffer of 31%. The target will remain 25% 
so long as OCC's shareholders' equity remains above the Target Capital 
Requirement amount. The reduction in buffer margin from OCC's 10-year 
average of 31% to 25% reflects OCC's commitment to operating as an 
industry utility and ensuring that market participants benefit as much 
as possible from OCC's operational efficiencies in the future. This 
reduction will permit OCC to charge lower fees to market participants 
rather than maximize refunds to clearing members and dividend 
distributions to Stockholder Exchanges. OCC will review its fee 
schedule on a quarterly basis to manage revenue as closely to this 
target as possible.\12\ For example, if the Business Risk Buffer is 
materially above 25% after the first quarter of a particular year, OCC 
may decrease fees for the remainder of the year, and conversely if the 
Business Risk Buffer is materially below 25% at this time, OCC may 
increase fees for the remainder of the year.
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    \12\ If OCC's fee schedule needs to be changed in order to 
achieve the 25% Business Risk Buffer, OCC would file a proposed rule 
change seeking approval of the revised fee schedule.
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    The Capital Plan will allow OCC to refund approximately $40 million 
from 2014 fees to clearing members in 2015 and to reduce fees in an 
amount to be determined by OCC's Board of Directors, effective in the 
second quarter of 2015. OCC will announce new fee levels early in 2015 
and will make such fees effective following notification to clearing 
members, making any necessary filings, and receiving any necessary 
approvals from the Commission. OCC will endeavor to provide clearing 
members with no less than 60-day notice in advance of the effectiveness 
of changes to fee levels, particularly those that result in increases 
to fee levels. No dividends will be declared until December 2015 and no 
dividends will be paid until 2016.
    Changes to the Fee, Refund or Dividend Policies will require the 
affirmative vote of two-thirds of the directors then in office and 
approval of the shareholders of all of OCC's outstanding Class B Common 
Stock. The formulas for determining the amount of refunds and dividends 
under the Refund and Dividend Policies, respectively, which are 
described in more detail below, are based on, among other things, the 
current tax treatment of refunds as a deductible expense. The Refund 
and Dividend Policies will provide that in the event that refunds 
payable under the Refund Policy are not tax deductible, the policies 
would be amended to restore the relative economic benefits between the 
recipients of the refunds and the Stockholder Exchanges.
1. Fee Policy
    Under the Fee Policy, in setting fees each year, OCC will calculate 
an annual revenue target based on a forward twelve months expense 
forecast divided by the difference between one and the Business Risk 
Buffer of 25% (i.e., OCC will divide the expense forecast by .75). 
Establishing a Business Risk Buffer at 25% will allow OCC to manage the 
risk that fees may generate less revenue than expected due to lower-
than-expected trading volume or other factors, or that expenses may be 
higher than projected. The Fee Policy also will include provisions from 
existing Article IX, Section 9, of OCC's By-Laws to effectively state 
that the fee schedule also may include additional amounts necessary to 
(i) maintain such reserves as are deemed reasonably necessary by OCC's 
Board of Directors to provide facilities for the conduct of OCC's 
business and to conduct development and capital planning activities in 
connection with OCC's services to the options exchanges, clearing 
members and the general public, and (ii) accumulate such additional 
surplus as the Board of Directors may deem advisable to permit OCC to 
meet its obligations to clearing members and the general public. 
However, OCC states that these provisions will be used only in 
extraordinary circumstances and to the extent that the Board of 
Directors has determined that the required amount of such additional 
reserves or additional surplus will exceed the full amount that will be 
accumulated through the Business Risk Buffer (prior to payment of 
refunds or dividends) so OCC's fees will ordinarily be based on its 
projected operating expenses and the Business Risk Buffer of 25%.
    Under the advance notice proposal, OCC will use the following 
formula to calculate its annual revenue target as follows:
    Annual Revenue Target = Forward 12 Months Expense Forecast/(1-.25).
    Because OCC's clearing fee schedules typically reflect different 
rates for different categories of transactions, fee projections will 
include projections as to relative volume in each such category. The 
clearing fee schedule will therefore be set to achieve a blended or 
average rate per contract sufficient, when multiplied by total 
projected contract volume, to achieve the Annual Revenue Target. Under 
extraordinary circumstances, OCC will add any amount determined to be 
necessary for additional reserves or surplus and divide the resulting 
number by the projected contract volume to determine the applicable 
average fee per cleared contract needed to achieve the additional 
amounts required. Consistent with past practice, OCC will notify its 
clearing members of the fees OCC determines it will apply for any 
particular period by describing the change in an information memorandum 
distributed to all clearing members. Consistent with past practice, OCC 
also will notify regulators of the fees it determines would apply for 
any particular period by filing an amendment to its schedule of fees as 
a proposed rule change for immediate effectiveness under Section 
19(b)(3)(A) of the Act and Rule 19b-4(f)(2) thereunder.
2. Refund Policy
    Under the Refund Policy, except at a time when Replenishment 
Capital is outstanding as described below, OCC will declare a refund to 
clearing members in December of each year, beginning in 2015, in an 
amount equal to 50% of the excess, if any, of (i) the pre-tax income 
for the year prior to the refund over (ii) the sum of (x) the amount of 
pre-tax income after the refund necessary to produce after-tax income 
sufficient to maintain

