[Federal Register Volume 87, Number 141 (Monday, July 25, 2022)]
[Notices]
[Pages 44167-44171]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-15771]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-95319; File No. SR-OCC-2022-001]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of Proposed Rule Change Concerning The Options 
Clearing Corporation's Margin Methodology for Incorporating Variations 
in Implied Volatility

July 19, 2022.

I. Introduction

    On January 24, 2022, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2022-001 (``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 change 
quantitative models related to certain volatility products.\3\ The 
Proposed Rule Change was published for public comment in the Federal 
Register on February 11, 2022.\4\ The Commission has received comments 
regarding the Proposed Rule Change.\5\
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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, at 87 FR 8072.
    \4\ Securities Exchange Act Release No. 94165 (Feb. 7, 2022), 87 
FR 8072 (Feb. 11, 2022) (File No. SR-OCC-2022-001) (``Notice of 
Filing''). OCC also filed a related advance notice (SR-OCC-2022-801) 
(``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 February 11, 2022. Securities Exchange Act 
Release No. 94166 (Feb. 7, 2022), 87 FR 8063 (Feb. 11, 2022) (File 
No. SR-OCC-2022-801).
    \5\ Comments on the Proposed Rule Change are available at 
https://www.sec.gov/comments/sr-occ-2022-001/srocc2022001.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.
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    On March 24, 2022, pursuant to Section 19(b)(2) of the Exchange 
Act,\6\ the Commission designated a longer period within which to 
approve, disapprove, or institute proceedings to determine whether to 
approve or disapprove the Proposed Rule Change.\7\ On May 12, 2022, the 
Commission instituted proceedings to determine whether to approve or 
disapprove the Proposed Rule Change.\8\ This order approves the 
Proposed Rule Change.
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    \6\ 15 U.S.C. 78s(b)(2).
    \7\ Securities Exchange Act Release No. 94165 (Feb. 7, 2022), 87 
FR 8072 (Feb. 11, 2022) (File No. SR-OCC-2022-001).
    \8\ Securities Exchange Act Release No. 94900 (May 12, 2022), 87 
FR 30284 (May 18, 2022) (File No. SR-OCC-2022-001).
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    OCC is a central counterparty (``CCP''), which means it interposes 
itself as the buyer to every seller and seller to every buyer for 
financial transactions. As the CCP for the listed options markets in 
the U.S., as well as for certain futures, OCC is exposed to the risk 
that one or more of its members may fail to make a payment or to 
deliver securities. OCC addresses such exposures, in part, by requiring 
its members to provide collateral, including margin collateral. Margin 
is the collateral that CCPs, like OCC, collect to cover potential 
changes in a member's positions over a set period of time. Typically, 
margin is designed to cover such exposures during normal market 
conditions, which means that margin collateral should be sufficient to 
exposures at least 99 out of 100 days.
    Margin requirements may fluctuate from day to day; however, CCPs 
seek to reduce fluctuations that could otherwise impose systemic risk. 
For example, if a CCP collects too little margin during relatively 
stable market conditions, then it would need to collect significantly 
more margin during stressed market conditions. Margin requirements that 
are strongly reactive to market movements are considered to be 
``procyclical.'' By contrast, a CCP may collect slightly more margin 
during quiet times to reduce the additional strain it places on members 
during times of market stress.
    OCC's process for setting margin requirements considers several 
distinct risk factors, including volatility. OCC's current models for 
estimating the impact of volatility on member positions have a number 
of limitations that may result in procyclical margin requirements. OCC 
is proposing to change its models to reduce the level of procyclicality 
in its margin requirements caused by changes in volatility. The changes 
OCC is proposing would also provide for offsets between products based 
on the same underlying asset. Based on data provided by OCC, the 
proposed model changes would likely increase margin requirements 
slightly overall, which, in turn, would reduce the additional

