[Federal Register Volume 83, Number 149 (Thursday, August 2, 2018)]
[Notices]
[Pages 37855-37864]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16529]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83735; File No. SR-OCC-2018-008]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change, as Modified by Amendments No. 1 
and 2, Related to The Options Clearing Corporation's Stress Testing and 
Clearing Fund Methodology

July 27, 2018.

I. Introduction

    On May 30, 2018, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2018-008 (``Proposed Rule Change'') 
pursuant to Section 19(b) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 \2\ thereunder to propose 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'').\3\ 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:
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Notice of Filing infra note 5, at 83 FR 28018.
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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 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 stress testing methodology and would be replaced by the proposed 
Rules, Policy, and Methodology Description described herein.

[[Page 37856]]

    On June 7, 2018, OCC filed Amendment No. 1 to the Proposed Rule 
Change.\4\ The Proposed Rule Change, as amended, was published for 
public comment in the Federal Register on June 15, 2018.\5\ On July 11, 
2018, OCC filed Amendment No. 2 to the Proposed Rule Change.\6\ The 
Commission received five comment letters in support of the proposal.\7\ 
This order approves the Proposed Rule Change as modified by Amendments 
No. 1 and 2.
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    \4\ In Amendment No. 1, OCC corrected formatting errors in 
Exhibits 5A and 5B without changing the substance of the Proposed 
Rule Change.
    \5\ Securities Exchange Act Release No. 83406 (Jun. 11, 2018), 
83 FR 28018 (Jun. 15, 2018) (SR-OCC-2018-008) (``Notice of 
Filing''). On May 30, 2018, OCC also filed a related advance notice 
(SR-OCC-2018-803) (``Advance Notice'') with the Commission pursuant 
to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, entitled the Payment, Clearing, 
and Settlement Supervision Act of 2010 and Rule 19b-4(n)(1)(i) under 
the Act. 12 U.S.C. 5465(e)(1). 15 U.S.C. 78s(b)(1) and 17 CFR 
240.19b-4, respectively. The Advance Notice was published in the 
Federal Register on July 6, 2018. Securities Exchange Act Release 
No. 83561 (Jun. 29, 2018), 83 FR 31594 (Jul. 6, 2018) (SR-OCC-2018-
803).
    \6\ In Amendment No. 2, OCC made three non-substantive changes 
to the proposal. Specifically, OCC (1) updated a cross-reference in 
Article VI, Section 27 of the OCC By-Laws to reflect the relocation 
of OCC's clearing fund-related rules, (2) added an Interpretation 
and Policy to proposed Rule 1001 to clarify the applicability of the 
5 percent month-over-month limitation in the reduction of clearing 
fund size is not intended to apply to the initial changes in to 
OCC's clearing fund sizing resulting from implementation of the 
proposed methodology, and (3) clarified an implementation date of 
September 1, 2018 for the proposed changes in the filing.
    \7\ See letter from Andrej Bolkovic, CEO, ABN AMRO Clearing 
Corporation LLC (``AACC''), dated June 26, 2018, to Brent Fields, 
Secretary, Commission (AACC Letter I); letter from Chris Concannon, 
President and COO, Cboe Global Markets (``CBOE''), dated July 6, 
2018, to Brent Fields, Secretary, Commission (CBOE Letter I); letter 
from Matthew R. Scott, President, Merrill Lynch Professional 
Clearing Corp. (``MLPRO''), dated July 6, 2018, to Brent J. Fields, 
Secretary, Commission (MLPRO Letter I); letter from Kurt Eckert, 
Partner, Wolverine Execution Services (``WEX''), dated July 12, 
2018, to Brent Fields, Secretary, Commission (WEX Letter I); and 
letter from Mark Dehnert, Managing Director, Goldman Sachs & Co. LLC 
(``GS''), dated July 17, 2018, to Brent J. Fields, Secretary, 
Commission (GS Letter I), available at https://www.sec.gov/comments/sr-occ-2018-008/occ2018008.htm.
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II. Background

    The Proposed Rule Change concerns proposed changes to OCC's By-Laws 
\8\ and Rules,\9\ the formalization of the substantially new Policy, 
and the adoption of OCC's new Methodology Description.\10\ According to 
OCC, the changes comprising the Proposed Rule Change are primarily 
designed to enhance OCC's overall resiliency, particularly with respect 
to the level of OCC's pre-funded financial resources.\11\
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    \8\ OCC's By-Laws are available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.
    \9\ OCC's Rules are available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \10\ See Notice of Filing, 83 FR at 28018.
    \11\ See id.
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    As enumerated in the Notice of Filing, the specific modifications 
that OCC proposes are as follows: (1) Reorganize, restate, and 
consolidate the provisions of OCC's By-Laws and Rules relating to the 
clearing fund into a 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 proposed Policy and Methodology 
Description; (5) document governance, monitoring, and review processes 
related to the 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 from $150,000 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; (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, including 
retiring OCC's existing Clearing Fund Intra-Month Re-sizing Procedure, 
Financial Resources Monitoring and Call Procedure, and Monthly Clearing 
Fund Sizing Procedure, as these procedures would be replaced by the 
proposed Rules, Policy, and Methodology Description.\12\
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    \12\ See id. at 28018-19.
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    The remainder of this section will first provide an overview of 
OCC's current process for sizing the clearing fund, followed by a more 
detailed discussion of the specific changes proposed by OCC, with 
particular focus on the following categories: (a) Stress testing; (b) 
total financial resources; (c) financial resource sufficiency; (d) 
allocation of clearing fund contributions; and (e) textual 
clarification and consolidation.

