Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to Advance Notice, as Modified by Amendment No. 2, Concerning Enhanced and New Tools for Recovery Scenarios, 44083-44091 [2018-18655]
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Federal Register / Vol. 83, No. 168 / Wednesday, August 29, 2018 / Notices
OCC to a matched book quickly, thereby
containing its losses.
The Commission believes that these
tools are designed to provide greater
certainty to Clearing Members seeking
to estimate the potential risks and losses
arising from their use of OCC, while
enabling OCC to promptly return to a
matched book. The Commission
believes that returning to a matched
book pursuant to these provisions in the
context of OCC’s default management
and recovery facilitates OCC’s
operational capacity to timely contain
losses and liquidity demands while
continuing to meet its obligations. Thus,
the Commission believes that the
proposed changes are consistent with
Rule 17Ad–22(e)(13).46
5. Public Disclosure of Key Aspects of
Default Rules
Rules 17Ad–22(e)(23)(i) and (ii)
require, in relevant part, that OCC
establish, implement, maintain, and
enforce written policies and procedures
reasonably designed to provide for the
public disclosure of all relevant rules
and material procedures, including key
aspects of default rules and procedures,
as well as sufficient information to
enable participants to identify and
evaluate the risks, fees and other
material costs they incur by
participating in OCC.47 The
Commission believes that the proposed
changes address key aspects of OCC’s
default rules and procedures, thereby
providing Clearing Members with a
better understanding of the potential
risks and costs they might face in an
extreme event where OCC may use its
proposed recovery tools, including the
potential use of the Special Charge.
Accordingly, the Commission believes
that OCC has disclosed these key
aspects of its default rules and
procedures, consistent with Rule 17Ad–
22(e)(23)(i) and (ii).48
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IV. Conclusion
On the basis of the foregoing, the
Commission finds that the Amended
Proposed Rule Change is consistent
with the requirements of the Exchange
Act, and in particular, with the
requirements of Section 17A of the
Exchange Act 49 and the rules and
regulations thereunder.
It is therefore ordered, pursuant to
Section 19(b)(2) of the Exchange Act,50
46 Id.
47 17
that the Proposed Rule Change (SR–
OCC–2017–020), as modified by
Amendment No. 2, be, and it hereby is,
approved.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.51
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018–18672 Filed 8–28–18; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–83919; File No. SR–
CboeBZX–2018–044]
Self-Regulatory Organizations; Cboe
BZX Exchange, Inc.; Notice of
Designation of a Longer Period for
Commission Action on a Proposed
Rule Change Regarding BZX Rule
14.11(c) (Index Fund Shares)
August 23, 2018.
On June 21, 2018, Cboe BZX
Exchange, Inc. (‘‘BZX’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act
of 1934 (‘‘Act’’) 1 and Rule 19b–4
thereunder,2 a proposed rule change to
allow the quantitative requirements of
BZX Rule 14.11(c)(3), (4), and (5) to be
satisfied by either the underlying index
or the fund’s portfolio. The proposed
rule change was published for comment
in the Federal Register on July 11,
2018.3 The Commission has received no
comment letters on the proposed rule
change.
Section 19(b)(2) of the Act 4 provides
that, within 45 days of the publication
of notice of the filing of a proposed rule
change, or within such longer period up
to 90 days as the Commission may
designate if it finds such longer period
to be appropriate and publishes its
reasons for so finding or as to which the
self-regulatory organization consents,
the Commission shall either approve the
proposed rule change, disapprove the
proposed rule change, or institute
proceedings to determine whether the
proposed rule change should be
disapproved. The 45th day after
publication of the notice for this
proposed rule change is August 25,
2018. The Commission is extending this
45-day time period.
CFR 240.17Ad–22(e)(23)(i) and (ii).
49 In
approving this Amended Proposed Rule
Change, the Commission has considered the
proposed rule’s impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
50 15 U.S.C. 78s(b)(2).
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CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 See Securities Exchange Act Release No. 83594
(July 5, 2018), 83 FR 32158.
4 15 U.S.C. 78s(b)(2).
