[Federal Register Volume 83, Number 116 (Friday, June 15, 2018)]
[Notices]
[Pages 28018-28039]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-12855]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83406; File No. SR-OCC-2018-008]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change, as Modified by Amendment No. 
1, Related to The Options Clearing Corporation's Stress Testing and 
Clearing Fund Methodology

June 11, 2018.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on May 30, 2018, The Options Clearing Corporation 
(``OCC'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by OCC. On June 7, 2018, 
OCC filed Amendment No. 1 to the proposed rule change.\3\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, OCC corrected formatting errors in 
Exhibits 5A and 5B without changing the substance of the proposed 
rule change.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The proposed rule change by OCC concerns proposed changes to OCC's 
By-Laws and Rules, the formalization of a substantially new Clearing 
Fund Methodology Policy (``Policy''), and the adoption of a document 
describing OCC's new Clearing Fund and stress testing methodology 
(``Methodology Description''). The proposed changes are primarily 
designed to enhance OCC's overall resiliency, particularly with respect 
to the level of OCC's pre-funded financial resources. Specifically, the 
proposed changes would:
    (1) Reorganize, restate, and consolidate the provisions of OCC's 
By-Laws and Rules relating to the Clearing Fund into a newly revised 
Chapter X of OCC's Rules;
    (2) modify the coverage level of OCC's Clearing Fund sizing 
requirement to protect OCC against losses stemming from the default of 
the two Clearing Member Groups that would potentially cause the largest 
aggregate credit exposure for OCC in extreme but plausible market 
conditions (i.e., adopt a ``Cover 2 Standard'' for sizing the Clearing 
Fund);
    (3) adopt a new risk tolerance for OCC to cover a 1-in-50 year 
hypothetical market event at a 99.5% confidence level over a two-year 
look-back period;
    (4) adopt a new Clearing Fund and stress testing methodology, which 
would be underpinned by a new scenario-based one-factor risk model 
stress testing approach, as detailed in the newly proposed Policy and 
Methodology Description;
    (5) document governance, monitoring, and review processes related 
to Clearing Fund and stress testing;
    (6) provide for certain anti-procyclical limitations on the 
reduction in Clearing Fund size from month to month;
    (7) increase the minimum Clearing Fund contribution requirement for 
Clearing Members to $500,000;
    (8) modify OCC's allocation weighting methodology for Clearing Fund 
contributions;
    (9) reduce from five to two business days the timeframe within 
which Clearing Members are required to fund Clearing Fund deficits due 
to monthly or intra-month resizing or due to Rule amendments;
    (10) provide additional clarity in OCC's Rules regarding certain 
anti-procyclicality measures in OCC's margin model; and
    (11) make a number of other non-substantive clarifying, conforming, 
and organizational changes to OCC's By-Laws, Rules, Collateral Risk 
Management Policy, Default Management Policy, and filed procedures, 
including retiring OCC's existing Clearing Fund Intra-Month Re-sizing 
Procedure, Financial Resources Monitoring and Call Procedure (``FRMC 
Procedure''), and Monthly Clearing Fund Sizing Procedure, as these 
procedures would no longer be relevant to OCC's proposed Clearing Fund 
and

[[Page 28019]]

stress testing methodology and would be replaced by the proposed Rules, 
Policy, and Methodology Description described herein.
    The proposed amendments to OCC's By-Laws and Rules can be found in 
Exhibits 5A and 5B, respectively. Material proposed to be added to 
OCC's By-Laws and Rules as currently in effect is marked by 
underlining, and material proposed to be deleted is marked in 
strikethrough text.\4\ As proposed, existing Chapter X would be deleted 
and replaced with new Chapter X in its entirety, as set forth in 
Exhibit 5B.
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    \4\ OCC recently proposed changes to Article VIII of its By-Laws 
in connection with advance notice and proposed rule change filings 
related to enhanced and new tools for recovery scenarios. See 
Securities Exchange Act Release No. 82351 (December 19, 2017), 82 FR 
61107 (December 26, 2017) (SR-OCC-2017-020) and Securities Exchange 
Act Release No. 82513 (January 17, 2018). 83 FR 3244 (January 23, 
2018) (SR-OCC-2017-809). The proposed changes currently pending 
Commission review in SR-OCC-2017-020 and SR-OCC-2017-809 are 
indicated in Exhibit 5B with double underlined and double 
strikethrough text.
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    The proposed Policy and Methodology Description have been submitted 
in Exhibits 5C and 5D, respectively, and have been submitted without 
marking to facilitate review and readability of the documents as they 
are being submitted in their entirety as new rule text.\5\
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    \5\ Id. Proposed changes currently pending Commission review in 
SR-OCC-2017-020 and SR-OCC-2017-809 are indicated in Exhibit 5C with 
double underlined and double strikethrough text.
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    The Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, 
and Monthly Clearing Fund Sizing Procedure can be found in Exhibits 5E, 
5F and 5G, respectively, with the deletion (or retirement) of these 
procedures indicated by strikethrough text.
    The proposed changes to OCC's Collateral Risk Management Policy and 
Default Management Policy can be found in Exhibits 5H and 5I, 
respectively. Material proposed to be added to the policies as 
currently in effect is marked by underlining, and material proposed to 
be deleted is marked in strikethrough text.
    All terms with initial capitalization not defined herein have the 
same meaning as set forth in OCC's By-Laws and Rules.\6\
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    \6\ OCC's By-Laws and Rules can be found on OCC's public 
website: http://optionsclearing.com/about/publications/bylaws.jsp.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

(1) Purpose
Overview of OCC's Existing Clearing Fund Methodology
    OCC currently sizes its Clearing Fund at an amount sufficient to 
protect OCC against losses under simulated default scenarios that 
include (1) an idiosyncratic default scenario that includes the default 
of the single Clearing Member Group whose default would be likely to 
result in the largest draw against the Clearing Fund at a 99% 
confidence level and (2) a minor systemic event default scenario 
involving the near-simultaneous default of two randomly-selected 
Clearing Member Groups calculated at a 99.9% confidence level (``Cover 
1 Standard'').\7\ OCC then uses the daily peak of such draw estimates 
to determine the monthly size of the Clearing Fund, which is 
established at the greater of (i) a ``base amount'' equal to the peak 
five-day rolling average of the Clearing Fund Draws \8\ observed over 
the preceding three calendar months, plus a prudential margin of safety 
equal to $1.8 billion, or (ii) 110% of OCC's committed credit 
facilities. Upon each monthly determination of the Clearing Fund's 
size, each Clearing Member is required to contribute an amount equal to 
the sum of: (i) The $150,000 minimum membership requirement, and (ii) 
an amount equal to the weighted average of the Clearing Member's 
proportionate share of open interest, volume, and total risk 
charges.\9\ Any deficits resulting from a difference between a Clearing 
Member's required Clearing Fund contribution and the amount that such 
member currently has on deposit are due within five business days of 
the resizing.\10\
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    \7\ See Rule 1001(a).
    \8\ The term ``Clearing Fund Draw'' refers to an estimated 
stress loss exposure in excess of margin requirements.
    \9\ See Rule 1001(b).
    \10\ See Rule 1003.
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    Supplemental to the monthly Clearing Fund sizing process, OCC's 
Financial Risk Management department (``FRM'') assesses on a daily 
basis the sufficiency of the Clearing Fund by monitoring Clearing Fund 
Draw estimates in order to identify exposures that may require 
collection of additional margin from a Clearing Member Group or an 
intra-month resizing of the Clearing Fund in accordance with OCC's FRMC 
Procedure.\11\ In instances where an estimate of a particular Clearing 
Member Group's Clearing Fund Draw (referred to herein as an 
``idiosyncratic'' estimate) exceeds 75% of the amount currently in the 
Clearing Fund (i.e., the current Clearing Fund requirement less any 
deficits), OCC issues a margin call against the Clearing Member 
Group(s) generating such draw(s) for an amount equal to the difference 
between such estimated draw amount and the base amount of the Clearing 
Fund.\12\ The margin call per-Clearing Member may be limited to an 
amount equal to the lesser of $500 million or 100% of such Clearing 
Member's net capital, subject to OCC management discretion. All margin 
calls issued must be satisfied by each applicable Clearing Member 
within one hour of having been notified and remain in place until 
deficits associated with the next monthly Clearing Fund sizing are 
collected.\13\
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    \11\ See Securities Exchange Act Release No. 74980 (May 15, 
2015), 80 FR 29364 (May 21, 2015) (SR-OCC-2015-009). See also 
Securities Exchange Act Release No. 74981 (May 15, 2015), 80 FR 
29367 (May 21, 2015) (SR-OCC-2014-811).
    \12\ In the case where an estimated draw is associated with 
multiple Clearing Members within a single Clearing Member Group, the 
margin call is allocated among the individual Clearing Members in 
the Clearing Member Group based on each Clearing Member's 
proportionate share of the ``total risk'' for such Clearing Member 
Group, as that term is defined in current Rule 1001(b). See Rule 
1001(b). Accordingly, the term ``total risk'' in this context means 
the margin requirement with respect to all accounts of the Clearing 
Member Group exclusive of the net asset value of the positions in 
such accounts aggregated across all such accounts.
    \13\ See supra note 10.
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    In more extreme circumstances, where OCC observes an idiosyncratic 
Clearing Fund Draw estimate (after factoring in margin calls issued) 
exceeding 90% of the Clearing Fund, OCC increases the size of the 
Clearing Fund by a minimum amount equal to the greater of (i) $1 
billion, or (ii) 125% of the difference between the projected draw 
(reduced by margin calls issued) and the Clearing Fund in effect. Each 
Clearing Member not subject to OCC's minimum $150,000 Clearing Fund 
requirement (e.g., a Futures-Only Affiliated Clearing Member) receives 
a proportionate share of the Clearing Fund increase equal to its 
proportionate share of the variable portion of the Clearing Fund for 
the current month (i.e., the Clearing Member's proportionate share of 
the Clearing Fund amount as determined pursuant to current Rule 
1001(b)(y)). Any deficits

[[Page 28020]]

associated with the increase to the Clearing Fund must be satisfied 
within five business days of the resizing.
    OCC has identified a number of limitations to its current 
methodology, which is unable to incorporate historical stress test 
scenarios and which can result in disproportionate changes to the 
Clearing Fund size in response to even transitory changes in 
volatility. As a result, OCC is proposing to replace its current 
Clearing Fund sizing methodology with a new methodology that would 
allow OCC to size and assess the sufficiency of its Clearing Fund with 
a wider range of historical and hypothetical scenarios.
Proposed Changes to OCC's Clearing Fund and Stress Testing Rules and 
Methodology
    OCC is proposing a number of enhancements intended to strengthen 
its overall resiliency, particularly with respect to OCC's Pre-Funded 
Financial Resources,\14\ including, but not limited to, the following:
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    \14\ The proposed Policy would define OCC's ``Pre-Funded 
Financial Resources'' to mean margin of the defaulted Clearing 
Member and the required Clearing Fund less any deficits, exclusive 
of OCC's assessment powers.
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    (1) Reorganize, restate, and consolidate the provisions of OCC's 
By-Laws and Rules relating to the Clearing Fund into a newly revised 
Chapter X of OCC's Rules;
    (2) modify the coverage level of OCC's Clearing Fund sizing 
requirement to ensure that the size of the Clearing Fund is sufficient 
to protect OCC against losses stemming from the default of the two 
Clearing Member Groups that would potentially cause the largest 
aggregate credit exposure for OCC in extreme but plausible market 
conditions (i.e., adopt a ``Cover 2 Standard'' for sizing the Clearing 
Fund);
    (3) adopt a new risk tolerance for OCC to cover a 1-in-50 year 
hypothetical market event at a 99.5% confidence level over a two-year 
look-back period;
    (4) adopt a new Clearing Fund and stress testing methodology, which 
would be underpinned by a new scenario-based one-factor risk model 
stress testing approach, as detailed in the newly proposed Policy and 
Methodology Description; \15\
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    \15\ OCC has separately submitted to the Commission its 
Comprehensive Stress Testing and Clearing Fund Methodology document 
and Dynamic VIX Calibration Process paper, which are included in 
this filing as Exhibits 3A and 3B, and for which OCC has requested 
confidential treatment. These Exhibits are being provided as 
supplemental information to the filing and would not constitute part 
of OCC's rules, which have been provided in Exhibit 5.
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    (5) document governance, monitoring, and review processes related 
to Clearing Fund and stress testing;
    (6) provide for certain anti-procyclical \16\ limitations on the 
reduction in Clearing Fund size from month to month;
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    \16\ A quality that is positively correlated with the overall 
state of the market is deemed to be ``procyclical.'' For example, 
procyclicality may be evidenced by increasing margin or Clearing 
Fund requirements in times of stressed market conditions and low 
margin or Clearing Fund requirements when markets are calm. Hence, 
anti-procyclical features in a model are measures intended to 
prevent risk-base models from fluctuating too drastically in 
response to changing market conditions.
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    (7) increase the minimum Clearing Fund contribution requirement for 
Clearing Members to $500,000;
    (8) modify OCC's allocation weighting methodology for Clearing Fund 
contributions;
    (9) reduce from five to two business days the timeframe within 
which Clearing Members are required to fund Clearing Fund deficits due 
to monthly or intra-month resizing or due to Rule amendments;
    (10) provide additional clarity in OCC's Rules regarding certain 
anti-procyclicality measures in OCC's margin model; and
    (11) make a number of other non-substantive clarifying, conforming, 
and organizational changes to OCC's By-Laws, Rules, and filed 
procedures.
1. Reorganization and Consolidation of Clearing Fund By-Laws and Rules
    The primary provisions that address OCC's Clearing Fund are 
currently located in Article VIII of the By-Laws and Chapter X of the 
Rules. Because the proposed changes to the Clearing Fund would 
substantially amend the relevant By-Law and Rule provisions, OCC 
believes that this is an appropriate opportunity to consolidate the 
primary provisions that address the Clearing Fund into Chapter X of the 
Rules. As a result, the content of Article VIII of the By-Laws would be 
consolidated into Chapter X of the Rules, subject to the proposed 
amendments described herein.\17\ In place of this, Article VIII of the 
By-Laws would contain a general statement that OCC shall maintain a 
Clearing Fund, as provided in and subject to the terms of Chapter X of 
the Rules, and the size of the Clearing Fund shall at all times be 
subject to minimum sizing requirements and generally be calculated on a 
monthly basis by OCC; however, the size of the Clearing Fund may be 
adjusted more frequently than monthly under certain conditions 
specified in proposed Rule 1001. OCC believes that consolidating all of 
the Clearing Fund-related provisions of its By-Laws and Rules into one 
place would provide more clarity around, and enhance the readability 
of, OCC's Clearing Fund requirements.
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    \17\ While Article VIII of the By-Laws would effectively be 
reserved for future use, a statement would be added to indicate that 
OCC maintains the Clearing Fund as provided in and subject to the 
Rules provided in Chapter X.
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    OCC notes that, while the content of Article VIII is being moved 
out of the By-Laws and into the Rules, subject to the proposed changes 
described herein, OCC is not proposing to change the existing 
governance requirements with respect to amending the provisions 
currently contained in Article VIII. Article XI, Section 2 of the By-
Laws provides that the Board of Directors may amend the Rules by a 
majority vote, while Article XI, Section 1 of the By-Laws provides that 
amendments to the By-Laws require an affirmative vote of two-thirds of 
the directors then in office, but not less than a majority of the 
number of directors fixed by the By-Laws. To ensure that the latter, 
heightened governance standard continues to apply to the Clearing Fund 
provisions that will be moved from Article VIII of the By-Laws to 
Chapter X of the Rules, OCC is proposing to amend Article XI, Section 2 
of the By-Laws to apply the heightened approval requirements to the 
provisions of Chapter X of the Rules that would be carried over from 
the By-Laws. Specifically, OCC would amend Article XI of the By-Laws to 
stipulate that while the Rules may be amended at any time by the Board 
of Directors, any amendment of the introduction to newly proposed 
Chapter X of the Rules, Rule 1002, Rule 1006, Rule 1009 and Rule 1010 
(the substance of which is primarily derived from Article VIII of the 
By-Laws) shall require the affirmative vote of two-thirds of the 
directors then in office (but not less than a majority of the number of 
directors fixed by the By-Laws). Moreover, Article XI of the By-Laws 
would be amended to provide that the first sentence of proposed Rule 
1006(e) may not be amended by action of the Board of Directors without 
the approval of the holders of all of the outstanding Common Stock of 
the OCC entitled to vote thereon. Proposed Rule 1006(e) is derived from 
existing Article VIII, Section 5(d) of the By-Laws, which is currently 
subject to this stockholder consent requirement under Article XI, 
Section 1 of the By-Laws. A detailed discussion of other organizational 
changes can be found in Section 10 below.
    As noted above, and further described below, OCC also proposes to 
adopt a

