[Federal Register Volume 83, Number 105 (Thursday, May 31, 2018)]
[Notices]
[Pages 25081-25086]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-11615]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83326; File No. SR-OCC-2017-022]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change Related to The Options Clearing 
Corporation's Margin Methodology

May 24, 2018.

I. Introduction

    On November 13, 2017, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2017-022 (``Proposed Rule Change'') 
pursuant to Section 19(b) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 \2\ thereunder to propose several 
enhancements to OCC's margin methodology, the System for Theoretical 
Analysis and Numerical Simulations (``STANS''), OCC's proprietary risk 
management system that calculates clearing member margin 
requirements.\3\ The proposed changes would modify OCC's margin 
methodology to: (1) Obtain daily price data for equity products 
(including daily corporate action-adjusted returns of equities where 
prices and thus returns of securities are adjusted for any dividends 
issued, stock splits, etc.) for use in the daily estimation of 
econometric model parameters; (2) enhance its econometric model for 
updating statistical parameters (e.g., parameters concerning 
correlations or volatility) for all risk factors that reflect the most 
recent data obtained; (3) improve the sensitivity and stability of 
correlation estimates across risk factors by using de-volatized \4\ 
returns (but using a 500 day look back period); and (4) improve OCC's 
methodology related to the treatment of defaulting securities \5\ that 
would result in stable and realistic risk estimates for such 
securities.\6\ The Proposed Rule Change was published for comment in 
the Federal Register on December 4,

[[Page 25082]]

2017.\7\ On January 18, 2018, the Commission designated a longer period 
of time for Commission action on the Proposed Rule Change.\8\ As of May 
23, 2018, the Commission has received one comment letter on the 
proposal.\9\ 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\ See Notice infra note 7, at 82 FR 57306.
    \4\ De-volatization is a process of normalizing historical data 
with the associated volatility thus facilitating comparison between 
different sets of data.
    \5\ Within the context of OCC's margin system, securities that 
do not have enough historical data for calibration are classified as 
``defaulting securities.'' See Notice infra note 15, 82 FR at 61355.
    \6\ See Notice infra note 7, at 82 FR 61354.
    \7\ Release No. 82161 (Nov. 28, 2017), 82 FR 57306 (Dec. 4, 
2017) (File No. SR-OCC-2017-022) (``Notice''). On November 13, 2017, 
OCC also filed a related advance notice (SR-OCC-2017-811) (``Advance 
Notice'') with the Commission pursuant to Section 806(e)(1) of Title 
VIII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act, entitled the Payment, Clearing, and Settlement Supervision Act 
of 2010 and Rule 19b-4(n)(1)(i) under the Act. 12 U.S.C. 5465(e)(1) 
and 17 CFR 240.19b-4(n)(1)(i), respectively. The Advance Notice was 
published in the Federal Register on December 27, 2017. Release No. 
82371 (Dec. 20, 2017), 82 FR 61354 (Dec. 27, 2017) (SR-OCC-2017-
811).
     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, available at http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. Therefore, OCC is required to 
comply with the Payment, Clearing and Settlement Supervision Act and 
file advance notices with the Commission. See 12 U.S.C. 5465(e).
    \8\ Release No. 82534 (Jan. 18, 2018), 83 FR 3376 (Jan. 24, 
2018) (File No. SR-OCC-2017-022).
    \9\ See letter from Michael Kitlas, dated November 28, 2017, to 
Eduardo A. Aleman, Assistant Secretary, Commission, available at 
https://www.sec.gov/comments/sr-occ-2017-022/occ2017022.htm 
(``Kitlas Letter''). After reviewing the Kitlas Letter, the 
Commission believes that it is nonresponsive to the Proposed Rule 
Change and therefore outside the scope of the proposal.
     Since the proposal contained in the Proposed Rule Change was 
also filed as an Advance Notice, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the Proposed Rule Change or the Advance Notice.
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II. Description of the Proposed Rule Change \10\
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    \10\ The description of the Proposed Rule Change is 
substantially excerpted from the Notice. See Notice, 82 FR at 57306-
57313.
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A. OCC's Current Margin Methodology

