Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Proposed Rule Change Related to The Options Clearing Corporation's Margin Methodology, 57306-57313 [2017-25989]

Download as PDF 57306 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices securities, to 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. Additionally, the Exchange believes the proposed rule change is consistent with the Section 6(b)(5) requirement that the rules of an exchange not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers. In particular, the proposed rule change will allow investors to more easily use SPY, IVV, DIA options, which protects investors and the public interest. The Exchange also believes the proposed rule change is consistent with Section 6(b)(1) of the Act, which provides that the Exchange be organized and have the capacity to be able to carry out the purposes of the Act and the rules and regulations thereunder, and the rules of the Exchange. The Exchange does not believe that the proposed rule would create additional capacity issues or affect market functionality. The Exchange believes that the proposed rule change, like other strike price programs currently offered by the Exchange, will benefit investors by giving them increased flexibility to more closely tailor their investment and hedging decisions. Moreover, the proposed rule change is consistent with the rules of other exchanges.9 sradovich on DSK3GMQ082PROD with NOTICES (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 necessary or appropriate in furtherance of the purposes of the Act. Rather, the Exchange believes that the proposed rule change will result in additional investment options and opportunities to achieve the investment and trading objectives of market participants seeking efficient trading and hedging vehicles, to the benefit of investors, market participants, and the marketplace in general. Additionally, this proposed rule change seeks to match the strike setting regime for IVV, SPY, and DIA options available on other options exchanges; thus, the proposed rule change may alleviate any potential burden on competition.10 (C) Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others Written comments were neither solicited nor received. 9 See Box Rule IM–5050–1 and Cboe Rule 5.5.08(b). 10 Id. VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Because the foregoing proposed rule change does not: (A) Significantly affect the protection of investors or the public interest; (B) impose any significant burden on competition; and (C) by its terms, 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 11 and paragraph (f)(6) of Rule 19b– 4 thereunder,12 the Exchange has designated this rule filing as noncontroversial. The Exchange has given the Commission 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 of the proposed rule change, or such shorter time as designated by the Commission. At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is: (1) Necessary or appropriate in the public interest; (2) for the protection of investors; or (3) otherwise in furtherance of the purposes of the 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 Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SRCboeBZX–2017–002 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–CboeBZX–2017–002. 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 (http://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 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-CboeBZX–2017–002 and should be submitted on or before December 26, 2017. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.13 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–25988 Filed 12–1–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–82161; File No. SR–OCC– 2017–022] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Proposed Rule Change Related to The Options Clearing Corporation’s Margin Methodology November 28, 2017. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’), 1 and Rule 19b–4 thereunder, 2 notice is hereby given that on November 13, 2017, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule 13 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 11 15 U.S.C. 78s(b)(3)(A). 12 17 CFR 240.19b–4. PO 00000 Frm 00112 Fmt 4703 1 15 Sfmt 4703 E:\FR\FM\04DEN1.SGM 04DEN1 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices change as described in Items I, II, and III below, which Items have been prepared by OCC. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. (A) Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change I. Clearing Agency’s Statement of the Terms of Substance of the Proposed Rule Change OCC’s margin methodology, the System for Theoretical Analysis and Numerical Simulations (‘‘STANS’’), is OCC’s proprietary risk management system that calculates Clearing Member margin requirements.6 STANS utilizes large-scale Monte Carlo simulations to forecast price and volatility movements in determining a Clearing Member’s margin requirement.7 The STANS margin requirement is calculated at the portfolio level of Clearing Member accounts with positions in marginable securities and consists of an estimate of a 99% expected shortfall 8 over a twoday time horizon and an add-on margin charge for model risk (the concentration/dependence stress test charge).9 The STANS methodology is used to measure the exposure of portfolios of options and futures cleared by OCC and cash instruments in margin collateral. A ‘‘risk factor’’ within OCC’s margin system may be defined as a product or attribute whose historical data is used to estimate and simulate the risk for an associated product. The majority of risk factors utilized in the STANS methodology are total returns on individual equity securities. Other risk factors considered include: Returns on equity indexes; returns on implied volatility 10 risk factors that are a set of nine chosen volatility pivots per This proposed rule change by OCC would modify OCC’s margin methodology to move away from the existing monthly data source provided by its current vendor and towards obtaining and incorporating daily price and returns (adjusted for any corporate actions) data of securities to estimate accurate margins.3 This would be further supported by enhancing OCC’s econometric model applied to different risk factors; 4 improving the sensitivity and stability of correlation estimates between them; and enhancing OCC’s methodology around the treatment of securities with limited historical data. OCC also proposes to make a few clarifying and clean-up changes to its margin methodology unrelated to the proposed changes described above. The proposed changes to OCC’s Margins Methodology document are contained in confidential Exhibit 5 of the filing. The proposed changes are described in detail in Item II below. The proposed rule change does not require any changes to the text of OCC’s ByLaws or Rules. All terms with initial capitalization that are not otherwise defined herein have the same meaning as set forth in the OCC By-Laws and Rules.5 II. Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change sradovich on DSK3GMQ082PROD with NOTICES In its filing with the Commission, OCC included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. OCC has prepared summaries, set forth in sections (A), (B), and (C) below, of the most significant aspects of these statements. 3 OCC also has filed an advance notice with the Commission in connection with the proposed changes. See SR–OCC–2017–811. 4 The use of risk factors in OCC’s margin methodology is discussed in more detail in the Background section of Item II below. 5 OCC’s By-Laws and Rules can be found on OCC’s public Web site: http://optionsclearing.com/ about/publications/bylaws.jsp. VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 (1) Purpose Background 6 See Securities Exchange Act Release No. 53322 (February 15, 2006), 71 FR 9403 (February 23, 2006) (SR–OCC–2004–20). 7 See OCC Rule 601. 8 The expected shortfall component is established as the estimated average of potential losses higher than the 99% value at risk threshold. The term ‘‘value at risk’’ or ‘‘VaR’’ refers to a statistical technique that, generally speaking, is used in risk management to measure the potential risk of loss for a given set of assets over a particular time horizon. 9 A detailed description of the STANS methodology is available at http:// optionsclearing.com/risk-management/margins/. 10 Generally speaking, the implied volatility of an option is a measure of the expected future volatility of the value of the option’s annualized standard deviation of the price of the underlying security, index, or future at exercise, which is reflected in the current option premium in the market. Using the Black-Scholes options pricing model, the implied volatility is the standard deviation of the underlying asset price necessary to arrive at the market price of an option of a given strike, time to maturity, underlying asset price and given the current risk-free rate. In effect, the implied volatility is responsible for that portion of the premium that cannot be explained by the then-current intrinsic value (i.e., the difference between the price of the underlying and the exercise price of the option) of the option, discounted to reflect its time value. PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 57307 product; 11 changes in foreign exchange rates; and changes in model parameters that sufficiently capture the model dynamics from a larger set of data. Under OCC’s current margin methodology, OCC obtains monthly price data for most of its equity-based products 12 from a widely used industry vendor. This data arrives around the second week of every month in arrears and requires a maximum of about four weeks for OCC to process the data after any clean up and reruns as may be required prior to installing into OCC’s margin system. As a result, correlations and statistical parameters for risk factors at any point in time represent backdated data and therefore may not be representative of the most recent market data. In the absence of daily updates, OCC employs an approach where one or many identified market proxies (or ‘‘scale-factors’’) are used to incorporate day-to-day market volatility across all associated asset classes throughout.13 The scale factor approach, however, assumes a perfect correlation of the volatilities between the security and its scale factor, which gives little room to capture the idiosyncratic risk of a given security and which may be different from the broad market risk represented by the scale factor. In risk management, it is a common practice to establish a floor for volatility at a certain level in order to protect against procyclicality 14 in the model. 11 In December 2015, the Commission approved a proposed rule change, and issued a Notice of No Objection to an advance notice filing, by OCC to its modify margin methodology by more broadly incorporating variations in implied volatility within STANS. See Securities Exchange Act Release No. 34–76781 (December 28, 2015), 81 FR 135 (January 4, 2016) (SR–OCC–2015–016) and Securities Exchange Act Release No. 34–76548 (December 3, 2015), 80 FR 76602 (December 9, 2015) (SR–OCC– 2015–804). 12 The securities underlying these products are also known as risk factors within OCC’s margin system. 13 Earlier this year, the Commission approved a proposed rule change and issued a Notice of No Objection to an advance notice filing by OCC which, among other things: (1) Expanded the number of scale factors used for equity-based products to more accurately measure the relationship between current and long-run market volatility with proxies that correlate more closely to certain products carried within the equity asset class, and (2) applied relevant scale factors to the greater of (i) the estimated variance of 1-day return scenarios or (ii) the historical variance of the daily return scenarios of a particular instrument, as a floor to mitigate procyclicality. See Securities Exchange Act Release No. 80147 (March 3, 2017), 82 FR 13163 (March 9, 2017) (SR–OCC–2017–001) and Securities Exchange Act Release No. 80143 (March 2, 2017), 82 FR 13036 (March 8, 2017) (SR– OCC–2017–801). 14 A quality that is positively correlated with the overall state of the market is deemed to be ‘‘procyclical.’’ For example, procyclicality may be evidenced by increasing margin or Clearing Fund E:\FR\FM\04DEN1.SGM Continued 04DEN1 57308 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices OCC imposes a floor on volatility estimates for its equity-based products using a 500-day look back period. These monthly updates coupled with the dependency of margins on scale factors and the volatility floor can result in imprecise changes in margins charged to Clearing Members, specifically across periods of heavy volatility when the correlation between the risk factor and a scale factor fluctuate. OCC’s current methodology for estimating covariance and correlations between risk factors relies on the same monthly data described above, resulting in a similar lag time between updates. In addition, correlation estimates are based off historical returns series, with estimates between a pair of risk factors being highly sensitive to the volatility of either risk factor in the chosen pair. The current approach therefore results in potentially less stable correlation estimates that may not be representative of current market conditions. Finally, under OCC’s existing margin methodology, theoretical price scenarios for ‘‘defaulting securities’’ 15 are simulated using uncorrelated return scenarios with an average zero return and a pre-specified volatility called ‘‘default variance.’’ The default variance is estimated as the average of the top 25 percent quantile of the conditional variances of all securities. As a result, these default estimates may be impacted by extremely illiquid securities with discontinuous data. In addition, the default variance (and the associated scale factors used to scale up volatility) is also subject to sudden jumps with the monthly simulation installations across successive months because it is derived from monthly data updates, as opposed to daily updates, which are prone to wider fluctuations and are subject to adjustments using scale factors. sradovich on DSK3GMQ082PROD with NOTICES Proposed Changes OCC proposes to modify its margin methodology by: (1) Obtaining daily price data for equity products (including daily corporate action-adjusted returns of equities where price and thus returns of securities are adjusted for any dividends issued, stock splits, etc.) for use in the daily estimation of econometric model parameters; (2) enhancing its econometric model for requirements in times of stressed market conditions and low margin or Clearing Fund requirements when markets are calm. Hence, anti-procyclical features in a model are measures intended to prevent risk-based models from fluctuating too drastically in response to changing market conditions. 15 Within the context of OCC’s margin system, securities that do not have enough historical data for calibration are classified as ‘‘defaulting securities.’’ VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 updating statistical parameters (e.g., parameters concerning correlations or volatility) for all risk factors that reflect the most recent data obtained; (3) improving the sensitivity and stability of correlation estimates across risk factors by using de-volatized 16 returns (but using a 500 day look back period); and (4) improving OCC’s methodology related to the treatment of defaulting securities that would result in stable and realistic risk estimates for such securities.17 The purpose of the proposed changes is to enhance OCC’s margin methodology to mitigate the issues described above that arise from the current monthly update and scale factor approach. Specifically, by introducing daily (as opposed to monthly) updates for price data (and thereby allowing for daily updates of statistical parameters in the model) and making other proposed model enhancements described herein, the proposed changes are designed to result in more accurate and responsive margin requirements and a model that is more stable and proactive during times of market volatility, with margins that are based off of the most recent market data. In addition, the proposed changes are intended to improve OCC’s approach to estimating covariance and correlations between risk factors in an effort to achieve more stable and sensitive correlation estimations and improve OCC’s methodology related to the treatment of defaulting securities by reducing the impact that illiquid securities with discontinuous data have on default variance estimates. The proposed changes are described in further detail below. 1. Daily Updates of Price Data OCC proposes to introduce daily updates for price data for equity products, including daily corporate action-adjusted returns of equities, Exchange Traded Funds (‘‘ETFs’’), Exchange Traded Notes (‘‘ETNs’’) and certain indexes. The daily price data would be obtained from a widely used external vendor, as is the case with the current monthly updates. The purpose of the proposed change is to ensure that OCC’s margin methodology is reliant on 16 De-volatization is a process of normalizing historical data with the associated volatility thus enabling any comparison between different sets of data. 17 In addition to the proposed methodology changes described herein, OCC also would make some clarifying and clean-up changes, unrelated to the proposed changes described above, to update its margin methodology to reflect existing practices for the daily calibration of seasonal and non-seasonal energy models and the removal of methodology language for certain products that are no longer cleared by OCC. PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 data that is more representative of current market conditions, thereby resulting in more accurate and responsive margin requirements. As described above, OCC currently obtains price data for all securities on a monthly basis from a third party vendor. After obtaining the monthly price data, additional time is required for OCC to process the data prior to installing into OCC’s margin system. As a result, correlations and statistical parameters for risk factors at any point in time represent back-dated data and therefore may not be representative of the most recent market data. To mitigate procyclicality within its margin methodology in the absence of daily updates, OCC employs the use of scalefactors to incorporate day-to-day market volatility across all associated asset classes. While the scale factors help to reduce procyclicality in the model, the scale factors do not necessarily capture the idiosyncratic risks of a given security, which may be different from the broad market risk represented by the scale factor. OCC proposes to address these issues associated with its current margin methodology by eliminating its dependency on monthly price data, which arrives in arrears and requires additional time for OCC to process the data prior to installing into OCC’s margin system through the introduction of daily updates for price data for equity products. The introduction of daily price updates would enable OCC’s margin methodology to better capture both market as well idiosyncratic risk by allowing for daily updates to the parameters associated with the econometric model (discussed below) that capture the risk associated with a particular product, and therefore ensure that OCC’s margin requirements are based on more current market conditions. As a result, OCC would also reduce its reliance on the use of scale factors to incorporate day-to-day market volatility, which, as noted above, give little room to capture the idiosyncratic risk of a given security and which may be different from the broad market risk represented by the scale factor. In addition, the processing time between receipt of the data and installation into the margin system would be reduced as the data review and processing for daily prices would be incorporated into OCC’s daily price editing process. 2. Proposed Enhancements to the Econometric Model In addition to introducing daily updates for price and corporate actionadjusted returns data, OCC is proposing enhancements to its econometric model E:\FR\FM\04DEN1.SGM 04DEN1 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices for calculating statistical parameters for all qualifying risk factors that reflect the most recent data obtained (e.g., OCC would be able to calculate parameters such as volatility and correlations on a daily basis using the new daily price data discussed above). Specifically, OCC proposes to enhance its econometric model by: (i) Introducing daily updates for statistical parameters; (ii) introducing features in its econometric model that are designed to take into account asymmetry in the model used to forecast volatility associated with a risk factor; (iii) modifying the statistical distribution used to model the returns of equity prices; (iv) introducing a secondday forecast for volatility into the model to estimate the two-day scenario distributions for risk factors; and (v) imposing a floor on volatility estimates using a 10-year look back period. These proposed model enhancements are described in detail below. i. Daily Updates for Statistical Parameters Under the proposal, the statistical parameters for the model would be updated on a daily basis using the new daily price data obtained by OCC (as described in section 1 above).18 As a result, OCC would no longer need to rely on scale factors to approximate dayto-day market volatility for equity-based products. Statistical parameters would be calibrated on daily basis, allowing OCC to calculate more accurate margin requirements that are representative of the most recent market data. sradovich on DSK3GMQ082PROD with NOTICES ii. Proposed Enhancements To Capture Asymmetry in Conditional Variance In addition to the daily update of statistical parameters, OCC proposes to include new features in its econometric model that are designed to take into account asymmetry in the conditional variance process. The econometric model currently used in STANS for all risk factors is a GARCH(1,1) with Student’s t-distributed innovations of logarithmic returns,19 which is a relatively straightforward and widely used model to forecast volatility.20 The 18 OCC notes that this change would apply to most risk factors with the exception of certain equity indexes, Treasury securities, and energy futures products, which are already updated on a daily basis. 19 The Student’s t distribution is a widely used statistical distribution to model the historical logarithmic price returns data of a security that allows for the presence of fat tails (aka kurtosis) or a non-zero conditional fourth moment. 20 See generally Tim Bollerslev, ‘‘Generalized Autoregressive Conditional Heteroskedasticity,’’ Journal of Econometrics, 31(3), 307–327 (1986). The acronym ‘‘GARCH’’ refers to an econometric model that can be used to estimate volatility based on historical data. The general distinction between the VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 current approach for forecasting the conditional variance for a given risk factor does not, however, consider the asymmetric volatility phenomenon observed in financial markets (also called the ‘‘leverage effect’’) where volatility is more sensitive and reactive to market downturns. As a result, OCC proposes to enhance its model by adding new features (i.e., incorporating asymmetry into its forecast volatility) designed to allow the conditional volatility forecast to be more sensitive to market downturns and thereby capture the most significant dynamics of the relationship between price and volatility observed in financial markets. OCC believes the proposed enhancement would result in more accurate and responsive margin requirements, particularly in market downturns. iii. Proposed Change in Statistical Distribution OCC further proposes to change the statistical distribution used to model the returns of equity prices. OCC’s current methodology uses a fat tailed distribution 21 (the Student’s tdistribution) to model returns; however, price scenarios generated using very large log-return scenarios (positive) that follow this distribution can approach infinity and could potentially result in excessively large price jumps, a known limitation of this distribution. OCC proposes to move to a more defined distribution (Standardized Normal Reciprocal Inverse Gaussian or NRIG) for modeling returns, which OCC believes would more appropriately simulate future returns based on the historical price data for the products in question (i.e., it has a better ‘‘goodness of fit’’ 22 to the historical data) and allows for more appropriate modeling of fat tails. As a result, OCC believes that the proposed change would lead to more consistent treatment of log returns both on the upside as well as downside of the distribution. iv. Second Day Volatility Forecast OCC also proposes to introduce a second-day forecast for volatility into the model to estimate the two-day scenario distributions for risk factors.23 ‘‘GARCH variance’’ and the ‘‘sample variance’’ for a given time series is that the GARCH variance uses the underlying time series data to forecast volatility. 21 A data set with a ‘‘fat tail’’ is one in which extreme price returns have a higher probability of occurrence than would be the case in a normal distribution. 22 The goodness of fit of a statistical model describes the extent to which observed data match the values generated by the model. 23 This proposed change would not apply to STANS implied volatility scenario risk factors. For PO 00000 Frm 00115 Fmt 4703 Sfmt 4703 57309 Under the current methodology, OCC typically uses a two-day horizon to determine its risk exposure to a given portfolio. This is done by simulating 10,000 theoretical price scenarios for the two-day horizon using a one-day forecast conditional variance, and the value at risk and expected shortfall components of the margin requirement are then determined from the simulated profit/loss distributions. These one-day and two-day returns scenarios are both simulated using the one-day forecast conditional variance estimate. This could lead to a risk factor’s coverage differing substantially on volatile trading days. As a result, OCC proposes to introduce a second-day forecast variance for all equity-based risk factors. The second-day conditional variance forecast would be estimated for each of the 10,000 Monte Carlo returns scenarios, resulting in more accurately estimated two-day scenario distributions, and therefore more accurate and responsive margin requirements. v. Anti-Procyclical Floor for Volatility Estimates Additionally, OCC proposes to modify its floor for volatility estimates. OCC currently imposes a floor on volatility estimates for its equity-based products using a 500-day look back period. OCC proposes to extend this look back period to 10-years (2520 days) in the enhanced model and to apply this floor to volatility estimates for other products (excluding implied volatility risk factor scenarios). The proposed model described herein is calibrated from historical data, and as a result, the level of the volatilities generated by the model will vary from time to time. OCC is therefore proposing to establish a volatility floor for the model using a 10year look back period to reduce the risk of procyclicality in its margin model. OCC believes that using a longer 10-year look back period will ensure that OCC captures sufficient historical events/ market shocks in the calculation of its anti-procyclical floor. The 10-year look back period also is in line with requirements of the European Market Infrastructure Regulation (including regulations thereunder) 24 concerning the calibration of risk factors. those risk factors, OCC’s existing methodology would continue to apply. See supra note 11. 