Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Relating to the Clearance and Settlement of Over-the-Counter Options, 59431-59439 [2012-23816]
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Federal Register / Vol. 77, No. 188 / Thursday, September 27, 2012 / Notices
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.12
Kevin M. O’Neill,
Deputy Secretary.
[FR Doc. 2012–23769 Filed 9–26–12; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–67906; File No. SR–OCC–
2012–14]
Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of Filing of Advance Notice Relating to
the Clearance and Settlement of Overthe-Counter Options
September 21, 2012.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’) 1 and Rule 19b–4(n)(1)(i),2
notice is hereby given that on August
30, 2012, The Options Clearing
Corporation (‘‘OCC’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’) the advance notice
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 advance notice from
interested persons.
I. Clearing Agency’s Statement of the
Terms of Substance of the Advance
Notice
The proposed changes contained in
the advance notice will permit OCC to
provide central clearing of index
options on the S&P 500 that are
negotiated bilaterally in the over-thecounter market and submitted to OCC
for clearance.
II. Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Advance Notice
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In its filing with the Commission,
OCC included statements concerning
the purpose of and basis for the advance
notice and discussed any comments it
received on the advance notice. The text
of these statements may be examined at
the places specified in Item IV below.
OCC has prepared summaries, set forth
in sections (A), (B), and (C) below, of the
most significant aspects of these
statements.3
12 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4(n)(i).
3 The Commission has modified the text of the
summaries prepared by OCC.
1 15
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(A) Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Advance Notice
The purpose of this proposed rule
change and advance notice is to allow
OCC to provide central clearing of OTC
index options on the S&P 500 Index.
The proposed rule change replaces a
previously proposed rule change which
was withdrawn by OCC.4 OCC will clear
the proposed OTC options in a manner
that is highly similar to the manner in
which it clears listed options, with only
such modifications as are appropriate to
reflect the unique characteristics of OTC
options.
OTC Options
OCC has entered into a license
agreement with Standard & Poor’s
Financial Services LLC (‘‘S&P’’) that
allows OCC to clear OTC options on
three equity indices published by the
S&P: the S&P 500 Index, the S&P
MidCap 400 Index and the S&P Small
Cap 600 Index. The initial OTC options
to be cleared by OCC will consist of
options on the S&P 500 Index. OCC may
clear OTC options on other indices and
on individual equity securities in the
future, subject to Commission approval
of one or more additional rule filings.
The current rule filing defines ‘‘OTC
option’’ and ‘‘OTC index option’’
generically in order to simplify future
amendments to provide for additional
underlying interests. OTC options will
have predominantly common terms and
characteristics, but also include unique
terms negotiated by the parties.
Transactions in OTC options will not be
executed through the facilities of any
exchange, but will instead be entered
into bilaterally and submitted to OCC
for clearance through one or more
providers of trade affirmation services.5
OTC options will be similar to
exchange-traded standardized equity
index options called ‘‘FLEX Options’’
that are currently traded on certain
options exchanges.6 FLEX Options are
4 Securities Exchange Act Release No. 34–66090
(January 3, 2012), 77 FR 1107 (January 9, 2012) (SR–
OCC–2011–19).
5 The initial provider of the trade affirmation
services in connection with the OTC options will
be MarkitSERV.
6 Note that FINRA Rule 2360(a)(16) refers to FLEX
Options as ‘‘FLEX Equity Options,’’ which it
defines as ‘‘any options contract issued, or subject
to issuance by, The Options Clearing Corporation
whereby the parties to the transaction have the
ability to negotiate the terms of the contract
consistent with the rules of the exchange on which
the options contract is traded.’’ OCC does not
believe this definition would capture OTC options
as they are not traded on any exchange.
Nevertheless, as discussed below, OCC is working
with FINRA to amend certain of FINRA’s rules to
clarify the proper application of such rules to OTC
options.
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exchange-traded put and call options
that allow for customization of certain
terms. For example, FLEX index
Options traded on the Chicago Board
Options Exchange have six
customizable terms: (1) Underlying
index, (2) put or call, (3) expiration date,
(4) exercise price, (5) American or
European exercise style, and (6) method
of calculating settlement value. OCC is
the issuer and guarantor of FLEX
Options and clears FLEX Options traded
on multiple exchanges.
Similar to FLEX Options, OTC
options will allow for customization of
a limited number of variable terms with
a specified range of values that may be
assigned to each as agreed between the
buyer and seller. Parties submitting
transactions in OTC options for clearing
by OCC will be able to customize six
discrete terms: (1) Underlying index; 7
(2) put or call; (3) exercise price; (4)
expiration date; (5) American or
European exercise style; and (6) method
of calculating exercise settlement value
on the expiration date.8 The variable
terms and permitted values will be
specified in the proposed Section 6 of
Article XVII of the By-Laws. With
respect to future OTC options accepted
for clearing, OCC intends that such
future OTC options will conform to the
general variable terms and limits on the
variable terms set forth in proposed
Section 6 of the By-Laws, and will
either amend the Interpretations and
Policies thereunder to specify additional
requirements for specific OTC options
or publish such requirements on OCC’s
Web site.
Clearing of OTC Options
OCC proposes to clear OTC options
subject to the same basic rules and
procedures used for the clearance of
listed index options. The proposed rules
require that the counterparties to the
OTC options must be eligible contract
participants (‘‘ECPs’’), as defined in
Section 3a(65) of the Securities
Exchange Act of 1934,9 as amended (the
‘‘Exchange Act’’) and Section 1a(18) of
the Commodity Exchange Act,10 as
amended (the ‘‘CEA’’). Because an OTC
option will be a ‘‘security’’ as defined in
7 Initially, however, the S&P 500 Index will be the
only permitted underlying index.
8 The expiration date of an OTC option must fall
on a business day. The method of determining the
exercise settlement value of an OTC option on its
expiration date may be either the opening
settlement value or the closing settlement value of
the underlying index (calculated by S&P using the
opening or closing price, as applicable, in the
primary market of each component security of the
underlying index on the specified expiration date),
in each case as reported to OCC by CBOE.
9 15 U.S.C. 78c(a)(65).
10 7 U.S.C. 1a(18).
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the Exchange Act, the proposed rules
also require that the transactions be
cleared through a clearing member of
OCC that is registered with the
Commission as a broker-dealer or one of
the small number of clearing members
that are ‘‘non-U.S. securities firms’’ as
defined in OCC’s By-Laws. OCC is not
proposing to require clearing members
to meet any different financial standards
for clearing OTC options. However,
clearing members must be specifically
approved by OCC to clear OTC options
pursuant to new Interpretation and
Policy .11 to Section 1 of Article V in
order to assure the operational readiness
of such clearing members to clear OTC
options. Clearing members seeking to
clear OTC options will be required to
submit a business expansion request
and complete an operational review.
The operational review consists of an
initial meeting with the clearing
member’s staff to evaluate the staff’s
experience, confirm the staff’s
familiarity with current OCC systems
and procedures, complete an
operational questionnaire, perform a
high level review of the clearing
member’s systems and processing
capabilities, and review other pertinent
operational information. Successful
testing of messaging capability between
the clearing member, MarkitSERV and
OCC is also necessary. These procedures
will determine whether the firm is
operationally ready to clear OTC Index
Options.
Exercise of an OTC option will be
settled by payment of cash by the
assigned writer and to the exercising
holder through OCC’s cash settlement
system on the business day following
exercise in exactly the same manner as
is the case with exercise settlement of
listed index options. As in the case of
listed index options, the exercisesettlement amount will be equal to the
difference between the current value of
the underlying interest and the exercise
price of the OTC option, times the
multiplier that determines the size of
the OTC option. In the case of OTC
index options on the S&P 500, the
multiplier will be fixed at 1. The
multipliers for additional OTC index
options that OCC may in the future clear
may be fixed at such value as OCC
determines and provides for in its ByLaws and Rules.
OCC will calculate clearing margin for
the OTC options using its STANS
margin system on the same basis as for
listed index options and will otherwise
apply the same risk management
practices to both OTC options and listed
index options, including new risk
modeling enhancements for longer-tenor
options discussed below under ‘‘Risk
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Management Enhancement for LongerTenor Options.’’ Because OCC currently
clears listed options on all three of the
underlying indexes on which OCC is
currently licensed to clear OTC options,
and because the customizable terms of
these OTC options are relatively limited
and the range of values that
customizable terms may be given is
limited, OCC does not believe that
valuation and risk management for these
OTC options present challenges that are
different from those faced in the listed
options market. Nevertheless, as
discussed further below, OCC is
proposing special OTC Options
Auctions to be used in the unlikely
event that OCC would be unable to close
out positions in OTC options of a failed
clearing member through other means.
OTC options may be carried in a
clearing member’s firm account, in
market-maker accounts or in its
securities customers’ account, as
applicable. Although customer positions
in OTC options will be carried in the
securities customers’ account (an
omnibus account), OCC will use a
‘‘customer ID’’ to identify positions of
individual customers based on
information provided by clearing
members.11 However, positions are not
presently intended to be carried in
individual customer sub-accounts, and
positions in OTC options will be
margined at OCC in the omnibus
customers’ account on the same basis as
listed options. If a clearing member
takes the other side of a transaction with
its customer in an OTC option, the
transaction will result in the creation of
a long or short position (as applicable)
in the clearing member’s customers’
account and the opposite short or long
position in the clearing member’s firm
account. The positions could also be
includable in the internal crossmargining account, subject to any
necessary regulatory approvals.
The trade data for an OTC option
trade will be entered into the system of
MarkitSERV or another trade
confirmation/affirmation vendor
approved by OCC for this purpose (the
‘‘OTC Trade Source’’).12 While
11 Such customer IDs are necessary in order to
allow OCC to comply with certain terms of OCC’s
license agreement with S&P. As described further
below, customer IDs will be used for other purposes
as well.
12 MarkitSERV, LLC is owned by Markit Group
Limited, Markit Group Holdings Limited and The
Depository Trust & Clearing Corporation.
MarkitSERV Limited is a wholly-owned U.K.
subsidiary of MarkitSERV, LLC. MarkitSERV, LLC
and MarkitSERV Limited (collectively,
‘‘MarkitSERV’’) provide derivatives transaction
processing, electronic confirmation, portfolio
reconciliation services, and other related services
for firms that conduct business in the over-the-
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MarkitSERV will be the only OTC Trade
Source at launch, OCC will permit
additional OTC Trade Sources in the
future in response to sufficient market
demand from OCC’s clearing members
and subject to the ability of any such
OTC Trade Source to meet OCC’s
requirements for operational readiness
and interoperability with OCC’s
systems, as well as requirements with
respect to relevant business experience
and reputation, adequate personnel and
expertise, financial qualification and
such other factors as OCC deems
relevant. OCC will receive confirmed
trades from the OTC Trade Source. It
will be permissible for parties to submit
trades for clearance that were entered
into bilaterally at any time in the past,
provided that the eligibility for
clearance will be determined as of the
date the trade is submitted to OCC for
clearance.13 The OTC Trade Source will
process the trade and submit it as a
confirmed trade to OCC for clearing. If
the trade meets OCC’s validation
requirements, OCC will so notify the
OTC Trade Source, which will notify
the submitting parties. Customers of
clearing members may have direct
access to the OTC Trade Source for
purposes of entering or affirming trade
data and receiving communications
regarding the status of transactions, in
which case mechanisms will be put in
place for a clearing member to authorize
a customer to enter a trade for the
clearing member’s customers’ account
or for the clearing member to affirm a
trade once entered.
In order for a clearing member to be
approved for clearing OTC options, the
clearing member must enter into a
standard agreement with MarkitSERV
(or another OTC Trade Source with
which the clearing member intends to
enter trade data, if and when OCC enters
into arrangements with other OTC Trade
Sources). At launch, OTC options will
not be subject to the same clearing
member trade assignment rules and
procedures through which exchangetraded options can be cleared by a
clearing member other than the
executing clearing member. This
functionality may be added at a later
date. OCC and MarkitSERV will adopt
procedures to permit a customer that
counter derivatives markets through a variety of
electronic systems, including the MarkitWire
system. MarkitWire, owned by MarkitSERV
Limited, is an OTC derivatives electronic
confirmation/affirmation service offered by
MarkitSERV as part of its post-trade processing
suite of products. The role of MarkitSERV and
MarkitWire in OCC’s clearing of OTC options is
described in further detail below.
13 OCC’s license agreement with S&P imposes
certain requirements relating to minimum time
remaining to expiration of an OTC option.
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has an account with Clearing Member A
(‘‘CM A’’) to enter into an OTC option
transaction with Clearing Member B
(‘‘CM B’’) and have the position
included in its account at CM A and
cleared in CM A’s customers’ account at
OCC.
OTC options will be fungible with
each other to the extent that there are
OTC options in the system with
identical terms. However, OCC will not
treat OTC options as fungible with
index options listed on any exchange,
even if an OTC option has terms
identical to the terms of the exchangelisted option.