The Commission finds that it is
appropriate to designate a longer period
within which to take action on the
proposed rule change so that it has
sufficient time to consider the proposed
rule change. Accordingly, the
Commission, pursuant to Section
19(b)(2) of the Act,5 designates October
9, 2018, as the date by which the
Commission shall either approve or
disapprove or institute proceedings to
determine whether to disapprove the
proposed rule change (File Number SR–
CboeBZX–2018–044).
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.6
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018–18674 Filed 8–28–18; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–83927; File No. SR–OCC–
2017–809]
Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of No Objection to Advance Notice, as
Modified by Amendment No. 2,
Concerning Enhanced and New Tools
for Recovery Scenarios
August 23, 2018.
I. Introduction
On December 8, 2017, The Options
Clearing Corporation (‘‘OCC’’) filed with
the Securities and Exchange
Commission (‘‘Commission’’) advance
notice SR–OCC–2017–809 (‘‘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
(‘‘Clearing Supervision 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
Rules and By-Laws to enhance OCC’s
existing tools to address the risks of
liquidity shortfalls and credit losses and
to establish new tools by which OCC
could re-establish a matched book and,
if necessary, allocate uncovered losses
following a default as well as provide
for additional financial resources. The
Advance Notice was published for
public comment in the Federal Register
51 17
48 Id.
1 15
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44083
5 Id.
6 17
CFR 200.30–3(a)(31).
U.S.C. 5465(e)(1).
2 17 CFR 240.19b–4(n)(1)(i).
3 15 U.S.C. 78a et seq.
1 12
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on January 23, 2018.4 On January 23,
2018, the Commission requested OCC
provide it with additional information
regarding the Advance Notice.5 OCC
responded to the request, and the
Commission received the information
on July 13, 2018.6
On July 11, 2018, OCC filed
Amendment Nos. 1 and 2 to the
Advance Notice to make certain changes
to clarify the use of the recovery tools
and to improve the overall transparency
regarding the use of the recovery tools.7
Notice of the Amendments to the
Advance Notice was published for
public comment in the Federal Register
on August 7, 2018.8 Comments received
on the proposal contained in the
Advance Notice are discussed below.9
This publication serves as notice that
the Commission does not object to the
changes set forth in the Advance Notice,
as amended by Amendment No. 2
(‘‘Amended Advance Notice’’).
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II. Background 10
The Amended Advance Notice
concerns proposed changes to OCC’s
Rules and By-Laws to enhance OCC’s
existing tools to address the risks of
liquidity shortfalls and credit losses and
to establish new tools by which OCC
could re-establish a matched book and,
if necessary, allocate uncovered losses
following the default of a Clearing
4 Exchange Act Release No. 82513 (Jan. 17, 2018),
83 FR 3244 (Jan. 23, 2018) (SR–2017–809) (‘‘Notice
of Filing’’). On December 18, 2017, OCC also filed
a related proposed rule change (SR–OCC–2017–020)
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 December 26,
2017. Exchange Act Release No. 82531 (Dec. 19,
2017), 82 FR 61107 (Dec. 26, 2017).
5 See Memorandum from Office of Clearance and
Settlement, Division of Trading and Markets, dated
January 23, 2018, available at https://www.sec.gov/
comments/sr-occ-2017-809/occ2017809-2948229161855.pdf.
6 See Memorandum from Office of Clearance and
Settlement, Division of Trading and Markets, dated
July 17, 2018, available at https://www.sec.gov/
comments/sr-occ-2017-809/occ2017809-04062512169148.pdf.
7 Amendment No. 2 was filed to supersede and
replace Amendment No. 1 in its entirety due to
technical defects in Amendment No. 1.
8 See Exchange Act Release No. 83761 (Aug. 1,
2018), 83 FR 38738 (Aug. 7, 2018) (‘‘Notice of
Amendment’’).
9 The letters are available at: https://www.sec.gov/
comments/sr-occ-2017-022/occ2017020.htm.
Since the proposal contained in the Advance
Notice was also filed as a proposed rule change, all
comments received on the proposal are considered
regardless of whether the comments are submitted
on the proposed rule change or the Advance Notice.
10 Capitalized terms used but not defined herein
have the meanings specified in OCC’s Rules and ByLaws, available at https://www.theocc.com/about/
publications/bylaws.jsp.
