Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning Proposed Changes to The Options Clearing Corporation's Margin Methodology, 61354-61360 [2017-27832]
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61354
Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices
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and the LS Trust (the ‘‘Advisory
Agreement’’).2 The Adviser will provide
the Funds with continuous and
comprehensive investment management
services subject to the supervision of,
and policies established by, each Fund’s
board of directors or trustees, as
applicable (‘‘Board’’). The Advisory
Agreement permits the Adviser, subject
to the approval of the Board, to delegate
to one or more sub-advisers (each, a
‘‘Sub-Adviser’’ and collectively, the
‘‘Sub-Advisers’’) the responsibility to
provide the day-to-day portfolio
investment management of each Fund,
subject to the supervision and direction
of the Adviser. The primary
responsibility for managing the Funds
will remain vested in the Adviser. The
Adviser will hire, evaluate, allocate
assets to and oversee the Sub-Advisers,
including determining whether a SubAdviser should be terminated, at all
times subject to the authority of the
Board.
2. Applicants request an exemption to
permit the Adviser, subject to Board
approval, to hire certain Sub-Advisers
pursuant to Sub-Advisory Agreements
and materially amend existing SubAdvisory Agreements without obtaining
the shareholder approval required under
Section 15(a) of the Act and Rule 18f–
2 under the Act.3 Applicants also seek
an exemption from the Disclosure
Requirements to permit a Fund to
disclose (as both a dollar amount and a
percentage of the Fund’s net assets): (a)
The aggregate fees paid to the Adviser
and any Wholly-Owned Sub-Advisers;
and (b) the aggregate fees paid to NonAffiliated Sub-Advisers (collectively,
‘‘Aggregate Fee Disclosure’’). For any
Fund that employs an Affiliated SubAdviser, the Fund will provide separate
disclosure of any fees paid to the
Affiliated Sub-Adviser.
3. Applicants agree that any order
granting the requested relief will be
subject to the terms and conditions
stated in the Application. Such terms
and conditions provide for, among other
2 Applicants request relief with respect to the
named Applicants, any existing or future Series of
the Companies, and any Sub-Advised Series. For
purposes of the requested order, ‘‘successor’’ is
limited to an entity that results from reorganization
into another jurisdiction or a change in the type of
business organization.
3 The requested relief will not extend to any SubAdviser, other than a Wholly-Owned Sub-Adviser,
that is an affiliated person, as defined in Section
2(a)(3) of the Act, of a Fund or an Adviser, other
than by reason of serving as a sub-adviser to one
or more of the Funds (‘‘Affiliated Sub-Adviser’’).
Each future Series shall obtain shareholder
approval (including formal approval of the initial
shareholder(s)) of the Manager of Managers
Structure (including with respect to Wholly-Owned
Subadvisers), prior to relying on the requested
relief.
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safeguards, appropriate disclosure to
Fund shareholders and notification
about sub-advisory changes and
enhanced Board oversight to protect the
interests of the Funds’ shareholders.
4. Section 6(c) of the Act provides that
the Commission may exempt any
person, security, or transaction or any
class or classes of persons, securities, or
transactions from any provisions of the
Act, or any rule thereunder, if such
relief is necessary or appropriate in the
public interest and consistent with the
protection of investors and purposes
fairly intended by the policy and
provisions of the Act. Applicants
believe that the requested relief meets
this standard because, as further
explained in the Application, the
Advisory Agreements will remain
subject to shareholder approval, while
the role of the Sub-Advisers is
substantially similar to that of
individual portfolio managers, so that
requiring shareholder approval of SubAdvisory Agreements would impose
unnecessary delays and expenses on the
Funds. Applicants believe that the
requested relief from the Disclosure
Requirements meets this standard
because it will improve the Adviser’s
ability to negotiate fees paid to the SubAdvisers that are more advantageous for
the Funds.
For the Commission, by the Division of
Investment Management, under delegated
authority.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017–27807 Filed 12–26–17; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–82371; File No. SR–OCC–
2017–811]
Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of Filing of Advance Notice
Concerning Proposed Changes to The
Options Clearing Corporation’s Margin
Methodology
December 20, 2017.
Pursuant to Section 806(e)(1) of Title
VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act,
entitled Payment, Clearing and
Settlement Supervision Act of 2010
(‘‘Clearing Supervision Act’’) 1 and Rule
19b–4(n)(1)(i) under the Securities
Exchange Act of 1934 (‘‘Act’’),2 notice is
hereby given that on November 13,
2017, The Options Clearing Corporation
1 12
2 17
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U.S.C. 5465(e)(1).
CFR 240.19b–4(n)(1)(i).