Clearing members that carry customer
positions in cleared OTC options will be
subject to all OCC rules governing OCCcleared options generally, as well as all
applicable rules of the Commission and
of any self-regulatory organization,
including the Financial Industry
Regulatory Authority (‘‘FINRA’’), of
which they are a member. Section 8 of
Article III of OCC’s By-Laws provides
that, subject to the By-Laws and Rules,
‘‘the Board of Directors may suspend
Clearing Members and may prescribe
and impose penalties for the violation of
the By-Laws or the Rules of the
Corporation, and it may, by Rule or
otherwise, establish all disciplinary
procedures applicable to Clearing
Members and their partners, officers,
directors and employees.’’ As a
condition to admission, Section 3(c) of
Article V of the By-Laws provides that
a clearing member must agree, among
other things, to ‘‘pay such fines as may
be imposed on it in accordance with the
By-Laws and Rules.’’ Rule 305 permits
OCC to impose restrictions on the
clearing activities of a clearing member
if it finds that the financial or
operational condition of the clearing
member makes it necessary or advisable
to do so for the protection of OCC, other
clearing members, or the general public.
Rule 1201(a) provides that OCC ‘‘may
censure, suspend, expel or limit the
activities, functions or operations of any
Clearing Member for any violation of the
By-Laws and Rules or its agreements
with the Corporation.’’ In addition to, or
in lieu of, such actions, OCC is
permitted under the same paragraph to
impose fines. Rule 1202(b) establishes
procedures for taking any such
disciplinary actions. The foregoing
provisions are sufficient to permit OCC
to fine or otherwise discipline a clearing
member that fails to abide by OCC’s ByLaws and Rules applicable to OTC
options, or to prohibit such clearing
member from continuing to clear such
options.
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Regulatory Status of the OTC Options
An OTC option will be a ‘‘security’’ as
defined in both the Securities Act of
1933, as amended (the ‘‘Securities Act’’)
and, as noted above, the Exchange Act.
OCC will be the ‘‘issuer’’ of the OTC
options. The OTC options will be
neither ‘‘swaps’’ nor ‘‘security-based
swaps’’ for purposes of the Dodd-Frank
Wall Street Reform and Consumer
Protection Act (‘‘Dodd-Frank’’).14
Most of OCC’s clearing members are
members of FINRA and subject to
FINRA’s rules, which have different
provisions for ‘‘listed’’ and ‘‘OTC
options’’ and contain various definitions
distinguishing between the two. In some
cases, OTC options would fall into
neither category under FINRA’s
definitions and in other cases, they
would fall within what OCC perceives
to be the wrong category. FINRA and
OCC are working together to implement
appropriate amendments to FINRA rules
to clarify the proper application of such
rules to cleared OTC options.
and MarkitSERV will affirm such
submission to both parties. OCC then
validates the trade information for
compliance with applicable
requirements, such as the identification
of an account of an eligible clearing
member in which each side of the trade
will be cleared, that the variable terms
are within permissible ranges, and that
minimum size requirements under
OCC’s license agreement with S&P are
met. This validation will be completed
by OCC immediately upon submission.
OCC’s clearing system will
automatically accept the trade if it
passes the validation process and will
otherwise reject it.15 A trade that is
rejected by OCC may be corrected and
submitted as a new transaction. Clearing
members and customers with access to
MarkitSERV will be able to determine
whether a trade has been accepted or
rejected both through MarkitSERV and,
in the case of clearing members, through
their interface with OCC’s clearing
system.
MarkitSERV Trade Submission
Mechanics
MarkitSERV provides an interface to
OCC that allows OCC to receive
messages containing details of
transactions in OTC options submitted
for clearing by clearing members with
access to MarketWire and also allows
OCC to transmit messages to MarkitWire
participants identifying the status of
submitted transactions. MarkitWire
applications use product-specific
templates to simplify deal entry and
negotiations. The templates specify the
data required for a given product and
also the business validation rules for
each field. MarkitSERV has included
OCC’s validation requirements for OTC
options in its trade templates.
The trade data for each OTC option
transaction must be entered into
MarkitWire. MarkitSERV will use a
‘‘confirmation/affirmation’’ procedure
in which one party to the trade enters
the trade data to the MarkitWire
platform, which issues a confirmation to
the counterparty to be affirmed, rejected
or requested to be revised. If the trade
details are confirmed, the trade will
then be submitted to OCC for clearance
MarkitSERV’s Regulatory Status 16
MarkitSERV is not registered as a
clearing agency under the Exchange Act,
and the Commission staff has asked
OCC to consider whether MarkitSERV
would be required to so register in order
to provide the proposed services to the
OTC options market. OCC believes that
no such registration is necessary based
upon relevant interpretive guidance
issued by the Commission.
Section 3(a)(23)(A) of the Exchange
Act 17 defines a ‘‘clearing agency’’
broadly. The definition includes, in
relevant part, ‘‘any person who * * *
provides facilities for comparison of
data respecting the terms of settlement
of securities transactions[.]’’ In 1998, the
Commission issued a release entitled
‘‘Confirmation and Affirmation of
Securities Trades; Matching’’ (the
‘‘Matching Release’’).18 In the Matching
Release, the Commission published ‘‘its
interpretation that a ‘matching’ service
that compares securities trade
information from a broker-dealer and
the broker-dealer’s customer is a
14 Section 1a(47)(A)(i) of CEA, 7 U.S.C.
1a(47)(A)(i), as added by Section 721(a)(21) of
Dodd-Frank, defines ‘‘swaps’’ broadly to include
options on indices. However, Section 1a(47)(B)(iii)
of the CEA, 7 U.S.C. 1a(47)(B)(iii), excludes from
the ‘‘swap’’ definition any option on any index of
securities that is subject to the Securities Act and
the Exchange Act. A contract that is excluded from
the definition of a ‘‘swap’’ under Section 1a(47)(B)
of the CEA, 7 U.S.C. 1a(47)(B) (other than Section
1a(47)(B)(x), 7 U.S.C 1a(47)(B)(x)) is not a ‘‘securitybased swap’’ for purposes of Section 3a(68) of the
Exchange Act, 15 U.S.C. 78c(a)(68).
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15 Once accepted, a trade is guaranteed by OCC.
Note, however, that OTC options for which the
premium payment date communicated by
MarkitSERV to OCC is prior to the business day on
which the OTC option is submitted to OCC for
clearing (referred to as a ‘‘Backloaded OTC Option’’)
will not be accepted and guaranteed until the
selling clearing member has met its initial morning
cash settlement obligations to OCC on the following
business day.
16 MarkitSERV offers different services in
different markets, and this discussion is addressed
only to the ‘‘confirmation/affirmation’’ procedure to
be used in submitting trades to OCC.
17 15 U.S.C. 78c(a)(23)(A).
18 Securities Exchange Act Release No. 34–39829
(April 13, 1998), 63 FR 17943 (April 13, 1998).
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clearing agency function.’’ The
Matching Release distinguishes between
such a matching service and a
‘‘confirmation/affirmation service’’
where the ‘‘vendor intermediary will
only transmit information between the
parties to a trade, and the parties will
confirm and affirm the accuracy of the
information.’’ The Commission noted
that ‘‘matching’’ constitutes the
‘‘comparison of data respecting the
terms of settlement of securities
transactions’’ and that such services
therefore trigger status as a clearing
agency, while confirmation/affirmation
services would not, by themselves,
constitute such a data comparison. The
Commission concluded in the Matching
Release that ‘‘an intermediary that
captures trade information from a buyer
and a seller of securities and performs
an independent reconciliation or
matching of that information is
providing facilities for the comparison
of data within the scope of Exchange
Act Section 3(a)(23).’’ The Commission
stated that ‘‘matching’’ is ‘‘so closely
tied to the clearance and settlement
process that it is different not only in
degree but also different in kind from
the * * * confirmation and affirmation
process.’’ The Matching Release goes on
to state: ‘‘A vendor that provides
confirmation/affirmation services only
will exchange messages between a
broker-dealer and its institutional
customer. The broker-dealer and its
institutional customer will compare the
trade information contained in those
messages, and the institution itself will
issue the affirmed confirmation.’’ This is
precisely what occurs when a
counterparty to a trade affirms the trade
data through MarkitSERV and requests
submission to OCC for clearance.
MarkitSERV transmits messages only; it
does not ‘‘compare’’ or ‘‘match’’ trade
data submitted by two parties.
The ‘‘confirmation/affirmation’’
functionality (as described above) to be
provided by MarkitSERV (through
MarkitWire) with respect to OTC
options is functionally identical to the
confirmation/affirmation service
described in the Matching Release and
OCC believes such service would not be
a ‘‘matching’’ service within the
meaning of the release. OCC believes
that MarkitSERV will not be a ‘‘clearing
agency’’ with respect to the services to
be provided in connection with OTC
options. The confirmation/affirmation
service described in the Matching
Release referred ‘‘to the transmission of
messages among broker-dealers,
institutional investors, and custodian
banks regarding the terms of a trade
executed for the institutional investor.’’
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MarkitWire’s confirmation/affirmation
process will allow for the transmission
of messages among OCC’s clearing
members (most of which are registered
broker-dealers), their customers (all of
whom will be ECPs and will therefore
be large and financially sophisticated
market participants) and OCC, which is
itself registered and subject to the
Commission’s oversight as a clearing
agency.
By contrast, the ‘‘matching’’ services
contemplated in the Matching Release
would involve ‘‘the process whereby an
intermediary compares the broker
dealer’s trade data submission * * *
with the institution’s allocation
instructions * * * to determine
whether the two descriptions of the
trade agree.’’ MarkitWire performs no
such comparison. Under the
confirmation/affirmation procedure,
trade data is entered into MarkitWire by
one party and such data is made
available to the counterparty to be
affirmed, rejected or requested to be
revised. MarkitWire merely facilitates
the transfer of information between the
parties sufficient to allow the
comparison to be made. A binding
transaction (i.e., an ‘‘affirmed
confirmation’’ in the language of the
Matching Release) is not produced
through any action of MarkitSERV, but
is instead created by the completion, by
the counterparty, of an affirmation of
the trade data entered by the first party.
MarkitWire provides no ‘‘independent
reconciliation or matching’’ of trade
data. Rather MarkitWire is providing
essentially a messaging service among
OCC and the parties to trades in OTC
Options. The Matching Release is clear
as to the distinction between a matching
service and a confirmation/affirmation
service, and OCC believes that there is
no ambiguity that the services to be
provided by MarkitWire with respect to
OTC options fall into the latter, rather
than the former, category.
Risk Management Enhancements for
Longer-Tenor Options
Although OCC’s license agreement
with S&P allows OCC to clear OTC
options with tenors of up to fifteen
years, OCC has elected at this time to
clear only OTC options on the S&P 500
index with tenors of up to five years.
However, OCC currently clears FLEX
Options on the S&P 500 with tenors of
up to 15 years. While OCC believes that
its current risk management practices
are adequate for current clearing
activity, OCC is in the process of
implementing risk modeling
enhancements with respect to longertenor options, including OTC options.
The enhancements are part of OCC’s
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ongoing efforts to test and improve its
risk management operations with
respect to all longer-tenor options that
OCC currently clears. These procedures
will be submitted for review in a
separate ‘‘advance notice’’ filing and
OCC will not commence clearing of
OTC options until such procedures have
been approved and implemented.
The proposed enhancements are as
follows:
• First, OCC will introduce indicative
over-the-counter quotations into the
daily dataset of prices used to risk
manage OCC-cleared products. These
quotations will be obtained from a
service provider that will collect OTC
dealer polling information on a daily
basis and provide such data to OCC.
• Second, OCC will introduce
variations in the implied volatilities
used in the modeling of all cleared
options whose residual tenors are at
least three years. To date, OCC’s margin
methodology has assumed that implied
volatilities of option contracts are static
over the two-day risk horizon. While
OCC’s backtesting has identified few
exceedances related to implied volatility
shocks, such shocks could occur and
taking them into account in OCC’s
margin model will allow more robust
risk management. OCC proposes to
achieve this result by incorporating into
the risk factors included in OCC’s
models time series of proportional
changes in implied volatilities for a
range of representative volatilities.
• Third, OCC will introduce a
valuation adjustment into its calculation
of portfolio net asset value. This
adjustment will be based on the
aggregate sensitivity of the longer-tenor
options in a portfolio to the overall level
of implied volatilities at three and five
years, and to the implied volatility
skew.
A review of individual S&P 500 Index
put and call options positions that are
in the money by varying amounts and
have expiration dates between four and
nine years out indicates that the
inclusion of modeled implied
volatilities tends to result in less margin
being held against short call positions
and more being held against short put
positions. These results are consistent
with what would be expected given the
strong negative correlation that exists
between changes in implied volatility
and market returns. On average, OCC
observed a decrease in the margin
requirement of approximately 24% on
the nine call options tested and a 63%
increase associated with the nine put
options.
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Proposed By-Law and Rule Changes
The specific proposed changes to
OCC’s By-Laws and Rules to provide for
the clearing of OTC options relate
primarily to: (i) Specification of
customizable terms; (ii) procedures for
submission and acceptance of trades for
clearance; and (iii) specification of
criteria for eligibility of clearing
members to clear transactions in OTC
options and limitation of the types of
customers for whom clearing members
may effect transactions in OTC options.
Otherwise, the currently proposed OTC
options will be cleared and settled
under the same provisions applicable to
clearance of listed index options. Many
of the proposed amendments are selfexplanatory, and OCC has therefore
attempted to confine the following
discussion to a broad overview with
specific explanation only where the
reasons for the change may be less
obvious.