[[Page 44168]]

amount of margin OCC would need to collect during periods of market 
stress.
    The proposed changes to OCC's models are a continuation of 
volatility model changes that OCC has implemented over the past several 
years. In 2015, the Commission approved OCC's proposal to more broadly 
incorporate variations in implied volatility in OCC's margin 
methodology.\9\ In 2018, OCC modified its implied volatility model to 
address issues highlighted by large spikes in volatility. The following 
sections describe the proposed changes to OCC's models in more detail 
as well as the consistency of the proposed changes with applicable law.
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    \9\ See Securities Exchange Act Release No. 76781 (Dec. 28, 
2015), 81 FR 135 (Jan. 4, 2016) (File No. SR-OCC-2015-016).
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II. Background 10
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    \10\ 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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    The System for Theoretical Analysis and Numerical Simulations 
(``STANS'') is OCC's methodology for calculating margin.\11\ STANS 
includes econometric models that incorporate a number of risk factors. 
OCC defines a risk factor in STANS as a product or attribute whose 
historical data is used to estimate and simulate the risk for an 
associated product. The majority of risk factors utilized in STANS are 
the returns on individual equity securities; however, a number of other 
risk factors may be considered, including, among other things, returns 
on implied volatility.\12\
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    \11\ In February 2021, the Commission approved a proposed rule 
change by OCC to adopt a new document describing OCC's system for 
calculating daily and intraday margin requirements for its Clearing 
Members (the ``STANS Methodology Description''). See Securities 
Exchange Release No. 91079 (Feb. 8, 2021), 86 FR 9410 (Feb. 12, 
2021) (File No. SR-OCC-2020-016) (``STANS Methodology Approval'').
    \12\ Using the Black-Scholes options pricing model, the implied 
volatility is the standard deviation of the underlying asset price 
necessary to arrive at the market price of an option of a given 
strike, time to maturity, underlying asset price and the current 
risk-free rate. In December 2015, the Commission approved a proposed 
rule change and issued a Notice of No Objection to an advance notice 
filing by OCC to modify its margin methodology by more broadly 
incorporating variations in implied volatility within STANS. See 
Securities Exchange Act Release No. 76781 (Dec. 28, 2015), 81 FR 135 
(Jan. 4, 2016) (File No. SR-OCC-2015-016) and Securities Exchange 
Act Release No. 76548 (Dec. 3, 2015), 80 FR 76602 (Dec. 9, 2015) 
(File No. SR-OCC-2015-804). In December 2018, the Commission 
approved a proposed rule change and issued a Notice of No Objection 
to an advance notice filing by OCC to introduce an exponentially 
weighted moving average for the daily forecasted volatility of 
implied volatility risk factors in STANS. See Securities Exchange 
Act Release No. 84879 (Dec. 20, 2018), 83 FR 67392 (Dec. 28, 2018) 
(File No. SR-OCC-2018-014) and Securities Exchange Act Release No. 
84838 (Dec. 18, 2018), 83 FR 66791 (Dec. 27, 2018) (File No. SR-OCC-
2018-804).
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    OCC's STANS Methodology Description includes subsections on (i) 
implied volatility risk factors to measure the expected future 
volatility of an option's underlying security at expiration, (ii) a 
synthetic futures model to price specified products such as 
volatility index-based futures, and (iii) a specialized factor model 
to price variance futures.\13\ As described below, and in more 
detail in the Notice of Filing, OCC proposes to change three 
quantitative models related to certain volatility products. 
Specifically, OCC proposes the following changes:
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    \13\ See STANS Methodology Approval, 86 FR at 9411.

    (1) implement a new model for incorporating variations in implied 
volatility within STANS for products based on the S&P 500 Index (``S&P 
500''); such proposed model being the ``S&P 500 Implied Volatility 
Simulation Model'');
    (2) implement a new model to margin futures on volatility indexes 
\14\ (``Volatility Index Futures''); such proposed model being the 
``Volatility Index Futures Model''); and
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    \14\ A volatility index is an index designed to measure the 
volatiles implied by the prices of options on an underlying index.
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    (3) replace OCC's model for margining variance futures; \15\ such 
model being the ``Variance Futures Model.''
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    \15\ A variance future is an exchange-traded futures contract 
based on the expected realized variance of an underlying interest.
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A. S&P 500 Implied Volatility Simulation Model

