
[Federal Register Volume 82, Number 44 (Wednesday, March 8, 2017)]
[Notices]
[Pages 13036-13039]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-04498]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80143; File No. SR-OCC-2017-801]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection To Advance Notice Filing Concerning the Options 
Clearing Corporation's Margin Coverage During Times of Increased 
Volatility

March 2, 2017.
    The Options Clearing Corporation (``OCC'') filed on January 4, 2017 
with the Securities and Exchange Commission (``Commission'') advance 
notice SR-OCC-2017-801 (``Advance Notice'') pursuant to Section 
806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of 
2010 (``Payment, Clearing and Settlement Supervision Act'') \1\ and 
Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934 
(``Exchange Act'') to modify its process for systematically monitoring 
market conditions and performing adjustments to its margin coverage 
when market volatility increases beyond historically observed levels. 
The Advance Notice was published for comment in the Federal Register on 
February 7, 2017.\3\ The Commission has not received any comments on 
the Advance Notice to date. This publication serves as 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 Payment, Clearing and Settlement 
Supervision Act and file advance notices with the Commission.
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ See Securities Exchange Act Release No. 79915 (February 1, 
2017), 82 FR 9613 (February 7, 2017) (File No. SR-OCC-2017-801). OCC 
also filed a proposed rule change with the Commission pursuant to 
Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder, 
seeking approval of changes to its rules necessary to implement the 
Advance Notice. 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, 
respectively. This proposed rule change was published in the Federal 
Register on January 25, 2017. Securities Exchange Act Release No. 
79818 (January 18, 2017), 82 FR 8455 (January 25, 2017) (SR-OCC-
2017-001).
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I. Background

    OCC protects itself against potential losses that could result from 
the default of a clearing member by requiring margin to be posted in 
connection with each member's positions. The amount of margin 
calculated and collected from OCC's clearing members, along with 
mutualized clearing-fund resources, is intended to make available to 
OCC sufficient financial resources for the orderly transfer or 
liquidation of a defaulting clearing member's positions. OCC's 
proprietary risk management system, the System for Theoretical Analysis 
and Numerical Simulations (``STANS''), calculates each clearing 
member's margin requirement by utilizing Monte Carlo simulations to 
forecast price movements related to the positions in each clearing 
member's portfolio. The STANS margin requirement is intended to be 
sufficient to collateralize the member's losses across its portfolio 
over a two-day period, under normal market conditions.
    To determine margin requirements, STANS utilizes time-series data, 
including pricing data on assets underlying the options contracts that 
OCC clears, and performs calculations related to, among other things, 
the volatilities of these underliers. The margin amount collected from 
each clearing member also accounts for expected changes in the value of 
collateral posted in connection with that member's portfolio.
    One of the primary risk drivers in the STANS methodology relates to 
the volatility of individual equity securities, which is derived from 
pricing data imported monthly into STANS. Between data feeds, the STANS 
margin methodology relies on a process that adjusts the individual 
volatility measures of equity-based option underliers (e.g., GE or IBM) 
by a multiplier derived from the volatility of the Standard 
&Poor's[supreg] 500 index (``SPX''). OCC refers to that multiplier as 
the uniform scale factor. To account for intra-month changes in 
volatility, the uniform scale factor adjusts individual volatilities of 
applicable underliers by a factor tied to the relationship between the 
short-term and long term volatility of the SPX. Specifically, the 
uniform scale factor is used as a proxy to ``scale up'' volatilities of 
equity-based option underliers \4\ when near-term volatility estimates 
fall below a certain ratio relative to long-term average volatility, 
based on the volatility of the SPX. OCC asserts that, by applying a 
scale factor in this way, margin requirements better account for intra-
month volatility risks for individual equity-based option underliers 
and thereby better ensure that clearing members maintain sufficient 
margin assets in connection with option positions based upon those 
underliers.
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    \4\ The uniform scale factor applies to the volatility measures 
for single-name and index underliers. It does not apply to exchange-
traded funds, futures, or volatility-based underliers. For the 
latter types of options, STANS uses a constant volatility measure 
calculated from monthly data feeds.
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II. Description of the Advance Notice

