[Federal Register Volume 86, Number 28 (Friday, February 12, 2021)]
[Notices]
[Pages 9410-9413]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-02859]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-91079; File No. SR-OCC-2020-016]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change to Concerning the Options Clearing 
Corporation's System for Theoretical Analysis and Numerical Simulation 
(``STANS'') Methodology Documentation

February 8, 2021.

I. Introduction

    On December 9, 2020, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2020-016 (``Proposed Rule Change'') 
pursuant to Section 19(b) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to adopt a new 
document describing OCC's system for calculating daily and intra-day 
margin requirements for its Clearing Members.\3\ The Proposed Rule 
Change was published for public comment in the Federal Register on 
December 29, 2020.\4\ The Commission has received no comments regarding 
the Proposed Rule Change. This order approves the Proposed Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Notice of Filing infra note 4, 85 FR at 85788.
    \4\ Securities Exchange Act Release No. 34-90763 (Dec. 21, 
2020), 85 FR 85788 (Dec. 29, 2020) (File No. SR-OCC-2020-016) 
(``Notice of Filing'').
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II. Background

    To manage the credit risk posed by its Clearing Members, OCC 
collects margin collateral both daily and intraday. OCC uses its System 
for Theoretical Analysis and Numerical Simulation (``STANS'') to set 
risk-based margin requirements for its Clearing Members. The margin 
requirements calculated using STANS consist of an estimate of a 99 
percent expected shortfall (``ES'') over a two-day time horizon with 
additional charges for model risk, stress tests, liquidation costs, and 
various add-ons.
    OCC maintains technical documentation that describes how the 
various quantitative components of STANS were developed and operate, 
including the various parameters and assumptions contained within those 
components \5\ and the mathematical theories underlying the selection 
of those quantitative methods (``Model Whitepapers''). The Model 
Whitepapers are currently synthesized in a single document, the Margins 
Methodology, describing how STANS operates from end to end. Pursuant to 
section 19(b) of the Exchange Act and Rule 19b-4 thereunder,\6\ OCC has 
filed, and the Commission has approved, sections of OCC's Margins 
Methodology as rules in the past.\7\ OCC has not, however, filed the 
Margins Methodology in its entirety. Additionally, OCC has requested 
confidential treatment for those sections of the Margins Methodology 
that it has filed with the Commission.\8\
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    \5\ See Securities Exchange Act Release No. 82473 (Jan. 9, 
2018), 83 FR 2271 (Jan. 16, 2018) (File No. SR-OCC-2017-011), which 
describes how OCC periodically reviews the parameters and 
assumptions used by STANS pursuant to its Model Risk Management 
Policy and in accordance with 17 CFR 240.17Ad-22(e)(6).
    \6\ 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4.
    \7\ See Securities Exchange Act Release No. 74966 (May 14, 
2015), 80 FR 29784 (May 22, 2015) (File No. SR-OCC-2015-010); 
Securities Exchange Act Release No. 76128 (Dec. 28, 2015), 81 FR 135 
(Jan. 4, 2016) (File No. SR-OCC-2015-016); Securities Exchange Act 
Release No. 79818 (Jan. 18, 2017), 82 FR 8455 (Jan. 25, 2017) (File 
No. SR-OCC-2017-001); Securities Exchange Act Release No. 82161 
(Nov. 28, 2017), 82 FR 57306 (Dec. 4, 2017) (File No. SR-OCC-2017-
022); Securities Exchange Act Release No. 84524 (Nov. 2, 2018), 83 
FR 55918 (Nov. 8, 2018) (File No. SR-OCC-2018-014); Securities 
Exchange Act Release No. 85440 (Mar. 28, 2019), 84 FR 13082 (Apr. 3, 
2019) (File No. SR-OCC-2019-002); Securities Exchange Act Release 
No. 85755 (Apr. 30, 2019), 87 FR 19815 (May 6, 2019) (File No. SR-
OCC-2019-004); Securities Exchange Act Release No. 86296 (Jul. 3, 
2019), 84 FR 32816 (Jul. 9, 2019) (File No. SR-OCC-2019-005); 
Securities Exchange Act Release No. 87387 (Oct. 23, 2019), 84 FR 
57890 (Oct. 29, 2019) (File No. SR-OCC-2019-010); Securities 
Exchange Act Release No. 89392 (Jul. 24, 2020), 85 FR 45938 (Jul. 
30,2020) (File No. SR-OCC-2020-007); Securities Exchange Act Release 
No. 90139 (Oct. 8, 2020), 85 FR 65886 (Oct. 16, 2020) (File No. SR- 
OCC-2020-012).
    \8\ See id.
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    OCC now proposes to replace the Margins Methodology in its entirety 
(both sections that have and have not been filed as rules) with a 
description of OCC's system for calculating daily and intra-day margin 
requirements for its Clearing Members (the ``STANS Methodology 
Description'').\9\ OCC stated that the proposed STANS Methodology 
Description includes the material aspects of OCC's risk-based margin 
system.\10\ OCC intends to make the proposed STANS Methodology