Article I of the By-Laws contains
defined terms used throughout the ByLaws and Rules. OCC proposes to
modify certain existing definitions and
include certain new definitions in order
to incorporate OTC options into existing
rules and facilitate the creation of new
provisions unique to OTC options.
Throughout the By-Laws and Rules,
OCC proposes to replace the term
‘‘Exchange transaction,’’ which is
currently defined in Article I, in
relevant part, as ‘‘a transaction on or
through the facilities of an Exchange for
the purchase, writing or sale of a cleared
contract’’ with the term ‘‘confirmed
trade’’ so as to make the relevant
portions of the By-Laws and Rules
applicable to transactions in OTC
options as well as listed options,
without causing confusion about the
role of the OTC Trade Source in OCC’s
clearing of OTC options. ‘‘Confirmed
trade’’ is proposed to be defined in
Article I to include transactions
‘‘effected on or through the facilities of
an exchange’’ or ‘‘affirmed through the
facilities of an OTC Trade Source’’ in
order to include transactions in both
listed options and OTC options. The
current definition of ‘‘confirmed trade’’
in Rule 101 is proposed to be deleted as
unnecessary given the new definition.
Much of the length of this rule filing is
attributable to the fact that the term
‘‘Exchange transaction’’ is used so many
places in the rules. OCC has entered
into agreements in the past which
reference the term ‘‘Exchange
transaction’’ or ‘‘exchange transaction.’’
OCC is also proposing to add an
Interpretation and Policy to the new
definition of ‘‘confirmed trade’’ in order
to avoid any ambiguity concerning how
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such terms should be interpreted in any
such agreement.
OCC proposes to add a new
Interpretation and Policy .11 to Section
1 of Article V of the By-Laws, providing
the additional criteria that must be met
by a clearing member in order to clear
OTC index options. Among these new
criteria are that clearing members
seeking to clear OTC index options on
underlying indices published by
Standard & Poor’s Financial Services
LLC (‘‘S&P’’) must execute and maintain
in effect a short-form license agreement
in such form as specified from time to
time by S&P. The current form of S&P
short-form index license agreement is
attached hereto as Exhibit 3.
The Interpretations and Policies
under Section 1, Article VI allow
clearing members to adjust their
positions with OCC for certain
enumerated reasons. OCC proposes to
amend the Interpretations and Policies
to clarify that adjustment of positions in
OTC options will be effected through a
manual process (as opposed to the
electronic process available to posttrade adjustments in listed options), to
the extent permitted by OCC. For the
same reason, OCC is proposing to
amend Rule 403 to prohibit clearing
member trade assignment (‘‘CMTA’’)
transactions in OTC options. Trade
‘‘give-ups’’ that are effected through the
CMTA process in the case of listed
options will, in the case of OTC options,
be effected through MarkitSERV before
the trades are submitted to OCC for
clearing.
Article XVII of the By-Laws governs
index options in general and OCC is
proposing amendments to Article XVII
in order to set forth the terms applicable
to the initial OTC options proposed to
be cleared by OCC—options on the S&P
500 Index—and to differentiate OTC
index options from other index options
cleared by OCC. For example, certain
amendments to the definitions are
necessary because OTC options will be
permitted to have a much wider range
of expiration dates than exchangetraded options (other than FLEX
Options). Additional definitional
amendments ensure that OTC index
options will constitute a separate class
of options from other cash-settled index
options even if both index options have
the same terms and cover the same
underlying interest.
Section 3 of Article XVII provides for
adjustment of the terms of outstanding
index options as necessary to reflect
possible changes in the underlying
index—such as those creating a
discontinuity in the level of the index—
that could theoretically make an
adjustment necessary to protect the
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59435
legitimate expectations of holders and
writers of options on the index.
Pursuant to paragraph (g) of Section 3,
most but not all such adjustments
would be made, in the case of listed
index options, by an adjustment panel
consisting of representatives of the
exchanges on which the options are
traded. In the case of OTC options, any
such adjustments will be made by OCC
in its sole discretion. However, in
exercising that discretion, OCC may take
into consideration adjustment made by
the adjustment panel with respect to
exchange-traded options covering the
same underlying index.19
OCC proposes to add a new Section
6 to Article XVII to set forth certain
provisions unique to OTC index
options, including the variable terms
allowed for OTC index options and the
general limitations on such variable
terms. In general, all OTC index options
must conform to the terms and
limitations set forth in Section 6, and
additional specific requirements
applicable to specific OTC index
options will either be set forth in the
Interpretations and Policies under
Section 6 or published separately on
OCC’s Web site. Section 6 also makes
clear that although OTC index options
are not fungible with exchange-traded
index options, OTC index options of the
same series (i.e., options having
identical terms) will be fungible with
each other. In addition to the terms and
limitations applicable to OTC index
options, Section 6 will establish that
clearing members will be deemed to
have made a number of representations
and warranties in connection with their
activities in OTC options each time they
affirm a confirmed trade entered into an
OTC Trade Source.
OCC has submitted a rulemaking
petition to the Commission 20 seeking an
amendment to Commission Rule 238 21
that would exempt the OTC Options
from most provisions of the Securities
Act. Unless another exemption from the
registration requirements of the
Securities Act is available, OCC intends
to rely upon Rule 506 of Regulation D 22
under the Securities Act, which is a safe
harbor under the Securities Act
exemption in Section 4(a)(2) 23 for
offerings by an issuer not involving a
public offering. OCC intends to satisfy
19 Because index options, unlike options on
individual stocks, rarely, if ever, require
adjustments, allocation of the adjustment authority
may have little practical significance.
20 See SEC File No. 4–644 (Submitted January 13,
2012), available at https://www.sec.gov/rules/
petitions/2012/petn4-644.pdf.
21 17 CFR 230.238.
22 17 CFR 230.506.
23 15 U.S.C. 77d(a)(2).
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the conditions of Rule 506 of Regulation
D as in effect at the time OCC relies
upon the safe harbor. Participants in the
existing markets for OTC equity options
offered and sold in the United States
commonly rely on the private offering
exemption under these provisions and
such reliance is therefore consistent
with existing practice. OTC Options will
be available for purchase only by highly
sophisticated investors that are both
‘‘eligible contract participants,’’ as
defined in Section 3a(65) of the
Exchange Act,24 and ‘‘accredited
investors,’’ as defined in Rule 501(a)
under Regulation D.25 Section 6(f) of
Article XVII includes representations of
clearing members necessary to ensure
that there is no general solicitation or
general advertising in connection with
the offer or sale of the OTC Options
until such time as OCC notifies clearing
members that such restriction no longer
applies.
Chapter IV of the Rules sets forth the
requirements for reporting of confirmed
trades to OCC, and Rule 401 thereunder
governs reporting of transactions in
listed options by participant Exchanges.
OCC is proposing to add new Rule 404
to govern the details of reporting of
confirmed trades in OTC options by an
OTC Trade Source.
As discussed above, positions in OTC
options will generally be margined in
the same manner as positions in listed
options using STANS and pursuant to
Chapter VI of the Rules. However, OCC
proposes to amend Rule 611 to establish
different procedures for the segregation
of long positions in OTC options for
margining purposes. Long positions in
listed options are held in a clearing
member’s customers’ account or firm
non-lien account and by default are
deemed to be ‘‘segregated,’’ meaning
that they are not subject to OCC’s lien
and are given no collateral value when
determining the margin requirement in
the account. Such positions may be
unsegregated only when a clearing
member instructs OCC to unsegregate a
long position and represents to OCC that
the long position is part of a spread
transaction carried for a single customer
whose margin requirement on the
corresponding short position has been
reduced in recognition of the spread.
OCC will then unsegregate the long
position and so reduce OCC’s margin
requirement. However, in case of long
positions in OTC options that are
carried in a clearing member’s
customers’ account and for which OCC
has received a customer ID, OCC
proposes that it will automatically
24 15
25 17
U.S.C. 77c(a)(65).
CFR 230.501.
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unsegregate such long positions if OCC
identifies a qualifying short position in
OTC options carried under the same
customer ID. Clearing members will not
be required to give an affirmative
instruction to OCC to unsegregate a long
position in OTC options or make a
separate representation regarding the
spread transaction. Instead, by carrying
a qualifying spread position in a
customer account, clearing members are
deemed to have represented to OCC that
the customer’s margin has been reduced
in recognition of the spread. Based on
discussion with the clearing members, it
is OCC’s understanding that, in practice,
broker-dealers reduce customers’ margin
requirements to reflect spread positions.
Therefore, OCC believes that automatic
recognition of such spreads by OCC
together with the deemed representation
will greatly increase operational
efficiency while providing equal
assurance that long positions in OTC
options will be unsegregated only if an
identified customer will receive the
benefit of the reduced margin required
for spread transactions.
Rule 1001 sets forth the amount of the
contribution that each clearing member
is required to make to the clearing fund.
OCC proposes to amend Rule 1001(c) so
that, for purposes of calculating the
daily average number of cleared
contracts held by a clearing member in
open positions with OCC during a
calendar month (which number is used
in turn to determine the clearing
member’s contribution to the clearing
fund), open positions in OTC options
will be adjusted as needed to account
for any differences between the
multiplier or unit of trading with
respect to OTC options relative to nonOTC options covering the same
underlying index or interest so that OTC
options and non-OTC options are given
comparable weight in the
computation.26
In general, the rules in Chapter XI
governing the suspension of a clearing
member will apply equally to clearing
members that transact in OTC options.
Rule 1104 provides broad authority for
OCC to liquidate a suspended clearing
member’s margin and clearing fund
deposits ‘‘in the most orderly manner
practicable.’’ Rule 1106 provides
similarly worded authority to close out
open positions in options and certain
other cleared contacts carried by a
suspended clearing member. In 2011,
the Commission approved an OCC rule
change providing OCC the express
26 For example, the index multiplier applicable to
OTC index options on the S&P 500 Index will be
fixed at 1. In comparison, the index multiplier
applicable to listed index options is 100.
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authority to use a private auction as one
of the means by which OCC may close
out open positions and liquidate margin
and clearing fund deposits of a
suspended clearing member.27 OCC
anticipates it will use this auction
process for OTC options as well. As an
additional tool to ensure its ability to
close out positions in OTC options
promptly, OCC is proposing to amend
Rule 1106 to provide for an alternative
auction procedure specifically
applicable only to OTC index options
and related positions hedging, or
hedged by, OTC index options (an ‘‘OTC
Options Auction’’). An OTC Options
Auction would be used only in unusual
circumstances where OCC determines it
is not feasible to close out open
positions in OTC index options through
the other means provided for in OCC’s
Rules and By-Laws.28 The amendments
to Rule 1106 summarize the OTC
Options Auction procedures and
incorporate by reference the detailed
procedures contained in a document
entitled ‘‘OTC Options Auction
Procedures,’’ which will be posted on
the Corporation’s Web site and
otherwise made available to clearing
members upon request of OCC. A copy
of the OTC Options Auction Procedures
was attached to the filing as Exhibit 5.
Rule 1106(e)(2)(C) clarifies that, in the
event that the liquidation of a clearing
member results in a deficiency that
would otherwise result in a
proportionate charge against the
clearing fund contributions of other
clearing members, each OTC Index
Option Member (as defined below) that
failed to purchase or assume its share of
an auction portfolio will be the first to
absorb the deficiency, through a
‘‘Priority Charge’’ against such clearing
members’ clearing fund contributions.
The Priority Charge is a ‘‘first loss’’
mechanism, and is not intended to
increase a clearing member’s total
maximum exposure to OCC.
Under the OTC Options Auction
procedures, all clearing members
authorized to clear transactions in OTC
index options (‘‘OTC Index Option
Members’’), other than the defaulting
27 See Securities Exchange Act Release No. 34–
65654 (October 28, 2011), 76 FR 68238 (November
3, 2011) (SR–OCC–2011–08). OCC subsequently
filed a rule change, currently pending Commission
approval, providing detailed procedures for the
conduct of such an auction. See Securities
Exchange Act Release No. 34–67443 (July 16, 2012),
77 FR 42784 (July 20, 2012) (SR–OCC–2012–11).
28 OCC anticipates that these procedures would
be applicable to other OTC derivatives that may be
cleared by OCC in the future. However, OCC has
limited the currently proposed rule to OTC index
options, and will amend it as and if appropriate to
apply to other over-the-counter products that OCC
may propose to clear in the future.
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clearing member, will be required to
participate in the OTC Options Auction
by submitting competitive bids for all or
a portion of the defaulting clearing
member’s OTC index option portfolio.
Each such participant will be subject to
a minimum participation level based on
the participant’s proportionate share of
the total ‘‘risk margin’’ requirement
posted by all OTC Index Options
Members in the previous month for all
positions (not limited to OTC option
positions) held in accounts eligible to
hold OTC options positions (‘‘OTC
Eligible Accounts’’), after removing the
defaulting clearing member.29 This
method of calculating the minimum
participation level in the OTC Options
Auction results in all OTC Index Option
Members being required to participate
in the OTC Options Auction based on
their clearing activity related to all
positions in OTC Eligible Accounts.
