Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning Modifications To Back Testing Procedures in Order To Enhance Monitoring of Margin Coverage and Model Risk Exposure, 73673-73676 [2014-29002]

Download as PDF Federal Register / Vol. 79, No. 238 / Thursday, December 11, 2014 / Notices month period beginning June 1, 2014, and ending November 30, 2014. This filing does not propose any substantive changes to the Penny Pilot Program: All classes currently participating will remain the same and all minimum increments will remain unchanged. The Exchange believes the benefits to public customers and other market participants who will be able to express their true prices to buy and sell options have been demonstrated to outweigh the increase in quote traffic. 2. Statutory Basis The basis under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’) for this proposed rule change is found in Section 6(b)(5), in that the proposed rule change is designed to promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system and, in general, to protect investors and the public interest. In particular, the proposed rule change, which extends the Penny Pilot Program for an additional six months, will enable public customers and other market participants to express their true prices to buy and sell options for the benefit of all market participants. mstockstill on DSK4VPTVN1PROD with NOTICES B. Self-Regulatory Organization’s Statement on Burden on Competition This proposed rule change does not impose any burden on competition. Specifically, the Exchange believes that, by extending the expiration of the Penny Pilot Program, the proposed rule change will allow for further analysis of the Penny Pilot Program and a determination of how the Penny Pilot Program should be structured in the future. In doing so, the proposed rule change will also serve to promote regulatory clarity and consistency, thereby reducing burdens on the marketplace and facilitating investor protection. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others The Exchange has not solicited, and does not intend to solicit, comments on this proposed rule change. The Exchange has not received any written comments from members or other interested parties. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Because the foregoing proposed rule change does not significantly affect the protection of investors or the public VerDate Sep<11>2014 19:07 Dec 10, 2014 Jkt 235001 interest, does not impose any significant burden on competition, and, by its terms, does not become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate, it has become effective pursuant to Section 19(b)(3)(A) of the Act 4 and Rule 19b– 4(f)(6) thereunder.5 The Exchange provided the Commission with written notice of its intent to file the proposed rule change, along with a brief description and text of the proposed rule change, at least five business days prior to the date of filing the proposed rule change as required by Rule 19b– 4(f)(6). At any time within 60 days of the filing of such proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act. If the Commission takes such action, the Commission shall institute proceedings to determine whether the proposed rule should be approved or disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Exchange Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form https://www.sec.gov/ rules/sro.shtml); or • Send an Email to rule-comments@ sec.gov. Please include File No. SR–ISE– 2014–55 on the subject line. Paper Comments • Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–ISE–2014–55. 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 Commissions Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for 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 10:00am and 3:00pm. Copies of such filing also will be available for inspection and copying at the principal office of the ISE. 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–ISE– 2014–55 and should be submitted by January 2, 2015. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.6 Brent J. Fields, Secretary. [FR Doc. 2014–29012 Filed 12–10–14; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–73749; File No. SR–OCC– 2014–810] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning Modifications To Back Testing Procedures in Order To Enhance Monitoring of Margin Coverage and Model Risk Exposure December 5, 2014. Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act entitled the Payment, Clearing, and Settlement Supervision Act of 2010 1 (‘‘Payment, Clearing and Settlement Supervision Act’’) and Rule 19b– 4(n)(1)(i) under the Securities Exchange Act of 1934 2 notice is hereby given that on November 13, 2014, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the advance notice as described in Items I and II below, which Items have been 6 17 CFR 200.30–3(a)(12). U.S.C. 5465(e)(1). 2 17 CFR 240.19b–4(n)(1)(i). 4 15 U.S.C. 78s(b)(3)(A). 5 17 CFR 240.19b–4(f)(6). PO 00000 Frm 00132 Fmt 4703 1 12 Sfmt 4703 73673 E:\FR\FM\11DEN1.SGM 11DEN1 73674 Federal Register / Vol. 79, No. 238 / Thursday, December 11, 2014 / Notices prepared by OCC.3 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 This advance notice is filed by OCC in connection with a proposed change to its operations (the ‘‘Change’’) in the form of modifications to its back testing procedures in order to enhance its monitoring of margin coverage and model risk exposure. 