Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to Advance Notice, as Modified by Amendments No. 1 and 2, Concerning Proposed Changes to the Options Clearing Corporation's Stress Testing and Clearing Fund Methodology, 37570-37579 [2018-16417]

Download as PDF 37570 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices the proposed rule change (SR– NASDAQ–2018–038). For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.8 Robert W. Errett, Deputy Secretary. [FR Doc. 2018–16425 Filed 7–31–18; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–83714; File No. SR–OCC– 2018–803] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to Advance Notice, as Modified by Amendments No. 1 and 2, Concerning Proposed Changes to the Options Clearing Corporation’s Stress Testing and Clearing Fund Methodology sradovich on DSK3GMQ082PROD with NOTICES July 26, 2018. I. Introduction On May 30, 2018, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) advance notice SR–OCC–2018–803 (‘‘Advance Notice’’) 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 (‘‘Act’’) 1 and Rule 19b–4(n)(1)(i) 2 under the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 3 to propose changes to OCC’s By-Laws and Rules, the formalization of a substantially new Clearing Fund Methodology Policy (‘‘Policy’’), and the adoption of a document describing OCC’s new Clearing Fund and stress testing methodology (‘‘Methodology Description’’).4 The proposed changes are primarily designed to enhance OCC’s overall resiliency, particularly with respect to the level of OCC’s prefunded financial resources. Specifically, the proposed changes would: (1) Reorganize, restate, and consolidate the provisions of OCC’s ByLaws and Rules relating to the Clearing Fund into a newly revised Chapter X of OCC’s Rules; (2) modify the coverage level of OCC’s Clearing Fund sizing requirement to protect OCC against losses stemming from the default of the two Clearing 8 17 CFR 200.30–3(a)(12). U.S.C. 5465(e)(1). 2 17 CFR 240.19b–4(n)(1)(i). 3 15 U.S.C. 78a et seq. 4 See Notice of Filing infra note 6, at 83 FR 31594. 1 12 VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 Member Groups that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions (i.e., adopt a ‘‘Cover 2 Standard’’ for sizing the Clearing Fund); (3) adopt a new risk tolerance for OCC to cover a 1-in-50 year hypothetical market event at a 99.5% confidence level over a two-year look-back period; (4) adopt a new Clearing Fund and stress testing methodology, which would be underpinned by a new scenario-based one-factor risk model stress testing approach, as detailed in the newly proposed Policy and Methodology Description; (5) document governance, monitoring, and review processes related to Clearing Fund and stress testing; (6) provide for certain anti-procyclical limitations on the reduction in Clearing Fund size from month to month; (7) increase the minimum Clearing Fund contribution requirement for Clearing Members to $500,000; (8) modify OCC’s allocation weighting methodology for Clearing Fund contributions; (9) reduce from five to two business days the timeframe within which Clearing Members are required to fund Clearing Fund deficits due to monthly or intra-month resizing or due to Rule amendments; (10) provide additional clarity in OCC’s Rules regarding certain antiprocyclicality measures in OCC’s margin model; and (11) make a number of other nonsubstantive clarifying, conforming, and organizational changes to OCC’s ByLaws, Rules, Collateral Risk Management Policy, Default Management Policy, and filed procedures, including retiring OCC’s existing Clearing Fund Intra-Month Resizing Procedure, Financial Resources Monitoring and Call Procedure (‘‘FRMC Procedure’’), and Monthly Clearing Fund Sizing Procedure, as these procedures would no longer be relevant to OCC’s proposed Clearing Fund and stress testing methodology and would be replaced by the proposed Rules, Policy, and Methodology Description described herein. On June 7, 2018, OCC filed Amendment No. 1 to the Advance Notice.5 The Advance Notice, as amended, was published for public comment in the Federal Register on July 6, 2018.6 On July 11, 2018, OCC filed 5 In Amendment No. 1, OCC corrected formatting errors in Exhibits 5A and 5B without changing the substance of the proposed rule change. 6 Securities Exchange Act Release No. 83561 (Jun. 29, 2018), 83 FR 31594 (Jul. 6, 2018) (‘‘Notice of PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 Amendment No. 2 to the Advance Notice.7 The Commission received five comment letters in support of the proposal contained in the Advance Notice.8 This publication serves as notice of no objection to the Advance Notice. II. Background The Advance Notice concerns proposed changes to OCC’s By-Laws 9 and Rules,10 the formalization of the substantially new Policy, and the adoption of OCC’s new Methodology Description.11 According to OCC, the changes comprising the Advance Notice are primarily designed to enhance OCC’s overall resiliency, particularly with respect to the level of OCC’s prefunded financial resources.12 Filing’’). On May 30, 2018, OCC also filed a related proposed rule change (SR–OCC–2018–008) with the Commission pursuant to Section 19(b)(1) of the Exchange Act and Rule 19b–4 thereunder, seeking approval of changes to its rules necessary to implement the Advance Notice (‘‘Proposed Rule Change’’). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b– 4, respectively. The Proposed Rule Change was published in the Federal Register on June 15, 2018. Securities Exchange Act Release No. 83406 (Jun. 11, 2018), 83 FR 28018 (Jun. 15, 2018). 7 In Amendment No. 2, OCC made three nonsubstantive changes to the proposal. Specifically, OCC (1) updated a cross-reference in Article VI, Section 27 of the OCC By-Laws to reflect the relocation of OCC’s clearing fund-related rules, (2) added an Interpretation and Policy to proposed Rule 1001 to clarify the applicability of the 5 percent month-over-month limitation in the reduction of clearing fund size is not intended to apply to the initial changes in to OCC’s clearing fund sizing resulting from implementation of the proposed methodology, and (3) clarified an implementation date of September 1, 2018 for the proposed changes in the filing. 8 See letter from Andrej Bolkovic, CEO, ABN AMRO Clearing Corporation LLC (‘‘AACC’’), dated June 26, 2018, to Brent Fields, Secretary, Commission (AACC Letter I) ; letter from Chris Concannon, President and COO, Cboe Global Markets (‘‘CBOE’’), dated July 6, 2018, to Brent Fields, Secretary, Commission (CBOE Letter I); letter from Matthew R. Scott, President, Merrill Lynch Professional Clearing Corp. (‘‘MLPRO’’), dated July 6, 2018, to Brent J. Fields, Secretary, Commission (MLPRO Letter I); letter from Kurt Eckert, Partner, Wolverine Execution Services (‘‘WEX’’), dated July 12, 2018, to Brent Fields, Secretary, Commission (WEX Letter I); and letter from Mark Dehnert, Managing Director, Goldman Sachs & Co. LLC (‘‘GS’’), dated July 17, 2018, to Brent J. Fields, Secretary, Commission (GS Letter I), available at https://www.sec.gov/comments/sr-occ2018-008/occ2018008.htm. Since the proposal contained in the Advance Notice was also filed as a proposed rule change, all public comments received on the proposal are considered regardless of whether the comments are submitted on the proposed rule change or the Advance Notice. 9 OCC’s By-Laws are available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_bylaws.pdf. 10 OCC’s Rules are available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. 11 See Notice of Filing, 83 FR at 31594. 12 See id. E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices As enumerated in the Notice of Filing, the specific modifications that OCC proposes are as follows: (1) Reorganize, restate, and consolidate the provisions of OCC’s By-Laws and Rules relating to the clearing fund into a revised Chapter X of OCC’s Rules; (2) modify the coverage level of OCC’s clearing fund sizing requirement to protect OCC against losses stemming from the default of the two clearing member groups that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions (i.e., adopt a ‘‘Cover 2 Standard’’ for sizing the clearing fund); (3) adopt a new risk tolerance for OCC to cover a 1in-50 year hypothetical market event at a 99.5% confidence level over a twoyear look-back period; (4) adopt a new clearing fund and stress testing methodology, which would be underpinned by a new scenario-based one-factor risk model stress testing approach, as detailed in the proposed Policy and Methodology Description; (5) document governance, monitoring, and review processes related to the clearing fund and stress testing; (6) provide for certain anti-procyclical limitations on the reduction in clearing fund size from month to month; (7) increase the minimum clearing fund contribution requirement for clearing members from $150,000 to $500,000; (8) modify OCC’s allocation weighting methodology for clearing fund contributions; (9) reduce from five to two business days the timeframe within which clearing members are required to fund clearing fund deficits due to monthly or intramonth resizing; (10) provide additional clarity in OCC’s Rules regarding certain anti-procyclicality measures in OCC’s margin model; and (11) make a number of other non-substantive clarifying, conforming, and organizational changes to OCC’s By-Laws, Rules and filed procedures, including retiring OCC’s existing Clearing Fund Intra-Month Resizing Procedure, Financial Resources Monitoring and Call Procedure, and Monthly Clearing Fund Sizing Procedure, as these procedures would be replaced by the proposed Rules, Policy, and Methodology Description.13 The remainder of this section will first provide an overview of OCC’s current process for sizing the clearing fund, followed by a more detailed discussion of the specific changes to that process being proposed in the Advance Notice, with particular focus on the following categories: (a) Stress testing; (b) total financial resources; (c) financial resource sufficiency; (d) allocation of clearing fund 13 See id. at 31594–95. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 contributions; and (e) textual clarification and consolidation. A. OCC’s Current Process for Sizing the Clearing Fund OCC’s process for determining the size of its clearing fund was initially approved in 2011,14 and enhanced in 2015,15 resulting in OCC’s current process. Currently, OCC resizes its clearing fund at the beginning of each month to maintain financial resources, in excess of margin, to cover its credit exposures to its clearing members. The current process is effectively an extension of OCC’s daily margin process, in which OCC calculates what it refers to as the ‘‘daily draw’’ based on observations from its margin model at specific confidence levels each day.16 OCC tracks the rolling five-day average of these daily draws and, at the beginning of each month, sets the clearing fund size to the sum of (1) the largest five-day rolling average observed over the last three months and (2) a $1.8 billion buffer.17 As described in detail below, OCC is proposing three primary changes to the existing approach. First, instead of simply relying on its margin model, OCC would rely on the proposed stress testing framework, including both sizing and sufficiency stress tests. Second, OCC would set the size of its clearing fund based on a Cover 2 Standard. Third, OCC would eliminate the current $1.8 billion static buffer because it would be obsolete in light of the new sizing stress tests and increased coverage afforded by the move to a Cover 2 Standard that, together, would function as a dynamic buffer. B. Stress Testing OCC proposes to adopt a new stress testing methodology, as detailed in both the proposed Policy and the proposed Methodology Description.18 OCC believes that its proposed methodology would enable it to measure its credit 14 See Securities Exchange Act Release No. 65386 (Sep. 23, 2011), 76 FR 60572 (Sep. 29, 2011) (Order Approving Clearing Fund I). 15 See Securities Exchange Act Release No. 75528 (Jul. 27, 2015), 80 FR 45690 (Jul. 31, 2015) (Order Approving Clearing Fund II). 16 See Order Approving Clearing Fund I, 76 FR at 60572–60573. Each day, OCC estimates credit exposures under the stressed margin model for two scenarios: the greater of the two estimates is the daily draw. The two scenarios are of (1) the single largest credit exposure that would arise out of the default of a single clearing member group (‘‘idiosyncratic default’’) and (2) the credit exposure that would arise out of the default of two-randomly selected clearing member groups (‘‘minor systemic default’’). See Notice of Filing, 83 FR at 31595. 17 See Order Approving Clearing Fund II, 80 FR at 45691. 18 See Notice of Filing, 83 FR at 31597. PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 37571 exposure at a level sufficient to cover potential losses under extreme but plausible market conditions.19 To do so, OCC proposes to conduct daily stress tests that consider a range of relevant stress scenarios and related price changes, including but not limited to: (1) Relevant peak historic price volatilities; (2) shifts in other market factors including, as appropriate, price determinants and yield curves; and (3) the default of one or multiple clearing members.20 The stress scenarios used in OCC’s proposed methodology would consist of two types of scenarios: historical scenarios and hypothetical scenarios.21 Historical Scenarios would replicate historical events in current market conditions, which include the set of currently existing securities and their prices and volatility levels.22 Hypothetical scenarios, rather than replicating past events, would simulate events in which market conditions change in ways that may have not yet been observed.23 Hypothetical Scenarios, constructed using statistical methods, would generally include price shocks specific to various instruments, such as equity products, volatility products, and fixed income products. Each scenario would represent a draw from a multivariate distribution fitted to historical data regarding the relevant instrument (e.g., returns of the S&P 500).24 In a hypothetical scenario, the shock to a risk driver would be used to determine the relative shock to each associated risk factor (i.e., related underlying security).25 For example, OCC would establish the size of its clearing fund according to a scenario that is based on statistically generated up or down price shocks for the SPX assuming a 1-in-80 year market event.26 OCC’s proposed stress testing framework would categorize OCC’s 19 See id. id. at 31598. 21 See id. Because not all of the underlying securities in current portfolios existed during the events on which historical scenarios are based, OCC has developed methodologies to approximate the past price and volatility movements as appropriate. See id. at 31600. 22 See id. at 31598. 23 See id. 24 See id. at 31599. Risk drivers are a selected set of securities or market indices (e.g., the Cboe S&P 500 Index (‘‘SPX’’) or the Cboe Volatility Index (‘‘VIX’’)) that are used to represent the main sources or drivers for the price changes of the risk factors. See id. at 31597, n. 26. The term risk factor refers broadly to all of the individual underlying securities (such as Google, IBM and Standard & Poor’s Depositary Receipts (‘‘SPDR’’), S&P 500 Exchange Traded Funds (‘‘SPY’’), etc.) listed on a market. See id. 25 See id. at 31598. 26 See id. at 31599. 20 See E:\FR\FM\01AUN1.SGM 01AUN1 37572 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices inventory of stress tests by each stress test’s intended purpose: Adequacy, sizing, sufficiency, and informational.27 Specifically, OCC would use the (1) ‘‘Adequacy Stress Tests’’ to determine whether the financial resources collected from all clearing members collectively are adequate to cover OCC’s risk tolerance; (2) ‘‘Sizing Stress Tests’’ to establish the monthly size of the clearing fund; (3) ‘‘Sufficiency Stress Tests’’ to monitor whether OCC’s credit exposure to the portfolios of individual clearing member groups is at a level sufficiently large enough to necessitate OCC calling for additional resources so that OCC continues to maintain sufficient financial resources to guard against potential losses under a wide range of stress scenarios, including extreme but plausible market conditions; and (4) ‘‘Informational Stress Tests’’ to monitor and assess the size of OCC’s pre-funded financial resources against a wide range of stress scenarios that may include extreme but implausible and reverse stress testing scenarios.28 sradovich on DSK3GMQ082PROD with NOTICES C. Total Financial Resources As noted above, OCC proposes to (i) to adopt a new clearing fund methodology, which would be underpinned by a new scenario-based one-factor risk model stress testing approach,29 modify the coverage level of OCC’s clearing fund sizing requirement to a Cover 2 Standard; (iii) provide for certain anti-procyclical limitations on the reduction in clearing fund size from month to month; and (iv) reduce from five business days to two business days the timeframe within which clearing members are required to satisfy clearing fund deficits due to monthly or intramonth resizing.30 1. Proposal To Change the Monthly Clearing Fund Size Calculation As discussed above, OCC proposes to replace the methodology by which it determines the monthly clearing fund size with an approach based on hypothetical stress scenarios that assume SPX shocks (up and down) associated with a 1-in-80-year market event.31 Under the proposal, OCC would continue determining the size of its clearing fund each month based on the peak-five daily rolling average of estimated stress exposures; however, such exposures would be based on the output from OCC’s stress testing 27 See id. at 31600. id. at 31600–02. 29 OCC detailed the new methodology in the proposed Policy and Methodology Description. 30 See Notice of Filing, 83 FR at 31596. 31 See id. at 31599. 