    OCC's margin methodology, STANS, calculates clearing member margin 
requirements.\11\ STANS utilizes large-scale Monte Carlo simulations to 
forecast price and volatility movements in determining a clearing 
member's margin requirement.\12\ The STANS margin requirement is 
calculated at the portfolio level of clearing member accounts with 
positions in marginable securities and consists of an estimate of a 99% 
expected shortfall \13\ over a two-day time horizon and an add-on 
margin charge for model risk (the concentration/dependence stress test 
charge).\14\ The STANS methodology is used to measure the exposure of 
portfolios of options and futures cleared by OCC and cash instruments 
in margin collateral.\15\
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    \11\ See Release No. 53322 (Feb. 15, 2006), 71 FR 9403 (Feb. 23, 
2006) (File No. SR-OCC-2004-20).
    \12\ See OCC Rule 601; see also Notice, 82 FR at 57307.
    \13\ See Notice, 82 FR at 57307.
     The expected shortfall component is established as the 
estimated average of potential losses higher than the 99% value at 
risk threshold. See Notice, 82 FR at 57307, note 8.
    \14\ See Notice, 82 FR at 57307. A detailed description of the 
STANS methodology is available at http://optionsclearing.com/risk-management/margins/. See Notice, 82 FR at 57307, note 9.
    \15\ See Notice, 82 FR at 57307.
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    A ``risk factor'' within OCC's margin system may be defined as a 
product or attribute whose historical data are used to estimate and 
simulate the risk for an associated product.\16\ The majority of risk 
factors utilized in the STANS methodology are total returns on 
individual equity securities. Other risk factors considered include: 
Returns on equity indexes; returns on implied volatility risk factors 
that are a set of nine chosen volatility pivots per product; changes in 
foreign exchange rates; securities underlying equity-based products; 
and changes in model parameters that sufficiently capture the model 
dynamics from a larger set of data.\17\
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    \16\ Id.
    \17\ Id.
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    Under OCC's current margin methodology, OCC obtains monthly price 
data for most of its equity-based products from a third-party 
vendor.\18\ This data arrive around the second week of every month in 
arrears and require approximately four weeks for OCC to process prior 
to installing into OCC's margin system.\19\ As a result, correlations 
and statistical parameters for risk factors at any point in time 
represent stale data and therefore may not be representative of the 
most recent market data.\20\ In the absence of daily updates, OCC 
employs an approach where one or more identified market proxies (or 
``scale-factors'') are used to incorporate day-to-day market volatility 
across all associated asset classes throughout.\21\ The scale-factor 
approach, however, assumes a perfect correlation of the volatilities 
between the security and its scale-factor, which gives little room to 
capture the idiosyncratic risk of a given security and is different 
from the broad market risk represented by the scale-factor.\22\
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    \18\ Id.
    \19\ Id.
    \20\ Id.
    \21\ Id.
    \22\ Id.
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    In addition, OCC imposes a floor on volatility estimates for its 
equity-based products using a 500-day look back period.\23\ OCC 
believes that using monthly price data, coupled with the dependency of 
margins on scale-factors and the volatility floor can result in 
imprecise changes in margins charged to clearing members, specifically 
across periods of heavy volatility when the correlation between the 
risk factor and a scale-factor fluctuate.\24\
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    \23\ See Notice, 82 FR at 57307.
     In risk management, it is a common practice to establish a 
floor for volatility at a certain level in order to protect against 
procyclicality in the model. See Notice, 82 FR at 57307, note 14.
    \24\ See Notice, 82 FR at 57307.
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    OCC's current methodology for estimating covariance and 
correlations between risk factors relies on the same monthly data 
described above, resulting in a similar lag time between updates.\25\ 
In addition, correlation estimates are based off historical returns 
series, with estimates between a pair of risk factors being highly 
sensitive to the volatility of either risk factor in the chosen 
pair.\26\ Accordingly, OCC believes that the current approach results 
in potentially less stable correlation estimates that may not be 
representative of current market conditions.\27\
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    \25\ Id.
    \26\ Id.
    \27\ Id.
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    Finally, under OCC's existing margin methodology, theoretical price 
scenarios for ``defaulting securities'' \28\ are simulated using 
uncorrelated return scenarios with an average zero return and a pre-
specified volatility called ``default variance.'' \29\ The default 
variance is estimated as the average of the top 25 percent quantile of 
the conditional variances of all securities.\30\ As a result, OCC 
believes that these default estimates may be impacted by extremely 
illiquid securities with discontinuous data.\31\ In addition, OCC 
believes that the default variance (and the associated scale-factors 
used to scale up volatility) is also subject to sudden jumps across 
successive months because it is derived from monthly data updates, as 
opposed to daily updates, which are prone to wider fluctuations and are 
subject to adjustments using scale-factors.\32\
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    \28\ See supra note 5.
    \29\ See Notice, 82 FR at 57307.
    \30\ Id.
    \31\ Id.
    \32\ Id.
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B. Description of the Proposal in the Proposed Rule Change \33\
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    \33\ The description of the proposal is substantially excerpted 
from the Notice. See Notice, 82 FR at 57306-57311.
     In addition to the proposed methodology changes described 
herein, OCC also would make some clarifying and clean-up changes, 
unrelated to the proposed changes described herein, to update its 
margin methodology to reflect existing practices for the daily 
calibration of seasonal and non-seasonal energy models and the 
removal of methodology language for certain products that are no 
longer cleared by OCC. See Notice, 82 FR at 57307, note 17.
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    The Proposed Rule Change proposes changes to STANS. More 
specifically,