    OCC considers variations in implied volatility within STANS to 
ensure that the anticipated cost of liquidating options positions in an 
account recognizes the possibility that implied volatility could change 
during the two-business day liquidation time horizon and lead to 
corresponding changes in the market prices of the options. OCC relies 
on its Implied Volatilities Scenarios Model to simulate the variations 
in implied volatility that OCC uses to re-price options within STANS 
for substantially all option contracts \16\ available to be cleared by 
OCC that have a residual tenor \17\ of less than three years. As noted 
above, OCC now proposes to implement a new model, the S&P 500 Implied 
Volatility Simulation Model, for incorporating variations in implied 
volatility within STANS for products based on the S&P 500 Index.
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    \16\ OCC's Implied Volatilities Scenarios Model excludes: (i) 
binary options, (ii) options on commodity futures, (iii) options on 
U.S. Treasury securities, and (iv) Asians and Cliquets.
    \17\ The ``tenor'' of an option is the amount of time remaining 
to its expiration.
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    In the Notice of Filing, OCC stated that its current Implied 
Volatilities Scenarios Model is subject to certain limitations and 
issues.\18\ Such issues relate to (1) volatility of volatility 
forecasting; (2) volatility surface discontinuities; and (3) arbitrage 
constraints and cross-product offsets. OCC proposes to replace the 
current Implied Volatilities Scenarios Model for the S&P 500 product 
group with the proposed S&P 500 Implied Volatility Simulation Model to 
address such limitations, which are described below. OCC would continue 
to use the current Implied Volatilities Scenarios Model for the 
products other than S&P 500-based products.\19\
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    \18\ See Notice of Filing, 87 FR at 8074.
    \19\ See Notice of Filing, 87 FR at 8075, n. 31.
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    Volatility of volatility forecasting. In the current Implied 
Volatilities Scenarios Model, OCC uses a GARCH model \20\ to forecast 
the volatility of implied volatility risk factors.\21\ OCC's past 
analysis has demonstrated that the volatility changes forecasted by the 
GARCH model were extremely sensitive to sudden spikes in volatility, 
which at times resulted in margin requirements that OCC believes were 
unreasonable.\22\ OCC's current Implied Volatilities Scenarios Model 
relies on an exponentially weighted moving average \23\ of forecasted 
volatilities over a specified look-back period to reduce the model's 
sensitivity to large, sudden shocks in market volatility. OCC stated 
that reliance on an exponentially weighted moving average reduces and 
delays the impact of large implied volatility spikes, but that it does 
so in an artificial way that does not target the limitations and issues 
with the model noted above.\24\
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    \20\ The acronym ``GARCH'' refers to an econometric model that 
can be used to estimate volatility based on historical data. See 
generally Tim Bollerslev, ``Generalized Autoregressive Conditional 
Heteroskedasticity,'' Journal of Econometrics, 31(3), 307-327 
(1986).
    \21\ See Notice of Filing, 87 FR at 8073.
    \22\ See id.
    \23\ An exponentially weighted moving average is a statistical 
method that averages data in a way that gives more weight to the 
most recent observations using an exponential scheme. As noted 
above, OCC introduced an exponentially weighted moving average for 
the daily forecasted volatility of implied volatility risk factors 
in STANS in 2018. See supra note 12. OCC found that using unweighted 
daily forecasted volatilities of implied volatilities caused jumps 
in aggregate margin requirements of up to 80 percent overnight, 
which OCC believes were unreasonable. See Securities Exchange Act 
Release No. 84879 (Dec. 20, 2018), 83 FR 67392, 67393 (Dec. 28, 
2018) (File No. SR-OCC-2018-014) and Securities Exchange Act Release 
No. 84838 (Dec. 18, 2018), 83 FR 66791, 66792 (Dec. 27, 2018) (File 
No. SR-OCC-2018-804).
    \24\ See Notice of Filing, 87 FR at 8074.
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    In the proposed S&P 500 Implied Volatility Simulation Model, OCC

[[Page 44169]]