Required participation ensures that the
OTC Options Auction will have
sufficient participants authorized to
clear transactions in OTC index options
and that the most active clearing
members in OTC index options will
submit bids for the largest percentage of
the auction portfolio, increasing the
likelihood of the acquisition of OTC
options positions by clearing members
with appropriate financial strength, risk
management capabilities and trading
expertise. Each participant may submit
bids at varying quantities and varying
prices, so long as the participant’s bids
equal or exceed its minimum
participation level. A participant may
use bids from non-OTC Index Options
Members and non-clearing members in
order to meet its minimum participation
level, subject to certain Corporation
requirements including that it guarantee
the performance of such third parties.
Each bid will indicate what percentage
of the auction portfolio the participant
is bidding on and the amount of the bid.
Bids will be stated in terms of a price
for the entire auction portfolio, and may
be either positive or negative. (Negative
bids imply an auction portfolio that has
a negative net asset value and indicate
how much the Corporation would be
required to pay the participant to
assume the relevant percentage of the
auction portfolio.) The Corporation will
rank the submitted bids from best to
worst and the auction portfolio will be
allocated among the bidding
participants accordingly until the
29 This minimum participation level will be
multiplied by 1.15 to calculate each participant’s
minimum bid size, such that the sum of all
participants’ bids will equal 115% of the auction
portfolio, in order to increase the likelihood that the
entire auction portfolio will be allocated to
participants.
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auction portfolio is exhausted. The bid
price that is sufficient to clear the entire
auction portfolio will become the single
price to be used for all winning bids,
even if a participant’s stated bid was
better.
In order to provide a strong incentive
to ensure competitive bidding by the
OTC Index Option Members required to
participate in an OTC Options Auction,
OTC Index Options Members who fail to
win their minimum participation in the
auction will be subject to a potential
priority charge against its clearing fund
contribution. If the cost of liquidating a
suspended clearing member’s positions
exhausts the clearing member’s margin
and clearing fund contribution and any
other assets of the suspended clearing
member available to OCC, then OCC,
pursuant to Section 5 of Article VIII of
the By-Laws, would ordinarily
withdraw the amount of the deficiency
from the clearing fund and charge it on
a proportionate basis against all other
clearing members’ computed
contributions as fixed at the time. When
an OTC Options Auction has been held
in respect of a suspended OTC Index
Options Member, however, some or all
of any such remaining loss would be
assessed first against the clearing fund
contributions of any OTC Options
Auction participant(s) whose bids are
insufficiently competitive to be
allocated a portion of the auction
portfolio equal to such participant’s
minimum required participation. This
priority charge would be made
regardless of the reason for the
shortfall—i.e., whether or not the loss
resulted from the closing out of OTC
options positions. The priority charge
would be calculated based on an
‘‘assessment ratio,’’ which is formulated
to provide incentive to all OTC Options
Auction participants to participate to
their full minimum participation level
in the auction. The method of
calculating the assessment ratio is such
that if the net asset value of the auction
portfolio is zero the assessment ratio
will also be zero and no priority charge
will be made. As the absolute net asset
value of the auction portfolio (whether
positive or negative) increases, the
assessment ratio also increases, all other
factors being equal. If all OTC Options
Auction participants submit bids such
that each receives an allocation of OTC
options positions equal to its minimum
participation level, no priority charge
will be made regardless of whether or
not there is a liquidation shortfall. If a
liquidation shortfall remains after any
priority charges, or if no priority charges
were required, the Corporation will then
make a proportionate charge against the
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59437
clearing fund contributions of all
clearing members, including those that
participated in the OTC Options
Auction, in the usual manner pursuant
to Section 5 of Article VIII of OCC’s ByLaws.
In order to protect the estate of the
suspended clearing member, OCC
reserves some discretion in supervising
the auction. In the event that the bid
price that clears the entire auction
portfolio is determined by OCC to be an
outlier bid, OCC may choose as the
winning bid a price that clears at least
80% of the auction portfolio. The
remaining auction portfolio will then be
re-auctioned as described above.
OCC anticipates that the likelihood of
having to use this alternative auction is
small. Nevertheless, in view of the fact
that positions in OTC index options are
expected to be large and that there may
be no active trading market in options
with terms precisely identical to the
terms of the OTC index options in
question, OCC believes that this is an
appropriate failsafe provision. It should
be noted that the Chicago Mercantile
Exchange Inc. (‘‘CME’’) has rules
allowing its clearing house and certain
CME committees to administer an
auction process to liquidate positions in
interest rate swaps (‘‘IRS’’) in the event
of a default of a CME clearing member
authorized to submit IRS for clearing (an
‘‘IRS Member’’).30 Although the
financial safeguards supporting IRS
clearing, including its ‘‘guaranty fund,’’
and the IRS auction process are different
from OCC’s clearing fund and OTC
Options Auction in that, among other
things, there is a separate guaranty fund
for IRS, the IRS auction shares certain
similarities with the OTC Options
Auction. In particular, the IRS auction
process requires mandatory
participation of IRS clearing members
with open interest in a position being
auctioned and, in order to provide
incentive for IRS Members to submit
quality bids in an IRS auction, provides
that in the event there is a loss to CME’s
clearing house associated with an IRS
Member’s default, IRS Members that do
not submit quality bids in an IRS
auction are subject to having their IRS
guaranty fund deposit assessed before
assessments are made against other IRS
clearing members’ guaranty fund
deposits. In its original rule filing, OCC
had proposed a different failsafe
solution whereby OCC could terminate
30 See CME Rules 8G14, 8G25 and 8G802.B. See
also Commodity Futures Trading Commission Rule
Change Submission No. 12–061RR of CME, the
Board of Trade of the City of Chicago Inc. and the
New York Mercantile Exchange, available at:
https://www.cmegroup.com/market-regulation/files/
12-061rr.pdf.
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open positions of a suspended clearing
member by setting a close-out value that
non-defaulting clearing members
holding the opposite side of the
suspended clearing member’s positions
would be required to accept or pay in
settlement of the terminated positions.
However, clearing members objected to
that proposed method and have
advocated the auction procedures
proposed here in lieu of the early
termination proposal.31 Clearing
members in an OTC advisory group
were active in designing the OTC
Options Auction procedures, including
the priority charges.
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Impact of Clearing OTC Options on
Other OCC-Cleared Products
Cleared OTC options will not be
fungible with listed options. However,
an OTC option may have economic
characteristics that are substantially
similar or identical to the characteristics
of options in series of listed options that
OCC clears. While it is possible that in
any given instance a market participant
may elect to enter into an OTC option
in lieu of an economically similar listed
product, OCC does not believe that its
clearing of OTC options will adversely
affect the efficiency or liquidity of the
listed markets. The OTC options
markets currently exist to accommodate
a variety of commercial and other needs
of market participants, including the
ability to customize the terms of
transactions. While the availability of an
OCC guarantee for OTC transactions in
which the parties would otherwise be
exposed to each others’
creditworthiness may cause transactions
that currently occur in the non-cleared
OTC markets to migrate to the clearedOTC markets, OCC does not believe it
will cause significant migration from the
listed markets to the cleared OTC
markets. The limitation of the OTC
options markets to ECPs as well as the
significant minimum transaction size
and tenor requirements that are
applicable to certain transactions in the
currently proposed OTC options under
the S&P License Agreement will limit
the use of cleared OTC options and
should help to ensure that there is no
substantial migration from the listed
markets to the OTC markets for this
product. The existing bilateral OTC
options markets have existed for years
alongside the listed options markets,
and OCC believes that dealers in such
31 See comment letter from Alessandro Cocco,
Managing Director of J.P. Morgan Clearing
Corporation and J.P. Morgan Securities LLC, to Ms.
Elizabeth M. Murphy, Secretary, Securities and
Exchange Commission (January 30, 2012), available
at https://www.sec.gov/comments/sr-occ-2011-19/
occ201119-2.pdf.
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bilateral options often use the listed
markets to hedge positions taken in
such bilateral options and other OTC
derivatives.
Notice of Launch Date
Following approval of this rule
change by the Commission, OCC
expects to provide notice to its clearing
members of the date on which it intends
to implement this rule change and begin
clearing OTC options.
*
*
*
*
*
The proposed changes to OCC’s ByLaws are consistent with the purposes
and requirements of Section 17A of the
Exchange Act 32 because they are
designed to permit OCC to clear OTC
options subject to the same basic rules,
procedures and risk management
practices that have been used
successfully by OCC in clearing
transactions in listed options. OCC
believes that clearance and settlement of
OTC options pursuant to this rule filing
is fully consistent with OCC’s
obligations with respect to the prompt
and accurate clearance and settlement of
securities transactions and the
protection of securities investors and
the public interest. The proposed rule
change is not inconsistent with any
existing rule of OCC.
The proposals contained in the
advance notice shall not take effect until
all regulatory actions required with
respect to the proposals are completed.
(B) Clearing Agency’s Statement on
Burden on Competition
OCC does not believe that the
proposed changes contained in the
advance notice will have any impact or
impose any burden on competition.
(C) Clearing Agency’s Statement on
Comments on the Advance Notice
Received From Members, Participants,
or Others
Written comments were not and are
not intended to be solicited with respect
to the advance notice, and, except as
discussed below, none have been
received. OCC has been actively
engaged with a number of clearing
members that have expressed an interest
in clearing OTC Options. The following
are the only substantive written
comments that were received, and they
have been addressed, in the manner
indicated:
• OCC received a written comment
that the role of the Default Management
Advisory Committee, as described in the
OTC Options Auction procedures that
were attached as Exhibit 5 to this rule
filing, should be clarified. OCC has
revised the procedures to clarify that the
Default Management Advisory
Committee will be a standing committee
and will be formed from the inception
of OCC’s clearing of OTC Options. It
will not be an ad hoc committee formed
at the time of a default.
• OCC received a written comment
asking that the Membership/Risk
Committee have a role in setting
exercise settlement values with respect
to OTC index options in unusual
circumstances pursuant to Section
4(a)(2) of Article XVII of the By-Laws.
OCC has revised the rules to provide
that OCC will consult with that
committee when appropriate in setting
exercise settlement values pursuant to
Section 4(a)(2).
• OCC received a written comment
asking for limitations on the
indemnification of OCC by clearing
members under Section 6(f) of Article
XVII of the By-Laws. In response to this
comment OCC has added an exclusion
from the indemnity for claims,
liabilities, or expenses that result
primarily from OCC’s gross negligence
or willful misconduct or from OCC
conduct that causes the offer or sale of
the OTC Options to become subject to
the registration provisions of Section 5
of the Securities Act.33
III. Date of Effectiveness of the Advance
Notice and Timing for Commission
Action
The proposed changes contained in
the advance notice may be implemented
pursuant to Section 806(e)(1)(G) of
Clearing Supervision Act 34 if the
Commission does not object to the
proposed changes within 60 days of the
later of (i) the date that the advance
notice was filed with the Commission or
(ii) the date that any additional
information requested by the
Commission is received. The clearing
agency shall not implement the
proposed changes contained in the
advance notice if the Commission
objects to the proposed changes.
The Commission may extend the
period for review by an additional 60
days if the proposed changes raise novel
or complex issues, subject to the
Commission providing the clearing
agency with prompt written notice of
the extension. Proposed changes may be
implemented in fewer than 60 days
from the date the advance notice is
filed, or the date further information
requested by the Commission is
received, if the Commission notifies the
clearing agency in writing that it does
not object to the proposed changes and
33 15
32 15
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Federal Register / Vol. 77, No. 188 / Thursday, September 27, 2012 / Notices
authorizes the clearing agency to
implement the proposed changes on an
earlier date, subject to any conditions
imposed by the Commission.
OCC has also filed the advance notice
as a proposed rule change pursuant to
Section 19(b)(1) of the Act 35 and Rule
19b–4 thereunder.36 Pursuant to those
provisions, within 45 days of the date of
publication of this notice in the Federal
Register or within such longer period
up to 90 days (i) as the Commission may
designate if it finds such longer period
to be appropriate and publishes its
reasons for so finding or (ii) as to which
the self-regulatory organization
consents, the Commission will:
(A) By order approve or disapprove
the proposed rule change or
(B) Institute proceedings to determine
whether the proposed rule change
should be disapproved.
The clearing agency shall post notice
on its Web site of proposed changes that
are implemented.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing.
Comments may be submitted by any of
the following methods:
erowe on DSK2VPTVN1PROD with
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rulecomments@sec.gov. Please include File
Number SR–OCC–2012–14 on the
subject line.
Paper Comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street NE., Washington, DC
20549–1090.
All submissions should refer to File
Number SR–OCC–2012–14. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
Internet Web site (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the advance notice that
are filed with the Commission, and all
written communications relating to the
advance notice 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 Web site viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE.
Washington, DC 20549, on official
business days between the hours of 10
a.m. and 3 p.m. Copies of such filings
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/components/
docs/legal/rules_and_bylaws/
sr_occ_12_14.pdf. 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–
2012–14 and should be submitted on or
before October 18, 2012.
By the Commission.
Kevin O’Neill,
Deputy Secretary.