[[Page 25083]]

OCC proposes to: (1) Obtain daily price data for equity products 
(including daily corporate action-adjusted returns of equities where 
price and thus returns of securities are adjusted for any dividends 
issued, stock splits, etc.) for use in the daily estimation of 
econometric model parameters; (2) enhance its econometric model for 
updating statistical parameters (e.g., parameters concerning 
correlations or volatility) for all risk factors that reflect the most 
recent data obtained; (3) improve the sensitivity and stability of 
correlation estimates across risk factors by using de-volatized \34\ 
returns (but using a 500 day look back period); and (4) improve OCC's 
methodology related to the treatment of defaulting securities \35\ that 
would result in stable and realistic risk estimates for such 
securities.
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    \34\ De-volatization is a process of normalizing historical data 
with the associated volatility thus facilitating comparison between 
different sets of data.
    \35\ See supra note 5.
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    As a general matter, OCC believes that introducing daily updates 
for price data would result in more accurate margin requirements that 
are based off of the most recent market data. OCC also believes that 
the other model enhancements would, among other things, improve OCC's 
approach to estimating covariance and correlations between risk factors 
in an effort to achieve more accurate and timely correlation 
estimations.\36\ OCC further represents that the proposed changes would 
improve OCC's methodology related to the treatment of defaulting 
securities by reducing the impact that illiquid securities with 
discontinuous data have on default variance estimates. Each of these 
proposals is discussed in more detail below.
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    \36\ OCC's covariance and correlation analytics estimate whether 
risk factors are positively or inversely related and to what extent 
any relationship exists.
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1. Daily Updates of Price Data
    OCC proposes to introduce daily updates for price data for equity 
products, including daily corporate action-adjusted returns of 
equities, Exchange Traded Funds (``ETFs''), Exchange Traded Notes 
(``ETNs'') and certain indexes.\37\ OCC believes that the proposed 
change would help ensure that OCC's margin methodology is reliant on 
data that is more representative of current market conditions, thereby 
resulting in more accurate and responsive margin requirements.\38\ In 
addition, OCC believes that the introduction of daily price updates 
would enable OCC's margin methodology to better capture both market and 
idiosyncratic risk by allowing for daily updates to the parameters 
associated with the econometric model (discussed below) that captures 
the risk associated with a particular product, and therefore help 
ensure that OCC's margin requirements are based on more current market 
conditions.\39\ As a result, OCC would also reduce its reliance on the 
use of scale-factors to incorporate day-to-day market volatility, which 
OCC believes give little room to capture the idiosyncratic risk of a 
given security and is different from the broad market risk represented 
by the scale-factor.\40\
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    \37\ See Notice, 82 FR at 57307.
    \38\ Id.
    \39\ Id.
    \40\ Id.
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2. Proposed Enhancements to the Econometric Model
    In addition to introducing daily updates for price and corporate 
action-adjusted returns data, OCC proposes to make enhancements to its 
econometric model for calculating statistical parameters for all 
qualifying risk factors that reflect the most recent data obtained 
(e.g., OCC would be able to calculate parameters such as volatility and 
correlations on a daily basis using the new daily price data discussed 
above). More specifically, OCC proposes to enhance its econometric 
model by: (i) Introducing daily updates for statistical parameters; 
(ii) introducing features in its econometric model that are designed to 
take into account asymmetry in the model used to forecast volatility 
associated with a risk factor; (iii) modifying the statistical 
distribution used to model the returns of equity prices; (iv) 
introducing a second-day forecast for volatility into the model to 
estimate the two-day scenario distributions for risk factors; and (v) 
imposing a floor on volatility estimates using a 10-year look back 
period. These proposed model enhancements are described in detail 
below.
i. Daily Updates for Statistical Parameters
    Under the proposal, the statistical parameters for the model would 
be updated on a daily basis using the new daily price data obtained by 
OCC from a reliable third-party (as described above).\41\ As a result, 
OCC would no longer need to rely on scale-factors to approximate day-
to-day market volatility for equity-based products.\42\ OCC believes 
that calibrating statistical parameters on a daily basis would allow 
OCC to calculate more accurate margin requirements that represent the 
most recent market data.\43\
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    \41\ See Notice, 82 FR at 57307. OCC notes that this change 
would apply to most risk factors with the exception of certain 
equity indexes, Treasury securities, and energy futures products, 
which are already updated on a daily basis. See Notice, 82 FR 57307, 
at note 18.
    \42\ See Notice, 82 FR at 57307.
    \43\ Id.
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ii. Proposed Enhancements To Capture Asymmetry in Conditional Variance
    The current approach for forecasting the conditional variance for a 
given risk factor does not consider the asymmetric volatility 
phenomenon observed in financial markets (also called the ``leverage 
effect'') where volatility is more accurate and timely and reactive to 
market downturns.\44\ Under the proposal, OCC would amend its 
econometric model to include new features (i.e., incorporating 
asymmetry into its forecast volatility) designed to allow the 
conditional volatility forecast to be more accurate and timely to 
market downturns and thereby capture the most significant dynamics of 
the relationship between price and volatility observed in financial 
markets.\45\ OCC believes the proposed enhancement would result in more 
accurate and responsive margin requirements, particularly in market 
downturns.\46\
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    \44\ See Notice, 82 FR at 57306.
    \45\ Id.
    \46\ Id.
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iii. Proposed Change in Statistical Distribution
    OCC also proposes to change the statistical distribution used to 
model the returns of equity prices. OCC's current methodology uses a 
fat tailed distribution \47\ (the Student's t-distribution) to model 
returns; \48\ however, price scenarios generated using very large log-
return scenarios (positive) that follow this distribution can approach 
infinity and could potentially result in excessively large price jumps, 
a known limitation of this distribution.\49\ Under the proposal, OCC 
would adopt a more defined distribution (Standardized Normal

[[Page 25084]]