[[Page 28021]]

new Policy and Methodology Description to supplement its proposed Rules 
and provide further details around OCC's Clearing Fund and stress 
testing methodology and the related governance framework.
2. Adoption of a Cover 2 Standard for OCC's Clearing Fund
    Under existing Rule 1001(a) and consistent with applicable Exchange 
Act requirements,\18\ OCC currently maintains a Cover 1 Standard with 
respect to the size of its Clearing Fund. The current methodology uses 
a sizing approach whereby OCC estimates draws against the Clearing Fund 
under a simulated idiosyncratic default scenario (representing 
simulated losses of a single Clearing Member Group) and a minor 
systemic default scenario (representing all pairings of two Clearing 
Member Groups, with each pair of distinct Clearing Member Groups being 
deemed equally likely).
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    \18\ See 17 CFR 240.17Ad-22(b)(3) and (e)(4)(iii).
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    OCC is proposing to amend its Rules and adopt a new Policy and 
Methodology Description to implement a Cover 2 Standard with respect to 
sizing the Clearing Fund. As a result, new Rule 1001(a), which replaces 
existing Rule 1001(a), would provide, in part, that the size of the 
Clearing Fund shall be established on a monthly basis at an amount 
determined by OCC to be sufficient to protect it against losses 
stemming from the default of the two Clearing Member Groups that would 
potentially cause the largest aggregate credit exposure for OCC under 
stress test scenarios that represent extreme but plausible market 
conditions (subject to certain minimum sizing requirements) (such 
stress tests being ``Sizing Stress Tests'').\19\ The proposed Sizing 
Stress Tests would be supplemented by additional historical or 
hypothetical stress test scenarios (``Sufficiency Stress Tests'') and, 
in the event Sufficiency Stress Tests call for a larger Clearing Fund 
size, the Clearing Fund shall be re-sized based on such Sufficiency 
Stress Tests (as described in more detail in Section 4.e below).
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    \19\ The calculated size of the Clearing Fund may also be 
determined more frequently than monthly under certain conditions, as 
specified within proposed Rule 1001(c).
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    The adoption of a Cover 2 Standard for the Clearing Fund would 
continue to satisfy OCC's existing obligations under the Securities 
Exchange Act of 1934 (``Exchange Act'' or ``Act''),\20\ and also would 
be consistent with international standards and best practices for 
central counterparties (``CCPs'').\21\ OCC believes that moving to an 
industry best practice Cover 2 Standard would increase OCC's resiliency 
and enable it to better withstand the default of multiple Clearing 
Members. OCC's proposed approach of adopting a Cover 2 Standard is 
reiterated in the proposed Policy and Methodology Description, and the 
stress tests referred to in new Rule 1001(a) are described in more 
detail in Section 4 below.\22\
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    \20\ 15 U.S.C. 78a et seq. See supra note 17.
    \21\ See Committee on Payment and Settlement Systems and 
Technical Committee of the International Organization of Securities 
Commissions, Principles for financial market infrastructures (Apr. 
16, 2012), available at http://www.bis.org/publ/cpss101a.pdf.
    \22\ Under the proposed Clearing Fund methodology, OCC would no 
longer maintain the prudential margin of safety, as currently 
provided for in existing Rule 1001(a). As described further herein, 
OCC's proposed risk tolerance would be set at a 1-in-50 year market 
event; however, OCC would size its Clearing Fund to cover a more 
conservative 1-in-80 year event, creating a buffer beyond its risk 
tolerance. As a result, OCC believes the prudential margin of safety 
would no longer be necessary.
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3. New Risk Tolerance for OCC's Pre-Funded Financial Resources
    OCC proposes to adopt a new risk tolerance with respect to credit 
risk that its Clearing Fund, along with OCC's other Pre-Funded 
Financial Resources,\23\ should be sufficient to cover a wide range of 
foreseeable stress scenarios that include, but are not limited to, the 
default of the two Clearing Member Groups that would potentially cause 
the largest aggregate credit exposure in extreme but plausible market 
conditions. In developing a risk tolerance with regard to the sizing of 
the Clearing Fund, OCC believes that a 1-in-50 year hypothetical market 
event \24\ represents the outer range of extreme but plausible 
scenarios for OCC's cleared products. Accordingly, OCC proposes to 
adopt a new risk tolerance with respect to sizing its Pre-Funded 
Financial Resources that would cover a 1-in-50 year hypothetical market 
event on a Cover 2 Standard at a 99.5% confidence level over a two-year 
look-back period. The hypothetical scenarios used to establish the 
proposed risk tolerance would be based on the statistical fit of the 
historical returns for the ``risk drivers'' of equity products (or 
``risk factors'') for a 1-in-50 year decline and rally in the Standard 
& Poor's S&P 500 Index (``SPX'').\25\ OCC would then set the size of 
its Clearing Fund on a monthly basis at an amount sufficient to cover 
this risk tolerance, as described in more detail in Section 4.d below.
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    \23\ Under the proposed Policy, ``Pre-Funded Financial 
Resources'' would be defined as the margin of the defaulted Clearing 
Member and the required Clearing Fund less any deficits. OCC would 
not include assessment powers as a Pre-Funded Financial Resource.
    \24\ OCC notes that a 1-in-50 year hypothetical market event 
corresponds to a 99.9921% confidence interval under OCC's chosen 
distribution of 2-day logarithmic S&P 500 index returns. The 
construction of Hypothetical stress test scenarios, including the 1-
in-50 year market event used for OCC's risk tolerance, is discussed 
in Section 4 below.
    \25\ ``Risk factors'' refer broadly to all of the individual 
underlying securities (such as Google, IBM and Standard & Poor's 
Depositary Receipts (``SPDR''), S&P 500 Exchange Traded Funds 
(``SPY''), etc.) listed on a market. The ``risk drivers'' are a 
selected set of securities or market indices (e.g., the SPX or the 
Cboe Volatility Index (``VIX'')) that are used to represent the main 
sources or drivers for the price changes of the risk factors. The 
use and application of risk factors and risk drivers in OCC's 
proposed methodology are discussed further in Section 4 below.
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4. Adoption of New Clearing Fund and Stress Testing Methodology
    OCC proposes to adopt a new methodology for sizing and monitoring 
its Clearing Fund and overall Pre-Funded Financial Resources, which 
primarily would be detailed in the proposed Policy and the Methodology 
Description. OCC believes that its proposed methodology would enable it 
to measure its credit exposure and to size its Pre-Funded Financial 
Resources at a level sufficient to cover potential losses under extreme 
but plausible market conditions.
    Under the requirements of the proposed Policy, OCC would base its 
determination of the Clearing Fund size on the results of stress tests 
conducted daily using standard predetermined parameters and 
assumptions. These daily stress tests would consider a range of 
relevant stress scenarios and possible price changes in liquidation 
periods, including but not limited to: (1) Relevant peak historic price 
volatilities; (2) shifts in other market factors including, as 
appropriate, price determinants and yield curves; and (3) the default 
of one or multiple Clearing Members. OCC also would conduct reverse 
stress tests for informational purposes aimed at identifying extreme 
default scenarios and extreme market conditions for which the OCC's 
financial resources would be insufficient.
    As further described in the proposed Methodology Description, the 
stress scenarios used in the proposed methodology would consist of two 
types of scenarios: ``Historical Scenarios'' and ``Hypothetical 
Scenarios.'' Historical Scenarios would replicate historical events in 
current market conditions, which include the set of currently existing 
securities, their prices and volatility levels. These scenarios provide 
OCC with information regarding

[[Page 28022]]

pre-defined reference points determined to be relevant benchmarks for 
assessing OCC's exposure to Clearing Members and the adequacy of its 
financial resources. Hypothetical Scenarios would represent events in 
which market conditions change in ways that have not yet been observed. 
The Hypothetical Scenarios would be derived using statistical methods 
(e.g., draws from estimated multivariate distributions) or created 
based on expert judgment (e.g., a 15% decline in market prices and 50% 
in volatility). These scenarios would give OCC the ability to change 
the distribution and level of stress in ways necessary to produce an 
effective forward-looking stress testing methodology. OCC would use 
these pre-determined stress scenarios in stress tests, conducted on a 
daily basis, to determine OCC's risk exposure to each Clearing Member 
Group by simulating the profits and losses of the positions in their 
respective account portfolios under each such stress scenario.
    The proposed Methodology Description would also describe OCC's 
proposed approach for constructing stress test portfolios. For purposes 
of the proposed methodology, OCC would construct portfolios based on 
``liquidation positions,'' which are designed to more closely reflect 
how positions would be internalized (or netted) as part of OCC's 
default management process. The liquidation position set is created 
through an internalization process where long and short positions in 
the same contract series are closed out within an account type at the 
Clearing Member level. This replicates the process OCC would perform in 
the case of a Clearing Member default when offsetting positions are 
internalized before liquidating the remainder of the defaulter's 
portfolio. For simplicity purposes, OCC developed its current set of 
liquidation positions by internalizing within an account type at the 
Clearing Member level but does not incorporate potential 
internalization that can occur across account types. As a result, 
liquidation positions only reflect a portion of the potential exposure-
reducing benefits associated with internalization and may lead to more 
conservative estimates of exposure.
    As described further below, the proposed Policy and Methodology 
Description would include stress tests designed to: (1) Determine the 
size of the Clearing Fund (i.e., Sizing Stress Tests run using OCC's 
inventory of ``Sizing Scenarios''), (2) assess OCC's Clearing Fund size 
with respect to its risk tolerance and any other scenarios determined 
by the Risk Committee (i.e., Adequacy Stress Tests run using OCC's 
inventory of ``Adequacy Scenarios''), (3) measure the exposure of the 
Clearing Fund to the portfolios of individual Clearing Member Groups 
and determine whether any such exposure is sufficiently large as to 
necessitate OCC calling for additional margin resources from that 
individual Clearing Member Group (or Groups) or from Clearing Members 
generally through an intra-month resizing of the Clearing Fund (i.e., 
Sufficiency Stress Tests run using OCC's inventory of ``Sufficiency 
Scenarios''), and (4) monitor and assess OCC's total financial 
resources under a variety of market conditions (i.e., Informational 
Stress Tests run using OCC's inventory of ``Informational Scenarios'').
    OCC's proposed stress testing model, the construction of 
Hypothetical and Historical Scenarios, and the variety of stress tests 
thereunder are described in more detail below.
a. Proposed Stress Testing Model
(i). Risk Drivers and Stress Scenarios
    As detailed in the proposed Methodology Description, the proposed 
stress testing methodology is a scenario-based risk factor model with 
the following principal elements. First, a set of risk drivers are 
selected based on the portfolio exposures of all Clearing Member Groups 
in the aggregate. Second, each individual underlying security contained 
in the portfolio of a Clearing Member Group (each a ``risk factor'') is 
mapped to a risk driver, and the sensitivity or ``beta'' of the 
security with respect to the corresponding risk driver is estimated 
(i.e., the sensitivity of the price of the security relative to the 
price of the risk driver). Third, a set of stress scenarios is 
generated by assigning a stress shock to each of the risk drivers, with 
the shocks of an individual underlying security or risk factor 
determined by the shock of its risk driver and its sensitivity (or 
beta) to the risk driver. Fourth, for each of the stress scenarios, the 
risk exposure or shortfall of each portfolio of a Clearing Member is 
calculated and aggregated at the Clearing Member Group level.
    Under the proposed stress testing methodology, each individual 
underlying security in the Clearing Members' portfolios is represented 
by a risk factor (such as Google, IBM, Standard & Poor's Depositary 
Receipts (``SPDR''), S&P 500 Exchange Traded Funds (``SPY''), etc.). 
The number of risk factors is typically in the thousands. Because the 
vast amount of OCC's products are equity based, the risk drivers 
comprise a small set of underlying securities or market indices (e.g., 
Cboe S&P 500 Index (``SPX''), or the VIX) that are used to represent 
the main sources or drivers for the price changes of the risk factors. 
Other relevant risk drivers are included to cover U.S. and Canadian 
Government Security collateral positions, as well as commodity based 
exchange-traded funds (``ETFs'') and futures products. The risk drivers 
are selected based on the characteristics of the risk factors in the 
Clearing Members' portfolios.
    After the risk drivers are selected, each risk factor would be 
mapped to one risk driver. This mapping allows OCC to simulate 
movements for a large number of risk factors by the movements of a 
smaller number of risk drivers. In general, the mapping depends on the 
type of risk factor. For example, equity price risk factors generally 
are mapped to SPX and volatility risk factors to VIX. Government bond 
risk factors generally would be mapped to either U.S. Dollar (``USD'') 
Treasury yields or Canadian Dollar (``CAD'') government bond yields 
depending on the currency. The Treasury ETFs generally would be mapped 
to one of the Treasury bond ETFs. The commodity products generally 
would be mapped to one of the representative ETFs of the corresponding 
commodity class. All other risk factors initially would be mapped by 
default to SPX.
    Under the proposed Methodology Description, risk drivers and the 
corresponding shocks would be reviewed regularly by OCC's Stress 
Testing Working Group (``STWG''), a cross-departmental team including 
senior officers from FRM, Quantitative Risk Management (``QRM''), Model 
Validation Group (``MVG''), and Enterprise Risk Management. The 
addition of a new risk driver or change in an existing risk driver 
would most likely be driven by a change in OCC's product exposure or by 
other changes in the market. Changes to risk drivers would be reviewed 
and approved by the STWG. QRM would recalibrate scenario shocks at 
least annually. In addition, on a quarterly basis (or more frequently 
if QRM or STWG determines that updates are necessary to capture 
significant market events in a timely fashion), QRM would recalibrate 
the risk driver shocks and report those results to the STWG who would 
review and approve any updates to the risk driver shocks.
    To simulate a stressed market scenario, OCC would construct two 
kinds of scenarios, namely Hypothetical Scenarios (including 
statistically derived scenarios) and Historical Scenarios. Hypothetical 
Scenarios constructed using statistical methods

[[Page 28023]]

would be based on various quantiles of the fitted distribution of the 
log returns of the main risk driver (e.g., SPX). Historical Scenarios 
on the other hand would be created using historic price moves for the 
risk factors on a given date where the scenario is defined. Additional 
details on the proposed stress testing model by asset class are 
discussed below.
(i). Equity Risk Drivers and Shocks
    Under the proposed methodology, price shocks used for equity 
instruments in the statistically-derived Hypothetical Scenarios would 
be based on the quantiles of fitted statistical distributions of the 2-
day returns of the risk driver (e.g., a 1-in-80 year event SPX down 
shock). For example, as noted above, OCC uses the SPX as a risk driver 
for equity price moves. OCC would construct the majority of its 
Hypothetical Scenarios by fitting an appropriate statistical 
distribution to SPX returns. OCC would construct a historical dataset 
of SPX 2-day log returns dating back to 1957,\26\ to characterize its 
fat-tailed \27\ and asymmetric distribution. In order to reduce pro-
cyclicality in Clearing Fund sizing and also to represent betas in a 
stressed market, OCC would shock risk factors using (1) a historical 
beta and (2) a beta equal to 1. The portfolio level profit and loss 
would be calculated with both betas separately for each Hypothetical 
Scenario, and OCC would use the calculation yielding the worst of the 
two outcomes in the subsequent Clearing Fund sizing.
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    \26\ OCC would extend this dataset from March 1957 to the 
present if OCC determines that price shocks need to be re-
calibrated. As a general matter, OCC has established this look-back 
period primarily on the basis of the quality of available data. The 
SPX, in its current form, dates back to 1957, and OCC therefore uses 
all of the index's data since that date. Furthermore, based on OCC's 
analysis of various observation windows dating back to the Great 
Depression, OCC has observed that the price shocks vary with the 
different periods used in the calibration. OCC's decision to use the 
entire history of the SPX is based on its desire to minimize the 
effects associated with a pre-defined observation window, and to 
avoid the subjective determination of higher or lower periods of 
volatility or the sudden exclusion of dates that fall outside of a 
fixed look back period. As noted above, QRM would recalibrate the 
risk driver shocks on a quarterly basis and report those results to 
the STWG who would review and approve any updates to the risk driver 
shocks.
    \27\ 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.
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    The proposed Methodology Description would describe in detail OCC's 
proposed methodology for calculating price shocks for equity 
instruments, including leveraged products and any underlying baskets.
(ii). Volatility Shock Model
    As noted above, under the proposed methodology, OCC would use the 
VIX as the key risk driver for volatility shocks in its proposed stress 
testing model. The VIX is a measure of the one-month implied volatility 
\28\ of the SPX, which represents the market's expectation of stock 
market volatility over the next 30-day period. For risk factors with 
SPX as their risk driver, implied volatility shocks would be modeled 
from SPX implied volatility shocks and the price beta of the risk 
factor.\29\ For non-SPX driven risk factors, the implied volatility 
shock would be based on historical volatility beta regressed directly 
against the VIX. Accordingly, the proposed Methodology Description 
would describe in detail OCC's proposed methodology for calibrating VIX 
shocks, including those risk factors with SPX as the key risk driver, 
those risk factors with a non-SPX risk driver, and implied volatilities 
of any underlying baskets.
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    \28\ Generally speaking, the implied volatility of an option is 
a measure of the expected future volatility of the value of the 
option's annualized standard deviation of the price of the 
underlying security, index, or future at exercise, which is 
reflected in the current option premium in the market. Using the 
Black-Scholes options pricing model, the implied volatility is the 
standard deviation of the underlying asset price necessary to arrive 
at the market price of an option of a given strike, time to 
maturity, underlying asset price and given the current risk-free 
rate. In effect, the implied volatility is responsible for that 
portion of the premium that cannot be explained by the then-current 
intrinsic value (i.e., the difference between the price of the 
underlying and the exercise price of the option) of the option, 
discounted to reflect its time value.
    \29\ For defined Historical Scenarios, the implied volatility 
shock leverages a beta based on the ratio of the risk factor price 
shock to the SPX price shock.
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(iii). Price Shock Models for Other Instruments
    OCC's proposed Methodology Description also would describe OCC's 
proposed approach to modeling price shocks for fixed income instruments 
and futures products. Specifically, the Methodology Description would 
discuss OCC's proposed approach for modeling foreign exchange currency 
shocks and yield curve shocks, which are used to shock U.S. Treasury 
bonds and Canadian government bonds held as collateral. The Methodology 
Description would also cover price and volatility shocks for commodity/
energy products. The price shock model for commodity/energy products is 
the same as that for equity class drivers and the volatility shock 
model used for options on commodities is the same as that for non-SPX 
driven risk factors.
b. Stress Testing Scenario Construction
    OCC proposes to construct Hypothetical and Historical scenarios 
using two different methodologies: a statistical methodology and a 
historical/defined shock methodology. Each of these approaches is 
discussed in further detail below.
(i). Hypothetical Scenarios
    Under the proposed methodology, price shocks determined in the 
statistically-derived Hypothetical Scenarios would be based on the 
quantiles of fitted statistical distributions of the 2-day log returns 
of the risk driver. For example, Adequacy Scenarios would be based on 
the generated statistical down and up shocks for the SPX from a 1-in-50 
year market event. On the other hand, Sizing Scenarios would be based 
on the generated statistical down and up shocks for the SPX from a 1-
in-80 year market event. Specifically, OCC would use four Hypothetical 
Scenarios to guide the sizing of the Clearing Fund: (1) A 1-in-80 year 
market rally using a historical beta; (2) a 1-in-80 year market rally 
using a beta equal to 1; (3) a 1-in-80 year market decline using a 
historical beta; and (4) a 1-in-80 year market decline using a beta 
equal to 1.
    Not all Statistical Scenarios would be generated using fitted 
distributions, however. For example, the Statistical Scenarios for 
interest rates are based on the ``Principal Component Analysis'' 
methods (a commonly used statistical method to analyze the movements of 
yield curves of Treasury bonds), while the Statistical Scenarios for 
commodity ETFs would be based on the empirical price changes.
    The proposed Methodology Description would describe how OCC would 
calibrate price and volatility shocks for equities, fixed income 
products, and commodity/energy products in its Hypothetical Scenarios.
(ii). Historical Scenarios
    OCC would construct Historical Scenarios using historically 
accurate price moves for risk factors on a given date, provided the 
underlying securities were available on the date for which the scenario 
is defined. Historical Scenarios, which are based on significant market 
events, would allow OCC to analyze how current portfolios would perform 
if a historical event were to occur again. Because not all of the 
securities or risk factors in current portfolios existed on past 
scenario dates, OCC has developed methodologies to approximate the past 
price and volatility movements of such risk