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Member as well as provide for
additional financial resources. Each of
the proposed tools is contemplated to be
deployed by OCC in an extreme stress
event that has placed OCC into a
recovery or orderly wind-down
scenario. The proposed changes include
modifying OCC’s powers of assessment,
introducing a framework for requesting
voluntary payments to the Clearing
Fund, and establishing OCC’s authority
to extinguish open positons (i.e.,
conduct tear-ups) as well as authorizing
OCC’s Board to re-allocate losses from
tear-ups.
A. Proposed Changes to OCC’s Powers
of Assessment
OCC maintains a Clearing Fund
comprised of required contributions
from Clearing Members, and OCC has
authority to use the Clearing Fund, by
a proportionate charge or otherwise, to
cover certain losses suffered by OCC.11
When an amount is paid out of a
Clearing Member’s required
contribution to the Clearing Fund, the
Clearing Member is generally required
to promptly make good any deficiency
in its required contribution to the
Clearing Fund from such payment.12
Generally, this requirement to promptly
make good on any deficiency arising
from the default of a Clearing Member
has been referred to as an ‘‘assessment’’
by OCC against a Clearing Member;
however, as further described below,
OCC is making clarifying changes to a
Clearing Member’s obligation to
contribute to the Clearing Fund,
including defining and delineating
between a Clearing Member’s obligation
to answer ‘‘assessments’’ charged by
OCC under certain circumstances
described further below and a Clearing
Member’s obligations where OCC seeks
to effect a ‘‘replenishment’’ of the
Clearing Fund.
Currently, a Clearing Member’s
obligation to make good its required
contribution to the Clearing Fund is not
subject to any pre-determined limit.
However, a Clearing Member may limit
the amount of its liability to contribute
to the Clearing Fund by winding-down
its clearing activities and terminating its
11 See OCC By-Laws, Article VIII. For example,
under Section 5 of Article VIII of the OCC By-Laws,
when a Clearing Member defaults, OCC will pay for
the resulting losses or expenses by first applying
other funds available to OCC in the accounts of the
defaulting Clearing Member and then applying the
defaulting Clearing Member’s required contribution
to the Clearing Fund. If the losses and expenses
exceed those amounts, then OCC will charge the
amount of the remaining deficiency on a
proportionate basis against all non-defaulting
Clearing Members’ required contributions to the
Clearing Fund.
12 See OCC By-Laws, Article VIII, Section 6.
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membership. To do so, a Clearing
Member must provide written notice to
OCC that it is terminating its
membership by no later than the fifth
business day after application of the
proportionate charge.13 This
termination would limit the Clearing
Member’s obligation to meet a future
assessment to an additional 100 percent
of the amount of its then-required
Clearing Fund contribution. Thus,
terminating clearing membership is the
only means by which a Clearing
Member can currently limit its liability
for amounts due to the Clearing Fund.
OCC proposed three changes to modify
its existing authority to assess
proportionate charges against Clearing
Members’ required contributions to the
Clearing Fund: (1) A cooling-off period
and cap on assessments; (2) termination
of clearing membership during a
cooling-off period; and (3)
replenishment of resources following a
cooling-off period.
1. Cooling-Off Period and Cap on
Assessments
The proposal would introduce a
minimum fifteen calendar day ‘‘coolingoff’’ period that automatically begins
when OCC imposes a proportionate
charge related to the default of a
Clearing Member against non-defaulting
Clearing Members’ Clearing Fund
contributions. During a cooling-off
period, the aggregate liability for a
Clearing Member would be capped at
200 percent of its then-required
contribution to the Clearing Fund. The
cooling-off period would be extended if
one or more specific events related to
the default of a Clearing Member (as set
forth in OCC’s By-laws) 14 occur(s)
13 In addition to providing the written notice, to
effectively terminate membership, a Clearing
Member must satisfy two other conditions. First,
after submitting the written notice, the Clearing
Member cannot submit for clearance any opening
purchase transaction or opening written transaction
or initiate a Stock Loan through any of the Clearing
Member’s accounts. Second, the Clearing Member
has to close out or transfer all of its open positions
with OCC, in each case as promptly as practicable
after giving written notice. See OCC By-Laws,
Article VIII, Section 6.