Reciprocal Inverse Gaussian or NRIG) for modeling returns, which OCC 
believes would more appropriately simulate future returns based on the 
historical price data for the products in question and allow for more 
appropriate modeling of fat tails.\50\ As a result, OCC believes that 
the proposed change would lead to more consistent treatment of log 
returns both on the upside as well as downside of the distribution.\51\
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    \47\ A data set with a ``fat tail'' is one in which extreme 
price returns have a higher probability of occurrence than would be 
the case in a normal distribution. See Notice, 82 FR at 57307, note 
21.
    \48\ See Notice, 82 FR at 57307.
    \49\ Id.
    \50\ Id.
    \51\ Id.
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iv. Second Day Volatility Forecast
    OCC further proposes to introduce a second-day forecast for 
volatility into the econometric model to estimate the two-day scenario 
distributions for risk factors.\52\ Under the current methodology, OCC 
typically uses a two-day horizon to determine its risk exposure to a 
given portfolio.\53\ This is done by simulating 10,000 theoretical 
price scenarios for the two-day horizon using a one-day forecast 
conditional variance, and the value at risk and expected shortfall 
components of the margin requirement are then determined from the 
simulated profit/loss distributions.\54\ These one-day and two-day 
returns scenarios are both simulated using the one-day forecast 
conditional variance estimate.\55\ OCC believes that this could lead to 
a risk factor's coverage differing substantially on volatile trading 
days.\56\ As a result, OCC proposes to introduce a second-day forecast 
variance for all equity-based risk factors.\57\ The second-day 
conditional variance forecast would be estimated for each of the 10,000 
Monte Carlo returns scenarios, resulting in more accurately estimated 
two-day scenario distributions, and therefore more accurate and 
responsive margin requirements.\58\
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    \52\ Id. This proposed change would not apply to STANS implied 
volatility scenario risk factors. For those risk factors, OCC's 
existing methodology would continue to apply. See Notice, 82 FR at 
57306, note 23.
    \53\ See Notice, 82 FR at 57307.
    \54\ Id.
    \55\ Id.
    \56\ Id.
    \57\ Id.
    \58\ Id.
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v. Anti-Procyclical Floor for Volatility Estimates
    In addition, OCC proposes to modify its floor for volatility 
estimates. OCC currently imposes a floor on volatility estimates for 
its equity-based products using a 500-day look back period.\59\ Under 
the proposal, OCC would extend this look back period to 10 years (2520 
days) in the enhanced model and apply this floor to volatility 
estimates for other products (excluding implied volatility risk factor 
scenarios).\60\ OCC believes that using a longer 10-year look back 
period will help ensure that OCC captures sufficient historical events/
market shocks in the calculation of its anti-procyclical floor.\61\
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    \59\ Id.
    \60\ Id.
    \61\ Id.
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3. Proposed Enhancements to Correlation Estimates
    As described above, OCC's current methodology for estimating 
covariance and correlations between risk factors relies on the same 
monthly price data feeding the econometric model, resulting in a 
similar lag time between updates.\62\ In addition, correlation 
estimates are based off historical returns series, with estimates 
between a pair of risk factors being highly sensitive to the volatility 
of either risk factor in the chosen pair.\63\ The current approach 
therefore results in correlation estimates being sensitive to volatile 
historical data.\64\
