[Federal Register Volume 85, Number 77 (Tuesday, April 21, 2020)]
[Notices]
[Pages 22197-22200]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-08386]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88654; File No. SR-OCC-2020-004]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Modify the Sequence for 
Processing Options Transactions

April 15, 2020.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 6, 2020, 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. 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.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    This proposed rule change by OCC would amend Interpretations and 
Policies .04 to Rule 801 and Interpretations and Policies .04 to Rule 
805 to describe a proposed change to the sequence in which options 
transactions are processed, as described below. The proposed changes to 
OCC's Rules are included in Exhibit 5 of the filing. Material proposed 
to be added to OCC's Rules as currently in effect is marked by 
underlining and material proposed to be deleted is marked with 
strikethrough text. All terms with initial capitalization that are not 
otherwise defined herein have the same meaning as set forth in the By-
Laws and Rules.\3\
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    \3\ 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
Background
    OCC currently processes all securities and commodity futures 
options transactions in the following order: \4\
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    \4\ A ``commodity future'' is defined in Article I(c)(24) of By-
Laws as ``a futures contract within the exclusive jurisdiction of 
the Commodity Futures Trading Commission that is traded on, through 
the facilities of, or subject to the rules of a futures market.'' 
Options on securities futures currently do not exist.

Options Processing Sequence for All Accounts
    Opening Buys
    Opening Sells
    Closing Buys
    Exercises
    Closing Sells
    Assignments

    Based on discussions with Clearing Members, OCC is proposing to 
modify the sequence in which options transactions are processed at OCC 
for all account types to provide that all sell transactions are 
processed before exercises (i.e., closing sells would be processed 
before exercises under the proposed change).\5\ For instance, for

[[Page 22198]]