28 See VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 framework going forward as opposed to the margin-derived approach described above.32 As its benchmark for identifying extreme but plausible market conditions, OCC proposes to adopt a credit risk tolerance defined by OCC’s largest potential aggregate credit exposure to two clearing member groups under a 1-in-50-year hypothetical market event as opposed to the greater of exposures arising under an idiosyncratic default or a minor systemic default.33 OCC further proposes to base its daily draw on the aggregate credit exposures estimated under a 1-in-80-year hypothetical market event.34 Additionally, OCC proposes to size the clearing fund to a Cover 2 Standard.35 OCC believes that sizing the clearing fund to cover a 1-in-80-year event would provide sufficient coverage in excess of the exposures estimated under a 1-in-50-year event to justify no longer collecting the $1.8 prudential margin of safety.36 2. Proposal To Limit Reductions in Clearing Fund Size From Month to Month Currently, OCC does not constrain month-over-month changes in the size of the clearing fund. OCC proposes to adopt two limitations on month-overmonth decreases in the size of the clearing fund. First, OCC proposes to prohibit a clearing fund decrease of more than 5 percent month-overmonth.37 Second, OCC proposes to limit the clearing fund decreases based on its daily monitoring of OCC’s financial resources. When determining the size of the clearing fund at the beginning of a given month, OCC would not allow that size to be less than 90 percent of the peak credit exposures estimated under the stress tests used for daily monitoring during the last five business days of the preceding month.38 These limitations are designed to reduce the potential for cyclical movements in the size of the 32 See id. at 31600. Specifically, OCC would identify its exposures under a 1-in-80-year hypothetical event. See id. 33 See id. at 31597. As discussed above, OCC’s hypothetical stress scenarios represent draws from a fitted distribution of 2-day log returns for a given risk driver. OCC noted in its proposal that a 1-in50-year hypothetical market event corresponds to a 99.9921 percent confidence interval under OCC’s chosen distribution of 2-day logarithmic S&P 500 index returns. See id., n. 25. 34 See id. at 31600. 35 See id. at 31597. 36 See id., n. 23. 37 See id. at 31603. 38 See id. As discussed below, OCC proposes to monitor the sufficiency of its financial resources daily by comparing the size of the clearing fund to the output of several historical stress tests. PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 clearing fund, as well as reduce the need for OCC to call for additional financial resources intra-month.39 3. Timing of Clearing Fund Contributions In addition to revising the methodology for sizing OCC’s total financial resources, OCC proposes generally to reduce the time in which each clearing member must make its clearing fund contribution.40 Clearing members currently have five business days to satisfy a clearing fund deficiency arising out of the monthly sizing or intra-month resizing processes. OCC proposes to reduce that time to two business days.41 OCC also proposes to require clearing members to satisfy any clearing fund deficit resulting from a decrease in the value of the clearing member’s existing contribution within one hour of notification by OCC.42 D. Financial Resource Sufficiency As noted above, OCC proposes to (i) adopt a new clearing fund methodology, as detailed in the newly-proposed Policy and Methodology Description and (ii) document governance, monitoring, and review processes related to the clearing fund and stress testing.43 Proposed changes to OCC’s clearing fund methodology include the assessment of OCC’s clearing fund against a wide range of historical scenarios.44 1. Proposal To Monitor the Sufficiency of OCC’s Financial Resources Currently, OCC monitors the sufficiency of its financial resources daily by estimating whether the size of the clearing fund is sufficient to cover a maximum potential loss from a simulated idiosyncratic default.45 Under its current procedures, when OCC observes credit exposures estimated under the idiosyncratic default in excess of 75 percent of the clearing fund size, OCC issues a margin call against the clearing member group generating the credit exposures.46 The size of such a margin call is the difference between the idiosyncratic default exposure and the 39 See id. id. at 31605. 41 See id. 42 See id. 43 See id. at 31596. 44 See id. 45 See id. at 31595–96. As noted above, an idiosyncratic default is one of the two scenarios that OCC currently uses to determine the size of the clearing fund each month. See supra note 16. Specifically, the single largest credit exposure that would arise out of the default of a single clearing member group. 46 See id. at 31595. 40 See E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES base clearing fund amount.47 The margin call is allocated among the individual clearing members in the clearing member group based on each clearing member’s proportionate share of the risk to OCC.48 OCC may limit the size of the margin call to each clearing member to the lesser of $500 million or 100 percent of such clearing member’s net capital.49 OCC’s current procedures also call for increases to the total size of the clearing fund in more extreme scenarios. When OCC observes credit exposures estimated under the idiosyncratic default 50 exceeding 90 percent of the clearing fund size OCC must, under its procedures, increase the size of the clearing fund.51 The size of the increase to the clearing fund is the greater of $1 billion or 125 percent of the difference between the idiosyncratic default exposure and the clearing fund.52 OCC proposes to revise this process by replacing the above-described idiosyncratic default approach with an approach that compares the size of the clearing fund to the exposures estimated under a set of historical scenario stress tests (‘‘Sufficiency Stress Tests’’).53 The Sufficiency Stress Tests proposed by OCC include the largest market moves up and down during 2008 on a cover 2 basis and the market moves associated with the 1987 market crash on a cover 1 basis.54 OCC proposes to call for additional margin when it observes that one or more clearing member groups’ exposure under a Sufficiency Stress Test exceeds 75 percent of the clearing fund.55 Under the proposal, the size of the margin call would be the amount by which the Sufficiency Stress Test exposure exceeds the 75 percent threshold.56 Similar to the current process, OCC proposes to retain authority to limit such margin calls to each clearing member to $500 million or 100 percent of the clearing member’s net capital.57 OCC also proposes to revise the process for increasing the size of the 47 See id. As noted above in section II.A., the base clearing fund amount is the size of the clearing fund less the $1.8 billion prudential margin of safety. 48 See id., n. 13. 49 See id. at 31595. 50 OCC would reduce the size of the idiosyncratic default exposure by factoring in margin calls issued due to a breach of the 75 percent threshold described above. See id. at 31596. 51 See id. 52 See id. 53 See id. at 31600. 54 See id. at 31601. OCC proposes to measure the clearing fund against the two largest exposures under the 2008-like events and the one largest exposure under a 1987-like event. See id. 55 See id. 56 See id. 57 See id. at 31601–02. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 clearing fund under more extreme scenarios. OCC proposes to increase the size of the clearing fund when it observes a Sufficiency Stress Test exposure in excess of 90 percent of the clearing fund.58 Similar to the current process, the size of the clearing fund increase would be the greater of $1 billion or 125 percent of the difference between the Sufficiency Stress Test exposure and the clearing fund.59 OCC also proposes to provide new authority to its Chief Executive Officer, Chief Administrative Officer, and Chief Operating Officer to temporarily increase the size of the clearing fund, subject to notice and later review by OCC’s Board Risk Committee (‘‘RC’’).60 Additionally, OCC proposes to add a new threshold at which it would commence enhanced monitoring of a clearing member group.61 Where OCC observes that a clearing member group’s Sufficiency Stress Test exposure exceeds 65 percent of the clearing fund, OCC would commence enhanced monitoring of, and provide notice to the clearing member group.62 2. Proposal To Document Governance Processes Related to the Clearing Fund and Stress Testing OCC proposes to establish, as part of its rules, processes for the governance, monitoring, and review of the stress testing framework and clearing fund methodology described above.63 Such processes would cover daily, monthly, and annual review of OCC’s stress testing framework and clearing fund methodology. On a daily basis, OCC’s staff would monitor the size of the clearing fund against OCC’s risk tolerance and sufficiency stress tests.64 OCC staff would be required to report material issues to the Executive Vice President of OCC’s Financial Risk Management group (‘‘EVP–FRM’’). The EVP–FRM would further escalate issues with OCC management as applicable. On a monthly basis, OCC’s staff would provide reports and analyses of the daily stress tests to OCC’s Management Committee and RC.65 OCC’s staff would also be responsible for conducting a comprehensive analysis of stress test results, scenarios, models, parameters, and assumptions monthly or more frequently when the products cleared or markets served by OCC display high volatility or become less liquid or when the size or concentration of positions held by OCC’s participants increases significantly.66 On an annual basis, OCC’s Model Validation Group would be required to perform a model validation of OCC’s clearing fund methodology.67 The RC would review such validations.68 The RC would also be responsible for annual review and approval of the Policy.69 E. Allocation of Clearing Fund Contributions As noted above, OCC proposes to (i) increase the minimum clearing fund contribution requirement for clearing members to $500,000 and (ii) modify OCC’s allocation weighting methodology for clearing fund contributions.70 1. Proposal To Increase the Minimum Clearing Fund Contribution Currently, the minimum amount a clearing member must contribute to OCC’s clearing fund (the ‘‘fixed amount’’) is $150,000.71 OCC proposes to increase the fixed amount to $500,000.72 The minimum contribution requirement has been in place since June 5, 2000,73 and has remained static while the average size of OCC’s clearing fund has increased significantly.74 OCC also noted that other CCPs’ minimum requirements are well in excess of OCC’s minimum contribution requirement.75 OCC analyzed the impact of the proposed change on its clearing members and discussed such impacts with the potentially affected clearing members, the majority of which did not express concerns over the proposed increase.76 66 See id. 59 See id. 60 See id. at 31602. 61 See id. at 31601. Based on OCC’s procedures, staff understands that such monitoring would entail escalation within OCC’s Financial Risk Management group noting the relevant clearing member, the future potential for breach of the 75 percent margin call threshold, and a summary of the apparent risk drivers resulting in the stress exposures. 62 See id. 63 See id. at 31602. 64 See id. 65 See id. at 31602–03. PO 00000 58 See Frm 00115 Fmt 4703 Sfmt 4703 37573 id. id. at 31603. 68 See id. 69 See id. 70 See id. at 31596. 71 See id. at 31604. The initial amount that a new clearing member must contribute to OCC’s clearing fund is also $150,000. See id. at 31603. 72 See id. at 31604. OCC similarly proposes to increase the initial contribution. See id. at 31603. 73 See id. (citing Securities Exchange Act Release No. 42897 (June 5, 2000), 65 FR 36750 (June 9, 2000) (SR–OCC–99–9)). 74 See id. at 31603–04. 75 See id. at 31603. 76 See id. at 31604. 67 See E:\FR\FM\01AUN1.SGM 01AUN1 37574 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices 2. Proposal To Modify the Clearing Fund Allocation Weighting In addition to the fixed amount described above, most clearing members are required to contribute an additional amount to OCC’s clearing fund (the ‘‘variable amount’’). The variable amount is based on the weighted average of each clearing member’s proportionate share of total risk, open interest, and volume.77 Currently, OCC uses the following weighting in its allocation of clearing fund requirements: 35 percent total risk; 50 percent open interest; and 15 percent volume.78 OCC proposes to modify the allocation weighting as follows: 70 percent total risk; 15 percent open interest; and 15 percent volume.79 F. Textual Clarification and Consolidation Finally, as noted above, OCC proposes to (i) reorganize, restate, and consolidate the provisions of OCC’s By-Laws and Rules relating to the Clearing Fund into a newly-revised Chapter X of OCC’s Rules; (ii) provide additional clarity in OCC’s Rules regarding certain antiprocyclicality measures in OCC’s margin model; and (iii) make a number of other non-substantive clarifying, conforming, and organizational changes to OCC’s By-Laws, Rules, and filed procedures, including retiring OCC’s existing Clearing Fund Intra-Month Resizing Procedure, Financial Resources Monitoring and Call Procedure, and Monthly Clearing Fund Sizing Procedure, as these procedures would be replaced by the proposed Rules, Policy, and Methodology Description.80 1. Proposal To Reorganize, Restate, and Consolidate Certain Rule Text sradovich on DSK3GMQ082PROD with NOTICES The primary provisions that address OCC’s Clearing Fund are currently located in Article VIII of the By-Laws and Chapter X of the Rules.81 OCC believes that consolidating all of the Clearing Fund-related provisions of its By-Laws and Rules into one place would provide more clarity around, and enhance the readability of, OCC’s Clearing Fund requirements.82 Given the scope of changes described above, 77 See id. Total risk refers to a clearing member’s margin requirement. See id., n. 44. Additionally, the current methodology calculates volume based on executed volume. See id. at 31604. 78 See id. 79 See id. The definition of total risk would remain the same, but OCC would calculate volume based on cleared volume as opposed to executed volume. See id. 80 See id. at 31596. 81 See id. 82 See id. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 OCC believes that it is appropriate to make such revisions at this time.83 The changes to the provisions currently residing in OCC’s By-Laws require an affirmative vote of two-thirds of the directors then in office, but not less than a majority of the number of directors fixed by the By-Laws; however, changes to OCC’s rules generally require only a majority vote of OCC’s Board of Directors.84 OCC proposes to amend its By-Laws to maintain the existing requirements for modifying those rules that would be moved from Article VIII of OCC’s ByLaws to Chapter X of its Rules.85 2. Proposal To Add Rule Text Clarifying Anti-Procyclicality Measures in OCC’s Margin Model OCC’s existing methodology for calculating margin requirements incorporates measures designed to ensure that margin requirements are not lower than those that would be calculated using volatility estimated over a historical look-back period of at least ten years.86 OCC now proposes to amend its Rule 601(c) to reflect this practice.87 OCC believes that the proposed change would provide more clarity and transparency in its rules.88 3. Proposal To Make Other NonSubstantive Changes to OCC’s Rules OCC proposes a number of clarifying, conforming, and organizational changes to its By-Laws, Rules, Collateral Risk Management Policy, Default Management Policy, and Clearing Fundrelated procedures in connection with the proposed enhancements to its PreFunded Financial Resources and the relocation of OCC’s Clearing Fundrelated By-Laws into Chapter X of the Rules.89 In addition to the relocation of rules described above, OCC would also make minor, non-substantive revisions. For example, OCC would replace text referencing ‘‘computed contributions to the Clearing Fund’’ and ‘‘as fixed at the time’’ with text stating ‘‘required contributions to the Clearing Fund’’ and ‘‘as calculated at the time’’ to more accurately reflect that these rules are intended to refer to a Clearing Member’s required Clearing Fund contribution amount as calculated under the proposed rules.90 PO 00000 Further, OCC proposes to update references to Article VIII of the By-Laws in its Collateral Risk Management Policy and Default Management Policy to reflect the relocation of OCC’s Clearing Fund-related By-Laws into Chapter X of the Rules.91 Finally, OCC proposes to replace procedures regarding its processes for (i) the monthly resizing of its Clearing Fund, (ii) the addition of financial resources, and (iii) the execution of any intra-month resizing of the Clearing Fund.92 OCC proposes to retire its existing procedures because the relevant rule requirements would be maintained in the proposed rules as well as the Clearing Fund Methodology Policy and Clearing Fund Methodology Description included as part of the Advance Notice.93 III. Summary of Comments As noted above, the Commission received five comment letters—AACC Letter I, CBOE Letter I, MLPRO Letter I, WEX Letter I, and GS Letter I— supporting the changes proposed in the Advance Notice.94 Two of the commenters urge the Commission to approve the proposal as expeditiously as possible.95 AACC believes that the proposal would remediate two problems with the current clearing fund methodology: (1) OCC’s current clearing fund sizing methodology failing to contain sufficient anti-procyclicality measures, and (2) OCC’s current clearing fund contribution allocation methodology failing to appropriately incentivize clearing member risk management.96 Regarding the clearing fund sizing methodology, AACC believes that the proposal would implement a number of measures intended to provide stability and consistency to the size of OCC’s clearing fund.97 Specifically, AACC supports (1) sizing the clearing fund based on a variety of risk factors, and (2) testing the size of the clearing fund on a daily basis against extreme but plausible market events, thereby lowering the likelihood that OCC’s clearing fund would be insufficient to protect OCC and market participants in the event of a clearing member default.98 MLPRO believes that the proposed changes would create a more transparent and predictable model.99 91 See id. at 31607. id. at 31607–08. 93 See id. at 31608. 94 See supra note 8. 95 AACC Letter I at 1; MLPRO Letter I at I. 96 AACC Letter I at 1. 97 Id. at 2. 98 Id. at 2–3. 99 MLPRO Letter I at 2. 83 See id. 84 See id. 85 See id. at 31596–97. 86 See id. at 31606. 