[[Page 12218]]

shareholders' equity at the Target Capital Requirement for the 
following year plus (y) the amount of pre-tax income after the refund 
necessary to fund any additional reserves or additional surplus not 
already included in the Target Capital Requirement. Such refund will be 
paid in the year following the declaration after the issuance of OCC's 
audited financial statements, provided that (i) the payment does not 
result in total shareholders' equity falling below the Target Capital 
Requirement, and (ii) such payment is otherwise permitted by applicable 
Delaware law and applicable federal laws and regulations. OCC will not 
be able to pay a refund on a particular date unless dividends were paid 
on the same date. If Replenishment Capital has been contributed and 
remains outstanding, OCC will not pay refunds until such time as the 
Target Capital Requirement is restored through the accumulation of 
retained earnings. Refunds in accordance with the Refund Policy will 
resume once the Target Capital Requirement is restored and all 
Replenishment Capital is repaid in full, provided that the restoration 
of the Target Capital Requirement and the repayment of Replenishment 
Capital occurred within 24 months of the issuance date of the 
Replenishment Capital. If within 24 months of the issuance date of any 
Replenishment Capital, such Replenishment Capital has not been repaid 
in full or shareholders' equity has not been restored to the Target 
Capital Requirement, OCC will no longer pay refunds to clearing 
members, even if the Target Capital Requirement is restored and all 
Replenishment Capital is repaid at a later date.
3. Dividend Policy
    The Dividend Policy provides that, except at a time when 
Replenishment Capital is outstanding, OCC will declare a dividend on 
its Class B Common Stock in December of each year in an aggregate 
amount equal to the excess, if any, of (i) after-tax income for the 
year, after application of the Refund Policy (unless the Refund Policy 
has been eliminated, in which case the refunds shall be deemed to be 
$0) over (ii) the sum of (A) the amount required to be retained in 
order to maintain total shareholders' equity at the Target Capital 
Requirement for the following year, plus (B) the amount of any 
additional reserves or additional surplus not already included in the 
Target Capital Requirement. Such dividend will be paid in the year 
following the declaration after the issuance of OCC's audited financial 
statements, provided that (i) the payment does not result in total 
shareholders' equity falling below the Target Capital Requirement, and 
(ii) such payment is otherwise permitted by applicable Delaware law and 
applicable federal laws and regulations. If Replenishment Capital has 
been contributed and remains outstanding, OCC would not pay dividends 
until such time as the Target Capital Requirement is restored.