[[Page 28024]]

factors. Under the proposed methodology, a technique known as 
``Survival Method Pricing'' would be used to backfill missing 
historical shocks. In the backfill technique, the observable 2-day 
returns of all risk factors would be averaged by industry sectors, and 
these sector averages would then be used to backfill the missing price 
returns of the securities (for example, Facebook stock would use the 
technology sector average under a 2008 Historical Scenario).\30\
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    \30\ With respect to volatility risk driver shocks, the exact 
volatility scenarios for a historical event may often be overridden 
by VIX shocks generated using OCC's dynamic VIX calibration process 
because: (1) The historical volatility data is not available; and 
(2) even when the data is available, the sizes of the exact 
historical moves are too low to generate any realistic losses.
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c. Clearing Fund Sizing and Stress Testing
    Under the proposed methodology, OCC would perform daily stress 
testing using a wide range of scenarios, both Hypothetical and 
Historical, designed to serve multiple purposes. Specifically, OCC's 
proposed stress testing inventory would contain scenarios designed to: 
(1) Determine whether the financial resources collected from all 
Clearing Members collectively are adequate to cover OCC's risk 
tolerance; (2) establish the monthly size of the Clearing Fund; (3) 
measure the exposure of the Clearing Fund to the portfolios of 
individual Clearing Member Groups, and determine whether any such 
exposure is sufficiently large as to necessitate OCC calling for 
additional resources so that OCC continues to maintain sufficient 
financial resources to guard against potential losses under a wide 
range of stress scenarios, including extreme but plausible market 
conditions; and (4) monitor and assess the size of OCC's Pre-Funded 
Financial Resources against a wide range of stress scenarios that may 
include extreme but implausible and reverse stress testing scenarios. 
Each of these categories of stress tests is discussed in further detail 
below.
(i). Adequacy Stress Tests
    Under the proposed Policy and Methodology Description, on a daily 
basis, OCC would perform a set of Adequacy Stress Tests designed to 
determine whether the financial resources collected from all Clearing 
Members collectively are adequate to cover OCC's risk tolerance (and 
other specified scenarios as may be approved by the Risk Committee) 
(i.e., Adequacy Scenarios). The performance of these Adequacy Stress 
Tests would allow OCC to assess the size of its Clearing Fund against 
its risk tolerance; however, Adequacy Stress Tests would not drive 
calls for additional financial resources. Adequacy Scenarios would 
include, at a minimum, scenarios reflecting OCC's proposed risk 
tolerance, which corresponds to a Clearing Fund size that would cover a 
1-in-50 year market event on a Cover 2 Standard. Adequacy Stress Tests 
should demonstrate that OCC maintains sufficient Pre-Funded Financial 
resources to cover all Adequacy Scenarios at a 99.5% coverage level 
over a two-year look back period.
(ii). Sizing Stress Tests
    Under the proposed Policy and Methodology Description, FRM would 
determine the monthly Clearing Fund size based on the results of Sizing 
Stress Tests conducted daily using standard predetermined parameters 
and assumptions. Specifically, OCC would use Sizing Stress Tests to 
project the Clearing Fund size necessary for OCC to maintain sufficient 
Pre-Funded Financial Resources to cover losses arising from the default 
of the two Clearing Member Groups that would potentially cause the 
largest aggregate credit exposure to OCC as a result of a 1-in-80 year 
hypothetical market event, which OCC believes would provide sufficient 
coverage of OCC's 1-in-50 year event risk tolerance (and any other 
Adequacy Scenarios as may be approved by the Risk Committee) and to 
guard against intra-month scenario volatility and procyclicality.\31\
---------------------------------------------------------------------------

    \31\ In addition, OCC proposes conforming changes to delete 
Interpretation and Policy .02 of Rule 1001, which concerns the 
minimum confidence level used to size the Clearing Fund, as the 
confidence level used to size the Clearing Fund would now be 
addressed in the Policy and Methodology Description.
---------------------------------------------------------------------------

    Under existing Rule 1001(a), OCC's Clearing Fund size determination 
is based on the peak five-day rolling average of its Clearing Fund 
sizing calculations observed over the preceding three calendar months 
plus a prudential margin of safety. As described in the proposed Policy 
and Methodology Description, OCC would continue to determine the 
Clearing Fund size for a given month by using a peak five-day rolling 
average of the Sizing Stress Test results over the prior three months 
but, as noted above, would no longer require a prudential margin of 
safety.\32\ OCC believes that sizing the Clearing Fund at a more 
conservative 1-in-80 year market event scenario (over the proposed 1-
in-50 year risk tolerance) would help to reduce volatility in its 
Clearing Fund sizing methodology and ensure that OCC continues to 
maintain sufficient resources in the event of large peaks and volatile 
markets, thereby providing a similar anti-procyclical buffer to the 
current prudential margin of safety.
---------------------------------------------------------------------------

    \32\ See supra note 21.
---------------------------------------------------------------------------

    In addition, under the proposed Policy, the minimum size of the 
Clearing Fund would continue to be set in accordance with OCC's minimum 
liquidity resources to equal 110% of OCC's committed liquidity 
facilities plus OCC's Cash Clearing Fund Requirement. However, if a 
temporary increase to the Cash Clearing Fund Requirement is made 
pursuant to OCC's Rules, the Executive Chairman, Chief Administrative 
Officer, or Chief Operating Officer would be authorized to determine 
whether such an increase should result in an increase in the minimum 
size of the Clearing Fund (which is tied to, in part, OCC's Cash 
Clearing Fund Requirement).
    OCC also proposes to introduce some anti-procyclical measures for 
its monthly sizing process, which are discussed in Section 6 below.
(iii). Sufficiency Stress Tests
    On a daily basis, OCC would run a set of Sufficiency Stress Tests 
to measure the exposure of the Clearing Fund to the portfolios of 
individual Clearing Member Groups and determine whether any such 
exposure is sufficiently large as to necessitate OCC calling for 
additional resources (1) from that individual Clearing Member Group (or 
Groups) in the form of margin or (2) from Clearing Members generally 
through an intra-month resizing of the Clearing Fund. OCC initially 
expects to implement a set of historically-based Sufficiency Scenarios 
that would include, among others, the worst two-day price moves, up and 
down, during the 2008 financial crisis, which constitute the two most 
extreme two-day price moves observed in the entire history of SPX with 
the exception of the 1987 market crash, to be covered on a Cover 2 
basis. OCC also would include as a Sufficiency Scenario a historical 
October 1987 market crash event to be covered on a Cover 1 basis.
    Under the proposed Sufficiency Stress Tests, the largest Clearing 
Fund Draw from each Sufficiency Scenario shall be compared against the 
Clearing Fund size on a daily basis to assess whether OCC maintains 
sufficient financial resources to cover the stress scenario. If a 
Sufficiency Stress Test indicates that a Clearing Fund Draw would 
breach certain established thresholds, OCC would initiate (depending on 
the threshold breached) the process of (1) conducting additional 
monitoring, (2)

[[Page 28025]]

collecting additional margin from the specific Clearing Member Group 
(or Groups) causing the breach, or (3) in extreme cases, resizing the 
Clearing Fund. Such thresholds have been designed to ensure that OCC's 
Pre-Funded Financial Resources would remain sufficient to cover losses 
that may be incurred by its largest one or two Clearing Member Groups, 
depending on the scenario in question. Each proposed threshold is set 
forth below, and included with each threshold are mitigating actions 
that OCC would take in the event of a breach of the threshold.
(1). Enhanced Monitoring
    Under the proposed Policy, in the event that Sufficiency Stress 
Tests identify a Clearing Fund Draw for one or two Clearing Member 
Groups that causes the largest aggregate credit exposure to OCC to 
exceed 65% of the current Clearing Fund requirement less deficits, but 
that does not breach a Sufficiency Stress Test Threshold (as defined 
below), FRM would promptly conduct enhanced monitoring and notify the 
relevant Clearing Member Group (or Groups) that they are approaching a 
margin call threshold in accordance with internal OCC procedures.\33\
---------------------------------------------------------------------------

    \33\ OCC notes that it performs a similar enhanced monitoring 
process under its current FRMC Procedure when Idiosyncratic Clearing 
Fund Draws exceed 65% of the Clearing Fund currently in effect.
---------------------------------------------------------------------------

(2). Sufficiency Stress Test Threshold 1--Intra-Day Margin Calls
    OCC proposes to amend Rule 609 to provide that, in addition to its 
existing authority to require intra-day margin deposits, OCC may 
require additional margin deposits if a Sufficiency Stress Test 
identifies a breach that exceeds 75% of the current Clearing Fund 
requirement less deficits (the ``75% threshold'' or ``Sufficiency 
Stress Test Threshold 1''). The proposed change is designed to ensure 
that OCC continues to maintain sufficient Pre-Funded Financial 
Resources to cover its largest one or two Clearing Member Group 
exposures under a wide range of stress scenarios, including extreme but 
plausible scenarios, where one of the proposed Sufficiency Stress Test 
scenarios identifies a potential breach in OCC's Clearing Fund size. In 
the event of a breach of the 75% threshold, OCC would initially 
collateralize this potential stress exposure by collecting margin from 
the Clearing Member Group(s) driving the breach.
    Pursuant to the proposed Policy and Methodology Description, if a 
Sufficiency Stress Test identifies a Clearing Fund Draw for any one or 
two Clearing Member Groups that exceeds Sufficiency Stress Test 
Threshold 1, OCC would be authorized to issue a margin call against the 
Clearing Member Group(s) and/or Clearing Member(s) causing the breach 
in accordance with Rule 609. In the case of Cover 1 Sufficiency 
Scenarios (e.g., the historical Cover 1 1987 scenario), the amount of 
the margin call for a Clearing Member Group would be equal to the 
excess of such Clearing Member Group's projected Clearing Fund Draw 
over the 75% threshold. In the case of Cover 2 Sufficiency Scenarios 
(e.g., a historical Cover 2 2008 market event scenario) the total 
amount of the margin call shall be equal to the excess of the Cover 2 
Clearing Fund Draw over the 75% threshold.\34\ In the event a Clearing 
Member Group's Clearing Fund Draws exceed the 75% threshold in more 
than one Sufficiency Scenario, the Clearing Member Group would be 
subject to the largest margin call resulting from scenarios. Margin 
calls would be allocated to Clearing Members and related accounts 
within the Clearing Member Group in accordance with OCC procedures.\35\
---------------------------------------------------------------------------

    \34\ In the event only one Clearing Member Group's Clearing Fund 
Draw exceeds 50% of Sufficiency Stress Test Threshold 1, that 
Clearing Member Group would pay the entire call. In the event both 
Clearing Member Groups' Clearing Fund Draws exceed 50% of 
Sufficiency Stress Test Threshold 1, both Clearing Member Groups 
would pay an amount equal to the excess of their respective Clearing 
Fund Draw over 50% of the Sufficiency Stress Test threshold.
    \35\ OCC notes that under the current FRMC Procedure, in the 
event that FRM observes a scenario where the Idiosyncratic Clearing 
Fund Draw exceeds 75% of the Clearing Fund, an intra-day margin call 
would be issued against the Clearing Member or Clearing Member Group 
that caused such a draw, with the amount of the margin call being 
the difference between the projected draw and the ``base amount.'' 
See supra note 10 and accompanying text.
---------------------------------------------------------------------------

    All margin calls would be required to be approved by a Vice 
President (or higher) of FRM and would remain in effect until the 
collection of additional funds associated with the next monthly 
resizing of the Clearing Fund, after which the margin call would be (1) 
released or (2) recalculated based on the current Clearing Fund 
Draw.\36\ If the margin call imposed on an individual Clearing Member 
exceeds $500 million, OCC's Stress Testing and Liquidity Risk 
Management group (``STLRM'') would provide written notification to the 
Executive Chairman and Chief Executive Officer, President and Chief 
Operating Officer, and Chief Administrative Officer (collectively 
referred to as the ``Office of the Chief Executive Officer'' or 
``OCEO'').\37\ If the margin call imposed on an individual Clearing 
Member would exceed 100% an individual Clearing Member's net capital, 
the issue would be escalated to the OCEO, and each of the Executive 
Chairman, Chief Administrative Officer, and Chief Operating Officer 
would have the authority to determine whether OCC should continue 
calling for additional margin in excess of this amount. OCC believes 
that this notification and escalation process would enable OCC to 
appropriately require those Clearing Members that bring elevated risk 
exposures to OCC to bear the costs of those risks in the form of margin 
charges while also allowing OCC to take into consideration a particular 
Clearing Member's ability to meet the call based on its financial 
condition, and the amount of collateral it has available to pledge when 
certain pre-identified thresholds have been exceeded.
---------------------------------------------------------------------------

    \36\ OCC notes that, under the current FRMC Procedure, for the 
days prior to the collection of any Clearing Fund payments due that 
result from the re-sizing of the Clearing Fund on the first business 
day of the month, both the base Clearing Fund requirement and the 
Clearing Fund in effect are further reduced by any outstanding 
deficits. The proposed changes would clarify that upon the 
collection of funds to satisfy such deficits, any margin calls would 
be (1) released or (2) recalculated based on the current Clearing 
Fund Draw.
    \37\ OCC notes that, under its current FRMC Procedure, margin 
calls may be subject to a per-Clearing Member cap equal to the 
lesser of $500 million or 100% of such Clearing Member's net 
capital; however, OCC's management retains discretion under the FRMC 
Procedure to call for additional margin beyond those amounts with 
certain reporting requirements when these caps are exceeded. Under 
the proposed Policy, these thresholds would no longer be 
characterized as ``caps'' and there would no longer be a requirement 
for reporting to OCC's Management Committee and Risk Committee as 
the $500 million threshold would no longer function as a cap and the 
100% of net capital threshold would now require escalation to the 
OCEO for approval of further margin calls. OCC believes the proposed 
changes to the reporting and approval process are appropriate given 
that (1) OCC management (typically an officer of OCEO) currently has 
discretion to waive any margin call caps, (2) under the proposal, 
these thresholds would no longer be characterized as caps and 
therefore there would be an assumption that OCC would call for 
margin in excess of these thresholds, (3) since the adoption of 
OCC's current FRMC Procedure, OCC has gained comfort in its Clearing 
Members' ability to meet and maintain margin calls in excess of 
these thresholds and (4) OCEO would retain the ability to notify or 
escalate an issue to the Risk Committee if they determine such 
actions are necessary.
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(3). Sufficiency Stress Test Threshold 2--Intra-Month Clearing Fund 
Resizing
    Under proposed Rule 1001(c) (and as described in the proposed 
Policy and Methodology Description), if a Sufficiency Stress Test were 
to identify a Clearing Fund Draw for any one or two Clearing Member 
Groups that exceed 90% of the current Clearing

[[Page 28026]]