87 See id. 88 See id. 89 See id. 90 See id. at 31607, n. 52. Frm 00116 Fmt 4703 92 See Sfmt 4703 E:\FR\FM\01AUN1.SGM 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES Similarly, GS supports OCC’s proposal to include more comprehensive testing scenarios by including observed market events over a longer historical period, which would improve the overall quality of OCC’s stress testing and strengthen OCC’s ability to model risk scenarios.100 Additionally, WEX believes that the proposed changes, specifically changes regarding how the monthly clearing fund sizing process will address anti-procyclicality, should help reduce operational issues related to a clearing member’s obligations increasing and decreasing.101 AACC states that, from a theoretical perspective, OCC’s proposed sizing methodology constitutes a significant improvement over the current sizing methodology in that the size of the clearing fund would be less influenced by changes in volatility because OCC is introducing other risk drivers into the sizing methodology as well as monitoring and augmenting such risk drivers on a daily basis based on market conditions.102 AACC also comments that the proposal would cause the size of OCC’s clearing fund to become more stable because OCC would test for adequacy and sufficiency on a daily basis using a series of historical and hypothetical stress tests that are rooted in extreme but plausible market events.103 Commenters also believe that the proposal would improve OCC’s risk models by correcting existing shortcomings.104 CBOE comments that the adoption of a Cover 2 standard would ensure that the size of the clearing fund is sufficient to protect OCC against losses from the simultaneous default of its two largest Clearing Members under extreme, but plausible market conditions.105 GS also agrees with OCC’s proposal to adopt a Cover 2 Standard.106 MLPRO comments that the adoption of a Cover 2 standard in establishing a new model to measure the adequacy of the clearing fund and address potential default scenarios would address issues that MLPRO 100 GS Letter I at 2. In its letter, GS refers to OCC’s movement to a 1-in-80-year period from a 1-in-50year model. The Commission notes that OCC’s current process is not based on a 1-in-50-year model, and that OCC is now proposing to adopt a new risk tolerance based on a 1-in-50-year hypothetical event. See Notice of Filing, 83 FR at 31596. Further, OCC proposes to base the size of the clearing fund on the aggregate credit exposures estimated under a 1-in-80-year hypothetical market event (as opposed to an historical market event). See id. at 31600. 101 WEX Letter I at 1. 102 AACC Letter I at 3. 103 Id. 104 CBOE Letter I at 1; MLPRO Letter I at 1–2. 105 CBOE Letter I at 1. 106 GS Letter I at 2. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 identifies with OCC’s current model.107 MLPRO also supports OCC’s (1) adopting risk tolerance and stress testing assumptions that are developed from extreme, but plausible scenarios, and (2) calibrating individual equity price movements to the price shock for the applicable equity index to address issues with the current model.108 Regarding the changes to the clearing fund allocation methodology, commenters believe that the proposal would better align clearing members’ required clearing fund contribution to the risk they present to OCC and other market participants.109 AACC states that the proposed changes would place more emphasis on the economic risk presented by a clearing member’s cleared contracts than the operational risk presented by a high volume clearing member, thereby better recognizing that certain types of clearing members present a relatively lower risk to OCC even though they may represent a higher percentage of overall activity (i.e., clearing members with marketmaker and other risk-neutral customers).110 Similarly, WEX supports allocation based on cleared volumes as opposed to executed volumes in consideration of where a positon is cleared as opposed to where it is executed.111 MLPRO also supports increases the weighting of total risk in the allocation process.112 Commenters also believe that the proposed changes make sense from a default and liquidation perspective.113 Commenters AACC and WEX believe that the proposed changes would have positive effects on the listed options market.114 Similarly, MLPRO believes that the proposed changes would increase liquidity in the listed options market.115 Additionally, GS believes that the proposed changes will greatly enhance OCC’s resiliency and risk management.116 IV. Discussion and Commission Findings Although the Act does not specify a standard of review for an advance notice, the stated purpose of the Act is instructive: to mitigate systemic risk in the financial system and promote financial stability by, among other 107 MLPRO Letter I at 1–2. 108 Id. 109 AACC Letter I at 4; WEX Letter I at 1; GS Letter I at 1. 110 AACC Letter I at 4. 111 WEX Letter I at 2. 112 MLPRO Letter I at 2. 113 AACC Letter I at 4; GS Letter I at 1. 114 AACC Letter I at 5; WEX Letter I at 2. 115 MLPRO Letter I at 1. 116 GS Letter I at 2. PO 00000 Frm 00117 Fmt 4703 Sfmt 4703 37575 things, promoting uniform risk management standards for SIFMUs and strengthening the liquidity of SIFMUs.117 Section 805(a)(2) of the Act 118 authorizes the Commission to prescribe regulations containing risk-management standards for the payment, clearing, and settlement activities of designated clearing entities engaged in designated activities for which the Commission is the supervisory agency. Section 805(b) of the Act 119 provides the following objectives and principles for the Commission’s risk-management standards prescribed under Section 805(a): • To promote robust risk management; • to promote safety and soundness; • to reduce systemic risks; and • to support the stability of the broader financial system. Section 805(c) provides, in addition, that the Commission’s risk-management standards may address such areas as risk-management and default policies and procedures, among others areas.120 The Commission has adopted riskmanagement standards under Section 805(a)(2) of the Act and Section 17A of the Exchange Act (the ‘‘Clearing Agency Rules’’).121 The Clearing Agency Rules require, among other things, each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures that are reasonably designed to meet certain minimum requirements for its operations and risk-management practices on an ongoing basis.122 As such, it is appropriate for the Commission to review advance notices against the Clearing Agency Rules and the objectives and principles of these risk management standards as described in Section 805(b) of the Act. As discussed below, the Commission believes the proposal in the Advance Notice is consistent with the objectives and principles described in Section 805(b) of the Act,123 and in the Clearing 117 See 12 U.S.C. 5461(b). U.S.C. 5464(a)(2). 119 12 U.S.C. 5464(b). 120 12 U.S.C. 5464(c). 121 17 CFR 240.17Ad–22. See Securities Exchange Act Release No. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7–08–11). See also Securities Exchange Act Release No. 78961 (September 28, 2016), 81 FR 70786 (October 13, 2016) (S7–03–14) (‘‘Covered Clearing Agency Standards’’). The Commission established an effective date of December 12, 2016, and a compliance date of April 11, 2017, for the Covered Clearing Agency Standards. OCC is a ‘‘covered clearing agency’’ as defined in Rule 17Ad–22(a)(5). 122 17 CFR 240.17Ad–22. 123 12 U.S.C. 5464(b). 118 12 E:\FR\FM\01AUN1.SGM 01AUN1 37576 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES Agency Rules, in particular Rules 17Ad–22(e)(1) and 17Ad–22(e)(4).124 A. Consistency With Section 805(b) of the Act The Commission believes that the proposal contained in OCC’s Advance Notice is consistent with the stated objectives and principles of Section 805(b) of the Act. Specifically, as discussed below, the Commission believes that the changes proposed in the Advance Notice are consistent with promoting robust risk management in the area of credit risk, promoting safety and soundness, reducing system risks, and supporting the stability of the broader financial system.125 First, as described above, OCC’s current process for sizing the clearing fund was established in 2011 and strengthened under a 2015 interim approach. The current process is essentially an extension of OCC’s margin model. In general, margin requirements for clearing members are very reactive to market movements and changes in clearing member portfolios. Because OCC’s current process for sizing the clearing fund is based on a relatively dynamic daily margin process, the size of the clearing fund can at times be volatile and cyclical in nature. The changes proposed in the Advance Notice based the sizing and monitoring of OCC’s clearing fund on a stable inventory of stress tests rather than continuing to rely on a dynamic margin model. The Commission believes this new approach would provide OCC with a more precise, rigorous, and stable assessment of the financial resources it would need to hold in its clearing fund to cover its credit risk exposure to its members in extreme but plausible market conditions, which in turn would enhance OCC’s overall risk management. Second, with respect to the robustness of the new stress testing framework itself, the Commission believes that the stress tests proposed in OCC’s framework are an improvement over OCC’s current approach in this area, as the stress tests comprise a wide range of foreseeable stress scenarios. The scenarios cover historical events as extreme as the 2008 financial crisis and 1987 market crash as well as hypothetical events derived from a dataset of historical S&P returns. OCC’s proposed stress testing framework would also include a category of stress tests designed specifically for review of 124 17 CFR 240.17Ad–22(e)(1); 17 CFR 240.17Ad– 22(e)(4). 125 12 U.S.C. 5464(b). VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 OCC’s financial resources against implausible scenarios and reverse stress tests. Such stress tests would not directly affect the total amount of OCC’s financial resources, but would facilitate a more forward looking risk management process. Accordingly, while as an ongoing supervisory matter the Commission expects OCC to consider and, as necessary, implement future enhancements to its suite of stress tests, the Commission believes that the suite of stress tests that OCC proposes to establish in its risk management framework pursuant to the Advance Notice represents a material improvement to OCC’s current risk management practices for estimating potential future losses in extreme but plausible market conditions. Third, as described above, OCC proposes to adopt several enhancements to its methodology for determining the size of its clearing fund. OCC proposes to adopt an internal credit risk tolerance based on hypothetical stress scenarios, which would provide OCC with a benchmark that it believes represents extreme but plausible market conditions. The Commission believes that establishing such a tolerance is a valuable step in accurately estimating the total financial resources necessary to cover OCC’s exposures in extreme but plausible market conditions. Next, OCC proposes to set the size of its clearing fund to cover a scenario that is more extreme than its internal tolerance to ensure consistent coverage, which the Commission believes would be another valuable step in accurately estimating OCC’s necessary total financial resources. Further, OCC proposes to cover its two largest credit exposures when setting the size of the clearing fund, which goes further than OCC’s current practice of covering the greater of OCC’s single largest exposure or two random exposures. For the same reasons, the Commission believes this, too, would improve OCC’s risk management practices. Finally, OCC proposes to limit the potential reductions in the size of the clearing fund month-over-month. Such limitations would avoid large drops in the clearing fund size over a short period of time and unnecessary reductions followed by immediate calls for additional resources at the beginning of each month. Taken together, the Commission believes that all of these enhancements to the calculation of OCC’s clearing fund requirements would enhance OCC’s risk management practices and allow it to more accurately estimate the total financial resources necessary to cover its exposures in PO 00000 Frm 00118 Fmt 4703 Sfmt 4703 extreme but plausible market conditions. Fourth, the proposal discussed above would expand and improve upon the scope of stress scenarios against which OCC monitors is financial resources. Under the proposal OCC would continue to review the size of its clearing fund against exposures under a stress scenario designed to replicate the 1987 market crash, and would also introduce monitoring against other historical scenarios such as the largest market moves up and down observed during the 2008 financial crisis. In addition, OCC would continue its practice of collecting additional resources in margin collateral and clearing fund requirements where stress exposures exceed 75 percent and 90 percent, respectively, of the size of the clearing fund. Based on a review of the parameters of the scenario replicating the 1987 market crash, the Commission believes that the scenario presents potential losses that are extreme while also plausible in light of their historical basis. Additionally, the Commission believes that the scenario would provide stress exposure estimates that would be meaningful for the monitoring of OCC’s total financial resources. The Commission also believes that the introduction of new historical scenarios, such as those replicating the financial crisis, would provide additional depth to the monitoring of OCC’s financial resources. The Commission believes, therefore, that the changes proposed in the Advance Notice include the adoption of a wide range of stress scenarios for the testing of OCC’s financial resources. Consequently, the Commission believes that the expansion of the scope of stress scenarios, along with the inclusion of a scenario replicating the 1987 market crash, will result in a stress testing framework that promotes robust risk management at OCC. Fifth, OCC would document its periodic review and analysis of its stress testing framework and clearing fund methodology, which would include (1) daily review of stress test outputs, (2) monthly (or more frequently as needed) analysis of the stress test results, scenarios, models, parameters, and assumptions, and (3) annual validation of the clearing fund methodology. OCC also would clearly define the process for escalating the results of its daily and monthly analyses and require on an annual basis Board level review and approval of the Clearing Fund Methodology Policy. The Commission believes that these governance processes would help ensure that OCC is in a position to continuously monitor, E:\FR\FM\01AUN1.SGM 01AUN1 sradovich on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices analyze, and adjust as necessary both the stress testing framework and the clearing fund methodology, thereby helping to ensure the accuracy and reliability of the methodology by which OCC tests the sufficiency of its financial resources. Taken together, and for the reasons discussed above, the Commission believes that these proposals would promote robust risk management at OCC by better ensuring that OCC maintains sufficient financial resources in excess of margin to enable it to cover a wide range of stress scenarios that include, but are not limited to the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions. By enhancing the precision with which OCC estimates the total financial resources that it must maintain, reducing the time it takes OCC to fund clearing fund contributions, and limiting month-to-month reductions in the size of the clearing fund, the Commission also believes the changes proposed in the Advance Notice promote safety and soundness. The Commission agrees that, by shortening the timeframe within which each clearing member must make its required clearing fund contribution, OCC would be able to better ensure that it is able to obtain the funds owed from clearing members in a timely fashion so that OCC can continue to meet its overall financial resource requirements.126 Reducing the period of time between the identification of credit exposures and the collection of collateral to cover such exposures reduces the period of time during which OCC could be under collateralized. Ensuring that OCC is able to obtain collateral in a timely manner promotes safety and soundness. Similarly, limiting large reductions and cyclical swings in the size of OCC’s clearing fund reduces the potential for OCC to give up resources only to find that they are necessary to cover its credit exposures to participants. Consequently, the Commission believes that the proposed reduction in funding time and limitations designed to constrain procyclical changes in the size of the clearing fund promote safety and soundness. In addition, the Commission believes that the limitations on clearing fund size reductions described above, as well as the proposed allocation methodology changes, are designed to reduce systemic risk and promote the stability of the broader financial system. Reducing the likelihood of procyclical 126 See Notice of Filing, 83 FR at 31605. VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 swings in the size of OCC’s clearing fund should provide more certainty and stability to OCC’s clearing members. For example, such increased certainty should help reduce the risk that clearing members would be surprised and destabilized by a request from OCC for a clearing fund size increase, thereby limiting the likelihood that such requests could destabilize the broader financial system or heighten systemic risk. The Commission believes that the increases of the initial and minimum contributions to the clearing fund are commensurate with the growth of OCC’s clearing fund over time.127 Finally, the Commission believes that the proposed changes to OCC’s allocation weighting will allow OCC to better manage its credit exposures to its clearing members by better aligning each clearing member’s contributions to the credit risk it poses to OCC, thereby allowing OCC to better manage its credit exposures to its participants. The Commission believes that increased certainty and the alignment of obligations with risk would both reduce potential systemic risks and promote the stability of the broader financial system by reducing the likelihood of unexpected and potentially destabilizing clearing fund obligations for clearing members. Finally, the Commission believes that OCC’s proposed textual clarifications and reorganization would also support the stability of the broader financial system. The reorganization and consolidation of rule provisions related to OCC’s clearing fund would enhance the readability of OCC’s public-facing rules, and additional clarification of OCC’s margin rules would promote transparency by providing the public with information about OCC’s risk management processes. The Commission believes that the additional clarity and transparency provided by these proposed change would support the stability of the broader financial system by removing potential sources of confusion or misunderstanding regarding the operations and potential consequences of OCC’s risk management processes in respect of the clearing fund. Accordingly, and for the reasons stated, the Commission believes the changes proposed in the Advance Notice are consistent with Section 805(b) of the Act.128 127 OCC’s overall clearing fund size has increased significantly since the current initial and minimum contributions were set in 2000. See id. at 31603– 04. 