A. OCC's Current Process for Sizing the Clearing Fund

    OCC's process for determining the size of its clearing fund was 
initially approved in 2011,\13\ and enhanced in 2015,\14\ resulting in 
OCC's current process. Currently, OCC resizes its clearing fund at the 
beginning of each month to maintain financial resources, in excess of 
margin, to cover its credit exposures to its clearing members. The 
current process is effectively an extension of OCC's daily margin 
process, in which OCC calculates what it refers to as the ``daily 
draw'' based on observations from its margin model at specific 
confidence levels each day.\15\ OCC tracks the rolling five-day average 
of these daily draws and, at the beginning of each month, sets the 
clearing fund size to the sum of (1) the largest five-day rolling 
average observed over the last three months and (2) a $1.8 billion 
buffer.\16\
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    \13\ See Securities Exchange Act Release No. 65386 (Sep. 23, 
2011), 76 FR 60572 (Sep. 29, 2011) (Order Approving Clearing Fund 
I).
    \14\ See Securities Exchange Act Release No. 75528 (Jul. 27, 
2015), 80 FR 45690 (Jul. 31, 2015) (Order Approving Clearing Fund 
II).
    \15\ See Order Approving Clearing Fund I, 76 FR at 60572-60573. 
Each day, OCC estimates credit exposures under the stressed margin 
model for two scenarios: The greater of the two estimates is the 
daily draw. The two scenarios are of (1) the single largest credit 
exposure that would arise out of the default of a single clearing 
member group (``idiosyncratic default'') and (2) the credit exposure 
that would arise out of the default of two-randomly selected 
clearing member groups (``minor systemic default''). See Notice of 
Filing, 83 FR at 28019.
    \16\ See Order Approving Clearing Fund II, 80 FR at 45691.
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    As described in detail below, OCC is proposing three primary 
changes to the existing approach. First, instead of simply relying on 
its margin model, OCC would rely on the proposed stress testing 
framework, including both sizing and sufficiency stress tests. Second, 
OCC would set the size of its clearing fund based on a Cover 2 
Standard. Third, OCC would eliminate the current $1.8 billion static 
buffer because it would be obsolete in light of the new sizing stress 
tests and increased coverage afforded by the move to a Cover 2 Standard 
that, together, would function as a dynamic buffer.

B. Stress Testing

    OCC proposes to adopt a new stress testing methodology, as detailed 
in both the proposed Policy and the proposed

[[Page 37857]]

Methodology Description.\17\ OCC believes that its proposed methodology 
would enable it to measure its credit exposure at a level sufficient to 
cover potential losses under extreme but plausible market 
conditions.\18\ To do so, OCC proposes to conduct daily stress tests 
that consider a range of relevant stress scenarios and related price 
changes, 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.\19\
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    \17\ See Notice of Filing, 83 FR at 28021.
    \18\ See id.
    \19\ See id.
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    The stress scenarios used in OCC's proposed methodology would 
consist of two types of scenarios: Historical scenarios and 
hypothetical scenarios.\20\ Historical Scenarios would replicate 
historical events in current market conditions, which include the set 
of currently existing securities and their prices and volatility 
levels.\21\ Hypothetical scenarios, rather than replicating past 
events, would simulate events in which market conditions change in ways 
that may have not yet been observed.\22\ Hypothetical Scenarios, 
constructed using statistical methods, would generally include price 
shocks specific to various instruments, such as equity products, 
volatility products, and fixed income products. Each scenario would 
represent a draw from a multivariate distribution fitted to historical 
data regarding the relevant instrument (e.g., returns of the S&P 
500).\23\ In a hypothetical scenario, the shock to a risk driver would 
be used to determine the relative shock to each associated risk factor 
(i.e., related underlying security).\24\ For example, OCC would 
establish the size of its clearing fund according to a scenario that is 
based on statistically generated up or down price shocks for the SPX 
assuming a 1-in-80 year market event.\25\
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    \20\ See id. Because not all of the underlying securities in 
current portfolios existed during the events on which historical 
scenarios are based, OCC has developed methodologies to approximate 
the past price and volatility movements as appropriate. See id. at 
28023.
    \21\ See id. at 28021.
    \22\ See id. at 28022.
    \23\ See id. at 28023. Risk drivers are a selected set of 
securities or market indices (e.g., the Cboe S&P 500 Index (``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. See id. at 28021, n. 25. The term risk factor refers 
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. 
See id.
    \24\ See id. at 28022.
    \25\ See id. at 28023.
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    OCC's proposed stress testing framework would categorize OCC's 
inventory of stress tests by each stress test's intended purpose: 
Adequacy, sizing, sufficiency, and informational.\26\ Specifically, OCC 
would use the (1) ``Adequacy Stress Tests'' to determine whether the 
financial resources collected from all clearing members collectively 
are adequate to cover OCC's risk tolerance; (2) ``Sizing Stress Tests'' 
to establish the monthly size of the clearing fund; (3) ``Sufficiency 
Stress Tests'' to monitor whether OCC's credit exposure to the 
portfolios of individual clearing member groups is at a level 
sufficiently large enough 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) ``Informational Stress Tests'' to 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.\27\
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    \26\ See id. at 28024.
    \27\ See id. at 28024-26.
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C. Total Financial Resources

    As noted above, OCC proposes to (i) to adopt a new clearing fund 
methodology, which would be underpinned by a new scenario-based one-
factor risk model stress testing approach,\28\ modify the coverage 
level of OCC's clearing fund sizing requirement to a Cover 2 Standard; 
(iii) provide for certain anti-procyclical limitations on the reduction 
in clearing fund size from month to month; and (iv) reduce from five 
business days to two business days the timeframe within which clearing 
members are required to satisfy clearing fund deficits due to monthly 
or intra-month resizing.\29\
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    \28\ OCC detailed the new methodology in the proposed Policy and 
Methodology Description.
    \29\ See Notice of Filing, 83 FR at 28020.
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1. Proposal To Change the Monthly Clearing Fund Size Calculation
    As discussed above, OCC proposes to replace the methodology by 
which it determines the monthly clearing fund size with an approach 
based on hypothetical stress scenarios that assume SPX shocks (up and 
down) associated with a 1-in-80-year market event.\30\ Under the 
proposal, OCC would continue determining the size of its clearing fund 
each month based on the peak-five daily rolling average of estimated 
stress exposures; however, such exposures would be based on the output 
from OCC's stress testing framework going forward as opposed to the 
margin-derived approach described above.\31\
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    \30\ See id. at 28023.
    \31\ See id. at 28024. Specifically, OCC would identify its 
exposures under a 1-in-80-year hypothetical event. See id.
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    As its benchmark for identifying extreme but plausible market 
conditions, OCC proposes to adopt a credit risk tolerance defined by 
OCC's largest potential aggregate credit exposure to two clearing 
member groups under a 1-in-50-year hypothetical market event as opposed 
to the greater of exposures arising under an idiosyncratic default or a 
minor systemic default.\32\ OCC further proposes to base its daily draw 
on the aggregate credit exposures estimated under a 1-in-80-year 
hypothetical market event.\33\ Additionally, OCC proposes to size the 
clearing fund to a Cover 2 Standard.\34\
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    \32\ See id. at 28021. As discussed above, OCC's hypothetical 
stress scenarios represent draws from a fitted distribution of 2-day 
log returns for a given risk driver. OCC noted in its proposal that 
a 1-in-50-year hypothetical market event corresponds to a 99.9921 
percent confidence interval under OCC's chosen distribution of 2-day 
logarithmic S&P 500 index returns. See id., n. 24.
    \33\ See id. at 28024.
    \34\ See id. at 28021.
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    OCC believes that sizing the clearing fund to cover a 1-in-80-year 
event would provide sufficient coverage in excess of the exposures 
estimated under a 1-in-50-year event to justify no longer collecting 
the $1.8 prudential margin of safety.\35\
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    \35\ See id., n. 23.
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2. Proposal To Limit Reductions in Clearing Fund Size From Month to 
Month
    Currently, OCC does not constrain month-over-month changes in the 
size of the clearing fund. OCC proposes to adopt two limitations on 
month-over-month decreases in the size of the clearing fund. First, OCC 
proposes to prohibit a clearing fund decrease of more than 5 percent 
month-over-month.\36\ Second, OCC proposes to limit the clearing fund 
decreases based on its daily monitoring of OCC's financial resources. 
When determining the size of the clearing fund at the beginning of a 
given month, OCC would not allow that size to be less than 90 percent 
of the peak credit exposures estimated under the stress tests used for 
daily monitoring during the last five business days of the