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) and (B) below, of the most significant aspects of these statements. (A) Clearing Agency’s Statement on Comments on the Advance Notice Received From Members, Participants or Others Written comments on the advance notice were not and are not intended to be solicited with respect to the advance notice and none have been received. mstockstill on DSK4VPTVN1PROD with NOTICES (B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, Clearing and Settlement Supervision Act Description of Change The proposed Change would modify OCC’s back testing procedures in order to enhance its monitoring of margin coverage and model risk exposure. Such monitoring would allow OCC to identify and make improvements to its margin methodology and enhance OCC’s ability to manage risk. OCC has implemented back testing procedures in order to test its methodology for determining the amount of margin to collect from clearing members and validate the assumptions and mechanisms inherent in its methodology and to make any necessary changes to the methodology. Each trading day, OCC estimates the risk on accounts and uses this estimate as a basis for each account’s margin charge. 3 OCC initially filed a similar advance notice on October 31, 2014, as File No. SR–OCC–2014–808. However to correct certain errors in that filing relating to two backtesting program tests, OCC withdrew it and made a new filing (File No. SR– OCC–2014–810) on November 13, 2014. VerDate Sep<11>2014 19:57 Dec 10, 2014 Jkt 235001 On the following business day, OCC’s back tests compare an account’s observed profit and loss (‘‘P&L’’) with the prior day’s estimated risk using a variety of analytical and statistical tools. These daily tests measure the performance of the account’s risk measures, and therefore, also measure the performance of OCC’s underlying methodology for calculating these measures. OCC’s back testing program enables OCC to assess performance of its margining systems and determine whether financial risks are adequately or inadequately captured by the quantitative models in use. Currently, OCC employs the ‘‘traffic light’’ test published by the Basel Committee on Banking Supervision in 1996 (the ‘‘Traffic Light Test’’).4 In conducting the Traffic Light Test, OCC determines the actual number of instances in which the realized loss on an account exceeded the margin, known as an ‘‘exceedance,’’ over an observation period of one year. The number of exceedances during the observation period is compared against the number of expected exceedances that are independent and identically distributed over time. OCC will employ an enhanced version of the Traffic Light Test that takes into account the dependency of exceedances between accounts. OCC has conducted daily back testing of margin accounts since 2006. OCC’s staff analyzes the exceedances and makes monthly reports to OCC’s Enterprise Risk Management Committee (‘‘ERMC’’).5 The reports to the ERMC include pertinent conclusions based on results from the full set of back tests. When back testing reveals the potential opportunity for remediation of OCC’s margin methodology, OCC undertakes a root cause analysis to determine the cause of any issues. Any significant failures of OCC’s methodology lead to OCC undertaking a model improvement project designed to correct the problems. OCC has analyzed its back testing program and identified several enhancements to the program. The following section details the nature of the proposed enhancements.6 4 See, ‘‘Supervisory Framework for the Use of ‘Backtesting’ in Conjunction with Internal Model Approach to Market Risk Capital Requirement.’’ Located at https://www.bis.org/publ/bcbs22.htm. 5 The Enterprise Risk Management Committee is chaired by the Chief Risk Officer, and consists of the Executive Chairman, Chief Operations Officer, General Counsel, Chief Information Officer, Chief Audit Executive, the Chief Compliance Officer and other members as determined by the Chair. 6 The relevant systems changes are scheduled to be installed on December 5, 2014. PO 00000 Frm 00133 Fmt 4703 Sfmt 4703 1. Proposed Enhancement of and Increase in Statistical Tests The proposed changes would enhance existing statistical tests and add three new statistical tests. The first proposed change to OCC’s back testing program is that OCC proposes to enhance the Traffic Light Test so that it may be applied to exceedances across all of OCC’s margin accounts. Given that exceedances are not independent across margin accounts, OCC will enhance this test so that it will produce a single numerical output that measures aggregation across margin accounts. In addition to the enhanced Traffic Light Test, OCC will implement other industry standard tests based on exceedances in order to provide a more comprehensive set of tests. The second proposed change to OCC’s back testing program is that OCC will add the Kupiec Test,7 which is a new proportion of failures test that compares the actual number of exceedances with the number that would be expected in light of the confidence level associated with the calculation of margin. For example, when calculating margin with a confidence level of 99%, the number of exceedances is expected to be 1% of the total observations, i.e., the P&Ls for all accounts for all days during the measurement period. If the actual number of exceedances is near the expected number, this is an indication that the calculated margin requirements are accurate estimates of the accounts’ estimated losses. The third proposed change to OCC’s back testing program is that OCC will add the Christoffersen Independence Test,8 which is a new statistical test that measures the extent to which exceedances are independent of each other. Specifically, if OCC’s margin models are correctly assessing risk, the probability of an exceedance occurring at any two points in time should be the same as the probability of an exceedance occurring at either point in time, individually, without the exceedance occurring at the other point in time. The fourth proposed change to OCC’s back testing program is a new test, the Probtile test, that compares the distribution of the daily observed P&L to the daily forecasted P&L distribution. If the distribution of P&L movement ratios approximates a uniform random distribution, this is an indication that 7 See, Kupiec, P. ‘‘Techniques for Verifying the Accuracy of Risk Management Models,’’ Journal of Derivatives, v3, P73–84. (1995). 