Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving Proposed Rule Change Relating to The Options Clearing Corporation's Counterparty Credit Risk Management Policy, 60242-60246 [2017-27231]

Download as PDF 60242 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Notices those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website 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 LCH SA and on LCH SA’s website at http://www.lch.com/assetclasses/cdsclear. 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–LCH SA–2017–013 and should be submitted on or before January 9, 2018. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.14 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–27236 Filed 12–18–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–82312; File No. SR–OCC– 2017–009] Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving Proposed Rule Change Relating to The Options Clearing Corporation’s Counterparty Credit Risk Management Policy sradovich on DSK3GMQ082PROD with NOTICES December 13, 2017. On October 12, 2017, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) proposed rule change SR–OCC–2017–009 pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1 and Rule 19b–4 thereunder.2 The proposed rule change was published for comment in the Federal Register on November 1, 2017.3 The Commission did not receive any comment letters on the proposed rule 14 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 See Securities Exchange Act Release No. 34– 81949 (Oct. 26, 2017), 82 FR 50719 (Nov. 1, 2017) (File No. SR–OCC–2017–009). 1 15 VerDate Sep<11>2014 17:47 Dec 18, 2017 Jkt 244001 change. This order approves the proposed rule change. I. Description of the Proposed Rule Change This proposed rule change by OCC will formalize OCC’s Counterparty Credit Risk Management Policy (‘‘CCRM Policy’’). The proposed rule change does not require any changes to the text of OCC’s By-Laws or Rules.4 OCC stated that, as a central counterparty (‘‘CCP’’) providing clearance, settlement, and risk management services, it is exposed to and must manage a range of risks, including credit risk. According to OCC, the purpose of the CCRM Policy is to outline OCC’s overall approach to identify, measure, monitor, and manage its exposures to direct and indirect participants, Liquidity Providers,5 asset custodians, settlement banks, letter of credit issuers, investment counterparties, other clearing agencies, and financial market utilities (‘‘FMUs’’) 6 (each a ‘‘Counterparty’’) arising from its payment, clearing, and settlement processes. OCC noted that the CCRM Policy is part of a broader framework used by OCC to manage credit risk, including OCC’s By-Laws, Rules, and other policies and procedures that are designed collectively to ensure that OCC appropriately manages counterparty credit risk. The CCRM Policy outlines the key components of OCC’s framework for identifying, measuring, monitoring, and managing OCC’s exposures to its Counterparties. This framework includes: (1) The identification of credit risk, (2) Counterparty access and participation standards, (3) the measurement of Counterparty exposures, (4) the monitoring and managing of Counterparty exposures, and (5) voluntary termination of Counterparty relationships. Each of these components is described in more detail below. A. Identification of Credit Risk The CCRM Policy identifies various ways in which credit risk originates 4 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 Under the CCRM Policy, ‘‘Liquidity Provider’’ is defined as a Commercial Bank or a non-banking institution—generally a pension fund—that provides a committed liquidity facility to OCC. 6 Under the CCRM Policy, ‘‘Financial Market Utility’’ is defined as a derivatives clearing organization partnering with OCC to provide a cross-margin program; a clearing agency providing settlement services of securities arising from the exercise, assignment or maturity of options or futures; or the Depository providing book-entry securities transfers and asset custodian services. PO 00000 Frm 00070 Fmt 4703 Sfmt 4703 from the failure of a Counterparty to perform. With respect to a Clearing Member, the CCRM Policy details a number of different ways in which OCC may be exposed to credit risk. This includes the potential failure of a Clearing Member to pay for purchased options, to meet expiration-related settlement obligations, or to make certain mark-to-market variation payments or initial margin deposits. It also includes the potential insufficiency of a defaulting Clearing Member’s margin and Clearing Fund deposits in a liquidation scenario. Other sources of credit risk identified in the CCRM Policy include the inability of OCC to access collateral (e.g., cash or securities) from a custodian or investment counterparty that is needed to facilitate a liquidation, or a failure by an issuer of a letter of credit to honor its corresponding obligations. The CCRM Policy also identifies that certain relationships with other FMUs, such as cross-margining programs and cash market settlement services, represent critical linkages that may present certain degrees of credit exposure based on the terms and design of the linkage. The CCRM Policy also notes that OCC may face additional risks from Counterparties, such as the potential failure of a Liquidity Provider to honor a borrowing request. B. Counterparty Access and Participation Standards Under the CCRM Policy, OCC’s management of Counterparty credit risks begins with an initial evaluation process intended to ascertain that Counterparties meet certain minimum financial and operational standards and are considered as having a low probability of defaulting on their obligations prior to engaging or effecting any new transactions or expansion of business with OCC. To accomplish this objective, OCC evaluates each Counterparty against established minimum standards of creditworthiness, overall financial condition, and operational capabilities. Pursuant to the Policy, the standards used to evaluate Counterparties shall be objective, risk-based, and publiclydisclosed to permit fair and open access. These standards shall be developed independently for Clearing Members, Commercial and Central Banks, investment counterparties, Liquidity Providers and FMUs, accounting for differences in their regulatory reporting and overall business operations. Clearing Membership Standards OCC’s minimum participation standards for Clearing Member are E:\FR\FM\19DEN1.SGM 19DEN1 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Notices found in Article V of OCC’s By-Laws, Chapters II and III of OCC’s Rules, and other publicly-disclosed supplemental documentation (together, ‘‘Participation Standards Documentation’’). Under the Policy, OCC’s Credit Risk Management and Member Services Departments shall evaluate each Clearing Member applicant against the minimum standards of creditworthiness and for its overall financial condition and operational capabilities as provided in the Participation Standards Documentation. Such evaluation shall also consider the Counterparty’s aggregation of exposure on an individual and related-entities level, as applicable, as well as any material exposure that may arise from tiered participation arrangements. The Credit Risk Management and Member Services Departments shall document the results of this evaluation in a memorandum, including the Clearing Member applicant’s ability to meet relevant participation standards, and report those results to OCC’s Executive Chairman, Chief Operating Officer, or Chief Administrative Officer for review and approval, where appropriate, or for recommendation to the Risk Committee or Board of Directors.7 sradovich on DSK3GMQ082PROD with NOTICES Commercial and Central Banks OCC’s minimum standards for asset custodians, settlement banks, letter of credit issuers, and investment counterparties are found in OCC Rule 604 and relevant OCC procedures. The Credit Risk Management Department shall coordinate with various departments (such as Collateral Services or Treasury) to evaluate each bank against the minimum standards of creditworthiness and for its overall financial condition and operational capabilities as provided in OCC Rule 7 Pursuant to Article V, Section 2 of OCC’s ByLaws, the Executive Chairman, Chief Operating Officer and Chief Administrative Officer each have delegated authority to approve Clearing Member applicants provided that (1) there is no recommendation to impose additional membership criteria in accordance with Article V of the By-Laws and (2) the Risk Committee is given not less than five days to determine the application should be reviewed at a meeting of the Risk