securities options transactions, this proposal would change the order 
in which such transactions are processed in ``customers' accounts,'' 
``firm accounts,'' and ``Market-Maker accounts'' such that all sell 
transactions are processed prior to exercises.\6\ OCC is proposing to 
amend Interpretations and Policies .04 to Rule 801 and Interpretations 
and Policies .04 to Rule 805 to reflect this change in the processing 
sequence for options transactions.
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    \5\ Opening buys increase long positions and closing sells 
decrease long positions. Opening sells increase short positions and 
closing buys decrease short positions.
    \6\ OCC Clearing Members hold omnibus accounts at OCC for 
customer positions (i.e., a ``customers' account'' as defined in 
Article I, Section 1.C.(37) of the By-Laws) to the extent they 
conduct a customer business. They also hold omnibus accounts at OCC 
for non-customer positions (i.e., a ``firm account'' as defined in 
Article I, Section 1.F.(6) of the By-Laws) to the extent they 
conduct a proprietary business. To the extent they clear for Market-
Makers, they also hold ``Market-Maker accounts'' as defined in 
Article I, Section 1.M.(1) of the By-Laws.
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    This proposed change is made possible by increased proficiency in 
Clearing Member position processing and is intended to help Clearing 
Members comply with certain exchange requirements that are described 
below.\7\ OCC's current processing sequence was adopted at a time when 
trade processing was a far different process than it is today. OCC used 
to receive a batch file from each exchange at the end of the trading 
day showing the trades that had been executed on the exchange that day. 
OCC would then process those trades on a batch basis prior to the open 
of trading the following business day. Now, OCC receives, and Clearing 
Members can see, trades executed on an exchange on a near real-time 
basis.\8\ Clearing Members utilize this information as well as certain 
tools provided by OCC (described below) to balance exercise notices 
against existing long positions during the trading day.
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    \7\ The proposed rule change also is designed to help facilitate 
the ability to run OCC's current clearing system, known as ENCORE, 
in parallel with a new clearing system on which OCC is working, as 
the proposed processing sequence is the one expected to be used in 
the new clearing system. As OCC's core clearing system, ENCORE 
processes trades received from OCC's participant exchanges and 
settlements among OCC's Clearing Members.
    \8\ This functionality has been available in ENCORE since 2002.
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Customers' and Firm Account Processing for Securities Options 
Transactions
    As noted, OCC's current processing sequence has been in place for 
many years and was designed when options transactions were processed on 
a batch basis. It originally was designed to protect a Clearing Member 
against the risk that an erroneously coded transaction could result in 
the Clearing Member not exercising a customer's long position. In 
particular, because the vast majority of customer securities options 
positions are maintained on a gross basis at OCC, a miscoded sell 
transaction of one customer could close out a long position in the same 
series of another customer, thereby preventing that customer from 
exercising that option.\9\ For example, Customer A and Customer B use 
the same Clearing Member. Customer A wants to exercise a long position, 
and on the same day Customer B directs the Clearing Member to execute 
an opening sell. If the Customer B trade is erroneously marked as a 
closing sell, the long position that Customer A seeks to exercise could 
be closed out by that closing sell and thus be unavailable for 
exercise.
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    \9\ There are a small subset of customer and firm sub-accounts 
that have elected to be held on a net basis. These accounts are 
discussed below.
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    Processing exercises before closing sells ensured that all intended 
exercises would be processed irrespective of a mismarked customer 
transaction. OCC believes this is no longer necessary due to increased 
proficiency in Clearing Member position processing. In particular, 
Clearing Members now have the ability to use certain functions provided 
by OCC to confirm that submitted exercises have sufficient long 
positions. These functions include a screen in OCC's ENCORE clearing 
system called the Exercise screen that shows Clearing Members during a 
trading day whether they have ``Insufficient Longs'' (i.e., 
insufficient long positions) for the exercise notices they have 
received during that trading day.\10\ These functions also include 
OCC's On Demand Position file (``ODP'') that allows Clearing Members 
during a trading day to balance long positions versus exercises that 
are received during that trading day to ensure that the Clearing 
Members have sufficient long positions for those exercises. In 
addition, they have the ability to correct open/close errors by 
entering a position adjustment in ENCORE prior to exercises being 
processed. In the example above, where Customer B's trade is 
erroneously marked as a closing sell, Customer A's long position could 
be closed out by that closing sell and thus be unavailable for 
exercise. Position Adjustments allow a firm to correct open/close 
errors associated with a trade. This correction functionality can only 
be used for non-critical aspects of a trade and cannot be used, for 
instance, to change the price, symbol or other critical aspects of a 
trade.
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    \10\ See supra note 7.
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    Clearing Members have indicated that they believe this change will 
help them comply with certain exchange rules that require customers to 
only exercise ``outstanding'' net long positions. As an example, BATS 
Rule 23.1(a) provides that, ``an outstanding options contract may be 
exercised during the time period specified in the Rules of [OCC] by the 
tender to [OCC] of an exercise notice in accordance with the Rules of 
[OCC].'' \11\ BATS Rule 16.1(a)(43) defines ``outstanding'' as ``an 
options contract which has been issued by [OCC] and has neither been 
the subject of a closing writing transaction nor has reached its 
expiration date.'' Clearing Members have indicated that issues could 
arise under the rule in situations where a customer position is subject 
to conflicting closing sale and exercise instructions, which could lead 
to a position being exercised that was intended to be closed out under 
OCC's current processing sequence.
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    \11\ See also FINRA Rule 2360(b)(23), NYSE American Options Rule 
980(a), and NYSE Arca Rule 6.24-O(a).
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Market Maker and Other Net Account Processing for Securities Options 
Transactions
    The processing sequence set forth above for customer and firm 
accounts also applies to Market-Maker accounts held by Clearing 
Members. Market-Maker accounts, however, are held on a net basis. This 
means that at the end of each trading day, OCC nets offsetting 
positions in the same options series in each Market-Maker account.\12\ 
Prior to 2014, this netting occurred at the end of the processing 
sequence immediately before assignments.
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    \12\ A few Clearing Members have established the functionality 
to designate sub-accounts within their omnibus customer and firm 
accounts held at OCC. These sub-accounts are established for a 
specific customer or joint back office account and the account 
holders can elect to hold these accounts on a net basis to assist 
with the position reconciliation process. When the account holders 
elect to hold the accounts in this manner, they are subject to the 
same netting process to which Market-Maker accounts are subject. See 
Interpretation and Policy .04 to Article VI, Section 3 of OCC's By-
Laws.
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    In response to operational risk concerns related to the processing 
of dividend play transactions by Market-Makers, a modification to OCC's 
systems was approved by OCC's Board of Directors to insert a step in 
the processing sequence that would limit Market-Maker exercises to net 
long positions.\13\ From a systems perspective,