8 See, Christoffersen, Peter, ‘‘Evaluating Interval Forecasts.’’ International Economic Review, 39 (4), 841–862. (1998). Economic Review, 39 (4), 841–862. (1998). E:\FR\FM\11DEN1.SGM 11DEN1 Federal Register / Vol. 79, No. 238 / Thursday, December 11, 2014 / Notices OCC’s margin models are providing accurate forecasts of potential losses in an account. Combined, these new statistical tests will provide OCC with the pertinent information necessary to evaluate the effectiveness of its models in determining margin coverage. mstockstill on DSK4VPTVN1PROD with NOTICES 2. Proposed Data Set Changes OCC proposes to enhance the data sets being back tested to allow for testing against various assumed portfolio and market data scenarios, in addition to the performance of actual portfolios against actual, current market conditions. First, OCC would back test hypothetical portfolios, allowing for the design and monitoring of portfolios that have magnified sensitivities to particular aspects of the models used in the margin computations. Back testing against hypothetical portfolios would provide a more comprehensive insight into the adequacy of the underlying model assumptions under market conditions prevailing in the back test observation periods. Under the second data set enhancement, OCC would back test current accounts against earlier observation periods. Currently, accounts are ‘‘frozen’’ by assuming that the time to maturity and the degree to which options are in-the-money or out-of-themoney remain constant during the chosen observation period. The market data observed over the observation period is used to generate the margin forecasts and P&L. Under the enhancement, observation periods would be chosen to reflect special market conditions, which is useful because even though margin coverage might be adequate in the current environment, margin coverage could be inadequate under stressed conditions, such as periods of high volatility. The ability to select specific observation periods would not limit the back testing to the current environments but rather would highlight performance of margin coverage and model performance in market scenarios other than prevailing market conditions. 3. Proposed Forecast Horizons Changes Currently, OCC conducts back testing using a one-day time horizon, which means that it compares calculated margin with realized profit and losses that occur on the business day following the calculation. OCC’s margin calculations assume that positions would be liquidated over a two-day period. This test, therefore, compares two-day margin numbers to a one-day profit and loss calculation. OCC’s existing back testing methodology makes adjustments in its testing to VerDate Sep<11>2014 19:07 Dec 10, 2014 Jkt 235001 account for the difference between the two-day liquidation period used in its margin calculation and the one-day horizon used in the profit and loss calculation. OCC intends to revise its back testing methodology to take into account losses over a two-day time horizon, without such adjustments, which would match the two-day liquidation period used in the margin calculation. OCC therefore proposes to implement functionality into its back testing system to conduct a two-day time horizon back test, which will compare calculated margin against a two-day profit and loss calculation. OCC also proposes to revise its back testing methodology to compare one-day margin calculations against one-day profit and loss calculations, and will implement system functionality for such a test. Issues identified in any of these back tests will be reported to the ERMC. OCC believes that its adoption of the additional forecast horizons tests will allow it to have a more accurate view of the sufficiency of its margin methodology. 4. Proposed Root Cause Analysis Changes The proposed Change will improve OCC’s ability to conduct root cause analyses by providing OCC’s back testing staff with additional, automated, investigation tools. Currently, and when necessary, OCC’s back test staff conducts investigations in order to identify the root cause exceedances. The investigation itself is a manual process that is dependent upon the facts and circumstances pertaining to a given exceedance. OCC is now proposing to make system modifications that will provide OCC’s back testing staff with addition tools that will facilitate such investigations. Specifically, OCC proposes to add system functionality that will show attribution of losses due to underlying price movements and implied volatility movements. Further, under the improvements OCC would be able to incorporate hypothetical accounts and positions into the tests and would be able to identify risk factors that move above or below the projected values. These changes will improve OCC’s ability to conduct investigations that identify the root cause of exceedances, which will in turn lead to improving OCC’s back testing methodology and its margin coverage. Anticipated Effect on and Management of Risk OCC believes the proposed Change to its back testing procedures would reduce the level of risk presented by PO 00000 Frm 00134 Fmt 4703 Sfmt 4703 73675 OCC because it would enhance OCC’s back testing by providing it with more tools to identify gaps in its margin methodology and develop corrective changes thereto.9 For example, enhanced and increased statistical testing would provide additional information about the adequacy of margin coverage and thus strengthen the assessment of margin and model performance. Changes to data sets would include hypothetical portfolios and earlier observation periods would allow testing of margin coverage under a greater variety of market conditions. Modifying the tests to take into account losses over a two-day period would increase the accuracy of the testing because this two-period matches the assumed