Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to an Advance Notice Concerning Modifications To Backtesting Procedures in Order To Enhance Monitoring of Margin Coverage and Model Risk Exposure, 37323-37326 [2015-15994]

Download as PDF asabaliauskas on DSK5VPTVN1PROD with NOTICES Federal Register / Vol. 80, No. 125 / Tuesday, June 30, 2015 / Notices The Exchange also believes that having the CFR serve in the advisory capacity of the Market Performance Committee and Regulatory Advisory Committee is consistent with and facilitates a governance and regulatory structure that furthers the objectives of Section 6(b)(5) of the Exchange Act. The Exchange believes that member participation on the proposed CFR would be sufficient to provide for the fair representation of members in the administration of the affairs of the Exchange, including rulemaking and the disciplinary process, consistent with Section 6(b)(3) of the Exchange Act. The Exchange believes that eliminating references to ‘‘Chief Executive Officer’’ of NYSE Regulation in Rules 48, 49 and 86 and replacing them with CRO, which is used throughout the Exchange’s rules, removes impediments to and perfects a national market system because it would reduce potential confusion that may result from retaining different designations for the same individual in the Exchange’s rulebook. Removing potentially confusing conflicting designations would also further the goal of transparency and add consistency to the Exchange’s rules. Finally, making conforming amendments to Rules 0, 1, 22, 36, 37, 46, 46A, 48, 49, 54, 70, 103, 103A, 103B, 104, 308, 422, 475, 476, 476A, 497 and 9310 in connection with creation of the proposed ROC and the CFR subcommittee and termination of the Delegation Agreement removes impediments to and perfects the mechanism of a free and open market by removing confusion that may result from having obsolete references in the Exchange’s rulebook. The Exchange further believes that the proposal removes impediments to and perfects the mechanism of a free and open market by ensuring that persons subject to the Exchange’s jurisdiction, regulators, and the investing public can more easily navigate and understand the Exchange’s rulebook. The Exchange believes that eliminating obsolete references would not be inconsistent with the public interest and the protection of investors because investors will not be harmed and in fact would benefit from increased transparency, thereby reducing potential confusion. Removing such obsolete references will also further the goal of transparency and add clarity to the Exchange’s rules. B. Self-Regulatory Organization’s Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not VerDate Sep<11>2014 17:34 Jun 29, 2015 Jkt 235001 necessary or appropriate in furtherance of the purposes of the Exchange Act. The proposed rule change is not intended to address competitive issues but rather is concerned solely with the administration and functioning of the Exchange’s board of directors. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were solicited or received with respect to the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or 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. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: 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– NYSE–2015–27 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–NYSE–2015–27. 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 proposed rule PO 00000 Frm 00105 Fmt 4703 Sfmt 4703 37323 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 10:00 a.m. and 3:00 p.m. Copies of the filing will also be available for inspection and copying at the NYSE’s principal office and on its Internet Web site at www.nyse.com. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NYSE– 2015–27 and should be submitted on or before July 21, 2015. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.57 Robert W. Errett, Deputy Secretary. [FR Doc. 2015–15984 Filed 6–29–15; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–75290; File No. SR–OCC– 2014–810] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to an Advance Notice Concerning Modifications To Backtesting Procedures in Order To Enhance Monitoring of Margin Coverage and Model Risk Exposure June 24, 2015. On November 13, 2014, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) advance notice SR–OCC–2014–810 (‘‘Advance Notice’’) pursuant to Section 806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of 2010 (‘‘Payment, Clearing and Settlement Supervision Act’’) 1 and Rule 19b–4(n)(1)(i) under 57 17 CFR 200.30–3(a)(12). U.S.C. 5465(e)(1). The Financial Stability Oversight Council designated OCC a systemically important financial market utility on July 18, 2012. See Financial Stability Oversight Council 2012 Annual Report, Appendix A, https:// www.treasury.gov/initiatives/fsoc/Documents/ 2012%20Annual%20Report.pdf. Therefore, OCC is 1 12 E:\FR\FM\30JNN1.SGM Continued 30JNN1 37324 Federal