would forecast volatility for S&P 500 1-month at-the-money (``ATM'') 
implied volatility based on the 30-day VVIX, Cboe's option-implied 
volatility-of-volatility index. OCC would further smooth the daily 30-
day VVIX to control for procyclicality. OCC asserted that, based on a 
performance analysis, the proposed S&P 500 Implied Volatility 
Simulation Model would (1) provide adequate margin coverages for both 
upward and downward movements of implied volatility over the margin 
risk horizon; and (2) remain stable across both time and low, medium, 
and high volatility market conditions.\25\
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    \25\ See Notice of Filing, 87 FR at 8076.
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    Volatility surface discontinuities. The current Implied 
Volatilities Scenarios Model relies on a ``nearest neighbor'' method to 
map the implied volatility surface between reference points.\26\ The 
reliance on a nearest neighbor method introduces discontinuity in the 
implied volatility curve for a given tenor. Further, the current 
Implied Volatilities Scenarios Model's use of arithmetic implied 
volatility returns can result in near-zero implied volatility in 
simulated scenarios, which OCC states is unrealistic.\27\ Additionally, 
the current model includes implied volatility scenarios for call and 
put options with the same tenor and strike price that are not equal, 
which contributes to inconsistencies in the implied volatility 
scenarios. OCC now proposes to model the implied volatility surface 
directly to generate a surface that would be smooth and continuous in 
both term structure and moneyness \28\ dimensions.\29\ Modeling the 
implied volatility surface directly rather than mapping the surface 
based on a series of reference points would simplify OCC's margin 
methodology and help avoid the discontinuities discussed above.
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    \26\ The Implied Volatilities Scenarios Model models a 
volatility surface by incorporating nine risk factors based on a 
range of tenors and option deltas. The ``delta'' of an option 
represents the sensitivity of the option price to the price of the 
underlying security.
    \27\ See Notice of Filing, 87 FR at 8074.
    \28\ The term ``moneyness'' refers to the relationship between 
the current market price of the underlying interest and the exercise 
price. See Notice of Filing, 87 FR at 8073, n. 12.
    \29\ Key risk factors driving the implied volatility surface are 
explicitly modeled within the model itself. See Notice of Filing, 87 
FR at 8076.
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    Arbitrage constraints and cross-product offsets. The current 
Implied Volatilities Scenarios Model does not impose constraints to 
ensure that simulated surfaces are arbitrage-free. Because of this 
potential for arbitrage, OCC believes the implied volatilities are not 
adequate inputs to price Variance Futures and Volatility Index Futures 
accurately, both of which assume an arbitrage-free condition.\30\ 
Further, the current Implied Volatilities Scenarios Model may not 
provide natural offsetting of risks in Clearing Member accounts that 
contain combinations of S&P 500 options, variance futures, and/or 
volatility index futures because OCC models such options and futures 
independent of each other rather than as inherently related components 
of a broader system, which could in turn result in unnecessarily large 
margin requirements for certain Clearing Members.
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    \30\ See Notice of Filing, 87 FR at 8074.
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    Under the proposed model, put and call options with the same tenors 
and strike prices would have the same implied volatility scenarios. 
Imposing such a constraint on arbitrage would be sufficient to allow 
OCC to use the output of the proposed model for margining volatility 
index futures and variance futures.\31\ Use of the proposed S&P 500 
Implied Volatility Simulation Model as an input to margining volatility 
index futures and variance futures also would, in turn, support margin 
offsets between S&P 500 options, VIX futures, and S&P 500 variance 
futures.
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    \31\ See Notice of Filing, 87 FR at 8076. OCC intends to rely on 
the output from the proposed S&P 500 Implied Volatility Simulation 
Model as an input to the proposed Volatility Index Futures Model and 
Variance Futures Model described below. See Notice of Filing, 87 FR 
at 8075.
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B. Volatility Index Futures Model