128 12 U.S.C. 5464(b). PO 00000 Frm 00119 Fmt 4703 Sfmt 4703 37577 B. Consistency With Rule 17Ad–22(e)(4) Under the Exchange Act 1. Total Financial Resources Rules 17Ad–22(e)(4)(i) and (iii) under the Exchange Act requires, among other things, that OCC establish, implement, maintain, and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes by, among other things, maintaining financial resources at the minimum to enable OCC to cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions.129 As described above, the proposal includes enhancements to OCC’s methodology for sizing its clearing fund to ensure that it maintains sufficient financial resources, including: (i) Adoption of an internal credit risk tolerance that OCC believes represents extreme but plausible market conditions; (ii) sizing the clearing fund to cover credit exposures under scenarios that are more extreme than OCC’s risk tolerance, (iii) sizing the clearing fund to cover the default of the two clearing member groups that that would potentially cause the largest aggregate credit exposure for OCC; (iv) limiting the potential reduction in clearing fund size month-over-month; and (v) shortening the time by which each clearing member must fund its clearing fund contribution. Taken together, the Commission believes that proposed changes described above are designed to improve the process by which OCC sizes its total financial resources and are consistent with the requirements of Rules 17Ad–22(e)(4)(i) and (iii) under the Exchange Act. First, the proposal is designed to cover credit exposures in excess of those posed by any one clearing member group because OCC is proposing to cover the largest aggregate exposure to two clearing member groups. Second, the proposal is designed to cover credit exposures in extreme but plausible market conditions because OCC proposes to size its clearing fund based on scenarios that are more extreme than those that OCC believes to represent extreme but plausible market conditions. Further, based on the Commission’s detailed analysis of the relevant scenarios 129 17 E:\FR\FM\01AUN1.SGM CFR 240.17Ad–22(e)(4)(i) and (iii). 01AUN1 37578 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices sradovich on DSK3GMQ082PROD with NOTICES through the supervisory process, the Commission believes that OCC has defined extreme but plausible scenarios in an acceptable manner for the markets served. Finally, the Commission believes that proposal would support the consistent and stable maintenance of an appropriate level of total financial resources by limiting month-over-month reductions in the size of clearing fund and requiring clearing members to make clearing fund contributions within two business days. Accordingly, the Commission believes that the proposed modifications to OCC’s clearing fund sizing methodology are consistent with Exchange Act Rule 17Ad–22(e)(4)(i) and (iii).130 2. Financial Resource Sufficiency Rule 17Ad–22(e)(4)(vi) under the Exchange Act requires OCC to establish, implement, maintain, and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes by testing the sufficiency of its total financial resources available to meet the minimum financial resource requirements under paragraphs Rules 17Ad–22(e)(4)(i) through (iii).131 Such testing must include (A) conducting stress testing of OCC’s total financial resources once each day using standard predetermined parameters and assumptions; (B) conducting a comprehensive analysis on at least a monthly basis of the existing stress testing scenarios, models, and underlying parameters and assumptions, and considering modifications to ensure they are appropriate for determining the covered clearing agency’s required level of default protection in light of current and evolving market conditions; (C) conducting a comprehensive analysis of stress testing scenarios, models, and underlying parameters and assumptions more frequently than monthly when the products cleared or markets served display high volatility or become less liquid, or when the size or concentration of positions held by the covered clearing agency’s participants increases significantly; and (D) reporting the results of such analyses to appropriate decision makers at OCC, including but not limited to, its risk management committee or board of directors, and using these results to evaluate the adequacy of and adjust its margin methodology, model parameters, models used to generate clearing or guaranty fund requirements, and any other relevant aspects of its credit risk management framework, in supporting compliance with the minimum financial resources requirements set forth in paragraphs (e)(4)(i) through (iii) of Rule 17Ad–22.132 Additionally, pursuant to Rule 17Ad–22(e)(4)(vii) of the Exchange Act, the policies and procedures required under Rule 17Ad–22(e)(4) must include the performance of a model validation of OCC’s credit risk models not less than annually or more frequently as may be contemplated by OCC’s risk management framework.133 After reviewing and assessing the proposal, the Commission believes that the proposed changes described above are consistent with Rules 17Ad– 22(e)(4)(vi) and (vii) under the Exchange Act,134 because, among other reasons, (i) they are designed to improve the testing of OCC’s financial resources; (ii) expanding the scope of stress scenarios against which OCC monitors its financial resources would increase the likelihood that OCC maintains sufficient financial resources at all times; and (iii) the formalization of OCC’s processes for the periodic review and analysis its stress testing framework and clearing fund methodology is designed to support OCC’s monitoring of its financial resources. In addition, the Commission believes that (i) the daily testing of OCC’s financial resources against the sufficiency stress tests, including stress tests based on market movements in the 2008 financial crisis and the 1987 market crash included in the proposal would be consistent with the daily stress testing requirements of Rule 17Ad–22(e)(4)(vi)(A), as described above; (ii) the at least monthly analysis of stress test results, scenarios, models, parameters, and assumptions, with more frequent review and analysis as required would be consistent with the monthly comprehensive analysis requirements set forth in Rule 17Ad–22(e)(4)(vi)(B) and (C) as described above; and (iii) the annual validation of OCC’s clearing fund methodology discussed in more detail above would be consistent with model validation requirements of Rule 17Ad–22(e)(4)(vii). The proposal also contemplates the reporting and escalation of such testing, analyses, and validations to OCC’s management and Board of Directors, which the Commission believes would be consistent with the reporting 130 Id. 133 17 CFR 240.17Ad–22(e)(4)(vi) (citing 17 CFR 240.17Ad–22(e)(4)(i)–(iii)). VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 PO 00000 CFR 240.17Ad–22(e)(4)(vi)(A)–(D). CFR 240.17Ad–22(e)(4)(vii). 134 17 CFR 240.17Ad–22(e)(4)(vi) and (vii). 3. Proposal To Modify the Clearing Fund Allocation Methodology As noted above, Rule 17Ad–22(e)(4) under the Exchange Act requires that OCC establish, implement, maintain, and enforce written policies and procedures reasonably designed to, among other things, effectively manage its credit exposures to participants.136 As discussed above, OCC manages its credit exposures not covered by margin through the allocation of clearing fund requirements to its clearing members. OCC proposes to determine the size of is clearing fund based on the measurement of its credit exposures under hypothetical stress scenarios, and to monitor such exposures under historical stress scenarios. OCC also proposes to increase the initial and minimum clearing fund contribution amounts from $150,000 to $500,000, and to modify the allocation weighting used to determine the variable amount that most clearing members contribute to the clearing fund. Specifically, under the proposal, the proposed clearing fund contribution requirements would be based on an allocation methodology of 70 percent of total risk, 15 percent of open interest and 15 percent of open interest (as opposed to the current weighting of 35 percent total risk, 50 percent open interest, and 15 percent volume). The Commission believes that the changes described above are reasonably designed to improve OCC’s management of its credit exposures to participants. First, OCC’s overall clearing fund size has increased significantly since the current initial and minimum contributions were set in 2000 and OCC’s requirements are lower than the minimum requirements imposed by other CCPs. The Commission believes that the proposed changes to OCC’s initial and minimum clearing fund contribution amounts are designed to better manage the risks posed by clearing members with minimal open interest, and are commensurate with the growth of OCC’s clearing fund over time. The Commission also believes that the changes to OCC’s allocation weighting will allow OCC to better 132 17 131 17 requirements of Rule 17Ad– 22(e)(4)(vi)(D). Accordingly, taken together and for the reasons discussed above, the Commission believes that the proposed stress testing and clearing fund methodology governance changes are consistent with Exchange Act Rules 17Ad–22(e)(4)(vi) and (vii).135 Frm 00120 Fmt 4703 Sfmt 4703 135 Id. 136 17 E:\FR\FM\01AUN1.SGM CFR 240.17Ad–22(e)(4). 01AUN1 Federal Register / Vol. 83, No. 148 / Wednesday, August 1, 2018 / Notices manage its credit exposures to its clearing members by better aligning each clearing member’s contributions to the credit risk it poses to OCC, thereby allowing OCC to better manage its credit exposures to its participants. Accordingly, based on the foregoing, the Commission believes that the proposed changes pertaining to the sizing, monitoring, and allocation of clearing fund requirements are consistent with Exchange Act Rule 17Ad–22(e)(4).137 C. Consistency With Rule 17Ad–22(e)(1) Under the Exchange Act Rule 17Ad–22(e)(1) under the Exchange Act requires that OCC establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions.138 The Commission has stated that, in establishing and maintaining policies and procedures to address legal risk, a covered clearing agency generally should consider whether its rules, policies and procedures, and contracts are clear, understandable, and consistent with relevant laws and regulations.139 The Commission believes that the proposed consolidation and reorganization of OCC’s Rules described above would improve readability by locating all rules related to the clearing fund in one place, thereby enhancing the clarity, transparency, consistency, and understandability of OCC’s Rules related to the clearing fund. Additionally, by amending the Rules to accurately reflect OCC’s current margin practices, the Commission believes OCC’s Rules will be more transparent and understandable. Accordingly, the Commission believes that the proposed textual reorganization and clarifications are consistent with Rule 17Ad–22(e)(1).140 sradovich on DSK3GMQ082PROD with NOTICES V. Conclusion It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Payment Supervision Act, that the Commission does not object to Advance Notice (SR– OCC–2018–803) and that OCC is authorized to implement the proposed change. 137 Id. 138 17 CFR 240.17Ad–22(e)(1). Clearing Agency Standards at 70802. 140 17 CFR 240.17Ad–22(e)(1). 139 Covered VerDate Sep<11>2014 20:07 Jul 31, 2018 Jkt 244001 By the Commission. Robert W. Errett, Deputy Secretary. [FR Doc. 2018–16417 Filed 7–31–18; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–83723; File No. SR– BatsBZX–2016–30] Self-Regulatory Organizations; Bats BZX Exchange, Inc.; Order Setting Aside Action by Delegated Authority and Disapproving a Proposed Rule Change, as Modified by Amendments No. 1 and 2, To List and Trade Shares of the Winklevoss Bitcoin Trust July 26, 2018. I. Introduction On June 30, 2016, Bats BZX Exchange, Inc. (‘‘BZX’’) filed a proposed rule change with the Commission, seeking to list and trade shares of the Winklevoss Bitcoin Trust.1 The Commission, acting through authority delegated to the Division of Trading and Markets,2 disapproved the proposed rule change on March 10, 2017,3 and BZX then filed a timely petition seeking Commission review of the disapproval by delegated authority.4 The Commission granted made this filing under Section 19(b)(1) of the Securities Exchange Act of 1934, 15 U.S.C. 78s(b)(1) (‘‘Exchange Act’’) and Rule 19b–4 thereunder, 17 CFR 240.19b–4. The Commission published notice of the proposed rule change in the Federal Register on July 14, 2016. See Exchange Act Release No. 78262 (July 8, 2016), 81 FR 45554 (July 14, 2016) (SR–BatsBZX–2016–30). On August 23, 2016, the Commission designated a longer period within which to act on the proposed rule change. See Exchange Act Release No. 78653 (Aug. 23, 2016), 81 FR 59256 (Aug. 29, 2016). On October 12, 2016, the Commission instituted proceedings under Section 19(b)(2)(B) of the Exchange Act, 15 U.S.C. 78s(b)(2)(B), to determine whether to approve or disapprove the proposed rule change. See Exchange Act Release No. 79084 (Oct. 12, 2016), 81 FR 71778 (Oct. 18, 2016). On October 20, 2016, BZX filed Amendment No. 1 to the proposed rule change, replacing the original filing in its entirety, and Amendment No. 1 was published for comment in the Federal Register on November 3, 2016. See Exchange Act Release No. 79183 (Oct. 28, 2016), 81 FR 76650 (Nov. 3, 2016) (‘‘Amendment No. 1’’). On January 4, 2017, the Commission designated a longer period for Commission action on the proposed rule change. See Exchange Act Release No. 79725 (Jan. 4, 2017), 82 FR 2425 (Jan. 9, 2017). On February 22, 2017, BZX filed Amendment No. 2 to the proposed rule change (‘‘Amendment No. 2’’). Amendment No. 2 is available on the Commission’s website at https:// www.sec.gov/comments/sr-batsbzx-2016-30/batsbzx 201630-1594698-132357.pdf. 2 See 17 CFR 200.30–3(a)(12). 3 See Exchange Act Release No. 80206 (Mar. 10, 2017), 82 FR 14076 (Mar. 16, 2017) (‘‘March Disapproval Order’’). 4 On March 17, 2017, pursuant to Rule 430 of the Rules of Practice, see 17 CFR 201.430(b)(1), BZX PO 00000 1 BZX Frm 00121 Fmt 4703 Sfmt 4703 37579 BZX’s Petition for Review, seeking public comments in support of or in opposition to the March Disapproval Order.5 Today’s order sets aside the March Disapproval Order, and, for the reasons discussed below, disapproves BZX’s proposed rule change.6 In response to BZX’s Petition for Review, the Commission has conducted a de novo review of BZX’s proposal 7— giving careful consideration to the entire record, including BZX’s amended proposal and Petition for Review and all comments and statements submitted by BZX and other persons—to determine whether the proposal is consistent with the requirements of the Exchange Act and the rules and regulations issued thereunder that are applicable to a national securities exchange.8 Specifically, the Commission has considered whether the BZX proposal is consistent with Exchange Act Section 6(b)(5), which requires, in relevant part, that the rules of a national securities exchange be designed ‘‘to prevent fraudulent and manipulative acts and practices’’ and ‘‘to protect investors and the public interest.’’ 9 Under the Commission’s Rules of Practice, the ‘‘burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued submitted a Notice of Intention to Petition for Review of Order Disapproving a Proposed Rule Change, and on March 24, 2017, BZX submitted its Petition for Review (‘‘Petition for Review’’). BZX’s Notice of Intention to Petition for Review is available on the Commission’s website at: https:// www.sec.gov/rules/sro/batsbzx/2017/batsbzxpetitionforreview.pdf. BZX’s Petition for Review is available on the Commission’s website at: https:// www.sec.gov/rules/sro/batsbzx/2017/petition-forreview-sr-batsbzx-2016-30.pdf. 5 On April 24, 2017, pursuant to Rule 431 of the Rules of Practice, see 17 CFR 201.431, the Commission issued an order granting the Petition for Review, see Exchange Act Release No. 80511 (Apr. 24, 2017), 82 FR 19770 (Apr. 28, 2017) (‘‘Review Order’’), and designated May 15, 2017, as the date by which any party to the action or any other person could file a written statement in support of or in opposition to the March Disapproval Order. See id. 6 Commissioner Peirce dissents from the Commission’s disapproval of this proposal, and her written dissent can be found on the Commission’s website, https://www.sec.gov. 7 Pursuant to Rule 431(a) of the Commission’s Rules of Practice, the Commission may affirm, reverse, modify, set aside, or remand for further proceedings, in whole or in part, an action made pursuant to delegated authority. 17 CFR 201.431(a). 8 Section 19(b)(2)(C) of the Exchange Act directs the Commission to approve a proposed rule change of an SRO, such as a national securities exchange, if the Commission finds that the proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to the SRO and directs the Commission to disapprove the proposed rule change if it is unable to make such a finding. See 15 U.S.C. 78s(b)(2)(C). 9 15 U.S.C. 78f(b)(5). E:\FR\FM\01AUN1.SGM 01AUN1