[[Page 9411]]

Description available to Clearing Members.\11\
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    \9\ OCC also proposes conforming changes to its Margin Policy.
    \10\ See Notice of Filing, 85 FR at 85789.
    \11\ See Notice of Filing, 85 FR at 85790.
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    The proposed STANS Methodology Description would include 
substantially the same information as the Margins Methodology with the 
exception of various details, described below, that OCC does not 
believe would be appropriately included in the STANS Methodology 
Description.\12\ OCC stated that the purpose of the STANS Methodology 
Description would be to enable an informed reader to understand OCC's 
modeling choices and the interconnectedness of STANS model components 
in producing OCC margin requirements, and that the portions of the 
Margins Methodology not carried forward in the STANS Methodology 
Description are extraneous to this purpose.\13\
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    \12\ OCC does not propose to change its margin methodology as 
part of the Proposed Rule Change.
    \13\ See Notice of Filing, 85 FR at 85790.
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Proposed STANS Methodology Description

    As noted above, the proposed STANS Methodology Description covers 
OCC's system for calculating daily and intra-day margin requirements 
for its Clearing Members. The proposed document includes three sections 
with various subsections as described below and in greater detail in 
the Notice of Filing. The STANS Methodology Description begins with an 
executive summary. The executive summary would state that the purpose 
of STANS is to determine margin requirements for OCC's Clearing 
Members, and would describe the types of positions and collateral 
modeled through STANS. The executive summary would also briefly 
describe OCC's procedures related to both model monitoring and price 
editing.
    Model components. The bulk of the STANS Methodology Description 
covers the model components in STANS, including model and econometric 
calibration, copula construction, implied volatility smoothing and 
options pricing, and the application of the theoretical derivatives 
prices to actual positions in Clearing Members' accounts to calculate 
margin requirements through the aggregation of various component 
charges. The sub-sections related to model and econometric calibration 
cover the use of (i) returns on equity securities that are based on 
current market prices to create econometric parameters and for pricing; 
(ii) implied volatility risk factors to measure the expected future 
volatility of an option's underlying security at expiration; (iii) 
Nelson-Siegel framework to price treasury securities; (iv) a generic 
futures model to price linear derivatives with limited term structures; 
(v) a specialized factor model to price variance futures; (vi) a 
synthetic futures model to price specified products such as volatility 
index-based futures (e.g., VIX futures); and (vii) econometric 
parameters related to volatility forecasts and marginal distributions, 
and calibrates these parameters using ten-year histories of the 
foregoing data inputs.
    The sub-sections related to copula construction describes the use 
of a copula to quantify the joint behavior and dependence structure of 
the risk factors used by STANS.\14\ The STANS Methodology Description 
covers OCC's process for estimating the copula as well as simulating 
price movements based on random draws from the multivariate Student's 
t-distribution described by the copula. The document also describes 
OCC's process for identifying and separately processing risk factors 
with incomplete data sets that lack sufficient data to estimate the 
copula. Specifically, the STANS Methodology Description addresses the 
application of conditional and default simulations to estimate 
correlations for risk factors excluded from the copula simulation in 
STANS due to a lack of data.
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    \14\ A copula is a mathematical construct used in probability 