    To calculate margin for Clearing Member portfolios, OCC currently 
relies on its ``Synthetic Futures Model'' to calculate the theoretical 
value of volatility index futures, among other products.\32\ As noted 
above, OCC now proposes to implement its new Volatility Index Futures 
model, which would be used to calculate the theoretical values of 
futures on certain volatility futures indexes (i.e., indexes designed 
to measure volatilities implied by prices of options on a particular 
underlying index).\33\
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    \32\ See Securities Exchange Act Release No. 85873 (May 16, 
2019), 84 FR 23620 (May 22, 2019) (File No. SR-OCC-2019-002) 
(approving a proposed rule change regarding the measurement of 
volatilities implied by prices of options on a particular underlying 
interest). OCC also applies the Synthetic Futures Model to (i) 
futures on the American Interbank Offered Rate (``AMERIBOR''); (ii) 
futures products linked to indexes comprised of continuous yield 
based on the most recently issued (i.e., ``on-the-run'') U.S. 
Treasury notes listed by Small Exchange Inc. (``Small Treasury Yield 
Index Futures''); and (iii) futures products linked to Light Sweet 
Crude Oil (WTI) listed by Small Exchange (``Small Crude Oil 
Futures''). See Securities Exchange Act Release No. 89392 (Jul. 24, 
2020), 85 FR 45938 (Jul. 30, 2020) (File No. SR-OCC-2020-007) 
(application of OCC's Synthetic Futures model to AMERIBOR futures); 
Securities Exchange Act Release No. 90139 (Oct. 8, 2020), 85 FR 
65886 (Oct. 16, 2020) (File No. SR-OCC-2020-012) (application of 
OCC's Synthetic Futures model to Small Treasury Yield Index 
Futures); Securities Exchange Act Release No. 91833 (May 10, 2021), 
86 FR 26586 (May 14, 2021) (File No. SR-OCC-2021-005) (application 
of OCC's Synthetic Futures model to Small Crude Oil Futures).
    \33\ OCC would continue to use the current Synthetic Futures 
Model to model prices for interest rate futures on AMERIBOR, Small 
Treasury Yield Index Futures and Small Crude Oil Futures. See Notice 
of Filing, 87 FR at 8074, n. 25.
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    In the Notice of Filing, OCC stated that its current Synthetic 
Futures Model is subject to certain limitations and issues.\34\ First, 
the current Synthetic Futures Model relies on a GARCH variance forecast 
that, as noted above, is sensitive to large volatility shocks. OCC 
mitigates this sensitivity by imposing a floor for variance estimates 
based on the underlying index (e.g., VIX). The proposed Volatility 
Index Futures Model would instead rely on a direct link between the 
volatility index futures price and the underlying S&P 500 options price 
to mitigate the model's sensitivity to large volatility shocks. Such a 
link would come from reliance on the output of the proposed S&P 500 
Implied Volatility Simulation Model, which does not rely on a GARCH 
process and, therefore, the input to the proposed Volatility Index 
Futures Model would not have the same sensitivity to large volatility 
shocks as the current Synthetic Futures Model.
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    \34\ See Notice of Filing, 87 FR at 8074.
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    Second, the current Synthetic Futures Model makes the rolling 
volatility futures contracts take on different variances from 
calibration at futures roll dates, which could translate to jumps in 
margin. The proposed Volatility Index Futures Model would be based on 
an entirely different approach that would not incorporate the same 
potential jumps in margin. Specifically, OCC proposes to adopt a 
parameter-free approach based on the replication of log-contract, which 
measures the expected realized volatility using S&P 500 options, as 
discussed in Cboe's VIX white paper.\35\
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    \35\ See Cboe, VIX White Paper (2019), available at https://www.cboe.com/micro/vix/vixwhite.pdf.
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    As described in the confidential exhibits OCC submitted with the 
Proposed Rule Change, the proposed Volatility Index Futures Model would 
provide more consistent margin coverage across the term structure when 
compared to the current Synthetic Futures Model. Based on OCC's 
testing, the proposed model would continue to provide adequate margin 
coverage during periods of low and high volatility as well as for 
short-term futures. Further, the proposed model

[[Page 44170]]

would provide for more efficient margin coverage for VIX futures 
portfolios hedged with S&P 500 options.

C. Variance Futures Model

    Variance futures are commodity futures for which the underlying 
interest is a variance. OCC's current model for calculating the 
theoretical value of variance futures, adopted in 2007, is an 
econometric model designed to capture long- and short-term conditional 
variance of the underlying S&P 500 to generate variance futures prices. 
OCC now proposes to replace its current model for margining variance 
futures with the proposed Variance Futures Model, which would be based 
on a replication technique using the log-contract to price variance 
futures similar to the proposed Volatility Index Futures Model.\36\
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    \36\ This approach is based on Cboe's published method for 
pricing S&P 500 variance futures. See Cboe, S&P 500 Variance Futures 
Contract Specification (Dec. 10, 2012), available at http://www.cboe.com/products/futures/va-s-p-500-variance-futures/contract-specifications.
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    OCC believes that its current model for margining variance futures 
has several disadvantages.\37\ First, OCC currently models variance 
futures by simulating a final settlement price rather than a near-term 
variance futures price, which is not consistent with OCC's two-day 
liquidation horizon.\38\ The proposed Variance Futures Model would 
simulate a near-term variance futures price rather than a final 
settlement price, consistent with OCC's two-day liquidation assumption.
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    \37\ See Notice of Filing, 87 FR at 8075.
    \38\ OCC's processes for managing the default of a Clearing 
Member assume that OCC can close out the defaulter's portfolio 
within two days of default.
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    Second, similar to the Implied Volatilities Scenarios Model and 
Synthetic Futures Model, OCC's current model for margining variance 
futures relies on a GARCH model that OCC believes: (1) does not provide 
appropriate risk offsets with other instruments inherently related to 
the S&P 500 implied volatility and (2) does not generate margin 
requirements that are sufficiently conservative for short positions and 
aggressive for long positions to avoid causing model backtesting 
failures.\39\
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    \39\ See Notice of Filing, 87 FR at 8075.
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    Instead of relying on a GARCH variance forecast, the proposed 
Variance Futures Model would approximate the implied component of 
variance futures (i.e., the unrealized variance) based on option prices 
generated using the proposed S&P 500 Implied Volatility Simulation 
Model. As described in the confidential exhibits OCC submitted with the 
Proposed Rule Change, this would significantly reduce long-side 
coverage exceedances relative to the current model while maintaining 
coverage for periods of low and high volatility. It would also offer 
offsets for variance futures with the options of the same underlying 
security.