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(‘‘OCC’’) filed with the Securities and
Exchange Commission (‘‘Commission’’)
an advance notice as described in Items
I and II below, which Items have been
prepared by OCC. The Commission is
publishing this notice to solicit
comments on the advance notice from
interested persons.
I. Clearing Agency’s Statement of the
Terms of Substance of the Advance
Notice
This advance notice is filed in
connection with proposed changes to
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 III below.
The proposed changes do 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
Advance Notice
In its filing with the Commission,
OCC included statements concerning
the purpose of and basis for the advance
notice and discussed any comments it
received on the advance notice. The text
of these statements may be examined at
the places specified in Item IV below.
OCC has prepared summaries, set forth
in sections A and B below, of the most
significant aspects of these statements.
3 OCC also has filed a proposed rule change with
the Commission in connection with the proposed
changes. See SR–OCC–2017–022.
4 The use of risk factors in OCC’s margin
methodology is discussed in more detail in the
Description of the Proposed Change section below.
5 OCC’s By-Laws and Rules can be found on
OCC’s public website: https://optionsclearing.com/
about/publications/bylaws.jsp.
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Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices
(A) Clearing Agency’s Statement on
Comments on the Advance Notice
Received From Members, Participants or
Others
Written comments were not and are
not intended to be solicited with respect
to the proposed rule change and none
have been received. OCC will notify the
Commission of any written comments
received by OCC.
(B) Advance Notices Filed Pursuant to
Section 806(e) of the Payment, Clearing,
and Settlement Supervision Act
Description of the Proposed Change
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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 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
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 https://
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
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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.
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
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).
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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61355
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.
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.
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.
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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Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices
Proposed Changes
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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
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.
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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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 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 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 of 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
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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
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.
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
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.
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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.
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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
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.
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.
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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
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/
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.
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61357
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.
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
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’’).
25 See supra note 16.
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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 default
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’’).
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.
daltland on DSKBBV9HB2PROD with NOTICES
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.
Anticipated Effect on and Management
of Risk
OCC believes that the proposed
changes would reduce the nature and
level of risk presented by OCC because
they would result in a margin
methodology that is more accurate,
responsive, stable, and robust, thereby
reducing risks to OCC, its Clearing
Members, and the markets it serves.
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.27 For the
reasons noted above, these monthly
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
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.
27 See supra note 13 and accompanying text.
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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 fat 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 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 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
changes would result in the reduction of
risk for OCC, its Clearing Members, and
the markets it serves.
Clearing Member Outreach
OCC has discussed the proposed
changes with its Financial Risk
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Advisory Council 28 at a meeting held
on October 25, 2016. OCC also provided
general updates to members at OCC
Roundtable 29 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
Members resulting from the proposed
change.30
Consistency With the Payment, Clearing
and Settlement Supervision Act
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The stated purpose of the Clearing
Supervision Act is to mitigate systemic
risk in the financial system and promote
financial stability by, among other
things, promoting uniform risk
management standards for systemically
important financial market utilities and
strengthening the liquidity of
systemically important financial market
utilities.31 Section 805(a)(2) of the
Clearing Supervision Act 32 also
authorizes the Commission to prescribe
risk management standards for the
payment, clearing and settlement
activities of designated clearing entities,
like OCC, for which the Commission is
the supervisory agency. Section 805(b)
28 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.
29 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.
30 Specifically, OCC will discuss with those
Clearing Members how they plan to satisfy any
increase in their margin requirements associated
with the proposed change.
31 12 U.S.C. 5461(b).
32 12 U.S.C. 5464(a)(2).
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of the Clearing Supervision Act 33 states
that the objectives and principles for
risk management standards prescribed
under Section 805(a) shall be to:
• Promote robust risk management;
• promote safety and soundness;
• reduce systemic risks; and
• support the stability of the broader
financial system.
The Commission has adopted risk
management standards under Section
805(a)(2) of the Clearing Supervision
Act and the Act, which include
Commission Rules 17Ad–22(b)(1), (b)(2)
and (e)(6).34
Rules 17Ad–22(b)(1) and (2) 35 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
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
33 12
U.S.C. 5464(b).
CFR 240. 17Ad–22. See Securities Exchange
Act Release Nos. 68080 (October 22, 2012), 77 FR
66220 (November 2, 2012) (S7–08–11) (‘‘Clearing
Agency Standards’’); 78961 (September 28, 2016, 81
FR 70786 (October 13, 2016) (S7–03–14)
(‘‘Standards for Covered Clearing Agencies’’). The
Standards for Covered Clearing Agencies became
effective on December 12, 2016. OCC is a ‘‘covered
clearing agency’’ as defined in Rule 17Ad–22(a)(5)
and therefore OCC must comply with new section
(e) of Rule 17Ad–22.