liquidation period used in the margin calculations. OCC would also be able to more accurately determine the root cause of exceedances, while rejecting results that incorrectly suggest a needed improvement in its margin methodology, and then would be able to narrowly tailor solutions to the identified root causes. Ultimately, by allowing OCC to more readily and precisely identify gaps in its margin methodology, the Change will reduce risk to OCC and the markets that it serves. Consistency With the Payment, Clearing and Settlement Supervision Act The Change is consistent with Section 805(b)(1) of Payment, Clearing and Settlement Supervision Act because it promotes robust risk management.10 OCC’s receipt of margin from its clearing members protects OCC and market participants from risks presented by the markets OCC serves. OCC uses back testing in order to evaluate the sufficiency and adequacy of the amount of margin it collects from its clearing members. As described above, the Change will provide OCC will [sic] additional tools to identify gaps in its margin methodology. Such identification process will lead to improvements to OCC margin models thereby promoting robust risk management. III. Date of Effectiveness of the Advance Notice and Timing for Commission Action The proposed change may be implemented if the Commission does not object to the proposed change within 60 days of the later of (i) the date that the Commission receives the notice 9 Depending on the nature of a proposed change, it may be necessary for OCC to file a proposed rule change filing or advance notice filing with the Commission. 10 12 U.S.C. 5465(b)(1). E:\FR\FM\11DEN1.SGM 11DEN1 73676 Federal Register / Vol. 79, No. 238 / Thursday, December 11, 2014 / Notices of proposed change, or (ii) the date the Commission receives any further information it requests for consideration of the notice. The clearing agency shall not implement the proposed change if the Commission has any objection to the proposed change. The Commission may extend the period for review by an additional 60 days if the proposed change raises novel or complex issues, subject to the Commission providing the clearing agency with prompt written notice of the extension. A proposed change may be implemented in less than 60 days from the date the advance noticed 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 change and authorizes the clearing agency to implement the proposed change on an earlier date, subject to any conditions imposed by the Commission. 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, including whether the proposed change, is consistent with the Payment, Clearing and Settlement Supervision Act. Comments may be submitted by any of the following methods: mstockstill on DSK4VPTVN1PROD with NOTICES 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–2014–810 on the subject line. Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–OCC–2014–810. 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 VerDate Sep<11>2014 19:07 Dec 10, 2014 Jkt 235001 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 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of OCC and on OCC’s Web site https://www.theocc.com/components/ docs/legal/rules_and_bylaws/sr_occ_14_ 810.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–2014–810 and should be submitted on or before January 2, 2015. By the Commission. Kevin M. O’Neill, Deputy Secretary. [FR Doc. 2014–29002 Filed 12–10–14; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–73759; File No. SR–EDGA– 2014–30] Self-Regulatory Organizations; EDGA Exchange, Inc.; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change To Amend the EdgeBook Cloud Service on EDGA Exchange, Inc. December 5, 2014. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on November 25, 2014, EDGA Exchange, Inc. (the ‘‘Exchange’’ or ‘‘EDGA’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. The Exchange has designated this proposal as a ‘‘noncontroversial’’ proposed rule change pursuant to Section 19(b)(3)(A) of the Act 3 and Rule 19b–4(f)(6)(iii) thereunder,4 which renders it effective upon filing with the Commission. The Commission is publishing this notice to 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 15 U.S.C. 78s(b)(3)(A). 4 17 CFR 240.19b–4(f)(6)(iii). PO 00000 Frm 00135 Fmt 4703 Sfmt 4703 solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange filed a proposal to eliminate references to and fees for the Flex Download and Snapshot offerings available as part of the Exchange’s EdgeBook Cloud service, which are optional services that are to be discontinued by the Exchange. The Exchange will continue to offer the Replay portion of the EdgeBook Cloud service, but proposes to rename it EDGA Historical Depth Data as well as amend its related fees. The text of the proposed rule change is available at the Exchange’s Web site at https://www.directedge.com/, at the principal office of the Exchange, 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 parts of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The EdgeBook Cloud is a service that allows Members and non-Members of the Exchange to obtain and query historical trade and quote data (‘‘historical data’’) representing the realtime data feed previously disseminated by the Exchange.5 The EdgeBook Cloud currently includes the three separate offerings: Replay, FlexDownload, and Snapshot. The Exchange proposes to eliminate references to and fees for the Flex Download and Snapshot offerings available as part of the Exchange’s EdgeBook Cloud service, which are optional services that are to be discontinued by the Exchange. The 5 See Securities Exchange Act Release No. 66403 (February 15, 2012), 77 FR 10593 (February 22, 2012) (SR–EDGA–2012–05) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to an Offering of a New Historical Data Feed Service to Members and Non-Members). E:\FR\FM\11DEN1.SGM 11DEN1