Agencies

[Federal Register Volume 83, Number 148 (Wednesday, August 1, 2018)]
[Notices]
[Pages 37570-37579]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16417]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83714; File No. SR-OCC-2018-803]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection to Advance Notice, as Modified by Amendments No. 
1 and 2, Concerning Proposed Changes to the Options Clearing 
Corporation's Stress Testing and Clearing Fund Methodology

July 26, 2018.

I. Introduction
---------------------------------------------------------------------------

    \8\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

    On May 30, 2018, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') advance 
notice SR-OCC-2018-803 (``Advance Notice'') 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 (``Act'') \1\ and Rule 19b-4(n)(1)(i) \2\ under 
the Securities Exchange Act of 1934 (``Exchange Act'') \3\ to propose 
changes to OCC's By-Laws and Rules, the formalization of a 
substantially new Clearing Fund Methodology Policy (``Policy''), and 
the adoption of a document describing OCC's new Clearing Fund and 
stress testing methodology (``Methodology Description'').\4\ The 
proposed changes are primarily designed to enhance OCC's overall 
resiliency, particularly with respect to the level of OCC's pre-funded 
financial resources. Specifically, the proposed changes would:
---------------------------------------------------------------------------

    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ See Notice of Filing infra note 6, at 83 FR 31594.
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    (1) Reorganize, restate, and consolidate the provisions of OCC's 
By-Laws and Rules relating to the Clearing Fund into a newly revised 
Chapter X of OCC's Rules;
    (2) modify the coverage level of OCC's Clearing Fund sizing 
requirement to protect OCC against losses stemming from the default of 
the two Clearing Member Groups that would potentially cause the largest 
aggregate credit exposure for OCC in extreme but plausible market 
conditions (i.e., adopt a ``Cover 2 Standard'' for sizing the Clearing 
Fund);
    (3) adopt a new risk tolerance for OCC to cover a 1-in-50 year 
hypothetical market event at a 99.5% confidence level over a two-year 
look-back period;
    (4) adopt a new Clearing Fund and stress testing methodology, which 
would be underpinned by a new scenario-based one-factor risk model 
stress testing approach, as detailed in the newly proposed Policy and 
Methodology Description;
    (5) document governance, monitoring, and review processes related 
to Clearing Fund and stress testing;
    (6) provide for certain anti-procyclical limitations on the 
reduction in Clearing Fund size from month to month;
    (7) increase the minimum Clearing Fund contribution requirement for 
Clearing Members to $500,000;
    (8) modify OCC's allocation weighting methodology for Clearing Fund 
contributions;
    (9) reduce from five to two business days the timeframe within 
which Clearing Members are required to fund Clearing Fund deficits due 
to monthly or intra-month resizing or due to Rule amendments;
    (10) provide additional clarity in OCC's Rules regarding certain 
anti-procyclicality measures in OCC's margin model; and
    (11) make a number of other non-substantive clarifying, conforming, 
and organizational changes to OCC's By-Laws, Rules, Collateral Risk 
Management Policy, Default Management Policy, and filed procedures, 
including retiring OCC's existing Clearing Fund Intra-Month Re-sizing 
Procedure, Financial Resources Monitoring and Call Procedure (``FRMC 
Procedure''), and Monthly Clearing Fund Sizing Procedure, as these 
procedures would no longer be relevant to OCC's proposed Clearing Fund 
and stress testing methodology and would be replaced by the proposed 
Rules, Policy, and Methodology Description described herein.
    On June 7, 2018, OCC filed Amendment No. 1 to the Advance 
Notice.\5\ The Advance Notice, as amended, was published for public 
comment in the Federal Register on July 6, 2018.\6\ On July 11, 2018, 
OCC filed Amendment No. 2 to the Advance Notice.\7\ The Commission 
received five comment letters in support of the proposal contained in 
the Advance Notice.\8\ This publication serves as notice of no 
objection to the Advance Notice.
---------------------------------------------------------------------------

    \5\ In Amendment No. 1, OCC corrected formatting errors in 
Exhibits 5A and 5B without changing the substance of the proposed 
rule change.
    \6\ Securities Exchange Act Release No. 83561 (Jun. 29, 2018), 
83 FR 31594 (Jul. 6, 2018) (``Notice of Filing''). On May 30, 2018, 
OCC also filed a related proposed rule change (SR-OCC-2018-008) with 
the Commission pursuant to Section 19(b)(1) of the Exchange Act and 
Rule 19b-4 thereunder, seeking approval of changes to its rules 
necessary to implement the Advance Notice (``Proposed Rule 
Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, respectively. 
The Proposed Rule Change was published in the Federal Register on 
June 15, 2018. Securities Exchange Act Release No. 83406 (Jun. 11, 
2018), 83 FR 28018 (Jun. 15, 2018).
    \7\ In Amendment No. 2, OCC made three non-substantive changes 
to the proposal. Specifically, OCC (1) updated a cross-reference in 
Article VI, Section 27 of the OCC By-Laws to reflect the relocation 
of OCC's clearing fund-related rules, (2) added an Interpretation 
and Policy to proposed Rule 1001 to clarify the applicability of the 
5 percent month-over-month limitation in the reduction of clearing 
fund size is not intended to apply to the initial changes in to 
OCC's clearing fund sizing resulting from implementation of the 
proposed methodology, and (3) clarified an implementation date of 
September 1, 2018 for the proposed changes in the filing.
    \8\ See letter from Andrej Bolkovic, CEO, ABN AMRO Clearing 
Corporation LLC (``AACC''), dated June 26, 2018, to Brent Fields, 
Secretary, Commission (AACC Letter I) ; letter from Chris Concannon, 
President and COO, Cboe Global Markets (``CBOE''), dated July 6, 
2018, to Brent Fields, Secretary, Commission (CBOE Letter I); letter 
from Matthew R. Scott, President, Merrill Lynch Professional 
Clearing Corp. (``MLPRO''), dated July 6, 2018, to Brent J. Fields, 
Secretary, Commission (MLPRO Letter I); letter from Kurt Eckert, 
Partner, Wolverine Execution Services (``WEX''), dated July 12, 
2018, to Brent Fields, Secretary, Commission (WEX Letter I); and 
letter from Mark Dehnert, Managing Director, Goldman Sachs & Co. LLC 
(``GS''), dated July 17, 2018, to Brent J. Fields, Secretary, 
Commission (GS Letter I), available at https://www.sec.gov/comments/sr-occ-2018-008/occ2018008.htm.
    Since the proposal contained in the Advance Notice was also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the proposed rule change or the Advance Notice.
---------------------------------------------------------------------------

II. Background

    The Advance Notice concerns proposed changes to OCC's By-Laws \9\ 
and Rules,\10\ the formalization of the substantially new Policy, and 
the adoption of OCC's new Methodology Description.\11\ According to 
OCC, the changes comprising the Advance Notice are primarily designed 
to enhance OCC's overall resiliency, particularly with respect to the 
level of OCC's pre-funded financial resources.\12\
---------------------------------------------------------------------------

    \9\ OCC's By-Laws are available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.
    \10\ OCC's Rules are available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \11\ See Notice of Filing, 83 FR at 31594.
    \12\ See id.

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[[Page 37571]]

    As enumerated in the Notice of Filing, the specific modifications 
that OCC proposes are as follows: (1) Reorganize, restate, and 
consolidate the provisions of OCC's By-Laws and Rules relating to the 
clearing fund into a revised Chapter X of OCC's Rules; (2) modify the 
coverage level of OCC's clearing fund sizing requirement to protect OCC 
against losses stemming from the default of the two clearing member 
groups that would potentially cause the largest aggregate credit 
exposure for OCC in extreme but plausible market conditions (i.e., 
adopt a ``Cover 2 Standard'' for sizing the clearing fund); (3) adopt a 
new risk tolerance for OCC to cover a 1-in-50 year hypothetical market 
event at a 99.5% confidence level over a two-year look-back period; (4) 
adopt a new clearing fund and stress testing methodology, which would 
be underpinned by a new scenario-based one-factor risk model stress 
testing approach, as detailed in the proposed Policy and Methodology 
Description; (5) document governance, monitoring, and review processes 
related to the clearing fund and stress testing; (6) provide for 
certain anti-procyclical limitations on the reduction in clearing fund 
size from month to month; (7) increase the minimum clearing fund 
contribution requirement for clearing members from $150,000 to 
$500,000; (8) modify OCC's allocation weighting methodology for 
clearing fund contributions; (9) reduce from five to two business days 
the timeframe within which clearing members are required to fund 
clearing fund deficits due to monthly or intra-month resizing; (10) 
provide additional clarity in OCC's Rules regarding certain anti-
procyclicality measures in OCC's margin model; and (11) make a number 
of other non-substantive clarifying, conforming, and organizational 
changes to OCC's By-Laws, Rules and filed procedures, including 
retiring OCC's existing Clearing Fund Intra-Month Re-sizing Procedure, 
Financial Resources Monitoring and Call Procedure, and Monthly Clearing 
Fund Sizing Procedure, as these procedures would be replaced by the 
proposed Rules, Policy, and Methodology Description.\13\
---------------------------------------------------------------------------

    \13\ See id. at 31594-95.
---------------------------------------------------------------------------

    The remainder of this section will first provide an overview of 
OCC's current process for sizing the clearing fund, followed by a more 
detailed discussion of the specific changes to that process being 
proposed in the Advance Notice, with particular focus on the following 
categories: (a) Stress testing; (b) total financial resources; (c) 
financial resource sufficiency; (d) allocation of clearing fund 
contributions; and (e) textual clarification and consolidation.

A. OCC's Current Process for Sizing the Clearing Fund

    OCC's process for determining the size of its clearing fund was 
initially approved in 2011,\14\ and enhanced in 2015,\15\ resulting in 
OCC's current process. Currently, OCC resizes its clearing fund at the 
beginning of each month to maintain financial resources, in excess of 
margin, to cover its credit exposures to its clearing members. The 
current process is effectively an extension of OCC's daily margin 
process, in which OCC calculates what it refers to as the ``daily 
draw'' based on observations from its margin model at specific 
confidence levels each day.\16\ OCC tracks the rolling five-day average 
of these daily draws and, at the beginning of each month, sets the 
clearing fund size to the sum of (1) the largest five-day rolling 
average observed over the last three months and (2) a $1.8 billion 
buffer.\17\
---------------------------------------------------------------------------

    \14\ See Securities Exchange Act Release No. 65386 (Sep. 23, 
2011), 76 FR 60572 (Sep. 29, 2011) (Order Approving Clearing Fund 
I).
    \15\ See Securities Exchange Act Release No. 75528 (Jul. 27, 
2015), 80 FR 45690 (Jul. 31, 2015) (Order Approving Clearing Fund 
II).
    \16\ See Order Approving Clearing Fund I, 76 FR at 60572-60573. 
Each day, OCC estimates credit exposures under the stressed margin 
model for two scenarios: the greater of the two estimates is the 
daily draw. The two scenarios are of (1) the single largest credit 
exposure that would arise out of the default of a single clearing 
member group (``idiosyncratic default'') and (2) the credit exposure 
that would arise out of the default of two-randomly selected 
clearing member groups (``minor systemic default''). See Notice of 
Filing, 83 FR at 31595.
    \17\ See Order Approving Clearing Fund II, 80 FR at 45691.
---------------------------------------------------------------------------

    As described in detail below, OCC is proposing three primary 
changes to the existing approach. First, instead of simply relying on 
its margin model, OCC would rely on the proposed stress testing 
framework, including both sizing and sufficiency stress tests. Second, 
OCC would set the size of its clearing fund based on a Cover 2 
Standard. Third, OCC would eliminate the current $1.8 billion static 
buffer because it would be obsolete in light of the new sizing stress 
tests and increased coverage afforded by the move to a Cover 2 Standard 
that, together, would function as a dynamic buffer.

B. Stress Testing

    OCC proposes to adopt a new stress testing methodology, as detailed 
in both the proposed Policy and the proposed Methodology 
Description.\18\ OCC believes that its proposed methodology would 
enable it to measure its credit exposure at a level sufficient to cover 
potential losses under extreme but plausible market conditions.\19\ To 
do so, OCC proposes to conduct daily stress tests that consider a range 
of relevant stress scenarios and related price changes, including but 
not limited to: (1) Relevant peak historic price volatilities; (2) 
shifts in other market factors including, as appropriate, price 
determinants and yield curves; and (3) the default of one or multiple 
clearing members.\20\
---------------------------------------------------------------------------

    \18\ See Notice of Filing, 83 FR at 31597.
    \19\ See id.
    \20\ See id. at 31598.
---------------------------------------------------------------------------

    The stress scenarios used in OCC's proposed methodology would 
consist of two types of scenarios: historical scenarios and 
hypothetical scenarios.\21\ Historical Scenarios would replicate 
historical events in current market conditions, which include the set 
of currently existing securities and their prices and volatility 
levels.\22\ Hypothetical scenarios, rather than replicating past 
events, would simulate events in which market conditions change in ways 
that may have not yet been observed.\23\ Hypothetical Scenarios, 
constructed using statistical methods, would generally include price 
shocks specific to various instruments, such as equity products, 
volatility products, and fixed income products. Each scenario would 
represent a draw from a multivariate distribution fitted to historical 
data regarding the relevant instrument (e.g., returns of the S&P 
500).\24\ In a hypothetical scenario, the shock to a risk driver would 
be used to determine the relative shock to each associated risk factor 
(i.e., related underlying security).\25\ For example, OCC would 
establish the size of its clearing fund according to a scenario that is 
based on statistically generated up or down price shocks for the SPX 
assuming a 1-in-80 year market event.\26\
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    \21\ See id. Because not all of the underlying securities in 
current portfolios existed during the events on which historical 
scenarios are based, OCC has developed methodologies to approximate 
the past price and volatility movements as appropriate. See id. at 
31600.
    \22\ See id. at 31598.
    \23\ See id.
    \24\ See id. at 31599. Risk drivers are a selected set of 
securities or market indices (e.g., the Cboe S&P 500 Index (``SPX'') 
or the Cboe Volatility Index (``VIX'')) that are used to represent 
the main sources or drivers for the price changes of the risk 
factors. See id. at 31597, n. 26. The term risk factor refers 
broadly to all of the individual underlying securities (such as 
Google, IBM and Standard & Poor's Depositary Receipts (``SPDR''), 
S&P 500 Exchange Traded Funds (``SPY''), etc.) listed on a market. 
See id.
    \25\ See id. at 31598.
    \26\ See id. at 31599.
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    OCC's proposed stress testing framework would categorize OCC's

[[Page 37572]]

inventory of stress tests by each stress test's intended purpose: 
Adequacy, sizing, sufficiency, and informational.\27\ Specifically, OCC 
would use the (1) ``Adequacy Stress Tests'' to determine whether the 
financial resources collected from all clearing members collectively 
are adequate to cover OCC's risk tolerance; (2) ``Sizing Stress Tests'' 
to establish the monthly size of the clearing fund; (3) ``Sufficiency 
Stress Tests'' to monitor whether OCC's credit exposure to the 
portfolios of individual clearing member groups is at a level 
sufficiently large enough to necessitate OCC calling for additional 
resources so that OCC continues to maintain sufficient financial 
resources to guard against potential losses under a wide range of 
stress scenarios, including extreme but plausible market conditions; 
and (4) ``Informational Stress Tests'' to monitor and assess the size 
of OCC's pre-funded financial resources against a wide range of stress 
scenarios that may include extreme but implausible and reverse stress 
testing scenarios.\28\
---------------------------------------------------------------------------

    \27\ See id. at 31600.
    \28\ See id. at 31600-02.
---------------------------------------------------------------------------

C. Total Financial Resources

    As noted above, OCC proposes to (i) to adopt a new clearing fund 
methodology, which would be underpinned by a new scenario-based one-
factor risk model stress testing approach,\29\ modify the coverage 
level of OCC's clearing fund sizing requirement to a Cover 2 Standard; 
(iii) provide for certain anti-procyclical limitations on the reduction 
in clearing fund size from month to month; and (iv) reduce from five 
business days to two business days the timeframe within which clearing 
members are required to satisfy clearing fund deficits due to monthly 
or intra-month resizing.\30\
---------------------------------------------------------------------------

    \29\ OCC detailed the new methodology in the proposed Policy and 
Methodology Description.
    \30\ See Notice of Filing, 83 FR at 31596.
---------------------------------------------------------------------------