24 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories. Specifically, the proposed floor would be compliant with Article 28 of Commission Delegated Regulation (EU) No. 153/2013 of 19 December 2012 Supplementing Regulation (EU) No. 648/2012 of the European Parliament and of the E:\FR\FM\04DEN1.SGM Continued 04DEN1 57310 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices sradovich on DSK3GMQ082PROD with NOTICES 3. Proposed Enhancements to Correlation Estimates As described above, OCC’s current methodology for estimating covariance and correlations between risk factors relies on the same monthly price data feeding the econometric model, resulting in a similar lag time between updates. In addition, correlation estimates are based off historical returns series, with estimates between a pair of risk factors being highly sensitive to the volatility of either risk factors in the chosen pair. The current approach therefore results in correlation estimates being sensitive to volatile historical data. In order to address these limitations, OCC proposes to enhance its methodology for calculating correlation estimates by moving to a daily process for updating correlations (with a minimum of one week’s lag) to ensure Clearing Member account margins are more current and thus more accurate. Moreover, OCC proposes to enhance its approach to modeling correlation estimates by de-volatizing 25 the returns series to estimate the correlations. Under the proposed approach, OCC would first consider the returns excess of the mean (i.e., the average estimated from historical data sample) and then further scale them by the corresponding estimated conditional variances. OCC believes that by using de-volatized returns, which is a widely suggested approach in relevant literature, it would lead to normalizing returns across a variety of asset classes and make the correlation estimator less sensitive to sudden market jumps and therefore more stable. 4. Defaulting Securities Methodology Finally, OCC proposes to enhance its methodology for estimating the defaulting variance in its model. OCC’s margin system is dependent on market data to determine Clearing Member margin requirements. Securities that do not have enough historical data are classified as to be a ‘‘defaulting security’’ within OCC systems (e.g., IPO securities). As noted above, within current STANs systems, the theoretical price scenarios for defaulting securities are simulated using uncorrelated return scenarios with a zero mean and a default variance, with the default variance being estimated as the average of the top 25 percent quantile of the conditional variances of all securities. Council with regard to Regulatory Technical Standards on Requirements for Central Counterparties (the ‘‘Regulatory Technical Standards’’). 25 See supra note 16. VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 As a result, these default estimates may be impacted by extremely illiquid securities with discontinuous data. In addition, the default variance (and the associated scale factors used to scale up volatility) is also subject to sudden jumps with the monthly simulation installations across volatile months. To mitigate these concerns, OCC proposes to: (i) Use only optionable equity securities to estimate the defaulting variance; (ii) use a shorter time series to enable calibration of the model for all securities; and (iii) simulating default correlations with the driver Russell 2000 index (‘‘RUT’’). i. Proposed Modifications to Securities and Quantile Used in Estimation OCC proposes that only optionable equity securities, which are typically more liquid, be considered while estimating the default variance. This limitation would eliminate from the estimation almost all illiquid securities with discontinuous data that could contribute to high conditional variance estimates and thus a high default variance. In addition, OCC proposes to estimate the default variance as the lowest estimate of the top 10% of the floored conditional variance across the risk factors. This change in methodology is designed to ensure that while the estimate is aggressive it is also robust to the presence of outliers caused by a few extremely volatile securities that influence the location parameter of a distribution. Moreover, as a consequence of the daily updates described above, the default variances would change daily and there would be no scale factor to amplify the effect of the variance on risk factor coverage. ii. Proposed Change in Time Series In addition, OCC proposes to use a shorter time series to enable calibration of the model for all securities. Currently, OCC does not calibrate parameters for defaulting securities that have historical data of less than two years. OCC is proposing to shorten this time period to around 6 months (180 days) to enable calibration of the model for all securities within OCC systems. OCC believes that this shorter time series is sufficient to produce stable calibrated parameters. iii. Proposed Default Correlation Finally, OCC proposes that returns scenarios for defaulting securities, securities with insufficient historical data, be simulated using a default correlation with the driver RUT.26 The 26 OCC notes that, in certain limited circumstances where there are reasonable grounds backed by the existing return history to support an PO 00000 Frm 00116 Fmt 4703 Sfmt 4703 RUT Index is a small cap index and is hence a natural choice to represent most new issues that are small cap and deemed to be a ‘‘defaulting security.’’ The default correlation is roughly equal to the median of all positively correlated securities with the index. Since 90% of the risk factors in OCC systems correlate positively to the RUT index, OCC would only consider those risk factors to determine the median. OCC believes that the median of the correlation distribution has been steady over a number of simulations and is therefore proposing that it replace the current methodology of simulating uncorrelated scenarios, which OCC believes is not a realistic approach. Clearing Member Outreach OCC has discussed the proposed changes with its Financial Risk Advisory Council 27 at a meeting held on October 25, 2016. OCC also provided general updates to members at OCC Roundtable 28 meetings on June 20, 2017, and November 9, 2017. Clearing Members expressed interest in seeing how reactive margin changes would be under the proposal; however, there were no objections or significant concerns expressed regarding the proposed changes. OCC will provide at least 30days of parallel reporting prior to implementation so that Clearing Members can see the impact of the proposed changes. In addition, OCC would publish an Information Memorandum to all Clearing Members describing the proposed change and will provide additional periodic Information Memoranda updates prior to the implementation date. Additionally, OCC would perform targeted and direct outreach with Clearing Members that would be most impacted by the proposed changes to the margin methodology and OCC would work closely with such Clearing Members to coordinate the implementation and associated funding for such Clearing alternative approach in which the returns are strongly correlated with those of an existing risk factor (a ‘‘proxy’’) with a full price history, the Margins Methodology allows OCC’s Financial Risk Management staff to construct a ‘‘conditional’’ simulation to override any default treatment that would have otherwise been applied to the defaulting security. 27 The Financial Risk Advisory Council is a working group consisting of representatives of Clearing Members and exchanges formed by OCC to review and comment on various risk management proposals. 28 The OCC Roundtable was established to bring Clearing Members, exchanges and OCC together to discuss industry and operational issues. It is comprised of representatives of the senior OCC staff, participant exchanges and Clearing Members, representing the diversity of OCC’s membership in industry segments, OCC-cleared volume, business type, operational structure and geography. E:\FR\FM\04DEN1.SGM 04DEN1 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices sradovich on DSK3GMQ082PROD with NOTICES Members resulting from the proposed change.29 (2) Statutory Basis OCC believes that the proposed rule change is consistent with Section 17A of the Securities Exchange Act of 1934, as amended (the ‘‘Act’’),30 and the rules thereunder applicable to OCC. Section 17A(b)(3)(F) of Act 31 requires that the rules of a clearing agency be designed to assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible. OCC believes the propose rule change would enhance its margin methodology in a manner designed to safeguard the securities and funds in its custody or control for the reasons set forth below. As noted above, OCC’s current margin methodology relies on monthly price data being obtained from a third party vendor. This data arrives monthly in arrears and requires additional time for OCC to process the data prior to installing into OCC’s margin system. As a result, correlations and statistical parameters for risk factors at any point in time represent back-dated data and therefore may not be representative of the most recent market data. To mitigate procyclicality within its margin methodology in the absence of daily updates, OCC employs a scale factor approach to incorporate day-to-day market volatility across all associated asset classes throughout.32 For the reasons noted above, these monthly updates coupled with the dependency of margins on scale factors can result in imprecise changes in margins charged to Clearing Members, specifically across periods of heavy volatility. OCC proposes to enhance its margin methodology to introduce daily updates for equity price data, thereby allowing for daily updates of statistical parameters in its margin model for most risk factors. In addition, the proposed changes would introduce features to the model to better account for the asymmetric volatility phenomenon observed in financial markets and allow for conditional volatility forecast to be more sensitive to market downturns. The proposed changes would also introduce a new statistical distribution for modeling equity price returns that OCC believes would have a better goodness of fit and would more appropriately account for fait tails. 29 Specifically, OCC will discuss with those Clearing Members how they plan to satisfy any increase in their margin requirements associated with the proposed change. 30 15 U.S.C. 78q–1. 31 15 U.S.C. 78q–1(b)(3)(F). 