[FR Doc. 2012–23816 Filed 9–26–12; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–67904; File No. SR–
NASDAQ–2012–106]
Self-Regulatory Organizations; The
NASDAQ Stock Market LLC; Notice of
Filing and Immediate Effectiveness of
Proposed Rule Change To Offer
Members the Ability To Pay a
Regulatory Fine Pursuant to an
Installment Plan
September 21, 2012.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on
September 14, 2012, The NASDAQ
Stock Market LLC (‘‘NASDAQ’’ or
‘‘Exchange’’) filed with the Securities
and Exchange Commission
(‘‘Commission’’) the proposed rule
change as described in Items I and II
which Items have been prepared by the
Exchange. The Commission is
publishing this notice to solicit
comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of the Substance
of the Proposed Rule Change
The Exchange proposes a rule change
to offer members the ability to pay a
regulatory fine pursuant to an
installment plan, under certain
conditions. The text of the proposed
rule change is available at https://
nasdaq.cchwallstreet.com, at the
Exchange’s principal office, and at the
Commission’s Public Reference Room.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
Exchange 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. The
Exchange has prepared summaries, set
forth in Sections A, B, and C below, of
the most significant aspects of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
NASDAQ is proposing to amend Rule
8320 governing ‘‘Payment of Fines,
Other Monetary Sanctions, or Costs;
Summary Action for Failure to Pay’’ to
offer members the ability to pay a
regulatory fine pursuant to an
installment plan, under certain
conditions. In order for a member to be
eligible to pay a regulatory fine via an
installment plan, the fine under the
applicable letter of acceptance, waiver,
and consent (‘‘AWC’’) 3 must be $50,000
or more. A fine of less than $50,000 is
not eligible for the installment plan.
When submitting its AWC, the member
must check the installment plan option
on the election of payment form
included with the AWC. A sample
election of payment form and AWC are
included in Exhibit 3 4 to this proposed
rule change. A down payment of
twenty-five percent (25%) or more of
the total fine must be submitted with
the signed AWC.
After receipt of the AWC and down
payment, an installment package,
including a promissory note and
payment schedule, will be mailed to the
member. A sample promissory note and
payment schedule are included in
Exhibit 3 to this proposed rule change.
The member must then submit an
executed (signed and notarized)
promissory note for the unpaid balance
3 See
NASDAQ Rule 9216(a).
Commission notes that Exhibit 3 is an
exhibit to the proposed rule change, not to this
Notice.
4 The
35 15
36 17
U.S.C. 78s(b)(1).
CFR 240.19b–4.
VerDate Mar<15>2010
15:00 Sep 26, 2012
1 15
2 17
Jkt 226001
PO 00000
U.S.C. 78s(b)(1).
CFR 240.19b–4.
Frm 00068
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59439
E:\FR\FM\27SEN1.SGM
27SEN1
]]>Agencies
[Federal Register Volume 77, Number 188 (Thursday, September 27, 2012)]
[Notices]
[Pages 59431-59439]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-23816]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67906; File No. SR-OCC-2012-14]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Advance Notice Relating to the Clearance and
Settlement of Over-the-Counter Options
September 21, 2012.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4(n)(1)(i),\2\ notice is hereby given that
on August 30, 2012, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') the
advance notice 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 advance notice from interested
persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4(n)(i).
---------------------------------------------------------------------------
I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
The proposed changes contained in the advance notice will permit
OCC to provide central clearing of index options on the S&P 500 that
are negotiated bilaterally in the over-the-counter market and submitted
to OCC for clearance.
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the advance notice and
discussed any comments it received on the advance notice. The text of
these statements may be examined at the places specified in Item IV
below. OCC has prepared summaries, set forth in sections (A), (B), and
(C) below, of the most significant aspects of these statements.\3\
---------------------------------------------------------------------------
\3\ The Commission has modified the text of the summaries
prepared by OCC.
---------------------------------------------------------------------------
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
The purpose of this proposed rule change and advance notice is to
allow OCC to provide central clearing of OTC index options on the S&P
500 Index. The proposed rule change replaces a previously proposed rule
change which was withdrawn by OCC.\4\ OCC will clear the proposed OTC
options in a manner that is highly similar to the manner in which it
clears listed options, with only such modifications as are appropriate
to reflect the unique characteristics of OTC options.
---------------------------------------------------------------------------
\4\ Securities Exchange Act Release No. 34-66090 (January 3,
2012), 77 FR 1107 (January 9, 2012) (SR-OCC-2011-19).
---------------------------------------------------------------------------
OTC Options
OCC has entered into a license agreement with Standard & Poor's
Financial Services LLC (``S&P'') that allows OCC to clear OTC options
on three equity indices published by the S&P: the S&P 500 Index, the
S&P MidCap 400 Index and the S&P Small Cap 600 Index. The initial OTC
options to be cleared by OCC will consist of options on the S&P 500
Index. OCC may clear OTC options on other indices and on individual
equity securities in the future, subject to Commission approval of one
or more additional rule filings. The current rule filing defines ``OTC
option'' and ``OTC index option'' generically in order to simplify
future amendments to provide for additional underlying interests. OTC
options will have predominantly common terms and characteristics, but
also include unique terms negotiated by the parties. Transactions in
OTC options will not be executed through the facilities of any
exchange, but will instead be entered into bilaterally and submitted to
OCC for clearance through one or more providers of trade affirmation
services.\5\
---------------------------------------------------------------------------
\5\ The initial provider of the trade affirmation services in
connection with the OTC options will be MarkitSERV.
---------------------------------------------------------------------------
OTC options will be similar to exchange-traded standardized equity
index options called ``FLEX Options'' that are currently traded on
certain options exchanges.\6\ FLEX Options are exchange-traded put and
call options that allow for customization of certain terms. For
example, FLEX index Options traded on the Chicago Board Options
Exchange have six customizable terms: (1) Underlying index, (2) put or
call, (3) expiration date, (4) exercise price, (5) American or European
exercise style, and (6) method of calculating settlement value. OCC is
the issuer and guarantor of FLEX Options and clears FLEX Options traded
on multiple exchanges.
---------------------------------------------------------------------------
\6\ Note that FINRA Rule 2360(a)(16) refers to FLEX Options as
``FLEX Equity Options,'' which it defines as ``any options contract
issued, or subject to issuance by, The Options Clearing Corporation
whereby the parties to the transaction have the ability to negotiate
the terms of the contract consistent with the rules of the exchange
on which the options contract is traded.'' OCC does not believe this
definition would capture OTC options as they are not traded on any
exchange. Nevertheless, as discussed below, OCC is working with
FINRA to amend certain of FINRA's rules to clarify the proper
application of such rules to OTC options.
---------------------------------------------------------------------------
Similar to FLEX Options, OTC options will allow for customization
of a limited number of variable terms with a specified range of values
that may be assigned to each as agreed between the buyer and seller.
Parties submitting transactions in OTC options for clearing by OCC will
be able to customize six discrete terms: (1) Underlying index; \7\ (2)
put or call; (3) exercise price; (4) expiration date; (5) American or
European exercise style; and (6) method of calculating exercise
settlement value on the expiration date.\8\ The variable terms and
permitted values will be specified in the proposed Section 6 of Article
XVII of the By-Laws. With respect to future OTC options accepted for
clearing, OCC intends that such future OTC options will conform to the
general variable terms and limits on the variable terms set forth in
proposed Section 6 of the By-Laws, and will either amend the
Interpretations and Policies thereunder to specify additional
requirements for specific OTC options or publish such requirements on
OCC's Web site.
---------------------------------------------------------------------------
\7\ Initially, however, the S&P 500 Index will be the only
permitted underlying index.
\8\ The expiration date of an OTC option must fall on a business
day. The method of determining the exercise settlement value of an
OTC option on its expiration date may be either the opening
settlement value or the closing settlement value of the underlying
index (calculated by S&P using the opening or closing price, as
applicable, in the primary market of each component security of the
underlying index on the specified expiration date), in each case as
reported to OCC by CBOE.
---------------------------------------------------------------------------
Clearing of OTC Options
OCC proposes to clear OTC options subject to the same basic rules
and procedures used for the clearance of listed index options. The
proposed rules require that the counterparties to the OTC options must
be eligible contract participants (``ECPs''), as defined in Section
3a(65) of the Securities Exchange Act of 1934,\9\ as amended (the
``Exchange Act'') and Section 1a(18) of the Commodity Exchange Act,\10\
as amended (the ``CEA''). Because an OTC option will be a ``security''
as defined in
[[Page 59432]]
the Exchange Act, the proposed rules also require that the transactions
be cleared through a clearing member of OCC that is registered with the
Commission as a broker-dealer or one of the small number of clearing
members that are ``non-U.S. securities firms'' as defined in OCC's By-
Laws. OCC is not proposing to require clearing members to meet any
different financial standards for clearing OTC options. However,
clearing members must be specifically approved by OCC to clear OTC
options pursuant to new Interpretation and Policy .11 to Section 1 of
Article V in order to assure the operational readiness of such clearing
members to clear OTC options. Clearing members seeking to clear OTC
options will be required to submit a business expansion request and
complete an operational review. The operational review consists of an
initial meeting with the clearing member's staff to evaluate the
staff's experience, confirm the staff's familiarity with current OCC
systems and procedures, complete an operational questionnaire, perform
a high level review of the clearing member's systems and processing
capabilities, and review other pertinent operational information.
Successful testing of messaging capability between the clearing member,
MarkitSERV and OCC is also necessary. These procedures will determine
whether the firm is operationally ready to clear OTC Index Options.
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78c(a)(65).
\10\ 7 U.S.C. 1a(18).
---------------------------------------------------------------------------
Exercise of an OTC option will be settled by payment of cash by the
assigned writer and to the exercising holder through OCC's cash
settlement system on the business day following exercise in exactly the
same manner as is the case with exercise settlement of listed index
options. As in the case of listed index options, the exercise-
settlement amount will be equal to the difference between the current
value of the underlying interest and the exercise price of the OTC
option, times the multiplier that determines the size of the OTC
option. In the case of OTC index options on the S&P 500, the multiplier
will be fixed at 1. The multipliers for additional OTC index options
that OCC may in the future clear may be fixed at such value as OCC
determines and provides for in its By-Laws and Rules.
OCC will calculate clearing margin for the OTC options using its
STANS margin system on the same basis as for listed index options and
will otherwise apply the same risk management practices to both OTC
options and listed index options, including new risk modeling
enhancements for longer-tenor options discussed below under ``Risk
Management Enhancement for Longer-Tenor Options.'' Because OCC
currently clears listed options on all three of the underlying indexes
on which OCC is currently licensed to clear OTC options, and because
the customizable terms of these OTC options are relatively limited and
the range of values that customizable terms may be given is limited,
OCC does not believe that valuation and risk management for these OTC
options present challenges that are different from those faced in the
listed options market. Nevertheless, as discussed further below, OCC is
proposing special OTC Options Auctions to be used in the unlikely event
that OCC would be unable to close out positions in OTC options of a
failed clearing member through other means.
OTC options may be carried in a clearing member's firm account, in
market-maker accounts or in its securities customers' account, as
applicable. Although customer positions in OTC options will be carried
in the securities customers' account (an omnibus account), OCC will use
a ``customer ID'' to identify positions of individual customers based
on information provided by clearing members.\11\ However, positions are
not presently intended to be carried in individual customer sub-
accounts, and positions in OTC options will be margined at OCC in the
omnibus customers' account on the same basis as listed options. If a
clearing member takes the other side of a transaction with its customer
in an OTC option, the transaction will result in the creation of a long
or short position (as applicable) in the clearing member's customers'
account and the opposite short or long position in the clearing
member's firm account. The positions could also be includable in the
internal cross-margining account, subject to any necessary regulatory
approvals.
---------------------------------------------------------------------------
\11\ Such customer IDs are necessary in order to allow OCC to
comply with certain terms of OCC's license agreement with S&P. As
described further below, customer IDs will be used for other
purposes as well.
---------------------------------------------------------------------------
The trade data for an OTC option trade will be entered into the
system of MarkitSERV or another trade confirmation/affirmation vendor
approved by OCC for this purpose (the ``OTC Trade Source'').\12\ While
MarkitSERV will be the only OTC Trade Source at launch, OCC will permit
additional OTC Trade Sources in the future in response to sufficient
market demand from OCC's clearing members and subject to the ability of
any such OTC Trade Source to meet OCC's requirements for operational
readiness and interoperability with OCC's systems, as well as
requirements with respect to relevant business experience and
reputation, adequate personnel and expertise, financial qualification
and such other factors as OCC deems relevant. OCC will receive
confirmed trades from the OTC Trade Source. It will be permissible for
parties to submit trades for clearance that were entered into
bilaterally at any time in the past, provided that the eligibility for
clearance will be determined as of the date the trade is submitted to
OCC for clearance.\13\ The OTC Trade Source will process the trade and
submit it as a confirmed trade to OCC for clearing. If the trade meets
OCC's validation requirements, OCC will so notify the OTC Trade Source,
which will notify the submitting parties. Customers of clearing members
may have direct access to the OTC Trade Source for purposes of entering
or affirming trade data and receiving communications regarding the
status of transactions, in which case mechanisms will be put in place
for a clearing member to authorize a customer to enter a trade for the
clearing member's customers' account or for the clearing member to
affirm a trade once entered.