[[Page 37858]]

preceding month.\37\ These limitations are designed to reduce the 
potential for cyclical movements in the size of the clearing fund, as 
well as reduce the need for OCC to call for additional financial 
resources intra-month.\38\
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    \36\ See id. at 28027.
    \37\ See id. As discussed below, OCC proposes to monitor the 
sufficiency of its financial resources daily by comparing the size 
of the clearing fund to the output of several historical stress 
tests.
    \38\ See id.
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3. Timing of Clearing Fund Contributions
    In addition to revising the methodology for sizing OCC's total 
financial resources, OCC proposes generally to reduce the time in which 
each clearing member must make its clearing fund contribution.\39\ 
Clearing members currently have five business days to satisfy a 
clearing fund deficiency arising out of the monthly sizing or intra-
month resizing processes. OCC proposes to reduce that time to two 
business days.\40\ OCC also proposes to require clearing members to 
satisfy any clearing fund deficit resulting from a decrease in the 
value of the clearing member's existing contribution within one hour of 
notification by OCC.\41\
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    \39\ See id. at 28028-29.
    \40\ See id. at 28029.
    \41\ See id. at 28028.
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D. Financial Resource Sufficiency

    As noted above, OCC proposes to (i) adopt a new clearing fund 
methodology, as detailed in the newly-proposed Policy and Methodology 
Description and (ii) document governance, monitoring, and review 
processes related to the clearing fund and stress testing.\42\ Proposed 
changes to OCC's clearing fund methodology include the assessment of 
OCC's clearing fund against a wide range of historical scenarios.\43\
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    \42\ See id. at 28020.
    \43\ See id.
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1. Proposal To Monitor the Sufficiency of OCC's Financial Resources
    Currently, OCC monitors the sufficiency of its financial resources 
daily by estimating whether the size of the clearing fund is sufficient 
to cover a maximum potential loss from a simulated idiosyncratic 
default.\44\ Under its current procedures, when OCC observes credit 
exposures estimated under the idiosyncratic default in excess of 75 
percent of the clearing fund size, OCC issues a margin call against the 
clearing member group generating the credit exposures.\45\ The size of 
such a margin call is the difference between the idiosyncratic default 
exposure and the base clearing fund amount.\46\ 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 risk 
to OCC.\47\ OCC may limit the size of the margin call to each clearing 
member to the lesser of $500 million or 100 percent of such clearing 
member's net capital.\48\
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    \44\ See id. at 28019. As noted above, an idiosyncratic default 
is one of the two scenarios that OCC currently uses to determine the 
size of the clearing fund each month. See supra note 15. 
Specifically, the single largest credit exposure that would arise 
out of the default of a single clearing member group.
    \45\ See id.
    \46\ See id. As noted above in section II.A., the base clearing 
fund amount is the size of the clearing fund less the $1.8 billion 
prudential margin of safety.
    \47\ See id., n. 13.
    \48\ See id. at 28019.
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    OCC's current procedures also call for increases to the total size 
of the clearing fund in more extreme scenarios. When OCC observes 
credit exposures estimated under the idiosyncratic default \49\ 
exceeding 90 percent of the clearing fund size OCC must, under its 
procedures, increase the size of the clearing fund.\50\ The size of the 
increase to the clearing fund is the greater of $1 billion or 125 
percent of the difference between the idiosyncratic default exposure 
and the clearing fund.\51\
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    \49\ OCC would reduce the size of the idiosyncratic default 
exposure by factoring in margin calls issued due to a breach of the 
75 percent threshold described above. See id.
    \50\ See id.
    \51\ See id.
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    OCC proposes to revise this process by replacing the above-
described idiosyncratic default approach with an approach that compares 
the size of the clearing fund to the exposures estimated under a set of 
historical scenario stress tests (``Sufficiency Stress Tests'').\52\ 
The Sufficiency Stress Tests proposed by OCC include the largest market 
moves up and down during 2008 on a cover 2 basis and the market moves 
associated with the 1987 market crash on a cover 1 basis.\53\
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    \52\ See id. at 28024.
    \53\ See id. OCC proposes to measure the clearing fund against 
the two largest exposures under the 2008-like events and the one 
largest exposure under a 1987-like event. See id.
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    OCC proposes to call for additional margin when it observes that 
one or more clearing member groups' exposure under a Sufficiency Stress 
Test exceeds 75 percent of the clearing fund.\54\ Under the proposal, 
the size of the margin call would be the amount by which the 
Sufficiency Stress Test exposure exceeds the 75 percent threshold.\55\ 
Similar to the current process, OCC proposes to retain authority to 
limit such margin calls to each clearing member to $500 million or 100 
percent of the clearing member's net capital.\56\
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    \54\ See id. at 28025.
    \55\ See id.
    \56\ See id.
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    OCC also proposes to revise the process for increasing the size of 
the clearing fund under more extreme scenarios. OCC proposes to 
increase the size of the clearing fund when it observes a Sufficiency 
Stress Test exposure in excess of 90 percent of the clearing fund.\57\ 
Similar to the current process, the size of the clearing fund increase 
would be the greater of $1 billion or 125 percent of the difference 
between the Sufficiency Stress Test exposure and the clearing fund.\58\ 
OCC also proposes to provide new authority to its Chief Executive 
Officer, Chief Administrative Officer, and Chief Operating Officer to 
temporarily increase the size of the clearing fund, subject to notice 
and later review by OCC's Board Risk Committee (``RC'').\59\
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    \57\ See id. at 28025-26.
    \58\ See id. at 28026.
    \59\ See id.
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    Additionally, OCC proposes to add a new threshold at which it would 
commence enhanced monitoring of a clearing member group.\60\ Where OCC 
observes that a clearing member group's Sufficiency Stress Test 
exposure exceeds 65 percent of the clearing fund, OCC would commence 
enhanced monitoring of, and provide notice to the clearing member 
group.\61\
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    \60\ See id. at 28025. Based on OCC's procedures, staff 
understands that such monitoring would entail escalation within 
OCC's Financial Risk Management group noting the relevant clearing 
member, the future potential for breach of the 75 percent margin 
call threshold, and a summary of the apparent risk drivers resulting 
in the stress exposures.
    \61\ See id.
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2. Proposal To Document Governance Processes Related to the Clearing 
Fund and Stress Testing
    OCC proposes to establish, as part of its rules, processes for the 
governance, monitoring, and review of the stress testing framework and 
clearing fund methodology described above.\62\ Such processes would 
cover daily, monthly, and annual review of OCC's stress testing 
framework and clearing fund methodology.
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    \62\ See id. at 28026.
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    On a daily basis, OCC's staff would monitor the size of the 
clearing fund against OCC's risk tolerance and sufficiency stress 
tests.\63\ OCC staff would be required to report material issues to the 
Executive Vice President of OCC's Financial Risk Management group 
(``EVP-FRM''). The EVP-FRM