Agencies

[Federal Register Volume 79, Number 238 (Thursday, December 11, 2014)]
[Notices]
[Pages 73673-73676]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-29002]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73749; File No. SR-OCC-2014-810]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Advance Notice Concerning Modifications To Back 
Testing Procedures in Order To Enhance Monitoring of Margin Coverage 
and Model Risk Exposure

December 5, 2014.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 \1\ (``Payment, 
Clearing and Settlement Supervision Act'') and Rule 19b-4(n)(1)(i) 
under the Securities Exchange Act of 1934 \2\ notice is hereby given 
that on November 13, 2014, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
advance notice as described in Items I and II below, which Items have 
been

[[Page 73674]]

prepared by OCC.\3\ The Commission is publishing this notice to solicit 
comments on the advance notice from interested persons.
---------------------------------------------------------------------------

    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ OCC initially filed a similar advance notice on October 31, 
2014, as File No. SR-OCC-2014-808. However to correct certain errors 
in that filing relating to two backtesting program tests, OCC 
withdrew it and made a new filing (File No. SR-OCC-2014-810) on 
November 13, 2014.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This advance notice is filed by OCC in connection with a proposed 
change to its operations (the ``Change'') in the form of modifications 
to its back testing procedures in order to enhance its monitoring of 
margin coverage and model risk exposure.

