Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of a Proposed Rule Change Relating to a New Risk Management Methodology, 76487-76490 [E5-7841]
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Federal Register / Vol. 70, No. 247 / Tuesday, December 27, 2005 / Notices
(B) Self-Regulatory Organization’s
Statement on Burden on Competition
NSCC does not believe that the
proposed rule change will have any
impact or impose any burden on
competition.
(C) Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received from
Members, Participants, or Others
The proposed rule change was
prepared after consultation with the
Buy-In Committee of the Securities
Industry Association. Written comments
relating to the proposed rule change
have not yet been solicited or received.
NSCC will notify the Commission of any
written comments received by NSCC.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within thirty-five days of the date of
publication of this notice in the Federal
Register or within such longer period:
(i) as the Commission may designate up
to ninety days of such date if it finds
such longer period to be appropriate
and publishes its reasons for so finding;
or (ii) as to which the self-regulatory
organization consents, the Commission
will:
(A) by order approve such proposed
rule change or
(B) institute proceedings to determine
whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
bjneal on PROD1PC70 with NOTICES
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml) or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–NSCC–2005–15 in the
subject line.
Paper Comments
• Send paper comments in triplicate
to Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–9303.
All submissions should refer to File
Number SR–NSCC–2005–15. This file
number should be included on the
subject line if e-mail is used. To help the
Commission process and review your
comments more efficiently, please use
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14:54 Dec 23, 2005
Jkt 208001
only one method. The Commission will
post all comments on the Commission’s
Internet Web site (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for inspection and copying in
the Commission’s Public Reference
Section, 100 F Street, NE., Washington,
DC 20549. Copies of such filings also
will be available for inspection and
copying at the principal office of NSCC
and on NSCC’s Web site, https://
www.nscc.com\legal. All comments
received will be posted without change;
the Commission does not edit personal
identifying information from
submissions. You should submit only
information that you wish to make
available publicly. All submissions
should refer to File Number SR–NSCC–
2005–15 and should be submitted on or
before January 17, 2005.
For the Commission by the Division of
Market Regulation, pursuant to delegated
authority.6
Jonathan G. Katz,
Secretary.
[FR Doc. E5–7855 Filed 12–23–05; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–52975; File No. SR–OCC–
2004–20]
Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of Filing of a Proposed Rule Change
Relating to a New Risk Management
Methodology
December 19, 2005.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 notice is hereby given that on
November 15, 2004, The Options
Clearing Corporation (‘‘OCC’’) filed with
the Securities and Exchange
Commission (‘‘Commission’’), and on
May 10, 2005, and December 13, 2005,
amended the proposed rule change as
described in Items I, II, and III below,
which items have been prepared
primarily by OCC. The Commission is
publishing this notice to solicit
6 17
1 15
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U.S.C. 78s(b)(1).
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comments on the proposed rule change,
as amended, from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The purpose of the proposed rule
change is to reflect the implementation
of a new risk management methodology
that OCC would use to determine the
amount of margin assets required to be
deposited by a clearing member with
respect to each account.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission,
OCC included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item IV below. OCC has prepared
summaries, set forth in sections (A), (B),
and (C) below, of the most significant
aspects of such statements.2
(A) Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
The proposed new risk management
methodology, the System for Theoretical
Analysis and Numerical Simulations,
will enhance OCC’s ability to measure
the risk of the portfolios in a clearing
member’s accounts more accurately and
therefore, will enable OCC to calculate
margin requirements more precisely.
1. The Existing Risk Management
Methodology: The Theoretical
Intermarket Margining System
Currently, OCC applies the
Theoretical Intermarket Margining
System (‘‘TIMS’’) for the calculation of
clearing members’ daily minimum
margin requirements, for the
determination of the size of OCC’s
clearing fund, for the computation of
additional margin requirements, and for
assessing risk in the Hedge Program.
TIMS is a univariate risk management
methodology that evaluates historical
data of approximately 3,000 underlying
assets to identify the expected gain or
loss on positions that would occur at ten
price points for equity instruments and
at twenty price points for non-equity
instruments within a range of likely
price movements of each underlying
interest. TIMS requires that options,
futures, and stock loan and borrow
2 The Commission has modified parts of these
statements.