32 See supra note 13 and accompanying text. VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 Moreover, the proposed changes would introduce a second-day volatility forecast into the model to provide for more accurate and timely estimations of its two-day scenario distributions. OCC also proposes to enhance its econometric model by establishing a volatility floor using a 10-year look back period to reduce procyclicality in the margin model. OCC believes the proposed changes would result in more accurate and responsive margin requirements and a model that is more stable and proactive during times of market volatility, with risk charges that are based off of most recent market data. In addition, the proposed rule change is intended to improve OCC’s approach to estimating covariance and correlations between risk factors in an effort to achieve more stable and sensitive correlation estimations and improve OCC’s methodology related to the treatment of defaulting securities by reducing the impact that illiquid securities with discontinuous data have on default variance estimates. The proposed methodology changes would be used by OCC to calculate margin requirements designed to limit its credit exposures to participants, and OCC uses the margin it collects from a defaulting Clearing Member to protect other Clearing Members from losses that may result from such a default. As a result, OCC believes the proposed rule changed is designed to assure the safeguarding of securities and funds in its custody or control in accordance with Section 17A(b)(3)(F) of the Act.33 Rules 17Ad–22(b)(1) and (2) 34 require that a registered clearing agency that performs central counterparty services establish, implement, maintain and enforce written policies and procedures reasonably designed to, in part: (1) Measure its credit exposures to its participants at least once a day and limit its exposures to potential losses from defaults by its participants under normal market conditions so that the operations of the clearing agency would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control and (2) use margin requirements to limit its credit exposures to participants under normal market conditions and use risk-based models and parameters to set margin requirements. As noted above, the proposed changes would introduce the use of daily price updates into OCC’s margin methodology, which allows for daily updates to the statistical parameters in 33 Id. 34 17 PO 00000 CFR 240.17Ad–22(b)(1) and (2). Frm 00117 Fmt 4703 Sfmt 4703 57311 the model (e.g., parameters concerning volatility and correlation). These changes would be supported by a number of other risk-based enhancements to OCC’s econometric model designed to: (i) More appropriately account for asymmetry in conditional variance; (ii) more appropriately model the statistical distribution of price returns; (iii) provide for an anti-procyclical floor for volatility estimates based on a 10-year look back period; and (iv) more accurately model second-day volatility forecasts. Moreover, the proposed changes would improve OCC’s approach to estimating covariance and correlations between risk factors in an effort to achieve more stable and sensitive correlation estimations and improve OCC’s methodology related to the treatment of defaulting securities by reducing the impact that illiquid securities with discontinuous data have on default variance estimates. OCC would use the risk-based model enhancements described herein to measure its credit exposures to its participants on a daily basis and determine margin requirements based on such calculations. The proposed enhancements concerning daily price updates, daily updates of statistical parameters, and to more appropriately account for asymmetry in conditional variance would result in more accurate and responsive margin requirements and a model that is more stable and proactive during times of market volatility, with margin charges that are based off of the most recent market data. In addition, the proposed modifications to extend the look back period for determining volatility estimates for equity-based products from 500 days to 10 years will help to ensure that OCC captures sufficient historical events/ market shocks in the calculation of its anti-procyclical floor. Additionally, the proposed changes would enhance OCC’s margin methodology for calculating correlation estimates by moving to a daily process for updating correlations (with a minimum of one week’s lag) so that Clearing Member account margins are more current and thus more accurate and using de-volatized returns to normalize returns across a variety of asset classes and make the correlation estimator less sensitive to sudden market jumps and therefore more stable. Finally, the proposed changes to OCC’s methodology for the treatment of defaulting securities is designed to result in stable and realistic risk estimates for such securities The proposed changes are therefore designed to ensure that OCC sets margin E:\FR\FM\04DEN1.SGM 04DEN1 sradovich on DSK3GMQ082PROD with NOTICES 57312 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices requirements, using risk-based models and parameters, that would serve to limit OCC’s exposures to potential losses from defaults by its participants under normal market conditions so that the operations of OCC would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control. Accordingly, OCC believes the proposed changes are consistent with Rules 17Ad–22(b)(1) and (2).35 Rule 17Ad–22(e)(6) 36 further requires OCC to establish, implement, maintain and enforce written policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that, among other things: (i) Considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market; (ii) calculates margin sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default; and (iii) uses reliable sources of timely price data and uses procedures and sound valuation models for addressing circumstances in which pricing data are not readily available or reliable. As described in detail above, the proposed changes are designed to ensure that, among other things, OCC’s margin methodology: (i) More appropriately accounts for asymmetry in conditional variance; (ii) more appropriately models the statistical distribution of price returns, (iii) more accurately models second-day volatility forecasts; (iv) improves OCC’s approach to estimating covariance and correlations between risk factors to provide for stable and sensitive correlation estimations; and (v) improves OCC’s methodology related to the treatment of defaulting securities by reducing the impact that illiquid securities with discontinuous data have on default variance estimates. These methodology enhancements would be used to calculate daily margin requirements for OCC’s Clearing Members. In this way, the proposed changes are designed to consider, and produce margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market and to calculate margin sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default. (B) Clearing Agency’s Statement on Burden on Competition Section 17A(b)(3)(I) requires that the rules of a clearing agency do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of Act.38 OCC does not believe that the proposed rule change would impose any burden on competition. The proposed risk model enhancements would apply to all Clearing Members equally. While OCC expects that margin requirements may see slight reductions in the aggregate, the individual impact of the proposed changes will be mixed and depend on market conditions and the composition of the portfolio in question. The proposed rule change is primarily designed to allow OCC to determine margin requirements that more accurately represent the risk presented by its cleared products and that are more responsive to changes in volatility or overall market conditions. OCC does not believe that the proposed rule change would unfairly inhibit access to OCC’s services or disadvantage or favor any particular user in relationship to another user. Accordingly, OCC believes that any competitive impact would be necessary and appropriate in furtherance of the safeguarding of securities and funds which are in the custody or control of OCC or for which it is responsible, and in general, the protection of investors and the public interest. 37 Id. 35 Id. 36 17 Moreover, the proposed changes would introduce daily updates for price data for equity products, including daily corporate action-adjusted returns of equities, ETFs, ETNs, and certain indexes. This daily price data would be obtained from a widely used and reliable industry vendor. In this way, the proposed changes would ensure that OCC uses reliable sources of timely price data in its margin methodology, which better reflect current market conditions than the current monthly updates, thereby resulting in more accurate and responsive margin requirements. For these reasons, OCC believes that the proposed changes are consistent with Rule 17Ad–22(e)(6).37 The proposed rule changes are not inconsistent with the existing rules of OCC, including any other rules proposed to be amended. CFR 240.17Ad–2(e)(6). VerDate Sep<11>2014 18:22 Dec 01, 2017 38 15 Jkt 244001 PO 00000 U.S.C. 78q–1(b)(3)(I). Frm 00118 Fmt 4703 Sfmt 4703 (C) Clearing Agency’s Statement on Comments on the Proposed Rule Change Received from Members, Participants or Others Written comments on the proposed rule change were not and are not intended to be solicited with respect to the proposed rule change and none have been received. OCC will notify the Commission of any written comments received by OCC. 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 within such longer period up to 90 days (i) as the Commission may designate if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: (A) By order approve or disapprove the proposed rule change, or (B) institute proceedings to determine whether the proposed rule change should be disapproved. 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 (http://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– OCC–2017–022 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–2017–022. 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 (http://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 E:\FR\FM\04DEN1.SGM 04DEN1 Federal Register / Vol. 82, No. 231 / Monday, December 4, 2017 / Notices 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 such filing also will be available for inspection and copying at the principal office of OCC and on OCC’s Web site at https://www.theocc.com/about/ publications/bylaws.jsp. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–OCC–2017–022 and should be submitted on or before December 26, 2017. For the Commission, by the Division of Trading and Markets, pursuant to delegated Authority.39 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–25989 Filed 12–1–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–82164; File No. SR–CBOE– 2017–074] Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Clarifying How the Options Regulatory Fee is Assessed and Collected sradovich on DSK3GMQ082PROD with NOTICES November 28, 2017. 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 17, 2017, Cboe Exchange, Inc. (the ‘‘Exchange’’ or ‘‘Cboe Options’’) filed with the Securities and Exchange Commission (the ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. 39 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 VerDate Sep<11>2014 18:22 Dec 01, 2017 Jkt 244001 I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend its Fees Schedule relating to the Options Regulator Fee (‘‘ORF’’). The text of the proposed rule change is also available on the Exchange’s Web site (http://www.cboe.com/AboutCBOE/ CBOELegalRegulatoryHome.aspx), at the Exchange’s Office of the Secretary, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to amend its Fees Schedule to clarify how the ORF is assessed and collected.3 Background The ORF was established in October 2008 as a replacement of Registered Representative fees.4 The ORF is assessed by the Exchange to each Trading Permit Holder for options transactions executed or cleared by the Trading Permit Holder that are cleared by The Options Clearing Corporation (‘‘OCC’’) in the customer range (i.e., transactions that clear in a customer account at OCC) regardless of the exchange on which the transaction occurs.5 The ORF is designed to recover a material portion of the costs to the Exchange of the supervision and 3 The Exchange initially filed the proposed rule changes on November 16, 2017 (SR–CBOE–2017– 073). On November 17, 2017 the Exchange withdrew SR–CBOE–2017–073 and then subsequently submitted this filing (SR–CBOE– 2017–074). 4 See Securities Exchange Act Release No. 58817 (October 20, 2008), 73 FR 63744 (October 27, 2008) (the ‘‘Original ORF Filing’’). 5 The ORF also applies to customer-range transactions executed during Extended Trading Hours as defined in Cboe Options Rule 1.1(rrr). PO 00000 Frm 00119 Fmt 4703 Sfmt 4703 57313 regulation of Trading Permit Holder (‘‘TPH’’) customer options business, including performing routine surveillances, investigations, examinations, financial monitoring, as well as policy, rulemaking, interpretive and enforcement activities.6 The Exchange believes that revenue generated from the ORF, when combined with all of the Exchange’s other regulatory fees and fines, will cover a material portion, but not all, of the Exchange’s regulatory costs. The Exchange monitors the amount of revenue collected from the ORF to ensure that it, in combination with its other regulatory fees and fines, does not exceed the Exchange’s total regulatory costs. The Exchange monitors its regulatory costs and revenues at a minimum on a semi-annual basis. If the Exchange determines regulatory revenues exceed or are insufficient to cover a material portion of its regulatory costs, the Exchange will adjust the ORF by submitting a fee change filing to the Commission. The Exchange notifies TPHs of adjustments to the ORF via regulatory circular. The Exchange endeavors to provide TPHs with such notice at least 30 calendar days prior to the effective date of the change. Under the Exchange’s current process, the ORF is assessed to TPHs and collected indirectly from TPHs through their clearing firms by OCC on behalf of the Exchange. The following scenarios reflect how the ORF is currently assessed and collected (these apply regardless if the transaction is executed on the Exchange or on an away exchange): 1. If a TPH is the executing clearing firm on a transaction (‘‘Executing Clearing Firm’’), the ORF is assessed to and collected from that TPH by OCC on behalf of the Exchange. 2. If a TPH is the Executing Clearing Firm and the transaction is ‘‘given up’’ to a different TPH that clears the transaction (‘‘Clearing Give-up’’), the ORF is assessed to the Executing Clearing Firm (the ORF is the obligation of the Executing Clearing Firm). The ORF is collected from the Clearing Giveup. 3. If the Executing Clearing Firm is a non-TPH and the Clearing Give-up is a TPH, the ORF is assessed to and collected from the Clearing Give-up. 6 The Exchange notes that its regulatory responsibilities with respect to TPH compliance with options sales practice rules have largely been allocated to FINRA under a 17d–2 agreement. The ORF is not designed to cover the cost of that options sales practice regulation. See Securities Exchange Act Release No. 76309 (October 29, 2015), 80 FR 68361 (November 4, 2015). E:\FR\FM\04DEN1.SGM 04DEN1