[[Page 37859]]

would further escalate issues with OCC management as applicable.
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    \63\ See id.
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    On a monthly basis, OCC's staff would provide reports and analyses 
of the daily stress tests to OCC's Management Committee and RC.\64\ 
OCC's staff would also be responsible for conducting a comprehensive 
analysis of stress test results, scenarios, models, parameters, and 
assumptions monthly or more frequently when the products cleared or 
markets served by OCC display high volatility or become less liquid or 
when the size or concentration of positions held by OCC's participants 
increases significantly.\65\
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    \64\ See id. at 28026-27.
    \65\ See id. at 28026.
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    On an annual basis, OCC's Model Validation Group would be required 
to perform a model validation of OCC's clearing fund methodology.\66\ 
The RC would review such validations.\67\ The RC would also be 
responsible for annual review and approval of the Policy.\68\
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    \66\ See id. at 28027.
    \67\ See id.
    \68\ See id.
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E. Allocation of Clearing Fund Contributions

    As noted above, OCC proposes to (i) increase the minimum clearing 
fund contribution requirement for clearing members to $500,000 and (ii) 
modify OCC's allocation weighting methodology for clearing fund 
contributions.\69\
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    \69\ See id. at 28020.
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1. Proposal To Increase the Minimum Clearing Fund Contribution
    Currently, the minimum amount a clearing member must contribute to 
OCC's clearing fund (the ``fixed amount'') is $150,000.\70\ OCC 
proposes to increase the fixed amount to $500,000.\71\ The minimum 
contribution requirement has been in place since June 5, 2000,\72\ and 
has remained static while the average size of OCC's clearing fund has 
increased significantly.\73\ OCC also noted that other CCPs' minimum 
requirements are well in excess of OCC's minimum contribution 
requirement.\74\ OCC analyzed the impact of the proposed change on its 
clearing members and discussed such impacts with the potentially 
affected clearing members, the majority of which did not express 
concerns over the proposed increase.\75\
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    \70\ See id. at 28028. The initial amount that a new clearing 
member must contribute to OCC's clearing fund is also $150,000. See 
id. at 28027.
    \71\ See id. at 28028. OCC similarly proposes to increase the 
initial contribution. See id. at 28027.
    \72\ See id. (citing Securities Exchange Act Release No. 42897 
(June 5, 2000), 65 FR 36750 (June 9, 2000) (SR-OCC-99-9)).
    \73\ See id. at 28027.
    \74\ See id.
    \75\ See id.
---------------------------------------------------------------------------

2. Proposal To Modify the Clearing Fund Allocation Weighting
    In addition to the fixed amount described above, most clearing 
members are required to contribute an additional amount to OCC's 
clearing fund (the ``variable amount''). The variable amount is based 
on the weighted average of each clearing member's proportionate share 
of total risk, open interest, and volume.\76\ Currently, OCC uses the 
following weighting in its allocation of clearing fund requirements: 35 
percent total risk; 50 percent open interest; and 15 percent 
volume.\77\ OCC proposes to modify the allocation weighting as follows: 
70 percent total risk; 15 percent open interest; and 15 percent 
volume.\78\
---------------------------------------------------------------------------

    \76\ See id. at 28028. Total risk refers to a clearing member's 
margin requirement. See id., n. 43. Additionally, the current 
methodology calculates volume based on executed volume. See id. at 
28028.
    \77\ See id.
    \78\ See id. The definition of total risk would remain the same, 
but OCC would calculate volume based on cleared volume as opposed to 
executed volume. See id.
---------------------------------------------------------------------------

F. Textual Clarification and Consolidation

    Finally, as noted above, OCC proposes to (i) 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; (ii) 
provide additional clarity in OCC's Rules regarding certain anti-
procyclicality measures in OCC's margin model; and (iii) make a number 
of other non-substantive clarifying, conforming, and organizational 
changes to OCC's By-Laws, Rules, and filed procedures, including 
retiring OCC's existing Clearing Fund Intra-Month Re-sizing Procedure, 
Financial Resources Monitoring and Call Procedure, and Monthly Clearing 
Fund Sizing Procedure, as these procedures would be replaced by the 
proposed Rules, Policy, and Methodology Description.\79\
---------------------------------------------------------------------------

    \79\ See id. at 28020.
---------------------------------------------------------------------------

1. Proposal To Reorganize, Restate, and Consolidate Certain Rule Text
    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.\80\ 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.\81\ Given the scope of changes described 
above, OCC believes that it is appropriate to make such revisions at 
this time.\82\
---------------------------------------------------------------------------

    \80\ See id.
    \81\ See id.
    \82\ See id.
---------------------------------------------------------------------------

    The changes to the provisions currently residing in OCC's 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; however, changes to OCC's rules generally require only 
a majority vote of OCC's Board of Directors.\83\ OCC proposes to amend 
its By-Laws to maintain the existing requirements for modifying those 
rules that would be moved from Article VIII of OCC's By-Laws to Chapter 
X of its Rules.\84\
---------------------------------------------------------------------------

    \83\ See id.
    \84\ See id.
---------------------------------------------------------------------------

2. Proposal To Add Rule Text Clarifying Anti-Procyclicality Measures in 
OCC's Margin Model
    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.\85\ 
OCC now proposes to amend its Rule 601(c) to reflect this practice.\86\ 
OCC believes that the proposed change would provide more clarity and 
transparency in its rules.\87\
---------------------------------------------------------------------------

    \85\ See id. at 28029.
    \86\ See id.
    \87\ See id.
---------------------------------------------------------------------------

3. Proposal To Make Other Non-Substantive Changes to OCC's Rules
    OCC proposes a number of 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 of OCC's Clearing Fund-related By-Laws 
into Chapter X of the Rules.\88\
---------------------------------------------------------------------------