Fund size (after subtracting any monies deposited as a result of a 
margin call in accordance with a breach of Sufficiency Stress Test 
Threshold 1), OCC would effect an intra-month resizing of the Clearing 
Fund to ensure that OCC continues to maintain sufficient Pre-Funded 
Financial Resources to cover its exposures under a wide range of stress 
scenarios, including extreme but plausible market conditions. The 
amount of such an increase would be the greater of: (1) $1 billion or 
(2) 125% of the difference between the projected draw under the 
Sufficiency Stress Test (less any monies deposited pursuant to a margin 
call resulting from a breach of Sufficiency Stress Test Threshold 1) 
and the current Clearing Fund size. Each Clearing Member's 
proportionate share of the increase would be based on its proportionate 
share of the Clearing Fund as determined pursuant to proposed Rule 
1003(a), with the exception of those Clearing Members subject to the 
minimum contribution amount. OCC's Executive Chairman, Chief 
Administrative Officer or Chief Operating Officer would be responsible 
for reviewing and approving any intra-month increase to the size of the 
Clearing Fund based on a breach of Sufficiency Stress Test Threshold 2 
prior to implementation, and any such intra-month increase due to a 
breach of Sufficiency Stress Test Threshold 2 would remain in effect 
for any sizing calculations performed during the three month period 
subsequent to the intra-month increase to ensure that OCC continues to 
maintain sufficient financial resources to cover its credit exposures 
during that time.
    In addition to intra-month resizing based on Sufficiency Stress 
Testing, OCC proposes to include additional authority in proposed Rule 
1001(d) to provide the Risk Committee, or each of the Executive 
Chairman, Chief Administrative Officer, or Chief Operating Officer, 
upon notice to the Risk Committee, with the authority to increase the 
size of the Clearing Fund at any time for the protection of OCC, 
Clearing Members or the general public. Any determination by the 
Executive Chairman, Chief Administrative Officer, or Chief Operating 
Officer to implement a temporary increase in Clearing Fund size would 
(1) be based upon then-existing facts and circumstances, (2) be in 
furtherance of the integrity of OCC and the stability of the financial 
system, and (3) take into consideration the legitimate interests of 
Clearing Members and market participants. Under the proposed Policy, 
any temporary increase in Clearing Fund size would be reviewed by the 
Risk Committee at its next regularly scheduled meeting, or as soon as 
otherwise practical, and, if such temporary increase is still in effect 
at the time of that meeting, the Risk Committee would determine whether 
(1) the increase in Clearing Fund size is no longer required or (2) the 
Clearing Fund sizing methodology should be modified to ensure that OCC 
continues to maintain sufficient Pre-Funded Financial Resources to 
cover its established risk tolerance.\38\
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    \38\ In the event that the Risk Committee would determine to 
permanently increase or change the methodology used to size the 
Clearing Fund, OCC would initiate any regulatory approval process 
required to effect such a change in Clearing Fund size. However, OCC 
would not decrease the size of its Clearing Fund while the 
regulatory approvals for such permanent increase are being obtained 
to ensure that OCC continues to maintain sufficient financial 
resources during that time.
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(iv). Informational Stress Tests
    Under the proposed Policy and Methodology Description, OCC would 
run a variety of stress tests for informational purposes (i.e., 
Informational Stress Tests) to monitor and assess the size of OCC's 
Pre-Funded Financial Resources against other stress scenarios. The 
Informational Stress Tests could be comprised of a number of Historical 
and Hypothetical scenarios, which may include extreme but implausible 
scenarios and reverse stress test scenarios (i.e., ``Informational 
Scenarios''). Informational Scenarios would not directly drive the size 
of the Clearing Fund or calls for additional margin; however, they 
would be an important risk monitoring tool that OCC would use to 
evaluate the appropriateness of its Adequacy, Sizing, and Sufficiency 
Scenarios and perform risk escalations and evaluations.
    OCC would continually evaluate its inventory of Informational 
Scenarios and could add additional Informational Scenarios, as needed, 
to ensure that it understands the limits of its Pre-Funded Financial 
Resources. Scenarios may later be reclassified as a different scenario 
type with the approval of OCC's Risk Committee. For instance, a new 
scenario would typically be introduced as an Informational Scenario, 
but later may be elevated to a Sizing or Sufficiency Scenario.
5. Clearing Fund and Stress Testing Governance, Monitoring and Review
    The proposed Policy would establish governance, monitoring and 
review requirements for OCC's Clearing Fund and stress testing 
methodology. On a daily basis, STLRM would monitor the results of all 
of the Adequacy and Sufficiency Stress Tests, including whether the 
Adequacy Stress Test demonstrates that OCC maintains Pre-Funded 
Financial Resources above OCC's Adequacy Scenarios, in accordance with 
internal OCC procedures. Under the proposed Policy, STLRM or the 
Executive Vice President of FRM (``EVP-FRM'') would immediately 
escalate any material issues identified with respect to the adequacy of 
OCC's financial resources to the STWG (provided that STWG review is 
practical under the circumstances) and the Management Committee to 
determine if it would be appropriate to recommend a change to the 
Hypothetical Scenarios used to size the Clearing Fund in accordance 
with applicable OCC procedures.
    Under the proposed Policy, on a monthly basis, STLRM would prepare 
reports that provide details and trend analysis of daily stress tests 
with respect to the Clearing Fund, including the results of daily 
Adequacy Stress Tests, Sizing Stress Tests and Sufficiency Stress Tests 
and review the adequacy of OCC's financial resources in accordance with 
internal procedures. On a monthly basis, STWG would perform a 
comprehensive analysis of these stress testing results, as well as 
information related to the scenarios, models, parameters, and 
assumptions impacting the sizing of the Clearing Fund. Pursuant to this 
review, STWG would consider, and may recommend at its discretion, 
modifications to OCC's stress test scenario inventory and models for 
financial resources (including the creation and/or retirement of stress 
test scenarios, the reclassification of stress test scenarios, and/or 
modifications to the stress test scenarios' underlying parameters and 
assumptions), as well as related Policies and Procedures, to ensure 
their appropriateness for determining OCC's required level of financial 
resources in light of current and evolving market conditions, and as 
pursuant to the related Procedures established for this purpose. The 
reviews would be conducted more frequently than monthly when the 
products cleared or markets served display high volatility or become 
less liquid; the size or concentration of positions held by OCC's 
participants increases significantly; or as otherwise appropriate. The 
Policy would require that OCC maintain procedures for determining 
whether, and in what circumstances, such intra-month reviews shall be 
conducted, and would indicate the persons responsible for making the 
determination.
    Pursuant to the proposed Policy, STLRM would report the results of 
stress tests and its monthly analysis to

[[Page 28027]]

OCC's Management Committee and Risk Committee on at least a monthly 
basis and would maintain procedures for determining whether, and in 
what circumstances, the results of stress tests must be reported to the 
Management Committee or the Risk Committee more frequently than 
monthly, and would indicate the persons responsible for making the 
determination. In the performance of monthly review of stress testing 
results and analysis and considering whether escalation is appropriate, 
due consideration would be given to the intended purpose of the 
proposed Policy to: (1) Assess the adequacy of, and adjust as 
necessary, OCC's total amount of financial resources; (2) support 
compliance with the minimum financial resources requirements under 
applicable regulations; and (3) evaluate the adequacy of, and recommend 
adjustments to OCC's margin methodology, margin parameters, models used 
to generate margin or guaranty fund requirements, and any other 
relevant aspects of OCC's credit risk management.
    Under the proposed Policy, OCC's Model Validation Group would be 
required to perform a model validation of OCC's Clearing Fund model on 
an annual basis, and the Risk Committee would be responsible for 
reviewing the model validation report. The Risk Committee would also be 
required to review and approve the Policy on an annual basis.
    Under the proposed Policy, stress test inventories would be 
maintained by STLRM, and the STWG would be required to review and 
approve or recommend changes to stress test inventories recommended by 
STLRM staff in accordance with STWG procedures. The STWG would meet at 
least monthly and approve or recommend approval of changes to the 
inventory in accordance with the stress test procedures. The approval 
authority for such changes would be as follows:
     Informational Stress Tests--The STWG may approve the 
creation or retirement of Informational Stress Tests; and
     Sizing, Sufficiency, and Adequacy Stress Tests--The STWG 
may recommend approval to the Management Committee (however, if timing 
considerations make such recommendation to the Management Committee 
impracticable, then STWG would make its recommendation to the OCEO) and 
the Risk Committee the creation or retirement of Adequacy, Sizing, or 
Sufficiency Stress Tests.
    Pursuant to the proposed Policy, any request for an exception to 
the Policy must be made in writing to a member of the OCEO, who would 
then be responsible for reviewing the exception request and providing a 
decision in writing to the person requesting the exception. All 
requests for exceptions and their dispositions would be reported to the 
Board or Risk Committee no later than its next regularly scheduled 
meeting, in a format approved by the Chair of the Board or Risk 
Committee. Finally, the Policy would require that violations of the 
Policy be reported to the Policy owner and OCC's Chief Compliance 
Officer.
6. Limitations on Reduction in Monthly Clearing Fund Size
    OCC also proposes to adopt rules imposing certain anti-procyclical 
measures for its monthly Clearing Fund sizing process. Under proposed 
Rule 1001(a), the size of the Clearing Fund would not be permitted to 
decrease more than 5% from month-to-month to avoid pro-cyclicality. 
This limitation, which is also reflected in the proposed Policy and 
Methodology Description, is designed to promote stability and to 
prevent the Clearing Fund from decreasing rapidly when a previous peak 
falls out of the look-back period.
    In addition, if the results of a daily Sufficiency Stress Test over 
the final five business days preceding the monthly Clearing Fund sizing 
exceed 90% of the projected Clearing Fund size for the upcoming month, 
the Clearing Fund size must be set such that the peak Sufficiency 
Stress Test draw is no greater than 90% of the Clearing Fund size. The 
proposed change is designed to reduce the likelihood that the Clearing 
Fund would be set at a size such that a Clearing Member Group with 
stress test exposures that are trending upward at the end of the sizing 
period would exceed the threshold for an intra-month resize immediately 
following the decline.
7. Clearing Fund Contribution Allocations
a. Proposed Changes to Initial Contributions
    Pursuant to existing Article VIII, Section 2 of the By-Laws, the 
minimum initial Clearing Fund contribution of each newly admitted 
Clearing Member is set at an amount equal to at least $150,000, which 
is also equal to OCC's minimum ``fixed'' contribution amount (discussed 
in detail below). Under proposed Rule 1002(d), which is based on 
existing Article VIII, Section 2(a), OCC would increase the initial 
Clearing Fund contribution amount to $500,000. OCC's existing minimum 
contribution requirements have been in place since June 5, 2000,\39\ 
and as a result, OCC undertook an analysis to determine the 
appropriateness of this amount given the passage of time. As part of 
this analysis, OCC considered a number of factors such as the potential 
impact on Clearing Members that are at the minimum or otherwise below 
or just over the newly proposed $500,000 requirement, the impact to 
those members in dollar and percentage terms as well as compared to 
their net capital, evolving market conditions, evolution in the size of 
the Clearing Fund, minimum contribution requirements of other CCPs, and 
heightened regulatory obligations on OCC given its status as a 
systemically important financial market utility. For example, OCC notes 
that the minimum initial (and fixed) contribution requirement has 
remained static over time while the Clearing Fund has grown from 
approximately $2 billion in 2000 to several multiples of that, both 
currently and under the proposed changes described herein. 
Additionally, OCC reviewed the contribution requirements of other CCPs 
and noted that they were well in excess of OCC's current minimum 
contribution requirement (and in several cases, would be in excess of 
the newly proposed minimum amount).\40\ OCC also performed an analysis 
of Clearing Members that had a Clearing Fund contribution requirement 
larger than the current minimum requirement of $150,000 but less than 
or equal to the proposed requirement of $500,000.\41\ OCC also reviewed 
the impact of this change and discussed it with potentially impacted 
Clearing Members firm, the majority of which did not express concerns 
over the proposed increase. As a result of this analysis, OCC

[[Page 28028]]

determined $500,000 would be the appropriate initial and minimum 
Clearing Fund contribution amount required to maintain membership at 
OCC. Consistent with existing authority, OCC's Risk Committee would 
also be able to fix a different initial contribution amount with regard 
to any new Clearing Member at the time its application is approved. In 
either case, the initial contribution amount would remain in effect for 
not more than three months after the admission of the relevant Clearing 
Member. After that time, or at an earlier time as may be determined by 
the Risk Committee, the Clearing Member's contribution amount would 
instead be determined using the allocated contribution method in 
proposed Rule 1003. OCC also proposes to clarify in new Rule 1002(d) 
that initial contribution requirements would at all times remain 
subject to the minimum ``fixed amount'' of $500,000 under proposed Rule 
1003 and to adjustments by OCC under Rule 1004.
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    \39\ On June 5, 2000, the Commission approved a proposed rule 
change by OCC to merge the equity and non-equity elements of its 
Clearing Fund into a combined Clearing Fund with a minimum 
contribution requirement of $150,000. See Securities Exchange Act 
Release No. 42897 (June 5, 2000), 65 FR 36750 (June 9, 2000) (SR-
OCC-99-9). OCC notes that, as a practical matter, the $150,000 
minimum contribution amount dates back prior to June 2000 for the 
majority of its Clearing Members as most members already contributed 
to both the equity and non-equity elements of the Clearing Fund and 
were subject to a $75,000 minimum contribution for each element 
prior to the June 2000 rule change.
    \40\ For example, at the time of OCC's analysis, ICE Clear US 
had a minimum contribution requirement of $2,000,000 and CME had 
minimum contribution requirements of $500,000 for exchange listed 
futures and options and $2.5 million for OTC products covered in its 
Base Guaranty Fund.
    \41\ Based on this analysis, OCC determined that there are 
currently eleven Clearing Members either subject to the minimum 
Clearing Fund contribution requirement of $150,000 or below the 
proposed $500,000 requirement that would be impacted by the 
proposal.
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b. Proposed Changes to Contribution Allocation Methodology
    Current Rule 1001(b) provides, in part, that each Clearing Member's 
monthly contribution requirement is based on a sum of $150,000 (which 
is a fixed amount, equal to the current initial contribution amount) 
plus such Clearing Member's proportionate share of the amount necessary 
for OCC to maintain the total Clearing Fund size required under Rule 
1001(a) (which is a variable amount). OCC proposes to adopt new Rule 
1003(a), which would increase the minimum ``fixed'' contribution amount 
to $500,000, consistent with the proposed increase in the minimum 
initial contribution described above. Specifically, proposed Rule 
1003(a) would provide that each Clearing Member's contribution to the 
Clearing Fund shall equal the sum of (x) $500,000 (a higher ``fixed 
amount,'' equal to the proposed initial contribution amount described 
above) and (y) such Clearing Member's proportionate share of an amount 
sufficient to cause the amount of the Clearing Fund (after taking into 
account each Clearing Member's fixed amount) to be equal to the 
Clearing Fund size determined pursuant to proposed Rule 1001(a) (the 
``variable amount''). The proposed change was determined under the same 
analysis and justification discussed above regarding the proposed 
change in the minimum initial contribution amount (i.e., OCC analyzed 
the potential impact on Clearing Members that are at the minimum fixed 
contribution amount or otherwise below or just over the newly proposed 
$500,000 requirement, the impact to those members in dollar and 
percentage terms as well as compared to their net capital, evolving 
market conditions, evolution in the size of the Clearing Fund, minimum 
contribution requirements of other CCPs, and heightened regulatory 
expectations on OCC given its status as a systemically important 
financial market utility). Collectively, proposed Rules 1002(d) and 
Rule 1003(a) would effectively provide for a new minimum Clearing Fund 
contribution amount of $500,000 per Clearing Member.\42\
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    \42\ OCC notes that the current exception for Futures-Only 
Affiliated Clearing Members in By-Law Article VIII, Section 2 and 
Rule 1001(f) would be retained under proposed Rules 1002(d) and 
1002(f).
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    OCC also proposes to clarify in proposed Rule 1004, in line with 
its current operational practice, that OCC may adjust an individual 
Clearing Member's Clearing Fund contributions due to mergers, 
consolidations, position transfers, business expansions, membership 
approval, or other similar events in order to ensure that Clearing Fund 
allocations are appropriately aligned with the change in risks 
associated with such events (e.g., the increased risk a Clearing Member 
may present after taking on positions of another Clearing Member 
through a merger or position transfer).
8. Allocation Weighting Methodology
    Under existing Rule 1001(b), Clearing Fund contributions are 
allocated among Clearing Members based on a weighted average of each 
Clearing Member's proportionate share of total risk,\43\ open interest, 
and volume in all accounts (including paired X-M accounts) according to 
the following weighting allocation methodology: 35% total risk, 50% 
open interest, and 15% volume. OCC proposes to modify its allocation 
methodology in new Rule 1003 to more closely align Clearing Members' 
Clearing Fund contribution requirements with the level of risk they 
bring to OCC. Specifically, OCC proposes that Clearing Fund 
contribution requirements would be based on an allocation methodology 
of 70% total risk, 15% volume and 15% open interest.\44\ OCC also 
proposes to modify the volume component of the weighting allocation 
methodology to provide that OCC would use cleared volume, as opposed to 
executed volume, to base the allocation on where the position is 
ultimately cleared.\45\
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    \43\ As noted above, ``total risk'' in this context means the 
margin requirement with respect to all accounts of the Clearing 
Member Group exclusive of the net asset value of the positions in 
such accounts aggregated across all such accounts.
    \44\ Under the proposed Policy, this new allocation approach 
would be phased in over a three month period following 
implementation of the proposed changes herein by gradually shifting 
35% of the weighting to total risk from open interest by 10% in the 
first month, 10% in the second month, and 15% in the third month. 
Accordingly, OCC proposes conforming changes to delete 
Interpretation and Policy .03 of Rule 1001, which concerns the 
phase-in of the former allocation methodology, and would no longer 
be required.
    \45\ For both volume and open interest, OCC would adjust stock 
loan shares by a factor of 100 to normalize them with the size of a 
standard option contract. Interpretation and Policy .04 of existing 
Rule 1001, which concerns the calculation used to determine cleared 
contract equivalent units for stock loan and borrow positions, would 
be relocated to Interpretation and Policy .01 of proposed Rule 1003 
without change.
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    In addition, OCC proposes to adopt new Interpretation and Policy 
.02 of Rule 1003, which would be based without material amendment on 
the clauses in paragraphs (d) and (e) of current Rule 1001 that address 
how OTC options are included within the fraction used to compute a 
Clearing Member's proportionate share of open interest and volume, 
respectively. The numerator and denominator in each case would continue 
to include OTC option contracts within the number of open cleared 
contracts of a Clearing Member, with that number of OTC option 
contracts being adjusted to ensure that it is approximately equal to 
the number of options contracts, other than OTC option contracts, that 
would cover the same notional value or units of the same underlying 
interest. OCC believes that placing this aspect of the computation in 
an Interpretation and Policy would enhance the readability of Rule 
1003(b).
    OCC's contribution allocation and associated weighting methodology 
also would be generally described in the proposed Policy and 
Methodology Description documents.
9. Reduction in Time To Fund Deficits
    OCC proposes to adopt new Rule 1005(a), which would address the 
time within which a Clearing Member would generally be required to 
satisfy a deficit in its required Clearing Fund contribution to reduce 
the timeframe during which OCC potentially would be operating with less 
than its required amount of Pre-Funded Financial Resources. As a 
general rule, whenever a report made available by OCC as described in 
proposed Rule 1007 shows a deficit, the applicable Clearing Member(s) 
would be required to satisfy the deficit in a form approved by OCC no 
later than one hour after being notified by OCC of such deficit. 
Examples of deficits that would need to be satisfied by this deadline 
include