14 Specifically, a cooling-off period would
automatically begin after a proportionate charge
arises in response to: (i) Any Clearing Member
failure to discharge duly any obligation on or
arising from any confirmed trade accepted by OCC,
(ii) any Clearing Member (including any Appointed
Clearing Member) failure to perform any obligations
(including its obligations to the correspondent
clearing corporation) under or arising from any
exercised or assigned option contract or any other
contract or obligation issued or guaranteed by OCC
or in respect of which it is otherwise liable, (iii) any
Clearing Member failure to perform any obligation
to OCC in respect of the stock loan and borrow
positions of such Clearing Member, or (iv) OCC
suffered any loss or expense upon any liquidation
of a Clearing Member’s open positions. See OCC ByLaws, Article VIII, Section 5(a)(i)–(iv).
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during that fifteen calendar day period
and results in one or more proportionate
charges against the Clearing Fund. Such
an extension would run until the earlier
of (i) the fifteenth calendar day from the
date of the most recent proportionate
charge resulting from that subsequent
event, or (ii) the twentieth day from the
date of the proportionate charge that
initiated the cooling-off period.
Once the cooling-off period ends,
each remaining Clearing Member would
be required to replenish the Clearing
Fund in the amount necessary to meet
its then-required contribution. Any
remaining losses or expenses suffered
by OCC as a result of any events that
occurred during that cooling-off period
could not be charged against the
amounts Clearing Members have
contributed to replenish the Clearing
Fund upon the expiration of the
cooling-off period. However, after the
end of a cooling-off period, the
occurrence of another specified event
that results in a proportionate charge
against the Clearing Fund would trigger
a new cooling-off period.
2. Membership Termination During a
Cooling-Off Period
As noted above, to limit its liability to
replenish the Clearing Fund, a Clearing
Member currently must provide written
notice of its intent to terminate its
clearing membership by no later than
the fifth business day after a
proportionate charge. OCC’s proposal
would extend the time frame for a
Clearing Member to provide such notice
of termination, which would allow the
terminating Clearing Member to avoid
liability to replenish the Clearing Fund
after the cooling-off period. Specifically,
to terminate its status as a Clearing
Member and not be liable for
replenishment at the end of a coolingoff period, a Clearing Member would be
required to: (i) Notify OCC in writing of
its intent to terminate by no later than
the last day of the cooling-off period, (ii)
not initiate any opening purchase or
opening writing transaction, and, if the
Clearing Member is a Market Loan
Clearing Member or a Hedge Clearing
Member, not initiate any Stock Loan
transaction through any of its accounts,
and (iii) close-out or transfer all open
positions by no later than the last day
of the cooling-off period. If a Clearing
Member fails to satisfy all of these
conditions by the end of a cooling-off
period, it would not have completed all
of the requirements necessary to
terminate its status as a Clearing
Member, and therefore, it would remain
subject to its obligation to replenish the
Clearing Fund after the cooling-off
period ends.
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Given the products cleared by OCC
and the composition of its clearing
membership, OCC determined that a
minimum 15-calendar day cooling-off
period, rolling up to a maximum of 20
calendar days, is likely to be a sufficient
amount of time for OCC to manage the
ongoing default(s) and take necessary
steps in furtherance of stabilizing the
clearing system. Further, based on its
conversations with Clearing Members,
OCC believes that the proposed coolingoff period is likely to be a sufficient
amount of time for Clearing Members
(and their customers) to orderly reduce
or rebalance their positions, in an
attempt to mitigate stress losses and
exposure to potential initial margin
increases during the stress event.15 OCC
also believes the proposed cooling-off
period, coupled with the other proposed
changes to OCC’s assessment powers, is
likely to provide Clearing Members with
an adequate measure of stability and
predictability as to the potential use of
Clearing Fund resources, which would,
according to OCC, remove the existing
incentive for Clearing Members to
withdraw following a proportionate
charge (i.e., to avoid facing potentially
unlimited liability for replenishing the
Clearing Fund).