35 17 CFR 240.17Ad–22(b)(1) and (2).
34 17
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61359
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
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).36
36 Id.
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Rule 17Ad–22(e)(6) 37 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.
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
37 17
CFR 240.17Ad–2(e)(6).
VerDate Sep<11>2014
21:43 Dec 26, 2017
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).38
III. Date of Effectiveness of the Advance
Notice and Timing for Commission
Action
The proposed change may be
implemented if the Commission does
not object to the proposed change
within 60 days of the later of: (i) The
date the proposed change was filed with
the Commission or (ii) the date any
additional information requested by the
Commission is received. OCC shall not
implement the proposed change if the
Commission has any objection to the
proposed change.
The Commission may extend the
period for review by an additional 60
days if the proposed change raises novel
or complex issues, subject to the
Commission providing the clearing
agency with prompt written notice of
the extension. A proposed change may
be implemented in less than 60 days
from the date the advance notice is
filed, or the date further information
requested by the Commission is
received, if the Commission notifies the
clearing agency in writing that it does
not object to the proposed change and
authorizes the clearing agency to
implement the proposed change on an
earlier date, subject to any conditions
imposed by the Commission.
OCC shall post notice on its website
of proposed changes that are
implemented.
The proposal shall not take effect
until all regulatory actions required
with respect to the proposal are
completed.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the advance notice is
consistent with the Clearing
Supervision Act. Comments may be
submitted by any of the following
methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
OCC–2017–811 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Secretary, Securities and Exchange
38 Id.
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Commission, 100 F Street NE,
Washington, DC 20549.
All submissions should refer to File
Number SR–OCC–2017–811. 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 website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the advance notice that
are filed with the Commission, and all
written communications relating to the
advance notice between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for 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 OCC and on OCC’s website at
hhttps://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–2017–811 and
should be submitted on or before
January 17, 2018.
By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017–27832 Filed 12–26–17; 8:45 am]
BILLING CODE 8011–01–P
SOCIAL SECURITY ADMINISTRATION
[Docket No. SSA 2017–0002]
Privacy Act of 1974; Matching Program
AGENCY:
Social Security Administration
(SSA).
Notice of a New Matching
Program.
ACTION:
In accordance with the
provisions of the Privacy Act, as
amended, this notice announces a new
matching program with the Railroad
Retirement Board (RRB).
DATES: The deadline to submit
comments on the proposed matching
SUMMARY:
E:\FR\FM\27DEN1.SGM
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]]>Agencies
[Federal Register Volume 82, Number 247 (Wednesday, December 27, 2017)]
[Notices]
[Pages 61354-61360]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-27832]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-82371; File No. SR-OCC-2017-811]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Advance Notice Concerning Proposed Changes to The
Options Clearing Corporation's Margin Methodology
December 20, 2017.
Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act, entitled Payment, Clearing
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'')
\1\ and Rule 19b-4(n)(1)(i) under the Securities Exchange Act of 1934
(``Act''),\2\ notice is hereby given that on November 13, 2017, The
Options Clearing Corporation (``OCC'') filed with the Securities and
Exchange Commission (``Commission'') an advance notice as described in
Items I and II below, which Items have been prepared by OCC. The
Commission is publishing this notice to solicit comments on the advance
notice from interested persons.
---------------------------------------------------------------------------
\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
---------------------------------------------------------------------------
I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
This advance notice is filed in connection with proposed changes to
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.
---------------------------------------------------------------------------
\3\ OCC also has filed a proposed rule change with the
Commission in connection with the proposed changes. See SR-OCC-2017-
022.
\4\ The use of risk factors in OCC's margin methodology is
discussed in more detail in the Description of the Proposed Change
section below.
---------------------------------------------------------------------------
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 III below. The proposed changes do 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\
---------------------------------------------------------------------------
\5\ OCC's By-Laws and Rules can be found on OCC's public
website: https://optionsclearing.com/about/publications/bylaws.jsp.
---------------------------------------------------------------------------
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the advance notice and
discussed any comments it received on the advance notice. The text of
these statements may be examined at the places specified in Item IV
below. OCC has prepared summaries, set forth in sections A and B below,
of the most significant aspects of these statements.
[[Page 61355]]
(A) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants or Others
Written comments were not and are not intended to be solicited with
respect to the proposed rule change and none have been received. OCC
will notify the Commission of any written comments received by OCC.
(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment,
Clearing, and Settlement Supervision Act
Description of the Proposed Change
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.