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.\40\ 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)(A) of the Exchange Act,\41\ and Rule 17Ad-22(e)(6) 
\42\ thereunder, as described in detail below.
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    \40\ 15 U.S.C. 78s(b)(2)(C).
    \41\ 15 U.S.C. 78q-1(b)(3)(A).
    \42\ 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 the custody or 
control of the clearing agency or for which it is responsible.\43\ 
Based on its review of the record, and for the reasons described below, 
the Commission believes that allowing OCC to make the proposed model 
changes described above is consistent with the safeguarding of 
securities and funds which are in its custody or control or for which 
it is responsible.
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    \43\ 15 U.S.C. 78q-1(b)(3)(F).
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    The proposed models provide for margin coverage levels that are 
consistent with, and in certain instances (e.g., long-side variance 
futures coverage) better than, the current models. The proposed models 
would also simplify OCC's methodology for simulating variations in 
implied volatilities while simultaneously supporting offsets for 
products with the same underlying (e.g., volatility and variance 
products based on the S&P 500). The Commission believes that providing 
for such offsets would more accurately represent the relationship 
between the products OCC clears. Ensuring that OCC's margin models 
accurately reflect the relationships between the products OCC clears 
would, in turn, facilitate OCC's ability to set margins that more 
accurately reflect the risks posed by such products. Setting margins 
that accurately reflect the risks posed by the products OCC clears 
could reduce the likelihood that OCC would not have sufficient margin 
to address losses arising out of the default of a Clearing Member. 
Reducing the likelihood that OCC holds insufficient margin to address 
default losses would, in turn, further assure the safeguarding of 
surviving Clearing Members' collateral by reducing the likelihood that 
OCC would be forced to charge losses to the Clearing Fund.
    The Commission believes, therefore, that the proposed model changes 
are consistent with the requirements of Section 17A(b)(3)(F) of the 
Exchange Act.\44\
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    \44\ 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

    Rule 17Ad-22(e)(6) under the Exchange Act requires that a covered 
clearing agency establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to cover, if the covered 
clearing agency provides central counterparty services, its credit 
exposures to its participants by establishing a risk-based margin 
system that, among other things, (1) considers, and produces margin 
levels commensurate with, the risks and particular attributes of each 
relevant product, portfolio, and market \45\ and (2) calculates 
sufficient margin 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.\46\
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    \45\ 17 CFR 240.17Ad-22(e)(6)(i).
    \46\ 17 CFR 240.17Ad-22(e)(6)(iii)
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    As described above, the proposed models would remove the reliance 
on GARCH models that have demonstrated extreme sensitivity to sudden 
spikes in volatility. The Commission believes that such reactivity can 
produce instability and in certain instances over or underestimation of 
margin requirements.\47\ The proposed models would also replace the 
modeling techniques that currently allow for discontinuities and jumps 
in margin (e.g., simulating scenarios with near-zero implied 
volatility). Such