3. Replenishment and Assessment
The proposal would clarify the
distinction between ‘‘replenishment’’ of
the Clearing Fund and a Clearing
Member’s obligation to answer
‘‘assessments’’ charged by OCC. In this
context, the term ‘‘replenish’’ (and its
variations) would refer to a Clearing
Member’s standing duty, following any
proportionate charge against the
Clearing Fund, to return its Clearing
Fund contribution to the amount
required from such Clearing Member for
the month in question. The term
‘‘assessment’’ (and its variations) would
refer to the amount, during any coolingoff period, that a Clearing Member
would be required to contribute to the
Clearing Fund in excess of the amount
of the Clearing Member’s pre-funded
required Clearing Fund contribution.
B. Proposed Authority To Request
Voluntary Payments
OCC proposed new Rule 1011 to
provide a framework for receipt of
voluntary payments in a circumstance
where a Clearing Member has defaulted
and OCC has determined that it may not
have sufficient resources to satisfy its
obligations and liabilities resulting from
such default.16 OCC would initiate a call
15 See
Notice of Amendment, 83 FR at 38746.
determination would be made
notwithstanding availability of remaining resources
16 OCC’s
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44085
for voluntary payments by issuing a
notice inviting all non-defaulting
Clearing Members to make payments to
the Clearing Fund in addition to any
amounts they are otherwise required to
contribute pursuant to Rule 1001
(‘‘Voluntary Payment Notice’’). The
Voluntary Payment Notice would
specify the terms applicable to any
voluntary payment, including but not
limited to, that any voluntary payment
may not be withdrawn once made, that
no Clearing Member shall be obligated
to make a voluntary payment, and that
OCC shall retain full discretion to
accept or reject any voluntary payment.
In the event that OCC eventually
obtains additional financial resources
from the defaulting Clearing Member,
OCC would give priority to repayment
of Clearing Members that made
Voluntary Payments. Specifically, if
OCC subsequently recovers from the
defaulted Clearing Member or the estate
of the defaulted Clearing Member, OCC
would seek to first compensate all nondefaulting Clearing Members that made
voluntary payments.17 If the amount
recovered from the defaulted Clearing
Member were less than the aggregate
amount of voluntary payments, nondefaulting Clearing Members that made
voluntary payments each would receive
a percentage of the amount recovered
that corresponds to that Clearing
Member’s percentage of the total
amount of voluntary payments received.
C. Proposed Authority To Conduct
Voluntary Tear-Ups and Partial TearUps
OCC proposed new Rule 1111 to
establish a framework to extinguish
positions of a suspended or defaulted
Clearing Member on a voluntary basis
(‘‘Voluntary Tear-Up’’) or on a
mandatory basis (‘‘Partial-Tear Up’’)
and, in certain extreme circumstances,
to allocate any uncovered losses in the
event that OCC does not have sufficient
financial resources to conduct the tearunder Rules 707 (addressing the treatment of funds
in a Clearing Member’s X–M accounts); 1001
(addressing the size of OCC’s Clearing Fund and the
amount of a Clearing Member’s contribution); 1104–
1107 (concerning the treatment of the portfolio of
a defaulted Clearing Member); and 2210 and 2211
(concerning the treatment of Stock Loan positions
of a defaulted Clearing Member).
17 As discussed further in Section II.C.1 below,
OCC’s proposed authority with respect to Voluntary
Payments and Voluntary Payments would work
together to establish a hierarchy of repayment in the
event that OCC subsequently recovers from the
defaulted Clearing Member. Under proposed rules
1011(b) and 1111(a)(ii), OCC would first seek to
compensate those non-defaulting Clearing Members
who had submitted Voluntary Payments and,
thereafter, to the extent funds remained, OCC
would then seek to compensation those nondefaulting Clearing Members who had participated
in the Voluntary Tear-Up.
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up. A Voluntary Tear-Up, if provided,
would precede a Partial-Tear Up, and
any Partial Tear-Up would take into
account any positions extinguished as
part of a Voluntary Tear-Up. Further,
Rule 1111(h) would provide that no
action or omission by OCC pursuant to,
and in accordance with, Rule 1111 shall
constitute a default by OCC, provided
that Rule 1111(h) would not apply in
the event that OCC pays Clearing
Members a pro rata amount of the
applicable Tear-Up price because OCC
does not have adequate resources to pay
the full Tear-Up price.