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) and (B) 
below, of the most significant aspects of these statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants or Others

    Written comments on the advance notice were not and are not 
intended to be solicited with respect to the advance notice and none 
have been received.

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, 
Clearing and Settlement Supervision Act

Description of Change
    The proposed Change would modify OCC's back testing procedures in 
order to enhance its monitoring of margin coverage and model risk 
exposure. Such monitoring would allow OCC to identify and make 
improvements to its margin methodology and enhance OCC's ability to 
manage risk.
    OCC has implemented back testing procedures in order to test its 
methodology for determining the amount of margin to collect from 
clearing members and validate the assumptions and mechanisms inherent 
in its methodology and to make any necessary changes to the 
methodology. Each trading day, OCC estimates the risk on accounts and 
uses this estimate as a basis for each account's margin charge. On the 
following business day, OCC's back tests compare an account's observed 
profit and loss (``P&L'') with the prior day's estimated risk using a 
variety of analytical and statistical tools. These daily tests measure 
the performance of the account's risk measures, and therefore, also 
measure the performance of OCC's underlying methodology for calculating 
these measures. OCC's back testing program enables OCC to assess 
performance of its margining systems and determine whether financial 
risks are adequately or inadequately captured by the quantitative 
models in use.
    Currently, OCC employs the ``traffic light'' test published by the 
Basel Committee on Banking Supervision in 1996 (the ``Traffic Light 
Test'').\4\ In conducting the Traffic Light Test, OCC determines the 
actual number of instances in which the realized loss on an account 
exceeded the margin, known as an ``exceedance,'' over an observation 
period of one year. The number of exceedances during the observation 
period is compared against the number of expected exceedances that are 
independent and identically distributed over time. OCC will employ an 
enhanced version of the Traffic Light Test that takes into account the 
dependency of exceedances between accounts.
---------------------------------------------------------------------------

    \4\ See, ``Supervisory Framework for the Use of `Backtesting' in 
Conjunction with Internal Model Approach to Market Risk Capital 
Requirement.'' Located at https://www.bis.org/publ/bcbs22.htm.
---------------------------------------------------------------------------

    OCC has conducted daily back testing of margin accounts since 2006. 
OCC's staff analyzes the exceedances and makes monthly reports to OCC's 
Enterprise Risk Management Committee (``ERMC'').\5\ The reports to the 
ERMC include pertinent conclusions based on results from the full set 
of back tests. When back testing reveals the potential opportunity for 
remediation of OCC's margin methodology, OCC undertakes a root cause 
analysis to determine the cause of any issues. Any significant failures 
of OCC's methodology lead to OCC undertaking a model improvement 
project designed to correct the problems.
---------------------------------------------------------------------------

    \5\ The Enterprise Risk Management Committee is chaired by the 
Chief Risk Officer, and consists of the Executive Chairman, Chief 
Operations Officer, General Counsel, Chief Information Officer, 
Chief Audit Executive, the Chief Compliance Officer and other 
members as determined by the Chair.
---------------------------------------------------------------------------

    OCC has analyzed its back testing program and identified several 
enhancements to the program. The following section details the nature 
of the proposed enhancements.\6\
---------------------------------------------------------------------------

    \6\ The relevant systems changes are scheduled to be installed 
on December 5, 2014.
---------------------------------------------------------------------------

1. Proposed Enhancement of and Increase in Statistical Tests
    The proposed changes would enhance existing statistical tests and 
add three new statistical tests. The first proposed change to OCC's 
back testing program is that OCC proposes to enhance the Traffic Light 
Test so that it may be applied to exceedances across all of OCC's 
margin accounts. Given that exceedances are not independent across 
margin accounts, OCC will enhance this test so that it will produce a 
single numerical output that measures aggregation across margin 
accounts.
    In addition to the enhanced Traffic Light Test, OCC will implement 
other industry standard tests based on exceedances in order to provide 
a more comprehensive set of tests. The second proposed change to OCC's 
back testing program is that OCC will add the Kupiec Test,\7\ which is 
a new proportion of failures test that compares the actual number of 
exceedances with the number that would be expected in light of the 
confidence level associated with the calculation of margin. For 
example, when calculating margin with a confidence level of 99%, the 
number of exceedances is expected to be 1% of the total observations, 
i.e., the P&Ls for all accounts for all days during the measurement 
period. If the actual number of exceedances is near the expected 
number, this is an indication that the calculated margin requirements 
are accurate estimates of the accounts' estimated losses.
---------------------------------------------------------------------------