1. Proposal To Change the Monthly Clearing Fund Size Calculation
    As discussed above, OCC proposes to replace the methodology by 
which it determines the monthly clearing fund size with an approach 
based on hypothetical stress scenarios that assume SPX shocks (up and 
down) associated with a 1-in-80-year market event.\31\ Under the 
proposal, OCC would continue determining the size of its clearing fund 
each month based on the peak-five daily rolling average of estimated 
stress exposures; however, such exposures would be based on the output 
from OCC's stress testing framework going forward as opposed to the 
margin-derived approach described above.\32\
---------------------------------------------------------------------------

    \31\ See id. at 31599.
    \32\ See id. at 31600. Specifically, OCC would identify its 
exposures under a 1-in-80-year hypothetical event. See id.
---------------------------------------------------------------------------

    As its benchmark for identifying extreme but plausible market 
conditions, OCC proposes to adopt a credit risk tolerance defined by 
OCC's largest potential aggregate credit exposure to two clearing 
member groups under a 1-in-50-year hypothetical market event as opposed 
to the greater of exposures arising under an idiosyncratic default or a 
minor systemic default.\33\ OCC further proposes to base its daily draw 
on the aggregate credit exposures estimated under a 1-in-80-year 
hypothetical market event.\34\ Additionally, OCC proposes to size the 
clearing fund to a Cover 2 Standard.\35\
---------------------------------------------------------------------------

    \33\ See id. at 31597. As discussed above, OCC's hypothetical 
stress scenarios represent draws from a fitted distribution of 2-day 
log returns for a given risk driver. OCC noted in its proposal that 
a 1-in-50-year hypothetical market event corresponds to a 99.9921 
percent confidence interval under OCC's chosen distribution of 2-day 
logarithmic S&P 500 index returns. See id., n. 25.
    \34\ See id. at 31600.
    \35\ See id. at 31597.
---------------------------------------------------------------------------

    OCC believes that sizing the clearing fund to cover a 1-in-80-year 
event would provide sufficient coverage in excess of the exposures 
estimated under a 1-in-50-year event to justify no longer collecting 
the $1.8 prudential margin of safety.\36\
---------------------------------------------------------------------------

    \36\ See id., n. 23.
---------------------------------------------------------------------------

2. Proposal To Limit Reductions in Clearing Fund Size From Month to 
Month
    Currently, OCC does not constrain month-over-month changes in the 
size of the clearing fund. OCC proposes to adopt two limitations on 
month-over-month decreases in the size of the clearing fund. First, OCC 
proposes to prohibit a clearing fund decrease of more than 5 percent 
month-over-month.\37\ Second, OCC proposes to limit the clearing fund 
decreases based on its daily monitoring of OCC's financial resources. 
When determining the size of the clearing fund at the beginning of a 
given month, OCC would not allow that size to be less than 90 percent 
of the peak credit exposures estimated under the stress tests used for 
daily monitoring during the last five business days of the preceding 
month.\38\ These limitations are designed to reduce the potential for 
cyclical movements in the size of the clearing fund, as well as reduce 
the need for OCC to call for additional financial resources intra-
month.\39\
---------------------------------------------------------------------------

    \37\ See id. at 31603.
    \38\ See id. As discussed below, OCC proposes to monitor the 
sufficiency of its financial resources daily by comparing the size 
of the clearing fund to the output of several historical stress 
tests.
    \39\ See id.
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3. Timing of Clearing Fund Contributions
    In addition to revising the methodology for sizing OCC's total 
financial resources, OCC proposes generally to reduce the time in which 
each clearing member must make its clearing fund contribution.\40\ 
Clearing members currently have five business days to satisfy a 
clearing fund deficiency arising out of the monthly sizing or intra-
month resizing processes. OCC proposes to reduce that time to two 
business days.\41\ OCC also proposes to require clearing members to 
satisfy any clearing fund deficit resulting from a decrease in the 
value of the clearing member's existing contribution within one hour of 
notification by OCC.\42\
---------------------------------------------------------------------------

    \40\ See id. at 31605.
    \41\ See id.
    \42\ See id.
---------------------------------------------------------------------------

D. Financial Resource Sufficiency

    As noted above, OCC proposes to (i) adopt a new clearing fund 
methodology, as detailed in the newly-proposed Policy and Methodology 
Description and (ii) document governance, monitoring, and review 
processes related to the clearing fund and stress testing.\43\ Proposed 
changes to OCC's clearing fund methodology include the assessment of 
OCC's clearing fund against a wide range of historical scenarios.\44\
---------------------------------------------------------------------------

    \43\ See id. at 31596.
    \44\ See id.
---------------------------------------------------------------------------

1. Proposal To Monitor the Sufficiency of OCC's Financial Resources
    Currently, OCC monitors the sufficiency of its financial resources 
daily by estimating whether the size of the clearing fund is sufficient 
to cover a maximum potential loss from a simulated idiosyncratic 
default.\45\ Under its current procedures, when OCC observes credit 
exposures estimated under the idiosyncratic default in excess of 75 
percent of the clearing fund size, OCC issues a margin call against the 
clearing member group generating the credit exposures.\46\ The size of 
such a margin call is the difference between the idiosyncratic default 
exposure and the

[[Page 37573]]

base clearing fund amount.\47\ The margin call is allocated among the 
individual clearing members in the clearing member group based on each 
clearing member's proportionate share of the risk to OCC.\48\ OCC may 
limit the size of the margin call to each clearing member to the lesser 
of $500 million or 100 percent of such clearing member's net 
capital.\49\
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    \45\ See id. at 31595-96. As noted above, an idiosyncratic 
default is one of the two scenarios that OCC currently uses to 
determine the size of the clearing fund each month. See supra note 
16. Specifically, the single largest credit exposure that would 
arise out of the default of a single clearing member group.
    \46\ See id. at 31595.
    \47\ See id. As noted above in section II.A., the base clearing 
fund amount is the size of the clearing fund less the $1.8 billion 
prudential margin of safety.
    \48\ See id., n. 13.
    \49\ See id. at 31595.
---------------------------------------------------------------------------

    OCC's current procedures also call for increases to the total size 
of the clearing fund in more extreme scenarios. When OCC observes 
credit exposures estimated under the idiosyncratic default \50\ 
exceeding 90 percent of the clearing fund size OCC must, under its 
procedures, increase the size of the clearing fund.\51\ The size of the 
increase to the clearing fund is the greater of $1 billion or 125 
percent of the difference between the idiosyncratic default exposure 
and the clearing fund.\52\
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    \50\ OCC would reduce the size of the idiosyncratic default 
exposure by factoring in margin calls issued due to a breach of the 
75 percent threshold described above. See id. at 31596.
    \51\ See id.
    \52\ See id.
---------------------------------------------------------------------------

    OCC proposes to revise this process by replacing the above-
described idiosyncratic default approach with an approach that compares 
the size of the clearing fund to the exposures estimated under a set of 
historical scenario stress tests (``Sufficiency Stress Tests'').\53\ 
The Sufficiency Stress Tests proposed by OCC include the largest market 
moves up and down during 2008 on a cover 2 basis and the market moves 
associated with the 1987 market crash on a cover 1 basis.\54\
---------------------------------------------------------------------------

    \53\ See id. at 31600.
    \54\ See id. at 31601. OCC proposes to measure the clearing fund 
against the two largest exposures under the 2008-like events and the 
one largest exposure under a 1987-like event. See id.
---------------------------------------------------------------------------

    OCC proposes to call for additional margin when it observes that 
one or more clearing member groups' exposure under a Sufficiency Stress 
Test exceeds 75 percent of the clearing fund.\55\ Under the proposal, 
the size of the margin call would be the amount by which the 
Sufficiency Stress Test exposure exceeds the 75 percent threshold.\56\ 
Similar to the current process, OCC proposes to retain authority to 
limit such margin calls to each clearing member to $500 million or 100 
percent of the clearing member's net capital.\57\
---------------------------------------------------------------------------

    \55\ See id.
    \56\ See id.
    \57\ See id. at 31601-02.
---------------------------------------------------------------------------

    OCC also proposes to revise the process for increasing the size of 
the clearing fund under more extreme scenarios. OCC proposes to 
increase the size of the clearing fund when it observes a Sufficiency 
Stress Test exposure in excess of 90 percent of the clearing fund.\58\ 
Similar to the current process, the size of the clearing fund increase 
would be the greater of $1 billion or 125 percent of the difference 
between the Sufficiency Stress Test exposure and the clearing fund.\59\ 
OCC also proposes to provide new authority to its Chief Executive 
Officer, Chief Administrative Officer, and Chief Operating Officer to 
temporarily increase the size of the clearing fund, subject to notice 
and later review by OCC's Board Risk Committee (``RC'').\60\
---------------------------------------------------------------------------

    \58\ See id.
    \59\ See id.
    \60\ See id. at 31602.
---------------------------------------------------------------------------

    Additionally, OCC proposes to add a new threshold at which it would 
commence enhanced monitoring of a clearing member group.\61\ Where OCC 
observes that a clearing member group's Sufficiency Stress Test 
exposure exceeds 65 percent of the clearing fund, OCC would commence 
enhanced monitoring of, and provide notice to the clearing member 
group.\62\
---------------------------------------------------------------------------

    \61\ See id. at 31601. Based on OCC's procedures, staff 
understands that such monitoring would entail escalation within 
OCC's Financial Risk Management group noting the relevant clearing 
member, the future potential for breach of the 75 percent margin 
call threshold, and a summary of the apparent risk drivers resulting 
in the stress exposures.
    \62\ See id.
---------------------------------------------------------------------------

2. Proposal To Document Governance Processes Related to the Clearing 
Fund and Stress Testing
    OCC proposes to establish, as part of its rules, processes for the 
governance, monitoring, and review of the stress testing framework and 
clearing fund methodology described above.\63\ Such processes would 
cover daily, monthly, and annual review of OCC's stress testing 
framework and clearing fund methodology.
---------------------------------------------------------------------------

    \63\ See id. at 31602.
---------------------------------------------------------------------------

    On a daily basis, OCC's staff would monitor the size of the 
clearing fund against OCC's risk tolerance and sufficiency stress 
tests.\64\ OCC staff would be required to report material issues to the 
Executive Vice President of OCC's Financial Risk Management group 
(``EVP-FRM''). The EVP-FRM would further escalate issues with OCC 
management as applicable.
---------------------------------------------------------------------------

    \64\ See id.
---------------------------------------------------------------------------

    On a monthly basis, OCC's staff would provide reports and analyses 
of the daily stress tests to OCC's Management Committee and RC.\65\ 
OCC's staff would also be responsible for conducting a comprehensive 
analysis of stress test results, scenarios, models, parameters, and 
assumptions monthly or more frequently when the products cleared or 
markets served by OCC display high volatility or become less liquid or 
when the size or concentration of positions held by OCC's participants 
increases significantly.\66\
---------------------------------------------------------------------------

    \65\ See id. at 31602-03.
    \66\ See id.
---------------------------------------------------------------------------

    On an annual basis, OCC's Model Validation Group would be required 
to perform a model validation of OCC's clearing fund methodology.\67\ 
The RC would review such validations.\68\ The RC would also be 
responsible for annual review and approval of the Policy.\69\
---------------------------------------------------------------------------

    \67\ See id. at 31603.
    \68\ See id.
    \69\ See id.
---------------------------------------------------------------------------

E. Allocation of Clearing Fund Contributions

    As noted above, OCC proposes to (i) increase the minimum clearing 
fund contribution requirement for clearing members to $500,000 and (ii) 
modify OCC's allocation weighting methodology for clearing fund 
contributions.\70\
---------------------------------------------------------------------------

    \70\ See id. at 31596.
---------------------------------------------------------------------------

1. Proposal To Increase the Minimum Clearing Fund Contribution
    Currently, the minimum amount a clearing member must contribute to 
OCC's clearing fund (the ``fixed amount'') is $150,000.\71\ OCC 
proposes to increase the fixed amount to $500,000.\72\ The minimum 
contribution requirement has been in place since June 5, 2000,\73\ and 
has remained static while the average size of OCC's clearing fund has 
increased significantly.\74\ OCC also noted that other CCPs' minimum 
requirements are well in excess of OCC's minimum contribution 
requirement.\75\ OCC analyzed the impact of the proposed change on its 
clearing members and discussed such impacts with the potentially 
affected clearing members, the majority of which did not express 
concerns over the proposed increase.\76\
---------------------------------------------------------------------------

    \71\ See id. at 31604. The initial amount that a new clearing 
member must contribute to OCC's clearing fund is also $150,000. See 
id. at 31603.
    \72\ See id. at 31604. OCC similarly proposes to increase the 
initial contribution. See id. at 31603.
    \73\ See id. (citing Securities Exchange Act Release No. 42897 
(June 5, 2000), 65 FR 36750 (June 9, 2000) (SR-OCC-99-9)).
    \74\ See id. at 31603-04.
    \75\ See id. at 31603.
    \76\ See id. at 31604.

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

[[Page 37574]]

2. Proposal To Modify the Clearing Fund Allocation Weighting
    In addition to the fixed amount described above, most clearing 
members are required to contribute an additional amount to OCC's 
clearing fund (the ``variable amount''). The variable amount is based 
on the weighted average of each clearing member's proportionate share 
of total risk, open interest, and volume.\77\ Currently, OCC uses the 
following weighting in its allocation of clearing fund requirements: 35 
percent total risk; 50 percent open interest; and 15 percent 
volume.\78\ OCC proposes to modify the allocation weighting as follows: 
70 percent total risk; 15 percent open interest; and 15 percent 
volume.\79\
---------------------------------------------------------------------------

    \77\ See id. Total risk refers to a clearing member's margin 
requirement. See id., n. 44. Additionally, the current methodology 
calculates volume based on executed volume. See id. at 31604.
    \78\ See id.
    \79\ See id. The definition of total risk would remain the same, 
but OCC would calculate volume based on cleared volume as opposed to 
executed volume. See id.
---------------------------------------------------------------------------

F. Textual Clarification and Consolidation

    Finally, as noted above, OCC proposes to (i) reorganize, restate, 
and consolidate the provisions of OCC's By-Laws and Rules relating to 
the Clearing Fund into a newly-revised Chapter X of OCC's Rules; (ii) 
provide additional clarity in OCC's Rules regarding certain anti-
procyclicality measures in OCC's margin model; and (iii) make a number 
of other non-substantive clarifying, conforming, and organizational 
changes to OCC's By-Laws, Rules, and filed procedures, including 
retiring OCC's existing Clearing Fund Intra-Month Re-sizing Procedure, 
Financial Resources Monitoring and Call Procedure, and Monthly Clearing 
Fund Sizing Procedure, as these procedures would be replaced by the 
proposed Rules, Policy, and Methodology Description.\80\
---------------------------------------------------------------------------

    \80\ See id. at 31596.
---------------------------------------------------------------------------

1. Proposal To Reorganize, Restate, and Consolidate Certain Rule Text
    The primary provisions that address OCC's Clearing Fund are 
currently located in Article VIII of the By-Laws and Chapter X of the 
Rules.\81\ OCC believes that consolidating all of the Clearing Fund-
related provisions of its By-Laws and Rules into one place would 
provide more clarity around, and enhance the readability of, OCC's 
Clearing Fund requirements.\82\ Given the scope of changes described 
above, OCC believes that it is appropriate to make such revisions at 
this time.\83\
---------------------------------------------------------------------------

    \81\ See id.
    \82\ See id.
    \83\ See id.
---------------------------------------------------------------------------

    The changes to the provisions currently residing in OCC's By-Laws 
require an affirmative vote of two-thirds of the directors then in 
office, but not less than a majority of the number of directors fixed 
by the By-Laws; however, changes to OCC's rules generally require only 
a majority vote of OCC's Board of Directors.\84\ OCC proposes to amend 
its By-Laws to maintain the existing requirements for modifying those 
rules that would be moved from Article VIII of OCC's By-Laws to Chapter 
X of its Rules.\85\
---------------------------------------------------------------------------