    \88\ See id. at 28029-30.
---------------------------------------------------------------------------

    In addition to the relocation of rules described above, OCC would 
also make minor, non-substantive revisions. For example, OCC would 
replace text referencing ``computed contributions to the Clearing 
Fund'' and ``as fixed at the time'' with text stating ``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

[[Page 37860]]

amount as calculated under the proposed rules.\89\
---------------------------------------------------------------------------

    \89\ See id. at 28031, n. 52.
---------------------------------------------------------------------------

    Further, 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.\90\
---------------------------------------------------------------------------

    \90\ See id. at 28031.
---------------------------------------------------------------------------

    Finally, OCC proposes to replace procedures regarding its processes 
for (i) the monthly resizing of its Clearing Fund, (ii) the addition of 
financial resources, and (iii) the execution of any intra-month 
resizing of the Clearing Fund.\91\ OCC proposes to retire its existing 
procedures because the relevant rule requirements would be maintained 
in the proposed rules as well as the Clearing Fund Methodology Policy 
and Clearing Fund Methodology Description included as part of the 
Proposed Rule Change.\92\
---------------------------------------------------------------------------

    \91\ See id.
    \92\ See id.
---------------------------------------------------------------------------

III. Summary of Comments

    As noted above, the Commission received five comment letters--AACC 
Letter I, CBOE Letter I, MLPRO Letter I, WEX Letter I, and GS Letter 
I--supporting the changes in the Proposed Rule Change.\93\ Two of the 
commenters urge the Commission to approve the proposal as expeditiously 
as possible.\94\ AACC believes that the proposal would remediate two 
problems with the current clearing fund methodology: (1) OCC's current 
clearing fund sizing methodology failing to contain sufficient anti-
procyclicality measures, and (2) OCC's current clearing fund 
contribution allocation methodology failing to appropriately 
incentivize clearing member risk management.\95\
---------------------------------------------------------------------------

    \93\ See supra note 7.
    \94\ AACC Letter I at 1; MLPRO Letter I at I.
    \95\ AACC Letter I at 1.
---------------------------------------------------------------------------

    Regarding the clearing fund sizing methodology, AACC believes that 
the proposal would implement a number of measures intended to provide 
stability and consistency to the size of OCC's clearing fund.\96\ 
Specifically, AACC supports (1) sizing the clearing fund based on a 
variety of risk factors, and (2) testing the size of the clearing fund 
on a daily basis against extreme but plausible market events, thereby 
lowering the likelihood that OCC's clearing fund would be insufficient 
to protect OCC and market participants in the event of a clearing 
member default.\97\ MLPRO believes that the proposed changes would 
create a more transparent and predictable model.\98\ Similarly, GS 
supports OCC's proposal to include more comprehensive testing scenarios 
by including observed market events over a longer historical period, 
which would improve the overall quality of OCC's stress testing and 
strengthen OCC's ability to model risk scenarios.\99\ Additionally, WEX 
believes that the proposed changes, specifically changes regarding how 
the monthly clearing fund sizing process will address anti-
procyclicality, should help reduce operational issues related to a 
clearing member's obligations increasing and decreasing.\100\
---------------------------------------------------------------------------

    \96\ Id. at 2.
    \97\ Id. at 2-3.
    \98\ MLPRO Letter I at 2.
    \99\ GS Letter I at 2. In its letter, GS refers to OCC's 
movement to a 1-in-80-year period from a 1-in-50-year model. The 
Commission notes that OCC's current process is not based on a 1-in-
50-year model, and that OCC is now proposing to adopt a new risk 
tolerance based on a 1-in-50-year hypothetical event. See Notice of 
Filing, 83 FR at 31596. Further, OCC proposes to base the size of 
the clearing fund on the aggregate credit exposures estimated under 
a 1-in-80-year hypothetical market event (as opposed to an 
historical market event). See id. at 31600.
    \100\ WEX Letter I at 1.
---------------------------------------------------------------------------

    AACC states that, from a theoretical perspective, OCC's proposed 
sizing methodology constitutes a significant improvement over the 
current sizing methodology in that the size of the clearing fund would 
be less influenced by changes in volatility because OCC is introducing 
other risk drivers into the sizing methodology as well as monitoring 
and augmenting such risk drivers on a daily basis based on market 
conditions.\101\ AACC also comments that the proposal would cause the 
size of OCC's clearing fund to become more stable because OCC would 
test for adequacy and sufficiency on a daily basis using a series of 
historical and hypothetical stress tests that are rooted in extreme but 
plausible market events.\102\
---------------------------------------------------------------------------

    \101\ AACC Letter I at 3.
    \102\ Id.
---------------------------------------------------------------------------

    Commenters also believe that the proposal would improve OCC's risk 
models by correcting existing shortcomings.\103\ CBOE comments that the 
adoption of a Cover 2 standard would ensure that the size of the 
clearing fund is sufficient to protect OCC against losses from the 
simultaneous default of its two largest Clearing Members under extreme, 
but plausible market conditions.\104\ GS also agrees with OCC's 
proposal to adopt a Cover 2 Standard.\105\ MLPRO comments that the 
adoption of a Cover 2 standard in establishing a new model to measure 
the adequacy of the clearing fun and address potential default 
scenarios would address issues that MLPRO identifies with OCC's current 
model.\106\ MLPRO also supports OCC's (1) adopting risk tolerance and 
stress testing assumptions that are developed from extreme, but 
plausible scenarios, and (2) calibrating individual equity price 
movements to the price shock for the applicable equity index to address 
issues with the current model.\107\
---------------------------------------------------------------------------

    \103\ CBOE Letter I at 1; MLPRO Letter I at 1-2.
    \104\ CBOE Letter I at 1.
    \105\ GS Letter I at 2.
    \106\ MLPRO Letter I at 1-2.
    \107\ Id.
---------------------------------------------------------------------------

    Regarding the changes to the clearing fund allocation methodology, 
commenters believe that the proposal would better align clearing 
members' required clearing fund contribution to the risk they present 
to OCC and other market participants.\108\ AACC states that the 
proposed changes would place more emphasis on the economic risk 
presented by a clearing member's cleared contracts than the operational 
risk presented by a high volume clearing member, thereby better 
recognizing that certain types of clearing members present a relatively 
lower risk to OCC even though they may represent a higher percentage of 
overall activity (i.e., clearing members with market-maker and other 
risk-neutral customers).\109\ Similarly, WEX supports allocation based 
on cleared volumes as opposed to executed volumes in consideration of 
where a positon is cleared as opposed to where it is executed.\110\ 
MLPRO also supports increases the weighting of total risk in the 
allocation process.\111\ Commenters also believe that the proposed 
changes make sense from a default and liquidation perspective.\112\
---------------------------------------------------------------------------