OCC’s use of both Voluntary and
Partial Tear-Up would be subject to
certain prerequisites. First, any tear-up
would occur after one or more failed
auctions pursuant to Rule 1104 or 1106.
Second, any tear-up would occur after
OCC has determined that it may not
have sufficient resources to satisfy its
obligations and liabilities resulting from
such default.18
OCC represented that it would initiate
its tear-up process on a date sufficiently
in advance of the exhaustion of its
financial resources such that OCC
would expect to have adequate
remaining resources to cover the
amount it must pay to extinguish the
positions of Clearing Members and
customers.19 The holders of torn-up
positions would be assigned a price, and
OCC would draw on its remaining
financial resources to extinguish the
torn-up positions at the assigned price.
Although OCC does not intend, in the
first instance, for its tear-up process to
serve as a means of loss allocation, OCC
recognizes that circumstances may arise
such that, despite its best efforts, OCC
may not have adequate remaining
financial resources to extinguish torn-up
positions at the full assigned price,
resulting in the allocation of uncovered
losses by the tear-up process. As further
described below, a Clearing Member
allocated an uncovered loss would then
have an unsecured claim against OCC
for the value of the difference between
the pro rata amount paid to the Clearing
Member and the full amount the
Clearing Member should have received.
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1. Voluntary Tear-Up
As noted above, a Voluntary Tear-Up
would provide an opportunity to
18 As with Voluntary Payments, this
determination would be made notwithstanding
availability of remaining resources under Rules 707,
1001, 1104–1107, 2210, and 2211. See note 16
supra.
19 Specifically, OCC stated that it anticipated that
it would determine the date on which to initiate
Partial Tear-Ups by monitoring its remaining
financial resources against the potential exposure of
the remaining unauctioned positions from the
portfolio(s) of the defaulted Clearing Member(s).
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holders of certain positions opposite a
defaulting Clearing Member to
voluntarily extinguish those positions.
Although the Risk Committee of OCC’s
Board of Directors (‘‘Risk Committee’’)
approval is not necessary to commence
a Voluntary Tear-Up, the Risk
Committee would be responsible for
determining the scope of a Voluntary
Tear-Up. Proposed Rule 1111(c) would
provide discretion to the Risk
Committee when determining the
appropriate scope, but the discretion
would be subject to, and limited by,
certain conditions, i.e., that the
determination should be: (i) Based on
then-existing facts and circumstances;
(ii) be in furtherance of the integrity of
OCC and the stability of the financial
system; and (iii) take into consideration
the legitimate interests of Clearing
Members and market participants.
Once the Risk Committee has
determined the scope, OCC would
initiate the call for Voluntary Tear-Ups
by issuing a notice (‘‘Voluntary Tear-Up
Notice’’) to inform all non-defaulting
Clearing Members of the opportunity to
participate in a Voluntary Tear-Up.20
The Voluntary Tear-Up Notice would
specify the terms applicable to any
Voluntary Tear-Up, including, but not
limited to, that no Clearing Member or
customers of a Clearing Member shall be
obligated to participate in a Voluntary
Tear-Up, and that OCC shall retain full
discretion to accept or reject any
Voluntary Tear-Up.
Clearing Members and their
customers that participated in a
Voluntary Tear-Up and incurred losses
would have a claim to amounts
subsequently recovered from a defaulted
Clearing Member (or the estate of the
defaulted Clearing Member). The claim
would be junior to Clearing Members
who made a voluntary payment to the
Clearing Fund, and OCC would satisfy
the claims on a pro-rata basis.
2. Partial Tear-Up
Under proposed Rule 1111(b), OCC’s
Board would be responsible for the
decision to conduct a mandatory Partial
Tear-Up. The Risk Committee would
then be responsible for determining the
appropriate scope of the Partial TearUp, subject to the conditions in Rule
1111(c) discussed above.