theory to calculate the cumulative distribution of a set of random 
variables.
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    The sub-sections related to implied volatility smoothing and 
options pricing describe how OCC uses the inputs and outputs described 
in the subsections on model and econometric calibration and copula 
construction. Specifically, the STANS Methodology Description discusses 
OCC's processing for performing implied volatility smoothing as well as 
pricing European-style options, American-style options, Asian FLEX 
options,\15\ and Cliquet options.\16\ The document also discusses how 
STANS can also be used to price forward start options.\17\
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    \15\ Asian options are European-style options for which the 
settlement price is determined based on the difference between the 
aggregate exercise price and the aggregate current underlying 
interest value, which is based on the average of twelve monthly 
price observations. See Securities Exchange Release No. 74966 (May 
14, 2015), 80 FR 29784 (May 22, 2015) (File No. SR-OCC-2015-010).
    \16\ Cliquet options are European-style options for which the 
settlement price is determined based on the (positive) sum of capped 
returns of an index on pre-determined dates over a specified period 
of time. See id., n. 9.
    \17\ Forward start options are options for which the strike 
price in dollars is unknown prior to the determination date of the 
strike shortly before expiration. See Notice of Filing, 85 FR at 
85796.
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    The sub-sections related to the aggregation of various component 
charges discuss a based margin charge, error compensation charge, 
liquidation cost charge, and positive risk reversal charge. The base 
margin charge consists of an ES calculation with the addition of 
Extreme Value Theory loss modeling and a stress test component. The 
error compensation charge is designed to compensate for the estimation 
error inherent in ES calculations. The liquidation cost charge is 
designed to cover the costs of selling long positions at the current 
bid price and covering short positions at the current ask price 
following the default of a Clearing Member. The positive risk reversal 
charge ensures that total calculated margin requirement is at least 
equal to the estimated liquidation cost, even in the event a position 
is liquidated at the current market price.
    Model utilities. The final substantive section of the STANS 
Methodology Description addresses several model utilities that OCC 
applies at various points in the STANS methodology, to incorporate 
various market and operational factors that affect options pricing and 
thereby produce model results which more accurately reflect current and 
potential market conditions. Such utilities include the incorporation 
of expected cash dividends on a stock into options pricing in STANS. 
The STANS Methodology Description also addresses OCC's processes for 
obtaining relevant risk factors for both the most recent opening price 
and the most recent closing price to include a joint distribution of 
both overnight and daily returns on relevant risk factors within the 
copula described above. Further, the STANS Methodology Description 
discusses OCC's process for addressing option expirations occurring 
during the period in which OCC closes out a defaulted Clearing Member's 
portfolio. Finally, the document describes the portfolio specific 
haircut model that OCC uses to haircut values for withdrawals or 
deposits of collateral made throughout the day.

Additional Details

    As noted above, STANS Methodology Description would not include 
details from the Margins Methodology that OCC believes are extraneous 
to the purpose of enabling an informed reader to understand OCC's 
modeling choices and the interconnectedness of STANS model components 
in producing OCC margin requirements. As described below, and in 
greater detail in the Notice of Filing, the details in the Margins 
Methodology that would not be included in the

[[Page 9412]]