F. OCC's Status as an Industry Utility

    According to OCC, OCC has always been operated on an ``industry 
utility'' model. The Stockholder Exchanges have contributed only 
minimal capital to OCC.\13\ OCC's By-Laws currently require that OCC 
set its clearing fees at a level that is designed to cover operating 
expenses and to maintain such reserves and accumulate such additional 
capital as are deemed reasonably necessary for OCC to meet its 
obligations to its clearing members and the public. Clearing fees that 
are collected in excess of these amounts are refunded annually on a pro 
rata basis to the clearing members that paid them. Under this model, 
OCC has never paid dividends to the Stockholder Exchanges, but has paid 
significant refunds to clearing members each year. OCC is aware that 
some portion of those refunds may not be passed through by the clearing 
members to their end user customers. Accordingly, OCC believes that by 
adopting an approach that pays dividends to the Stockholder Exchanges, 
which have invested a significant amount of additional capital ($150 
million), but that reduces the historical pre-refund average buffer of 
31% by adopting a Business Risk Buffer of 25%, the approach outlined in 
its Capital Plan maintains, and perhaps better aligns with, an industry 
utility model.
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    \13\ According to OCC, its common stock and paid in capital 
total $2,659,999. See OCC 2013 Annual Report, Financial Statements, 
Statements of Financial Condition, available on OCC's Web site, 
http://optionsclearing.com/components/docs/about/annual-reports/occ_2013_annual_report.pdf.
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    According to OCC, given the very large increase in capital that OCC 
has determined to be appropriate and to meet the increased 
responsibilities imposed upon it as a systemically important financial 
market utility, OCC has decided that the best alternative available to 
it is to obtain a substantial further capital contribution from the 
Stockholder Exchanges. OCC believes that this cannot be accomplished 
without modification of the past practice of not providing dividends to 
stockholders. Accordingly, OCC is establishing a new Fee Policy, Refund 
Policy, and Dividend Policy. Because of the Business Risk Buffer being 
set at 25%, the combination of the Fee, Refund and Dividend Policies 
will effectively cap the dividends to be paid to the Stockholder 
Exchanges at a level that OCC's Board of Directors (with the advice of 
outside financial experts) has determined results in a reasonable rate 
of return on contributed capital, particularly in comparison to the 
implied cost of capital to the clearing members and their customers of 
an alternative approach considered by the Board of Directors that would 
require the accumulation of retained earnings through higher fees and 
no refunds for several years. OCC will continue to refund a percentage 
of excess clearing fees to clearing members, thereby benefiting both 
clearing members and their customers.
    OCC believes that the Capital Plan therefore effectively preserves 
OCC's industry utility model of providing its services in an efficient 
manner, while also enhancing the benefits to the end user customers by 
charging lower initial fees due to the decrease in the buffer margin 
from OCC's 10-year average of 31% to 25%. OCC states that it believes 
clearing members and customers will benefit from the proposed Capital 
Plan because the plan will allow OCC to continue to provide clearing 
services at low cost, including through a significant refund of 2014 
fees, a reduction of fees beginning in 2015 and projected continuing 
refunds and lower fees for the foreseeable future.
    According to OCC, it believes that Stockholder Exchanges will 
benefit from the dividend they receive and, perhaps more importantly, 
they will be assured that OCC is in a position to provide clearing 
services for their markets on an on-going basis within the same basic 
structure that has served these markets well since their inception and 
without the need to radically change the structure to address potential 
demands of outside equity investors. Non-Stockholder Exchanges also 
will benefit by continuing to receive OCC's clearing services for their 
products on the same basis as they presently do.\14\
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    \14\ According to OCC, Non-Stockholder Exchanges contribute 
capital by purchasing a promissory note in the principal amount of 
$1,000,000. See Section 2 of Article VIIB of OCC's By-Laws. The 
required Capital Contribution of Non-Stockholder exchanges will not 
change under the Capital Plan.
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    OCC also believes that the Capital Plan will better align the 
interests of Stockholder Exchanges and clearing members with respect to 
expenses, because changes to the level of operating expenses directly 
affect the Target Capital Requirement. In short,

[[Page 12219]]

OCC believes that the present proposal represents a fair and reasonable 
balancing of the interests of the Stockholder Exchanges, the other 
exchanges for which OCC provides clearing services, clearing members, 
customers, and the general public while providing an immediate infusion 
of capital and a structure within which OCC can meet its obligations to 
the public as a systemically important financial market utility.