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positions that have the same underlying
interest be categorized into classes and
that classes be categorized into unique
product groups consisting of one or
more related classes. TIMS calculates
the total risk of each clearing member
account as the sum of the worst scenario
outcomes of each product group in the
account. TIMS recognizes offsetting
positions within each clearing member
account but only to the extent that the
offsetting positions are in the same
product group.
Although TIMS has consistently
produced sufficient base margin
requirements, this methodology has a
number of shortcomings that have riskrelevant consequences. Among these are
the following:
a. Because TIMS requires that each
class group belong to only one product
group, any offsetting effects among
instruments in different product groups
are ignored when margin requirements
are calculated. This inherent lack of
methodological flexibility tends to
overestimate portfolio risk thereby
imposing unnecessarily high margin
requirements on clearing members.
b. TIMS assumes perfect correlation of
price movements for underlying
interests belonging to the same product
group. As a result, margin requirements
for unhedged product group portfolios
are often overstated, and margin
requirements for hedged product group
portfolios are often understated.
c. TIMS calculates the total account
risk as the sum of the worst scenario
outcomes of all product groups. In that
sense, TIMS does not measure the price
risk of the total portfolio; rather it
measures the price risk of the various
subportfolios as represented by product
groups. Since portfolio risk can never be
larger than the sum of the portfolio
components’ risks, but could be smaller
to the extent of any offsetting
relationships, TIMS’s aggregation of
product group risks results in an
upwardly biased estimation of a clearing
member’s portfolio risk.
d. TIMS’s aggregation methodology
often implies an economically
impossible correlation (positive or
negative) between product groups in an
account. Suppose, for example, that an
account has a (delta) long position in
the broad-based index group and a
(delta) short position in the individual
equities group. By aggregating the risks
in these two groups, TIMS implies that
a decline in all broad-based indices
could exist simultaneously with a rise
in all individual equities—an
impossible economic scenario.
e. In analyzing historical data, TIMS
focuses on a range of potential price
movements. However, covering 99% of
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all potential price movements does not
result in coverage of 99% of all profit/
loss outcomes, which is the desired
goal. Using the TIMS method, some
accounts may have margin requirements
covering 98% of profit/loss outcomes
while others are covered at 99.9%.
These small statistical differences can
have large dollar implications.
2. The New Risk Management
Methodology: The System for
Theoretical Analysis and Numerical
Simulations
The System for Theoretical Analysis
and Numerical Simulations (‘‘STANS’’)
preserves TIMS’s analysis of the
historical price movements of
underlying assets and of the correlation
of such price movements among
underlying assets. However, STANS
evaluates price risk on a portfolio level
and more accurately evaluates the
correspondence of price movements
among underlying assets and therefore,
is able to calculate margin requirements
more accurately than TIMS.
STANS is a multivariate risk
management methodology that
considers the range of likely price
movements for each of the
approximately 8,000 assets underlying
OCC options. STANS measures the
historical correlations among the price
movements of the different assets.
STANS generates simulated returns for
all underlying assets based on this
historical data, measures the historical
price volatility of each of these
underlying assets, and evaluates the
relationship structure of the entire
portfolio. STANS reduces the
imprecision produced by TIMS in the
following ways:
a. Because STANS does not use
TIMS’s product group concept, STANS
recognizes the relationship of each asset
class to all other asset classes rather
than recognizing only the relationships
among asset classes in the same product
group. Therefore, STANS will more
accurately identify offsetting positions,
and margin requirements will be
adjusted downward accordingly.
b. STANS identifies a more realistic
correlative relationship among
underlying assets than TIMS. STANS
does not exclude opposite moves for
positively correlated assets. In contrast,
price scenarios within the TIMS
methodology are all concordant.
c. Because STANS eliminates product
groups, it is able to evaluate the
interrelationships among all
instruments in a clearing member’s
portfolio rather than only within a
product group. STANS’s estimates of
portfolio risk are neither upwardly nor
downwardly biased.
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d. STANS generates a distribution of
10,000 potential profit/loss outcomes for
the entire portfolio rather than simply a
range of potential price movements. As
a result, margin requirements are more
precise for every account, and therefore,
STANS ensures that all accounts will
have coverage for predicted liquidation
outcomes at the selected confidence
levels.
These characteristics will improve the
accuracy of margin calculations and as
a result, will improve the financial
stability of OCC and the derivatives
markets. In addition, STANS allows for
easy integration of various types of nonequity products, such as fixed-income
related products and commodities. The
implementation of STANS thus
facilitates joint risk assessment
initiatives that can produce clearing and
settlement efficiencies beneficial to
investors.