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    \62\ Id.
    \63\ Id.
    \64\ Id.
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    In order to address these limitations, OCC proposes to enhance its 
methodology for calculating correlation estimates by moving to a daily 
process for updating correlations (with a minimum of one week's lag) to 
help ensure clearing member account margins are more current and thus 
more accurate.\65\ Moreover, OCC proposes to enhance its approach to 
modeling correlation estimates by de-volatizing \66\ the returns series 
to estimate the correlations.\67\ Under the proposed approach, OCC 
would first consider the returns excess of the mean (i.e., the average 
estimated from historical data sample) and then further scale them by 
the corresponding estimated conditional variances.\68\ OCC believes 
that using de-volatized returns would lead to normalizing returns 
across a variety of asset classes and make the correlation estimator 
less sensitive to sudden market jumps and therefore more stable.\69\
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    \65\ Id.
    \66\ Id.
    \67\ Id.
    \68\ Id.
    \69\ Id.
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4. Defaulting Securities Methodology
    Under the proposal, OCC would enhance its methodology for 
estimating the defaulting variance in its model.\70\ OCC's margin 
system is dependent on market data to determine clearing member margin 
requirements.\71\ Securities that do not have enough historical data 
are classified as ``defaulting securities'' within OCC systems.\72\ As 
noted above, within current STANS systems, the theoretical price 
scenarios for defaulting securities are simulated using uncorrelated 
return scenarios with a zero mean and a default variance, with the 
default variance being estimated as the average of the top 25 percent 
quantile of the conditional variances of all securities.\73\ As a 
result, these default estimates may be impacted by extremely illiquid 
securities with discontinuous data.\74\ In addition, the default 
variance (and the associated scale-factors used to scale up volatility) 
is also subject to sudden jumps across volatile months.\75\ To mitigate 
these concerns, OCC proposes to: (i) Use only optionable equity 
securities to estimate the defaulting variance; (ii) use a shorter time 
series to enable calibration of the model for all securities; and (iii) 
simulate default correlations with the driver Russell 2000 index 
(``RUT'').\76\
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    \70\ Id.
    \71\ See Notice, 82 FR at 57306-57308.
    \72\ See Notice, 82 FR at 57307.
    \73\ Id.
    \74\ Id.
    \75\ Id.
    \76\ Id.
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i. Proposed Modifications to Securities and Quantile Used in Estimation
    Under the proposal, only optionable equity securities, which are 
typically more liquid, would be considered while estimating the default 
variance.\77\ This limitation would eliminate from the estimation 
almost all illiquid securities with discontinuous data that could 
contribute to high conditional variance estimates and thus a high 
default variance.\78\ In addition, OCC proposes to estimate the default 
variance as the lowest estimate of the top 10% of the floored 
conditional variance across the risk factors.\79\ OCC believes that 
this change in methodology would help ensure that while the estimate is 
aggressive it is also robust to the presence of outliers caused by a 
few extremely volatile securities that influence the location parameter 
of a distribution.\80\ Moreover, as a consequence of the daily updates 
described above, the default variances would change daily and there 
would be no scale-factor to amplify the effect of the variance on risk 
factor coverage.\81\
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    \77\ Id.
    \78\ Id.
    \79\ Id.
    \80\ Id.
    \81\ Id.