The proposed rule would also provide
the Board with the discretion to conduct
a mandatory Partial Tear-Up to
extinguish the remaining open positions
of any defaulted Clearing Member or
20 Because OCC does not know the identities of
Clearing Members’ customers, OCC would depend
on each Clearing Member to notify its customers
with positions in scope of the Voluntary Tear-Up
of the opportunity to participate in such tear-up.
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customer of such defaulted Clearing
Member(s) (‘‘Remaining Open
Positions’’) and/or any related open
positions necessary to mitigate further
disruptions to the markets affected by
the Remaining Open Positions (‘‘Related
Open Positions’’). The open positions
subject to tear-up opposite to the
Remaining Open Positions and the
Related Open Positions would be
designated in accordance with the
methodology in Rule 1111(e).
Specifically, for Remaining Open
Positions, the aggregate amount in the
identical Cleared Contracts and Cleared
Securities would be designated on a
pro-rata basis to non-defaulting Clearing
Members that have an open position in
such Cleared Contract or Cleared
Security. For Remaining Open
Positions, all open positions in Cleared
Contracts and Cleared Securities
identified in the scope of the Partial
Tear-Up would be extinguished.
After the scope of the Partial Tear-Up
is determined, OCC would initiate the
Partial Tear-Up process by issuing a
notice (‘‘Partial Tear-Up Notice’’). The
Partial Tear-Up Notice would: (i)
Identify the Remaining Open Positions
and Related Open Positions designated
for tear-up; (ii) identify the Tear-Up
Positions; (iii) specify the termination
price (‘‘Partial Tear-Up Price’’) for each
position to be torn-up; and (iv) list the
date and time, as determined by the
Risk Committee, that the Partial Tear-Up
will occur (‘‘Partial Tear-Up Time’’).
Rule 1111(f) would provide that, to
determine the Partial Tear-Up Price,
OCC would use its discretion, acting in
good faith and in a commercially
reasonable manner, to adopt methods of
valuation expected to produce
reasonably accurate substitutes for the
values that would have been obtained
from the relevant market if it were
operating normally, including but not
limited to the use of pricing models that
use the market price of the underlying
interest or the market prices of its
components. Rule 1111(f) further
specifies that OCC may consider the
same information set forth in subpart (c)
of Section 27, Article VI of OCC’s ByLaws.21 OCC stated that it is likely to
21 Section 27, Article VI addresses the valuation
of positions that may be subject to close-out netting
in the event of OCC’s insolvency or default.
Specifically, it states that in determining a close-out
amount, OCC may consider any information that it
deems relevant, including, but not limited to, any
of the following factors: (i) Prices for underlying
interests in recent transactions, as reported by the
market or markets for such interests; (ii) quotations
from leading dealers in the underlying interest,
setting forth the price (which may be a dealing price
or an indicative price) that the quoting dealer
would charge or pay for a specified quantity of the
underlying interest; (iii) relevant historical and
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use the last established end-of-day
settlement price, in accordance with its
existing practices concerning pricing
and valuation. However, given that it is
not possible to know in advance the
precise circumstances that would cause
OCC to conduct a tear-up, Rule 1111(f)
would allow OCC to exercise discretion,
if necessary, in establishing the Partial
Tear-Up Price by some means other than
its existing practices concerning pricing
and valuation. For example, OCC
represented that it has observed certain
rare circumstances in which a closing
price for an underlying security of an
option may be stale or unavailable. A
stale or unavailable closing price could
be the result of a halt on trading in the
underlying security, a corporate action
resulting in a cash-out or conversion of
the underlying security (but that has not
yet been finalized), or the result of an
ADR whose underlying security is being
impacted by certain provisions under
foreign laws. OCC stated it would
consider these circumstances in
determining whether use of the
discretion that would be afforded under
proposed Rule 1111(f) might be
warranted.22
Every Partial Tear-Up position would
be automatically terminated at the
Partial Tear-Up Time, without the need
for any further step by any party to the
position. Upon termination, either OCC
or the relevant Clearing Member would
be obligated to pay to the other party the
applicable Partial Tear-Up Price. The
corresponding open position would be
deemed terminated at the Partial TearUp Price. In the event that, given the
amount of remaining resources, OCC
would not be able to pay the full Partial
Tear-Up Price, OCC would pay each
torn-up Clearing Member a pro-rata
amount of the applicable Partial TearUp Price based on the amounts of such
resources remaining. Those Clearing
Members would then have an unsecured
claim against OCC for the value of the
difference between the pro rata amount
and the Partial Tear-Up Price.