To reflect the implementation of
STANS in OCC’s By-Laws and Rules,
OCC proposes to replace most of Rule
601 and to eliminate Rule 602. Proposed
new Rule 601 is conceptual rather than
attempting a mechanical, step-wise
description of margin requirement
calculations. It is therefore more concise
than the existing Rule 601. OCC
presently calculates margin
requirements for equity and non-equity
products separately with Rule 601 being
applicable to equities and Rule 602
being applicable to non-equitities.
STANS will calculate margin on equity
and non-equity products in one
integrated set of calculations. Thus, the
calculation of margin requirements for
all products will be as set forth in new
Rule 601. OCC proposes to delete crossreferences to Rule 602 as appropriate
throughout the Rules.
Proposed Rule 601(c) contains a basic
conceptual description of how, pursuant
to STANS, OCC would determine the
amount of margin assets a clearing
member is required to deposit with
OCC. Proposed Rule 601(c) uses the
concepts of ‘‘margin requirement,’’
‘‘margin assets,’’ ‘‘marking prices’’ and
‘‘minimum expected liquidating value’’
to aid in the description of STANS and
margin requirement calculations.
Definitions of each of these terms have
been included in the proposed
amendments to Article I of the By-Laws
or Rule 601 as appropriate. OCC
proposes to delete terms that are defined
in the existing Rule 601(b) that are
relevant to TIMS and not relevant to
STANS. For example, the terms
‘‘premium margin’’ and ‘‘risk margin’’
are no longer used. The ‘‘margin
requirement’’ as determined using
STANS is at least equal to the
‘‘minimum expected liquidating value’’
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of the account (if such expected value
is less than zero). The ‘‘minimum
expected liquidating value’’ may be
conceptualized as (i) the current net
asset value of positions in the account
(i.e., what used to be called ‘‘premium
margin’’) plus (ii) an additional amount
sufficient to cover the impact of the
largest expected adverse market
movement (i.e., what used to be called
‘‘risk margin’’). Because STANS does
not actually derive the minimum
expected liquidating value in this
additive way and because STANS is
designed to project expected values for
margin assets whose prices are not
referred to as ‘‘premiums,’’ the old
terminology was deemed inappropriate.
The proposed definition of ‘‘marking
price’’ is quite flexible and allows OCC
to use its discretion in determining
marking prices and to use different
marking prices for the same asset or
liability depending upon the purpose
for which a marking price is needed. An
example of where the latter situation
may occur is in the case of stock loan
and borrow positions. Marking prices in
the stock lending market are determined
by the conventions of that market, and
OCC would generally observe the prices
used in that market for purposes of
determining the daily marks passed
through OCC between the lender and
the borrower. OCC might, however,
have a different view of the correct
marking price to use for purposes of
calculating the risk of those positions in
STANS.
The purpose of proposed Rule 601(e),
‘‘Exclusions from Margin Requirement
Calculation,’’ is to identify in one place
those positions that are excluded from
margin requirement calculations
altogether. Existing Rule 601(e)
indicates that exercised or expired
positions in cleared contracts or stock
loan and borrow positions are excluded
from margin requirement calculations.
Rule 601(a) indicates that short
positions in option contracts or
BOUNDs for which a deposit in lieu of
margin has been made are excluded
from margin requirement calculations.
Rule 614 indicates that long positions in
cleared securities that have been
pledged to a pledgee are excluded from
margin requirement calculations. By
definition, margin-ineligible stock loan
positions and stock borrow positions are
excluded from margin requirement
calculations. Consolidating these
provisions in one place facilitates
understanding.
The release of margin assets to
clearing members as described in
existing Rule 601(e) has been revised to
be clearer and more concise and is now
covered in Rule 601(f). The existing rule
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contains a somewhat artificial
description of margin assets being
released under a position-specific
determination. Consistent with the more
integrated approach of the STANS
methodology, proposed Rule 601(f)
simply states that OCC will permit the
release of margin with respect to a
clearing member’s account if the
amount of margin assets in a clearing
member’s account exceeds the amount
of margin assets required to be in the
account pursuant to Rule 601 and if any
other obligations of the clearing member
to OCC have been satisfied.
Existing Rule 2111(b) and Rule
2409(b) envision that a provisional
margin requirement will be calculated
with respect to cross-rate foreign
currency options and FX Index Options.