---------------------------------------------------------------------------
\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 https://optionsclearing.com/risk-management/margins/.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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. 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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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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[[Page 61356]]
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 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 of 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 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
[[Page 61357]]
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.
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\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'').
---------------------------------------------------------------------------
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
[[Page 61358]]
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 default
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.
---------------------------------------------------------------------------
Anticipated Effect on and Management of Risk
OCC believes that the proposed changes would reduce the nature and
level of risk presented by OCC because they would result in a margin
methodology that is more accurate, responsive, stable, and robust,
thereby reducing risks to OCC, its Clearing Members, and the markets it
serves.
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.\27\
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.
---------------------------------------------------------------------------
\27\ 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 fat 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 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 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
changes would result in the reduction of risk for OCC, its Clearing
Members, and the markets it serves.
Clearing Member Outreach
OCC has discussed the proposed changes with its Financial Risk
[[Page 61359]]
Advisory Council \28\ at a meeting held on October 25, 2016. OCC also
provided general updates to members at OCC Roundtable \29\ 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 Members resulting from the proposed change.\30\
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\28\ 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.
\29\ 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.
\30\ Specifically, OCC will discuss with those Clearing Members
how they plan to satisfy any increase in their margin requirements
associated with the proposed change.
---------------------------------------------------------------------------
Consistency With the Payment, Clearing and Settlement Supervision Act
The stated purpose of the Clearing Supervision Act is to mitigate
systemic risk in the financial system and promote financial stability
by, among other things, promoting uniform risk management standards for
systemically important financial market utilities and strengthening the
liquidity of systemically important financial market utilities.\31\
Section 805(a)(2) of the Clearing Supervision Act \32\ also authorizes
the Commission to prescribe risk management standards for the payment,
clearing and settlement activities of designated clearing entities,
like OCC, for which the Commission is the supervisory agency. Section
805(b) of the Clearing Supervision Act \33\ states that the objectives
and principles for risk management standards prescribed under Section
805(a) shall be to:
---------------------------------------------------------------------------
\31\ 12 U.S.C. 5461(b).
\32\ 12 U.S.C. 5464(a)(2).
\33\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
Promote robust risk management;
promote safety and soundness;
reduce systemic risks; and
support the stability of the broader financial system.
The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and the Act, which include
Commission Rules 17Ad-22(b)(1), (b)(2) and (e)(6).\34\
---------------------------------------------------------------------------
\34\ 17 CFR 240. 17Ad-22. See Securities Exchange Act Release
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016,
81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards for Covered
Clearing Agencies''). The Standards for Covered Clearing Agencies
became effective on December 12, 2016. OCC is a ``covered clearing
agency'' as defined in Rule 17Ad-22(a)(5) and therefore OCC must
comply with new section (e) of Rule 17Ad-22.
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Rules 17Ad-22(b)(1) and (2) \35\ 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.
---------------------------------------------------------------------------
\35\ 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 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).\36\
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\36\ Id.
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[[Page 61360]]
Rule 17Ad-22(e)(6) \37\ 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.
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\37\ 17 CFR 240.17Ad-2(e)(6).
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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).\38\
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\38\ Id.
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III. Date of Effectiveness of the Advance Notice and Timing for
Commission Action
The proposed change may be implemented if the Commission does not
object to the proposed change within 60 days of the later of: (i) The
date the proposed change was filed with the Commission or (ii) the date
any additional information requested by the Commission is received. OCC
shall not implement the proposed change if the Commission has any
objection to the proposed change.
The Commission may extend the period for review by an additional 60
days if the proposed change raises novel or complex issues, subject to
the Commission providing the clearing agency with prompt written notice
of the extension. A proposed change may be implemented in less than 60
days from the date the advance notice is filed, or the date further
information requested by the Commission is received, if the Commission
notifies the clearing agency in writing that it does not object to the
proposed change and authorizes the clearing agency to implement the
proposed change on an earlier date, subject to any conditions imposed
by the Commission.
OCC shall post notice on its website of proposed changes that are
implemented.
The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the advance
notice is consistent with the Clearing Supervision Act. Comments may be
submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-OCC-2017-811 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-OCC-2017-811. 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 website (https://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the advance notice that are filed with the
Commission, and all written communications relating to the advance
notice between the Commission and any person, other than those that may
be withheld from the public in accordance with the provisions of 5
U.S.C. 552, will be available for 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 OCC and on OCC's website at
hhttps://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-2017-811 and should be
submitted on or before January 17, 2018.
By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-27832 Filed 12-26-17; 8:45 am]
BILLING CODE 8011-01-P