Register / Vol. 80, No. 125 / Tuesday, June 30, 2015 / Notices the Securities Exchange Act of 1934 (‘‘Exchange Act’’) to modify backtesting procedures to better identify and make improvements to its monitoring of its margin methodology and to enhance its ability to manage risk.2 The Advance Notice was published for comment in the Federal Register on December 11, 2014.3 On January 9, 2015, pursuant to section 806(e)(1)(D) of the Payment, Clearing and Settlement Supervision Act,4 the Commission required OCC to provide additional information concerning the Advance Notice.5 The Commission did not receive any comments on the Advance Notice. This publication serves as a notice of no objection to the Advance Notice. asabaliauskas on DSK5VPTVN1PROD with NOTICES I. Description of the Advance Notice As described in OCC’s Notice,6 the proposed change modifies OCC’s backtesting procedures to enhance its monitoring of margin coverage and model risk exposure. Such monitoring will allow OCC to better identify and make improvements to its margin methodology and thus enhance OCC’s ability to manage risk.7 OCC implements backtesting procedures 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 exposure of accounts and uses this estimate as a basis for each account’s margin charge. On the following business day, OCC’s current backtesting procedures 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 OCC’s risk measures for each account, and, therefore, also measure the performance of OCC’s underlying margin methodology. OCC’s required to comply with the Clearing Supervision Act and file advance notices with the Commission. See 12 U.S.C. 5465(e). 2 17 CFR 240.19b–4(n)(1)(i). 3 See Securities Exchange Act Release No. 73749 (December 5, 2014), 79 FR 73673 (December 11, 2014) (SR–OCC–2014–810) (‘‘Notice’’). 4 12 U.S.C. 5465(e)(1)(D). 5 The Commission received a response from OCC with the additional information for consideration on April 29, 2015, which, pursuant to Sections 806(e)(1)(E) and (G) of the Payment, Clearing and Settlement Supervision Act, initiated a new 60 day period of review. See 12 U.S.C. 5465(e)(1)(E) and 12 U.S.C. 5465(e)(1)(G). 6 See supra note 3. 7 If OCC determines that the results of these modified backtesting procedures require changes to its margin model, OCC may be required to file an advance notice to effect those changes. See id. VerDate Sep<11>2014 17:34 Jun 29, 2015 Jkt 235001 backtesting 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. OCC has conducted daily backtesting of margin accounts since 2006. OCC employs the ‘‘traffic light’’ test published by the Basel Committee on Banking Supervision in 1996 (the ‘‘Traffic Light Test’’).8 In conducting the Traffic Light Test, OCC determines the actual number of instances in which the realized loss on an account exceeded the margin, referred to 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 under the assumption that the exceedances are independent and identically distributed over time. When backtesting results reveal 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 shortcomings of OCC’s methodology lead to OCC undertaking a model improvement project designed to correct the problems. After analyzing the exceedances, OCC provides monthly reports to OCC’s Enterprise Risk Management Committee (‘‘ERMC’’), which include, among other things, pertinent conclusions based on results from the full set of backtests. OCC analyzed its backtesting program and identified several enhancements to the program, as discussed in more detail below: (1) Enhancement of and increase in the number of statistical tests, (2) data set changes, (3) forecast horizon changes, and (4) root cause analysis changes. 1. Enhancement of and Increase in the Number of Statistical Tests As proposed in the Notice, OCC will enhance an existing statistical test and add three new statistical tests. OCC proposed to enhance its existing 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 to address the dependency of exceedances between accounts. In addition to the enhanced Traffic Light Test, OCC will implement three other industry standard tests related to 8 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. PO 00000 Frm 00106 Fmt 4703 Sfmt 4703 exceedances in order to provide a more comprehensive set of tests. First, OCC will add the Kupiec Test,9 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 not inaccurate estimates of the accounts’ estimated losses. Second, OCC will add the Christoffersen Independence Test,10 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. Third, OCC will add the Probtile test, which compares the distribution of the daily observed P&L to the daily forecasted P&L distribution. If the distribution of these P&L ratios approximates a uniform random distribution, this is an indication that OCC’s margin models are not providing inaccurate forecasts of potential losses in an account. Combined, these new statistical tests will provide OCC with additional pertinent information to evaluate the effectiveness of its models in determining margin coverage. 