    OCC proposes a number of enhancements to its STANS margin 
methodology to more accurately compute its clearing member margin 
requirements. Specifically, OCC proposes the following: (1) )To change 
the length of time-series data used to calculate the uniform scale 
factor; (2) to introduce new equity index-based scale factors; (3) to 
anchor individual risk factor volatilities to longer-term averages; and 
(4) to implement daily data updates of risk factors in OCC's 
statistical models used to value U.S. Treasury securities for 
collateral and margin purposes. Each proposed change is discussed in 
greater detail below.
    First, OCC proposes to change the time-series data period and 
thereby the data set used to calculate the uniform scale factor. One 
aspect of the uniform scale factor calculation relies on pricing 
information, or time-series data, relating to the individual components 
of the S&P 500 index dating back to 1946, which pre-dates the 1957 
introduction of SPX. Because the time-series data pre-dates the SPX's 
publication, OCC's current practice is to supplement the published SPX 
data with additional pricing information that relies upon assumptions 
about what theoretically

[[Page 13037]]

could have been the index's composition prior to 1957. OCC proposes to 
discontinue that practice going forward, and instead rely on post-1957 
information only. According to OCC, this change would improve the 
quality of data used in the uniform scale factor calculation.
    Second, OCC proposes to introduce four new scale factors for 
equity-based options. As noted above, the uniform scale factor is 
derived from SPX pricing information and currently serves as OCC's sole 
volatility proxy applicable to equity-based option underliers. 
According to OCC, the new scale factors are based upon indices whose 
volatility characteristics more closely correlate with the volatility 
characteristics of the underliers to which they will be applied; thus 
the new scale factors will serve as more appropriate volatility proxies 
for those products. More specifically, OCC proposes to introduce new 
scale factors based upon the following indices: (1) The Russell 
2000[supreg] Index (12/29/1978); (2) the Dow Jones Industrial Average 
Index (9/23/1997); (3) the NASDAQ-100 Index (2/4/1985); and (4) the S&P 
100 Index (1/2/1976).\5\ Although the SPX-based uniform scale factor 
will continue to serve as the default scale factor for most equity-
based products, the new scale factors will apply to a number of index 
options and options on exchange-traded funds and exchange-traded notes 
that more closely correlate to the indices used in the proposed scale 
factor calculations.
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    \5\ The dates in parentheticals are the dates from which OCC has 
historical data on the specified index.
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    Third, OCC proposes to anchor risk factor volatilities to longer-
term trends by applying either the uniform scale factor or the 
applicable proposed new scale factor, to the greater of two volatility 
estimates: (i) An observed, historical average; or (ii) a forecasted 
volatility measure. This proposal would modify the current practice of 
applying the uniform scale factor solely to the forecasted volatility 
measure for applicable underliers. OCC states that in those cases where 
observed, historical average volatilities exceed forecasted volatility 
measures, OCC's revised methodology would better ensure that short-term 
or temporary decreases in forecasted volatility do not result in 
significant margin reductions, thereby improving risk management.
    Finally, OCC proposes to implement daily updates to risk factors 
used to construct the U.S. Treasury yield curve and value U.S. Treasury 
securities for collateral and margin purposes. According to OCC, daily 
updates to the U.S. Treasury yield curve would better ensure that the 
STANS margin calculations accurately reflect the current state of the 
U.S. Treasury market, particularly during periods of heightened 
volatility, which would lead to more accurate margin calculations.

III. Discussion and Commission Findings

    Although the Payment, Clearing and Settlement Supervision Act does 
not specify a standard of review for an advance notice, the stated 
purpose of the Payment, Clearing and Settlement Supervision Act is 
instructive.\6\ The stated purpose of the Payment, Clearing and 
Settlement Supervision Act 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.\7\
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    \6\ See 12 U.S.C. 5461(b).
    \7\ Id.
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    Section 805(a)(2) of the Payment, Clearing and Settlement 
Supervision Act \8\ 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 \9\ states that the objectives 
and principles for the risk management standards prescribed under 
Section 805(a) shall be to:
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    \8\ 12 U.S.C. 5464(a)(2).
    \9\ 12 U.S.C. 5464(b).
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     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    The Commission has adopted risk management standards under Section 
805(a)(2) of the Payment, Clearing and Settlement Supervision Act 
(``Clearing Agency Standards'') and the Exchange Act.\10\ The Clearing 
Agency Standards became effective on January 2, 2013, and require 
registered clearing agencies 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. 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 Payment, 
Clearing and Settlement Supervision Act.\11\
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    \10\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
    \11\ 12 U.S.C. 5464(b).
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    The Commission finds the proposed change is consistent with the 
objectives and principles described in Section 805(b) of the Payment, 
Clearing and Settlement Supervision Act, as described below.\12\
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    \12\ Id.
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Consistency With Section 805(b) of the Payment, Clearing and Settlement 
Supervision Act