    \7\ See, Kupiec, P. ``Techniques for Verifying the Accuracy of 
Risk Management Models,'' Journal of Derivatives, v3, P73-84. 
(1995).
---------------------------------------------------------------------------

    The third proposed change to OCC's back testing program is that OCC 
will add the Christoffersen Independence Test,\8\ which is a new 
statistical test that measures the extent to which exceedances are 
independent of each other. Specifically, if OCC's margin models are 
correctly assessing risk, the probability of an exceedance occurring at 
any two points in time should be the same as the probability of an 
exceedance occurring at either point in time, individually, without the 
exceedance occurring at the other point in time. The fourth proposed 
change to OCC's back testing program is a new test, the Probtile test, 
that compares the distribution of the daily observed P&L to the daily 
forecasted P&L distribution. If the distribution of P&L movement ratios 
approximates a uniform random distribution, this is an indication that

[[Page 73675]]

OCC's margin models are providing accurate forecasts of potential 
losses in an account. Combined, these new statistical tests will 
provide OCC with the pertinent information necessary to evaluate the 
effectiveness of its models in determining margin coverage.
---------------------------------------------------------------------------

    \8\ See, Christoffersen, Peter, ``Evaluating Interval 
Forecasts.'' International Economic Review, 39 (4), 841-862. (1998). 
Economic Review, 39 (4), 841-862. (1998).
---------------------------------------------------------------------------