2. Data Set Changes In addition to the changes to its backtesting program, as described above, OCC also will make two enhancements to the data sets being backtested 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 will backtest hypothetical portfolios, allowing for the design and monitoring of portfolios that have magnified sensitivities to particular aspects of the models used in the 9 See, Kupiec, P. ‘‘Techniques for Verifying the Accuracy of Risk Management Models,’’ Journal of Derivatives, v3, P73–84 (1995). 10 See, Christoffersen, Peter, ‘‘Evaluating Interval Forecasts.’’ International Economic Review, 39 (4), 841–862 (1998). E:\FR\FM\30JNN1.SGM 30JNN1 Federal Register / Vol. 80, No. 125 / Tuesday, June 30, 2015 / Notices margin computations. Backtesting against hypothetical portfolios will provide a more comprehensive insight into the adequacy of the underlying model assumptions under market conditions prevailing in the backtest observation periods. Under the second data set enhancement, OCC will backtest current accounts against earlier observation periods. The market data observed over the observation period is used to generate the margin forecasts and P&L and observation periods will be chosen to reflect special market conditions. OCC believes this enhancement should be 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 will not limit the backtesting to the current environments but rather will highlight performance of margin coverage and model performance in market scenarios other than prevailing market conditions. asabaliauskas on DSK5VPTVN1PROD with NOTICES 3. Forecast Horizons Changes Currently, OCC conducts backtesting using a one-day time horizon, which means that it compares calculated margin with realized P&Lthat occur on the business day following the calculation. However, OCC’s margin calculations assume that positions will be liquidated over a two-day period, resulting in the test comparing two-day margin numbers to a one-day P&L calculation. This difference requires OCC to make adjustments to its existing backtesting methodology 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 P&L calculation. Pursuant to the proposal, OCC will revise its backtesting methodology to take into account losses over a two-day time horizon, which will match the twoday liquidation period used in the margin calculation without such adjustments. OCC will implement the necessary functionality into its backtesting system to conduct a two-day time horizon backtest, which will compare calculated margin against a two-day P&L calculation. OCC also will revise its backtesting methodology to compare one-day margin calculations against one-day P&L calculations, and will implement system functionality for such a test. All issues identified in any of these backtesting results will be reported to the ERMC. OCC believes that its adoption of the additional forecast horizons tests will allow it to have a VerDate Sep<11>2014 17:34 Jun 29, 2015 Jkt 235001 more accurate view of the sufficiency of its margin methodology. 4. Root Cause Analysis Changes Currently, OCC’s backtesting staff conducts investigations, as necessary, in order to identify the root cause of exceedances. The investigation itself is a manual process that is dependent upon the facts and circumstances pertaining to a given exceedance. Pursuant to its proposal, OCC will now make system modifications that will provide OCC’s backtesting staff with additional tools to facilitate such investigations. Specifically, OCC will add system functionality that should reveal attribution of losses due to underlying price movements and implied volatility movements. Further, these improvements will allow OCC to incorporate hypothetical accounts and positions into the tests and will allow OCC to identify risk factors that move above or below the projected values. These changes should improve OCC’s ability to conduct investigations and root cause analyses that identify the root cause of exceedances by providing OCC with additional automated investigative tools which should, in turn, lead to improving OCC’s backtesting methodology and its margin coverage. II. Discussion and Commission Findings Although Title VIII does not specify a standard of review for an advance notice, the Commission believes that the stated purpose of Title VIII is instructive.11 The stated purpose of Title VIII is to mitigate systemic risk in the financial system and promote financial stability by, among other things, promoting uniform risk management standards for systemicallyimportant financial market utilities and strengthening the liquidity of systemically important financial market utilities.12 Section 805(a)(2) of the Payment, Clearing and Settlement Supervision Act 13 authorizes the Commission to prescribe risk management standards for the payment, clearing, and settlement activities of designated clearing entities and financial institutions engaged in designated activities for which it is the supervisory agency or the appropriate financial regulator. Section 805(b) of the Payment, Clearing and Settlement Supervision Act 14 states that the objectives and principles for the risk 11 See 12 U.S.C. 5461(b). 