The provisional margin requirement
was intended to ensure that OCC would
not release premiums due to an account
of a clearing member in a non-U.S. time
zone at a time when it was holding
insufficient margin to cover a premium
debit in a later time zone and/or
increased margin requirements resulting
from activity in cross-rate and foreign
currency index options since the last
U.S. Dollar settlement. OCC proposes to
eliminate this provisional margin
requirement and will instead simply
hold any amounts otherwise payable to
a clearing member in a different time
zone until after the next regular
settlement time in the U.S. Experience
has shown that clearing members often
instruct OCC to credit any cash from
these early settlements to their OCC
accounts instead of releasing it, and the
amounts involved do not justify the
costs of administering the more
cumbersome procedure of calculating
provisional margin requirements.
Since June 2003, OCC has been
providing information to representatives
of the Office of Prudential Supervision
and Risk Analysis of the Division of
Market Regulation (‘‘Division’’) on the
statistical and operational features of the
STANS methodology. To become
comfortable with the STANS
methodology, the Division requested
that OCC produce various graphs,
simulations, and spreadsheets
evidencing STANS’s ability to calculate
margin requirements more accurately
than TIMS. OCC believes that it has
responded to all of the Division’s
inquiries to date and has provided
sufficient information for the Division to
reach a high degree of comfort with the
STANS methodology. The staff of OCC
remains available to address any further
questions that the Division staff may
have.
OCC expects that the amount of
margin it will collect under STANS will
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76489
be significantly less than the amount of
margin it currently collects under TIMS.
This is largely due to the fact that
STANS more accurately identifies
offsetting positions than TIMS. There
would also be a corresponding
reduction in the amount of clearing
fund collected by OCC under STANS
because under Chapter X, ‘‘Clearing
Fund Contributions,’’ clearing fund is
calculated as a percentage of margin.
The Division requested that OCC amend
its rules to increase the percentage used
to calculate the clearing fund because
the Division believes that for the time
being the clearing fund contribution
should not be significantly reduced. As
a result, OCC filed an amendment to the
proposed rule change to amend Chapter
X, Rule 1001, ‘‘Amount of
Contribution,’’ to increase the minimum
percentage in the clearing fund
calculation from 5 percent to 6 percent
of average aggregate margin.
OCC believes that the proposed rule
change is consistent with the purposes
and requirements of Section 17A of the
Act because it is designed to assure the
safeguarding of securities and funds
which are in the custody or control of
OCC, to reduce unnecessary costs to
investors by facilitating more accurate
margin calculations, and in general, to
protect investors and the public interest.
In addition, the proposed rule change is
not inconsistent with OCC’s existing
rules, including any other rules
currently proposed to be amended.
(B) Self-Regulatory Organization’s
Statement on Burden on Competition
OCC does not believe that the
proposed rule change would impose any
burden on competition.
(C) Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
Written comments were not and are
not intended to be solicited with respect
to the proposed rule change, and none
have been received.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within thirty five days of the date of
publication of this notice in the Federal
Register or within such longer period (i)
as the Commission may designate up to
ninety days of such date if it finds such
longer period to be appropriate and
publishes its reasons for so finding or
(ii) as to which the self-regulatory
organization consents, the Commission
will:
(a) By order approve the proposed
rule change or
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(b) Institute proceedings to determine
whether the proposed rule change
should be disapproved.
VI. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–52982; No. SR–OCC–2005–
20]
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml) or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–OCC–2004–20 on the
subject line.
Paper Comments
• Send paper comments in triplicate
to Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–9303.
bjneal on PROD1PC70 with NOTICES
For the Commission by the Division of
Market Regulation, pursuant to delegated
authority.3
Jonathan G. Katz,
Secretary.