Committee. Pursuant to Interpretation and Policy .06 to Article V, Section 1 of OCC’s By-Laws, the Risk Committee has the authority to impose additional requirements on Clearing Member applicants, such as increased capital or margin requirements as well as restrictions on clearing activities. The Risk Committee also has the authority to approve waivers of certain clearing membership requirements under Article V, Section 1 of the ByLaws. Approvals of a Clearing Member business expansion by the Executive Chairman, Chief Operating Officer or Chief Administrative Officer are subsequently presented to the Risk Committee for ratification, except in limited circumstances detailed in Article V, Section 1.03(e) of OCC’s ByLaws. VerDate Sep<11>2014 17:47 Dec 18, 2017 Jkt 244001 604 and related OCC procedures. Such evaluation shall also consider the Counterparty’s aggregation of exposure on an individual and related-entities level, as applicable, as well as whether OCC would be able to structure its custodial relationships in a manner that allows prompt access to its own and its Clearing Members’ assets. The latter shall include holding assets at supervised and regulated institutions that adhere to generally accepted accounting practices, maintain safekeeping procedures, and have internal controls that fully protect these assets. Under the Policy, Credit Risk Management and either the Collateral Services or Treasury Department, as applicable, shall document the results of its evaluation in a memorandum, including the bank’s ability to meet relevant participation standards, and report those results to OCC’s Executive Chairman, Chief Operating Officer or Chief Administrative Officer, each of which shall have the authority to approve new and expanded relationships with asset custodians, settlement banks, letter of credit issuers, investment counterparties, and Liquidity Providers. Liquidity Providers Under the Policy, OCC maintains internal procedures outlining the minimum standards for Commercial Banks 8 and non-bank institutions acting as Liquidity Providers. OCC’s Credit Risk Management and Treasury Departments would be responsible for evaluating each Liquidity Provider against the minimum standards of creditworthiness and for its overall financial condition and operational capabilities as provided in the procedures. Because Liquidity Providers present both credit and liquidity risk to OCC, the due diligence around such institutions shall include a review of each lender’s ability to perform their commitments as well as understand and manage their liquidity risks. Pursuant to the Policy, Credit Risk Management and Treasury shall document the results of the evaluation in a memorandum, including the Liquidity Provider’s ability to meet relevant participation standards, and report those results to the Executive Chairman, Chief Operating Officer or Chief 8 Under the Policy, ‘‘Commercial Bank’’ is defined as a banking or depository institution that is not an operating arm of a Central Bank. Commercial Bank relationships shall be governed by this Policy and all supporting bank-related procedures. Commercial Banks act as Liquidity Providers, asset custodians, settlement banks, letter of credit issuers, and investment counterparties on behalf of OCC. PO 00000 Frm 00071 Fmt 4703 Sfmt 4703 60243 Administrative Officer, each of which shall have the authority to approve new and expanded relationships with Liquidity Providers. FMUs Under the Policy, OCC maintains internal procedures outlining minimum standards for FMUs. OCC’s Business Operations and Credit Risk Management Departments shall evaluate each FMU for its overall financial condition and operational capabilities as provided in the procedure. Pursuant to the CCRM Policy, before entering into a link with any FMU, the Legal Department shall assist the aforementioned business units to identify legal risks relating to rights and interests, collateral arrangements, settlement finality and netting arrangements, and financial and custody risks. The Business Operations, Credit Risk Management, and Legal Departments shall document the results of its evaluation in a memorandum, including the FMU’s ability to meet relevant standards. All new and expanded FMU relationships shall be reviewed and approved by the Risk Committee and subsequently recommended for approval to the Board of Directors. C. Measuring Counterparty Credit Risk The CCRM Policy describes various ways in which OCC measures the credit risk posed by different Counterparties. With respect to Clearing Members, the CCRM Policy provides that OCC measures its credit exposures to Clearing Members under normal market conditions through the calculation of margin requirements and under extreme but plausible conditions through stress testing and the calculation of Clearing Fund requirements, in accordance with applicable OCC policies. Margin, Clearing Fund, and stress test results may be used by OCC’s Financial Risk Management Department (‘‘FRM’’) to evaluate OCC’s counterparty credit risk framework and inform Clearing Member surveillance processes. With respect to Commercial Banks, Central Banks,9 Liquidity Providers, and investment counterparties, OCC shall measure its credit exposures to these 9 Under the Policy, ‘‘Central Bank’’ is defined as a bank serving as a bank for both depository institutions and a government, a regulator for financial institutions, and/or a nation’s money manager. Central Banks act as asset custodians on behalf of OCC, and OCC uses access to accounts and services at a Central Bank, when available and where determined to be practical by the Board of Directors, to enhance its management of liquidity risk. Due to the inherently low credit risk presented by Central Banks, only limited monitoring activities would be performed pursuant to relevant OCC procedures. E:\FR\FM\19DEN1.SGM 19DEN1 60244 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Notices Counterparties by the balances generated from the various activities provided by these institutions in accordance with relevant internal procedures. FMUs provide a range of services to OCC, including the Depository Trust Company (‘‘DTC’’) as collateral custodian and provider of book-entry recordkeeping of securities transfers, Chicago Mercantile Exchange Inc. (‘‘CME’’) and ICE Clear U.S. as crossmargin clearing organizations, and the National Securities Clearing Corporation (‘‘NSCC’’) as a provider of securities settlement. Under the CCRM Policy, DTC credit exposures shall be measured by the collateral balances held and the value of securities lending/borrowing transactions facilitated. CME and ICE Clear U.S. credit exposures shall be measured by the projected margin impact in the event of suspension of a cross-margin program and, therefore, the absence of risk reducing positions cleared away from OCC. NSCC exposure shall be measured by the value of securities and cash to be settled in connection with the delivery obligations settled through NSCC. D. Monitoring and Managing Counterparty Credit Risk The CCRM Policy also describes the manner in which OCC monitors and manages credit risk from its Counterparties. Under the Policy, OCC’s monitoring and management of such risks is comprised of ‘‘Watch Level Reporting’’ processes in conjunction with other tools including margin adjustments, internal credit ratings, risk examinations, and monitoring of tiered participation arrangements and dormant Counterparties. sradovich on DSK3GMQ082PROD with NOTICES Watch Level Reporting Overview Under the Policy, Counterparties are monitored by OCC’s FRM, Business Operations, and Treasury Departments for ongoing compliance with the minimum participation standards described above to identify any trends that might signal the deterioration of a Counterparty’s ability to timely meet its obligations. When these trends are identified, Credit Risk Management shall report on a Counterparty through OCC’s Watch Level Reporting processes, which are described in further detail below. As a Counterparty approaches, or no longer meets minimum standards, FRM’s monitoring heightens and, in the case of Commercial Banks and Clearing Members, increasingly rigorous protective measures may be imposed to limit or eliminate OCC’s credit exposure. VerDate Sep<11>2014 17:47 Dec 18, 2017 Jkt 244001 Pursuant to the Policy, the Watch Level Reporting process shall be administered by OCC’s Management Committee, which maintains approval authority of Watch Level parameter changes. The Watch Level Reporting process provides each of the Executive Chairman, Chief Operating Officer, and Chief Administrative Officer with authority to take action to protect OCC given the facts and circumstances