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[[Page 25085]]

ii. Proposed Change in Time Series
    Under the proposal, OCC would use a shorter time series to enable 
calibration of the model for all securities.\82\ Currently, OCC does 
not calibrate parameters for defaulting securities that have historical 
data of less than two years.\83\ OCC proposes to shorten this time 
period to approximately 6 months (180 days) to enable calibration of 
the model for all securities within OCC systems.\84\ OCC believes that 
this shorter time series is sufficient to produce stable calibrated 
parameters.\85\
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    \82\ Id.
    \83\ Id.
    \84\ Id.
    \85\ Id.
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iii. Proposed Default Correlation
    Under the proposal, returns scenarios for defaulting securities 
\86\ would be simulated using a default correlation with the driver 
RUT.\87\ The default correlation of the RUT index is roughly equal to 
the median of all positively correlated securities with the index.\88\ 
Since 90% of the risk factors in OCC systems correlate positively to 
the RUT index, OCC would only consider those risk factors to determine 
the median.\89\ OCC believes that the median of the correlation 
distribution has been steady over a number of simulations and is 
therefore proposing that it replace the current methodology of 
simulating uncorrelated scenarios, which OCC believes is not a 
realistic approach.\90\
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    \86\ See supra note 5.
    \87\ See Notice, 82 FR at 57307. OCC notes that, in certain 
limited circumstances where there are reasonable grounds backed by 
the existing return history to support an alternative approach in 
which the returns are strongly correlated with those of an existing 
risk factor (referred to as a ``proxy'') with a full price history, 
OCC's margin methodology allows its Financial Risk Management staff 
to construct a ``conditional'' simulation to override any default 
treatment that would have otherwise been applied to the defaulting 
security. See Notice, 82 FR at 57307, note 26.
    \88\ See Notice, 82 FR at 57307.
    \89\ Id.
    \90\ Id.
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization.\91\ After carefully considering the Proposed Rule Change, 
the Commission finds the proposal is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to OCC. 
More specifically, the Commission finds that the Proposed Rule Change 
is consistent with Section 17A(b)(3)(F) of the Act \92\ and Rules 17Ad-
22(e)(6)(i), (e)(6)(iii), and (e)(6)(iv) \93\ thereunder.
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    \91\ 15 U.S.C. 78s(b)(2)(C).
    \92\ 15 U.S.C. 78q-1.
    \93\ 17 CFR 240.17Ad-22(e)(6)(i), (e)(6)(iii), and (e)(6)(iv).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of Act requires that the rules of a clearing 
agency be designed to, among other things, promote the prompt and 
accurate clearance and settlement of securities transactions, assure 
the safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible, and, in 
general, to protect investors and the public interest.\94\ Based on its 
review of the record, the Commission believes that the proposed changes 
promote the prompt and accurate clearance and settlement of securities 
transactions and safeguard the securities and funds in OCC's custody or 
control, and therefore, in general, protect investors and the public 
interest by enhancing OCC's margin methodology for the reasons set 
forth below.
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    \94\ 15 U.S.C. 78q-1(b)(3)(F).
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    First, as noted above, the STANS methodology is used to measure the 
exposure of portfolios of options and futures cleared by OCC and cash 
instruments in margin collateral on behalf of its clearing members, 
which allows OCC to calculate its clearing members' margin 
requirements. Currently, STANS makes these calculation based on monthly 
price data obtained from a third-party vendor. To make the calculations 
more accurate and representative of recent market data, OCC proposes to 
amend its margin methodology to require the use of daily updates for 
equity price data instead of monthly updates, thereby reducing OCC's 
reliance on scale-factors.\95\ The Commission believes that the change 
from monthly price data updates to daily price data updates would 
result in more accurate and timely estimations of OCC's clearing 
members' margin requirements.
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    \95\ See supra note 37.
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    Second, the proposal to amend OCC's margin methodology to require 
the use of daily updates for price data would allow for updates to the 
margin model's statistical parameters on a daily, instead of monthly, 
basis.\96\ Similarly, the proposal also would amend STANS to introduce 
other features that would improve the accuracy of its models and, 