[[Page 22199]]

this change was implemented by moving up the netting in the processing 
sequence such that it occurred before exercises, as set forth below.
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    \13\ A dividend play is a trading strategy that historically was 
primarily engaged in by Market-Makers and involved buying and 
selling an equal number of call options right before a dividend date 
on the underlying equity and exercising the long call options with 
the goal of capturing the dividend on the underlying equity.

Options Processing Sequence for Market Maker and Other Net Accounts
    Opening Buys
    Opening Sells
    Closing Buys
    Net Positions in Net Accounts (location after 2014 change)
    Exercises
    Closing Sells
    [Net Positions in Net Accounts (location prior to 2014 change)]
    Assignments

    From a Rules perspective, this change was implemented by adopting 
Interpretations and Policies .04 to Rule 801 and Interpretations and 
Policies .04 to Rule 805.\14\ In relevant part, these provisions 
provide that, ``[w]ith respect to any Market-Maker account, the 
Corporation shall process sell transactions in respect of option 
contracts prior to exercises in respect of such contracts.'' Despite 
this rule text, as indicated in the net processing sequence list 
immediately above, closing sells continued to be processed after 
exercises for Market-Maker and other net accounts after the 2014 
change. As described below, the proposed change to the options 
processing sequence that is the subject of this rule filing would 
modify the sequence for all accounts, including Market-Maker and other 
net accounts, such that closing sells would be processed before 
exercises.
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    \14\ See Exchange Act Release No. 73438 (October 27, 2014), 79 
FR 64843 (October 31, 2014) (SR-OCC-2014-15).
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Customer and House Account Processing for Options on Commodity Futures
    While OCC currently uses the same processing sequence for options 
on commodity futures, OCC understands that futures customers and 
Clearing Members are indifferent to the processing sequence for futures 
transactions. Futures firms submit very few trades marked as closing 
transactions, and as a result, are accustomed to submitting nightly 
adjustments to correct their open interest. This process reduces the 
potential of an exercise error since the firms verify their long 
positions on a daily basis.
Proposed Change to Processing Sequence
    OCC proposes to modify the processing sequence for all securities 
and futures options transactions for all account types to process all 
closing sell transactions prior to all exercise transactions. The 
proposed processing sequence is set forth below.

Proposed Options Processing Sequence for All Accounts
    Opening Buys
    Opening Sells
    Closing Buys
    Closing Sells
    Exercises
    Assignments