of the exposure presented by a Clearing Member or Commercial Bank. Under the Policy, Credit Risk Management shall provide monthly internal reporting to FRM summarizing the circumstances relating to (i) a violation; (ii) additional risks observed and any corrective measure taken by any Clearing Member, Commercial Bank, or FMU at or above Watch Level II (described below); and (iii) monthly reporting to OCC’s Credit and Liquidity Risk Working Group, Management Committee, and the Risk Committee of any Clearing Member or Commercial Bank at or above Watch Level III (described below). Clearing Member Watch Level Reporting and Bank Watch Level Reporting Pursuant to the CCRM Policy, the Clearing Member Watch Level Reporting process and Bank Watch Level Reporting process shall support initial and on-going participation standards by allowing OCC’s Credit Risk Management Department, with the support of other FRM business units, Business Operations and Treasury, to detect business-related concerns and/or financial or operational deterioration of a Counterparty to protect OCC and its Clearing Members against the potential default of a Clearing Member or Commercial Bank. Pursuant to the CCRM Policy, the Clearing Member Watch Level Reporting process and Bank Watch Level Reporting process shall be organized into a four-tiered surveillance structure. • Watch Level I. Watch Level I is the lowest tier of severity and shall be used to categorize Clearing Members and Commercial Banks presenting minimal to very low credit risk. This level of violation shall be identified but not reported. • Watch Level II. This tier shall be used to categorize Clearing Members and Commercial Banks presenting low to lower moderate credit risk. This level of violation shall be identified and reported to internal personnel pursuant to FRM procedures. • Watch Level III. This tier shall be used to categorize Clearing Members and Commercial Banks potentially presenting upper moderate to substantial credit risk. Violations in this PO 00000 Frm 00072 Fmt 4703 Sfmt 4703 tier may indicate a Clearing Member or Commercial Bank that is below early warning participation thresholds and may soon become non-compliant with OCC’s minimum participation standards, as specified in Article V of OCC’s By-Laws, Chapters II and III of OCC’s Rules, and internal OCC procedures. This level of violation shall be identified and reported to the Executive Chairman, Chief Operating Officer, or Chief Administrative Officer, who shall have the authority to approve the imposition or waiver of protective measures. The Risk Committee shall be informed of these violations on a monthly basis. • Watch Level IV. Watch Level IV is the highest tier of severity and shall be used to categorize Clearing Members and Commercial Banks potentially presenting high to very high credit risk with a heightened probability of default. Violations in this tier may indicate a Clearing Member or Commercial Bank may imminently become or has already become non-compliant with OCC’s minimum participation standards, as specified in Article V of OCC’s By-Laws, Chapters II and III of OCC’s Rules, and internal OCC procedures. This level of violation shall be identified and reported to OCC’s Credit and Liquidity Risk Working Group, with subsequent reporting to the Executive Chairman, Chief Operating Officer, or Chief Administrative Officer, who shall have the authority to approve the imposition or waiver of protective measures, including the option to restrict business of or suspend the Clearing Member or Commercial Bank. The Risk Committee shall be promptly informed of these violations, and a meeting of the Risk Committee may occur to discuss the event. In addition, under the Policy, if a Clearing Member is reporting that its aggregate uncollateralized stress test exposure under normal market conditions, minus the sum of base expected shortfall and stress test charges as computed under OCC’s margin methodology, exceeds 75% of the Clearing Member’s excess net capital, then the Clearing Member shall be identified and reported on Watch Level II. When this exposure exceeds 100% of net capital, a Clearing Member shall be identified and reported on Watch Level III and shall be subject to a margin call for the amount of exposure exceeding net capital. A margin call shall be the standard form of protective measures for position risk monitoring and shall not require officer approval or further prompt escalation. However, Clearing Members may be reported to the Executive Chairman, Chief Operating E:\FR\FM\19DEN1.SGM 19DEN1 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Notices Officer, or Chief Administrative Officer for consideration of additional protective measures. sradovich on DSK3GMQ082PROD with NOTICES FMU Watch Level Reporting The FMU Watch Level Reporting process allows Credit Risk Management, with the support of other FRM business units and Business Operations, to detect business-related concerns and/or financial or operational deterioration of a FMU. Pursuant to the CCRM Policy, the FMU Watch Level Reporting process is organized into a two-tiered surveillance structure. • Watch Level I. Watch Level I is the lowest tier of severity and shall be used to categorize FMUs presenting minimal to very low credit risk. This level of violation shall be identified but not reported. • Watch Level II. Watch Level II is the highest tier of severity and shall be used to categorize FMUs presenting low to lower moderate credit risk. This level of violation shall be identified and reported. Other Tools for Monitoring and Managing Credit Risk In addition to the Watch Level Reporting processes discussed above, the CCRM Policy discusses other tools and processes used by OCC to monitor and manage credit risks arising from its Counterparties. For example, in cases where ongoing monitoring of Clearing Members identifies circumstances impacting margin levels due to changing portfolio characteristics, market conditions, elevated Clearing Fund stress test results, upcoming holidays where trading is allowed but OCC is unable to call for additional margin deposits, and certain other situations, OCC shall have the authority to call for additional margin deposits or otherwise adjust margin requirements as further detailed in OCC’s margin and Clearing Fund-related policies. Under the Policy, OCC’s Credit Risk Management department also maintains Internal Credit Ratings (‘‘ICRs’’) which shall be incorporated into the Watch Level Reporting process and shall be designed to identify quarterly creditworthiness scores of Clearing Members and Commercial Banks. ICR reporting shall summarize the underlying cause of the ICR score, recent scoring trend, and exposure introduced by a Clearing Member or Commercial Bank. In addition, the CCRM Policy provides that Credit Risk Management shall perform examinations of the risk management frameworks, policies, procedures, and practices of each Clearing Member no less than once in a VerDate Sep<11>2014 17:47 Dec 18, 2017 Jkt 244001 three calendar year period, focusing on the risks posed to OCC. For certain exams, Credit Risk Management may coordinate with external parties to realize operational efficiencies for both the Clearing Member and OCC. The CCRM Policy also provides that OCC’s Counterparty monitoring includes managing the material risks that arise from indirect participants through tiered participation arrangements. In particular, Credit Risk Management, supported by other FRM business units and Business Operations, shall monitor the material risks that arise from indirect participants through tiered participation arrangements. Credit Risk Management (or other FRM business units, as appropriate) shall identify these tiered participation arrangements through standard monitoring processes when they present elevated risk to the Clearing Member or OCC. Furthermore, Clearing Member risk examinations shall seek to understand how direct participants identify, measure, and manage the risks posed to OCC from indirect participants. Additionally, under the CCRM Policy, OCC shall monitor Clearing Members, Commercial Banks, and investment counterparties during prolonged periods of inactivity, and Clearing Members shall be allowed to voluntarily enter a dormant state to reduce credit risk originating from unexpected trading activity. A dormant Clearing Member shall continuously adhere to all operational and financial standards and may reactivate its membership after submitting to an operational and financial review. OCC shall maintain sole discretion to terminate inactive Commercial Banks and investment counterparties to reduce credit risk. E. Counterparty Credit Risk Termination