12 Id. 13 12 14 12 PO 00000 U.S.C. 5464(a)(2). U.S.C. 5464(b). Frm 00107 Fmt 4703 Sfmt 4703 37325 management standards prescribed under Section 805(a) shall be to: • Promote robust risk management; • promote safety and soundness; • reduce systemic risks; and • support the stability of the broader financial system. The Commission has adopted risk management standards under Section 805(a)(2) of the Payment, Clearing and Settlement Supervision Act (‘‘Clearing Agency Standards’’).15 The Clearing Agency Standards became effective on January 2, 2013, and require registered clearing agencies that perform central counterparty (‘‘CCP’’) services to establish, implement, maintain, and enforce written policies and procedures that are reasonably designed to meet certain minimum requirements for their operations and risk management practices on an ongoing basis.16 As such, it is appropriate for the Commission to review advance notices against these Clearing Agency Standards, and the objectives and principles of these risk management standards as described in Section 805(b) of the Payment, Clearing and Settlement Supervision Act.17 The Commission believes that the proposal in this Advance Notice is designed to further the objectives and principles of Section 805(b) of the Payment, Clearing and Settlement Supervision Act.18 The Commission believes that the additional backtesting improvements should promote robust risk management by providing OCC with additional tools to test the performance of its margin methodology in a more comprehensive manner and better evaluate the effectiveness of its models in determining model coverage. First, the enhancement to OCC’s existing Traffic Light Test and the adoption of the three new statistical tests should provide a more comprehensive set of tests for it to use to evaluate its margin models. Second, the enhancement of the data sets to be backtested should provide OCC with additional informative data on the performance of margin coverage and model performance in market scenarios other than prevailing market conditions. 15 17 CFR 240.17Ad–22. Clearing Agency Standards are substantially similar to the risk management standards established by the Board of Governors of the Federal Reserve System governing the operations of designated financial market utilities that are not clearing entities and financial institutions engaged in designated activities for which the Commission or the Commodity Futures Trading Commission is the Supervisory Agency. See Financial Market Utilities, 77 FR 45907 (August 2, 2012). 17 12 U.S.C. 5464(b). 18 12 U.S.C. 5464(b). 16 The E:\FR\FM\30JNN1.SGM 30JNN1 37326 Federal Register / Vol. 80, No. 125 / Tuesday, June 30, 2015 / Notices Third, revising the backtesting methodology to take into account losses over a two-day time horizon, should allow OCC to have a more accurate view of the sufficiency of its margin methodology. Finally, system modifications that should reveal attribution of losses due to underlying price movements and implied volatility movements should provide OCC with additional, automated investigative tools to conduct analysis into the root causes of exceedances. In addition, the Commission believes that the proposal in this Advance Notice is consistent with Clearing Agency Standards, in particular, Rule 17Ad– 22(b)(4) under the Exchange Act,19 which, in relevant part, requires registered clearing agencies that perform central counterparty services establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for an annual model validation consisting of evaluating the performance of the clearing agency’s margin models and the related parameters and assumptions associated with such models. The Commission believes that this proposal is consistent with Exchange Act Rule 17Ad–22(b)(4) 20 because it provides OCC with the ability to employ improved statistical tests to better evaluate the performance of its margin models and thus improving its ability to validate such models. III. Conclusion It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Payment, Clearing and Settlement Supervision Act,21 that the Commission does not object to advance notice proposal (SR– OCC–2014–810) and that OCC is authorized to implement the proposal. By the Commission. Robert W. Errett, Deputy Secretary. [FR Doc. 2015–15994 Filed 6–29–15; 8:45 am] asabaliauskas on DSK5VPTVN1PROD with NOTICES BILLING CODE 8011–01–P 19 17 [File No. 500–1] In the Matter of Aspire Japan, Inc., Market & Research Corp. (n/k/a MRC Group Ltd.), McIntosh Bancshares Inc., Pure Minerals, Inc. (f/k/a Pure Pharmaceuticals Corp.) and Salamon Group, Inc.; Order of Suspension of Trading June 26, 2015. It appears to