[[Page 28029]]

those caused by a decrease in the value of a Clearing Member's 
contribution or by an adjusted contribution pursuant to proposed Rule 
1004. The one-hour deadline would be subject to the application of 
alternative timing requirements specified in Chapter X, such as in the 
case of deficits arising due to regular monthly sizing or an intra-
month resizing (as addressed in proposed Rule 1005(b)), and deficits 
arising due to amendments of OCC's Rules (as addressed in proposed Rule 
1002(e)). Proposed Rule 1004 would also provide OCC with discretion to 
agree to alternative written terms regarding the satisfaction of a 
deficit that would otherwise be governed by the requirements described 
above.
    Proposed Rule 1005(b), which is based on existing Rule 1003 with 
certain modifications, would address deficits arising due to regular 
monthly sizing of the Clearing Fund under proposed Rule 1001(a), as 
well as due to intra-month sizing adjustments under proposed Rule 
1001(c). The proposed provision would reduce the amount of time within 
which a Clearing Member must satisfy a deficit shown on a report made 
available by OCC under Rule 1007 from five business days of the date on 
which the report is made available to two business days of such date. 
OCC believes that this change is appropriate because it would expedite 
adjustment of Clearing Fund contributions to the appropriate size as 
determined by OCC and allow OCC to respond more quickly in rapidly 
changing or emergency market conditions.
    Proposed Rule 1002(e) would address the circumstance in which a 
Clearing Member's contribution is increased as a result of an amendment 
of OCC's Rules. The proposed provision is based on existing By-Law 
Article VIII, Section 2(b), modified, however, to require that such an 
increased contribution be satisfied within two business days of the 
Clearing Member receiving notice of the amendment, rather than within 
five business days of such notice (as is required under current By-Law 
Article VII, Section 2(b)). For the reasons noted above, OCC believes 
that this change is appropriate because it would expedite both the 
effectiveness of the increased contribution requirement (and, 
indirectly, the size of the Clearing Fund) and the actual funding of 
Clearing Member contributions related thereto. Consistent with OCC's 
current requirement, a Clearing Member would not be obligated to make 
such an increased contribution, however, if, before the effective date 
of the relevant amendment, it notifies OCC in writing that it is 
terminating its status as a Clearing Member and closes out or transfers 
all of its open long and short positions. In addition, newly proposed 
Interpretation and Policy .02 of Rule 1002 would clarify that the 
authority of a Clearing Member to terminate its status as such under 
Rule 1006(h) regarding assessments by OCC is separate and distinct from 
the analogous authority under Rule 1002(e) concerning membership 
terminations in connection with an increase in Clearing Fund 
contributions due to a change in OCC's Rules.
    In addition, and consistent with existing operational practice, new 
Rule 1005(c) would establish that, upon the failure of a Clearing 
Member for any reason to timely satisfy a deficit regarding its 
required Clearing Fund contribution, OCC would be authorized to 
withdraw an amount equal to such deficit from the Clearing Member's 
bank account maintained in respect of an OCC firm account. The proposed 
rule change is designed to ensure that OCC is able to obtain funds owed 
from its Clearing Members to satisfy a Clearing Fund deficit in a 
timely fashion so that OCC can continue to meet its overall financial 
resource requirements as stipulated under its rules and by applicable 
regulatory requirements. Any such withdrawn amount would thereafter be 
treated as a cash contribution to the Clearing Fund. The provision 
would also clarify that, if OCC is unable to withdraw an amount equal 
to the deficit, the Clearing Member's failure to satisfy such deficit 
in accordance with OCC's Rules may subject such Clearing Member to 
disciplinary action or suspension, including under Chapters XI and XII 
of OCC's Rules.
    OCC also proposes to specify in proposed Rules 1005(b) and 1002(e) 
that Clearing Members shall have until 9:00 a.m. Central Time on the 
second business day after the issuance of the Clearing Fund Status 
Report to meet their required Clearing Fund contribution if such 
contribution increases as a result of monthly Clearing Fund sizing or 
an intra-month resizing of the Clearing Fund. The proposed change would 
more closely align with the settlement time for the collection of other 
deficits (e.g., the required time for making good any deficiency 
generally under existing Article VIII, Section 6 of the By-Laws or for 
satisfying any margin deficits under Rule 605). The proposed change 
would also be reflected in the proposed Policy.
    Finally, OCC proposes to relocate the substance of current Rule 
1002 (regarding Clearing Fund reports) to proposed Rule 1007, with 
modifications that allow OCC to provide more real-time transparency to 
Clearing Members by mandating more frequent reporting, as well as 
certain modifications to address the intra-month resizing of the 
Clearing Fund. Current Rule 1002 provides that OCC must make available 
to each Clearing Member, within ten days after the close of each 
calendar month, a report that lists the current amount and form of such 
Clearing Member's contribution, the amount of the contribution required 
of such Clearing Member for the current calendar month, and any surplus 
over and above the amount required for the current calendar month. 
Under proposed Rule 1007, OCC would make available each business day 
certain reports listing the current amount and form of each Clearing 
Member's contribution to the Clearing Fund, the current amount of the 
contribution required of such Clearing Member (including the Clearing 
Member's required cash contribution to the Clearing Fund, as discussed 
in more detail in Section 10 below) and any deficit in the Clearing 
Member's contribution or surplus over and above the required amount, as 
applicable. OCC would also issue a report whenever the calculated size 
of the Clearing Fund has changed, whether as the result of regular 
monthly sizing of the Clearing Fund or otherwise.
10. Anti-Procyclicality Measures in OCC's Margin Methodology
    OCC proposes to amend current Rule 601(c), regarding margin 
requirements for accounts other than customers' accounts and firm non-
lien accounts, to clarify in OCC's Rules that OCC's existing 
methodology for calculating margin requirements incorporates measures 
designed to ensure that margin requirements are not lower than those 
that would be calculated using volatility estimated over a historical 
look-back period of at least ten years. The proposed change reflects an 
existing practice in OCC's margin methodology and is intended only to 
provide more clarity and transparency regarding this anti-
procyclicality measure in OCC's Rules.
11. Other Clarifying, Conforming, and Organizational Changes
    OCC also proposes a number of other clarifying, conforming, and 
organizational changes to its By-Laws, Rules, Collateral Risk 
Management Policy, Default Management Policy, and Clearing Fund-related 
procedures in connection with the proposed enhancements to its Pre-
Funded Financial Resources and the relocation

[[Page 28030]]

of OCC's Clearing Fund-related By-Laws into Chapter X of the Rules. 
Specifically, proposed Rules 1006(a)-(c) would address both the purpose 
of the Clearing Fund and the seven conditions under which the Clearing 
Fund generally may be used by OCC to make good certain losses that it 
suffers. The proposed Rule is based on a consolidation of existing 
Article VIII, Section 1(a) (concerning the maintenance and purpose of 
the Clearing Fund) and Section 5(a)-(c) (concerning the application of 
the Clearing Fund) with minor modifications. Accordingly, under 
proposed Rule 1006, and consistent with existing authority, OCC would 
maintain, and be permitted to use, the Clearing Fund to make good 
losses relating to: (1) The failure of a Clearing Member to discharge 
an obligation on or arising from any confirmed trade accepted by OCC; 
(2) the failure of any Clearing Member or the Canadian Depository for 
Securities to perform its obligations under or arising from any 
exercised or assigned option contract or matured future or any other 
contract or obligation issued, undertaken, or guaranteed by OCC or in 
respect of which OCC is otherwise liable; \46\ (3) the failure of any 
Clearing Member in respect of its stock loan or borrow positions to 
perform its obligations to OCC; (4) any liquidation of a Clearing 
Member's open positions; (5) any protective transactions effected for 
OCC's own account under Chapter XI of the Rules regarding the 
suspension of a Clearing Member; (6) the failure of any Clearing Member 
to make any required payment or render any required performance; or (7) 
the failure of any bank or securities or commodities clearing 
organization to perform obligations to OCC under certain conditions as 
set forth in proposed Rule 1006(c).\47\
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    \46\ OCC notes that proposed Rule 1006(a) would contain a minor 
modification to clarify that matured futures contracts are included 
within the scope of other contracts or obligations issued, 
undertaken, or guaranteed by OCC or in respect of which OCC is 
otherwise liable.
    \47\ Existing Interpretation and Policy .01 and .02 of Article 
VIII, Section 5 concerning the share of any deficiency to be borne 
by each Clearing Member as a result of a charge against the Clearing 
Fund would be consolidated and relocated to new Interpretation and 
Policy .01 of Rule 1006 with only minor, non-substantive conforming 
changes and cross-references to new Interpretation and Policy .01 of 
Rule 1006 would be added to proposed Rules 1006(b) and (c) to 
provide additional clarity in OCC's rules.
---------------------------------------------------------------------------

    Proposed Rule 1006(g) would address payments to and from Cross-
Guaranty Parties \48\ in respect of Common Members.\49\ This provision 
is based on current Article VIII, Sections 5(f) and 5(g) of OCC's By-
Laws, which would be transferred to Rule 1006(g) without material 
changes. OCC would, therefore, continue to use a suspended Clearing 
Member's Clearing Fund contribution, after appropriately applying other 
funds in the accounts of the Clearing Member, to make a required 
payment to a Cross-Guaranty Party pursuant to a Limited Cross-Guaranty 
Agreement in respect of such Clearing Member. Proposed Rule 1006(g) 
would clarify, however, that OCC would credit funds to the Clearing 
Fund that it receives in respect of a suspended Clearing Member from a 
Cross-Guaranty Party pursuant to a Limited Cross-Guaranty Agreement, 
where OCC must still make a charge on a proportionate basis against 
other Clearing Members' required contributions to the Clearing Fund 
even after application of such funds, or where OCC has already made a 
charge on a proportionate basis against other Clearing Members' 
required contributions to the Clearing Fund.
---------------------------------------------------------------------------

    \48\ A Cross-Guaranty Party is a party, other than OCC, to a 
Limited Cross Guaranty Agreement, which is an agreement between OCC 
and one or more other clearing corporations and/or clearing 
organizations relating to the cross-guaranty by OCC and the other 
party or parties of certain obligations of a suspended Common Member 
to the parties to the agreement. See Article I, Section 1.C.(35) of 
the By-Laws (defining Cross-Guaranty Party) and Section 1.L.(4) 
(defining Limited Cross-Guaranty Agreement).
    \49\ A Common Member is ``a Clearing Member that is concurrently 
a member or participant of a Cross-Guaranty Party.'' See Article I, 
Section 1.C.(27) of the By-Laws.
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    Proposed Interpretation and Policy .02-.04 to Rule 1006 would also 
address certain aspects of payments to and from Cross-Guaranty Parties 
in respect of Common Members. All of these proposed provisions are 
based without material amendment on existing Interpretations and 
Policies to Article VIII, Section 5 of OCC's By-Laws, as described 
below.
    Proposed Interpretation and Policy .02 to Rule 1006 is based 
without material amendment on existing Interpretation and Policy .03 to 
Article VIII, Section 5 of OCC's By-Laws. Under the proposed 
Interpretation and Policy, if OCC has a deficiency after it applies all 
the available funds of a suspended Common Member but cannot determine 
whether, when, or in what amount it will be entitled under a Limited 
Cross-Guaranty Agreement to receive funds from a Cross-Guaranty Party, 
OCC may make a charge against other Clearing Members' contributions for 
the deficiency in accordance with Rule 1006(b). If OCC receives funds 
from a Cross-Guaranty Party after making such a charge, OCC would 
credit the funds to the Clearing Fund in accordance with Rule 1006(g).
    Proposed Interpretation and Policy .03 to Rule 1006 is based 
without material amendment on existing Interpretation and Policy .04 to 
Article VIII, Section 5 of OCC's By-Laws. Under the proposed 
Interpretation and Policy, if OCC has a deficiency after it applies all 
the available funds of a suspended Common Member and OCC determines 
that it is likely to receive funds from a Cross-Guaranty Party under a 
Limited Cross-Guaranty Agreement, OCC may, in anticipation of receipt 
of such funds, forego making a charge, or make a reduced charge in 
accordance with proposed Rule 1006(b), against other Clearing Members' 
Clearing Fund contributions. If OCC does not subsequently receive the 
funds or receives a smaller amount than anticipated, OCC may make a 
charge or additional charges against contributions in accordance with 
proposed Rule 1006(b).
    Proposed Interpretation and Policy .04 to Rule 1006 is based 
without material amendment on existing Interpretation and Policy .05 to 
Article VIII, Section 5 of OCC's By-Laws. Under the proposed 
Interpretation and Policy, if, under a Limited Cross-Guaranty 
Agreement, OCC receives funds from a Cross-Guaranty Party in respect of 
a suspended Common Member but is subsequently required to return such 
funds for any reason, OCC may make itself whole by making a charge or 
additional charges, as the case may be, against the contributions of 
Clearing Members, other than the suspended Common Member.
    Existing Article VIII, Section 1(b) of OCC's By-Laws, which 
concerns the general lien on all cash, Government securities, and other 
property of the Clearing Member contributed to the Clearing Fund, would 
be moved without material change to new Rule 1006(i). Additionally, 
existing Interpretation and Policy .02 of Article VIII, Section 3 of 
OCC's By-Laws, which concerns the treatment of securities deposited in 
an account of OCC at an approved custodian, would be relocated to new 
Rule 1006(j) without change.
    OCC also proposes to relocate existing Article VIII, Sections 5(c), 
and (e) of OCC's By-Laws, which concern notice of any charges against 
the Clearing Fund, the use of current and retained earnings to address 
losses, and the use of the Clearing Fund to effect borrowings, to new 
Rules 1006(d), (e), and (f),\50\ respectively, without material

[[Page 28031]]

amendment.\51\ OCC would also relocate existing Article VIII, Section 6 
of OCC's By-Laws, which concerns the making good of any charges against 
the Clearing Fund (i.e., Clearing Fund replenishment and assessments) 
to new Rule 1006(h) without material changes.\52\ The proposed Policy 
and Methodology Description would also contain a discussion of OCC's 
Clearing Fund replenishment and assessment powers generally intended to 
reflect this existing authority in the By-Laws. In addition, the 
proposed Policy would (1) provide the Executive Chairman, Chief 
Administrative Officer, or Chief Operating Officer with the authority 
to approve proportionate charges against the Clearing Fund and (2) 
require that OCC's Accounting department maintain procedures for the 
allocation of losses due to a Clearing Member default and to replenish 
the Clearing Fund in the event a deficiency in the Clearing Fund 
results from events other than those specified in proposed Rule 1006.
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    \50\ Under clause (i) of new Rule 1006(f), OCC would also be 
permitted to take possession of Government securities in 
anticipation of a potential default by or suspension of a Clearing 
Member, as is currently the case under existing Interpretation and 
Policy .06 to Article VIII, Section 5.
    \51\ OCC notes that it would make a number of non-substantive 
clarifying changes to the rule text in proposed Rule 1006 so that 
existing rule text referencing ``computed contributions to the 
Clearing Fund'' and ``as fixed at the time'' would be rephrased as 
``required contributions to the Clearing Fund'' and ``as calculated 
at the time.'' The proposed change is designed to more accurately 
reflect that these rules are intended to refer to a Clearing 
Member's required Clearing Fund contribution amount as calculated 
under the proposed Rules, Policy and Methodology Description and 
eliminate any potential confusion with a Clearing Member's ``fixed 
amount'' as determined under Rule 1003(a).
    \52\ OCC notes that it would modify the rule text in question to 
clarify that a Clearing Member's obligation to make good the 
deficiency in its Clearing Fund contribution, resulting from a 
proportionate charge or otherwise, would be in relation to its 
currently ``required'' contribution amount and not the amount of the 
contribution on deposit as of the time of the charge.
---------------------------------------------------------------------------