Finally, the CCRM Policy addresses the voluntary off-boarding of Counterparties. Under the Policy, voluntary off-boarding shall be performed in a manner designed to wind down all credit exposures in an orderly fashion before a relationship is terminated. II. Discussion and Commission Findings Section 19(b)(2)(C) of the Act 10 directs the Commission to approve a proposed rule change of a selfregulatory organization if it finds that such proposed rule change is consistent with the requirements of the Act and rules and regulations thereunder applicable to such organization. The Commission finds that the proposal is 10 15 PO 00000 U.S.C. 78s(b)(2)(C). Frm 00073 Fmt 4703 Sfmt 4703 60245 consistent with Section 17A(b)(3)(F) of the Act 11 and Rules 17Ad–22(e)(3), (e)(4), (e)(16), (e)(18), (e)(19), and (e)(20) 12 thereunder, as described in detail below. A. Consistency With Section 17A(b)(3)(F) of the Act The Commission finds OCC’s proposed changes to be consistent with Section 17A(b)(3)(F) of the Act,13 which requires, among other things, that the rules of a clearing agency be designed to assure the safeguarding of securities and funds which are in its custody or control of for which it is responsible, in general, to protect investors and the public interest. As noted above, one of the risks OCC faces as a CCP is credit risk. OCC states that the CCRM Policy provides a framework that is designed to enable it to identify, evaluate, measure, monitor, and manage potential credit risks posed by its Counterparties. That framework includes: (1) The identification of credit risk, (2) Counterparty access and participation standards, (3) the measurement of Counterparty exposures, (4) the monitoring and managing of Counterparty exposures, and (5) voluntary termination of Counterparty relationships. Furthermore, OCC also noted that the CCRM Policy is part of a broader framework used by OCC to manage credit risk, including OCC’s ByLaws, Rules, and other policies and procedures that are designed collectively to ensure that OCC appropriately manages counterparty credit risk. By formalizing the components of the CCRM Policy, OCC has taken measures to provide that its the rules are designed to assure the safeguarding of securities and funds which are in its custody or control of for which it is responsible, and, in general, to protect investors and the public interest. B. Consistency With Rules 17Ad– 22(e)(3) and (e)(4) Rules 17Ad–22(e)(3) and (e)(4) 14 require each covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to, among other things, (i) maintain a sound risk management framework for addressing credit risk and (ii) effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and 11 15 U.S.C. 78q–1(b)(3)(F). CFR 240.17Ad–22(e)(1), (e)(4), (e)(16), (e)(18), (e)(19), (e)(20). 13 15 U.S.C. 78q–1(b)(3)(A). 14 17 CFR 240.17Ad–22(e)(3), (e)(4). 12 17 E:\FR\FM\19DEN1.SGM 19DEN1 60246 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Notices settlement processes. As noted above, by formalizing the CCRM Policy, OCC is organizing and describing in a central location the policies and procedures that compose its framework for the comprehensive management of credit risk. The CCRM Policy specifically describes the various processes by which OCC identifies, measures, monitors, and manages its credit exposures arising from its payment, clearing, and settlement processes. Accordingly, the Commission finds that the proposed changes are consistent with Rules 17Ad–22(e)(3) and (e)(4).15 sradovich on DSK3GMQ082PROD with NOTICES C. Consistency With Rule 17Ad– 22(e)(16) Rule 17Ad–22(e)(16) 16 requires each covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to among other things, safeguard the covered clearing agency’s own and its participants’ assets and minimize the risk of loss and delay in access to these assets. According to OCC, the access and participation requirements for Commercial and Central Banks outlined in the CCRM Policy enable it to appropriately evaluate each bank against relevant minimum standards of creditworthiness and for its overall financial condition and operational capabilities, and are therefore designed to minimize the risk of loss and delay in access to OCC’s assets and its participants’ assets. Accordingly, the Commission finds that these policies and procedures are consistent with the requirements in Rule 17Ad–22(e)(16).17 D. Consistency With Rule 17Ad– 22(e)(18) Rule 17Ad–22(e)(18) 18 requires each covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to among other things, establish objective, risk-based, and publicly disclosed criteria for participation, which permit fair and open access and require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency, and monitor compliance with such participation requirements on an ongoing basis. OCC stated that the CCRM Policy ensures that OCC has objective, risk-based, and publicly disclosed criteria for participation and requiring Clearing 15 Id. 16 17 E. Consistency With Rule 17Ad– 22(e)(19) Rule 17Ad–22(e)(19) 20 requires each covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to identify, monitor, and manage the material risks to the covered clearing agency arising from arrangements in which firms that are indirect participants in the covered clearing agency rely on the services provided by direct participants to access the covered clearing agency’s payment, clearing, or settlement facilities. OCC represented that the CCRM Policy outlines the process by which OCC identifies and monitors the material risks arising from indirect participants through tiered participation arrangements, including through the use of risk examinations of its Clearing Members. Accordingly, the Commission finds that these policies and procedures are consistent with the requirements in Rule 17Ad–22(e)(19).21 F. Consistency With Rule 17Ad– 22(e)(20) Rule 17Ad–22(e)(20) 22 requires each covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to among other things, identify, monitor, and manage risks related to any link the covered clearing agency establishes with one or more other clearing agencies or FMUs. OCC represented that the CCRM Policy outlines the standards OCC uses to evaluate FMU Counterparties prior to entering into any link arrangement (including the evaluations OCC would perform relating to rights and interests, collateral arrangements, settlement finality and netting arrangements, and financial and custody risks that may arise due to such link arrangement) and the processes by which OCC measures and monitors the risks arising from such FMU Counterparties (including its FMU Watch Level Reporting process). 19 Id. CFR 240.17Ad–22(e)(16). 20 17 17 Id. 18 17 Members to have sufficient financial resources to meet their obligations to OCC. Moreover, the CCRM Policy outlines the Watch Level Reporting process used by OCC to monitor compliance with such participation requirements on an ongoing basis. Accordingly, the Commission finds that these policies and procedures are consistent with the requirements in Rule 17Ad–22(e)(18).19 CFR 240.17Ad–22(e)(19). 21 Id. CFR 240.17Ad–22(e)(18). VerDate Sep<11>2014 17:47 Dec 18, 2017 22 17 Jkt 244001 PO 00000 CFR 240.17Ad–22(e)(20). Frm 00074 Fmt 4703 Sfmt 4703 Accordingly, the Commission finds that these policies and procedures are consistent with the requirements in Rule 17Ad–22(e)(20).23 III. Conclusion On the basis of the foregoing, the Commission finds that the proposed change is consistent with the requirements of the Act, and in particular, with the requirements of Section 17A of the Act 24 and the rules and regulations thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act,25 that the proposed rule change (SR– OCC–2017–009) be, and it hereby is, approved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.26 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–27231 Filed 12–18–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–82316; File No. SR–LCH SA–2017–012] Self-Regulatory Organizations; LCH SA; Notice of Proposed Rule Change, Security-Based Swap Submission, or Advance Notice Relating to LCH SA’s Recovery Plan December 13, 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 30, 2017, Banque Centrale de Compensation, which conducts business under the name LCH SA (‘‘LCH SA’’), filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change described in Items I, II, and III below, which Items have been prepared primarily by LCH SA. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. 23 Id. 24 In approving this proposed rule change, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 25 15 U.S.C. 78s(b)(2). 26 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. E:\FR\FM\19DEN1.SGM 19DEN1