the Securities and Exchange Commission that there is a lack of current and accurate information concerning the securities of Aspire Japan, Inc. (CIK No. 1317838) (‘‘ASJP’’ 1), a void Delaware corporation with its principal place of business in Los Angeles, California, with stock quoted on OTC Link (previously, ‘‘Pink Sheets’’) operated by OTC Markets Group Inc. (‘‘OTC Link’’) because it has not filed any periodic reports since the period ended April 30, 2011. On June 26, 2013, the Division of Corporation Finance (‘‘Corporation Finance’’) sent a delinquency letter to ASJP requesting compliance with its periodic reporting obligations at the address shown in its then-most recent filing with the Commission, but ASJP did not receive the delinquency letter due to its failure to maintain a valid address on file with the Commission as required by Commission rules (Rule 301 of Regulation S–T, 17 CFR 232.301 and Section 5.4 of the EDGAR Filer Manual). It appears to the Securities and Exchange Commission that there is a lack of current and accurate information concerning the securities of Market & Research Corp. (n/k/a MRC Group Ltd. (CIK No.) 1009830) (‘‘MTRE’’), a void Delaware corporation with its principal place of business in Westport, Connecticut, with stock quoted on OTC Link, because it has not filed any periodic reports since the period ended June 30, 2010. On April 29, 2013, Corporation Finance sent a delinquency letter to MTRE requesting compliance with its periodic reporting obligations at the address shown in its then-most recent filing with the Commission, but MTRE did not receive the delinquency letter due to its failure to maintain a valid address on file with the Commission as required by Commission rules (Rule 301 of Regulation S–T, 17 CFR 232.301 and Section 5.4 of the EDGAR Filer Manual). It appears to the Securities and Exchange Commission that there is a lack of current and accurate information CFR 240.17Ad–22(b)(3). 20 Id. 21 12 SECURITIES AND EXCHANGE COMMISSION 1 The short form of each issuer’s name is also its ticker symbol. U.S.C. 5465(e)(1)(I). VerDate Sep<11>2014 17:34 Jun 29, 2015 Jkt 235001 PO 00000 Frm 00108 Fmt 4703 Sfmt 4703 concerning the securities of McIntosh Bancshares Inc. (CIK No. 872545) (‘‘MITB’’), a Georgia corporation with its principal place of business in Jackson, Georgia, with stock quoted on OTC Link, because it has not filed any periodic reports since the period ended September 30, 2010. On April 29, 2013, Corporation Finance sent a delinquency letter to MITB requesting compliance with its periodic reporting obligations at the address shown in its then-most recent filing with the Commission, but MITB did not receive the delinquency letter due to its failure to maintain a valid address on file with the Commission as required by Commission rules (Rule 301 of Regulation S–T, 17 CFR 232.301 and Section 5.4 of the EDGAR Filer Manual). It appears to the Securities and Exchange Commission that there is a lack of current and accurate information concerning the securities of Pure Minerals, Inc. (f/k/a Pure Pharmaceuticals Corp.) (CIK No. 1364326) (‘‘PPMA’’), a revoked Nevada corporation with its principal place of business in Montreal, Quebec, Canada, with stock quoted on OTC Link, because it has not filed any periodic reports since the period ended December 31, 2010. On June 25, 2013, Corporation Finance sent a delinquency letter to PPMA requesting compliance with its periodic reporting obligations at the address shown in its then-most recent filing with the Commission which was delivered. It appears to the Securities and Exchange Commission that there is a lack of current and accurate information concerning the securities of Salamon Group, Inc. (CIK No. 1274211) (‘‘SLMU’’), a revoked Nevada corporation with its principal place of business in Kelowna, British Columbia, with stock quoted on OTC Link because it has not filed any periodic reports since the period ended June 30, 2012. On September 16, 2014, Corporation Finance sent a delinquency letter to SLMU requesting compliance with its periodic reporting obligations at the address shown in its then-most recent filing with the Commission, but SLMU did not receive the delinquency letter due to its failure to maintain a valid address on file with the Commission as required by Commission rules (Rule 301 of Regulation S–T, 17 CFR 232.301 and Section 5.4 of the EDGAR Filer Manual). The Commission is of the opinion that the public interest and the protection of investors require a suspension of trading in the securities of the above-listed companies. Therefore, it is ordered, pursuant to Section 12(k) of the Securities Exchange Act of 1934, that E:\FR\FM\30JNN1.SGM 30JNN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 80, Number 125 (Tuesday, June 30, 2015)]
[Notices]
[Pages 37323-37326]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-15994]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-75290; File No. SR-OCC-2014-810]

Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection to an Advance Notice Concerning Modifications To
Backtesting Procedures in Order To Enhance Monitoring of Margin
Coverage and Model Risk Exposure

June 24, 2015.
On November 13, 2014, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-OCC-2014-810 (``Advance Notice'') pursuant to Section
806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of
2010 (``Payment, Clearing and Settlement Supervision Act'') \1\ and
Rule 19b-4(n)(1)(i) under

[[Page 37324]]

the Securities Exchange Act of 1934 (``Exchange Act'') to modify
backtesting procedures to better identify and make improvements to its
monitoring of its margin methodology and to enhance its ability to
manage risk.\2\ The Advance Notice was published for comment in the
Federal Register on December 11, 2014.\3\ On January 9, 2015, pursuant
to section 806(e)(1)(D) of the Payment, Clearing and Settlement
Supervision Act,\4\ the Commission required OCC to provide additional
information concerning the Advance Notice.\5\ The Commission did not
receive any comments on the Advance Notice. This publication serves as
a notice of no objection to the Advance Notice.
---------------------------------------------------------------------------

\1\ 12 U.S.C. 5465(e)(1). The Financial Stability Oversight
Council designated OCC a systemically important financial market
utility on July 18, 2012. See Financial Stability Oversight Council
2012 Annual Report, Appendix A, https://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. Therefore, OCC is
required to comply with the Clearing Supervision Act and file
advance notices with the Commission. See 12 U.S.C. 5465(e).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ See Securities Exchange Act Release No. 73749 (December 5,
2014), 79 FR 73673 (December 11, 2014) (SR-OCC-2014-810)
(``Notice'').
\4\ 12 U.S.C. 5465(e)(1)(D).
\5\ The Commission received a response from OCC with the
additional information for consideration on April 29, 2015, which,
pursuant to Sections 806(e)(1)(E) and (G) of the Payment, Clearing
and Settlement Supervision Act, initiated a new 60 day period of
review. See 12 U.S.C. 5465(e)(1)(E) and 12 U.S.C. 5465(e)(1)(G).
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I. Description of the Advance Notice

As described in OCC's Notice,\6\ the proposed change modifies OCC's
backtesting procedures to enhance its monitoring of margin coverage and
model risk exposure. Such monitoring will allow OCC to better identify
and make improvements to its margin methodology and thus enhance OCC's
ability to manage risk.\7\
---------------------------------------------------------------------------

\6\ See supra note 3.
\7\ If OCC determines that the results of these modified
backtesting procedures require changes to its margin model, OCC may
be required to file an advance notice to effect those changes. See
id.
---------------------------------------------------------------------------

OCC implements backtesting procedures 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 exposure of accounts and uses this estimate as a
basis for each account's margin charge. On the following business day,
OCC's current backtesting procedures 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 OCC's risk measures for each account, and,
therefore, also measure the performance of OCC's underlying margin
methodology. OCC's backtesting 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.
OCC has conducted daily backtesting of margin accounts since 2006.
OCC employs the ``traffic light'' test published by the Basel Committee
on Banking Supervision in 1996 (the ``Traffic Light Test'').\8\ In
conducting the Traffic Light Test, OCC determines the actual number of
instances in which the realized loss on an account exceeded the margin,
referred to 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 under the
assumption that the exceedances are independent and identically
distributed over time. When backtesting results reveal 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 shortcomings of OCC's methodology lead to OCC undertaking a
model improvement project designed to correct the problems. After
analyzing the exceedances, OCC provides monthly reports to OCC's
Enterprise Risk Management Committee (``ERMC''), which include, among
other things, pertinent conclusions based on results from the full set
of backtests.
---------------------------------------------------------------------------

\8\ 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 analyzed its backtesting program and identified several
enhancements to the program, as discussed in more detail below: (1)
Enhancement of and increase in the number of statistical tests, (2)
data set changes, (3) forecast horizon changes, and (4) root cause
analysis changes.