[FR Doc. E5–7841 Filed 12–23–05; 8:45 am]
Self-Regulatory Organizations; the
Options Clearing Corporation; Notice
of Filing and Immediate Effectiveness
of Proposed Rule Change To Reflect
the Renaming of the NASDAQ
SmallCap Market to the NASDAQ
Capital Market
December 19, 2005.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 notice is hereby given that on
December 8, 2005, The Options Clearing
Corporation (‘‘OCC’’) filed with the
All submissions should refer to File
Securities and Exchange Commission
Number SR–OCC–2004–20. This file
(‘‘Commission’’) the proposed rule
number should be included on the
change described in Items I, II, and III
subject line if e-mail is used. To help the below, which items have been prepared
Commission process and review your
primarily by OCC. The OCC filed the
comments more efficiently, please use
proposed rule change pursuant to
only one method. The Commission will Section 19(b)(3)(A)(i) of the Act,2 and
post all comments on the Commission’s Rule 19b–4(f)(1) 3 thereunder so that the
Internet Web site (https://www.sec.gov/
proposal was effective upon filing with
rules/sro.shtml). Copies of the
the Commission. The Commission is
submission, all subsequent
publishing this notice to solicit
amendments, all written statements
comments on the rule change from
with respect to the proposed rule
interested parties.
change that are filed with the
I. Self-Regulatory Organization’s
Commission, and all written
Statement of the Terms of Substance of
communications relating to the
the Proposed Rule Change
proposed rule change between the
Commission and any person, other than
The proposed rule change would
those that may be withheld from the
make a technical change to Rule
public in accordance with the
604(b)(4).
provisions of 5 U.S.C. 552, will be
II. Self-Regulatory Organization’s
available for inspection and copying in
Statement of the Purpose of, and
the Commission’s Public Reference
Statutory Basis for, the Proposed Rule
Section, 100 F Street, NE., Washington,
DC 20549. Copies of such filing also will Change
be available for inspection and copying
In its filing with the Commission,
at the principal office of OCC and on
OCC included statements concerning
OCC’s Web site at https://
the purpose of and basis for the
www.optionsclearing.com.
proposed rule change and discussed any
All comments received will be posted comments it received on the proposed
without change; the Commission does
rule change. The text of these statements
not edit personal identifying
may be examined at the places specified
information from submissions. You
in Item IV below. OCC has prepared
should submit only information that
summaries, set forth in sections (A), (B),
you wish to make available publicly. All
submissions should refer to File
3 17 CFR 200.30-3(a)(12).
Number SR–OCC–2004–20 and should
1 15 U.S.C. 78s(b)(1).
be submitted on or before January 17,
2 15 U.S.C. 78s(b)(3)(A)(i).
2006.
3 17 CFR 240.19b–4(f)(1).
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and (C) below, of the most significant
aspects of these statements.4
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
The Nasdaq Stock Market, Inc.
renamed the NASDAQ SmallCap Market
as the NASDAQ Capital Market effective
September 27, 2005. This rule change
updates a reference to the NASDAQ
SmallCap Market in Rule 604(b)(4) by
making a conforming change.
OCC believes the proposed rule
change is consistent with Section 17A of
the Act,5 as amended, because it ensures
that OCC’s rules are accurate by
reflecting the current name associated
with a NASDAQ market tier. The
proposed rule change is not inconsistent
with the existing rules of OCC.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
OCC does not believe that the
proposed rule change would impose any
burden on competition.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
Written comments were not and are
not intended to be solicited with respect
to the proposed rule change, and none
have been received.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
The foregoing proposed rule change
has become effective upon filing
pursuant to Section 19(b)(3)(A) of the
Act 6 and Rule 19b–4(f)(1) 7 thereunder
because it constitutes a stated policy,
practice, or interpretation with respect
to the meaning, administration, or
enforcement of an existing rule. At any
time within sixty days of the filing of
the proposed rule change, the
Commission may summarily abrogate
such rule change if it appears to the
Commission that such action is
necessary or appropriate in the public
interest, for the protection of investors,
or otherwise in furtherance of the
purposes of the Act.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
4 The Commission has modified the text of the
summaries prepared by OCC.
5 15 U.S.C. 78q–1.
6 15 U.S.C. 78s(b)(3)(A).
7 17 CFR 240.19b–4(f)(1).
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]]>Agencies
[Federal Register Volume 70, Number 247 (Tuesday, December 27, 2005)]
[Notices]
[Pages 76487-76490]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-7841]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-52975; File No. SR-OCC-2004-20]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of a Proposed Rule Change Relating to a New Risk
Management Methodology
December 19, 2005.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on November 15, 2004, The
Options Clearing Corporation (``OCC'') filed with the Securities and
Exchange Commission (``Commission''), and on May 10, 2005, and December
13, 2005, amended the proposed rule change as described in Items I, II,
and III below, which items have been prepared primarily by OCC. The
Commission is publishing this notice to solicit comments on the
proposed rule change, as amended, from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The purpose of the proposed rule change is to reflect the
implementation of a new risk management methodology that OCC would use
to determine the amount of margin assets required to be deposited by a
clearing member with respect to each account.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of such
statements.\2\
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\2\ The Commission has modified parts of these statements.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The proposed new risk management methodology, the System for
Theoretical Analysis and Numerical Simulations, will enhance OCC's
ability to measure the risk of the portfolios in a clearing member's
accounts more accurately and therefore, will enable OCC to calculate
margin requirements more precisely.