STANS Methodology Description fall thematically into eight 
categories.\18\
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    \18\ See Notice of Filing, 85 FR at 85790.
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    First, the STANS Methodology Description would not describe 
historical modeling practices and potential future enhancements that do 
not describe how a model currently functions. For example, the STANS 
Methodology Description would not include background on OCC's decision 
to incorporate implied volatility modeling into STANS. Similarly, the 
STANS Methodology Description would not summarize historical changes 
OCC has made to the manner in which STANS calculates a total margin 
charge.
    Second, the STANS Methodology Description would not describe the 
set of current products to which each STANS component applies. For 
example, the STANS Methodology Description would list products eligible 
for implied volatility scenarios modeling in STANS.
    Third, the STANS Methodology Description would not describe OCC's 
model configuration choices. Such configuration choices include a list 
of control parameters of the Newton-Raphson method OCC uses to 
calculate implied volatilities for vanilla options. Similarly, the 
STANS Methodology Description would not describe the parameters that 
OCC uses to calibrate liquidation grids when calculating its 
liquidation cost charge.
    Fourth, the STANS Methodology Description would not describe model 
testing results and supporting rationale. Such testing results would 
include model testing and validation results for OCC's implied 
volatility model. Similarly, the STANS Methodology Description would 
not describe the mathematical rationale for the cumulative distribution 
function, inverse cumulative distribution function, and degrees of 
freedom for the Student's t-distribution used by the GARCH model for 
implied volatility risk factors.
    Fifth, the STANS Methodology Description would not describe 
standard mathematical and economic theories and techniques that are 
well-known in quantitative finance, readily found in public sources, 
and do not include OCC-specific modifications or applications. For 
example, the STANS Methodology Description would not describe the 
standard Glosten-Jagannathan-Runkle GARCH model and the use of a 
Student's t-distribution. Similarly, the STANS Methodology Description 
would not describe the Vega-weighted least squares calculation 
performed during the first round of optimization to produce arbitrage-
free options prices for European options.
    Sixth, the STANS Methodology Description would not include 
redundant descriptions of a model component appearing in multiple 
chapters. For example, the Executive Summary of the STANS Methodology 
Description would not include details of the STANS methodology also 
found in the main body of the document. Similarly, the section of the 
proposed STANS Methodology Description discussing conditional and 
default simulations would not include introductory text restating the 
use of time series in STANS, which is described elsewhere in the 
document.
    Seventh, the STANS Methodology Description would not describe OCC's 
implementation of a model in its internal technology systems. Such 
details include detailed steps for a linear interpolation/extrapolation 
used to construct a volatility surface from smoothed volatilities. 
Similarly, the STANS Methodology Description would not include 
discussion of the processes OCC uses to operationalize the STANS 
methodology in its systems.
    Finally, the STANS Methodology Description would not describe 
manual margin adjustments and add-ons that OCC employs pursuant to OCC 
rules, policies, or procedures outside of STANS. Such adjustments 
include additional margin charges related to cross-margin accounts 
established under OCC's Rule 704. Similarly, the STANS Methodology 
Description would not describe ``derived scenarios,'' which are a 
special case of conditional simulations related to exchange rate risk 
factors addressed elsewhere in OCC's procedures.

Changes to Margin Policy

    OCC also proposes conforming changes to its Margin Policy to 
reflect the adoption of the STANS Methodology Description and the 
retirement of the Margins Methodology. Additionally, OCC proposes to 
make other non-substantive changes to the Margin Policy to correct 
typographical errors, update references to other related internal OCC 
policies and procedures, and conform the policy to OCC's current 
internal policy template.

III. Discussion and Commission's Findings

    Section 19(b)(2)(C) of the Exchange Act directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to such organization.\19\ After carefully 
considering the Proposed Rule Change, the Commission finds that the 
proposal is consistent with the requirements of the Exchange 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 Exchange Act,\20\ Rule 17Ad-22(e)(6) \21\ 
thereunder, as described in detail below.
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    \19\ 15 U.S.C. 78s(b)(2)(C).
    \20\ 15 U.S.C. 78q-1(b)(3)(F).
    \21\ 17 CFR 240.17Ad-22(e)(6).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act

    Section 17A(b)(3)(F) of the Exchange Act requires, among other 
things, that the rules of a clearing agency be designed to assure the 
safeguarding of securities and funds which are in its custody or 
control or for which it is responsible.\22\ OCC uses STANS to set risk-
based margin requirements for its Clearing Members. OCC proposes to 
describe its modeling choices and the interconnectedness of STANS model 
components in producing such margin requirements within its rules by 
adopting the STANS Methodology Description. The aspects of STANS 
described in the STANS Methodology Description directly relate to OCC's 
ability to accurately risk manage Clearing Member portfolios by 
calculating and collecting an appropriate amount of collateral. The 
Commission notes that only some of the aspects of STANS addressed in 
the STANS Methodology Description are currently addressed in the 
portions of the Margins Methodology that OCC has filed with the 
Commission.
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    \22\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that, even with the removal of the 
additional details from the Margins Methodology described above, the 
proposed STANS Methodology Description is designed to help ensure that 
OCC's margin methodology calculates and collects margin sufficient to 
mitigate OCC's credit exposure to a Clearing Member default. The 
Commission also believes that accurate calculation of margin is 
necessary to help ensure that OCC is able to risk manage the default of 
a Clearing Member without recourse to the assets of non-defaulting 
Clearing Members, which supports the safeguarding of securities and 
funds in OCC's custody. Accordingly, the Commission believes that the 
replacement of the Margins Methodology with the STANS Margin