    Additionally, OCC proposes to amend the definition of ``Clearing 
Fund'' in Article I and Article V, Section 3 of the By-Laws to reflect 
the fact that OCC's Clearing Fund-related provisions would now be 
contained in Chapter X of the Rules. In addition, OCC proposes to 
change references to ``Chapter 11'' of the Rules in Article VI, Section 
27 of OCC's By-Laws to ``Chapter XI'' To conform the references to 
OCC's Rules. OCC proposes conforming changes to Rule 1106 to reflect 
the reorganization of Article VIII of the By-Laws into Chapter X of the 
Rules. OCC also proposes to amend Rule 609 to change the term 
``securities'' to ``contracts'' to clarify that its authority to call 
for intra-day margin also applies to non-securities products cleared by 
OCC.
    OCC also proposes conforming changes to delete existing 
Interpretations and Policies .02 and .03 of Rule 1001, which deal with 
the minimum confidence level used to size the Clearing Fund and the 
phase-in of the former weighting allocation methodology, respectively. 
Under the proposed change, the confidence level used to size the 
Clearing Fund and the phase-in of the proposed weighting allocation 
methodology would be addressed in the Policy and Methodology 
Description (as described above). As a result, these Interpretations 
and Policies would no longer be needed.
    In addition, consistent with its effort to aggregate all Clearing 
Fund-related provisions to Chapter X of the Rules, OCC proposes to 
relocate Article VIII, Sections 7 (Contribution Refund) and 8 (Recovery 
of Loss) of the By-Laws to new Rules 1009, and 1010, respectively, 
without material amendment.
    OCC also proposes to relocate certain By-Law provisions related to 
the form and method of Clearing Fund contributions into Chapter X of 
the Rules. Specifically, OCC proposes to relocate Article VIII, Section 
3(a) and (c); Interpretation and Policy .04 to Article VIII, Section 3; 
and Article VIII, Section 4 to proposed Rule 1002 concerning Clearing 
Fund contributions. These By-Law provisions would be relocated to 
Chapter X of the Rules without material amendment. OCC also would 
relocate Interpretation and Policy .01 to Rule 1001 concerning minimum 
Clearing Fund size into new Rule 1001(b). The form and method of OCC's 
Clearing Fund contributions also would be generally described in the 
proposed Policy and Methodology Description documents. In addition, and 
consistent with current OCC practice, the proposed Policy would impose 
a requirement that the specific securities eligible to be used as 
Clearing Fund contributions be permitted to be pledged in exchange for 
cash through one of OCC's committed liquidity facilities so that OCC 
continues to maintain sufficient eligible securities to fully access 
such facilities.
    As noted above, under proposed Rule 1007, OCC would make available 
on a daily basis certain reports listing the current amount and form of 
each Clearing Member's contribution to the Clearing Fund, the current 
amount of the contribution required of such Clearing Member, and any 
deficit in the Clearing Member's contribution or surplus over and above 
the required amount, as applicable. Proposed Rule 1007 would also 
include reporting on the Clearing Member's required cash contribution 
to the Clearing Fund.
    OCC also proposes to relocate existing Rule 1004 (Withdrawals) to 
new Rule 1008 and would modify the proposed rule to reflect that 
Clearing Members may withdraw excess Clearing Fund deposits on the same 
day that OCC issues a report to the Clearing Member showing a surplus 
(as opposed to the following business day), which is consistent with 
current operational practices.
    In addition, OCC proposes to update references to Article VIII of 
the By-Laws in its Collateral Risk Management Policy and Default 
Management Policy to reflect the relocation of OCC's Clearing Fund-
related By-Laws into Chapter X of the Rules.
    Finally, OCC currently maintains procedures regarding its processes 
for (i) the monthly resizing of its Clearing Fund (Monthly Clearing 
Fund Sizing Procedure), (ii) the addition of financial resources 
through intra-day margin calls and/or an intra-month increase of the 
Clearing Fund to ensure that it maintains adequate financial resources 
in the event of a default of a Clearing Member/Clearing Members Group 
presenting the largest exposure to OCC (FRMC Procedure), and the 
execution of any intra-month resizing of the Clearing Fund (Clearing 
Fund Intra-Month Re-sizing Procedure).\53\ OCC proposes to retire its 
existing Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, 
and Monthly Clearing Fund Sizing Procedure as these procedures would no 
longer be relevant to OCC's proposed Clearing Fund and stress test 
methodology and would be replaced by the proposed Rules, Policy and 
Methodology Description described herein.
---------------------------------------------------------------------------

    \53\ See supra note 10.
---------------------------------------------------------------------------

    OCC's Monthly Clearing Fund Sizing Procedure provides that the 
Clearing Fund is resized on the first business day of each month by 
identifying the peak five-day rolling average of Clearing Fund Draws 
(using OCC's current Clearing Fund methodology) over the most recent 
three-month period. This peak five-day rolling average is supplemented 
with a prudential margin of safety of $1.8 billion. The Monthly 
Clearing Fund Sizing Procedure further describes the internal 
procedural and administrative steps taken by OCC staff in the monthly 
Clearing Fund sizing processes (e.g., the internal reports and 
processes used to populate relevant data and calculate the monthly 
Clearing Fund size and the internal reporting and notifications made by 
OCC staff during the resizing process). Under the proposed Policy and 
Methodology Description, OCC would continue to

[[Page 28032]]

determine the Clearing Fund size for a given month by using a peak 
five-day rolling average of Clearing Fund Draws over the prior three 
months; however, these calculations would be done using the proposed 
Sizing Stress Test results and would no longer require a prudential 
margin of safety.\54\ The remaining internal procedural and 
administrative steps taken by OCC staff in the monthly Clearing Fund 
sizing processes would no longer be ``rules'' of OCC as defined by the 
Exchange Act \55\ as those aspects of the procedure: (1) Would no 
longer be relevant to OCC's proposed Clearing Fund and stress testing 
methodologies and processes, (2) would be reasonably and fairly implied 
by the proposed Rules, Policy, and Methodology Description, and/or (3) 
would otherwise not be deemed to be material aspects of OCC's Clearing 
Fund-related operations.\56\
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    \54\ See supra note 21.
    \55\ Section 19(b)(1) of the Exchange Act requires a self-
regulatory organization (``SRO'') such as OCC to file with the 
Commission any proposed rule or any proposed change in, addition to, 
or deletion from the rules of such SRO. See 15 U.S.C. 78s(b)(1). 
Section 3(a)(27) of the Exchange Act defines ``rules of a clearing 
agency'' to mean its (1) constitution, (2) articles of 
incorporation, (3) bylaws, (4) rules, (5) instruments corresponding 
to the foregoing and (6) such ``stated policies, practices and 
interpretations'' (``SPPI'') as the Commission may determine by 
rule. See 15 U.S.C. 78c(a)(27). Exchange Act Rule 19b-4(a)(6) 
defines the term ``SPPI'' to mean, in addition to certain publicly 
facing statements, ``any material aspect of the operation of the 
facilities of the [SRO].'' See 17 CFR 240.19b-4(a)(6). Rule 19b-4(c) 
provides, however, that an SPPI may not be deemed to be a proposed 
rule change if it is: (i) Reasonably and fairly implied by an 
existing rule of the SRO or (ii) concerned solely with the 
administration of the SRO and is not an SPPI with respect to the 
meaning, administration, or enforcement of an existing rule the SRO.
    \56\ OCC notes that it would adopt new internal procedures to 
address the procedural and administrative steps associated with the 
monthly Clearing Fund sizing, Clearing Fund sufficiency monitoring, 
and intra-month resizing processes; however, these procedures would 
not be filed as ``rules'' of OCC under the Exchange Act. These 
procedures also would conform to the proposed changes described 
herein.
---------------------------------------------------------------------------

    OCC's FRMC Procedure outlines various responsibilities, 
deliverables and communications with respect to OCC's financial 
resource monitoring and resource call processes. While the FRMC 
Procedure describes material aspects of OCC's current financial 
resource monitoring and call-related operations, it also describes the 
non-material procedural and administrative steps taken by OCC staff in 
carrying out these processes. For example, the FRMC Procedure contains 
procedural steps for (1) comparing Clearing Fund Draws against the 
Clearing Fund size and determining whether applicable thresholds are 
breached, (2) internal notifications and reporting within OCC regarding 
the imposition of enhanced monitoring or recommendations for margin 
calls or intra-month resizing of the Clearing Fund,\57\ (3) other 
external communications to Clearing Members \58\ regarding margin 
calls, and (4) determining whether a cash draft is required to satisfy 
a deficit resulting from a margin call. Under the proposal, the 
proposed Policy would continue to describe the material aspects of 
OCC's Clearing Fund operations as they relate to the financial resource 
monitoring and resource call process under the new Clearing Fund and 
stress testing methodology, subject to a number of modifications 
describe above.\59\ Any remaining procedural details would not be 
``rules'' of OCC as OCC believes that those aspects of the procedures: 
(1) Would no longer be relevant to OCC's proposed Clearing Fund and 
stress testing methodologies and processes, (2) would be reasonably and 
fairly implied by the proposed Rules, Policy, and Methodology 
Description, and/or (3) would otherwise not be deemed to be material 
aspects of OCC's Clearing Fund-related operations.
---------------------------------------------------------------------------

    \57\ OCC notes that the weekly reporting process currently 
described in the FRMC Procedure would no longer be codified in the 
``rules'' of OCC; however, the proposed Policy would establish new 
governance, monitoring and review requirements for OCC's Clearing 
Fund and stress testing methodology, which are described in detail 
above.
    \58\ The proposed Policy would contain a general requirement 
that Clearing Members be notified of any intra-day margin calls 
under the policy but the procedural details of such notification 
would be contained in the Clearing Fund Sufficiency Monitoring 
Procedure.
    \59\ See e.g., supra notes 32-36 and associated text.
---------------------------------------------------------------------------

    OCC's Clearing Fund Intra-Month Re-sizing Procedure outlines the 
various internal responsibilities, deliverables and communications with 
respect to an intra-month re-sizing the Clearing Fund as determined 
under the FRMC Procedure. The procedure describes the procedural and 
administrative steps taken by OCC staff in the intra-month resizing 
process, including the procedural steps for (1) calculating increased 
contribution requirements based on various internal reports and 
processes, (2) preparing information memoranda announcing an intra-
month resizing, (3) internal notifications and reporting within OCC 
regarding an intra-month resizing, (4) other external communications to 
Clearing Members \60\ and OCC's regulators regarding an intra-month 
resizing of the Clearing Fund, and (5) determining whether a cash draft 
is required to satisfy a deficit resulting from an intra-month resizing 
of the Clearing Fund. Under the proposed changes described herein, 
these procedural details would not be ``rules'' of OCC as OCC believes 
that those aspects of the procedure: (1) Would no longer be relevant to 
OCC's proposed Clearing Fund and stress testing methodologies and 
processes, (2) would be reasonably and fairly implied by the proposed 
Rules, Policy, and Methodology Description, and/or (3) would otherwise 
not be deemed to be material aspects of OCC's Clearing Fund-related 
operations.
---------------------------------------------------------------------------

    \60\ The proposed Policy would contain a general requirement 
that Clearing Members, OCC's Risk Committee, and OCC's regulators be 
notified of any intra-month Clearing Fund resizing but the 
procedural details of such notification would be contained in the 
Clearing Fund Sizing Procedure.
---------------------------------------------------------------------------

(2) Statutory Basis
    Section 17A(b)(3)(F) of the Act \61\ requires, among other things, 
that the rules of a clearing agency be designed to promote the prompt 
and accurate clearance and settlement of securities and derivatives 
transactions, to assure the safeguarding of securities and funds which 
are in its custody or control or for which it is responsible, and, in 
general, to protect investors and the public interest. OCC believes 
that the proposed changes, and in particular, the new Clearing Fund and 
stress testing methodology, would both enhance OCC's risk management 
capabilities as well as promote OCC's ability to more thoroughly size, 
monitor and test the sufficiency of its Pre-Funded Financial Resources 
under a wide range of hypothetical and historical stress scenarios. The 
proposed Clearing Fund and stress testing methodology is designed to 
improve OCC's ability to calibrate its Pre-Funded Financial Resources 
to withstand a broader range of extreme but plausible circumstances 
under which its one or two largest Clearing Members may default, 
thereby reducing the risk that such resources would be insufficient in 
an actual default. As a result, the proposed rule change is designed, 
in general, to enhance OCC's framework for measuring and managing its 
credit risks so that it can continue to provide prompt and accurate 
clearance and settlement of securities and derivatives transactions, 
assure the safeguarding of securities and funds which are in its 
custody or control or for which it is responsible, and, in general, 
protect investors and the public interest consistent with Section 
17A(b)(3)(F) of the Act.\62\
---------------------------------------------------------------------------

    \61\ 15 U.S.C. 78q-1(b)(3)(F).
    \62\ Id.
---------------------------------------------------------------------------

    As noted above, the proposed Clearing Fund and stress testing 
methodology would enhance OCC's framework for testing the sizing,

[[Page 28033]]

adequacy, and sufficiency of its Pre-Funded Financial Resources by 
incorporating a wide range of extreme hypothetical and historical 
stress scenarios. Under the proposal, OCC would establish a new risk 
tolerance with respect to sizing OCC's Pre-Funded Financial Resources 
to cover a 1-in-50 year hypothetical market event at a 99.5% confidence 
level over a two-year look-back period. As noted above, OCC believes 
that a 1-in-50 year hypothetical market event represents the outer 
range of extreme but plausible scenarios for OCC's cleared products. As 
a result, OCC would size its Clearing Fund based on more conservative 
1-in-80 year Hypothetical Scenarios, and would do so under a more 
conservative Cover 2 Standard, so that OCC sizes its Clearing Fund on a 
monthly basis at a level designed to cover its potential exposures 
under extreme but plausible market conditions. Moreover, OCC would 
utilize Sufficiency Stress Tests to evaluate the sufficiency of its 
Pre-Funded Financial Resources against potential credit exposures 
arising from range of scenarios to determine whether OCC should: (1) 
Implement the enhanced monitoring of Clearing Fund Draws, (2) require 
additional margin deposits, or (3) re-size the Clearing Fund on an 
intra-month basis so that OCC continues to maintain sufficient 
financial resources to cover a wide range of foreseeable stress 
scenarios that include, but are not limited to, the default of the two 
Clearing Member Groups that would potentially cause the largest 
aggregate credit exposure in extreme but plausible market conditions. 
Moreover, the proposed changes would introduce a number of 
Informational Stress Tests that would serve as valuable risk management 
tools for OCC to monitor and assess its Pre-Funded Financial Resources 
against a wide range of scenarios, including but not limited to extreme 
but implausible and reverse stress test scenarios.
    The proposed changes also would introduce certain anti-procyclical 
measures into the monthly Clearing Fund sizing process designed to 
limit the potential decrease of the Clearing Fund's size from month to 
month and therefore reduce the likelihood that a market shock would 
require OCC to call for further resources from Clearing Members on an 
intra-month basis. The measures would prevent the Clearing Fund from 
decreasing rapidly when a previous peak falls out of the three month 
look-back period, and also reduce the likelihood that the Clearing Fund 
would be set at a size such that a Clearing Member Group with stress 
test exposures that are trending upward at the end of the sizing period 
would exceed the threshold for an intra-month resize immediately 
following monthly resizing of the Clearing Fund.
    Taken together, OCC believes that the proposed changes to its 
Clearing Fund and stress testing methodology and Policy are designed to 
improve OCC's ability to calibrate its Pre-Funded Financial Resources, 
and when necessary, call for additional financial resources from its 
Clearing Members, so that it can withstand a wide range of stress 
scenarios under which its one or two largest Clearing Members may 
default, thereby reducing the risk that such resources would be 
insufficient in an actual default and enhancing OCC's ability to manage 
risks in its role as a systemically important financial market utility. 
As a result, OCC believes the proposed rule change is designed to 
enable OCC to manage its credit risks so that it can continue providing 
prompt and accurate clearance and settlement of securities and 
derivatives transactions, assuring the safeguarding of securities and 
funds which are in its custody or control or for which it is 
responsible, and, in general, protect investors and the public interest 
in a manner consistent with Section 17A(b)(3)(F) of the Act.\63\
---------------------------------------------------------------------------

    \63\ Id.
---------------------------------------------------------------------------

    OCC also proposes to increase its minimum initial and fixed 
Clearing Fund contribution amounts from $150,000 to $500,000. The 
proposed change would require a small subset of OCC's Clearing Members 
to contribute a relatively modest increase in their mutualized 
contribution to OCC's Clearing Fund (at most, a $350,000 increase). In 
proposing the new minimum contribution amounts, OCC analyzed, among 
other things, the potential impact on Clearing Members that are at the 
minimum or otherwise below or just over the newly proposed $500,000 
requirement, the impact to those members in dollar and percentage terms 
as well as compared to their net capital, evolving market conditions, 
evolution in the size of the Clearing Fund, minimum contribution 
requirements of other CCPs, and heightened regulatory obligations on 
OCC given its status as a systemically important financial market 
utility. In particular, OCC notes that its existing initial and minimum 
fixed contribution requirements have been in place since June 5, 2000, 
while its Clearing Fund has grown from approximately $2 billion in 2000 
to several multiples of that, both currently and under the proposal 
described herein.\64\ OCC believes that the proposed increase is 
appropriate given the increase in OCC's overall Clearing Fund size and 
is in line with or lower than the minimum requirements of other 
CCPs.\65\ OCC believes the proposed change to its minimum contribution 
amounts would require Clearing Members to contribute an appropriate 
amount of mutualized resources to OCC's default waterfall and is 
therefore designed to protect investors and the public interest in a 
manner consistent with Section 17A(b)(3)(F) of the Act.\66\
---------------------------------------------------------------------------

    \64\ See supra note 38 and accompanying text.
    \65\ See supra note 39.
    \66\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    Additionally, OCC proposes to modify its allocation weighting 
methodology to more closely align Clearing Members' Clearing Fund 
contribution requirements with the level of risk they present to OCC. 
Specifically, under the proposed Policy, Clearing Fund contribution 
requirements would be based on an allocation methodology of 70% of 
total risk, 15% of volume and 15% of open interest (as opposed to the 
current weighting of 35% total risk, 50% open interest, and 15% 
volume). In addition, OCC proposes to modify the volume component of 
its Clearing Fund contribution allocation weighting methodology to 
provide that OCC would use cleared volume, as opposed to executed 
volume, to base the volume component of the allocation on where the 
position is ultimately cleared as opposed to where it was executed. OCC 
believes that these changes would better align incentives for each 
Clearing Member to reduce the risk it introduces to the Clearing Fund 
by determining each Clearing Member's proportionate share of the 
Clearing Fund based on the risk it presents to OCC. As a result, OCC 
believes the proposed rule change is designed, in general, to protect 
investors and the public interest consistent with Section 17A(b)(3)(F) 
of the Act.\67\
---------------------------------------------------------------------------

    \67\ Id.
---------------------------------------------------------------------------

