[Federal Register Volume 86, Number 105 (Thursday, June 3, 2021)]
[Notices]
[Pages 29861-29864]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-11606]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-92038; File No. SR-OCC-2021-003]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change To Establish OCC's Persistent 
Minimum Skin-In-The-Game

May 27, 2021.

I. Introduction

    On February 10, 2021, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2021-003, (``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 establish a 
persistent minimum level of skin-in-the-game that OCC would contribute 
to cover default losses or liquidity shortfalls.\3\ The Proposed Rule 
Change was published for public comment in the Federal Register on 
March 2, 2021.\4\ The Commission has received comments regarding the 
proposal described in the Proposed Rule Change.\5\ 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, 86 FR at 12237.
    \4\ Securities Exchange Act Release No. 91199 (Feb. 24, 2021), 
86 FR 12237 (Mar. 2, 2021) (File No. SR-OCC-2021-003) (``Notice of 
Filing''). OCC also filed a related advance notice (SR-OCC-2021-801) 
(``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 
Exchange 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 March 1, 2021. Securities Exchange Act Release 
No. 91184 (Feb. 23, 2021), 86 FR 12057 (Mar. 1, 2021) (File No. SR-
OCC-2021-801). A Notice of No Objection to the Advance Notice was 
published in the Federal Register on April 12, 2021. See Securities 
Exchange Act Release No. 91491 (Apr. 7, 2021), 86 FR 19061 (Apr. 12, 
2021) (File No. SR-OCC-2021-801).
    \5\ Comments on the Proposed Rule Change are available at 
https://www.sec.gov/comments/sr-occ-2021-003/srocc2021003.htm.
    Since the proposal contained in the Proposed Rule Change was 
also filed as an advance notice, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the Proposed Rule Change or the Advance Notice. 
Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-occ-2021-801/occ2021801.htm.
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II. Background 6
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    \6\ Capitalized terms used but not defined herein have the 
meanings specified in OCC's Rules and By-Laws, available at https://www.theocc.com/about/publications/bylaws.jsp.
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    ``Skin-in-the-game,'' as a component of financial risk management, 
entails a covered clearing agency choosing, upon the occurrence of a 
default or series of defaults and application of all available assets 
of the defaulting participant(s), to apply its own capital contribution 
to the relevant clearing or guaranty fund in full to satisfy any 
remaining losses prior to the application of any (a) contributions by 
non-defaulting members to the clearing or guaranty fund, or (b) 
assessments that the covered clearing agency require non-defaulting 
participants to contribute following the exhaustion of such 
participant's funded contributions to the relevant clearing or guaranty 
fund.\7\
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    \7\ See Securities Exchange Act Release No. 78961 (Sep. 28, 
2016), 81 FR 70786, 70806 (Oct. 13, 2016) (S7-03-14) (``Covered 
Clearing Agency Standards'').
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    OCC's skin-in-the-game component of its financial risk management 
regime is described in its current rules, which provide for the use of 
OCC's own capital to mitigate losses arising out of a Clearing Member 
default.\8\ Specifically, OCC's rules provide for the offsetting of 
default losses remaining after the application of a defaulted Clearing 
Member's margin deposits and Clearing Fund contributions with OCC's 
capital in excess of 110 percent of the Target Capital Requirement at 
the time of the default.\9\ OCC's rules also provide for charging 
losses remaining after the application of OCC's excess capital to OCC 
senior management's deferred

[[Page 29862]]