1. Enhancement of and Increase in the Number of Statistical Tests

As proposed in the Notice, OCC will enhance an existing statistical
test and add three new statistical tests. OCC proposed to enhance its
existing 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 to
address the dependency of exceedances between accounts.
In addition to the enhanced Traffic Light Test, OCC will implement
three other industry standard tests related to exceedances in order to
provide a more comprehensive set of tests. First, OCC will add the
Kupiec Test,\9\ 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 not inaccurate estimates of the accounts'
estimated losses.
---------------------------------------------------------------------------

\9\ See, Kupiec, P. ``Techniques for Verifying the Accuracy of
Risk Management Models,'' Journal of Derivatives, v3, P73-84 (1995).
---------------------------------------------------------------------------

Second, OCC will add the Christoffersen Independence Test,\10\
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. Third, OCC will add the Probtile test, which compares the
distribution of the daily observed P&L to the daily forecasted P&L
distribution. If the distribution of these P&L ratios approximates a
uniform random distribution, this is an indication that OCC's margin
models are not providing inaccurate forecasts of potential losses in an
account. Combined, these new statistical tests will provide OCC with
additional pertinent information to evaluate the effectiveness of its
models in determining margin coverage.
---------------------------------------------------------------------------

\10\ See, Christoffersen, Peter, ``Evaluating Interval
Forecasts.'' International Economic Review, 39 (4), 841-862 (1998).
---------------------------------------------------------------------------

2. Data Set Changes

In addition to the changes to its backtesting program, as described
above, OCC also will make two enhancements to the data sets being
backtested 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 will
backtest hypothetical portfolios, allowing for the design and
monitoring of portfolios that have magnified sensitivities to
particular aspects of the models used in the

[[Page 37325]]

margin computations. Backtesting against hypothetical portfolios will
provide a more comprehensive insight into the adequacy of the
underlying model assumptions under market conditions prevailing in the
backtest observation periods.
Under the second data set enhancement, OCC will backtest current
accounts against earlier observation periods. The market data observed
over the observation period is used to generate the margin forecasts
and P&L and observation periods will be chosen to reflect special
market conditions. OCC believes this enhancement should be 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 will not limit the backtesting to the
current environments but rather will highlight performance of margin
coverage and model performance in market scenarios other than
prevailing market conditions.

3. Forecast Horizons Changes

Currently, OCC conducts backtesting using a one-day time horizon,
which means that it compares calculated margin with realized P&Lthat
occur on the business day following the calculation. However, OCC's
margin calculations assume that positions will be liquidated over a
two-day period, resulting in the test comparing two-day margin numbers
to a one-day P&L calculation. This difference requires OCC to make
adjustments to its existing backtesting methodology 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 P&L
calculation.
Pursuant to the proposal, OCC will revise its backtesting
methodology to take into account losses over a two-day time horizon,
which will match the two-day liquidation period used in the margin
calculation without such adjustments. OCC will implement the necessary
functionality into its backtesting system to conduct a two-day time
horizon backtest, which will compare calculated margin against a two-
day P&L calculation. OCC also will revise its backtesting methodology
to compare one-day margin calculations against one-day P&L
calculations, and will implement system functionality for such a test.
All issues identified in any of these backtesting results 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. Root Cause Analysis Changes

Currently, OCC's backtesting staff conducts investigations, as
necessary, in order to identify the root cause of exceedances. The
investigation itself is a manual process that is dependent upon the
facts and circumstances pertaining to a given exceedance. Pursuant to
its proposal, OCC will now make system modifications that will provide
OCC's backtesting staff with additional tools to facilitate such
investigations. Specifically, OCC will add system functionality that
should reveal attribution of losses due to underlying price movements
and implied volatility movements. Further, these improvements will
allow OCC to incorporate hypothetical accounts and positions into the
tests and will allow OCC to identify risk factors that move above or
below the projected values. These changes should improve OCC's ability
to conduct investigations and root cause analyses that identify the
root cause of exceedances by providing OCC with additional automated
investigative tools which should, in turn, lead to improving OCC's
backtesting methodology and its margin coverage.