Agencies

[Federal Register Volume 82, Number 231 (Monday, December 4, 2017)]
[Notices]
[Pages 57306-57313]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-25989]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-82161; File No. SR-OCC-2017-022]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Related to The Options 
Clearing Corporation's Margin Methodology

November 28, 2017.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), \1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on November 13, 2017, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule

[[Page 57307]]

change as described in Items I, II, and III below, which Items have 
been prepared by OCC. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    This proposed rule change by OCC would modify OCC's margin 
methodology to move away from the existing monthly data source provided 
by its current vendor and towards obtaining and incorporating daily 
price and returns (adjusted for any corporate actions) data of 
securities to estimate accurate margins.\3\ This would be further 
supported by enhancing OCC's econometric model applied to different 
risk factors; \4\ improving the sensitivity and stability of 
correlation estimates between them; and enhancing OCC's methodology 
around the treatment of securities with limited historical data. OCC 
also proposes to make a few clarifying and clean-up changes to its 
margin methodology unrelated to the proposed changes described above.
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    \3\ OCC also has filed an advance notice with the Commission in 
connection with the proposed changes. See SR-OCC-2017-811.
    \4\ The use of risk factors in OCC's margin methodology is 
discussed in more detail in the Background section of Item II below.
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    The proposed changes to OCC's Margins Methodology document are 
contained in confidential Exhibit 5 of the filing. The proposed changes 
are described in detail in Item II below. The proposed rule change does 
not require any changes to the text of OCC's By-Laws or Rules. All 
terms with initial capitalization that are not otherwise defined herein 
have the same meaning as set forth in the OCC By-Laws and Rules.\5\
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    \5\ OCC's By-Laws and Rules can be found on OCC's public Web 
site: http://optionsclearing.com/about/publications/bylaws.jsp.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

(1) Purpose
Background
    OCC's margin methodology, the System for Theoretical Analysis and 
Numerical Simulations (``STANS''), is OCC's proprietary risk management 
system that calculates Clearing Member margin requirements.\6\ STANS 
utilizes large-scale Monte Carlo simulations to forecast price and 
volatility movements in determining a Clearing Member's margin 
requirement.\7\ The STANS margin requirement is calculated at the 
portfolio level of Clearing Member accounts with positions in 
marginable securities and consists of an estimate of a 99% expected 
shortfall \8\ over a two-day time horizon and an add-on margin charge 
for model risk (the concentration/dependence stress test charge).\9\ 
The STANS methodology is used to measure the exposure of portfolios of 
options and futures cleared by OCC and cash instruments in margin 
collateral.
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    \6\ See Securities Exchange Act Release No. 53322 (February 15, 
2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-20).
    \7\ See OCC Rule 601.
    \8\ The expected shortfall component is established as the 
estimated average of potential losses higher than the 99% value at 
risk threshold. The term ``value at risk'' or ``VaR'' refers to a 
statistical technique that, generally speaking, is used in risk 
management to measure the potential risk of loss for a given set of 
assets over a particular time horizon.
    \9\ A detailed description of the STANS methodology is available 
at http://optionsclearing.com/risk-management/margins/.
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    A ``risk factor'' within OCC's margin system may be defined as a 
product or attribute whose historical data is used to estimate and 
simulate the risk for an associated product. The majority of risk 
factors utilized in the STANS methodology are total returns on 
individual equity securities. Other risk factors considered include: 
Returns on equity indexes; returns on implied volatility \10\ risk 
factors that are a set of nine chosen volatility pivots per product; 
\11\ changes in foreign exchange rates; and changes in model parameters 
that sufficiently capture the model dynamics from a larger set of data.
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    \10\ Generally speaking, the implied volatility of an option is 
a measure of the expected future volatility of the value of the 
option's annualized standard deviation of the price of the 
underlying security, index, or future at exercise, which is 
reflected in the current option premium in the market. Using the 
Black-Scholes options pricing model, the implied volatility is the 
standard deviation of the underlying asset price necessary to arrive 
at the market price of an option of a given strike, time to 
maturity, underlying asset price and given the current risk-free 
rate. In effect, the implied volatility is responsible for that 
portion of the premium that cannot be explained by the then-current 
intrinsic value (i.e., the difference between the price of the 
underlying and the exercise price of the option) of the option, 
discounted to reflect its time value.
    \11\ In December 2015, the Commission approved a proposed rule 
change, and issued a Notice of No Objection to an advance notice 
filing, by OCC to its modify margin methodology by more broadly 
incorporating variations in implied volatility within STANS. See 
Securities Exchange Act Release No. 34-76781 (December 28, 2015), 81 
FR 135 (January 4, 2016) (SR-OCC-2015-016) and Securities Exchange 
Act Release No. 34-76548 (December 3, 2015), 80 FR 76602 (December 
9, 2015) (SR-OCC-2015-804).
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    Under OCC's current margin methodology, OCC obtains monthly price 
data for most of its equity-based products \12\ from a widely used 
industry vendor. This data arrives around the second week of every 
month in arrears and requires a maximum of about four weeks for OCC to 
process the data after any clean up and reruns as may be required prior 
to installing into OCC's margin system. As a result, correlations and 
statistical parameters for risk factors at any point in time represent 
back-dated data and therefore may not be representative of the most 
recent market data. In the absence of daily updates, OCC employs an 
approach where one or many identified market proxies (or ``scale-
factors'') are used to incorporate day-to-day market volatility across 
all associated asset classes throughout.\13\ The scale factor approach, 
however, assumes a perfect correlation of the volatilities between the 
security and its scale factor, which gives little room to capture the 
idiosyncratic risk of a given security and which may be different from 
the broad market risk represented by the scale factor.
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    \12\ The securities underlying these products are also known as 
risk factors within OCC's margin system.
    \13\ Earlier this year, the Commission approved a proposed rule 
change and issued a Notice of No Objection to an advance notice 
filing by OCC which, among other things: (1) Expanded the number of 
scale factors used for equity-based products to more accurately 
measure the relationship between current and long-run market 
volatility with proxies that correlate more closely to certain 
products carried within the equity asset class, and (2) applied 
relevant scale factors to the greater of (i) the estimated variance 
of 1-day return scenarios or (ii) the historical variance of the 
daily return scenarios of a particular instrument, as a floor to 
mitigate procyclicality. See Securities Exchange Act Release No. 
80147 (March 3, 2017), 82 FR 13163 (March 9, 2017) (SR-OCC-2017-001) 
and Securities Exchange Act Release No. 80143 (March 2, 2017), 82 FR 
13036 (March 8, 2017) (SR-OCC-2017-801).
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    In risk management, it is a common practice to establish a floor 
for volatility at a certain level in order to protect against 
procyclicality \14\ in the model.