1. The Existing Risk Management Methodology: The Theoretical
Intermarket Margining System
Currently, OCC applies the Theoretical Intermarket Margining System
(``TIMS'') for the calculation of clearing members' daily minimum
margin requirements, for the determination of the size of OCC's
clearing fund, for the computation of additional margin requirements,
and for assessing risk in the Hedge Program. TIMS is a univariate risk
management methodology that evaluates historical data of approximately
3,000 underlying assets to identify the expected gain or loss on
positions that would occur at ten price points for equity instruments
and at twenty price points for non-equity instruments within a range of
likely price movements of each underlying interest. TIMS requires that
options, futures, and stock loan and borrow
[[Page 76488]]
positions that have the same underlying interest be categorized into
classes and that classes be categorized into unique product groups
consisting of one or more related classes. TIMS calculates the total
risk of each clearing member account as the sum of the worst scenario
outcomes of each product group in the account. TIMS recognizes
offsetting positions within each clearing member account but only to
the extent that the offsetting positions are in the same product group.
Although TIMS has consistently produced sufficient base margin
requirements, this methodology has a number of shortcomings that have
risk-relevant consequences. Among these are the following:
a. Because TIMS requires that each class group belong to only one
product group, any offsetting effects among instruments in different
product groups are ignored when margin requirements are calculated.
This inherent lack of methodological flexibility tends to overestimate
portfolio risk thereby imposing unnecessarily high margin requirements
on clearing members.
b. TIMS assumes perfect correlation of price movements for
underlying interests belonging to the same product group. As a result,
margin requirements for unhedged product group portfolios are often
overstated, and margin requirements for hedged product group portfolios
are often understated.
c. TIMS calculates the total account risk as the sum of the worst
scenario outcomes of all product groups. In that sense, TIMS does not
measure the price risk of the total portfolio; rather it measures the
price risk of the various subportfolios as represented by product
groups. Since portfolio risk can never be larger than the sum of the
portfolio components' risks, but could be smaller to the extent of any
offsetting relationships, TIMS's aggregation of product group risks
results in an upwardly biased estimation of a clearing member's
portfolio risk.
d. TIMS's aggregation methodology often implies an economically
impossible correlation (positive or negative) between product groups in
an account. Suppose, for example, that an account has a (delta) long
position in the broad-based index group and a (delta) short position in
the individual equities group. By aggregating the risks in these two
groups, TIMS implies that a decline in all broad-based indices could
exist simultaneously with a rise in all individual equities--an
impossible economic scenario.
e. In analyzing historical data, TIMS focuses on a range of
potential price movements. However, covering 99% of all potential price
movements does not result in coverage of 99% of all profit/loss
outcomes, which is the desired goal. Using the TIMS method, some
accounts may have margin requirements covering 98% of profit/loss
outcomes while others are covered at 99.9%. These small statistical
differences can have large dollar implications.
2. The New Risk Management Methodology: The System for Theoretical
Analysis and Numerical Simulations
The System for Theoretical Analysis and Numerical Simulations
(``STANS'') preserves TIMS's analysis of the historical price movements
of underlying assets and of the correlation of such price movements
among underlying assets. However, STANS evaluates price risk on a
portfolio level and more accurately evaluates the correspondence of
price movements among underlying assets and therefore, is able to
calculate margin requirements more accurately than TIMS.