G. Replenishment Capital Plan

    OCC is establishing a Replenishment Capital Plan whereby OCC's 
Stockholder Exchanges are obligated to provide on a pro rata basis a 
committed amount of Replenishment Capital should OCC's total 
shareholders' equity fall below the hard trigger, as described 
below.\15\ The aggregate committed amount for all five Stockholder 
Exchanges in the form of Replenishment Capital that could be 
outstanding at any time will be capped at the excess of (i) the lesser 
of (A) the Baseline Capital Requirement, which is currently $117 
million, at the time of the relevant funding, or (B) $200 million, over 
(ii) amounts of outstanding Replenishment Capital (``Cap Formula''). 
The $200 million figure in the Cap Formula takes into account projected 
growth in the Baseline Capital Requirement for the foreseeable future. 
The commitment to provide Replenishment Capital will not be limited by 
time, but rather only by the Cap Formula. Replenishment Capital will be 
called in whole or in part after the occurrence of a ``hard trigger'' 
event described below. If the Baseline Capital Requirement approaches 
or exceeds $200 million, OCC's Board of Directors may consider, as part 
of its annual review of the Replenishment Capital Plan, alternative 
arrangements to obtain replenishment capital in excess of the $200 
million committed under the Replenishment Capital Plan. In addition, 
the Refund Policy and the Dividend Policy will provide that, in the 
absence of obtaining any such alternative arrangements, the amount of 
the difference will be subtracted from amounts that would otherwise be 
available for the payment of refunds and dividends.
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    \15\ The Replenishment Capital Plan is a component of the 
Capital Plan.
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    Replenishment Capital contributed to OCC under the Replenishment 
Capital Plan will take the form of a new class of common stock (``Class 
C Common Stock'') of OCC to be issued to the Stockholder Exchanges 
solely in exchange for Replenishment Capital contributions.
    The Replenishment Capital Plan is a component of OCC's overall 
Capital Plan. In implementing the Replenishment Capital Plan, OCC's 
management would monitor OCC's levels of shareholders' equity to 
identify certain triggers, or reduced capital levels, that might 
require action. OCC has identified two key triggers--a soft trigger and 
a hard trigger--and proposes that OCC will take certain steps upon the 
occurrence of either. The ``soft trigger'' for re-evaluating OCC's 
capital will occur if OCC's shareholders' equity falls below the sum of 
(i) the Baseline Capital Requirement and (ii) 75% of the Target Capital 
Buffer. The soft trigger will be a warning sign that OCC's capital had 
fallen to a level that requires attention and responsive action to 
prevent it from falling to unacceptable levels. Upon a breach of the 
soft trigger, OCC's senior management and OCC's Board of Directors will 
review alternatives to increasing capital, and take appropriate action 
as necessary, including increasing fees or decreasing expenses, to 
restore shareholders' equity to the Target Capital Requirement.
    The ``hard trigger'' for making a mandatory Replenishment Capital 
call will occur if shareholders' equity falls below 125% of the 
Baseline Capital Requirement (``Hard Trigger Threshold''). OCC 
considers that a breach of the Hard Trigger Threshold is a sign that 
significant corrective action, with a more immediate impact than 
increasing fees or decreasing expenses, should be taken to increase 
OCC's capital, either as part of a recovery plan or a wind-down plan 
for OCC's business. OCC's shareholders' equity will have to fall more 
than $100,000,000 below the fully funded capital amount described above 
in order to breach the Hard Trigger Threshold. As a result, OCC views 
the breach of the Hard Trigger Threshold as unlikely and occurring only 
as a result of a significant, unexpected event. In the event of such a 
breach, OCC's Board of Directors must determine whether to attempt a 
recovery, a wind-down of OCC's operations, or a sale or similar 
transaction, subject in each case to any necessary stockholder 
consent.\16\ If the Board of Directors decides to wind-down OCC's 
operations, OCC will access the Replenishment Capital in an amount 
sufficient to fund the wind-down, as determined by the Board and 
subject to the Cap Formula. If the Board of Directors decides to 
attempt a recovery of OCC's capital and business, OCC will access the 
Replenishment Capital in an amount sufficient to return shareholders' 
equity to an amount equal to $20 million above the Hard Trigger 
Threshold, subject to the Cap Formula.
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    \16\ The requirement for stockholder consent would arise under 
OCC's Restated Certificate of Incorporation, which would provide 
that any decision to attempt a recovery would require separate 
approval by the stockholders, while a decision to wind-down would 
require separate approval by the stockholders.
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    While Replenishment Capital is outstanding, no refunds or dividends 
will be paid and, if any Replenishment Capital remains outstanding for 
more than 24 months or the Target Capital Requirement is not restored 
during that period, changes to how OCC calculates refunds and dividends 
may be necessary (as described in more detail in OCC's Refund Policy 
and Dividend Policy). In addition, while Replenishment Capital is 
outstanding, OCC will first utilize the entire amount of available 
funds to repurchase, on a pro rata basis from each Stockholder 
Exchange, to the extent permitted by applicable Delaware and federal 
law and regulations, outstanding shares of Class C Common Stock as soon 
as practicable after completion of the financial statements following 
the end of each calendar quarter at a price equal to the original 
amount paid for such shares, plus an additional ``gross up'' amount to 
compensate the holders of the Class C Common Stock for taxes on 
dividend income (if any) that they may have to recognize as a result of 
such repurchase.\17\ For this purpose, ``Available Funds'' will equal, 
as of the end of any calendar quarter, the excess, if any, of (x) 
shareholders' equity over (y) the Minimum Replenishment Level. The 
``Minimum Replenishment Level'' will mean $20 million above the Hard 
Trigger Threshold, so that OCC's shareholders' equity will remain at or 
above the Minimum Replenishment Level after giving effect to the 
repurchase.
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    \17\ According to OCC, based on current federal tax rates, if 
the full amount of the payment is classified as a dividend and the 
recipient is entitled to a dividends received deduction, this gross 
up is estimated to be approximately 12% of the payment.
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    According to OCC, the capital base described above will permit OCC 
to hold at all times cash and other assets of high quality and 
sufficiently liquid to allow OCC to meet its current and projected 
operating expenses under a range of scenarios, including adverse market 
conditions. OCC expects it will hold at all times liquid net assets 
funded by equity sufficient to cover potential general business losses 
so that OCC can continue operations and services as a going concern if 
those losses materialize, which assets will always be greater than 
either (x) six months of the covered clearing agency's