    \108\ AACC Letter I at 4; WEX Letter I at 1; GS Letter I at 1.
    \109\ AACC Letter I at 4.
    \110\ WEX Letter I at 2.
    \111\ MLPRO Letter I at 2.
    \112\ AACC Letter I at 4; GS Letter I at 1.
---------------------------------------------------------------------------

    Commenters AACC and WEX believe that the proposed changes would 
have positive effects on the listed options market.\113\ Similarly, 
MLPRO believes that the proposed changes would increase liquidity in 
the listed options market.\114\ Additionally, GS believes that the 
proposed changes will greatly enhance OCC's resiliency and risk 
management.\115\
---------------------------------------------------------------------------

    \113\ AACC Letter I at 5; WEX Letter I at 2.
    \114\ MLPRO Letter I at 1.
    \115\ GS Letter I at 2.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such

[[Page 37861]]

proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to such 
organization.\116\ After carefully considering the Proposed Rule 
Change, the Commission finds the proposal is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to OCC. More specifically, the Commission finds that the 
proposal is consistent with Section 17A(b)(3)(F) of the Act \117\ and 
Rules 17Ad-22(e)(1) and 17Ad-22(e)(4) thereunder.\118\
---------------------------------------------------------------------------

    \116\ 15 U.S.C. 78s(b)(2)(C).
    \117\ 15 U.S.C. 78q-1(b)(3)(F).
    \118\ 17 CFR 240.17Ad-22(e)(1); 17 CFR 240.17Ad-22(e)(4).
---------------------------------------------------------------------------

A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to, among other things, promote the prompt 
and accurate clearance and settlement of securities transactions, 
assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible, and, in general, to protect investors and the public 
interest.\119\ Based on its review of the record, the Commission 
believes that the proposed changes are designed to promote the prompt 
and accurate clearance and settlement of securities transactions, 
assure the safeguarding of securities and funds which are in OCC's 
custody or control, and, in general, protect investors and the public 
interest by enhancing OCC's overall risk management for the reasons set 
forth below.
---------------------------------------------------------------------------

    \119\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    First, as described above, OCC's current process for sizing the 
clearing fund was established in 2011 and strengthened under a 2015 
interim approach. The current process is essentially an extension of 
OCC's margin model. In general, margin requirements for clearing 
members are very reactive to market movements and changes in clearing 
member portfolios. Because OCC's current process for sizing the 
clearing fund is based on a relatively dynamic daily margin process, 
the size of the clearing fund can at times be volatile and cyclical in 
nature. The Proposed Rule Change would base the sizing and monitoring 
of OCC's clearing fund on a stable inventory of stress tests rather 
than continuing to rely on a dynamic margin model. The Commission 
believes this new approach would provide OCC with a more precise, 
rigorous, and stable assessment of the financial resources it would 
need to hold in its clearing fund to cover its credit risk exposure to 
its members in extreme but plausible market conditions.
    Second, with respect to the robustness of the new stress testing 
framework itself, the Commission believes that the stress tests 
proposed in OCC's framework are an improvement over OCC's current 
approach in this area, as the stress tests comprise a wide range of 
foreseeable stress scenarios. The scenarios cover historical events as 
extreme as the 2008 financial crisis and 1987 market crash as well as 
hypothetical events derived from a dataset of historical S&P returns. 
OCC's proposed stress testing framework would also include a category 
of stress tests designed specifically for review of OCC's financial 
resources against implausible scenarios and reverse stress tests. Such 
stress tests would not directly affect the total amount of OCC's 
financial resources, but would facilitate a more forward looking risk 
management process. Accordingly, while as an ongoing supervisory matter 
the Commission expects OCC to consider and, as necessary, implement 
future enhancements to its suite of stress tests, the Commission 
believes that the suite of stress tests that OCC proposes to establish 
in its risk management framework pursuant to the Proposed Rule Change 
represents a material improvement to OCC's current risk management 
practices for estimating potential future losses in extreme but 
plausible market conditions.
    Third, as described above, OCC proposes to adopt several 
enhancements to its methodology for determining the size of its 
clearing fund. OCC proposes to adopt an internal credit risk tolerance 
based on hypothetical stress scenarios, which would provide OCC with a 
benchmark that it believes represents extreme but plausible market 
conditions. The Commission believes that establishing such a tolerance 
is a valuable step in accurately estimating the total financial 
resources necessary to cover OCC's exposures in extreme but plausible 
market conditions. Next, OCC proposes to set the size of its clearing 
fund to cover a scenario that is more extreme than its internal 
tolerance to ensure consistent coverage, which the Commission believes 
would be another valuable step in accurately estimating OCC's necessary 
total financial resources. Further, OCC proposes to cover its two 
largest credit exposures when setting the size of the clearing fund, 
which goes further than OCC's current practice of covering the greater 
of OCC's single largest exposure or two random exposures. For the same 
reasons, the Commission believes this, too, would improve OCC's risk 
management practices. Finally, OCC proposes to limit the potential 
reductions in the size of the clearing fund month-over-month. Such 
limitations would avoid large drops in the clearing fund size over a 
short period of time and unnecessary reductions followed by immediate 
calls for additional resources at the beginning of each month.
    Fourth, the proposal discussed above would expand and improve upon 
the scope of stress scenarios against which OCC monitors is financial 
resources. Under the proposal, OCC would continue to review the size of 
its clearing fund against exposures under a stress scenario designed to 
replicate the 1987 market crash, and would also introduce monitoring 
against other historical scenarios such as the largest market moves up 
and down observed during the 2008 financial crisis. In addition, OCC 
would continue its practice of collecting additional resources in 
margin collateral and clearing fund requirements where stress exposures 
exceed 75 percent and 90 percent, respectively, of the size of the 
clearing fund. Based on a review of the parameters of the scenario 
replicating the 1987 market crash, the Commission believes that the 
scenario presents potential losses that are extreme while also 
plausible in light of their historical basis. Additionally, the 
Commission believes that the scenario would provide stress exposure 
estimates that would be meaningful for the monitoring of OCC's total 
financial resources. The Commission also believes that the introduction 
of new historical scenarios, such as those replicating the financial 
crisis, would provide additional depth to the monitoring of OCC's 
financial resources. The Commission believes, therefore, that the 
changes proposed in the Proposed Rule Change include the adoption of a 
wide range of stress scenarios for the testing of OCC's financial 
resources.
    Fifth, OCC would document its periodic review and analysis of its 
stress testing framework and clearing fund methodology, which would 
include (1) daily review of stress test outputs, (2) monthly (or more 
frequently as needed) analysis of the stress test results, scenarios, 
models, parameters, and assumptions, and (3) annual validation of the 
clearing fund methodology. OCC also would clearly define the process 
for escalating the results of its daily and monthly analyses and 
require on an annual basis Board level review and