    OCC also proposes a number of changes to its Rules to generally 
reduce the time for Clearing Members to fund Clearing Fund deficits. 
Specifically, new Rule 1005(a) would require that a Clearing Member 
satisfy any deficit in its required Clearing Fund contribution 
resulting from a decrease in the value of a Clearing Member's 
contribution or by an adjusted contribution pursuant to proposed Rule 
1004 by no later than one hour after being notified by OCC of such 
deficit. In addition, OCC would reduce the amount of time within which 
a Clearing Member must satisfy a deficit from five business days of the 
date on

[[Page 28034]]

which the report is made available to two business days of such date 
for any deficit arising due to regular monthly sizing of the Clearing 
Fund, an intra-month resizing of the Clearing Fund, or in circumstance 
in which a Clearing Member's contribution is increased as a result of 
an amendment of OCC's Rules. Additionally, and consistent with existing 
operational practice, the proposed changes would specify that, upon the 
failure of a Clearing Member for any reason to timely satisfy a deficit 
regarding its required Clearing Fund contribution, OCC would be 
authorized to withdraw an amount equal to such deficit from the 
Clearing Member's bank account maintained in respect of an OCC firm 
account. OCC also proposes to specify that Clearing Members shall have 
until 9:00 a.m. Central Time on the second business day after the 
issuance of the Clearing Fund Status Report to meet their required 
Clearing Fund contribution if such contribution increases as a result 
of monthly Clearing Fund sizing or an intra-month resizing of the 
Clearing Fund to more closely align with the settlement time for the 
collection of other deficits (e.g., the required time for making good 
any deficiency generally under existing Article VIII, Section 6 of the 
By-Laws or for satisfying any margin deficits under Rule 605). The 
proposed change is designed to ensure that OCC is able to obtain funds 
owed from its Clearing Members in a timely fashion so that OCC can 
continue to meet its overall financial resource requirements, thereby 
reducing the risk presented to OCC. As a result, OCC believes the 
proposed rule change is designed to enable OCC to manage its credit 
risks so that it can continue providing prompt and accurate clearance 
and settlement of securities and derivatives transitions, assuring the 
safeguarding of securities and funds which are in its custody or 
control or for which it is responsible, and, in general, protect 
investors and the public interest in a manner consistent with Section 
17A(b)(3)(F) of the Act.\68\
---------------------------------------------------------------------------

    \68\ Id.
---------------------------------------------------------------------------

    OCC also proposes a number of non-material changes, such as 
relocating provisions of OCC's By-Laws concerning the Clearing Fund to 
its Rules, making other clarifying and conforming changes to its Rules, 
Collateral Risk Management Policy and Default Management Policy, and 
clarifying certain pro-cyclicality measures in its existing margin 
methodology, which are not expected to have any impact on OCC's risk 
management practices or the risk presented to OCC or its participants. 
OCC believes that making these clarifying and conforming changes to its 
rules would provide more clarity around, and enhance the readability 
of, OCC's Clearing Fund requirements and thereby provide OCC's members 
and the public a clearer understanding of OCC's rules. OCC believes, 
therefore, that its rules following incorporation of the proposed 
changes, would be designed to, in general, protect the investors and 
the public interest in a manner consistent with Section 17A(b)(3)(F) of 
the Act.\69\
---------------------------------------------------------------------------

    \69\ Id.
---------------------------------------------------------------------------

    Taken together, OCC believes the enhancements discussed in this 
proposed rule change would provide for a more comprehensive approach to 
managing OCC's credit risks and would allow OCC to more accurately 
measure its credit risk exposures, better test the sufficiency of its 
financial resources, and respond quickly when OCC believes additional 
financial resources are required. Accordingly, for the reasons set 
forth above, OCC believes that the proposed rule change would enhance 
OCC's ability to measure and manage its credit risks and is therefore 
designed to promote the promote and accurate clearance and settlement 
of securities and derivatives transactions, to assure the safeguarding 
of securities and funds 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.\70\
---------------------------------------------------------------------------

    \70\ Id.
---------------------------------------------------------------------------

    OCC further believes the proposed rule change is consistent with 
the Act and the rules thereunder for the reasons set forth below.
Clearing Fund Sizing and Sufficiency Changes
    Rule 17Ad-22(b)(3) \71\ requires a registered clearing agency that 
performs CCP services to establish, implement, maintain and enforce 
written policies and procedures reasonably designed to maintain 
sufficient financial resources to withstand, at a minimum, a default by 
the participant family to which it has the largest exposure in extreme 
but plausible market conditions. Rules 17Ad-22(e)(4)(iii) and (iv) \72\ 
further require, in part, that a covered clearing agency establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to effectively identify, measure, monitor, and 
manage its credit exposures to participants and those arising from its 
payment, clearing, and settlement processes, including by maintaining 
additional financial resources (beyond those collected as margin or 
otherwise maintained to meet the requirements of Rule 17Ad-22(e)(4)(i) 
\73\) at the minimum to enable it to cover a wide range of foreseeable 
stress scenarios that include, but are not limited to, the default of 
the participant family that would potentially cause the largest 
aggregate credit exposure for the covered clearing agency in extreme 
but plausible market conditions and do so exclusive of assessments for 
additional guaranty fund contributions or other resources that are not 
prefunded.
---------------------------------------------------------------------------

    \71\ 17 CFR 240.17Ad-22(b)(3).
    \72\ 17 CFR 240.17Ad-22(e)(4)(iii) and (iv).
    \73\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    OCC believes that the proposed changes to its By-Laws, Rules and 
Clearing Fund and stress testing methodology are reasonably designed to 
measure and manage OCC's credit exposures to participants by 
maintaining sufficient Pre-Funded Financial Resources to cover a wide 
range of foreseeable stress scenarios that include, but are not limited 
to, the default of the two Clearing Member Groups that would 
potentially cause the largest aggregate credit exposure in extreme but 
plausible market conditions. In order to achieve this, OCC proposes to 
establish a risk tolerance with regard to the sizing of the Clearing 
Fund equal to a 1-in-50 year hypothetical market event, which OCC 
believes represents the outer range of extreme but plausible scenarios 
for OCC's cleared products for purposes of Rule 17Ad-22(e)(4) under the 
Act.\74\ In order to ensure sufficient coverage of this risk tolerance, 
which OCC believes represents the outer range of extreme but plausible 
market conditions for the purposes of Rule 17Ad-22(e)(4) under the 
Act,\75\ and to guard against intra-month scenario volatility and 
procyclicality, OCC proposes to size its Clearing Fund based on a more 
conservative 1-in-80 year hypothetical market event (i.e., the Sizing 
Stress Tests) on a Cover 2 Standard. The proposed changes are designed 
to size the Clearing Fund at a level that would be expected to cover 
OCC's potential exposures under extreme but plausible market 
conditions. In addition, OCC's Rules, Policy, and Methodology 
Description would provide for the collection of additional resources on 
an intra-month basis if certain Sufficiency Scenario thresholds are 
breached, as discussed in more detail above. These stress tests are 
designed, in total, to result in the collection of sufficient Pre-
Funded Financial Resources (which by

[[Page 28035]]

definition in the Policy would exclude OCC's replenishment and 
assessment powers), and when necessary call for additional financial 
resources, to cover a wide range of stress scenarios, including extreme 
but plausible market conditions.
---------------------------------------------------------------------------

    \74\ 17 CFR 240.17Ad-22(e)(4).
    \75\ Id.
---------------------------------------------------------------------------

    Additionally, the proposed changes to avoid pro-cyclicality in the 
Clearing Fund (e.g., preventing the Clearing Fund from decreasing more 
than 5% from month-to-month and using a three-month look back period in 
sizing the Clearing Fund) are designed to promote stability and to 
prevent the Clearing Fund from decreasing rapidly when a previous peak 
falls out of the look-back period. OCC believes that this conservative 
approach to anti-procyclicality would help to ensure that OCC continues 
to maintain adequate Pre-Funded Financial Resources during periods 
where volatility decreases significantly, market conditions change 
rapidly, or Clearing Member business activity causes a significant 
decrease in stress test results.
    OCC further believes that the proposed changes to its Rules to 
generally reduce the timeframe in which Clearing Members must meet 
deficits in their Clearing Fund contributions are appropriate because 
it would expedite the adjustment of Clearing Fund contributions to the 
appropriate size as determined by OCC's new Clearing Fund and stress 
test methodology, thereby allowing the Clearing Fund to respond more 
quickly in rapidly changing or emergency market conditions. Moreover, 
consistent with existing operational practice, new Rule 1005(c) would 
establish that, upon the failure of a Clearing Member for any reason to 
timely satisfy a deficit regarding its required Clearing Fund 
contribution, OCC would be authorized to withdraw an amount equal to 
such deficit from the Clearing Member's bank account maintained in 
respect of an OCC firm account. The proposed rule change is designed to 
ensure that OCC is able to obtain funds owed from its Clearing Members 
in a timely fashion so that OCC can continue to meet its overall 
financial resource requirements. OCC believes the proposed changes 
would help to ensure that OCC maintains sufficient resources to meet 
its financial resource requirements under Rule 17Ad-22.\76\
---------------------------------------------------------------------------

    \76\ Id.
---------------------------------------------------------------------------

    For these reasons, OCC believes the proposed changes are reasonably 
designed so that OCC can measure and manage its credit exposure to its 
participants through the maintenance of additional financial resources 
at a minimum to enable it to cover a wide range of foreseeable stress 
scenarios that include, but are not limited to, the default of the 
participant family that would potentially cause the largest aggregate 
credit exposure for OCC in extreme but plausible market conditions, and 
do so exclusive of assessments for additional Clearing Fund 
contributions or other resources that are not prefunded, in a manner 
consistent with Rule 17Ad-22(b)(3) and Rules 17Ad-22(e)(4)(iii) and 
(iv).\77\
---------------------------------------------------------------------------

    \77\ 17 CFR 240.17Ad-22(b)(3) and (e)(4)(iii) and (iv).
---------------------------------------------------------------------------

Proposed Stress Testing and Clearing Fund Methodology
    Rule 17Ad-22(e)(4)(vi)(A) \78\ requires, in part, that a covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to effectively identify, 
measure, monitor, and manage its credit exposures to participants and 
those arising from its payment, clearing, and settlement processes, 
including by testing the sufficiency of its total financial resources 
available to meet the minimum financial resource requirements under 
Rule 17Ad-22(e)(4)(iii) \79\ by conducting stress testing of its total 
financial resources once each day using standard predetermined 
parameters and assumptions.
---------------------------------------------------------------------------

    \78\ 17 CFR 240.17Ad-22(e)(4)(vi)(A).
    \79\ 17 CFR 240.17Ad-22(e)(4)(iii).
---------------------------------------------------------------------------

    OCC proposes to adopt a new stress testing methodology, as 
described in the proposed Policy and Methodology Description, to enable 
OCC to conduct a variety of Sizing Stress Tests, Adequacy Stress Tests, 
Sufficiency Stress Tests and Informational Stress Tests, each of which 
play different but complementary roles in promoting OCC's ability to 
more robustly identify, measure, monitor and manage its credit risks to 
its participants. These stress tests would be run on a daily basis 
using standard predetermined parameters and assumptions and would allow 
OCC to test the sufficiency of its Pre-Funded Financial Resources under 
a wide range of Historical Scenarios, which take into account stresses 
on a number of factors such as price and volatility, as well as testing 
the adequacy of OCC's Pre-Funded Financial Resources with respect to 
its proposed risk tolerance. In turn, these stress tests would enable 
OCC to more effectively design margin and Clearing Fund requirements 
that are calibrated to cover Clearing Member defaults under such 
scenarios. The proposed Clearing Fund and stress testing methodology 
would also use Sufficiency Stress Tests to determine whether OCC should 
call for additional collateral to ensure that it consistently maintains 
sufficient financial resources. OCC believes that the proposed changes 
are therefore designed to allow OCC to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes, by 
testing the sufficiency of its Pre-Funded Financial Resources available 
to meet its minimum financial resource requirements under Rule 17Ad-22 
\80\ in a manner consistent with Rule 17Ad-22(e)(4)(vi).\81\
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    \80\ 17 CFR 240.17Ad-22.
    \81\ 17 CFR 240.17Ad-22(e)(4)(vi).
---------------------------------------------------------------------------

Clearing Fund and Stress Testing Governance, Monitoring, and Review
    Rule 17Ad-22(e)(4)(vi) and (vii) \82\ require, in part, that a 
covered clearing agency establish, implement, maintain and enforce 
written policies and procedures reasonably designed to effectively 
identify, measure, monitor, and manage its credit exposures to 
participants and those arising from its payment, clearing, and 
settlement processes, including by (i) conducting a comprehensive 
analysis on at least a monthly basis of the existing stress testing 
scenarios, models, and underlying parameters and assumptions, and 
considering modifications to ensure they are appropriate for 
determining the covered clearing agency's required level of default 
protection in light of current and evolving market conditions; (ii) 
conducting a comprehensive analysis of stress testing scenarios, 
models, and underlying parameters and assumptions more frequently than 
monthly when the products cleared or markets served display high 
volatility or become less liquid, or when the size or concentration of 
positions held by the covered clearing agency's participants increases 
significantly; (iii) reporting the results of such analyses to 
appropriate decision makers at the covered clearing agency, including 
but not limited to, its risk management committee or board of 
directors, and using these results to evaluate the adequacy of and 
adjust its margin methodology, model parameters, models used to 
generate clearing or guaranty fund requirements, and any other relevant 
aspects of its credit risk management framework, in supporting 
compliance with the minimum financial resources requirements; and (iv) 
performing a model validation for its credit risk models not less than 
annually or more frequently as may be

[[Page 28036]]

contemplated by the covered clearing agency's risk management 
framework.
---------------------------------------------------------------------------

    \82\ 17 CFR 240.17Ad-22(e)(4)(vi)(B)-(D) and (vii).
---------------------------------------------------------------------------

    The proposed Policy would set forth requirements for the daily and 
monthly monitoring, review, and reporting of stress test results. 
Specifically, under the Policy, STLRM would monitor the results of all 
of the Adequacy and Sufficiency Stress Tests on a daily basis and 
immediately escalate any material issues identified with respect to the 
adequacy of OCC's financial resources to the STWG and the Management 
Committee to determine if it would be appropriate to recommend a change 
to the stress test scenarios used to size the Clearing Fund. In 
addition, the Policy would require that STWG perform a comprehensive 
monthly analysis of OCC's stress testing results, as well as 
information related to the scenarios, models, parameters, and 
assumptions impacting the sizing of the Clearing Fund and evaluate 
their appropriateness for determining OCC's required level of financial 
resources in light of current and evolving market conditions. Moreover, 
the Policy would require that such review be conducted more frequently 
than monthly when the products cleared or markets served display high 
volatility or become less liquid; the size or concentration of 
positions held by OCC's participants increases significantly; or as 
otherwise appropriate.
    Pursuant to the proposed Policy, STLRM would report the results of 
stress tests and its comprehensive monthly analysis to OCC's Management 
Committee and Risk Committee on at least a monthly basis and would 
maintain procedures for determining whether, and in what circumstances, 
the results of such stress tests should be reported to the Management 
Committee or the Risk Committee more frequently than monthly, and would 
indicate the persons responsible for making that determination. In the 
performance of the monthly review of stress testing results and 
analysis and considering whether escalation is appropriate, the Policy 
would require that due consideration be given to the intended purpose 
of the Policy to: (a) Assess the adequacy of, and adjust as necessary, 
OCC's total amount of financial resources; (b) support compliance with 
the minimum financial resources requirements under applicable 
regulations; and (c) evaluate the adequacy of, and recommend 
adjustments to OCC's margin methodology, margin parameters, models used 
to generate margin or guaranty fund requirements, and any other 
relevant aspects of OCC's credit risk management.
    In addition, the proposed Policy would require that OCC's Model 
Validation Group perform a model validation of OCC's Clearing Fund 
model on an annual basis and that the Risk Committee would be 
responsible for reviewing the model validation report.
    Based on the foregoing, OCC believes that the proposed Policy is 
reasonably designed to ensure that OCC: (i) Conducts a comprehensive 
analysis on at least a monthly basis of the existing stress testing 
scenarios, models, and underlying parameters and assumptions, and 
considers modifications to ensure they are appropriate for determining 
OCC's required level of default protection in light of current and 
evolving market conditions; (ii) conducts a comprehensive analysis of 
stress testing scenarios, models, and underlying parameters and 
assumptions more frequently than monthly when the products cleared or 
markets served display high volatility or become less liquid, or when 
the size or concentration of positions held by OCC's participants 
increases significantly; (iii) reports the results of such analyses to 
appropriate decision makers, including but not limited to, OCC's 
Management Committee and the Risk Committee of the Board, and uses 
these results to evaluate the adequacy of and adjust its margin 
methodology, model parameters, models used to generate Clearing Fund 
requirements, and any other relevant aspects of its credit risk 
management framework, in supporting compliance with the minimum 
financial resources requirements; and (iv) performs a model validation 
for its credit risk models not less than annually or more frequently as 
may be contemplated by OCC's risk management framework in accordance 
with Rules 17Ad-22(e)(4)(vi) and (vii).\83\
---------------------------------------------------------------------------

    \83\ Id.
---------------------------------------------------------------------------

Proposed Changes to Minimum Contribution Amount and Allocation 
Methodology
    Rule 17Ad-22(e)(4) \84\ generally requires that a covered clearing 
agency establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes. With 
respect to the use of Clearing Funds and the requirements of Rule 17Ad-
22(e)(4),\85\ the Commission has noted that, to the extent that a 
clearing agency uses guaranty or clearing fund contributions to 
mutualize risk across participants, the clearing agency generally 
should value margin and guaranty fund contributions so that the 
contributions are commensurate to the risks posed by the participants' 
activity, and the clearing agency also generally should consider the 
appropriate balance of individualized and pooled elements within its 
default waterfall, with a careful consideration of whether the balance 
of those elements mitigates risk and to what extent an imbalance among 
those elements might encourage moral hazard, in that one participant 
may take more risks because the other participants bear the costs of 
those risks.\86\
---------------------------------------------------------------------------