---------------------------------------------------------------------------
\12\ MarkitSERV, LLC is owned by Markit Group Limited, Markit
Group Holdings Limited and The Depository Trust & Clearing
Corporation. MarkitSERV Limited is a wholly-owned U.K. subsidiary of
MarkitSERV, LLC. MarkitSERV, LLC and MarkitSERV Limited
(collectively, ``MarkitSERV'') provide derivatives transaction
processing, electronic confirmation, portfolio reconciliation
services, and other related services for firms that conduct business
in the over-the-counter derivatives markets through a variety of
electronic systems, including the MarkitWire system. MarkitWire,
owned by MarkitSERV Limited, is an OTC derivatives electronic
confirmation/affirmation service offered by MarkitSERV as part of
its post-trade processing suite of products. The role of MarkitSERV
and MarkitWire in OCC's clearing of OTC options is described in
further detail below.
\13\ OCC's license agreement with S&P imposes certain
requirements relating to minimum time remaining to expiration of an
OTC option.
---------------------------------------------------------------------------
In order for a clearing member to be approved for clearing OTC
options, the clearing member must enter into a standard agreement with
MarkitSERV (or another OTC Trade Source with which the clearing member
intends to enter trade data, if and when OCC enters into arrangements
with other OTC Trade Sources). At launch, OTC options will not be
subject to the same clearing member trade assignment rules and
procedures through which exchange-traded options can be cleared by a
clearing member other than the executing clearing member. This
functionality may be added at a later date. OCC and MarkitSERV will
adopt procedures to permit a customer that
[[Page 59433]]
has an account with Clearing Member A (``CM A'') to enter into an OTC
option transaction with Clearing Member B (``CM B'') and have the
position included in its account at CM A and cleared in CM A's
customers' account at OCC.
OTC options will be fungible with each other to the extent that
there are OTC options in the system with identical terms. However, OCC
will not treat OTC options as fungible with index options listed on any
exchange, even if an OTC option has terms identical to the terms of the
exchange-listed option.
Clearing members that carry customer positions in cleared OTC
options will be subject to all OCC rules governing OCC-cleared options
generally, as well as all applicable rules of the Commission and of any
self-regulatory organization, including the Financial Industry
Regulatory Authority (``FINRA''), of which they are a member. Section 8
of Article III of OCC's By-Laws provides that, subject to the By-Laws
and Rules, ``the Board of Directors may suspend Clearing Members and
may prescribe and impose penalties for the violation of the By-Laws or
the Rules of the Corporation, and it may, by Rule or otherwise,
establish all disciplinary procedures applicable to Clearing Members
and their partners, officers, directors and employees.'' As a condition
to admission, Section 3(c) of Article V of the By-Laws provides that a
clearing member must agree, among other things, to ``pay such fines as
may be imposed on it in accordance with the By-Laws and Rules.'' Rule
305 permits OCC to impose restrictions on the clearing activities of a
clearing member if it finds that the financial or operational condition
of the clearing member makes it necessary or advisable to do so for the
protection of OCC, other clearing members, or the general public. Rule
1201(a) provides that OCC ``may censure, suspend, expel or limit the
activities, functions or operations of any Clearing Member for any
violation of the By-Laws and Rules or its agreements with the
Corporation.'' In addition to, or in lieu of, such actions, OCC is
permitted under the same paragraph to impose fines. Rule 1202(b)
establishes procedures for taking any such disciplinary actions. The
foregoing provisions are sufficient to permit OCC to fine or otherwise
discipline a clearing member that fails to abide by OCC's By-Laws and
Rules applicable to OTC options, or to prohibit such clearing member
from continuing to clear such options.
Regulatory Status of the OTC Options
An OTC option will be a ``security'' as defined in both the
Securities Act of 1933, as amended (the ``Securities Act'') and, as
noted above, the Exchange Act. OCC will be the ``issuer'' of the OTC
options. The OTC options will be neither ``swaps'' nor ``security-based
swaps'' for purposes of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank'').\14\
---------------------------------------------------------------------------
\14\ Section 1a(47)(A)(i) of CEA, 7 U.S.C. 1a(47)(A)(i), as
added by Section 721(a)(21) of Dodd-Frank, defines ``swaps'' broadly
to include options on indices. However, Section 1a(47)(B)(iii) of
the CEA, 7 U.S.C. 1a(47)(B)(iii), excludes from the ``swap''
definition any option on any index of securities that is subject to
the Securities Act and the Exchange Act. A contract that is excluded
from the definition of a ``swap'' under Section 1a(47)(B) of the
CEA, 7 U.S.C. 1a(47)(B) (other than Section 1a(47)(B)(x), 7 U.S.C
1a(47)(B)(x)) is not a ``security-based swap'' for purposes of
Section 3a(68) of the Exchange Act, 15 U.S.C. 78c(a)(68).
---------------------------------------------------------------------------
Most of OCC's clearing members are members of FINRA and subject to
FINRA's rules, which have different provisions for ``listed'' and ``OTC
options'' and contain various definitions distinguishing between the
two. In some cases, OTC options would fall into neither category under
FINRA's definitions and in other cases, they would fall within what OCC
perceives to be the wrong category. FINRA and OCC are working together
to implement appropriate amendments to FINRA rules to clarify the
proper application of such rules to cleared OTC options.
MarkitSERV Trade Submission Mechanics
MarkitSERV provides an interface to OCC that allows OCC to receive
messages containing details of transactions in OTC options submitted
for clearing by clearing members with access to MarketWire and also
allows OCC to transmit messages to MarkitWire participants identifying
the status of submitted transactions. MarkitWire applications use
product-specific templates to simplify deal entry and negotiations. The
templates specify the data required for a given product and also the
business validation rules for each field. MarkitSERV has included OCC's
validation requirements for OTC options in its trade templates.
The trade data for each OTC option transaction must be entered into
MarkitWire. MarkitSERV will use a ``confirmation/affirmation''
procedure in which one party to the trade enters the trade data to the
MarkitWire platform, which issues a confirmation to the counterparty to
be affirmed, rejected or requested to be revised. If the trade details
are confirmed, the trade will then be submitted to OCC for clearance
and MarkitSERV will affirm such submission to both parties. OCC then
validates the trade information for compliance with applicable
requirements, such as the identification of an account of an eligible
clearing member in which each side of the trade will be cleared, that
the variable terms are within permissible ranges, and that minimum size
requirements under OCC's license agreement with S&P are met. This
validation will be completed by OCC immediately upon submission. OCC's
clearing system will automatically accept the trade if it passes the
validation process and will otherwise reject it.\15\ A trade that is
rejected by OCC may be corrected and submitted as a new transaction.
Clearing members and customers with access to MarkitSERV will be able
to determine whether a trade has been accepted or rejected both through
MarkitSERV and, in the case of clearing members, through their
interface with OCC's clearing system.
---------------------------------------------------------------------------
\15\ Once accepted, a trade is guaranteed by OCC. Note, however,
that OTC options for which the premium payment date communicated by
MarkitSERV to OCC is prior to the business day on which the OTC
option is submitted to OCC for clearing (referred to as a
``Backloaded OTC Option'') will not be accepted and guaranteed until
the selling clearing member has met its initial morning cash
settlement obligations to OCC on the following business day.
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MarkitSERV's Regulatory Status \16\
---------------------------------------------------------------------------
\16\ MarkitSERV offers different services in different markets,
and this discussion is addressed only to the ``confirmation/
affirmation'' procedure to be used in submitting trades to OCC.
---------------------------------------------------------------------------
MarkitSERV is not registered as a clearing agency under the
Exchange Act, and the Commission staff has asked OCC to consider
whether MarkitSERV would be required to so register in order to provide
the proposed services to the OTC options market. OCC believes that no
such registration is necessary based upon relevant interpretive
guidance issued by the Commission.
Section 3(a)(23)(A) of the Exchange Act \17\ defines a ``clearing
agency'' broadly. The definition includes, in relevant part, ``any
person who * * * provides facilities for comparison of data respecting
the terms of settlement of securities transactions[.]'' In 1998, the
Commission issued a release entitled ``Confirmation and Affirmation of
Securities Trades; Matching'' (the ``Matching Release'').\18\ In the
Matching Release, the Commission published ``its interpretation that a
`matching' service that compares securities trade information from a
broker-dealer and the broker-dealer's customer is a
[[Page 59434]]
clearing agency function.'' The Matching Release distinguishes between
such a matching service and a ``confirmation/affirmation service''
where the ``vendor intermediary will only transmit information between
the parties to a trade, and the parties will confirm and affirm the
accuracy of the information.'' The Commission noted that ``matching''
constitutes the ``comparison of data respecting the terms of settlement
of securities transactions'' and that such services therefore trigger
status as a clearing agency, while confirmation/affirmation services
would not, by themselves, constitute such a data comparison. The
Commission concluded in the Matching Release that ``an intermediary
that captures trade information from a buyer and a seller of securities
and performs an independent reconciliation or matching of that
information is providing facilities for the comparison of data within
the scope of Exchange Act Section 3(a)(23).'' The Commission stated
that ``matching'' is ``so closely tied to the clearance and settlement
process that it is different not only in degree but also different in
kind from the * * * confirmation and affirmation process.'' The
Matching Release goes on to state: ``A vendor that provides
confirmation/affirmation services only will exchange messages between a
broker-dealer and its institutional customer. The broker-dealer and its
institutional customer will compare the trade information contained in
those messages, and the institution itself will issue the affirmed
confirmation.'' This is precisely what occurs when a counterparty to a
trade affirms the trade data through MarkitSERV and requests submission
to OCC for clearance. MarkitSERV transmits messages only; it does not
``compare'' or ``match'' trade data submitted by two parties.
---------------------------------------------------------------------------
\17\ 15 U.S.C. 78c(a)(23)(A).
\18\ Securities Exchange Act Release No. 34-39829 (April 13,
1998), 63 FR 17943 (April 13, 1998).
---------------------------------------------------------------------------
The ``confirmation/affirmation'' functionality (as described above)
to be provided by MarkitSERV (through MarkitWire) with respect to OTC
options is functionally identical to the confirmation/affirmation
service described in the Matching Release and OCC believes such service
would not be a ``matching'' service within the meaning of the release.
OCC believes that MarkitSERV will not be a ``clearing agency'' with
respect to the services to be provided in connection with OTC options.
The confirmation/affirmation service described in the Matching Release
referred ``to the transmission of messages among broker-dealers,
institutional investors, and custodian banks regarding the terms of a
trade executed for the institutional investor.'' MarkitWire's
confirmation/affirmation process will allow for the transmission of
messages among OCC's clearing members (most of which are registered
broker-dealers), their customers (all of whom will be ECPs and will
therefore be large and financially sophisticated market participants)
and OCC, which is itself registered and subject to the Commission's
oversight as a clearing agency.
By contrast, the ``matching'' services contemplated in the Matching
Release would involve ``the process whereby an intermediary compares
the broker dealer's trade data submission * * * with the institution's
allocation instructions * * * to determine whether the two descriptions
of the trade agree.'' MarkitWire performs no such comparison. Under the
confirmation/affirmation procedure, trade data is entered into
MarkitWire by one party and such data is made available to the
counterparty to be affirmed, rejected or requested to be revised.
MarkitWire merely facilitates the transfer of information between the
parties sufficient to allow the comparison to be made. A binding
transaction (i.e., an ``affirmed confirmation'' in the language of the
Matching Release) is not produced through any action of MarkitSERV, but
is instead created by the completion, by the counterparty, of an
affirmation of the trade data entered by the first party. MarkitWire
provides no ``independent reconciliation or matching'' of trade data.
Rather MarkitWire is providing essentially a messaging service among
OCC and the parties to trades in OTC Options. The Matching Release is
clear as to the distinction between a matching service and a
confirmation/affirmation service, and OCC believes that there is no
ambiguity that the services to be provided by MarkitWire with respect
to OTC options fall into the latter, rather than the former, category.
Risk Management Enhancements for Longer-Tenor Options
Although OCC's license agreement with S&P allows OCC to clear OTC
options with tenors of up to fifteen years, OCC has elected at this
time to clear only OTC options on the S&P 500 index with tenors of up
to five years. However, OCC currently clears FLEX Options on the S&P
500 with tenors of up to 15 years. While OCC believes that its current
risk management practices are adequate for current clearing activity,
OCC is in the process of implementing risk modeling enhancements with
respect to longer-tenor options, including OTC options. The
enhancements are part of OCC's ongoing efforts to test and improve its
risk management operations with respect to all longer-tenor options
that OCC currently clears. These procedures will be submitted for
review in a separate ``advance notice'' filing and OCC will not
commence clearing of OTC options until such procedures have been
approved and implemented.
The proposed enhancements are as follows:
First, OCC will introduce indicative over-the-counter
quotations into the daily dataset of prices used to risk manage OCC-
cleared products. These quotations will be obtained from a service
provider that will collect OTC dealer polling information on a daily
basis and provide such data to OCC.
Second, OCC will introduce variations in the implied
volatilities used in the modeling of all cleared options whose residual
tenors are at least three years. To date, OCC's margin methodology has
assumed that implied volatilities of option contracts are static over
the two-day risk horizon. While OCC's backtesting has identified few
exceedances related to implied volatility shocks, such shocks could
occur and taking them into account in OCC's margin model will allow
more robust risk management. OCC proposes to achieve this result by
incorporating into the risk factors included in OCC's models time
series of proportional changes in implied volatilities for a range of
representative volatilities.