STANS is a multivariate risk management methodology that considers
the range of likely price movements for each of the approximately 8,000
assets underlying OCC options. STANS measures the historical
correlations among the price movements of the different assets. STANS
generates simulated returns for all underlying assets based on this
historical data, measures the historical price volatility of each of
these underlying assets, and evaluates the relationship structure of
the entire portfolio. STANS reduces the imprecision produced by TIMS in
the following ways:
a. Because STANS does not use TIMS's product group concept, STANS
recognizes the relationship of each asset class to all other asset
classes rather than recognizing only the relationships among asset
classes in the same product group. Therefore, STANS will more
accurately identify offsetting positions, and margin requirements will
be adjusted downward accordingly.
b. STANS identifies a more realistic correlative relationship among
underlying assets than TIMS. STANS does not exclude opposite moves for
positively correlated assets. In contrast, price scenarios within the
TIMS methodology are all concordant.
c. Because STANS eliminates product groups, it is able to evaluate
the interrelationships among all instruments in a clearing member's
portfolio rather than only within a product group. STANS's estimates of
portfolio risk are neither upwardly nor downwardly biased.
d. STANS generates a distribution of 10,000 potential profit/loss
outcomes for the entire portfolio rather than simply a range of
potential price movements. As a result, margin requirements are more
precise for every account, and therefore, STANS ensures that all
accounts will have coverage for predicted liquidation outcomes at the
selected confidence levels.
These characteristics will improve the accuracy of margin
calculations and as a result, will improve the financial stability of
OCC and the derivatives markets. In addition, STANS allows for easy
integration of various types of non-equity products, such as fixed-
income related products and commodities. The implementation of STANS
thus facilitates joint risk assessment initiatives that can produce
clearing and settlement efficiencies beneficial to investors.
To reflect the implementation of STANS in OCC's By-Laws and Rules,
OCC proposes to replace most of Rule 601 and to eliminate Rule 602.
Proposed new Rule 601 is conceptual rather than attempting a
mechanical, step-wise description of margin requirement calculations.
It is therefore more concise than the existing Rule 601. OCC presently
calculates margin requirements for equity and non-equity products
separately with Rule 601 being applicable to equities and Rule 602
being applicable to non-equitities. STANS will calculate margin on
equity and non-equity products in one integrated set of calculations.
Thus, the calculation of margin requirements for all products will be
as set forth in new Rule 601. OCC proposes to delete cross-references
to Rule 602 as appropriate throughout the Rules.
Proposed Rule 601(c) contains a basic conceptual description of
how, pursuant to STANS, OCC would determine the amount of margin assets
a clearing member is required to deposit with OCC. Proposed Rule 601(c)
uses the concepts of ``margin requirement,'' ``margin assets,''
``marking prices'' and ``minimum expected liquidating value'' to aid in
the description of STANS and margin requirement calculations.
Definitions of each of these terms have been included in the proposed
amendments to Article I of the By-Laws or Rule 601 as appropriate. OCC
proposes to delete terms that are defined in the existing Rule 601(b)
that are relevant to TIMS and not relevant to STANS. For example, the
terms ``premium margin'' and ``risk margin'' are no longer used. The
``margin requirement'' as determined using STANS is at least equal to
the ``minimum expected liquidating value''
[[Page 76489]]
of the account (if such expected value is less than zero). The
``minimum expected liquidating value'' may be conceptualized as (i) the
current net asset value of positions in the account (i.e., what used to
be called ``premium margin'') plus (ii) an additional amount sufficient
to cover the impact of the largest expected adverse market movement
(i.e., what used to be called ``risk margin''). Because STANS does not
actually derive the minimum expected liquidating value in this additive
way and because STANS is designed to project expected values for margin
assets whose prices are not referred to as ``premiums,'' the old
terminology was deemed inappropriate.
The proposed definition of ``marking price'' is quite flexible and
allows OCC to use its discretion in determining marking prices and to
use different marking prices for the same asset or liability depending
upon the purpose for which a marking price is needed. An example of
where the latter situation may occur is in the case of stock loan and
borrow positions. Marking prices in the stock lending market are
determined by the conventions of that market, and OCC would generally
observe the prices used in that market for purposes of determining the
daily marks passed through OCC between the lender and the borrower. OCC
might, however, have a different view of the correct marking price to
use for purposes of calculating the risk of those positions in STANS.
The purpose of proposed Rule 601(e), ``Exclusions from Margin
Requirement Calculation,'' is to identify in one place those positions
that are excluded from margin requirement calculations altogether.
Existing Rule 601(e) indicates that exercised or expired positions in
cleared contracts or stock loan and borrow positions are excluded from
margin requirement calculations. Rule 601(a) indicates that short
positions in option contracts or BOUNDs for which a deposit in lieu of
margin has been made are excluded from margin requirement calculations.