[[Page 57308]]

OCC imposes a floor on volatility estimates for its equity-based 
products using a 500-day look back period. These monthly updates 
coupled with the dependency of margins on scale factors and the 
volatility floor can result in imprecise changes in margins charged to 
Clearing Members, specifically across periods of heavy volatility when 
the correlation between the risk factor and a scale factor fluctuate.
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    \14\ A quality that is positively correlated with the overall 
state of the market is deemed to be ``procyclical.'' For example, 
procyclicality may be evidenced by increasing margin or Clearing 
Fund requirements in times of stressed market conditions and low 
margin or Clearing Fund requirements when markets are calm. Hence, 
anti-procyclical features in a model are measures intended to 
prevent risk-based models from fluctuating too drastically in 
response to changing market conditions.
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    OCC's current methodology for estimating covariance and 
correlations between risk factors relies on the same monthly data 
described above, resulting in a similar lag time between updates. In 
addition, correlation estimates are based off historical returns 
series, with estimates between a pair of risk factors being highly 
sensitive to the volatility of either risk factor in the chosen pair. 
The current approach therefore results in potentially less stable 
correlation estimates that may not be representative of current market 
conditions.
    Finally, under OCC's existing margin methodology, theoretical price 
scenarios for ``defaulting securities'' \15\ are simulated using 
uncorrelated return scenarios with an average zero return and a pre-
specified volatility called ``default variance.'' The default variance 
is estimated as the average of the top 25 percent quantile of the 
conditional variances of all securities. As a result, these default 
estimates may be impacted by extremely illiquid securities with 
discontinuous data. In addition, the default variance (and the 
associated scale factors used to scale up volatility) is also subject 
to sudden jumps with the monthly simulation installations across 
successive months because it is derived from monthly data updates, as 
opposed to daily updates, which are prone to wider fluctuations and are 
subject to adjustments using scale factors.
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    \15\ Within the context of OCC's margin system, securities that 
do not have enough historical data for calibration are classified as 
``defaulting securities.''
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Proposed Changes
    OCC proposes to modify its margin methodology by: (1) Obtaining 
daily price data for equity products (including daily corporate action-
adjusted returns of equities where price and thus returns of securities 
are adjusted for any dividends issued, stock splits, etc.) for use in 
the daily estimation of econometric model parameters; (2) enhancing its 
econometric model for updating statistical parameters (e.g., parameters 
concerning correlations or volatility) for all risk factors that 
reflect the most recent data obtained; (3) improving the sensitivity 
and stability of correlation estimates across risk factors by using de-
volatized \16\ returns (but using a 500 day look back period); and (4) 
improving OCC's methodology related to the treatment of defaulting 
securities that would result in stable and realistic risk estimates for 
such securities.\17\
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    \16\ De-volatization is a process of normalizing historical data 
with the associated volatility thus enabling any comparison between 
different sets of data.
    \17\ In addition to the proposed methodology changes described 
herein, OCC also would make some clarifying and clean-up changes, 
unrelated to the proposed changes described above, to update its 
margin methodology to reflect existing practices for the daily 
calibration of seasonal and non-seasonal energy models and the 
removal of methodology language for certain products that are no 
longer cleared by OCC.
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    The purpose of the proposed changes is to enhance OCC's margin 
methodology to mitigate the issues described above that arise from the 
current monthly update and scale factor approach. Specifically, by 
introducing daily (as opposed to monthly) updates for price data (and 
thereby allowing for daily updates of statistical parameters in the 
model) and making other proposed model enhancements described herein, 
the proposed changes are designed to result in more accurate and 
responsive margin requirements and a model that is more stable and 
proactive during times of market volatility, with margins that are 
based off of the most recent market data. In addition, the proposed 
changes are intended to improve OCC's approach to estimating covariance 
and correlations between risk factors in an effort to achieve more 
stable and sensitive correlation estimations and improve OCC's 
methodology related to the treatment of defaulting securities by 
reducing the impact that illiquid securities with discontinuous data 
have on default variance estimates.
    The proposed changes are described in further detail below.
1. Daily Updates of Price Data
    OCC proposes to introduce daily updates for price data for equity 
products, including daily corporate action-adjusted returns of 
equities, Exchange Traded Funds (``ETFs''), Exchange Traded Notes 
(``ETNs'') and certain indexes. The daily price data would be obtained 
from a widely used external vendor, as is the case with the current 
monthly updates. The purpose of the proposed change is to ensure that 
OCC's margin methodology is reliant on data that is more representative 
of current market conditions, thereby resulting in more accurate and 
responsive margin requirements.
    As described above, OCC currently obtains price data for all 
securities on a monthly basis from a third party vendor. After 
obtaining the monthly price data, additional time is required for OCC 
to process the data prior to installing into OCC's margin system. As a 
result, correlations and statistical parameters for risk factors at any 
point in time represent back-dated data and therefore may not be 
representative of the most recent market data. To mitigate pro-
cyclicality within its margin methodology in the absence of daily 
updates, OCC employs the use of scale-factors to incorporate day-to-day 
market volatility across all associated asset classes. While the scale 
factors help to reduce procyclicality in the model, the scale factors 
do not necessarily capture the idiosyncratic risks of a given security, 
which may be different from the broad market risk represented by the 
scale factor.
    OCC proposes to address these issues associated with its current 
margin methodology by eliminating its dependency on monthly price data, 
which arrives in arrears and requires additional time for OCC to 
process the data prior to installing into OCC's margin system through 
the introduction of daily updates for price data for equity products. 
The introduction of daily price updates would enable OCC's margin 
methodology to better capture both market as well idiosyncratic risk by 
allowing for daily updates to the parameters associated with the 
econometric model (discussed below) that capture the risk associated 
with a particular product, and therefore ensure that OCC's margin 
requirements are based on more current market conditions. As a result, 
OCC would also reduce its reliance on the use of scale factors to 
incorporate day-to-day market volatility, which, as noted above, give 
little room to capture the idiosyncratic risk of a given security and 
which may be different from the broad market risk represented by the 
scale factor. In addition, the processing time between receipt of the 
data and installation into the margin system would be reduced as the 
data review and processing for daily prices would be incorporated into 
OCC's daily price editing process.
2. Proposed Enhancements to the Econometric Model
    In addition to introducing daily updates for price and corporate 
action-adjusted returns data, OCC is proposing enhancements to its 
econometric model

[[Page 57309]]

for calculating statistical parameters for all qualifying risk factors 
that reflect the most recent data obtained (e.g., OCC would be able to 
calculate parameters such as volatility and correlations on a daily 
basis using the new daily price data discussed above). Specifically, 
OCC proposes to enhance its econometric model by: (i) Introducing daily 
updates for statistical parameters; (ii) introducing features in its 
econometric model that are designed to take into account asymmetry in 
the model used to forecast volatility associated with a risk factor; 
(iii) modifying the statistical distribution used to model the returns 
of equity prices; (iv) introducing a second-day forecast for volatility 
into the model to estimate the two-day scenario distributions for risk 
factors; and (v) imposing a floor on volatility estimates using a 10-
year look back period.
    These proposed model enhancements are described in detail below.
i. Daily Updates for Statistical Parameters
    Under the proposal, the statistical parameters for the model would 
be updated on a daily basis using the new daily price data obtained by 
OCC (as described in section 1 above).\18\ As a result, OCC would no 
longer need to rely on scale factors to approximate day-to-day market 
volatility for equity-based products. Statistical parameters would be 
calibrated on daily basis, allowing OCC to calculate more accurate 
margin requirements that are representative of the most recent market 
data.
---------------------------------------------------------------------------

    \18\ OCC notes that this change would apply to most risk factors 
with the exception of certain equity indexes, Treasury securities, 
and energy futures products, which are already updated on a daily 
basis.
---------------------------------------------------------------------------

ii. Proposed Enhancements To Capture Asymmetry in Conditional Variance
    In addition to the daily update of statistical parameters, OCC 
proposes to include new features in its econometric model that are 
designed to take into account asymmetry in the conditional variance 
process. The econometric model currently used in STANS for all risk 
factors is a GARCH(1,1) with Student's t-distributed innovations of 
logarithmic returns,\19\ which is a relatively straightforward and 
widely used model to forecast volatility.\20\ The current approach for 
forecasting the conditional variance for a given risk factor does not, 
however, consider the asymmetric volatility phenomenon observed in 
financial markets (also called the ``leverage effect'') where 
volatility is more sensitive and reactive to market downturns. As a 
result, OCC proposes to enhance its model by adding new features (i.e., 
incorporating asymmetry into its forecast volatility) designed to allow 
the conditional volatility forecast to be more sensitive to market 
downturns and thereby capture the most significant dynamics of the 
relationship between price and volatility observed in financial 
markets. OCC believes the proposed enhancement would result in more 
accurate and responsive margin requirements, particularly in market 
downturns.
---------------------------------------------------------------------------

    \19\ The Student's t distribution is a widely used statistical 
distribution to model the historical logarithmic price returns data 
of a security that allows for the presence of fat tails (aka 
kurtosis) or a non-zero conditional fourth moment.
    \20\ See generally Tim Bollerslev, ``Generalized Autoregressive 
Conditional Heteroskedasticity,'' Journal of Econometrics, 31(3), 
307-327 (1986). The acronym ``GARCH'' refers to an econometric model 
that can be used to estimate volatility based on historical data. 
The general distinction between the ``GARCH variance'' and the 
``sample variance'' for a given time series is that the GARCH 
variance uses the underlying time series data to forecast 
volatility.
---------------------------------------------------------------------------

iii. Proposed Change in Statistical Distribution
    OCC further proposes to change the statistical distribution used to 
model the returns of equity prices. OCC's current methodology uses a 
fat tailed distribution \21\ (the Student's t-distribution) to model 
returns; however, price scenarios generated using very large log-return 
scenarios (positive) that follow this distribution can approach 
infinity and could potentially result in excessively large price jumps, 
a known limitation of this distribution. OCC proposes to move to a more 
defined distribution (Standardized Normal Reciprocal Inverse Gaussian 
or NRIG) for modeling returns, which OCC believes would more 
appropriately simulate future returns based on the historical price 
data for the products in question (i.e., it has a better ``goodness of 
fit'' \22\ to the historical data) and allows for more appropriate 
modeling of fat tails. As a result, OCC believes that the proposed 
change would lead to more consistent treatment of log returns both on 
the upside as well as downside of the distribution.
---------------------------------------------------------------------------