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Description is consistent with the requirements of Section 17A(b)(3)(F) 
of the Exchange Act.\23\
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    \23\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(6) Under the Exchange Act

    Rules 17Ad-22(e)(6) generally requires each covered clearing agency 
that provides central counterparty services to establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to cover its credit exposure to its participants by 
establishing a risk-based margin system that meets certain 
standards.\24\ As described above, the STANS Methodology Description 
addresses OCC's modeling choices and the interconnectedness of STANS 
model components in producing risk-based margin requirements.
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    \24\ 17 CFR 240.17Ad-22(e)(6).
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    Section (i) under Rule 17Ad-22(e)(6) requires that the policies and 
procedures required pursuant to Rule 17Ad-22(e)(6) describe a risk-
based margin system that considers and produces margin levels 
commensurate with the risks and particular attributes of each relevant 
product, portfolio, and market.\25\ As described above, the STANS 
Methodology Description covers various components of STANS designed to 
address the particular attributes of the products that OCC clears 
(e.g., American-style options, European-style options, Asian FLEX 
options, Cliquet options) as well as the risks presented by a specific 
portfolio (e.g., liquidation cost charges). Further, the STANS 
Methodology Description also describes OCC's process addressing the 
entrance of new products into the markets for which it clears 
(identifying and separately processing risk factors with incomplete 
data sets that lack sufficient data to estimate the copula).
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    \25\ 17 CFR 240.17Ad-22(e)(6)(i).
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    Section (iii) under Rule 17Ad-22(e)(6) requires that the policies 
and procedures required pursuant to Rule 17Ad-22(e)(6) describe a risk-
based margin system that calculates margin sufficient to cover its 
potential future exposure to participants in the interval between the 
last margin collection and the close out of positions following a 
participant default.\26\ As described above, the STANS Methodology 
Description discusses various model utilities that pertain to events 
occurring between the collection of margin and closing out of a 
defaulted Clearing Member's portfolio (e.g., cash dividend payments, 
option expiration, and changes to portfolio specific haircuts due to 
the withdrawal or deposit of collateral).
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    \26\ 17 CFR 240.17Ad-22(e)(6)(iii).
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    Section (v) under Rule 17Ad-22(e)(6) requires that the policies and 
procedures required pursuant to Rule 17Ad-22(e)(6) describe a risk-
based margin system that uses an appropriate method for measuring 
credit exposure to accounts for relevant product risk factors and 
portfolio effects across products.\27\ As discussed above, the STANS 
Methodology Description covers the various STANS components that 
provide the inputs and outputs necessary for OCC to conduct implied 
volatility smoothing and options pricing (e.g., model components 
addressing derivatives based on equities and treasuries as well as 
generic futures, variance futures, and volatility index-based futures) 
as well as the implied volatility smoothing and options pricing 
themselves.
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    \27\ 17 CFR 240.17Ad-22(e)(6)(v).
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    Based on the foregoing, the Commission believes that the 
replacement of the Margins Methodology with the STANS Margin 
Description is consistent with the requirements of Rule 17Ad-22(e)(6) 
under the Exchange Act.\28\
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    \28\ 17 CFR 240.17Ad-22(e)(6).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the 
Exchange Act, and in particular, the requirements of Section 17A of the 
Exchange Act \29\ and the rules and regulations thereunder.
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    \29\ 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 
Exchange Act,\30\ that the Proposed Rule Change (SR-OCC-2020-016) be, 
and hereby is, approved.
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    \30\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-02859 Filed 2-11-21; 8:45 am]
 BILLING CODE 8011-01-P