    \84\ 17 CFR 240.17Ad-22(e)(4).
    \85\ Id.
    \86\ See Securities Exchange Act Release No. 78961 (September 
28, 2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards 
for Covered Clearing Agencies'') at 70813.
---------------------------------------------------------------------------

    OCC believes that the proposed changes to its initial and minimum 
Clearing Fund contribution amounts strike an appropriate balance 
between individualized and mutualized resources for new Clearing 
Members and those Clearing Members with minimal open interest. As noted 
above, OCC's existing initial and minimum fixed contribution 
requirements have been in place since June 5, 2000, while its Clearing 
Fund has grown from approximately $2 billion in 2000 to several 
multiples of that, both currently and under the proposal described 
herein.\87\ As a result, OCC undertook an analysis to determine the 
appropriateness of this amount. As discussed in detail above, OCC 
considered a number of factors such as the potential impact on Clearing 
Members that are at the minimum or otherwise below or just over the 
newly proposed $500,000 requirement, the impact to those members in 
dollar and percentage terms as well as compared to their net capital, 
evolving market conditions, evolution in the size of the Clearing Fund, 
minimum contribution requirements of other CCPs, and heightened 
regulatory obligations on OCC given its status as a systemically 
important financial market utility. OCC believes that the proposed 
increase is appropriate given the increase in OCC's overall Clearing 
Fund size and is in line with or lower than the minimum requirements of 
other CCPs.\88\ OCC therefore believes the proposed change is 
reasonably designed to ensure OCC is able to manage its credit 
exposures to participants and those arising from its

[[Page 28037]]

payment, clearing, and settlement processes in a manner that considers 
an appropriate balance of individualized and pooled elements within its 
default waterfall.
---------------------------------------------------------------------------

    \87\ See supra note 38 and accompanying text.
    \88\ See supra note 39.
---------------------------------------------------------------------------

    Additionally, OCC proposes to modify its allocation weighting 
methodology to more closely align Clearing Members' Clearing Fund 
contribution requirements with the level of risk they bring to OCC. 
Specifically, the proposed Clearing Fund contribution requirements 
would be based on an allocation methodology of 70% of total risk, 15% 
of volume and 15% of open interest (as opposed to the current weighting 
of 35% total risk, 50% open interest, and 15% volume). OCC believes 
that this change would better align incentives for each Clearing Member 
to reduce the risk it introduces to the Clearing Fund by determining 
each Clearing Member's proportionate share of the Clearing Fund based 
on the risk it presents to OCC. OCC also proposes to modify the volume 
component of its Clearing Fund contribution allocation weighting 
methodology to provide that OCC would use cleared volume, as opposed to 
executed volume, to base the volume component of the allocation on 
where the position is ultimately cleared as opposed to where it was 
executed. OCC believes that the proposed change is designed to more 
appropriately allocate contribution requirements commensurate to the 
risks posed by its Clearing Members.
    For these reasons, OCC believes that the proposed changes are 
designed to manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes in a 
manner consistent with Rule 17Ad-22(e)(4).\89\
---------------------------------------------------------------------------

    \89\ 17 CFR 240.17Ad-22(e)(4).
---------------------------------------------------------------------------

Other Clarifying, Conforming and Organizational Changes
    Rule 17Ad-22(e)(1) \90\ requires a covered clearing agency to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to provide for a well-founded, clear, 
transparent, and enforceable legal basis for each aspect of its 
activities in all relevant jurisdictions. OCC believes that the 
proposed clarifying, conforming, and organizational changes to its By-
Laws and Rules are designed to provide Clearing Members with enhanced 
transparency and clarity regarding their obligations associated with 
the Clearing Fund. As discussed above, the primary provisions that 
address OCC's Clearing Fund are currently split between Article VIII of 
the By-Laws and Chapter X of the Rules. Consolidating all of these 
provisions to Chapter X of the Rules would provide Clearing Members 
with a single location in which to find and understand the primary 
obligations that are associated with the Clearing Fund. In addition, 
OCC would make a number of non-substantive changes to its rules 
designed to provide additional clarity and transparency, including for 
example: (1) Consolidating existing Interpretation and Policy .01 and 
.02 of Article VIII, Section 5 concerning the share of any deficiency 
to be borne by each Clearing Member as a result of a charge against the 
Clearing Fund into new Interpretation and Policy .01 of Rule 1006 with 
conforming changes and cross-references to new Interpretation and 
Policy .01 of Rule 1006 being added to proposed Rules 1006(b) and (c) 
to provide additional clarity in OCC's rules; (2) making minor 
modifications to proposed Rule 1006(a) to clarify that matured futures 
contracts are included within the scope of other contracts or 
obligations issued, undertaken, or guaranteed by OCC or in respect of 
which OCC is otherwise liable; (3) clarifying in the proposed Policy 
that the Executive Chairman, Chief Administrative Officer, or Chief 
Operating Officer would have the authority to approve proportionate 
charges against the Clearing Fund; (4) clarifying in the proposed 
Policy that OCC's Accounting department is responsible for maintaining 
procedures for the allocation of losses due to a Clearing Member 
default and to replenish the Clearing Fund in the event a deficiency in 
the Clearing Fund results from events other than those specified in 
proposed Rule 1006; (5) revising Rule 609 to change the term 
``securities'' to ``contracts'' to clarify that OCC's authority to call 
for intra-day margin also applies to non-securities products cleared by 
OCC; (6) codifying in the proposed Policy the existing OCC practice 
that the specific securities eligible to be used as Clearing Fund 
contributions be permitted to be pledged in exchange for cash through 
one of OCC's committed liquidity facilities so that OCC continues to 
maintain sufficient eligible securities to fully access such 
facilities; (7) clarifying in proposed Rule 1002 that the circumstances 
and terms for a Clearing Member terminating its clearing membership due 
to an increase in Clearing Fund contribution resulting from an 
amendment of the Rules is separate from the circumstances and terms for 
a Clearing Member terminating its status as a result of a proportionate 
charge against the Clearing Fund; (8) clarifying in the introduction to 
Chapter X of the Rules that the size of the Clearing Fund shall at all 
times be subject to minimum sizing requirements and generally be 
calculated on a monthly basis by OCC; however, the calculated size of 
the Clearing Fund may be determined more frequently than monthly under 
certain conditions specified in proposed Rule 1001; and (9) rephrasing 
current rule text referencing ``computed contributions to the Clearing 
Fund'' and ``as fixed at the time'' to be ``required contributions to 
the Clearing Fund'' and ``as calculated at the time'' to more 
accurately reflect that these rules are intended to refer to a Clearing 
Member's required Clearing Fund Contribution amount as calculated under 
the proposed Rules, Policy and Methodology Description and eliminate 
any potential confusion with a Clearing Member's ``fixed amount'' as 
determined under Rule 1003(a). OCC believes that this additional 
clarity, transparency and enhanced readability regarding the primary 
provisions pertaining to the Clearing Fund help to provide for a well-
founded, clear, transparent and enforceable legal basis for the rights 
and obligations of Clearing Members and OCC regarding the Clearing Fund 
consistent with Rule 17Ad-22(e)(1).\91\
---------------------------------------------------------------------------

    \90\ 17 CFR 240. 17Ad-22(e)(1).
    \91\ Id.
---------------------------------------------------------------------------

    In addition, Section 19(b)(1) of the Exchange Act and Rule 19b-4 
thereunder set forth the requirements for SRO proposed rule changes, 
including the regulatory filing requirements for SPPIs.\92\ OCC 
proposes to retire its existing Clearing Fund Intra-Month Re-sizing 
Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure, 
which were previously filed as ``rules'' with the Commission,\93\ as 
these procedures would no longer be relevant to OCC's proposed Clearing 
Fund and stress testing methodology and processes. Under the proposal, 
the material aspects of OCC's Clearing Fund-related operations would be 
contained in the proposed Rules, Policy and Methodology Description 
described herein. Any applicable procedural details would not be 
``rules'' of OCC as those aspects of the procedures: (1) Would no 
longer be relevant to OCC's proposed Clearing Fund and stress testing 
methodologies and processes, (2) would be reasonably and fairly implied 
by the proposed Rules, Policy, and Methodology Description, and/or (3)

[[Page 28038]]

would otherwise not be deemed to be material aspects of OCC's Clearing 
Fund-related operations. Accordingly, OCC believes the proposed changes 
would be consistent with the requirements of Rule 17Ad-22(e)(1).\94\
---------------------------------------------------------------------------

    \92\ See supra note 54.
    \93\ See supra note 10.
    \94\ Id.
---------------------------------------------------------------------------

    For the reasons set forth above, OCC believes the proposed rule 
change is designed to assure the safeguarding of securities and funds 
at OCC and, in general, protect investors and the public interest 
consistent with Section 17A(b)(3)(F) of the Act \95\ and the rules 
promulgated thereunder.
---------------------------------------------------------------------------

    \95\ Id.
---------------------------------------------------------------------------

(B) Clearing Agency's Statement on Burden on Competition

    Section 17A(b)(3)(I) of the Act \96\ requires that the rules of a 
clearing agency not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act. While certain 
aspects of the proposal would have an impact on certain Clearing 
Members, specifically in the form of higher Clearing Fund contribution 
requirements, OCC does not believe that the proposed rule change would 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. The potential impact on 
Clearing Members, and the appropriateness of those changes to further 
of the purposes of the Act, is described in detail below.
---------------------------------------------------------------------------

    \96\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    OCC is proposing a number of changes to its Clearing Fund and 
stress testing methodology (specifically, the implementation of a Cover 
2 Standard for the Clearing Fund; newly proposed risk tolerance; newly 
proposed stress testing framework for developing and maintaining 
Sizing, Adequacy, Sufficiency and Informational Stress Tests; changes 
in timing for funding Clearing Fund deficits; and related governance, 
monitoring and review activities), which may have an impact on certain 
of its Clearing Members due to potential changes in the total amount of 
Pre-Funded Financial Resources OCC would be required to maintain on a 
monthly basis and the need for OCC call for additional resources from 
particular Clearing Members on an intra-month basis. For example, the 
proposed methodology changes could at times result in significant 
changes to OCC's overall Clearing Fund size relative to the current 
methodology (resulting in either larger or smaller relative Clearing 
Fund sizes). In addition, OCC would adopt new Sufficiency Stress Tests 
to determine whether OCC should call for additional resources from its 
Clearing Members on an intra-month basis, which may impact a wider 
subset of OCC's Clearing Members than those typically subject to margin 
calls under the current methodology and FRMC Procedure.\97\ OCC does 
not believe the proposed changes to its Clearing Fund and stress 
testing methodology (including the introduction of new Sufficiency 
Scenarios) would unfairly inhibit access to OCC's services or 
disadvantage or favor any particular user in relationship to another 
user. The proposed changes are designed to improve OCC's ability to 
measure, monitor and manage its credit exposures to its participants 
consistent with its regulatory requirements under Rules 17Ad-22(b)(3) 
and (e)(4) \98\ and thereby enhance OCC's ability to manage risks in 
its role as a systemically important financial market utility. As a 
result, OCC believes that any impact on competition or OCC's Clearing 
Members would be necessary and appropriate in furtherance of the 
protection of investors and the public interest under the Act.
---------------------------------------------------------------------------

    \97\ OCC notes that, under its current methodology, the Clearing 
Fund has ranged in size from $5.7 billion to $17.9 billion since 
January 2016, which can result in significant changes in Clearing 
Fund contribution requirements and the need for, and size of, intra-
month margin calls or Clearing Fund resizing under its existing FRMC 
Procedure.
    \98\ 17 CFR 240.17Ad-22(b)(3) and (e)(4).
---------------------------------------------------------------------------

    OCC also proposes a number of changes to its Clearing Fund 
contribution allocation requirements, which would have an impact on 
OCC's Clearing Members. Under the proposed rule change, those Clearing 
Members currently contributing the minimum initial and fixed amounts 
(or amounts under or slightly higher than the proposed minimums) would 
primarily be impacted by the increase in the minimum Clearing Fund 
contribution requirement.\99\ As discussed above, OCC's existing 
initial and minimum fixed contribution requirements have been in place 
since June 5, 2000,\100\ and as a result, OCC undertook an analysis to 
determine the appropriateness of its current minimum requirements given 
the passage of time and the evolution of OCC's overall Clearing Fund 
size. As part of this analysis, OCC considered, among other things, the 
potential impact on Clearing Members that are at the minimum or 
otherwise close to the newly proposed $500,000 requirement, the impact 
to those members in dollar and percentage terms as well as compared to 
their net capital, evolving market conditions, evolution in the size of 
the Clearing Fund, minimum contribution requirements of other CCPs, and 
heightened regulatory obligations on OCC given its status as a 
systemically important financial market utility. In particular, OCC 
notes that its existing initial and minimum fixed contribution 
requirements have remained static since June 2000, while its Clearing 
Fund has grown from approximately $2 billion in 2000 to several 
multiples of that, both currently and under the proposal described 
herein. In addition, the proposed minimum contribution requirement of 
$500,000 is in line with or lower than the minimum requirements of 
other CCPs.\101\ As a result of this analysis, OCC determined $500,000 
would be an appropriate initial and minimum Clearing Fund contribution 
amount to maintain membership at OCC. OCC believes that the proposed 
minimum contribution requirement considers a proper balance of 
individualized and pooled elements within its default waterfall and 
would not unduly inhibit access to OCC's services or otherwise impose a 
burden competition. Moreover, OCC believes the proposed changes to its 
minimum contribution requirements are reasonably designed to ensure 
that OCC is able to manage its credit exposures to participants and 
those arising from its payment, clearing, and settlement processes and 
therefore any competitive impact would be necessary and appropriate in 
furtherance of the purposes of protecting investors and the public 
interest under the Act.
---------------------------------------------------------------------------

    \99\ OCC notes that there are currently eleven Clearing Members 
either subject to the minimum Clearing Fund contribution requirement 
of $150,000 or below the proposed $500,000 requirement. OCC also 
notes that other Clearing Members with generally smaller 
contribution requirements, and for which the contribution 
requirement consists mostly of the minimum fixed amount, would be 
more significantly impacted by the introduction of a higher minimum 
amount into the allocation formula. In addition, firms preparing to 
withdraw from membership by reducing open positions as they wind 
down their business or new Clearing Members coming online and slowly 
increasing their business could be impacted by the change in minimum 
fixed and initial contributions, respectively.
    \100\ See supra note 38.
    \101\ See supra note 39.
---------------------------------------------------------------------------

    Additionally, OCC proposes to modify its allocation weighting 
methodology to more closely align Clearing Members' Clearing Fund 
contribution requirements with the level of risk they bring to OCC. 
Specifically, the proposed Clearing Fund contribution requirements 
would be based on an allocation methodology of 70% of total risk, 15% 
of volume and 15% of open interest (as opposed to the current weighting 
of 35% total risk, 50% open interest, and 15% volume). The

[[Page 28039]]

proposed change would result in potentially higher contribution 
requirements for Clearing Members with large shares of overall margin 
relative to open interest, which could be the result of a portfolio 
that contains directional exposures driving higher margin requirements 
or accounts that have significant exposures in futures subject to 
customer gross margining requirements. OCC believes that this change is 
prudent from a risk management perspective as it would better align 
each Clearing Member's contribution requirement with the risk it 
presents to OCC by requiring those members that bring elevated levels 
of risk to contribute more to the Clearing Fund and thereby incentivize 
those firms to reduce the risk of their exposures. As a result, OCC 
believes that any impact on competition would be necessary and 
appropriate in furtherance of the purposes of protecting investors and 
the public interest under the Act.
    OCC also proposes to modify the volume component of its Clearing 
Fund contribution allocation weighting methodology to provide that OCC 
would use cleared volume, as opposed to executed volume, in allocating 
Clearing Fund contribution requirements. OCC believes that the proposed 
change also is designed to more appropriately allocate contribution 
requirements commensurate to the risks posed by its Clearing Members by 
basing the volume component of the allocation on where the position is 
ultimately cleared, and where the risk is ultimately maintained, as 
opposed to where it was executed. OCC notes that the Clearing Members 
most directly impacted by the proposed change are execution-only 
Clearing Members that directly give up trades through transfers to 
other Clearing Members and do not to clear or carry positions on a 
routine basis, and would therefore generally see reduced contribution 
requirements due to the change from executed volume to cleared volume. 
OCC believes the overall impact to non-execution-only Clearing Members 
due only to the change to cleared volume would be minimal. As a result, 
OCC does not believe the proposed change would have an impact or impose 
a burden on competition.
    OCC also proposes a number of non-material changes, such as 
relocating provisions of OCC's By-Laws concerning the Clearing Fund to 
its Rules, making other clarifying and conforming changes to its Rules, 
Policy and procedures, and clarifying certain pro-cyclicality measures 
in its existing margin methodology, which are not expected to have any 
impact on competition.

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants or Others

    Written comments on the proposed rule change were not and are not 
intended to be solicited with respect to the proposed rule change and 
none have been received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-OCC-2018-008 on the subject line.

Paper Comments

     Send paper comments in triplicate to Brent J. Fields, 
Secretary, Securities and Exchange Commission, 100 F Street NE, 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2018-008. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for website viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of such filing also will be available for inspection 
and copying at the principal office of OCC and on OCC's website at 
https://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_18_008.pdf.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly.
    All submissions should refer to File Number SR-OCC-2018-008 and 
should be submitted on or before July 6, 2018.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\102\
---------------------------------------------------------------------------

    \102\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-12855 Filed 6-14-18; 8:45 am]
 BILLING CODE 8011-01-P