Agencies

[Federal Register Volume 82, Number 242 (Tuesday, December 19, 2017)]
[Notices]
[Pages 60242-60246]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-27231]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-82312; File No. SR-OCC-2017-009]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change Relating to The Options Clearing 
Corporation's Counterparty Credit Risk Management Policy

December 13, 2017.
    On October 12, 2017, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-OCC-2017-009 pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder.\2\ The proposed rule change was published for comment in 
the Federal Register on November 1, 2017.\3\ The Commission did not 
receive any comment letters on the proposed rule change. This order 
approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 34-81949 (Oct. 26, 
2017), 82 FR 50719 (Nov. 1, 2017) (File No. SR-OCC-2017-009).
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I. Description of the Proposed Rule Change

    This proposed rule change by OCC will formalize OCC's Counterparty 
Credit Risk Management Policy (``CCRM Policy''). The proposed rule 
change does not require any changes to the text of OCC's By-Laws or 
Rules.\4\
---------------------------------------------------------------------------

    \4\ 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.
---------------------------------------------------------------------------

    OCC stated that, as a central counterparty (``CCP'') providing 
clearance, settlement, and risk management services, it is exposed to 
and must manage a range of risks, including credit risk. According to 
OCC, the purpose of the CCRM Policy is to outline OCC's overall 
approach to identify, measure, monitor, and manage its exposures to 
direct and indirect participants, Liquidity Providers,\5\ asset 
custodians, settlement banks, letter of credit issuers, investment 
counterparties, other clearing agencies, and financial market utilities 
(``FMUs'') \6\ (each a ``Counterparty'') arising from its payment, 
clearing, and settlement processes. OCC noted that the CCRM Policy is 
part of a broader framework used by OCC to manage credit risk, 
including OCC's By-Laws, Rules, and other policies and procedures that 
are designed collectively to ensure that OCC appropriately manages 
counterparty credit risk.
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    \5\ Under the CCRM Policy, ``Liquidity Provider'' is defined as 
a Commercial Bank or a non-banking institution--generally a pension 
fund--that provides a committed liquidity facility to OCC.
    \6\ Under the CCRM Policy, ``Financial Market Utility'' is 
defined as a derivatives clearing organization partnering with OCC 
to provide a cross-margin program; a clearing agency providing 
settlement services of securities arising from the exercise, 
assignment or maturity of options or futures; or the Depository 
providing book-entry securities transfers and asset custodian 
services.
---------------------------------------------------------------------------

    The CCRM Policy outlines the key components of OCC's framework for 
identifying, measuring, monitoring, and managing OCC's exposures to its 
Counterparties. This framework includes: (1) The identification of 
credit risk, (2) Counterparty access and participation standards, (3) 
the measurement of Counterparty exposures, (4) the monitoring and 
managing of Counterparty exposures, and (5) voluntary termination of 
Counterparty relationships. Each of these components is described in 
more detail below.

A. Identification of Credit Risk

    The CCRM Policy identifies various ways in which credit risk 
originates from the failure of a Counterparty to perform. With respect 
to a Clearing Member, the CCRM Policy details a number of different 
ways in which OCC may be exposed to credit risk. This includes the 
potential failure of a Clearing Member to pay for purchased options, to 
meet expiration-related settlement obligations, or to make certain 
mark-to-market variation payments or initial margin deposits. It also 
includes the potential insufficiency of a defaulting Clearing Member's 
margin and Clearing Fund deposits in a liquidation scenario. Other 
sources of credit risk identified in the CCRM Policy include the 
inability of OCC to access collateral (e.g., cash or securities) from a 
custodian or investment counterparty that is needed to facilitate a 
liquidation, or a failure by an issuer of a letter of credit to honor 
its corresponding obligations. The CCRM Policy also identifies that 
certain relationships with other FMUs, such as cross-margining programs 
and cash market settlement services, represent critical linkages that 
may present certain degrees of credit exposure based on the terms and 
design of the linkage. The CCRM Policy also notes that OCC may face 
additional risks from Counterparties, such as the potential failure of 
a Liquidity Provider to honor a borrowing request.

B. Counterparty Access and Participation Standards

    Under the CCRM Policy, OCC's management of Counterparty credit 
risks begins with an initial evaluation process intended to ascertain 
that Counterparties meet certain minimum financial and operational 
standards and are considered as having a low probability of defaulting 
on their obligations prior to engaging or effecting any new 
transactions or expansion of business with OCC. To accomplish this 
objective, OCC evaluates each Counterparty against established minimum 
standards of creditworthiness, overall financial condition, and 
operational capabilities. Pursuant to the Policy, the standards used to 
evaluate Counterparties shall be objective, risk-based, and publicly-
disclosed to permit fair and open access. These standards shall be 
developed independently for Clearing Members, Commercial and Central 
Banks, investment counterparties, Liquidity Providers and FMUs, 
accounting for differences in their regulatory reporting and overall 
business operations.
Clearing Membership Standards
    OCC's minimum participation standards for Clearing Member are

[[Page 60243]]

found in Article V of OCC's By-Laws, Chapters II and III of OCC's 
Rules, and other publicly-disclosed supplemental documentation 
(together, ``Participation Standards Documentation''). Under the 
Policy, OCC's Credit Risk Management and Member Services Departments 
shall evaluate each Clearing Member applicant against the minimum 
standards of creditworthiness and for its overall financial condition 
and operational capabilities as provided in the Participation Standards 
Documentation. Such evaluation shall also consider the Counterparty's 
aggregation of exposure on an individual and related-entities level, as 
applicable, as well as any material exposure that may arise from tiered 
participation arrangements. The Credit Risk Management and Member 
Services Departments shall document the results of this evaluation in a 
memorandum, including the Clearing Member applicant's ability to meet 
relevant participation standards, and report those results to OCC's 
Executive Chairman, Chief Operating Officer, or Chief Administrative 
Officer for review and approval, where appropriate, or for 
recommendation to the Risk Committee or Board of Directors.\7\
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    \7\ Pursuant to Article V, Section 2 of OCC's By-Laws, the 
Executive Chairman, Chief Operating Officer and Chief Administrative 
Officer each have delegated authority to approve Clearing Member 
applicants provided that (1) there is no recommendation to impose 
additional membership criteria in accordance with Article V of the 
By-Laws and (2) the Risk Committee is given not less than five days 
to determine the application should be reviewed at a meeting of the 
Risk Committee. Pursuant to Interpretation and Policy .06 to Article 
V, Section 1 of OCC's By-Laws, the Risk Committee has the authority 
to impose additional requirements on Clearing Member applicants, 
such as increased capital or margin requirements as well as 
restrictions on clearing activities. The Risk Committee also has the 
authority to approve waivers of certain clearing membership 
requirements under Article V, Section 1 of the By-Laws. Approvals of 
a Clearing Member business expansion by the Executive Chairman, 
Chief Operating Officer or Chief Administrative Officer are 
subsequently presented to the Risk Committee for ratification, 
except in limited circumstances detailed in Article V, Section 
1.03(e) of OCC's By-Laws.
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Commercial and Central Banks
    OCC's minimum standards for asset custodians, settlement banks, 
letter of credit issuers, and investment counterparties are found in 
OCC Rule 604 and relevant OCC procedures. The Credit Risk Management 
Department shall coordinate with various departments (such as 
Collateral Services or Treasury) to evaluate each bank against the 
minimum standards of creditworthiness and for its overall financial 
condition and operational capabilities as provided in OCC Rule 604 and 
related OCC procedures. Such evaluation shall also consider the 
Counterparty's aggregation of exposure on an individual and related-
entities level, as applicable, as well as whether OCC would be able to 
structure its custodial relationships in a manner that allows prompt 
access to its own and its Clearing Members' assets. The latter shall 
include holding assets at supervised and regulated institutions that 
adhere to generally accepted accounting practices, maintain safekeeping 
procedures, and have internal controls that fully protect these assets. 
Under the Policy, Credit Risk Management and either the Collateral 
Services or Treasury Department, as applicable, shall document the 
results of its evaluation in a memorandum, including the bank's ability 
to meet relevant participation standards, and report those results to 
OCC's Executive Chairman, Chief Operating Officer or Chief 
Administrative Officer, each of which shall have the authority to 
approve new and expanded relationships with asset custodians, 
settlement banks, letter of credit issuers, investment counterparties, 
and Liquidity Providers.
Liquidity Providers
    Under the Policy, OCC maintains internal procedures outlining the 
minimum standards for Commercial Banks \8\ and non-bank institutions 
acting as Liquidity Providers. OCC's Credit Risk Management and 
Treasury Departments would be responsible for evaluating each Liquidity 
Provider against the minimum standards of creditworthiness and for its 
overall financial condition and operational capabilities as provided in 
the procedures. Because Liquidity Providers present both credit and 
liquidity risk to OCC, the due diligence around such institutions shall 
include a review of each lender's ability to perform their commitments 
as well as understand and manage their liquidity risks. Pursuant to the 
Policy, Credit Risk Management and Treasury shall document the results 
of the evaluation in a memorandum, including the Liquidity Provider's 
ability to meet relevant participation standards, and report those 
results to the Executive Chairman, Chief Operating Officer or Chief 
Administrative Officer, each of which shall have the authority to 
approve new and expanded relationships with Liquidity Providers.
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    \8\ Under the Policy, ``Commercial Bank'' is defined as a 
banking or depository institution that is not an operating arm of a 
Central Bank. Commercial Bank relationships shall be governed by 
this Policy and all supporting bank-related procedures. Commercial 
Banks act as Liquidity Providers, asset custodians, settlement 
banks, letter of credit issuers, and investment counterparties on 
behalf of OCC.
---------------------------------------------------------------------------