    \84\ See id.
    \85\ See id. at 31596-97.
---------------------------------------------------------------------------

2. Proposal To Add Rule Text Clarifying Anti-Procyclicality Measures in 
OCC's Margin Model
    OCC's existing methodology for calculating margin requirements 
incorporates measures designed to ensure that margin requirements are 
not lower than those that would be calculated using volatility 
estimated over a historical look-back period of at least ten years.\86\ 
OCC now proposes to amend its Rule 601(c) to reflect this practice.\87\ 
OCC believes that the proposed change would provide more clarity and 
transparency in its rules.\88\
---------------------------------------------------------------------------

    \86\ See id. at 31606.
    \87\ See id.
    \88\ See id.
---------------------------------------------------------------------------

3. Proposal To Make Other Non-Substantive Changes to OCC's Rules
    OCC proposes a number of clarifying, conforming, and organizational 
changes to its By-Laws, Rules, Collateral Risk Management Policy, 
Default Management Policy, and Clearing Fund-related procedures in 
connection with the proposed enhancements to its Pre-Funded Financial 
Resources and the relocation of OCC's Clearing Fund-related By-Laws 
into Chapter X of the Rules.\89\
---------------------------------------------------------------------------

    \89\ See id.
---------------------------------------------------------------------------

    In addition to the relocation of rules described above, OCC would 
also make minor, non-substantive revisions. For example, OCC would 
replace text referencing ``computed contributions to the Clearing 
Fund'' and ``as fixed at the time'' with text stating ``required 
contributions to the Clearing Fund'' and ``as calculated at the time'' 
to more accurately reflect that these rules are intended to refer to a 
Clearing Member's required Clearing Fund contribution amount as 
calculated under the proposed rules.\90\
---------------------------------------------------------------------------

    \90\ See id. at 31607, n. 52.
---------------------------------------------------------------------------

    Further, OCC proposes to update references to Article VIII of the 
By-Laws in its Collateral Risk Management Policy and Default Management 
Policy to reflect the relocation of OCC's Clearing Fund-related By-Laws 
into Chapter X of the Rules.\91\
---------------------------------------------------------------------------

    \91\ See id. at 31607.
---------------------------------------------------------------------------

    Finally, OCC proposes to replace procedures regarding its processes 
for (i) the monthly resizing of its Clearing Fund, (ii) the addition of 
financial resources, and (iii) the execution of any intra-month 
resizing of the Clearing Fund.\92\ OCC proposes to retire its existing 
procedures because the relevant rule requirements would be maintained 
in the proposed rules as well as the Clearing Fund Methodology Policy 
and Clearing Fund Methodology Description included as part of the 
Advance Notice.\93\
---------------------------------------------------------------------------

    \92\ See id. at 31607-08.
    \93\ See id. at 31608.
---------------------------------------------------------------------------

III. Summary of Comments

    As noted above, the Commission received five comment letters--AACC 
Letter I, CBOE Letter I, MLPRO Letter I, WEX Letter I, and GS Letter 
I--supporting the changes proposed in the Advance Notice.\94\ Two of 
the commenters urge the Commission to approve the proposal as 
expeditiously as possible.\95\ AACC believes that the proposal would 
remediate two problems with the current clearing fund methodology: (1) 
OCC's current clearing fund sizing methodology failing to contain 
sufficient anti-procyclicality measures, and (2) OCC's current clearing 
fund contribution allocation methodology failing to appropriately 
incentivize clearing member risk management.\96\
---------------------------------------------------------------------------

    \94\ See supra note 8.
    \95\ AACC Letter I at 1; MLPRO Letter I at I.
    \96\ AACC Letter I at 1.
---------------------------------------------------------------------------

    Regarding the clearing fund sizing methodology, AACC believes that 
the proposal would implement a number of measures intended to provide 
stability and consistency to the size of OCC's clearing fund.\97\ 
Specifically, AACC supports (1) sizing the clearing fund based on a 
variety of risk factors, and (2) testing the size of the clearing fund 
on a daily basis against extreme but plausible market events, thereby 
lowering the likelihood that OCC's clearing fund would be insufficient 
to protect OCC and market participants in the event of a clearing 
member default.\98\ MLPRO believes that the proposed changes would 
create a more transparent and predictable model.\99\

[[Page 37575]]

Similarly, GS supports OCC's proposal to include more comprehensive 
testing scenarios by including observed market events over a longer 
historical period, which would improve the overall quality of OCC's 
stress testing and strengthen OCC's ability to model risk 
scenarios.\100\ Additionally, WEX believes that the proposed changes, 
specifically changes regarding how the monthly clearing fund sizing 
process will address anti-procyclicality, should help reduce 
operational issues related to a clearing member's obligations 
increasing and decreasing.\101\
---------------------------------------------------------------------------

    \97\ Id. at 2.
    \98\ Id. at 2-3.
    \99\ MLPRO Letter I at 2.
    \100\ GS Letter I at 2. In its letter, GS refers to OCC's 
movement to a 1-in-80-year period from a 1-in-50-year model. The 
Commission notes that OCC's current process is not based on a 1-in-
50-year model, and that OCC is now proposing to adopt a new risk 
tolerance based on a 1-in-50-year hypothetical event. See Notice of 
Filing, 83 FR at 31596. Further, OCC proposes to base the size of 
the clearing fund on the aggregate credit exposures estimated under 
a 1-in-80-year hypothetical market event (as opposed to an 
historical market event). See id. at 31600.
    \101\ WEX Letter I at 1.
---------------------------------------------------------------------------

    AACC states that, from a theoretical perspective, OCC's proposed 
sizing methodology constitutes a significant improvement over the 
current sizing methodology in that the size of the clearing fund would 
be less influenced by changes in volatility because OCC is introducing 
other risk drivers into the sizing methodology as well as monitoring 
and augmenting such risk drivers on a daily basis based on market 
conditions.\102\ AACC also comments that the proposal would cause the 
size of OCC's clearing fund to become more stable because OCC would 
test for adequacy and sufficiency on a daily basis using a series of 
historical and hypothetical stress tests that are rooted in extreme but 
plausible market events.\103\
---------------------------------------------------------------------------

    \102\ AACC Letter I at 3.
    \103\ Id.
---------------------------------------------------------------------------

    Commenters also believe that the proposal would improve OCC's risk 
models by correcting existing shortcomings.\104\ CBOE comments that the 
adoption of a Cover 2 standard would ensure that the size of the 
clearing fund is sufficient to protect OCC against losses from the 
simultaneous default of its two largest Clearing Members under extreme, 
but plausible market conditions.\105\ GS also agrees with OCC's 
proposal to adopt a Cover 2 Standard.\106\ MLPRO comments that the 
adoption of a Cover 2 standard in establishing a new model to measure 
the adequacy of the clearing fund and address potential default 
scenarios would address issues that MLPRO identifies with OCC's current 
model.\107\ MLPRO also supports OCC's (1) adopting risk tolerance and 
stress testing assumptions that are developed from extreme, but 
plausible scenarios, and (2) calibrating individual equity price 
movements to the price shock for the applicable equity index to address 
issues with the current model.\108\
---------------------------------------------------------------------------

    \104\ CBOE Letter I at 1; MLPRO Letter I at 1-2.
    \105\ CBOE Letter I at 1.
    \106\ GS Letter I at 2.
    \107\ MLPRO Letter I at 1-2.
    \108\ Id.
---------------------------------------------------------------------------

    Regarding the changes to the clearing fund allocation methodology, 
commenters believe that the proposal would better align clearing 
members' required clearing fund contribution to the risk they present 
to OCC and other market participants.\109\ AACC states that the 
proposed changes would place more emphasis on the economic risk 
presented by a clearing member's cleared contracts than the operational 
risk presented by a high volume clearing member, thereby better 
recognizing that certain types of clearing members present a relatively 
lower risk to OCC even though they may represent a higher percentage of 
overall activity (i.e., clearing members with market-maker and other 
risk-neutral customers).\110\ Similarly, WEX supports allocation based 
on cleared volumes as opposed to executed volumes in consideration of 
where a positon is cleared as opposed to where it is executed.\111\ 
MLPRO also supports increases the weighting of total risk in the 
allocation process.\112\ Commenters also believe that the proposed 
changes make sense from a default and liquidation perspective.\113\
---------------------------------------------------------------------------

    \109\ AACC Letter I at 4; WEX Letter I at 1; GS Letter I at 1.
    \110\ AACC Letter I at 4.
    \111\ WEX Letter I at 2.
    \112\ MLPRO Letter I at 2.
    \113\ AACC Letter I at 4; GS Letter I at 1.
---------------------------------------------------------------------------

    Commenters AACC and WEX believe that the proposed changes would 
have positive effects on the listed options market.\114\ Similarly, 
MLPRO believes that the proposed changes would increase liquidity in 
the listed options market.\115\ Additionally, GS believes that the 
proposed changes will greatly enhance OCC's resiliency and risk 
management.\116\
---------------------------------------------------------------------------

    \114\ AACC Letter I at 5; WEX Letter I at 2.
    \115\ MLPRO Letter I at 1.
    \116\ GS Letter I at 2.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    Although the Act does not specify a standard of review for an 
advance notice, the stated purpose of the Act is instructive: to 
mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for SIFMUs and strengthening the liquidity of SIFMUs.\117\
---------------------------------------------------------------------------

    \117\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    Section 805(a)(2) of the Act \118\ authorizes the Commission to 
prescribe regulations containing risk-management standards for the 
payment, clearing, and settlement activities of designated clearing 
entities engaged in designated activities for which the Commission is 
the supervisory agency. Section 805(b) of the Act \119\ provides the 
following objectives and principles for the Commission's risk-
management standards prescribed under Section 805(a):
---------------------------------------------------------------------------

    \118\ 12 U.S.C. 5464(a)(2).
    \119\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     To promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk-
management standards may address such areas as risk-management and 
default policies and procedures, among others areas.\120\
---------------------------------------------------------------------------

    \120\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------

    The Commission has adopted risk-management standards under Section 
805(a)(2) of the Act and Section 17A of the Exchange Act (the 
``Clearing Agency Rules'').\121\ The Clearing Agency Rules require, 
among other things, each covered clearing agency to establish, 
implement, maintain, and enforce written policies and procedures that 
are reasonably designed to meet certain minimum requirements for its 
operations and risk-management practices on an ongoing basis.\122\ As 
such, it is appropriate for the Commission to review advance notices 
against the Clearing Agency Rules and the objectives and principles of 
these risk management standards as described in Section 805(b) of the 
Act. As discussed below, the Commission believes the proposal in the 
Advance Notice is consistent with the objectives and principles 
described in Section 805(b) of the Act,\123\ and in the Clearing

[[Page 37576]]

Agency Rules, in particular Rules 17Ad-22(e)(1) and 17Ad-22(e)(4).\124\
---------------------------------------------------------------------------

    \121\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release 
No. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-
11). See also Securities Exchange Act Release No. 78961 (September 
28, 2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered 
Clearing Agency Standards''). The Commission established an 
effective date of December 12, 2016, and a compliance date of April 
11, 2017, for the Covered Clearing Agency Standards. OCC is a 
``covered clearing agency'' as defined in Rule 17Ad-22(a)(5).
    \122\ 17 CFR 240.17Ad-22.
    \123\ 12 U.S.C. 5464(b).
    \124\ 17 CFR 240.17Ad-22(e)(1); 17 CFR 240.17Ad-22(e)(4).
---------------------------------------------------------------------------

A. Consistency With Section 805(b) of the Act

    The Commission believes that the proposal contained in OCC's 
Advance Notice is consistent with the stated objectives and principles 
of Section 805(b) of the Act. Specifically, as discussed below, the 
Commission believes that the changes proposed in the Advance Notice are 
consistent with promoting robust risk management in the area of credit 
risk, promoting safety and soundness, reducing system risks, and 
supporting the stability of the broader financial system.\125\
---------------------------------------------------------------------------

    \125\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    First, as described above, OCC's current process for sizing the 
clearing fund was established in 2011 and strengthened under a 2015 
interim approach. The current process is essentially an extension of 
OCC's margin model. In general, margin requirements for clearing 
members are very reactive to market movements and changes in clearing 
member portfolios. Because OCC's current process for sizing the 
clearing fund is based on a relatively dynamic daily margin process, 
the size of the clearing fund can at times be volatile and cyclical in 
nature. The changes proposed in the Advance Notice based the sizing and 
monitoring of OCC's clearing fund on a stable inventory of stress tests 
rather than continuing to rely on a dynamic margin model. The 
Commission believes this new approach would provide OCC with a more 
precise, rigorous, and stable assessment of the financial resources it 
would need to hold in its clearing fund to cover its credit risk 
exposure to its members in extreme but plausible market conditions, 
which in turn would enhance OCC's overall risk management.
    Second, with respect to the robustness of the new stress testing 
framework itself, the Commission believes that the stress tests 
proposed in OCC's framework are an improvement over OCC's current 
approach in this area, as the stress tests comprise a wide range of 
foreseeable stress scenarios. The scenarios cover historical events as 
extreme as the 2008 financial crisis and 1987 market crash as well as 
hypothetical events derived from a dataset of historical S&P returns. 
OCC's proposed stress testing framework would also include a category 
of stress tests designed specifically for review of OCC's financial 
resources against implausible scenarios and reverse stress tests. Such 
stress tests would not directly affect the total amount of OCC's 
financial resources, but would facilitate a more forward looking risk 
management process. Accordingly, while as an ongoing supervisory matter 
the Commission expects OCC to consider and, as necessary, implement 
future enhancements to its suite of stress tests, the Commission 
believes that the suite of stress tests that OCC proposes to establish 
in its risk management framework pursuant to the Advance Notice 
represents a material improvement to OCC's current risk management 
practices for estimating potential future losses in extreme but 
plausible market conditions.
    Third, as described above, OCC proposes to adopt several 
enhancements to its methodology for determining the size of its 
clearing fund. OCC proposes to adopt an internal credit risk tolerance 
based on hypothetical stress scenarios, which would provide OCC with a 
benchmark that it believes represents extreme but plausible market 
conditions. The Commission believes that establishing such a tolerance 
is a valuable step in accurately estimating the total financial 
resources necessary to cover OCC's exposures in extreme but plausible 
market conditions. Next, OCC proposes to set the size of its clearing 
fund to cover a scenario that is more extreme than its internal 
tolerance to ensure consistent coverage, which the Commission believes 
would be another valuable step in accurately estimating OCC's necessary 
total financial resources. Further, OCC proposes to cover its two 
largest credit exposures when setting the size of the clearing fund, 
which goes further than OCC's current practice of covering the greater 
of OCC's single largest exposure or two random exposures. For the same 
reasons, the Commission believes this, too, would improve OCC's risk 
management practices. Finally, OCC proposes to limit the potential 
reductions in the size of the clearing fund month-over-month. Such 
limitations would avoid large drops in the clearing fund size over a 
short period of time and unnecessary reductions followed by immediate 
calls for additional resources at the beginning of each month. Taken 
together, the Commission believes that all of these enhancements to the 
calculation of OCC's clearing fund requirements would enhance OCC's 
risk management practices and allow it to more accurately estimate the 
total financial resources necessary to cover its exposures in extreme 
but plausible market conditions.
    Fourth, the proposal discussed above would expand and improve upon 
the scope of stress scenarios against which OCC monitors is financial 
resources. Under the proposal OCC would continue to review the size of 
its clearing fund against exposures under a stress scenario designed to 
replicate the 1987 market crash, and would also introduce monitoring 
against other historical scenarios such as the largest market moves up 
and down observed during the 2008 financial crisis. In addition, OCC 
would continue its practice of collecting additional resources in 
margin collateral and clearing fund requirements where stress exposures 
exceed 75 percent and 90 percent, respectively, of the size of the 
clearing fund. Based on a review of the parameters of the scenario 
replicating the 1987 market crash, the Commission believes that the 
scenario presents potential losses that are extreme while also 
plausible in light of their historical basis. Additionally, the 
Commission believes that the scenario would provide stress exposure 
estimates that would be meaningful for the monitoring of OCC's total 
financial resources. The Commission also believes that the introduction 
of new historical scenarios, such as those replicating the financial 
crisis, would provide additional depth to the monitoring of OCC's 
financial resources. The Commission believes, therefore, that the 
changes proposed in the Advance Notice include the adoption of a wide 
range of stress scenarios for the testing of OCC's financial resources. 
Consequently, the Commission believes that the expansion of the scope 
of stress scenarios, along with the inclusion of a scenario replicating 
the 1987 market crash, will result in a stress testing framework that 
promotes robust risk management at OCC.
    Fifth, OCC would document its periodic review and analysis of its 
stress testing framework and clearing fund methodology, which would 
include (1) daily review of stress test outputs, (2) monthly (or more 
frequently as needed) analysis of the stress test results, scenarios, 
models, parameters, and assumptions, and (3) annual validation of the 
clearing fund methodology. OCC also would clearly define the process 
for escalating the results of its daily and monthly analyses and 
require on an annual basis Board level review and approval of the 
Clearing Fund Methodology Policy. The Commission believes that these 
governance processes would help ensure that OCC is in a position to 
continuously monitor,