[[Page 12220]]

current operating expenses, or (y) the amount determined by the Board 
of Directors to be sufficient to ensure a recovery or orderly wind-down 
of critical operations and services. These assets will be held in 
addition to resources held to cover participant defaults, among other 
risks.\18\
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    \18\ OCC stated that these assets will be held in addition to 
resources held to cover participant defaults or other risks covered 
under certain credit risk standards and liquidity risk standards set 
forth in proposed Commission rules. See Securities Exchange Act 
Release No. 74202 (February 4, 2015), 80 FR 7056 (February 9, 2015) 
(SR-OCC-2014-813).
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II. Summary of Comments Received

    The Commission received five comment letters on OCC's proposal and 
three comment letters from OCC responding to the issues raised by the 
commenters.\19\ Three of the five commenters generally supported OCC's 
need to raise additional capital,\20\ but all five commenters opposed 
how the Capital Plan raised the additional capital.\21\ After careful 
review of those comments, the Commission has determined that most of 
the issues raised by the commenters do not relate to the nature or 
level of risks presented by OCC.
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    \19\ The Commission received one comment letter on the proposed 
rule change and advance notice (See SIFMA Letter) and four comment 
letters on the proposed rule change only (See BOX Letter; BATS 
Letter; MM Letter; and MIAX Letter). See supra note 5.
    \20\ See BOX Letter; SIFMA Letter; and MM Letter.
    \21\ See BOX Letter; SIFMA Letter; BATS Letter; MM Letter; and 
MIAX Letter.
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    One commenter, however, raised the issue that the Replenishment 
Capital Plan may create a misalignment of interests between the 
exchanges and clearing members, which could in turn create an imbalance 
in the management of certain risks.\22\ Specifically, this commenter 
stated that because no refunds are paid to clearing members while any 
portion of that Replenishment Capital remains outstanding and that 
refunds are discontinued permanently if the Replenishment Capital 
remains outstanding for two years, the plan effectively uses the fees 
to maximize and prioritize the dividends payable to the Stockholder 
Exchanges, which is at the expense of the clearing members.\23\ 
Further, this commenter notes that the proposed amendments to OCC's By-
Laws would allow the Stockholder Exchanges to manage the risk of their 
Replenishment Capital being required by determining whether retained 
earnings could be used to compensate for a loss or deficiency in the 
clearing fund, thereby also allowing the Stockholder Exchanges to 
determine to fund clearing fund deficiencies through additional 
retained earnings rather than risk having to fund their required 
Replenishment Capital commitment.\24\ As a result, this commenter 
believes that the Replenishment Capital Plan may create a misalignment 
of interests between the Stockholder Exchanges and clearing members, 
which could in turn create an imbalance in the management of certain 
risks.\25\
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    \22\ See SIFMA Letter.
    \23\ Id.
    \24\ Id.
    \25\ Id.
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    OCC asserts in its response that these concerns regarding 
Replenishment Capital are misplaced.\26\ OCC contends that its By-Laws 
provide that in lieu of charging a loss or deficiency proportionately 
to the clearing fund computed contributions of non-defaulting clearing 
members, OCC may, in its discretion, and subject to the unanimous 
approval of the holders of Class A Common Stock and Class B Common 
Stock, elect to charge such loss or deficiency in whole or in part to 
OCC's current earning or retained earnings.\27\ Accordingly, OCC 
considers the net effect of its Replenishment Capital Plan to be simply 
a timing effect, with Replenishment Capital treated as an advance 
against the refunds to which Stockholder Exchanges otherwise would have 
been entitled.\28\ OCC contends that it is neither the purpose nor the 
effect of the Replenishment Capital Plan to shift the potential loss 
from a clearing member default, which has always been mutualized, so 
long as OCC remains solvent.\29\
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    \26\ See OCC Letter III.
    \27\ Id.
    \28\ Id.
    \29\ Id.
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III. Discussion and Commission Findings