FMUs
    Under the Policy, OCC maintains internal procedures outlining 
minimum standards for FMUs. OCC's Business Operations and Credit Risk 
Management Departments shall evaluate each FMU for its overall 
financial condition and operational capabilities as provided in the 
procedure. Pursuant to the CCRM Policy, before entering into a link 
with any FMU, the Legal Department shall assist the aforementioned 
business units to identify legal risks relating to rights and 
interests, collateral arrangements, settlement finality and netting 
arrangements, and financial and custody risks. The Business Operations, 
Credit Risk Management, and Legal Departments shall document the 
results of its evaluation in a memorandum, including the FMU's ability 
to meet relevant standards. All new and expanded FMU relationships 
shall be reviewed and approved by the Risk Committee and subsequently 
recommended for approval to the Board of Directors.

C. Measuring Counterparty Credit Risk

    The CCRM Policy describes various ways in which OCC measures the 
credit risk posed by different Counterparties. With respect to Clearing 
Members, the CCRM Policy provides that OCC measures its credit 
exposures to Clearing Members under normal market conditions through 
the calculation of margin requirements and under extreme but plausible 
conditions through stress testing and the calculation of Clearing Fund 
requirements, in accordance with applicable OCC policies. Margin, 
Clearing Fund, and stress test results may be used by OCC's Financial 
Risk Management Department (``FRM'') to evaluate OCC's counterparty 
credit risk framework and inform Clearing Member surveillance 
processes.
    With respect to Commercial Banks, Central Banks,\9\ Liquidity 
Providers, and investment counterparties, OCC shall measure its credit 
exposures to these

[[Page 60244]]

Counterparties by the balances generated from the various activities 
provided by these institutions in accordance with relevant internal 
procedures.
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    \9\ Under the Policy, ``Central Bank'' is defined as a bank 
serving as a bank for both depository institutions and a government, 
a regulator for financial institutions, and/or a nation's money 
manager. Central Banks act as asset custodians on behalf of OCC, and 
OCC uses access to accounts and services at a Central Bank, when 
available and where determined to be practical by the Board of 
Directors, to enhance its management of liquidity risk. Due to the 
inherently low credit risk presented by Central Banks, only limited 
monitoring activities would be performed pursuant to relevant OCC 
procedures.
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    FMUs provide a range of services to OCC, including the Depository 
Trust Company (``DTC'') as collateral custodian and provider of book-
entry recordkeeping of securities transfers, Chicago Mercantile 
Exchange Inc. (``CME'') and ICE Clear U.S. as cross-margin clearing 
organizations, and the National Securities Clearing Corporation 
(``NSCC'') as a provider of securities settlement. Under the CCRM 
Policy, DTC credit exposures shall be measured by the collateral 
balances held and the value of securities lending/borrowing 
transactions facilitated. CME and ICE Clear U.S. credit exposures shall 
be measured by the projected margin impact in the event of suspension 
of a cross-margin program and, therefore, the absence of risk reducing 
positions cleared away from OCC. NSCC exposure shall be measured by the 
value of securities and cash to be settled in connection with the 
delivery obligations settled through NSCC.