    \21\ A data set with a ``fat tail'' is one in which extreme 
price returns have a higher probability of occurrence than would be 
the case in a normal distribution.
    \22\ The goodness of fit of a statistical model describes the 
extent to which observed data match the values generated by the 
model.
---------------------------------------------------------------------------

iv. Second Day Volatility Forecast
    OCC also proposes to introduce a second-day forecast for volatility 
into the model to estimate the two-day scenario distributions for risk 
factors.\23\ Under the current methodology, OCC typically uses a two-
day horizon to determine its risk exposure to a given portfolio. This 
is done by simulating 10,000 theoretical price scenarios for the two-
day horizon using a one-day forecast conditional variance, and the 
value at risk and expected shortfall components of the margin 
requirement are then determined from the simulated profit/loss 
distributions. These one-day and two-day returns scenarios are both 
simulated using the one-day forecast conditional variance estimate. 
This could lead to a risk factor's coverage differing substantially on 
volatile trading days. As a result, OCC proposes to introduce a second-
day forecast variance for all equity-based risk factors. The second-day 
conditional variance forecast would be estimated for each of the 10,000 
Monte Carlo returns scenarios, resulting in more accurately estimated 
two-day scenario distributions, and therefore more accurate and 
responsive margin requirements.
---------------------------------------------------------------------------

    \23\ This proposed change would not apply to STANS implied 
volatility scenario risk factors. For those risk factors, OCC's 
existing methodology would continue to apply. See supra note 11.
---------------------------------------------------------------------------

v. Anti-Procyclical Floor for Volatility Estimates
    Additionally, OCC proposes to modify its floor for volatility 
estimates. OCC currently imposes a floor on volatility estimates for 
its equity-based products using a 500-day look back period. OCC 
proposes to extend this look back period to 10-years (2520 days) in the 
enhanced model and to apply this floor to volatility estimates for 
other products (excluding implied volatility risk factor scenarios). 
The proposed model described herein is calibrated from historical data, 
and as a result, the level of the volatilities generated by the model 
will vary from time to time. OCC is therefore proposing to establish a 
volatility floor for the model using a 10-year look back period to 
reduce the risk of procyclicality in its margin model. OCC believes 
that using a longer 10-year look back period will ensure that OCC 
captures sufficient historical events/market shocks in the calculation 
of its anti-procyclical floor. The 10-year look back period also is in 
line with requirements of the European Market Infrastructure Regulation 
(including regulations thereunder) \24\ concerning the calibration of 
risk factors.
---------------------------------------------------------------------------

    \24\ Regulation (EU) No 648/2012 of the European Parliament and 
of the Council of 4 July 2012 on OTC derivatives, central 
counterparties and trade repositories. Specifically, the proposed 
floor would be compliant with Article 28 of Commission Delegated 
Regulation (EU) No. 153/2013 of 19 December 2012 Supplementing 
Regulation (EU) No. 648/2012 of the European Parliament and of the 
Council with regard to Regulatory Technical Standards on 
Requirements for Central Counterparties (the ``Regulatory Technical 
Standards'').

---------------------------------------------------------------------------

[[Page 57310]]

3. Proposed Enhancements to Correlation Estimates
    As described above, OCC's current methodology for estimating 
covariance and correlations between risk factors relies on the same 
monthly price data feeding the econometric model, resulting in a 
similar lag time between updates. In addition, correlation estimates 
are based off historical returns series, with estimates between a pair 
of risk factors being highly sensitive to the volatility of either risk 
factors in the chosen pair. The current approach therefore results in 
correlation estimates being sensitive to volatile historical data.
    In order to address these limitations, OCC proposes to enhance its 
methodology for calculating correlation estimates by moving to a daily 
process for updating correlations (with a minimum of one week's lag) to 
ensure Clearing Member account margins are more current and thus more 
accurate. Moreover, OCC proposes to enhance its approach to modeling 
correlation estimates by de-volatizing \25\ the returns series to 
estimate the correlations. Under the proposed approach, OCC would first 
consider the returns excess of the mean (i.e., the average estimated 
from historical data sample) and then further scale them by the 
corresponding estimated conditional variances. OCC believes that by 
using de-volatized returns, which is a widely suggested approach in 
relevant literature, it would lead to normalizing returns across a 
variety of asset classes and make the correlation estimator less 
sensitive to sudden market jumps and therefore more stable.
---------------------------------------------------------------------------

    \25\ See supra note 16.
---------------------------------------------------------------------------

4. Defaulting Securities Methodology
    Finally, OCC proposes to enhance its methodology for estimating the 
defaulting variance in its model. OCC's margin system is dependent on 
market data to determine Clearing Member margin requirements. 
Securities that do not have enough historical data are classified as to 
be a ``defaulting security'' within OCC systems (e.g., IPO securities). 
As noted above, within current STANs systems, the theoretical price 
scenarios for defaulting securities are simulated using uncorrelated 
return scenarios with a zero mean and a default variance, with the 
default variance being estimated as the average of the top 25 percent 
quantile of the conditional variances of all securities. As a result, 
these default estimates may be impacted by extremely illiquid 
securities with discontinuous data. In addition, the default variance 
(and the associated scale factors used to scale up volatility) is also 
subject to sudden jumps with the monthly simulation installations 
across volatile months. To mitigate these concerns, OCC proposes to: 
(i) Use only optionable equity securities to estimate the defaulting 
variance; (ii) use a shorter time series to enable calibration of the 
model for all securities; and (iii) simulating default correlations 
with the driver Russell 2000 index (``RUT'').
i. Proposed Modifications to Securities and Quantile Used in Estimation
    OCC proposes that only optionable equity securities, which are 
typically more liquid, be considered while estimating the default 
variance. This limitation would eliminate from the estimation almost 
all illiquid securities with discontinuous data that could contribute 
to high conditional variance estimates and thus a high default 
variance. In addition, OCC proposes to estimate the default variance as 
the lowest estimate of the top 10% of the floored conditional variance 
across the risk factors. This change in methodology is designed to 
ensure that while the estimate is aggressive it is also robust to the 
presence of outliers caused by a few extremely volatile securities that 
influence the location parameter of a distribution. Moreover, as a 
consequence of the daily updates described above, the default variances 
would change daily and there would be no scale factor to amplify the 
effect of the variance on risk factor coverage.
ii. Proposed Change in Time Series
    In addition, OCC proposes to use a shorter time series to enable 
calibration of the model for all securities. Currently, OCC does not 
calibrate parameters for defaulting securities that have historical 
data of less than two years. OCC is proposing to shorten this time 
period to around 6 months (180 days) to enable calibration of the model 
for all securities within OCC systems. OCC believes that this shorter 
time series is sufficient to produce stable calibrated parameters.
iii. Proposed Default Correlation
    Finally, OCC proposes that returns scenarios for defaulting 
securities, securities with insufficient historical data, be simulated 
using a default correlation with the driver RUT.\26\ The RUT Index is a 
small cap index and is hence a natural choice to represent most new 
issues that are small cap and deemed to be a ``defaulting security.'' 
The default correlation is roughly equal to the median of all 
positively correlated securities with the index. Since 90% of the risk 
factors in OCC systems correlate positively to the RUT index, OCC would 
only consider those risk factors to determine the median. OCC believes 
that the median of the correlation distribution has been steady over a 
number of simulations and is therefore proposing that it replace the 
current methodology of simulating uncorrelated scenarios, which OCC 
believes is not a realistic approach.
---------------------------------------------------------------------------

    \26\ OCC notes that, in certain limited circumstances where 
there are reasonable grounds backed by the existing return history 
to support an alternative approach in which the returns are strongly 
correlated with those of an existing risk factor (a ``proxy'') with 
a full price history, the Margins Methodology allows OCC's Financial 
Risk Management staff to construct a ``conditional'' simulation to 
override any default treatment that would have otherwise been 
applied to the defaulting security.
---------------------------------------------------------------------------

Clearing Member Outreach
    OCC has discussed the proposed changes with its Financial Risk 
Advisory Council \27\ at a meeting held on October 25, 2016. OCC also 
provided general updates to members at OCC Roundtable \28\ meetings on 
June 20, 2017, and November 9, 2017. Clearing Members expressed 
interest in seeing how reactive margin changes would be under the 
proposal; however, there were no objections or significant concerns 
expressed regarding the proposed changes. OCC will provide at least 30-
days of parallel reporting prior to implementation so that Clearing 
Members can see the impact of the proposed changes. In addition, OCC 
would publish an Information Memorandum to all Clearing Members 
describing the proposed change and will provide additional periodic 
Information Memoranda updates prior to the implementation date. 
Additionally, OCC would perform targeted and direct outreach with 
Clearing Members that would be most impacted by the proposed changes to 
the margin methodology and OCC would work closely with such Clearing 
Members to coordinate the implementation and associated funding for 
such Clearing

[[Page 57311]]

Members resulting from the proposed change.\29\
---------------------------------------------------------------------------

    \27\ The Financial Risk Advisory Council is a working group 
consisting of representatives of Clearing Members and exchanges 
formed by OCC to review and comment on various risk management 
proposals.
    \28\ The OCC Roundtable was established to bring Clearing 
Members, exchanges and OCC together to discuss industry and 
operational issues. It is comprised of representatives of the senior 
OCC staff, participant exchanges and Clearing Members, representing 
the diversity of OCC's membership in industry segments, OCC-cleared 
volume, business type, operational structure and geography.
    \29\ Specifically, OCC will discuss with those Clearing Members 
how they plan to satisfy any increase in their margin requirements 
associated with the proposed change.
---------------------------------------------------------------------------

(2) Statutory Basis
    OCC believes that the proposed rule change is consistent with 
Section 17A of the Securities Exchange Act of 1934, as amended (the 
``Act''),\30\ and the rules thereunder applicable to OCC. Section 
17A(b)(3)(F) of Act \31\ requires that the rules of a clearing agency 
be designed to assure the safeguarding of securities and funds which 
are in the custody or control of the clearing agency or for which it is 
responsible. OCC believes the propose rule change would enhance its 
margin methodology in a manner designed to safeguard the securities and 
funds in its custody or control for the reasons set forth below.
---------------------------------------------------------------------------