consequently, produce risk exposure and margin requirement calculations 
that better reflect current market conditions. For example, the 
proposal would: (i) Amend STANS to account for the asymmetric 
volatility phenomenon observed in financial markets and allow for the 
conditional volatility forecast to be more accurate and timely to 
market downturns; \97\ (ii) amend the statistical distribution for 
modeling equity price returns to more appropriately model fat tails 
and, consequently, more accurately model returns; (iii) introduce a 
second-day volatility forecast into the model to provide for more 
accurate and timely estimations of its two-day scenario distributions 
than currently provided by its one-day forecast variance; and (iv) 
amend STANS to impose a volatility floor using a 10-year look back 
period to reduce procyclicality in the margin model by capturing 
sufficient market events in its calculations. Taken together, the 
Commission believes that the introduction of these enhancements would 
improve the accuracy of the STANS margin models, and therefore would 
enable OCC to more effectively calculate clearing members' margin 
requirements.
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    \96\ Id.
    \97\ See Notice, 82 FR at 57307.
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    Third, as described earlier, OCC proposes to enhance its approach 
to model correlation estimates by moving to a daily process for 
updating correlations and by de-volatizing the return series to 
estimate the correlations. This change is intended to lead to 
normalized returns across a variety of asset classes and make the 
correlation estimator less sensitive to sudden market jumps and 
therefore more stable. The Commission believes that updating the 
correlations daily and de-volatizing the return series to reduce the 
estimator's sensitivity to market jumps will promote more accurate and 
robust models within the STANS methodology.
    Finally, to enhance its methodology for estimating the defaulting 
securities in its model, OCC proposes to: (i) Modify the method for 
estimating the default variance to include only optionable equity 
securities; (ii) use a shorter time series of six months instead of two 
years to enable calibration of the model for all securities within OCC 
systems; and (iii) simulate return scenarios for defaulting securities 
assuming a default correlation with the driver RUT. The Commission 
believes these changes will mitigate the effect that extremely illiquid 
securities with discontinuous data can have on OCC's default estimates, 
while further

[[Page 25086]]

decreasing the degree to which the default variance is subject to 
sudden jumps across volatile months.
    Taken together, the Commission believes that these proposals would 
improve the accuracy of OCC's credit exposure calculations and, 
consequently, OCC's calculations of its clearing members' margin 
requirements. As described above, the proposed changes are designed to 
better limit OCC's credit exposure to the clearing members in the event 
of a clearing member default, which could help ensure that OCC's 
operations are not disrupted in the event of a clearing member default. 
In particular, the daily updates of the pricing data, the enhancements 
to the econometric model, and the enhancements to the correlation 
estimates promote more accurate and stable model measurements that have 
less volatility. Moreover, the enhancements to the defaulting 
securities methodology will decrease the manner in which the default 
estimates are affected by illiquid securities and reduce the amount to 
which the default variance is subject to sudden jumps, further 
promoting stable model measurements with less volatility.
    By better limiting credit exposure to its clearing members, OCC's 
proposed changes are designed to help ensure that, in the event of a 
clearing member default, OCC's operations would not be disrupted. As a 
result, it could continue to clear and settle securities transactions 
as promptly and accurately as possible and safeguard the securities and 
funds in its custody or control, which generally would help protect 
investors and the public interest. Additionally, OCC's enhanced ability 
to determine margin requirements should help ensure that non-defaulting 
clearing members would not be exposed to losses that they cannot 
anticipate or control, which also generally would help protect 
investors and the public interest.
    As a result, the Commission believes the Proposed Rule Change is 
designed to promote the prompt and accurate clearance and settlement of 
securities transactions, assure the safeguarding of securities and 
funds which are in the custody or control of the clearing agency or for 
which it is responsible, and, in general, to protect investors and the 
public interest in accordance with Section 17A(b)(3)(F) of the Act.\98\
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    \98\ Id.
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B. Consistency With Rules 17Ad-22(e)(6)(i), (e)(6)(iii), and (e)(6)(iv) 
Under the Act