    For Market-Maker and other accounts held on a net basis, OCC 
proposes to net offsetting positions after closing sells but before 
exercises. Each Market-Maker account is held individually (i.e., on a 
Market-Maker by Market-Maker basis) at a Clearing Member on a net 
basis, unlike customer accounts. Holding each Market-Maker account in 
this manner helps with the position reconciliation process at Market-
Makers and allows them to see a single net position in each options 
series for risk management purposes.
    OCC has discussed the proposed change with its Clearing Members at 
the OCC Roundtable, which is an OCC-sponsored advisory group comprised 
of representatives from OCC's participant exchanges, a cross-section of 
OCC Clearing Members, and OCC staff, and during regular monthly 
operations update calls with Clearing Members and exchanges.\15\ OCC 
also issued Information Memos on its public website to inform Clearing 
Members of the proposed change.\16\ Based upon the feedback from these 
discussions, OCC believes that its current processing sequence for 
options transactions no longer needs to be designed to protect Clearing 
Members from errors in customers' accounts that would result in closing 
out a position that was intended to be exercised. As noted, Clearing 
Members have increased their position processing proficiency and can 
now use OCC tools to confirm that submitted exercises have sufficient 
long positions. They also have the ability to correct any errors prior 
to exercises being processed. Clearing Members also have indicated that 
they believe this change will help them comply with certain exchange 
rules that require customers to exercise only ``outstanding'' net long 
positions. By processing all buys and sells prior to exercises, they 
believe that the proposed change would help address situations in which 
a customer position is subject to conflicting closing sale and exercise 
instructions, which could lead to a position being exercised that was 
intended to be closed out under the current processing sequence.
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    \15\ OCC provided supplemental materials to its Clearing Members 
after the August 2019 Monthly Operations Update meeting to help 
illustrate the proposed change in the processing sequence. OCC 
provided these materials as Exhibit 3A to File No. SR-OCC-2020-004.
    \16\ See OCC Information Memo #45781, dated October 9, 2019, and 
Information Memo #46129, dated December 10, 2019. OCC provided these 
Information Memos as Exhibits 3B and 3C to File No. SR-OCC-2020-004.
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(2) Statutory Basis
    Section 17A(b)(3)(F) of the Act \17\ 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. OCC believes that the proposed rule change will promote 
the prompt and accurate clearance and settlement of securities 
transactions. In this regard, the proposed rule change would provide 
for the processing of closing sell transactions prior to exercises, 
which OCC's Clearing Members have indicated would help promote 
compliance with exchange rules noted above that require that only 
outstanding options positions be exercised. As indicated above, OCC's 
system no longer needs to be designed to protect Clearing Members from 
customer transaction marking errors in which a sell transaction is 
miscoded as a closing sell transaction. The near real-time processing 
of options transactions by OCC and OCC tools have helped Clearing 
Members increase their position processing proficiency. The proposed 
change to the position processing sequence would result in OCC's system 
allowing only net long positions to be exercised in all accounts, 
including individual customer accounts. This result is designed to 
promote compliance with exchange rules and further the goal of 
promoting the prompt and accurate clearance and settlement of 
securities transactions.
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    \17\ 15 U.S.C. 78q-1(b)(3)(F).
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    In addition, the proposed rule change is not inconsistent with the 
existing By-Laws and Rules of OCC, including any rules proposed to be 
amended.

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

    Section 17A(b)(3)(I) of the Act \18\ requires that the rules of a 
clearing agency not impose any burden on competition not necessary or 
appropriate in furtherance of the Act. OCC does not believe that the 
proposed

[[Page 22200]]

rule change would impact or impose any burden on competition. The 
proposed rule change would not affect the competitive dynamics between 
Clearing Members in that it would apply to all Clearing Members 
equally. The proposed rule change also would not inhibit access to 
OCC's services or disadvantage or favor any particular user in 
relationship to another. In this regard, as described above, the 
proposed rule change is designed to further facilitate the prompt and 
accurate clearance and settlement of securities transactions. It would 
change the processing sequence so that closing sells are processed 
before exercises, which would ensure from a systematic perspective that 
only net long positions can be exercised.
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    \18\ 15 U.S.C. 78q-1(b)(3)(I).
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(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 rule-comments@sec.gov. Please include 
File Number SR-OCC-2020-004 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-OCC-2020-004. 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/about/publications/bylaws.jsp.
    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-2020-004 and 
should be submitted on or before May 12, 2020.
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    \19\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-08386 Filed 4-20-20; 8:45 am]
BILLING CODE 8011-01-P