    Although the Payment, Clearing and Settlement Supervision Act does 
not specify a standard of review for an advance notice, its stated 
purpose is instructive.\30\ 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 and strengthening the 
liquidity of systemically important financial market utilities.\31\
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    \30\ See 12 U.S.C. 5461(b).
    \31\ Id.
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    Section 805(a)(2) of the Payment, Clearing and Settlement 
Supervision Act \32\ 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 \33\ states that the objectives 
and principles for the risk management standards prescribed under 
Section 805(a) shall be to:
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    \32\ 12 U.S.C. 5464(a)(2).
    \33\ 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.
    After carefully considering OCC's proposal, the comments received, 
and OCC's responses thereto, the Commission finds that OCC's Capital 
Plan is consistent with the objectives and principles described in 
Section 805(b) of the Payment, Clearing and Settlement Supervision 
Act.\34\
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    \34\ Id.
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    While most of the issues raised by the commenters do not relate to 
the nature or level of risks presented by OCC, one commenter raised a 
specific concern with respect to OCC's Replenishment Capital Plan. The 
Commission, however, believes that OCC's Capital Plan, when considered 
in its totality, does not adversely change the nature or level of risks 
presented by OCC. Although this commenter alleged a potential 
misalignment of interests between the Stockholder Exchanges and 
clearing members when Replenishment Capital is outstanding, decisions 
made regarding the capitalization of OCC are made by the Board of 
Directors. OCC's By-Laws address the use of capital to cover clearing 
member defaults in lieu of using the clearing fund and address the 
power of the Board of Directors to make decisions in such 
circumstances. Further, the Board of Directors' obligations under 
corporate law will require the Board of Directors to revisit on a 
periodic basis material provisions of the Capital Plan in the future, 
including those related to decisions regarding Replenishment Capital, 
and to review any credible new capital proposals that may be brought 
forward by management or members of the Board of Directors from time to 
time. The Commission believes such processes create a reasonable 
expectation that the potential concerns described by the commenter can 
be controlled by OCC, and therefore the Commission agrees with OCC that 
the commenter's contentions regarding the purpose and use of the 
Replenishment Capital are misplaced.
    The Capital Plan will provide OCC with an immediate injection of 
capital

[[Page 12221]]

and future committed capital to help ensure that it can continue to 
provide its clearing services if it suffers business losses as a result 
of a decline in revenues or otherwise. Given that OCC has been 
designated as a systemically important financial market utility, OCC's 
ability to provide its clearing services if it suffers business losses 
contributes to reducing systemic risks and supporting the stability of 
the broader financial system. In so doing, OCC's Capital Plan is 
consistent with the objectives of Section 805(b) of the Payment, 
Clearing and Settlement Supervision Act, \35\ which are to promote 
robust risk management, promote safety and soundness, reduce systemic 
risks, and support the stability of the broader financial system.
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    \35\ 12 U.S.C. 5464(b).
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IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Payment, Clearing and Settlement Supervision Act,\36\ that the 
Commission does not object to advance notice proposal (File No. SR-OCC-
2014-813) and that OCC is authorized to implement the proposal as of 
the date of this notice or the date of an order by the Commission 
approving a proposed rule change that reflects rule changes that are 
consistent with this advance notice proposal (File No. SR-OCC-2015-02), 
whichever is later.
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    \36\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2015-05117 Filed 3-5-15; 8:45 am]
 BILLING CODE 8011-01-P