[[Page 37862]]

approval of the Clearing Fund Methodology Policy. The Commission 
believes that these governance processes would help ensure that OCC is 
in a position to continuously monitor, analyze, and adjust as necessary 
both the stress testing framework and the clearing fund methodology, 
thereby helping to ensure the accuracy and reliability of the 
methodology by which OCC tests the sufficiency of its financial 
resources.
    Taken together, and for the reasons discussed above, the Commission 
believes that the proposed changes will increase the likelihood that 
OCC will have sufficient financial resources in excess of margin to 
address credit losses that could arise from a wide range of stress 
scenarios including, but 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. Having an 
improved capacity to access and apply sufficient financial resources to 
credit losses in a wide range of stress scenarios should, in turn, 
enhance OCC's ability to continue to promptly and accurately clear and 
settle securities transactions for participants in the options markets 
during periods of market stress. Therefore, the Commission believes 
that the proposal is consistent with promoting the prompt and accurate 
clearance and settlement of securities transactions.
    The Commission further believes that the proposed changes are 
consistent with assuring the safeguarding of securities and funds which 
are in OCC's custody or control, or for which it is responsible. By 
establishing a clearing fund that is sized to address credit losses 
that could arise from a wide range of stress scenarios including, but 
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, the proposal will enhance 
OCC's ability to use the clearing fund as a means to safeguard the 
securities and funds it holds for its Clearing Members during periods 
of market stress. In addition, the Commission believes that the 
proposed changes to OCC's allocation weighting will allow OCC to better 
manage its credit exposures to its clearing members by better aligning 
each clearing member's contributions to the credit risk it poses to 
OCC. This improved ability to manage credit exposure in the form of 
clearing fund amounts more closely calibrated to credit exposure 
should, in turn, improve OCC's ability to rely upon the clearing fund 
as a resource to safeguard the securities and funds it holds during 
periods of market stress.
    Finally, the Commission believes that OCC's proposed measures 
addressing the potential procyclical nature of clearing fund 
obligations, as well as the textual clarifications and reorganization 
set forth in the proposal, are consistent with the protection of 
investors and the public interest. The enhanced certainty for Clearing 
Members that should be achieved in the form of clearly established and 
understood limitations on the reduction in Clearing Fund size from 
month to month should make it easier for Clearing Members, and their 
customers and investors more broadly, to more easily anticipate and 
manage financial resource demands that can arise from OCC's risk 
management processes in respect of the clearing fund. In addition, the 
reorganization and consolidation of rule provisions related to OCC's 
clearing fund would enhance the readability of OCC's public-facing 
rules, and additional clarification of OCC's margin rules would promote 
transparency by providing the public with information about OCC's risk 
management processes. The Commission believes that the additional 
clarity, predictability and transparency provided by these proposed 
changes would generally be consistent with the protection of investors 
and the public interest by removing potential sources of confusion, 
surprise or misunderstanding regarding the operations and potential 
consequences of OCC's risk management processes in respect of the 
clearing fund.
    Accordingly, and for the reasons stated above, the Commission finds 
that the Proposed Rule Change is consistent with Section 17A(b)(3)(F) 
of the Act.\120\
---------------------------------------------------------------------------

    \120\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

B. Consistency With Rule 17Ad-22(e)(4) Under the Act

1. Total Financial Resources
    Rules 17Ad-22(e)(4)(i) and (iii) under the Act requires, among 
other things, that OCC 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 by, among other things, maintaining financial 
resources at the minimum to enable OCC 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.\121\
---------------------------------------------------------------------------

    \121\ 17 CFR 240.17Ad-22(e)(4)(i) and (iii).
---------------------------------------------------------------------------

    As described above, the proposal includes enhancements to OCC's 
methodology for sizing its clearing fund to ensure that it maintains 
sufficient financial resources, including: (i) Adoption of an internal 
credit risk tolerance that OCC believes represents extreme but 
plausible market conditions; (ii) sizing the clearing fund to cover 
credit exposures under scenarios that are more extreme than OCC's risk 
tolerance, (iii) sizing the clearing fund to cover the default of the 
two clearing member groups that that would potentially cause the 
largest aggregate credit exposure for OCC; (iv) limiting the potential 
reduction in clearing fund size month-over-month; and (v) shortening 
the time by which each clearing member must fund its clearing fund 
contribution.
    Taken together, the Commission believes that proposed changes 
described above are designed to improve the process by which OCC sizes 
its total financial resources and are consistent with the requirements 
of Rules 17Ad-22(e)(4)(i) and (iii) under the Act. First, the proposal 
is designed to cover credit exposures in excess of those posed by any 
one clearing member group because OCC is proposing to cover the largest 
aggregate exposure to two clearing member groups. Second, the proposal 
is designed to cover credit exposures in extreme but plausible market 
conditions because OCC proposes to size its clearing fund based on 
scenarios that are more extreme than those that OCC believes to 
represent extreme but plausible market conditions. Further, based on 
the Commission's detailed analysis of the relevant scenarios through 
the supervisory process, the Commission believes that OCC has defined 
extreme but plausible scenarios in an acceptable manner for the markets 
served. Finally, the Commission believes that proposal would support 
the consistent and stable maintenance of an appropriate level of total 
financial resources by limiting month-over-month reductions in the size 
of clearing fund and requiring clearing members to make clearing fund 
contributions within two business days. Accordingly, the Commission 
believes that the proposed modifications to OCC's clearing fund sizing 
methodology are consistent with Rule 17Ad-22(e)(4)(i) and (iii).\122\
---------------------------------------------------------------------------

    \122\ Id.