Third, OCC will introduce a valuation adjustment into its
calculation of portfolio net asset value. This adjustment will be based
on the aggregate sensitivity of the longer-tenor options in a portfolio
to the overall level of implied volatilities at three and five years,
and to the implied volatility skew.
A review of individual S&P 500 Index put and call options positions
that are in the money by varying amounts and have expiration dates
between four and nine years out indicates that the inclusion of modeled
implied volatilities tends to result in less margin being held against
short call positions and more being held against short put positions.
These results are consistent with what would be expected given the
strong negative correlation that exists between changes in implied
volatility and market returns. On average, OCC observed a decrease in
the margin requirement of approximately 24% on the nine call options
tested and a 63% increase associated with the nine put options.
[[Page 59435]]
Proposed By-Law and Rule Changes
The specific proposed changes to OCC's By-Laws and Rules to provide
for the clearing of OTC options relate primarily to: (i) Specification
of customizable terms; (ii) procedures for submission and acceptance of
trades for clearance; and (iii) specification of criteria for
eligibility of clearing members to clear transactions in OTC options
and limitation of the types of customers for whom clearing members may
effect transactions in OTC options. Otherwise, the currently proposed
OTC options will be cleared and settled under the same provisions
applicable to clearance of listed index options. Many of the proposed
amendments are self-explanatory, and OCC has therefore attempted to
confine the following discussion to a broad overview with specific
explanation only where the reasons for the change may be less obvious.
Article I of the By-Laws contains defined terms used throughout the
By-Laws and Rules. OCC proposes to modify certain existing definitions
and include certain new definitions in order to incorporate OTC options
into existing rules and facilitate the creation of new provisions
unique to OTC options. Throughout the By-Laws and Rules, OCC proposes
to replace the term ``Exchange transaction,'' which is currently
defined in Article I, in relevant part, as ``a transaction on or
through the facilities of an Exchange for the purchase, writing or sale
of a cleared contract'' with the term ``confirmed trade'' so as to make
the relevant portions of the By-Laws and Rules applicable to
transactions in OTC options as well as listed options, without causing
confusion about the role of the OTC Trade Source in OCC's clearing of
OTC options. ``Confirmed trade'' is proposed to be defined in Article I
to include transactions ``effected on or through the facilities of an
exchange'' or ``affirmed through the facilities of an OTC Trade
Source'' in order to include transactions in both listed options and
OTC options. The current definition of ``confirmed trade'' in Rule 101
is proposed to be deleted as unnecessary given the new definition. Much
of the length of this rule filing is attributable to the fact that the
term ``Exchange transaction'' is used so many places in the rules. OCC
has entered into agreements in the past which reference the term
``Exchange transaction'' or ``exchange transaction.'' OCC is also
proposing to add an Interpretation and Policy to the new definition of
``confirmed trade'' in order to avoid any ambiguity concerning how such
terms should be interpreted in any such agreement.
OCC proposes to add a new Interpretation and Policy .11 to Section
1 of Article V of the By-Laws, providing the additional criteria that
must be met by a clearing member in order to clear OTC index options.
Among these new criteria are that clearing members seeking to clear OTC
index options on underlying indices published by Standard & Poor's
Financial Services LLC (``S&P'') must execute and maintain in effect a
short-form license agreement in such form as specified from time to
time by S&P. The current form of S&P short-form index license agreement
is attached hereto as Exhibit 3.
The Interpretations and Policies under Section 1, Article VI allow
clearing members to adjust their positions with OCC for certain
enumerated reasons. OCC proposes to amend the Interpretations and
Policies to clarify that adjustment of positions in OTC options will be
effected through a manual process (as opposed to the electronic process
available to post-trade adjustments in listed options), to the extent
permitted by OCC. For the same reason, OCC is proposing to amend Rule
403 to prohibit clearing member trade assignment (``CMTA'')
transactions in OTC options. Trade ``give-ups'' that are effected
through the CMTA process in the case of listed options will, in the
case of OTC options, be effected through MarkitSERV before the trades
are submitted to OCC for clearing.
Article XVII of the By-Laws governs index options in general and
OCC is proposing amendments to Article XVII in order to set forth the
terms applicable to the initial OTC options proposed to be cleared by
OCC--options on the S&P 500 Index--and to differentiate OTC index
options from other index options cleared by OCC. For example, certain
amendments to the definitions are necessary because OTC options will be
permitted to have a much wider range of expiration dates than exchange-
traded options (other than FLEX Options). Additional definitional
amendments ensure that OTC index options will constitute a separate
class of options from other cash-settled index options even if both
index options have the same terms and cover the same underlying
interest.
Section 3 of Article XVII provides for adjustment of the terms of
outstanding index options as necessary to reflect possible changes in
the underlying index--such as those creating a discontinuity in the
level of the index--that could theoretically make an adjustment
necessary to protect the legitimate expectations of holders and writers
of options on the index. Pursuant to paragraph (g) of Section 3, most
but not all such adjustments would be made, in the case of listed index
options, by an adjustment panel consisting of representatives of the
exchanges on which the options are traded. In the case of OTC options,
any such adjustments will be made by OCC in its sole discretion.
However, in exercising that discretion, OCC may take into consideration
adjustment made by the adjustment panel with respect to exchange-traded
options covering the same underlying index.\19\
---------------------------------------------------------------------------
\19\ Because index options, unlike options on individual stocks,
rarely, if ever, require adjustments, allocation of the adjustment
authority may have little practical significance.
---------------------------------------------------------------------------
OCC proposes to add a new Section 6 to Article XVII to set forth
certain provisions unique to OTC index options, including the variable
terms allowed for OTC index options and the general limitations on such
variable terms. In general, all OTC index options must conform to the
terms and limitations set forth in Section 6, and additional specific
requirements applicable to specific OTC index options will either be
set forth in the Interpretations and Policies under Section 6 or
published separately on OCC's Web site. Section 6 also makes clear that
although OTC index options are not fungible with exchange-traded index
options, OTC index options of the same series (i.e., options having
identical terms) will be fungible with each other. In addition to the
terms and limitations applicable to OTC index options, Section 6 will
establish that clearing members will be deemed to have made a number of
representations and warranties in connection with their activities in
OTC options each time they affirm a confirmed trade entered into an OTC
Trade Source.
OCC has submitted a rulemaking petition to the Commission \20\
seeking an amendment to Commission Rule 238 \21\ that would exempt the
OTC Options from most provisions of the Securities Act. Unless another
exemption from the registration requirements of the Securities Act is
available, OCC intends to rely upon Rule 506 of Regulation D \22\ under
the Securities Act, which is a safe harbor under the Securities Act
exemption in Section 4(a)(2) \23\ for offerings by an issuer not
involving a public offering. OCC intends to satisfy
[[Page 59436]]
the conditions of Rule 506 of Regulation D as in effect at the time OCC
relies upon the safe harbor. Participants in the existing markets for
OTC equity options offered and sold in the United States commonly rely
on the private offering exemption under these provisions and such
reliance is therefore consistent with existing practice. OTC Options
will be available for purchase only by highly sophisticated investors
that are both ``eligible contract participants,'' as defined in Section
3a(65) of the Exchange Act,\24\ and ``accredited investors,'' as
defined in Rule 501(a) under Regulation D.\25\ Section 6(f) of Article
XVII includes representations of clearing members necessary to ensure
that there is no general solicitation or general advertising in
connection with the offer or sale of the OTC Options until such time as
OCC notifies clearing members that such restriction no longer applies.
---------------------------------------------------------------------------
\20\ See SEC File No. 4-644 (Submitted January 13, 2012),
available at https://www.sec.gov/rules/petitions/2012/petn4-644.pdf.
\21\ 17 CFR 230.238.
\22\ 17 CFR 230.506.
\23\ 15 U.S.C. 77d(a)(2).
\24\ 15 U.S.C. 77c(a)(65).
\25\ 17 CFR 230.501.
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Chapter IV of the Rules sets forth the requirements for reporting
of confirmed trades to OCC, and Rule 401 thereunder governs reporting
of transactions in listed options by participant Exchanges. OCC is
proposing to add new Rule 404 to govern the details of reporting of
confirmed trades in OTC options by an OTC Trade Source.
As discussed above, positions in OTC options will generally be
margined in the same manner as positions in listed options using STANS
and pursuant to Chapter VI of the Rules. However, OCC proposes to amend
Rule 611 to establish different procedures for the segregation of long
positions in OTC options for margining purposes. Long positions in
listed options are held in a clearing member's customers' account or
firm non-lien account and by default are deemed to be ``segregated,''
meaning that they are not subject to OCC's lien and are given no
collateral value when determining the margin requirement in the
account. Such positions may be unsegregated only when a clearing member
instructs OCC to unsegregate a long position and represents to OCC that
the long position is part of a spread transaction carried for a single
customer whose margin requirement on the corresponding short position
has been reduced in recognition of the spread. OCC will then
unsegregate the long position and so reduce OCC's margin requirement.
However, in case of long positions in OTC options that are carried in a
clearing member's customers' account and for which OCC has received a
customer ID, OCC proposes that it will automatically unsegregate such
long positions if OCC identifies a qualifying short position in OTC
options carried under the same customer ID. Clearing members will not
be required to give an affirmative instruction to OCC to unsegregate a
long position in OTC options or make a separate representation
regarding the spread transaction. Instead, by carrying a qualifying
spread position in a customer account, clearing members are deemed to
have represented to OCC that the customer's margin has been reduced in
recognition of the spread. Based on discussion with the clearing
members, it is OCC's understanding that, in practice, broker-dealers
reduce customers' margin requirements to reflect spread positions.
Therefore, OCC believes that automatic recognition of such spreads by
OCC together with the deemed representation will greatly increase
operational efficiency while providing equal assurance that long
positions in OTC options will be unsegregated only if an identified
customer will receive the benefit of the reduced margin required for
spread transactions.
Rule 1001 sets forth the amount of the contribution that each
clearing member is required to make to the clearing fund. OCC proposes
to amend Rule 1001(c) so that, for purposes of calculating the daily
average number of cleared contracts held by a clearing member in open
positions with OCC during a calendar month (which number is used in
turn to determine the clearing member's contribution to the clearing
fund), open positions in OTC options will be adjusted as needed to
account for any differences between the multiplier or unit of trading
with respect to OTC options relative to non-OTC options covering the
same underlying index or interest so that OTC options and non-OTC
options are given comparable weight in the computation.\26\
---------------------------------------------------------------------------
\26\ For example, the index multiplier applicable to OTC index
options on the S&P 500 Index will be fixed at 1. In comparison, the
index multiplier applicable to listed index options is 100.
---------------------------------------------------------------------------
In general, the rules in Chapter XI governing the suspension of a
clearing member will apply equally to clearing members that transact in
OTC options. Rule 1104 provides broad authority for OCC to liquidate a
suspended clearing member's margin and clearing fund deposits ``in the
most orderly manner practicable.'' Rule 1106 provides similarly worded
authority to close out open positions in options and certain other
cleared contacts carried by a suspended clearing member. In 2011, the
Commission approved an OCC rule change providing OCC the express
authority to use a private auction as one of the means by which OCC may
close out open positions and liquidate margin and clearing fund
deposits of a suspended clearing member.\27\ OCC anticipates it will
use this auction process for OTC options as well. As an additional tool
to ensure its ability to close out positions in OTC options promptly,
OCC is proposing to amend Rule 1106 to provide for an alternative
auction procedure specifically applicable only to OTC index options and
related positions hedging, or hedged by, OTC index options (an ``OTC
Options Auction''). An OTC Options Auction would be used only in
unusual circumstances where OCC determines it is not feasible to close
out open positions in OTC index options through the other means
provided for in OCC's Rules and By-Laws.\28\ The amendments to Rule
1106 summarize the OTC Options Auction procedures and incorporate by
reference the detailed procedures contained in a document entitled
``OTC Options Auction Procedures,'' which will be posted on the
Corporation's Web site and otherwise made available to clearing members
upon request of OCC. A copy of the OTC Options Auction Procedures was
attached to the filing as Exhibit 5.
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\27\ See Securities Exchange Act Release No. 34-65654 (October
28, 2011), 76 FR 68238 (November 3, 2011) (SR-OCC-2011-08). OCC
subsequently filed a rule change, currently pending Commission
approval, providing detailed procedures for the conduct of such an
auction. See Securities Exchange Act Release No. 34-67443 (July 16,
2012), 77 FR 42784 (July 20, 2012) (SR-OCC-2012-11).
\28\ OCC anticipates that these procedures would be applicable
to other OTC derivatives that may be cleared by OCC in the future.
However, OCC has limited the currently proposed rule to OTC index
options, and will amend it as and if appropriate to apply to other
over-the-counter products that OCC may propose to clear in the
future.
---------------------------------------------------------------------------
Rule 1106(e)(2)(C) clarifies that, in the event that the
liquidation of a clearing member results in a deficiency that would
otherwise result in a proportionate charge against the clearing fund
contributions of other clearing members, each OTC Index Option Member
(as defined below) that failed to purchase or assume its share of an
auction portfolio will be the first to absorb the deficiency, through a
``Priority Charge'' against such clearing members' clearing fund
contributions. The Priority Charge is a ``first loss'' mechanism, and
is not intended to increase a clearing member's total maximum exposure
to OCC.