compensation \10\ as well as non-defaulting Clearing Members.\11\
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    \8\ See Securities Exchange Release No. 88029 (Jan. 24, 2020), 
85 FR 5500, 5502 (Jan. 30, 2020) (File No. SR-OCC-2019-007) (``CMP 
Approval Order'').
    \9\ See OCC Rule 1006(e), available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (last 
visited Mar. 16, 2021). See also CMP Approval Order at 5502.
    \10\ Such deferred compensation is in trust with respect to 
OCC's Executive Deferred Compensation Plan (``EDCP''). See OCC Rule 
101(e)(1), available at available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (last 
visited Mar. 16, 2021). The specific EDCP funds that comprise a 
portion of OCC's skin-in-the-game are referred to in OCC's rules as 
the ``EDCP Unvested Balance.'' See id.
    \11\ See OCC Rule 1006(b), available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (last 
visited Mar. 16, 2021). See also CMP Approval Order at 5502. The 
application the EDCP Unvested Balance in parallel with non-
defaulting Clearing Members' Clearing Fund contributions would 
necessarily occur before assessments related to the exhaustion of 
OCC's Clearing Fund.
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    OCC reviewed feedback received in connection with the initial 
filing of its current rules, relevant papers from industry participants 
and stakeholders concerning skin-in-the-game, and regulatory regimes in 
jurisdictions outside the United States.\12\ OCC's current rules do 
not, however, dedicate OCC's excess capital for use solely as skin-in-
the-game, or guaranty that OCC maintain a minimum amount of skin-in-
the-game.\13\
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    \12\ See Notice of Filing, 86 FR at 12238-39. For example, OCC 
is cognizant of the European Market Infrastructure Regulation's 
expectation that skin-in-the-game be a minimum of 25 percent of the 
central counterparty's regulatory capital requirement. See Notice of 
Filing, 86 FR at 12239.
    \13\ See Notice of Filing, 86 FR at 12239.
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    Establishing the Minimum Corporate Contribution. OCC proposes to 
establish a persistent minimum level of skin-in-the-game that OCC would 
contribute to cover default losses or liquidity shortfalls. Such skin-
in-the-game would consist of a minimum amount of OCC's own pre-funded 
resources that OCC would contribute prior to charging a loss to the 
Clearing Fund (the ``Minimum Corporate Contribution'') and the EDCP 
Unvested Balance.\14\ As proposed, funds comprising the Minimum 
Corporate Contribution would be excluded from OCC's liquid net assets 
funded by equity (``LNAFBE'') for purposes of meeting OCC's Target 
Capital Requirement to ensure that OCC may maintain the Minimum 
Corporate Contribution exclusively for default management.\15\
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    \14\ OCC does not propose altering its rules regarding the use 
or sizing of the EDCP Unvested Balance.
    \15\ In addition to the Minimum Corporate Contribution, OCC 
would continue to commit its LNAFBE greater than 110 percent of its 
Target Capital Requirement prior to charging a loss to the Clearing 
Fund. As proposed, OCC would apply the Minimum Corporate 
Contribution to address default losses before applying its excess 
LNAFBE.
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    OCC proposes to define the Minimum Corporate Contribution to mean 
the minimum level of OCC's own funds maintained exclusively to cover 
credit losses or liquidity shortfalls, the level of which OCC's Board 
of Directors (the ``Board'') shall determine from time to time. To 
facilitate implementation of OCC's proposal, the Board approved an 
initial Minimum Corporate Contribution at such a level that OCC's total 
skin-in-the-game (i.e., the sum of the Minimum Corporate Contribution 
and OCC's current EDCP Unvested Balance) would equal 25 percent of 
OCC's Target Capital Requirement. OCC stated that, in setting the 
initial Minimum Corporate Contribution, the Board considered factors 
including, but not limited to, the regulatory requirements in each 
jurisdiction in which OCC is registered or in which OCC is actively 
seeking recognition, the amount similarly situated central 
counterparties commit of their own resources to address participant 
defaults, the EDCP Unvested Balance, OCC's LNAFBE greater than 110 
percent of its Target Capital Requirement, projected revenue and 
expenses, and other projected capital needs.\16\
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    \16\ See Notice of Filing, 86 FR at 12239-40.
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    Replenishing the Minimum Corporate Contribution. OCC proposes that, 
in the event it were to apply a portion of the Minimum Corporate 
Contribution to address losses or shortfalls arising out of a Clearing 
Member default, the size of the Minimum Corporate Contribution would be 
temporarily reduced, for a period of 270 days, to the amount remaining 
after its application.\17\ Each application of the Minimum Corporate 
Contribution would trigger a new 270-day period.\18\ Under the 
proposal, OCC would be obligated to notify Clearing Members of any such 
reduction of the Minimum Corporate Contribution. OCC believes that 270 
calendar days, or approximately nine months, is sufficient time for OCC 
to accumulate the funds necessary to reestablish the Minimum Corporate 
Contribution.\19\
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    \17\ For example, if the Minimum Corporate Contribution were 
$100 million and OCC applied $25 million to address default losses, 
then the Minimum Corporate Contribution would be temporarily set at 
$75 million.
    \18\ For example, if OCC were to contribute a portion of the 
Minimum Corporate Contribution on day 1 and another portion 100 days 
later, the Minimum Corporate Contribution would remain temporarily 
reduced until day 370.
    \19\ See Notice of Filing, 86 FR at 12240. OCC stated that the 
analysis on which its belief is based is the same analysis on which 
OCC relied to set various thresholds related to OCC's plan for 
replenishing its regulatory capital. See id.
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    OCC proposes change to its Rules, Capital Management Policy, 
Default Management Policy, Clearing Fund Methodology Policy, and 
Recovery and Orderly Wind-Down Plan to effectuate the changes described 
above.