    \30\ 15 U.S.C. 78q-1.
    \31\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    As noted above, OCC's current margin methodology relies on monthly 
price data being obtained from a third party vendor. This data arrives 
monthly in arrears and requires additional time for OCC to process the 
data prior to installing into OCC's margin system. As a result, 
correlations and statistical parameters for risk factors at any point 
in time represent back-dated data and therefore may not be 
representative of the most recent market data. To mitigate 
procyclicality within its margin methodology in the absence of daily 
updates, OCC employs a scale factor approach to incorporate day-to-day 
market volatility across all associated asset classes throughout.\32\ 
For the reasons noted above, these monthly updates coupled with the 
dependency of margins on scale factors can result in imprecise changes 
in margins charged to Clearing Members, specifically across periods of 
heavy volatility.
---------------------------------------------------------------------------

    \32\ See supra note 13 and accompanying text.
---------------------------------------------------------------------------

    OCC proposes to enhance its margin methodology to introduce daily 
updates for equity price data, thereby allowing for daily updates of 
statistical parameters in its margin model for most risk factors. In 
addition, the proposed changes would introduce features to the model to 
better account for the asymmetric volatility phenomenon observed in 
financial markets and allow for conditional volatility forecast to be 
more sensitive to market downturns. The proposed changes would also 
introduce a new statistical distribution for modeling equity price 
returns that OCC believes would have a better goodness of fit and would 
more appropriately account for fait tails. Moreover, the proposed 
changes would introduce a second-day volatility forecast into the model 
to provide for more accurate and timely estimations of its two-day 
scenario distributions. OCC also proposes to enhance its econometric 
model by establishing a volatility floor using a 10-year look back 
period to reduce procyclicality in the margin model. OCC believes the 
proposed changes would result in more accurate and responsive margin 
requirements and a model that is more stable and proactive during times 
of market volatility, with risk charges that are based off of most 
recent market data.
    In addition, the proposed rule change is intended to improve OCC's 
approach to estimating covariance and correlations between risk factors 
in an effort to achieve more stable and sensitive correlation 
estimations and improve OCC's methodology related to the treatment of 
defaulting securities by reducing the impact that illiquid securities 
with discontinuous data have on default variance estimates.
    The proposed methodology changes would be used by OCC to calculate 
margin requirements designed to limit its credit exposures to 
participants, and OCC uses the margin it collects from a defaulting 
Clearing Member to protect other Clearing Members from losses that may 
result from such a default. As a result, OCC believes the proposed rule 
changed is designed to assure the safeguarding of securities and funds 
in its custody or control in accordance with Section 17A(b)(3)(F) of 
the Act.\33\
---------------------------------------------------------------------------

    \33\ Id.
---------------------------------------------------------------------------

    Rules 17Ad-22(b)(1) and (2) \34\ require that a registered clearing 
agency that performs central counterparty services establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to, in part: (1) Measure its credit exposures to 
its participants at least once a day and limit its exposures to 
potential losses from defaults by its participants under normal market 
conditions so that the operations of the clearing agency would not be 
disrupted and non-defaulting participants would not be exposed to 
losses that they cannot anticipate or control and (2) use margin 
requirements to limit its credit exposures to participants under normal 
market conditions and use risk-based models and parameters to set 
margin requirements.
---------------------------------------------------------------------------

    \34\ 17 CFR 240.17Ad-22(b)(1) and (2).
---------------------------------------------------------------------------

    As noted above, the proposed changes would introduce the use of 
daily price updates into OCC's margin methodology, which allows for 
daily updates to the statistical parameters in the model (e.g., 
parameters concerning volatility and correlation). These changes would 
be supported by a number of other risk-based enhancements to OCC's 
econometric model designed to: (i) More appropriately account for 
asymmetry in conditional variance; (ii) more appropriately model the 
statistical distribution of price returns; (iii) provide for an anti-
procyclical floor for volatility estimates based on a 10-year look back 
period; and (iv) more accurately model second-day volatility forecasts. 
Moreover, the proposed changes would improve OCC's approach to 
estimating covariance and correlations between risk factors in an 
effort to achieve more stable and sensitive correlation estimations and 
improve OCC's methodology related to the treatment of defaulting 
securities by reducing the impact that illiquid securities with 
discontinuous data have on default variance estimates.
    OCC would use the risk-based model enhancements described herein to 
measure its credit exposures to its participants on a daily basis and 
determine margin requirements based on such calculations. The proposed 
enhancements concerning daily price updates, daily updates of 
statistical parameters, and to more appropriately account for asymmetry 
in conditional variance would result in more accurate and responsive 
margin requirements and a model that is more stable and proactive 
during times of market volatility, with margin charges that are based 
off of the most recent market data. In addition, the proposed 
modifications to extend the look back period for determining volatility 
estimates for equity-based products from 500 days to 10 years will help 
to ensure that OCC captures sufficient historical events/market shocks 
in the calculation of its anti-procyclical floor. Additionally, the 
proposed changes would enhance OCC's margin methodology for calculating 
correlation estimates by moving to a daily process for updating 
correlations (with a minimum of one week's lag) so that Clearing Member 
account margins are more current and thus more accurate and using de-
volatized returns to normalize returns across a variety of asset 
classes and make the correlation estimator less sensitive to sudden 
market jumps and therefore more stable. Finally, the proposed changes 
to OCC's methodology for the treatment of defaulting securities is 
designed to result in stable and realistic risk estimates for such 
securities The proposed changes are therefore designed to ensure that 
OCC sets margin

[[Page 57312]]

requirements, using risk-based models and parameters, that would serve 
to limit OCC's exposures to potential losses from defaults by its 
participants under normal market conditions so that the operations of 
OCC would not be disrupted and non-defaulting participants would not be 
exposed to losses that they cannot anticipate or control. Accordingly, 
OCC believes the proposed changes are consistent with Rules 17Ad-
22(b)(1) and (2).\35\
---------------------------------------------------------------------------

    \35\ Id.
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(6) \36\ further requires OCC to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to cover its credit exposures to its participants 
by establishing a risk-based margin system that, among other things: 
(i) Considers, and produces margin levels commensurate with, the risks 
and particular attributes of each relevant product, portfolio, and 
market; (ii) calculates margin sufficient to cover its potential future 
exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default; and (iii) uses reliable sources of timely price data and uses 
procedures and sound valuation models for addressing circumstances in 
which pricing data are not readily available or reliable.
---------------------------------------------------------------------------

    \36\ 17 CFR 240.17Ad-2(e)(6).
---------------------------------------------------------------------------

    As described in detail above, the proposed changes are designed to 
ensure that, among other things, OCC's margin methodology: (i) More 
appropriately accounts for asymmetry in conditional variance; (ii) more 
appropriately models the statistical distribution of price returns, 
(iii) more accurately models second-day volatility forecasts; (iv) 
improves OCC's approach to estimating covariance and correlations 
between risk factors to provide for stable and sensitive correlation 
estimations; and (v) improves OCC's methodology related to the 
treatment of defaulting securities by reducing the impact that illiquid 
securities with discontinuous data have on default variance estimates. 
These methodology enhancements would be used to calculate daily margin 
requirements for OCC's Clearing Members. In this way, the proposed 
changes are designed to consider, and produce margin levels 
commensurate with, the risks and particular attributes of each relevant 
product, portfolio, and market and to calculate margin sufficient to 
cover its potential future exposure to participants in the interval 
between the last margin collection and the close out of positions 
following a participant default.
    Moreover, the proposed changes would introduce daily updates for 
price data for equity products, including daily corporate action-
adjusted returns of equities, ETFs, ETNs, and certain indexes. This 
daily price data would be obtained from a widely used and reliable 
industry vendor. In this way, the proposed changes would ensure that 
OCC uses reliable sources of timely price data in its margin 
methodology, which better reflect current market conditions than the 
current monthly updates, thereby resulting in more accurate and 
responsive margin requirements.
    For these reasons, OCC believes that the proposed changes are 
consistent with Rule 17Ad-22(e)(6).\37\
---------------------------------------------------------------------------

    \37\ Id.
---------------------------------------------------------------------------

    The proposed rule changes are not inconsistent with the existing 
rules of OCC, including any other rules proposed to be amended.

(B) Clearing Agency's Statement on Burden on Competition

    Section 17A(b)(3)(I) requires that the rules of a clearing agency 
do not impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of Act.\38\ OCC does not believe that the 
proposed rule change would impose any burden on competition. The 
proposed risk model enhancements would apply to all Clearing Members 
equally. While OCC expects that margin requirements may see slight 
reductions in the aggregate, the individual impact of the proposed 
changes will be mixed and depend on market conditions and the 
composition of the portfolio in question. The proposed rule change is 
primarily designed to allow OCC to determine margin requirements that 
more accurately represent the risk presented by its cleared products 
and that are more responsive to changes in volatility or overall market 
conditions. OCC does not believe that the proposed rule change would 
unfairly inhibit access to OCC's services or disadvantage or favor any 
particular user in relationship to another user. Accordingly, OCC 
believes that any competitive impact would be necessary and appropriate 
in furtherance of the safeguarding of securities and funds which are in 
the custody or control of OCC or for which it is responsible, and in 
general, the protection of investors and the public interest.
---------------------------------------------------------------------------

    \38\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received from Members, Participants or Others

    Written comments on the proposed rule change were not and are not 
intended to be solicited with respect to the proposed rule change and 
none have been received. OCC will notify the Commission of any written 
comments received by OCC.

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 within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

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 (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-OCC-2017-022 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-2017-022. 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 (http://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

[[Page 57313]]

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 
such filing also will be available for inspection and copying at the 
principal office of OCC and on OCC's Web site at https://www.theocc.com/about/publications/bylaws.jsp.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-OCC-2017-022 and should be 
submitted on or before December 26, 2017.
---------------------------------------------------------------------------

    \39\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated Authority.\39\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-25989 Filed 12-1-17; 8:45 am]
BILLING CODE 8011-01-P