    The Commission believes that the changes proposed in the Proposed 
Rule Change are consistent with Rules 17Ad-22(e)(6)(i), (e)(6)(iii), 
and (e)(6)(iv) under the Act, which requires that OCC establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to cover its credit exposures to its participants 
by establishing a risk-based margin system that, among other things: 
(i) Considers, and produces margin levels commensurate with the risks 
and particular attributes of each relevant product, portfolio, and 
market; (ii) calculates margin sufficient to cover its potential future 
exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default; and (iii) uses reliable sources of timely price data and uses 
procedures and sound valuation models for addressing circumstances in 
which pricing data is not readily available or reliable.\99\
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    \99\ 17 CFR 240.17AD-22(e)(6)(i), (e)(6)(iii), and (e)(6)(iv).
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    As described above, the proposal contained in the Proposed Rule 
Change would make several amendments to OCC's margin methodology 
designed to improve how it: (i) Accounts for asymmetry in conditional 
variance; \100\ (ii) models the statistical distribution of price 
returns; \101\ (iii) models second-day volatility forecasts; \102\ (iv) 
estimates covariance and correlations between risk factors to provide 
for stable and sensitive correlation estimations; \103\ and (v) treats 
defaulting securities by reducing the impact that illiquid securities 
with discontinuous data have on default variance estimates.\104\
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    \100\ See Notice of Filing of Proposed Rule Change, 82 FR at 
57306.
    \101\ Id.
    \102\ Id.
    \103\ Id.
    \104\ See Notice of Filing of Proposed Rule change, 82 FR at 
57306-57307.
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    The Commission believes the modifications proposed are designed to 
improve the manner in which STANS would calculate daily margin 
requirements for OCC's clearing members. Consequently, the Commission 
believes that the proposal is designed to both (i) consider, and 
produce margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market \105\ and 
(ii) calculate margin sufficient to cover OCC's potential future 
exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default.\106\ Additionally, as discussed in the Proposed Rule 
Change,\107\ the proposal would introduce daily updates for price data 
for equity products, which data would be obtained from a reliable 
industry vendor. Taken together, the Commission believes that the 
changes and modifications proposed in the Proposed Rule Change would 
help ensure that OCC's margin methodology utilizes a reliable source of 
timely price data, which would better reflect current market conditions 
than the current monthly updates, and thereby result in more accurate 
and responsive margin requirements.\108\ Consequently, the Commission 
finds that the proposal is consistent with Rules 17Ad-22(e)(6)(i), 
(e)(6)(iii), and (e)(6)(iv) under the Act.
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    \105\ See 17 CFR 240.17Ad-22(e)(6)(i).
    \106\ See 17 CFR 240.17Ad-22(e)(6)(iii).
    \107\ See Notice, 82 FR at 57307.
    \108\ See 17 CFR 240.17Ad-22(e)(6)(iv).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed change is consistent with the requirements of the Act, and in 
particular, with the requirements of Section 17A of the Act \109\ and 
the rules and regulations thereunder.
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    \109\ 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,\110\ that the Proposed Rule Change (SR-OCC-2017-022) be, and it 
hereby is, approved.
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    \110\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\111\
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    \111\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-11615 Filed 5-30-18; 8:45 am]
 BILLING CODE 8011-01-P