III. Discussion and Commission 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.\20\ 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 \21\ and Rule17Ad-22(e)(2) 
thereunder.\22\
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    \20\ 15 U.S.C. 78s(b)(2)(C).
    \21\ 15 U.S.C. 78q-1(b)(3)(F).
    \22\ 17 CFR 240.17Ad-22(e)(2).
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    Before addressing the relevant portions of the Exchange Act and 
rules and regulations thereunder, however, we address a part of the 
comment submitted by Susquehanna International Group (``SIG'') not 
related to Section 17A(b)(3)(F) of the Exchange Act or Rule17Ad-
22(e)(2) thereunder.\23\ SIG argued, as one of its concerns, that OCC's 
fees, dues, and other charges would be per se unreasonable, and 
therefore inconsistent with Section 17A(b)(3)(D) of the Exchange Act, 
because funding the proposal with clearing fees would facilitate a 
shareholder windfall.\24\ We do not address these issues in this order 
because OCC has not proposed to change any fees, dues, or other charges 
in the Proposed Rule Change.\25\ The

[[Page 29863]]

reasonability of OCC's existing fees, dues, or other charges pursuant 
to Section 17A(b)(3)(D) of the Exchange Act is therefore beyond the 
scope of this Proposed Rule Change.
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    \23\ See letter from Richard J. McDonald, SIG, dated March 30, 
2021, to Vanessa Countryman, Secretary, Commission (``SIG Letter''), 
available at https://www.sec.gov/comments/sr-occ-2021-003/srocc2021003.htm. In its comment letter, SIG argues that the 
Proposed Rule Change is inconsistent with Sections 17A(b)(3)(D) and 
(F) of the Exchange Act. The Commission's consideration of SIG's 
concerns pertaining to Section 17A(b)(3)(F) is addressed in section 
III.A. below.
    \24\ SIG Letter at 3-4.
     SIG also (i) expresses concern regarding OCC's current 
retention of $325 million in capital; (ii) indicates that OCC should 
focus on reducing clearing fee rates; and (iii) suggests that the 
current organization of OCC's shareholders as for profit entities 
creates a misalignment of interests. SIG Letter at 2. Because these 
issues do not bear on the grounds for approval or disapproval 
applicable to the Proposed Rule Change, the Commission does not 
address them in this order.
    \25\ Another commenter read SIG's comment to imply that the 
inclusion of fees as part of the proposed skin-in-the-game would 
incentivize OCC members to increase their charges for providing 
clearing services as a method of mitigating the risk of their actual 
skin-in-the-game. See comment submitted by CJ Chou (April 8, 2021), 
available at https://www.sec.gov/comments/sr-occ-2021-003/srocc2021003.htm. As the Commission understands it, SIG's argument 
pertains to the size and use of OCC's fees, not changes in fees 
imposed on clients by the Clearing Members absent a fee increase by 
OCC.
    The commenter also expressed difficulty in obtaining 
quantitative data regarding clearing fee refunds and how much, 
proportionally, fees would contribute to the minimum skin-in-the-
game under the Proposed Rule Change. Id. With regard to quantitative 
data describing clearing fee refunds, the audited financial 
statements that OCC posts annually include a line item for 
refundable clearing fees where applicable. See e.g., OCC's 2020 
Financials at page 5, available at https://www.theocc.com/getattachment/9f5d22ff-d810-4690-948d-f9a207df083d/attachment.aspx. 
With regard to how much, proportionally, fees would contribute to 
the minimum skin-in-the-game under the Proposed Rule Change, the 
Commission t notes that OCC has publically stated that its revenues 
primarily consist of clearing fee revenues. Id. at 7.
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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 the custody or 
control of the clearing agency or for which it is responsible and, in 
general, to protect investors and the public interest.\26\ Based on its 
review of the record, the Commission finds the proposal is consistent 
with Section 17A(b)(3)(F) of the Exchange Act.
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    \26\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission continues to regard skin-in-the-game as a potential 
tool to align the various incentives of a covered clearing agency's 
stakeholders, including management and clearing members.\27\ OCC's 
current rules provide for the application of excess capital as skin-in-
the-game. The Commission believes that OCC's proposal to set aside 
capital to maintain a minimum amount of skin-in-the-game strengthens 
OCC's existing skin-in-the-game rules. OCC's current rules align senior 
management's personal economic incentives with OCC's overall risk 
management incentives,\28\ but do not guaranty that an amount of OCC 
capital would be set aside to ensure a pre-determined minimum level of 
skin-in-the-game.
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    \27\ Covered Clearing Agency Standards, 81 FR at 70805-06.
    \28\ See Securities Exchange Act Release No. 87257 (Oct. 8, 
2019), 84 FR 55194, 55199 (Oct. 15, 2019) (File No. SR-OCC-2019-
805).
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    The Commission believes that holding a defined Minimum Corporate 
Contribution, as opposed to an undefined amount of excess capital, 