[[Page 44171]]

discontinuities and jumps in margin may, in turn, lead to disparate 
margin requirements for instruments with similar risk profiles. 
Further, OCC's proposed reliance on output from the proposed S&P 500 
Implied Volatility Simulation Model as an input to the Volatility Index 
Futures model and Variance Futures model would capture the natural risk 
offsets between inherently related products. Providing for such offsets 
would more accurately represent the relationship between the products 
OCC clears. Ensuring that OCC's margin models accurately reflect the 
relationships between the products OCC clears would, in turn, 
facilitate OCC's ability to set margins that more accurately reflect 
the risks posed by such products. Further, providing for such offsets 
could reduce the likelihood that Clearing Members would be required to 
provide additional financial resources unnecessarily, which, in turn, 
could reduce the strain on such members during stress market 
conditions. Additionally, the proposed Variance Futures model would 
simulate a near-term variance futures price rather than a final 
settlement price, which is consistent with the risks OCC would face in 
the event of a Clearing Member default.
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    \47\ For example, OCC's current model would have increased 
aggregate margin requirements by 80 percent overnight in response to 
the increased volatility observed on February 5, 2018. See 
Securities Exchange Act Release No. 84879 (Dec. 20, 2018), 83 FR 
67392, 67393 (Dec. 28, 2018).
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    In response to the Notice of Filing,\48\ the Commission received a 
comment opposing the proposal on the basis that the change would reduce 
margins to a level that could ensure some Clearing Members would fail, 
with expenses borne by ``direct investors.'' \49\ The commenter's 
assertions, however, are inconsistent with the confidential performance 
data provided by OCC. The confidential information provided by OCC 
includes backtesting data demonstrating how the proposed models would 
have performed had they been in production at OCC from February 2018 
through February 2021. This backtesting period includes the period of 
increased volatility observed on February 5, 2018 that demonstrated the 
reactivity of OCC's current models.\50\ The confidential information 
provided by OCC and reviewed by the Commission demonstrates that, 
overall, the proposed models perform better than OCC's current models 
with regard to setting margin requirements to cover exposures presented 
by Clearing Member portfolios.\51\
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    \48\ See Notice of Filing, at 87 FR 8072.
    \49\ Comment from Mary (Feb. 7, 2022), available at https://www.sec.gov/comments/sr-occ-2022-001/srocc2022001-20114809-267072.htm. The commenter also raised a concern regarding the 
confidentiality of certain exhibits. Id. OCC asserted that the 
exhibits to the filing were entitled to confidential treatment 
because they contained commercial and financial information that is 
not customarily released to the public and is treated as the private 
information of OCC. Under Section 23(a)(3) of the Exchange Act, the 
Commission is not required to make public statements filed with the 
Commission in connection with a proposed rule change of a self-
regulatory organization if the Commission could withhold the 
statements from the public in accordance with the Freedom of 
Information Act (``FOIA''), 5 U.S.C. 552. 15 U.S.C. 78w(a)(3). The 
Commission has reviewed the documents for which OCC requests 
confidential treatment and concludes that they could be withheld 
from the public under the FOIA. FOIA Exemption 4 protects 
confidential commercial or financial information. 5 U.S.C. 
552(b)(4). Under Exemption 4, information is confidential if it ``is 
both customarily and actually treated as private by its owner and 
provided to government under an assurance of privacy.'' Food 
Marketing Institute v. Argus Leader Media, 139 S. Ct. 2356, 2366 
(2019). In its requests for confidential treatment, OCC stated that 
it has not disclosed the confidential exhibits to the public, and 
the information is the type that would not customarily be disclosed 
to the public. In addition, by requesting confidential treatment, 
OCC had an assurance of privacy because the Commission generally 
protects information that can be withheld under Exemption 4. Thus, 
the Commission has determined to accord confidential treatment to 
the confidential exhibits.
    \50\ See supra footnote 47.
    \51\ The Commission received other comments generally asserting 
that the proposal would reduce margin at the expense of retail 
investors and that there is a need to ``lower the amount of leverage 
in the system.'' As described above, the backtesting data provided 
by OCC demonstrates that the proposed models would set margin 
requirements that more effectively cover exposures presented by 
Clearing Member portfolios, which include customer positions.
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    Accordingly, the Commission believes that the proposed model 
changes are consistent with Rule 17Ad-22(e)(6) under the Exchange 
Act.\52\
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    \52\ 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 \53\ and the rules and regulations thereunder.
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    \53\ 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,\54\ that the Proposed Rule Change (SR-OCC-2022-001) be, 
and hereby is, approved.
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    \54\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\55\
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    \55\ 17 CFR 200.30-3(a)(12).

J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-15771 Filed 7-22-22; 8:45 am]
BILLING CODE 8011-01-P