II. Discussion and Commission Findings

Although Title VIII does not specify a standard of review for an
advance notice, the Commission believes that the stated purpose of
Title VIII is instructive.\11\ The stated purpose of Title VIII is to
mitigate systemic risk in the financial system and promote financial
stability by, among other things, promoting uniform risk management
standards for systemically-important financial market utilities and
strengthening the liquidity of systemically important financial market
utilities.\12\
---------------------------------------------------------------------------

\11\ See 12 U.S.C. 5461(b).
\12\ Id.
---------------------------------------------------------------------------

Section 805(a)(2) of the Payment, Clearing and Settlement
Supervision Act \13\ authorizes the Commission to prescribe risk
management standards for the payment, clearing, and settlement
activities of designated clearing entities and financial institutions
engaged in designated activities for which it is the supervisory agency
or the appropriate financial regulator. Section 805(b) of the Payment,
Clearing and Settlement Supervision Act \14\ states that the objectives
and principles for the risk management standards prescribed under
Section 805(a) shall be to:
---------------------------------------------------------------------------

\13\ 12 U.S.C. 5464(a)(2).
\14\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

Promote robust risk management;
promote safety and soundness;
reduce systemic risks; and
support the stability of the broader financial system.
The Commission has adopted risk management standards under Section
805(a)(2) of the Payment, Clearing and Settlement Supervision Act
(``Clearing Agency Standards'').\15\ The Clearing Agency Standards
became effective on January 2, 2013, and require registered clearing
agencies that perform central counterparty (``CCP'') services to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to meet certain minimum
requirements for their operations and risk management practices on an
ongoing basis.\16\ As such, it is appropriate for the Commission to
review advance notices against these Clearing Agency Standards, and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Payment, Clearing and Settlement
Supervision Act.\17\
---------------------------------------------------------------------------

\15\ 17 CFR 240.17Ad-22.
\16\ The Clearing Agency Standards are substantially similar to
the risk management standards established by the Board of Governors
of the Federal Reserve System governing the operations of designated
financial market utilities that are not clearing entities and
financial institutions engaged in designated activities for which
the Commission or the Commodity Futures Trading Commission is the
Supervisory Agency. See Financial Market Utilities, 77 FR 45907
(August 2, 2012).
\17\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

The Commission believes that the proposal in this Advance Notice is
designed to further the objectives and principles of Section 805(b) of
the Payment, Clearing and Settlement Supervision Act.\18\ The
Commission believes that the additional backtesting improvements should
promote robust risk management by providing OCC with additional tools
to test the performance of its margin methodology in a more
comprehensive manner and better evaluate the effectiveness of its
models in determining model coverage. First, the enhancement to OCC's
existing Traffic Light Test and the adoption of the three new
statistical tests should provide a more comprehensive set of tests for
it to use to evaluate its margin models. Second, the enhancement of the
data sets to be backtested should provide OCC with additional
informative data on the performance of margin coverage and model
performance in market scenarios other than prevailing market
conditions.

[[Page 37326]]

Third, revising the backtesting methodology to take into account losses
over a two-day time horizon, should allow OCC to have a more accurate
view of the sufficiency of its margin methodology. Finally, system
modifications that should reveal attribution of losses due to
underlying price movements and implied volatility movements should
provide OCC with additional, automated investigative tools to conduct
analysis into the root causes of exceedances.
---------------------------------------------------------------------------

\18\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

In addition, the Commission believes that the proposal in this
Advance Notice is consistent with Clearing Agency Standards, in
particular, Rule 17Ad-22(b)(4) under the Exchange Act,\19\ which, in
relevant part, requires registered clearing agencies that perform
central counterparty services establish, implement, maintain, and
enforce written policies and procedures reasonably designed to provide
for an annual model validation consisting of evaluating the performance
of the clearing agency's margin models and the related parameters and
assumptions associated with such models. The Commission believes that
this proposal is consistent with Exchange Act Rule 17Ad-22(b)(4) \20\
because it provides OCC with the ability to employ improved statistical
tests to better evaluate the performance of its margin models and thus
improving its ability to validate such models.
---------------------------------------------------------------------------

\19\ 17 CFR 240.17Ad-22(b)(3).
\20\ Id.
---------------------------------------------------------------------------

III. Conclusion

It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Payment, Clearing and Settlement Supervision Act,\21\ that the
Commission does not object to advance notice proposal (SR-OCC-2014-810)
and that OCC is authorized to implement the proposal.
---------------------------------------------------------------------------

\21\ 12 U.S.C. 5465(e)(1)(I).

By the Commission.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-15994 Filed 6-29-15; 8:45 am]
BILLING CODE 8011-01-P

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