would incentivize OCC further to maintain the appropriate amount of 
resources to manage a Clearing Member default because failure to do so 
would result in a direct cost to OCC. Incentivizing OCC to maintain an 
appropriate amount of resources, in turn, could reduce the potential 
losses charged to the Clearing Fund contributions of non-defaulting 
Clearing Members in the event of a Clearing Member default, which in 
turn would help assure the safeguarding of the Clearing Fund 
contributions of non-defaulting Clearing Members.
    In its comment letter, SIG argues that the Proposed Rule Change 
contravenes the protection of investors and the public interest.\29\ 
SIG states that OCC was established as a monopoly organization in order 
to serve as a market utility \30\ and that it has always been 
recognized and accepted by concerned parties that monies held as excess 
OCC capital are excess fees not yet rebated, as opposed to retained 
earnings.\31\ In support of its argument that OCC should not retain 
earnings generated through clearing fees, SIG states that OCC has not 
previously had to draw on such funds to address a shortfall.\32\
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    \29\ SIG Letter at 4.
    \30\ SIG Letter at 1.
    \31\ SIG Letter at 2.
    \32\ SIG Letter at 2.
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    The Commission is not persuaded by SIG's arguments with regard to 
Section 17A(b)(3)(F). As discussed above, the Commission believes that 
holding a defined Minimum Corporate Contribution would incentivize OCC 
further to maintain the appropriate amount of resources to manage a 
Clearing Member default. Aligning OCC's incentives with risk management 
considerations, such as default management, supports the public 
interest because it supports OCC's role as a utility for clearing and 
settling U.S. listed options. Further, OCC's rules do not require OCC 
to distribute retained earnings in excess of expenses.\33\
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    \33\ If OCC's capital exceeds 110 percent of its Target Capital 
Requirement, rules authorize, but does not require, OCC's Board to 
reduce the cost of clearing. See Securities Exchange Act Release No. 
88029 (Jan. 24, 2020), 85 FR 5500, 5502 (Jan. 30, 2020) (File No. 
SR-OCC-2019-007). If the Board chooses to reduce the cost of 
clearing, it is authorized to do so by lowering fees or declaring a 
fee holiday as well as issuing refunds. See Id.
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    In addition to providing those services customarily provided by 
clearing houses of national securities exchanges,\34\ OCC is a Covered 
Clearing Agency registered with the Commission.\35\ As a Covered 
Clearing Agency, OCC is obligated to comply with risk management 
standards that the Commission adopted under Section 805(a)(2) of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 \36\ 
and Section 17A of the Exchange Act (the ``Clearing Agency 
Rules'').\37\ The Clearing Agency Rules address having policies and 
procedures regarding, inter alia, the maintenance of assets to address 
losses attributable to Clearing Member defaults \38\ as well as general 
business risk losses.\39\
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    \34\ See Fourth Amended and Restated Certificate of 
Incorporation of OCC, Section III, available at https://www.theocc.com/getmedia/9d7754f6-99ca-4d69-a934-a6fa996c9c16/OCC_Certificate_of_Incorporation.pdf.
    \35\ 17 CFR 240.17Ad-22(a)(15).
    \36\ 12 U.S.C. 5464(a)(2).
    \37\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (Oct. 22, 2012), 77 FR 66220 (Nov. 2, 2012) (S7-08-11). See 
also Covered Clearing Agency Standards, 81 FR 70786. OCC is a 
``covered clearing agency'' as defined in Rule 17Ad-22(a)(5).
    \38\ See 17 CFR 240.17Ad-22(e)(4).
    \39\ See 17 CFR 240.17Ad-22(e)(15).
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    SIG argues further that OCC's proposal puts only the public's skin 
in the game. SIG states that market participants bear the risk 
imprudent decisions by the exchanges in their capacity as the OCC 
shareholders and of their designee board members because such 
participants would be denied a rebate of excess fees.\40\
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    \40\ SIG Letter at 3.
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    The Commission is not persuaded by this argument either. SIG's 
argument assumes that OCC's Clearing Members have a right to clearing 
fee revenues not applied to operating costs in a given year, but, as 
noted above in this section, OCC's rules, as approved by the 
Commission, do not require OCC to distribute retained earnings in 
excess of expenses. SIG's argument also assumes, without support, that 
OCC's five Exchange Directors would not only be willing to make 
``imprudent decisions to the detriment of OCC's Clearing Members,'' but 
that the Exchange Directors would be able to enlist sufficient support 
among OCC's nine Member Directors to force such ``imprudent decisions'' 
through the Board approval process.
    Based on the foregoing, the Commission believes that the Proposed 
Rule Change is consistent with the requirements of Section 17A(b)(3)(F) 
of the Exchange Act.\41\
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    \41\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(2) Under the Exchange Act