2. Proposed Data Set Changes
    OCC proposes to enhance the data sets being back tested to allow 
for testing against various assumed portfolio and market data 
scenarios, in addition to the performance of actual portfolios against 
actual, current market conditions. First, OCC would back test 
hypothetical portfolios, allowing for the design and monitoring of 
portfolios that have magnified sensitivities to particular aspects of 
the models used in the margin computations. Back testing against 
hypothetical portfolios would provide a more comprehensive insight into 
the adequacy of the underlying model assumptions under market 
conditions prevailing in the back test observation periods.
    Under the second data set enhancement, OCC would back test current 
accounts against earlier observation periods. Currently, accounts are 
``frozen'' by assuming that the time to maturity and the degree to 
which options are in-the-money or out-of-the-money remain constant 
during the chosen observation period. The market data observed over the 
observation period is used to generate the margin forecasts and P&L. 
Under the enhancement, observation periods would be chosen to reflect 
special market conditions, which is useful because even though margin 
coverage might be adequate in the current environment, margin coverage 
could be inadequate under stressed conditions, such as periods of high 
volatility. The ability to select specific observation periods would 
not limit the back testing to the current environments but rather would 
highlight performance of margin coverage and model performance in 
market scenarios other than prevailing market conditions.
3. Proposed Forecast Horizons Changes
    Currently, OCC conducts back testing using a one-day time horizon, 
which means that it compares calculated margin with realized profit and 
losses that occur on the business day following the calculation. OCC's 
margin calculations assume that positions would be liquidated over a 
two-day period. This test, therefore, compares two-day margin numbers 
to a one-day profit and loss calculation. OCC's existing back testing 
methodology makes adjustments in its testing to account for the 
difference between the two-day liquidation period used in its margin 
calculation and the one-day horizon used in the profit and loss 
calculation. OCC intends to revise its back testing methodology to take 
into account losses over a two-day time horizon, without such 
adjustments, which would match the two-day liquidation period used in 
the margin calculation. OCC therefore proposes to implement 
functionality into its back testing system to conduct a two-day time 
horizon back test, which will compare calculated margin against a two-
day profit and loss calculation. OCC also proposes to revise its back 
testing methodology to compare one-day margin calculations against one-
day profit and loss calculations, and will implement system 
functionality for such a test. Issues identified in any of these back 
tests will be reported to the ERMC. OCC believes that its adoption of 
the additional forecast horizons tests will allow it to have a more 
accurate view of the sufficiency of its margin methodology.
4. Proposed Root Cause Analysis Changes
    The proposed Change will improve OCC's ability to conduct root 
cause analyses by providing OCC's back testing staff with additional, 
automated, investigation tools. Currently, and when necessary, OCC's 
back test staff conducts investigations in order to identify the root 
cause exceedances. The investigation itself is a manual process that is 
dependent upon the facts and circumstances pertaining to a given 
exceedance. OCC is now proposing to make system modifications that will 
provide OCC's back testing staff with addition tools that will 
facilitate such investigations. Specifically, OCC proposes to add 
system functionality that will show attribution of losses due to 
underlying price movements and implied volatility movements. Further, 
under the improvements OCC would be able to incorporate hypothetical 
accounts and positions into the tests and would be able to identify 
risk factors that move above or below the projected values. These 
changes will improve OCC's ability to conduct investigations that 
identify the root cause of exceedances, which will in turn lead to 
improving OCC's back testing methodology and its margin coverage.
Anticipated Effect on and Management of Risk
    OCC believes the proposed Change to its back testing procedures 
would reduce the level of risk presented by OCC because it would 
enhance OCC's back testing by providing it with more tools to identify 
gaps in its margin methodology and develop corrective changes 
thereto.\9\ For example, enhanced and increased statistical testing 
would provide additional information about the adequacy of margin 
coverage and thus strengthen the assessment of margin and model 
performance. Changes to data sets would include hypothetical portfolios 
and earlier observation periods would allow testing of margin coverage 
under a greater variety of market conditions. Modifying the tests to 
take into account losses over a two-day period would increase the 
accuracy of the testing because this two-period matches the assumed 
liquidation period used in the margin calculations. OCC would also be 
able to more accurately determine the root cause of exceedances, while 
rejecting results that incorrectly suggest a needed improvement in its 
margin methodology, and then would be able to narrowly tailor solutions 
to the identified root causes. Ultimately, by allowing OCC to more 
readily and precisely identify gaps in its margin methodology, the 
Change will reduce risk to OCC and the markets that it serves.
---------------------------------------------------------------------------

    \9\ Depending on the nature of a proposed change, it may be 
necessary for OCC to file a proposed rule change filing or advance 
notice filing with the Commission.
---------------------------------------------------------------------------

Consistency With the Payment, Clearing and Settlement Supervision Act
    The Change is consistent with Section 805(b)(1) of Payment, 
Clearing and Settlement Supervision Act because it promotes robust risk 
management.\10\ OCC's receipt of margin from its clearing members 
protects OCC and market participants from risks presented by the 
markets OCC serves. OCC uses back testing in order to evaluate the 
sufficiency and adequacy of the amount of margin it collects from its 
clearing members. As described above, the Change will provide OCC will 
[sic] additional tools to identify gaps in its margin methodology. Such 
identification process will lead to improvements to OCC margin models 
thereby promoting robust risk management.
---------------------------------------------------------------------------

    \10\ 12 U.S.C. 5465(b)(1).
---------------------------------------------------------------------------

III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date that the Commission receives the notice

[[Page 73676]]

of proposed change, or (ii) the date the Commission receives any 
further information it requests for consideration of the notice. The 
clearing agency shall not implement the proposed change if the 
Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance noticed 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 change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    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, including whether the proposed 
change, is consistent with the Payment, Clearing and Settlement 
Supervision Act. Comments may be submitted by any of the following 
methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-OCC-2014-810 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2014-810. 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 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of OCC and on OCC's Web site https://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_14_810.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-2014-810 
and should be submitted on or before January 2, 2015.

    By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-29002 Filed 12-10-14; 8:45 am]
BILLING CODE 8011-01-P
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