    The Commission finds that OCC's proposal is consistent with 
promoting robust risk management, promoting safety and soundness, 
reducing systemic risk, and supporting the stability of the broader 
financial system, and is therefore consistent with the objectives and 
principles described in Section 805(b) of the Payment, Clearing and 
Settlement Supervision Act.\13\
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    \13\ 12 U.S.C. 5464(b).
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    First, the Commission finds that the proposed change to the SPX 
time-series data period used in connection with the uniform scale 
factor is consistent with promoting robust risk management. As 
described above, OCC is changing the manner in which it calculates the 
uniform scale factor by limiting SPX time-series data to only those 
dates subsequent to the introduction of the SPX in 1957. According to 
OCC, by relying on the published index, instead of assumptions about 
the SPX's constituents prior to its publication, the proposed change 
would improve the quality of data used in the uniform scale factor 
calculation, which is critical to managing certain intra-month 
volatility risks through OCC's risk management system, STANS. The 
Commission finds that OCC's proposed reliance on published index data 
throughout the time-series data period rather than assumptions to 
calculate the uniform scale factor is an appropriate improvement to the 
process for performing intra-month volatility adjustments in STANS. The 
Commission therefore finds the proposed change is consistent with the 
objective of promoting robust risk management.
    Second, the Commission finds that OCC's proposed change to 
introduce four new scale factors for exchange-traded funds and other 
equity-based option underliers that correlate more closely with the 
indices used in the proposed scale factor calculations is consistent 
with promoting robust risk

[[Page 13038]]

management. According to OCC, the proposed change would more accurately 
approximate intra-month volatility risks in STANS calculations for 
applicable equity-based options products and thereby more accurately 
reflect the risks associated with such underliers in margin 
calculations. Correspondingly, margin calculations should more closely 
reflect potential losses in clearing members' portfolios containing 
products to which the new scale factors would be applied, in 
furtherance of promoting robust risk management.
    Third, the Commission finds that the proposed change to apply the 
uniform scale factor and each proposed scale factor to the greater of 
the historical and forecasted volatility measure for applicable 
instruments is consistent with promoting robust risk management. 
According to OCC, the proposed change to anchor volatilities in 
observed, historical averages mitigates procyclical reductions in 
margin requirements.\14\ In particular, the proposed methodology is 
intended to protect against circumstances in which a decrease in the 
forecasted volatilities of option underliers would result in 
commensurate reductions in associated margin requirements, though such 
forecasts may be inconsistent with historical average volatilities 
based on longer-term, observed pricing behaviors. The Commission finds 
that by mitigating procyclical decreases in margin requirements, OCC's 
proposal is consistent with promoting robust risk management.
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    \14\ The term ``procyclicality'' as it relates to margin 
requirements in this context is intended to describe positive 
correlation between margin requirements associated with an options 
portfolio and the volatilities of individual constituents Murphy et 
al., Staff Working Paper No. 597: A comparative analysis of tools to 
limit the procyclicality of initial margin requirements, Bank of 
England (April 2016), http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp597.pdf.
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    Lastly, the Commission finds that the proposed change to 
incorporate daily updates into time-series data used to construct the 
U.S. Treasury yield curve for collateral and margin purposes is 
consistent with promoting robust risk management. According to OCC, the 
proposed change is designed to better ensure that the STANS margin 
calculations accurately reflect the value of U.S. Treasuries posted as 
collateral, especially during periods of heightened volatility. This, 
in turn, would better ensure that clearing members post sufficient 
collateral in support of their options portfolios and remain within 
OCC's risk tolerance. More accurate valuation of U.S. Treasuries for 
collateral and margin purposes should improve OCC's ability to monitor 
and manage its risks and therefore is consistent with promoting robust 
risk management.
    For the reasons stated above, the Commission finds that OCC's 
proposal promotes robust risk management through improvements to the 
data, scale factors, and methodology used in STANS margin calculations. 
The Commission also finds that the proposal thereby promotes the safety 
and soundness of OCC and its members by better capturing volatility 
risks in margin requirements, which, in turn, should serve to reduce 
systemic risks and support the stability of the broader financial 
system. Accordingly, the Commission finds that the proposal is 
consistent with the stated objectives and principles of Section 805(b) 
of the Payment, Clearing and Settlement Supervision Act.\15\
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    \15\ 12 U.S.C. 5464(b).
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Consistency With Rules 17Ad-22(b)(1) and (b)(2) Under the Exchange Act