---------------------------------------------------------------------------

[[Page 37863]]

2. Financial resource sufficiency
    Rule 17Ad-22(e)(4)(vi) under the Act requires OCC to 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 by testing the sufficiency 
of its total financial resources available to meet the minimum 
financial resource requirements under paragraphs Rules 17Ad-22(e)(4)(i) 
through (iii).\123\ Such testing must include (A) Conducting stress 
testing of OCC's total financial resources once each day using standard 
predetermined parameters and assumptions; (B) 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; (C) 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; and (D) reporting the results of 
such analyses to appropriate decision makers at OCC, 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 set forth in paragraphs 
(e)(4)(i) through (iii) of Rule 17Ad-22.\124\ Additionally, pursuant to 
Rule 17Ad-22(e)(4)(vii) under the Act, the policies and procedures 
required under Rule 17Ad-22(e)(4) must include the performance of a 
model validation of OCC's credit risk models not less than annually or 
more frequently as may be contemplated by OCC's risk management 
framework.\125\
---------------------------------------------------------------------------

    \123\ 17 CFR 240.17Ad-22(e)(4)(vi) (citing 17 CFR 240.17Ad-
22(e)(4)(i)-(iii)).
    \124\ 17 CFR 240.17Ad-22(e)(4)(vi)(A)-(D).
    \125\ 17 CFR 240.17Ad-22(e)(4)(vii).
---------------------------------------------------------------------------

    After reviewing and assessing the proposal, the Commission believes 
that the proposed changes described above are consistent with Rules 
17Ad-22(e)(4)(vi) and (vii) under the Act,\126\ because, among other 
reasons, (i) they are designed to improve the testing of OCC's 
financial resources; (ii) expanding the scope of stress scenarios 
against which OCC monitors its financial resources would increase the 
likelihood that OCC maintains sufficient financial resources at all 
times; and (iii) the formalization of OCC's processes for the periodic 
review and analysis its stress testing framework and clearing fund 
methodology is designed to support OCC's monitoring of its financial 
resources.
---------------------------------------------------------------------------

    \126\ 17 CFR 240.17Ad-22(e)(4)(vi) and (vii).
---------------------------------------------------------------------------

    In addition, the Commission believes that (i) the daily testing of 
OCC's financial resources against the sufficiency stress tests, 
including stress tests based on market movements in the 2008 financial 
crisis and the 1987 market crash included in the proposal would be 
consistent with the daily stress testing requirements of Rule 17Ad-
22(e)(4)(vi)(A), as described above; (ii) the at least monthly analysis 
of stress test results, scenarios, models, parameters, and assumptions, 
with more frequent review and analysis as required would be consistent 
with the monthly comprehensive analysis requirements set forth in Rule 
17Ad-22(e)(4)(vi)(B) and (C) as described above; and (iii) the annual 
validation of OCC's clearing fund methodology discussed in more detail 
above would be consistent with model validation requirements of Rule 
17Ad-22(e)(4)(vii). The proposal also contemplates the reporting and 
escalation of such testing, analyses, and validations to OCC's 
management and Board of Directors, which the Commission believes would 
be consistent with the reporting requirements of Rule 17Ad-
22(e)(4)(vi)(D).
    Accordingly, taken together and for the reasons discussed above, 
the Commission believes that the proposed stress testing and clearing 
fund methodology governance changes are consistent with Rules 17Ad-
2(e)(4)(vi) and (vii).\127\
---------------------------------------------------------------------------

    \127\ Id.
---------------------------------------------------------------------------

3. Proposal To Modify the Clearing Fund Allocation Methodology
    As noted above, Rule 17Ad-22(e)(4) under the Act requires that OCC 
establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to, among other things, effectively 
manage its credit exposures to participants.\128\
---------------------------------------------------------------------------

    \128\ 17 CFR 240.17Ad-22(e)(4).
---------------------------------------------------------------------------

    As discussed above, OCC manages its credit exposures not covered by 
margin through the allocation of clearing fund requirements to its 
clearing members. OCC proposes to determine the size of is clearing 
fund based on the measurement of its credit exposures under 
hypothetical stress scenarios, and to monitor such exposures under 
historical stress scenarios. OCC also proposes to increase the initial 
and minimum clearing fund contribution amounts from $150,000 to 
$500,000, and to modify the allocation weighting used to determine the 
variable amount that most clearing members contribute to the clearing 
fund. Specifically, under the proposal, the proposed clearing fund 
contribution requirements would be based on an allocation methodology 
of 70 percent of total risk, 15 percent of open interest and 15 percent 
of open interest (as opposed to the current weighting of 35 percent 
total risk, 50 percent open interest, and 15 percent volume).
    The Commission believes that the changes described above are 
reasonably designed to improve OCC's management of its credit exposures 
to participants. First, OCC's overall clearing fund size has increased 
significantly since the current initial and minimum contributions were 
set in 2000 and OCC's requirements are lower than the minimum 
requirements imposed by other CCPs. The Commission believes that the 
proposed changes to OCC's initial and minimum clearing fund 
contribution amounts are designed to better manage the risks posed by 
clearing members with minimal open interest, and are commensurate with 
the growth of OCC's clearing fund over time. The Commission also 
believes that the changes to OCC's allocation weighting will allow OCC 
to better manage its credit exposures to its clearing members by better 
aligning each clearing member's contributions to the credit risk it 
poses to OCC, thereby allowing OCC to better manage its credit 
exposures to its participants.
    Accordingly, based on the foregoing, the Commission believes that 
the proposed changes pertaining to the sizing, monitoring, and 
allocation of clearing fund requirements are consistent with Exchange 
Act Rule 17Ad-22(e)(4).\129\
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    \129\ Id.
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C. Consistency With Rule 17Ad-22(e)(1) Under the Act

    Rule 17Ad-22(e)(1) under the Act requires that OCC establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to

[[Page 37864]]

provide for a well-founded, clear, transparent, and enforceable legal 
basis for each aspect of its activities in all relevant 
jurisdictions.\130\ The Commission has stated that, in establishing and 
maintaining policies and procedures to address legal risk, a covered 
clearing agency generally should consider whether its rules, policies 
and procedures, and contracts are clear, understandable, and consistent 
with relevant laws and regulations.\131\
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    \130\ 17 CFR 240.17Ad-22(e)(1).
    \131\ Securities Exchange Act Release 78961 (Sep. 28, 2016), 81 
FR 70786, 70802 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards'').
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    The Commission believes that the proposed consolidation and 
reorganization of OCC's Rules described above would improve readability 
by locating all rules related to the clearing fund in one place, 
thereby enhancing the clarity, transparency, consistency, and 
understandability of OCC's Rules related to the clearing fund. 
Additionally, by amending the Rules to accurately reflect OCC's current 
margin practices, the Commission believes OCC's Rules will be more 
transparent and understandable.
    Accordingly, the Commission finds that the proposed textual 
reorganization and clarifications are consistent with Rule 17Ad-
22(e)(1).\132\
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    \132\ 17 CFR 240.17Ad-22(e)(1).
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V. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the Act, 
and in particular, the requirements of Section 17A of the Act \133\ and 
the rules and regulations thereunder.
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    \133\ In approving this Proposed Rule Change, the Commission has 
considered the proposed rules' impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\134\ that the Proposed Rule Change (SR-OCC-2018-008), as modified 
by Amendments No. 1 and 2, be, and hereby is, approved.
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    \134\ 15 U.S.C. 78s(b)(2).
    \135\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\135\
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2018-16529 Filed 8-1-18; 8:45 am]
 BILLING CODE 8011-01-P