    Rule 17Ad-22(e)(2) under the Exchange Act requires that a covered 
clearing agency establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to provide for governance 
arrangements

[[Page 29864]]

that, among other things, are clear and transparent; clearly prioritize 
the safety and efficiency of the covered clearing agency; and support 
the public interest requirements of the Exchange Act.\42\ In adopting 
Rule 17Ad-22(e)(2), the Commission discussed comments it received 
regarding the concept of skin-in-the-game as a potential tool to align 
the various incentives of a covered clearing agency's stakeholders, 
including management and clearing members.\43\ And, while the 
Commission declined to include a specific skin-in-the-game requirement 
in the rule, it stated its belief that ``the proper alignment of 
incentives is an important element of a covered clearing agency's risk 
management practices,'' and noted that skin-in-the-game ``may play a 
role in those risk management practices in many instances.'' \44\ OCC's 
current rules require the application management compensation and 
excess capital as skin-in-the-game, which in turn should help further 
align the interests of OCC's stakeholders, including OCC management and 
Clearing Members.\45\
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    \42\ 17 CFR 240.17Ad-22(e)(2).
    \43\ Covered Clearing Agency Standards, 81 FR at 70805-06.
    \44\ Covered Clearing Agency Standards, 81 FR at 70806.
    \45\ See CMP Approval Order at 5507.
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    As described above, OCC's proposal would not reduce the resources 
OCC would apply to address default losses or remove the current skin-
in-the-game component of OCC's rules. Rather, OCC proposes to set aside 
a defined amount of capital for the sole purpose of absorbing losses 
and shortfalls arising out of a Clearing Member default. OCC has 
clearly stated the factors that the Board would consider when 
determining the amount of resources to hold as skin-in-the-game, a 
portion of which would comprise the Minimum Corporate Contribution. OCC 
also proposes to establish a clear process for addressing reductions in 
the Minimum Corporate Contribution arising out of a Clearing Member's 
default. Accordingly, the Commission believes that the proposed changes 
to establish a persistent minimum level of skin-in-the-game are 
consistent with Rule 17Ad-22(e)(2) under the Exchange Act.\46\
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    \46\ 17 CFR 240.17Ad-22(e)(2).
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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 \47\ and the rules and regulations thereunder.
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    \47\ 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,\48\ that the Proposed Rule Change (SR-OCC-2021-003) be, 
and hereby is, approved.
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    \48\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\49\
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    \49\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-11606 Filed 6-2-21; 8:45 am]
BILLING CODE 8011-01-P