Under the OTC Options Auction procedures, all clearing members
authorized to clear transactions in OTC index options (``OTC Index
Option Members''), other than the defaulting
[[Page 59437]]
clearing member, will be required to participate in the OTC Options
Auction by submitting competitive bids for all or a portion of the
defaulting clearing member's OTC index option portfolio. Each such
participant will be subject to a minimum participation level based on
the participant's proportionate share of the total ``risk margin''
requirement posted by all OTC Index Options Members in the previous
month for all positions (not limited to OTC option positions) held in
accounts eligible to hold OTC options positions (``OTC Eligible
Accounts''), after removing the defaulting clearing member.\29\ This
method of calculating the minimum participation level in the OTC
Options Auction results in all OTC Index Option Members being required
to participate in the OTC Options Auction based on their clearing
activity related to all positions in OTC Eligible Accounts. Required
participation ensures that the OTC Options Auction will have sufficient
participants authorized to clear transactions in OTC index options and
that the most active clearing members in OTC index options will submit
bids for the largest percentage of the auction portfolio, increasing
the likelihood of the acquisition of OTC options positions by clearing
members with appropriate financial strength, risk management
capabilities and trading expertise. Each participant may submit bids at
varying quantities and varying prices, so long as the participant's
bids equal or exceed its minimum participation level. A participant may
use bids from non-OTC Index Options Members and non-clearing members in
order to meet its minimum participation level, subject to certain
Corporation requirements including that it guarantee the performance of
such third parties. Each bid will indicate what percentage of the
auction portfolio the participant is bidding on and the amount of the
bid. Bids will be stated in terms of a price for the entire auction
portfolio, and may be either positive or negative. (Negative bids imply
an auction portfolio that has a negative net asset value and indicate
how much the Corporation would be required to pay the participant to
assume the relevant percentage of the auction portfolio.) The
Corporation will rank the submitted bids from best to worst and the
auction portfolio will be allocated among the bidding participants
accordingly until the auction portfolio is exhausted. The bid price
that is sufficient to clear the entire auction portfolio will become
the single price to be used for all winning bids, even if a
participant's stated bid was better.
---------------------------------------------------------------------------
\29\ This minimum participation level will be multiplied by 1.15
to calculate each participant's minimum bid size, such that the sum
of all participants' bids will equal 115% of the auction portfolio,
in order to increase the likelihood that the entire auction
portfolio will be allocated to participants.
---------------------------------------------------------------------------
In order to provide a strong incentive to ensure competitive
bidding by the OTC Index Option Members required to participate in an
OTC Options Auction, OTC Index Options Members who fail to win their
minimum participation in the auction will be subject to a potential
priority charge against its clearing fund contribution. If the cost of
liquidating a suspended clearing member's positions exhausts the
clearing member's margin and clearing fund contribution and any other
assets of the suspended clearing member available to OCC, then OCC,
pursuant to Section 5 of Article VIII of the By-Laws, would ordinarily
withdraw the amount of the deficiency from the clearing fund and charge
it on a proportionate basis against all other clearing members'
computed contributions as fixed at the time. When an OTC Options
Auction has been held in respect of a suspended OTC Index Options
Member, however, some or all of any such remaining loss would be
assessed first against the clearing fund contributions of any OTC
Options Auction participant(s) whose bids are insufficiently
competitive to be allocated a portion of the auction portfolio equal to
such participant's minimum required participation. This priority charge
would be made regardless of the reason for the shortfall--i.e., whether
or not the loss resulted from the closing out of OTC options positions.
The priority charge would be calculated based on an ``assessment
ratio,'' which is formulated to provide incentive to all OTC Options
Auction participants to participate to their full minimum participation
level in the auction. The method of calculating the assessment ratio is
such that if the net asset value of the auction portfolio is zero the
assessment ratio will also be zero and no priority charge will be made.
As the absolute net asset value of the auction portfolio (whether
positive or negative) increases, the assessment ratio also increases,
all other factors being equal. If all OTC Options Auction participants
submit bids such that each receives an allocation of OTC options
positions equal to its minimum participation level, no priority charge
will be made regardless of whether or not there is a liquidation
shortfall. If a liquidation shortfall remains after any priority
charges, or if no priority charges were required, the Corporation will
then make a proportionate charge against the clearing fund
contributions of all clearing members, including those that
participated in the OTC Options Auction, in the usual manner pursuant
to Section 5 of Article VIII of OCC's By-Laws.
In order to protect the estate of the suspended clearing member,
OCC reserves some discretion in supervising the auction. In the event
that the bid price that clears the entire auction portfolio is
determined by OCC to be an outlier bid, OCC may choose as the winning
bid a price that clears at least 80% of the auction portfolio. The
remaining auction portfolio will then be re-auctioned as described
above.
OCC anticipates that the likelihood of having to use this
alternative auction is small. Nevertheless, in view of the fact that
positions in OTC index options are expected to be large and that there
may be no active trading market in options with terms precisely
identical to the terms of the OTC index options in question, OCC
believes that this is an appropriate failsafe provision. It should be
noted that the Chicago Mercantile Exchange Inc. (``CME'') has rules
allowing its clearing house and certain CME committees to administer an
auction process to liquidate positions in interest rate swaps (``IRS'')
in the event of a default of a CME clearing member authorized to submit
IRS for clearing (an ``IRS Member'').\30\ Although the financial
safeguards supporting IRS clearing, including its ``guaranty fund,''
and the IRS auction process are different from OCC's clearing fund and
OTC Options Auction in that, among other things, there is a separate
guaranty fund for IRS, the IRS auction shares certain similarities with
the OTC Options Auction. In particular, the IRS auction process
requires mandatory participation of IRS clearing members with open
interest in a position being auctioned and, in order to provide
incentive for IRS Members to submit quality bids in an IRS auction,
provides that in the event there is a loss to CME's clearing house
associated with an IRS Member's default, IRS Members that do not submit
quality bids in an IRS auction are subject to having their IRS guaranty
fund deposit assessed before assessments are made against other IRS
clearing members' guaranty fund deposits. In its original rule filing,
OCC had proposed a different failsafe solution whereby OCC could
terminate
[[Page 59438]]
open positions of a suspended clearing member by setting a close-out
value that non-defaulting clearing members holding the opposite side of
the suspended clearing member's positions would be required to accept
or pay in settlement of the terminated positions. However, clearing
members objected to that proposed method and have advocated the auction
procedures proposed here in lieu of the early termination proposal.\31\
Clearing members in an OTC advisory group were active in designing the
OTC Options Auction procedures, including the priority charges.
---------------------------------------------------------------------------
\30\ See CME Rules 8G14, 8G25 and 8G802.B. See also Commodity
Futures Trading Commission Rule Change Submission No. 12-061RR of
CME, the Board of Trade of the City of Chicago Inc. and the New York
Mercantile Exchange, available at: https://www.cmegroup.com/market-regulation/files/12-061rr.pdf.
\31\ See comment letter from Alessandro Cocco, Managing Director
of J.P. Morgan Clearing Corporation and J.P. Morgan Securities LLC,
to Ms. Elizabeth M. Murphy, Secretary, Securities and Exchange
Commission (January 30, 2012), available at https://www.sec.gov/comments/sr-occ-2011-19/occ201119-2.pdf.
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Impact of Clearing OTC Options on Other OCC-Cleared Products
Cleared OTC options will not be fungible with listed options.
However, an OTC option may have economic characteristics that are
substantially similar or identical to the characteristics of options in
series of listed options that OCC clears. While it is possible that in
any given instance a market participant may elect to enter into an OTC
option in lieu of an economically similar listed product, OCC does not
believe that its clearing of OTC options will adversely affect the
efficiency or liquidity of the listed markets. The OTC options markets
currently exist to accommodate a variety of commercial and other needs
of market participants, including the ability to customize the terms of
transactions. While the availability of an OCC guarantee for OTC
transactions in which the parties would otherwise be exposed to each
others' creditworthiness may cause transactions that currently occur in
the non-cleared OTC markets to migrate to the cleared-OTC markets, OCC
does not believe it will cause significant migration from the listed
markets to the cleared OTC markets. The limitation of the OTC options
markets to ECPs as well as the significant minimum transaction size and
tenor requirements that are applicable to certain transactions in the
currently proposed OTC options under the S&P License Agreement will
limit the use of cleared OTC options and should help to ensure that
there is no substantial migration from the listed markets to the OTC
markets for this product. The existing bilateral OTC options markets
have existed for years alongside the listed options markets, and OCC
believes that dealers in such bilateral options often use the listed
markets to hedge positions taken in such bilateral options and other
OTC derivatives.
Notice of Launch Date
Following approval of this rule change by the Commission, OCC
expects to provide notice to its clearing members of the date on which
it intends to implement this rule change and begin clearing OTC
options.
* * * * *
The proposed changes to OCC's By-Laws are consistent with the
purposes and requirements of Section 17A of the Exchange Act \32\
because they are designed to permit OCC to clear OTC options subject to
the same basic rules, procedures and risk management practices that
have been used successfully by OCC in clearing transactions in listed
options. OCC believes that clearance and settlement of OTC options
pursuant to this rule filing is fully consistent with OCC's obligations
with respect to the prompt and accurate clearance and settlement of
securities transactions and the protection of securities investors and
the public interest. The proposed rule change is not inconsistent with
any existing rule of OCC.
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\32\ 15 U.S.C. 78q-1.
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The proposals contained in the advance notice shall not take effect
until all regulatory actions required with respect to the proposals are
completed.
(B) Clearing Agency's Statement on Burden on Competition
OCC does not believe that the proposed changes contained in the
advance notice will have any impact or impose any burden on
competition.
(C) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants, or Others
Written comments were not and are not intended to be solicited with
respect to the advance notice, and, except as discussed below, none
have been received. OCC has been actively engaged with a number of
clearing members that have expressed an interest in clearing OTC
Options. The following are the only substantive written comments that
were received, and they have been addressed, in the manner indicated:
OCC received a written comment that the role of the
Default Management Advisory Committee, as described in the OTC Options
Auction procedures that were attached as Exhibit 5 to this rule filing,
should be clarified. OCC has revised the procedures to clarify that the
Default Management Advisory Committee will be a standing committee and
will be formed from the inception of OCC's clearing of OTC Options. It
will not be an ad hoc committee formed at the time of a default.
OCC received a written comment asking that the Membership/
Risk Committee have a role in setting exercise settlement values with
respect to OTC index options in unusual circumstances pursuant to
Section 4(a)(2) of Article XVII of the By-Laws. OCC has revised the
rules to provide that OCC will consult with that committee when
appropriate in setting exercise settlement values pursuant to Section
4(a)(2).
OCC received a written comment asking for limitations on
the indemnification of OCC by clearing members under Section 6(f) of
Article XVII of the By-Laws. In response to this comment OCC has added
an exclusion from the indemnity for claims, liabilities, or expenses
that result primarily from OCC's gross negligence or willful misconduct
or from OCC conduct that causes the offer or sale of the OTC Options to
become subject to the registration provisions of Section 5 of the
Securities Act.\33\
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\33\ 15 U.S.C. 77e.
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III. Date of Effectiveness of the Advance Notice and Timing for
Commission Action
The proposed changes contained in the advance notice may be
implemented pursuant to Section 806(e)(1)(G) of Clearing Supervision
Act \34\ if the Commission does not object to the proposed changes
within 60 days of the later of (i) the date that the advance notice was
filed with the Commission or (ii) the date that any additional
information requested by the Commission is received. The clearing
agency shall not implement the proposed changes contained in the
advance notice if the Commission objects to the proposed changes.
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\34\ 12 U.S.C. 5465.
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The Commission may extend the period for review by an additional 60
days if the proposed changes raise novel or complex issues, subject to
the Commission providing the clearing agency with prompt written notice
of the extension. Proposed changes may be implemented in fewer than 60
days from the date the advance notice is filed, or the date further
information requested by the Commission is received, if the Commission
notifies the clearing agency in writing that it does not object to the
proposed changes and
[[Page 59439]]
authorizes the clearing agency to implement the proposed changes on an
earlier date, subject to any conditions imposed by the Commission.
OCC has also filed the advance notice as a proposed rule change
pursuant to Section 19(b)(1) of the Act \35\ and Rule 19b-4
thereunder.\36\ Pursuant to those provisions, within 45 days of the
date of publication of this notice in the Federal Register or within
such longer period up to 90 days (i) as the Commission may designate if
it finds such longer period to be appropriate and publishes its reasons
for so finding or (ii) as to which the self-regulatory organization
consents, the Commission will:
(A) By order approve or disapprove the proposed rule change or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
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\35\ 15 U.S.C. 78s(b)(1).
\36\ 17 CFR 240.19b-4.
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The clearing agency shall post notice on its Web site of proposed
changes that are implemented.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. 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 email to rule-comments@sec.gov. Please include
File Number SR-OCC-2012-14 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-OCC-2012-14. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (https://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the advance notice that are filed
with the Commission, and all written communications relating to the
advance notice 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 Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street NE. Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Copies of such filings 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/components/docs/legal/rules_and_bylaws/sr_occ_12_14.pdf. 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-
2012-14 and should be submitted on or before October 18, 2012.
By the Commission.
Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2012-23816 Filed 9-26-12; 8:45 am]
BILLING CODE 8011-01-P