[[Page 37577]]

analyze, and adjust as necessary both the stress testing framework and 
the clearing fund methodology, thereby helping to ensure the accuracy 
and reliability of the methodology by which OCC tests the sufficiency 
of its financial resources.
    Taken together, and for the reasons discussed above, the Commission 
believes that these proposals would promote robust risk management at 
OCC by better ensuring that OCC maintains sufficient financial 
resources in excess of margin to enable it to cover a wide range of 
stress scenarios that include, but are not limited to the default of 
the participant family that would potentially cause the largest 
aggregate credit exposure for OCC in extreme but plausible market 
conditions.
    By enhancing the precision with which OCC estimates the total 
financial resources that it must maintain, reducing the time it takes 
OCC to fund clearing fund contributions, and limiting month-to-month 
reductions in the size of the clearing fund, the Commission also 
believes the changes proposed in the Advance Notice promote safety and 
soundness. The Commission agrees that, by shortening the timeframe 
within which each clearing member must make its required clearing fund 
contribution, OCC would be able to better ensure that it is able to 
obtain the funds owed from clearing members in a timely fashion so that 
OCC can continue to meet its overall financial resource 
requirements.\126\ Reducing the period of time between the 
identification of credit exposures and the collection of collateral to 
cover such exposures reduces the period of time during which OCC could 
be under collateralized. Ensuring that OCC is able to obtain collateral 
in a timely manner promotes safety and soundness. Similarly, limiting 
large reductions and cyclical swings in the size of OCC's clearing fund 
reduces the potential for OCC to give up resources only to find that 
they are necessary to cover its credit exposures to participants. 
Consequently, the Commission believes that the proposed reduction in 
funding time and limitations designed to constrain procyclical changes 
in the size of the clearing fund promote safety and soundness.
---------------------------------------------------------------------------

    \126\ See Notice of Filing, 83 FR at 31605.
---------------------------------------------------------------------------

    In addition, the Commission believes that the limitations on 
clearing fund size reductions described above, as well as the proposed 
allocation methodology changes, are designed to reduce systemic risk 
and promote the stability of the broader financial system. Reducing the 
likelihood of procyclical swings in the size of OCC's clearing fund 
should provide more certainty and stability to OCC's clearing members. 
For example, such increased certainty should help reduce the risk that 
clearing members would be surprised and destabilized by a request from 
OCC for a clearing fund size increase, thereby limiting the likelihood 
that such requests could destabilize the broader financial system or 
heighten systemic risk. The Commission believes that the increases of 
the initial and minimum contributions to the clearing fund are 
commensurate with the growth of OCC's clearing fund over time.\127\ 
Finally, the Commission believes that the proposed changes to OCC's 
allocation weighting will allow OCC to better manage its credit 
exposures to its clearing members by better aligning each clearing 
member's contributions to the credit risk it poses to OCC, thereby 
allowing OCC to better manage its credit exposures to its participants. 
The Commission believes that increased certainty and the alignment of 
obligations with risk would both reduce potential systemic risks and 
promote the stability of the broader financial system by reducing the 
likelihood of unexpected and potentially destabilizing clearing fund 
obligations for clearing members.
---------------------------------------------------------------------------

    \127\ OCC's overall clearing fund size has increased 
significantly since the current initial and minimum contributions 
were set in 2000. See id. at 31603-04.
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    Finally, the Commission believes that OCC's proposed textual 
clarifications and reorganization would also support the stability of 
the broader financial system. The reorganization and consolidation of 
rule provisions related to OCC's clearing fund would enhance the 
readability of OCC's public-facing rules, and additional clarification 
of OCC's margin rules would promote transparency by providing the 
public with information about OCC's risk management processes. The 
Commission believes that the additional clarity and transparency 
provided by these proposed change would support the stability of the 
broader financial system by removing potential sources of confusion or 
misunderstanding regarding the operations and potential consequences of 
OCC's risk management processes in respect of the clearing fund.
    Accordingly, and for the reasons stated, the Commission believes 
the changes proposed in the Advance Notice are consistent with Section 
805(b) of the Act.\128\
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    \128\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(4) Under the Exchange Act

1. Total Financial Resources
    Rules 17Ad-22(e)(4)(i) and (iii) under the Exchange Act requires, 
among other things, that OCC establish, implement, maintain, and 
enforce written policies and procedures reasonably designed to 
effectively identify, measure, monitor, and manage its credit exposures 
to participants and those arising from its payment, clearing, and 
settlement processes by, among other things, maintaining financial 
resources at the minimum to enable OCC to cover a wide range of 
foreseeable stress scenarios that include, but are not limited to, the 
default of the participant family that would potentially cause the 
largest aggregate credit exposure for OCC in extreme but plausible 
market conditions.\129\
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    \129\ 17 CFR 240.17Ad-22(e)(4)(i) and (iii).
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    As described above, the proposal includes enhancements to OCC's 
methodology for sizing its clearing fund to ensure that it maintains 
sufficient financial resources, including: (i) Adoption of an internal 
credit risk tolerance that OCC believes represents extreme but 
plausible market conditions; (ii) sizing the clearing fund to cover 
credit exposures under scenarios that are more extreme than OCC's risk 
tolerance, (iii) sizing the clearing fund to cover the default of the 
two clearing member groups that that would potentially cause the 
largest aggregate credit exposure for OCC; (iv) limiting the potential 
reduction in clearing fund size month-over-month; and (v) shortening 
the time by which each clearing member must fund its clearing fund 
contribution.
    Taken together, the Commission believes that proposed changes 
described above are designed to improve the process by which OCC sizes 
its total financial resources and are consistent with the requirements 
of Rules 17Ad-22(e)(4)(i) and (iii) under the Exchange Act. First, the 
proposal is designed to cover credit exposures in excess of those posed 
by any one clearing member group because OCC is proposing to cover the 
largest aggregate exposure to two clearing member groups. Second, the 
proposal is designed to cover credit exposures in extreme but plausible 
market conditions because OCC proposes to size its clearing fund based 
on scenarios that are more extreme than those that OCC believes to 
represent extreme but plausible market conditions. Further, based on 
the Commission's detailed analysis of the relevant scenarios

[[Page 37578]]

through the supervisory process, the Commission believes that OCC has 
defined extreme but plausible scenarios in an acceptable manner for the 
markets served. Finally, the Commission believes that proposal would 
support the consistent and stable maintenance of an appropriate level 
of total financial resources by limiting month-over-month reductions in 
the size of clearing fund and requiring clearing members to make 
clearing fund contributions within two business days. Accordingly, the 
Commission believes that the proposed modifications to OCC's clearing 
fund sizing methodology are consistent with Exchange Act Rule 17Ad-
22(e)(4)(i) and (iii).\130\
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    \130\ Id.
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2. Financial Resource Sufficiency
    Rule 17Ad-22(e)(4)(vi) under the Exchange Act requires OCC to 
establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes by testing 
the sufficiency of its total financial resources available to meet the 
minimum financial resource requirements under paragraphs Rules 17Ad-
22(e)(4)(i) through (iii).\131\ Such testing must include (A) 
conducting stress testing of OCC's total financial resources once each 
day using standard predetermined parameters and assumptions; (B) 
conducting a comprehensive analysis on at least a monthly basis of the 
existing stress testing scenarios, models, and underlying parameters 
and assumptions, and considering modifications to ensure they are 
appropriate for determining the covered clearing agency's required 
level of default protection in light of current and evolving market 
conditions; (C) conducting a comprehensive analysis of stress testing 
scenarios, models, and underlying parameters and assumptions more 
frequently than monthly when the products cleared or markets served 
display high volatility or become less liquid, or when the size or 
concentration of positions held by the covered clearing agency's 
participants increases significantly; and (D) reporting the results of 
such analyses to appropriate decision makers at OCC, including but not 
limited to, its risk management committee or board of directors, and 
using these results to evaluate the adequacy of and adjust its margin 
methodology, model parameters, models used to generate clearing or 
guaranty fund requirements, and any other relevant aspects of its 
credit risk management framework, in supporting compliance with the 
minimum financial resources requirements set forth in paragraphs 
(e)(4)(i) through (iii) of Rule 17Ad-22.\132\ Additionally, pursuant to 
Rule 17Ad-22(e)(4)(vii) of the Exchange Act, the policies and 
procedures required under Rule 17Ad-22(e)(4) must include the 
performance of a model validation of OCC's credit risk models not less 
than annually or more frequently as may be contemplated by OCC's risk 
management framework.\133\
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    \131\ 17 CFR 240.17Ad-22(e)(4)(vi) (citing 17 CFR 240.17Ad-
22(e)(4)(i)-(iii)).
    \132\ 17 CFR 240.17Ad-22(e)(4)(vi)(A)-(D).
    \133\ 17 CFR 240.17Ad-22(e)(4)(vii).
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    After reviewing and assessing the proposal, the Commission believes 
that the proposed changes described above are consistent with Rules 
17Ad-22(e)(4)(vi) and (vii) under the Exchange Act,\134\ because, among 
other reasons, (i) they are designed to improve the testing of OCC's 
financial resources; (ii) expanding the scope of stress scenarios 
against which OCC monitors its financial resources would increase the 
likelihood that OCC maintains sufficient financial resources at all 
times; and (iii) the formalization of OCC's processes for the periodic 
review and analysis its stress testing framework and clearing fund 
methodology is designed to support OCC's monitoring of its financial 
resources.
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    \134\ 17 CFR 240.17Ad-22(e)(4)(vi) and (vii).
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    In addition, the Commission believes that (i) the daily testing of 
OCC's financial resources against the sufficiency stress tests, 
including stress tests based on market movements in the 2008 financial 
crisis and the 1987 market crash included in the proposal would be 
consistent with the daily stress testing requirements of Rule 17Ad-
22(e)(4)(vi)(A), as described above; (ii) the at least monthly analysis 
of stress test results, scenarios, models, parameters, and assumptions, 
with more frequent review and analysis as required would be consistent 
with the monthly comprehensive analysis requirements set forth in Rule 
17Ad-22(e)(4)(vi)(B) and (C) as described above; and (iii) the annual 
validation of OCC's clearing fund methodology discussed in more detail 
above would be consistent with model validation requirements of Rule 
17Ad-22(e)(4)(vii). The proposal also contemplates the reporting and 
escalation of such testing, analyses, and validations to OCC's 
management and Board of Directors, which the Commission believes would 
be consistent with the reporting requirements of Rule 17Ad-
22(e)(4)(vi)(D).
    Accordingly, taken together and for the reasons discussed above, 
the Commission believes that the proposed stress testing and clearing 
fund methodology governance changes are consistent with Exchange Act 
Rules 17Ad-22(e)(4)(vi) and (vii).\135\
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    \135\ Id.
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3. Proposal To Modify the Clearing Fund Allocation Methodology
    As noted above, Rule 17Ad-22(e)(4) under the Exchange Act requires 
that OCC establish, implement, maintain, and enforce written policies 
and procedures reasonably designed to, among other things, effectively 
manage its credit exposures to participants.\136\
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    \136\ 17 CFR 240.17Ad-22(e)(4).
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    As discussed above, OCC manages its credit exposures not covered by 
margin through the allocation of clearing fund requirements to its 
clearing members. OCC proposes to determine the size of is clearing 
fund based on the measurement of its credit exposures under 
hypothetical stress scenarios, and to monitor such exposures under 
historical stress scenarios. OCC also proposes to increase the initial 
and minimum clearing fund contribution amounts from $150,000 to 
$500,000, and to modify the allocation weighting used to determine the 
variable amount that most clearing members contribute to the clearing 
fund. Specifically, under the proposal, the proposed clearing fund 
contribution requirements would be based on an allocation methodology 
of 70 percent of total risk, 15 percent of open interest and 15 percent 
of open interest (as opposed to the current weighting of 35 percent 
total risk, 50 percent open interest, and 15 percent volume).
    The Commission believes that the changes described above are 
reasonably designed to improve OCC's management of its credit exposures 
to participants. First, OCC's overall clearing fund size has increased 
significantly since the current initial and minimum contributions were 
set in 2000 and OCC's requirements are lower than the minimum 
requirements imposed by other CCPs. The Commission believes that the 
proposed changes to OCC's initial and minimum clearing fund 
contribution amounts are designed to better manage the risks posed by 
clearing members with minimal open interest, and are commensurate with 
the growth of OCC's clearing fund over time. The Commission also 
believes that the changes to OCC's allocation weighting will allow OCC 
to better

[[Page 37579]]

manage its credit exposures to its clearing members by better aligning 
each clearing member's contributions to the credit risk it poses to 
OCC, thereby allowing OCC to better manage its credit exposures to its 
participants.
    Accordingly, based on the foregoing, the Commission believes that 
the proposed changes pertaining to the sizing, monitoring, and 
allocation of clearing fund requirements are consistent with Exchange 
Act Rule 17Ad-22(e)(4).\137\
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    \137\ Id.
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C. Consistency With Rule 17Ad-22(e)(1) Under the Exchange Act

    Rule 17Ad-22(e)(1) under the Exchange Act requires that OCC 
establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to provide for a well-founded, clear, 
transparent, and enforceable legal basis for each aspect of its 
activities in all relevant jurisdictions.\138\ The Commission has 
stated that, in establishing and maintaining policies and procedures to 
address legal risk, a covered clearing agency generally should consider 
whether its rules, policies and procedures, and contracts are clear, 
understandable, and consistent with relevant laws and regulations.\139\
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    \138\ 17 CFR 240.17Ad-22(e)(1).
    \139\ Covered Clearing Agency Standards at 70802.
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    The Commission believes that the proposed consolidation and 
reorganization of OCC's Rules described above would improve readability 
by locating all rules related to the clearing fund in one place, 
thereby enhancing the clarity, transparency, consistency, and 
understandability of OCC's Rules related to the clearing fund. 
Additionally, by amending the Rules to accurately reflect OCC's current 
margin practices, the Commission believes OCC's Rules will be more 
transparent and understandable.
    Accordingly, the Commission believes that the proposed textual 
reorganization and clarifications are consistent with Rule 17Ad-
22(e)(1).\140\
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    \140\ 17 CFR 240.17Ad-22(e)(1).
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V. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Payment Supervision Act, that the Commission does not object to Advance 
Notice (SR-OCC-2018-803) and that OCC is authorized to implement the 
proposed change.

    By the Commission.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2018-16417 Filed 7-31-18; 8:45 am]
 BILLING CODE 8011-01-P
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