Rule 614 indicates that long positions in cleared securities that have
been pledged to a pledgee are excluded from margin requirement
calculations. By definition, margin-ineligible stock loan positions and
stock borrow positions are excluded from margin requirement
calculations. Consolidating these provisions in one place facilitates
understanding.
The release of margin assets to clearing members as described in
existing Rule 601(e) has been revised to be clearer and more concise
and is now covered in Rule 601(f). The existing rule contains a
somewhat artificial description of margin assets being released under a
position-specific determination. Consistent with the more integrated
approach of the STANS methodology, proposed Rule 601(f) simply states
that OCC will permit the release of margin with respect to a clearing
member's account if the amount of margin assets in a clearing member's
account exceeds the amount of margin assets required to be in the
account pursuant to Rule 601 and if any other obligations of the
clearing member to OCC have been satisfied.
Existing Rule 2111(b) and Rule 2409(b) envision that a provisional
margin requirement will be calculated with respect to cross-rate
foreign currency options and FX Index Options. The provisional margin
requirement was intended to ensure that OCC would not release premiums
due to an account of a clearing member in a non-U.S. time zone at a
time when it was holding insufficient margin to cover a premium debit
in a later time zone and/or increased margin requirements resulting
from activity in cross-rate and foreign currency index options since
the last U.S. Dollar settlement. OCC proposes to eliminate this
provisional margin requirement and will instead simply hold any amounts
otherwise payable to a clearing member in a different time zone until
after the next regular settlement time in the U.S. Experience has shown
that clearing members often instruct OCC to credit any cash from these
early settlements to their OCC accounts instead of releasing it, and
the amounts involved do not justify the costs of administering the more
cumbersome procedure of calculating provisional margin requirements.
Since June 2003, OCC has been providing information to
representatives of the Office of Prudential Supervision and Risk
Analysis of the Division of Market Regulation (``Division'') on the
statistical and operational features of the STANS methodology. To
become comfortable with the STANS methodology, the Division requested
that OCC produce various graphs, simulations, and spreadsheets
evidencing STANS's ability to calculate margin requirements more
accurately than TIMS. OCC believes that it has responded to all of the
Division's inquiries to date and has provided sufficient information
for the Division to reach a high degree of comfort with the STANS
methodology. The staff of OCC remains available to address any further
questions that the Division staff may have.
OCC expects that the amount of margin it will collect under STANS
will be significantly less than the amount of margin it currently
collects under TIMS. This is largely due to the fact that STANS more
accurately identifies offsetting positions than TIMS. There would also
be a corresponding reduction in the amount of clearing fund collected
by OCC under STANS because under Chapter X, ``Clearing Fund
Contributions,'' clearing fund is calculated as a percentage of margin.
The Division requested that OCC amend its rules to increase the
percentage used to calculate the clearing fund because the Division
believes that for the time being the clearing fund contribution should
not be significantly reduced. As a result, OCC filed an amendment to
the proposed rule change to amend Chapter X, Rule 1001, ``Amount of
Contribution,'' to increase the minimum percentage in the clearing fund
calculation from 5 percent to 6 percent of average aggregate margin.
OCC believes that the proposed rule change is consistent with the
purposes and requirements of Section 17A of the Act because it is
designed to assure the safeguarding of securities and funds which are
in the custody or control of OCC, to reduce unnecessary costs to
investors by facilitating more accurate margin calculations, and in
general, to protect investors and the public interest. In addition, the
proposed rule change is not inconsistent with OCC's existing rules,
including any other rules currently proposed to be amended.
(B) Self-Regulatory Organization's Statement on Burden on Competition
OCC does not believe that the proposed rule change would impose any
burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
Written comments were not and are not intended to be solicited with
respect to the proposed rule change, and none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within thirty five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which the self-regulatory organization consents,
the Commission will:
(a) By order approve the proposed rule change or
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(b) Institute proceedings to determine whether the proposed rule
change should be disapproved.
VI. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml) or
Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-OCC-2004-20 on the subject line.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-9303.
All submissions should refer to File Number SR-OCC-2004-20. This file
number should be included on the subject line if e-mail is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (https://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 100 F Street,
NE., Washington, DC 20549. Copies of such filing also will be available
for inspection and copying at the principal office of OCC and on OCC's
Web site at https://www.optionsclearing.com.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number SR-OCC-2004-20
and should be submitted on or before January 17, 2006.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\3\
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\3\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. E5-7841 Filed 12-23-05; 8:45 am]
BILLING CODE 8010-01-P