D. Monitoring and Managing Counterparty Credit Risk

    The CCRM Policy also describes the manner in which OCC monitors and 
manages credit risk from its Counterparties. Under the Policy, OCC's 
monitoring and management of such risks is comprised of ``Watch Level 
Reporting'' processes in conjunction with other tools including margin 
adjustments, internal credit ratings, risk examinations, and monitoring 
of tiered participation arrangements and dormant Counterparties.
Watch Level Reporting Overview
    Under the Policy, Counterparties are monitored by OCC's FRM, 
Business Operations, and Treasury Departments for ongoing compliance 
with the minimum participation standards described above to identify 
any trends that might signal the deterioration of a Counterparty's 
ability to timely meet its obligations. When these trends are 
identified, Credit Risk Management shall report on a Counterparty 
through OCC's Watch Level Reporting processes, which are described in 
further detail below. As a Counterparty approaches, or no longer meets 
minimum standards, FRM's monitoring heightens and, in the case of 
Commercial Banks and Clearing Members, increasingly rigorous protective 
measures may be imposed to limit or eliminate OCC's credit exposure.
    Pursuant to the Policy, the Watch Level Reporting process shall be 
administered by OCC's Management Committee, which maintains approval 
authority of Watch Level parameter changes. The Watch Level Reporting 
process provides each of the Executive Chairman, Chief Operating 
Officer, and Chief Administrative Officer with authority to take action 
to protect OCC given the facts and circumstances of the exposure 
presented by a Clearing Member or Commercial Bank. Under the Policy, 
Credit Risk Management shall provide monthly internal reporting to FRM 
summarizing the circumstances relating to (i) a violation; (ii) 
additional risks observed and any corrective measure taken by any 
Clearing Member, Commercial Bank, or FMU at or above Watch Level II 
(described below); and (iii) monthly reporting to OCC's Credit and 
Liquidity Risk Working Group, Management Committee, and the Risk 
Committee of any Clearing Member or Commercial Bank at or above Watch 
Level III (described below).
Clearing Member Watch Level Reporting and Bank Watch Level Reporting
    Pursuant to the CCRM Policy, the Clearing Member Watch Level 
Reporting process and Bank Watch Level Reporting process shall support 
initial and on-going participation standards by allowing OCC's Credit 
Risk Management Department, with the support of other FRM business 
units, Business Operations and Treasury, to detect business-related 
concerns and/or financial or operational deterioration of a 
Counterparty to protect OCC and its Clearing Members against the 
potential default of a Clearing Member or Commercial Bank. Pursuant to 
the CCRM Policy, the Clearing Member Watch Level Reporting process and 
Bank Watch Level Reporting process shall be organized into a four-
tiered surveillance structure.
     Watch Level I. Watch Level I is the lowest tier of 
severity and shall be used to categorize Clearing Members and 
Commercial Banks presenting minimal to very low credit risk. This level 
of violation shall be identified but not reported.
     Watch Level II. This tier shall be used to categorize 
Clearing Members and Commercial Banks presenting low to lower moderate 
credit risk. This level of violation shall be identified and reported 
to internal personnel pursuant to FRM procedures.
     Watch Level III. This tier shall be used to categorize 
Clearing Members and Commercial Banks potentially presenting upper 
moderate to substantial credit risk. Violations in this tier may 
indicate a Clearing Member or Commercial Bank that is below early 
warning participation thresholds and may soon become non-compliant with 
OCC's minimum participation standards, as specified in Article V of 
OCC's By-Laws, Chapters II and III of OCC's Rules, and internal OCC 
procedures. This level of violation shall be identified and reported to 
the Executive Chairman, Chief Operating Officer, or Chief 
Administrative Officer, who shall have the authority to approve the 
imposition or waiver of protective measures. The Risk Committee shall 
be informed of these violations on a monthly basis.
     Watch Level IV. Watch Level IV is the highest tier of 
severity and shall be used to categorize Clearing Members and 
Commercial Banks potentially presenting high to very high credit risk 
with a heightened probability of default. Violations in this tier may 
indicate a Clearing Member or Commercial Bank may imminently become or 
has already become non-compliant with OCC's minimum participation 
standards, as specified in Article V of OCC's By-Laws, Chapters II and 
III of OCC's Rules, and internal OCC procedures. This level of 
violation shall be identified and reported to OCC's Credit and 
Liquidity Risk Working Group, with subsequent reporting to the 
Executive Chairman, Chief Operating Officer, or Chief Administrative 
Officer, who shall have the authority to approve the imposition or 
waiver of protective measures, including the option to restrict 
business of or suspend the Clearing Member or Commercial Bank. The Risk 
Committee shall be promptly informed of these violations, and a meeting 
of the Risk Committee may occur to discuss the event.
    In addition, under the Policy, if a Clearing Member is reporting 
that its aggregate uncollateralized stress test exposure under normal 
market conditions, minus the sum of base expected shortfall and stress 
test charges as computed under OCC's margin methodology, exceeds 75% of 
the Clearing Member's excess net capital, then the Clearing Member 
shall be identified and reported on Watch Level II. When this exposure 
exceeds 100% of net capital, a Clearing Member shall be identified and 
reported on Watch Level III and shall be subject to a margin call for 
the amount of exposure exceeding net capital. A margin call shall be 
the standard form of protective measures for position risk monitoring 
and shall not require officer approval or further prompt escalation. 
However, Clearing Members may be reported to the Executive Chairman, 
Chief Operating

[[Page 60245]]

Officer, or Chief Administrative Officer for consideration of 
additional protective measures.
FMU Watch Level Reporting
    The FMU Watch Level Reporting process allows Credit Risk 
Management, with the support of other FRM business units and Business 
Operations, to detect business-related concerns and/or financial or 
operational deterioration of a FMU. Pursuant to the CCRM Policy, the 
FMU Watch Level Reporting process is organized into a two-tiered 
surveillance structure.
     Watch Level I. Watch Level I is the lowest tier of 
severity and shall be used to categorize FMUs presenting minimal to 
very low credit risk. This level of violation shall be identified but 
not reported.
     Watch Level II. Watch Level II is the highest tier of 
severity and shall be used to categorize FMUs presenting low to lower 
moderate credit risk. This level of violation shall be identified and 
reported.
Other Tools for Monitoring and Managing Credit Risk
    In addition to the Watch Level Reporting processes discussed above, 
the CCRM Policy discusses other tools and processes used by OCC to 
monitor and manage credit risks arising from its Counterparties. For 
example, in cases where ongoing monitoring of Clearing Members 
identifies circumstances impacting margin levels due to changing 
portfolio characteristics, market conditions, elevated Clearing Fund 
stress test results, upcoming holidays where trading is allowed but OCC 
is unable to call for additional margin deposits, and certain other 
situations, OCC shall have the authority to call for additional margin 
deposits or otherwise adjust margin requirements as further detailed in 
OCC's margin and Clearing Fund-related policies.
    Under the Policy, OCC's Credit Risk Management department also 
maintains Internal Credit Ratings (``ICRs'') which shall be 
incorporated into the Watch Level Reporting process and shall be 
designed to identify quarterly creditworthiness scores of Clearing 
Members and Commercial Banks. ICR reporting shall summarize the 
underlying cause of the ICR score, recent scoring trend, and exposure 
introduced by a Clearing Member or Commercial Bank.
    In addition, the CCRM Policy provides that Credit Risk Management 
shall perform examinations of the risk management frameworks, policies, 
procedures, and practices of each Clearing Member no less than once in 
a three calendar year period, focusing on the risks posed to OCC. For 
certain exams, Credit Risk Management may coordinate with external 
parties to realize operational efficiencies for both the Clearing 
Member and OCC.
    The CCRM Policy also provides that OCC's Counterparty monitoring 
includes managing the material risks that arise from indirect 
participants through tiered participation arrangements. In particular, 
Credit Risk Management, supported by other FRM business units and 
Business Operations, shall monitor the material risks that arise from 
indirect participants through tiered participation arrangements. Credit 
Risk Management (or other FRM business units, as appropriate) shall 
identify these tiered participation arrangements through standard 
monitoring processes when they present elevated risk to the Clearing 
Member or OCC. Furthermore, Clearing Member risk examinations shall 
seek to understand how direct participants identify, measure, and 
manage the risks posed to OCC from indirect participants.
    Additionally, under the CCRM Policy, OCC shall monitor Clearing 
Members, Commercial Banks, and investment counterparties during 
prolonged periods of inactivity, and Clearing Members shall be allowed 
to voluntarily enter a dormant state to reduce credit risk originating 
from unexpected trading activity. A dormant Clearing Member shall 
continuously adhere to all operational and financial standards and may 
reactivate its membership after submitting to an operational and 
financial review. OCC shall maintain sole discretion to terminate 
inactive Commercial Banks and investment counterparties to reduce 
credit risk.