    The Commission finds that OCC's proposal is consistent with the 
Clearing Agency Standards, specifically Rules 17Ad-22(b)(1) and (b)(2) 
under the Exchange Act.\16\ Rule 17Ad-22(b)(1) under the Exchange Act 
requires OCC to establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to, among other things, 
limit its exposures to potential losses from defaults by its 
participants under normal market conditions so that the operations of 
the clearing agency would not be disrupted and non-defaulting 
participants would not be exposed to losses that they cannot anticipate 
or control.\17\ Rule 17Ad-22(b)(2) under the Exchange Act requires OCC 
to establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to, among other things, use margin 
requirements to limit its credit exposures to participants under normal 
market conditions and use risk-based models and parameters to set such 
margin requirements.\18\
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    \16\ 17 CFR 240.17Ad-22(b)(1) and (b)(2). For purposes of these 
provisions, OCC is a registered clearing agency that performs 
central counterparty services.
    \17\ 17 CFR 240.17Ad-22(b)(1).
    \18\ 17 CFR 240.17Ad-22(b)(2).
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    The Commission finds that OCC's proposal is consistent with Rules 
17Ad-22(b)(1) and (b)(2) under the Exchange Act. The proposal would 
better enable OCC to limit its potential losses from clearing-member 
defaults under normal market conditions by improving the data, scale 
factors, and methodology used to derive certain volatility and other 
estimates for purposes of margin calculations. By improving these 
estimates, the STANS margin requirements would better ensure that OCC's 
members post sufficient collateral in connection with their options 
positions, thereby protecting OCC against the potential losses from a 
clearing-member default. Furthermore, by limiting OCC's exposure to 
such losses, the proposal better ensures that OCC would continue 
operations without disruption and that non-defaulting clearing members 
would not be exposed to losses they cannot anticipate or control.
    The proposal also would improve the risk-based models and 
parameters that OCC uses to set margin requirements and limit its 
credit exposures to clearing members under normal market conditions. 
STANS, as discussed above, is a risk-based, forecasting tool that OCC 
currently uses to calculate margin requirements that would be 
sufficient to collateralize each clearing member's losses over a two-
day period under normal market conditions. The proposal incrementally 
enhances STANS by improving the data, scale factors, and methodology 
used to derive certain volatility and other estimates relevant to risk-
based margin calculations. The proposal would improve the quality of 
data used to estimate risk drivers in the STANS margin calculations, 
for example, by relying solely on published index data throughout the 
uniform scale factor time-series data period. In addition, the four new 
scale factors would more accurately reflect intra-month volatility 
risks associated with applicable option underliers in the STANS margin 
calculations. The proposal also would better ensure that the STANS 
margin requirements remain anchored to historical average volatilities, 
and would thereby mitigate pro-cyclical reductions in margin 
requirements, by applying the uniform scale factor and each proposed 
scale factor to the greater of an observed, historical average and a 
forecasted volatility measure. Finally, incorporating daily updates 
into time-series data used to construct the U.S. Treasury yield curve 
would improve valuation of U.S. Treasury collateral and thereby the 
accuracy of STANS margin calculations, because margin requirements 
account for expected changes in the value of posted U.S. Treasury 
collateral.
    For the reasons stated above, the Commission finds that OCC's 
proposal is consistent with the Clearing Agency Standards, specifically 
Rules 17Ad-22(b)(1) and (b)(2) under the Exchange Act.

[[Page 13039]]

IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(G) of the 
Payment, Clearing and Settlement Supervision Act,\19\ that the 
Commission DOES NOT OBJECT to Advance Notice (SR-OCC-2017-801) and that 
OCC is AUTHORIZED to implement the proposed change.
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    \19\ 12 U.S.C. 5465(e)(1)(G).

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-04498 Filed 3-7-17; 8:45 am]
BILLING CODE 8011-01-P