E. Counterparty Credit Risk Termination

    Finally, the CCRM Policy addresses the voluntary off-boarding of 
Counterparties. Under the Policy, voluntary off-boarding shall be 
performed in a manner designed to wind down all credit exposures in an 
orderly fashion before a relationship is terminated.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \10\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and rules and regulations thereunder applicable 
to such organization. The Commission finds that the proposal is 
consistent with Section 17A(b)(3)(F) of the Act \11\ and Rules 17Ad-
22(e)(3), (e)(4), (e)(16), (e)(18), (e)(19), and (e)(20) \12\ 
thereunder, as described in detail below.
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    \10\ 15 U.S.C. 78s(b)(2)(C).
    \11\ 15 U.S.C. 78q-1(b)(3)(F).
    \12\ 17 CFR 240.17Ad-22(e)(1), (e)(4), (e)(16), (e)(18), 
(e)(19), (e)(20).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    The Commission finds OCC's proposed changes to be consistent with 
Section 17A(b)(3)(F) of the Act,\13\ which requires, among other 
things, that the rules of a clearing agency be designed to assure the 
safeguarding of securities and funds which are in its custody or 
control of for which it is responsible, in general, to protect 
investors and the public interest. As noted above, one of the risks OCC 
faces as a CCP is credit risk. OCC states that the CCRM Policy provides 
a framework that is designed to enable it to identify, evaluate, 
measure, monitor, and manage potential credit risks posed by its 
Counterparties. That framework includes: (1) The identification of 
credit risk, (2) Counterparty access and participation standards, (3) 
the measurement of Counterparty exposures, (4) the monitoring and 
managing of Counterparty exposures, and (5) voluntary termination of 
Counterparty relationships. Furthermore, OCC also noted that the CCRM 
Policy is part of a broader framework used by OCC to manage credit 
risk, including OCC's By-Laws, Rules, and other policies and procedures 
that are designed collectively to ensure that OCC appropriately manages 
counterparty credit risk. By formalizing the components of the CCRM 
Policy, OCC has taken measures to provide that its the rules are 
designed to assure the safeguarding of securities and funds which are 
in its custody or control of for which it is responsible, and, in 
general, to protect investors and the public interest.
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    \13\ 15 U.S.C. 78q-1(b)(3)(A).
---------------------------------------------------------------------------

B. Consistency With Rules 17Ad-22(e)(3) and (e)(4)

    Rules 17Ad-22(e)(3) and (e)(4) \14\ require each covered clearing 
agency to establish, implement, maintain and enforce written policies 
and procedures reasonably designed to, among other things, (i) maintain 
a sound risk management framework for addressing credit risk and (ii) 
effectively identify, measure, monitor, and manage its credit exposures 
to participants and those arising from its payment, clearing, and

[[Page 60246]]

settlement processes. As noted above, by formalizing the CCRM Policy, 
OCC is organizing and describing in a central location the policies and 
procedures that compose its framework for the comprehensive management 
of credit risk. The CCRM Policy specifically describes the various 
processes by which OCC identifies, measures, monitors, and manages its 
credit exposures arising from its payment, clearing, and settlement 
processes. Accordingly, the Commission finds that the proposed changes 
are consistent with Rules 17Ad-22(e)(3) and (e)(4).\15\
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    \14\ 17 CFR 240.17Ad-22(e)(3), (e)(4).
    \15\ Id.
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C. Consistency With Rule 17Ad-22(e)(16)

    Rule 17Ad-22(e)(16) \16\ requires each covered clearing agency to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to among other things, safeguard the 
covered clearing agency's own and its participants' assets and minimize 
the risk of loss and delay in access to these assets. According to OCC, 
the access and participation requirements for Commercial and Central 
Banks outlined in the CCRM Policy enable it to appropriately evaluate 
each bank against relevant minimum standards of creditworthiness and 
for its overall financial condition and operational capabilities, and 
are therefore designed to minimize the risk of loss and delay in access 
to OCC's assets and its participants' assets. Accordingly, the 
Commission finds that these policies and procedures are consistent with 
the requirements in Rule 17Ad-22(e)(16).\17\
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    \16\ 17 CFR 240.17Ad-22(e)(16).
    \17\ Id.
---------------------------------------------------------------------------

D. Consistency With Rule 17Ad-22(e)(18)

    Rule 17Ad-22(e)(18) \18\ requires each covered clearing agency to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to among other things, establish 
objective, risk-based, and publicly disclosed criteria for 
participation, which permit fair and open access and require 
participants to have sufficient financial resources and robust 
operational capacity to meet obligations arising from participation in 
the clearing agency, and monitor compliance with such participation 
requirements on an ongoing basis. OCC stated that the CCRM Policy 
ensures that OCC has objective, risk-based, and publicly disclosed 
criteria for participation and requiring Clearing Members to have 
sufficient financial resources to meet their obligations to OCC. 
Moreover, the CCRM Policy outlines the Watch Level Reporting process 
used by OCC to monitor compliance with such participation requirements 
on an ongoing basis. Accordingly, the Commission finds that these 
policies and procedures are consistent with the requirements in Rule 
17Ad-22(e)(18).\19\
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    \18\ 17 CFR 240.17Ad-22(e)(18).
    \19\ Id.
---------------------------------------------------------------------------

E. Consistency With Rule 17Ad-22(e)(19)

    Rule 17Ad-22(e)(19) \20\ requires each covered clearing agency to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to identify, monitor, and manage the 
material risks to the covered clearing agency arising from arrangements 
in which firms that are indirect participants in the covered clearing 
agency rely on the services provided by direct participants to access 
the covered clearing agency's payment, clearing, or settlement 
facilities. OCC represented that the CCRM Policy outlines the process 
by which OCC identifies and monitors the material risks arising from 
indirect participants through tiered participation arrangements, 
including through the use of risk examinations of its Clearing Members. 
Accordingly, the Commission finds that these policies and procedures 
are consistent with the requirements in Rule 17Ad-22(e)(19).\21\
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    \20\ 17 CFR 240.17Ad-22(e)(19).
    \21\ Id.
---------------------------------------------------------------------------

F. Consistency With Rule 17Ad-22(e)(20)

    Rule 17Ad-22(e)(20) \22\ requires each covered clearing agency to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to among other things, identify, 
monitor, and manage risks related to any link the covered clearing 
agency establishes with one or more other clearing agencies or FMUs. 
OCC represented that the CCRM Policy outlines the standards OCC uses to 
evaluate FMU Counterparties prior to entering into any link arrangement 
(including the evaluations OCC would perform relating to rights and 
interests, collateral arrangements, settlement finality and netting 
arrangements, and financial and custody risks that may arise due to 
such link arrangement) and the processes by which OCC measures and 
monitors the risks arising from such FMU Counterparties (including its 
FMU Watch Level Reporting process). Accordingly, the Commission finds 
that these policies and procedures are consistent with the requirements 
in Rule 17Ad-22(e)(20).\23\
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    \22\ 17 CFR 240.17Ad-22(e)(20).
    \23\ Id.
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed change is consistent with the requirements of the Act, and in 
particular, with the requirements of Section 17A of the Act \24\ and 
the rules and regulations thereunder.
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    \24\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\25\ that the proposed rule change (SR-OCC-2017-009) be, 
and it hereby is, approved.
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    \25\ 15 U.S.C. 78s(b)(2).
    \26\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\26\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-27231 Filed 12-18-17; 8:45 am]
 BILLING CODE 8011-01-P