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3. Re-Allocating Losses From Tear-Up
The proposed changes would provide
OCC with means to re-allocate losses,
costs, and expenses associated with the
tear-up process. First, the proposal
would amend Article VIII of the ByLaws to provide OCC discretion to use
current market data for the relevant market,
provided by reputable outside sources or generated
internally; and (iv) values derived from theoretical
pricing models using available prices for the
underlying interest or a related interest and other
relevant data.
22 See Letter from Joseph P. Kamnik, Sr. Vice
President and CRO, OCC, to Brent Fields, Secretary,
Commission, at 5 (Jul. 9, 2018) (‘‘OCC Letter’’).
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remaining Clearing Fund contributions
to re-allocate losses imposed on nondefaulting Clearing Members and
customers from a tear-up. Second, in
connection with a Partial Tear-Up,
proposed Rule 1111(g) would provide
the Board with discretion to re-allocate
losses, costs, and fees imposed upon
non-defaulting Clearing Members and
their customers among all nondefaulting Clearing Members to the
extent that such losses, costs, and fees
can be reasonably determined by OCC
(‘‘Special Charge’’). The Special Charge
would correspond to each nondefaulting Clearing Member’s
proportionate share of the variable
amount of the Clearing Fund at the time
of the Partial Tear-Up. The Special
Charge would be distinct and separate
from a Clearing Member’s obligation to
satisfy Clearing Fund assessments
during a cooling-off period and,
therefore, not subject to the cap on
assessments.
III. Discussion and Commission
Findings
Although the Clearing Supervision
Act does not specify a standard of
review for an advance notice, the stated
purpose of the Clearing Supervision 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 systemically
important financial market utilities
(‘‘SIFMUs’’) and strengthening the
liquidity of SIFMUs.23
Section 805(a)(2) of the Clearing
Supervision Act 24 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 Clearing Supervision Act 25
provides the following objectives and
principles for the Commission’s riskmanagement 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
23 See
12 U.S.C. 5461(b).
U.S.C. 5464(a)(2).
25 12 U.S.C. 5464(b).
24 12
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44087
risk-management and default policies
and procedures, among others areas.26
The Commission has adopted riskmanagement standards under Section
805(a)(2) of the Clearing Supervision
Act and Section 17A of the Exchange
Act (the ‘‘Clearing Agency Rules’’).27
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 riskmanagement practices on an ongoing
basis.28 As such, it is appropriate for the
Commission to review advance notices
against the objectives and principles of
these risk management standards as
described in Section 805(b) of the
Clearing Supervision Act and the
Clearing Agency Rules. As discussed
below, the Commission believes the
proposal in the Amended Advance
Notice is consistent with the objectives
and principles described in Section
805(b) of the Clearing Supervision
Act,29 and in the Clearing Agency Rules,
in particular Rules 17Ad–22(e)(2)(i),
(iii), and (v), (e)(4)(viii) and (ix), (e)(13),
and (e)(23)(i) and (ii).30
A. Consistency With Section 805(b) of
the Clearing Supervision Act
The Commission believes that the
proposal contained in OCC’s Amended
Advance Notice is consistent with the
stated objectives and principles of
Section 805(b) of the Clearing
Supervision Act. Specifically, as
discussed below, the Commission
believes that the changes proposed in
the Amended 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.31
First, the proposed rule changes
would provide OCC with additional
tools to address risks it may confront in
an extreme stress event that places OCC
in a recovery scenario. The Commission
26 12
U.S.C. 5464(c).
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).
28 17 CFR 240.17Ad–22.
29 12 U.S.C. 5464(b).
30 17 CFR 240.17Ad–22(e)(2)(i), (iii), and (v),
(e)(4)(viii) and (ix), (e)(13), and (e)(23)(i) and (ii).
31 12 U.S.C. 5464(b).
27 17
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believes that the new and amended
authority granted to OCC and described
in the Amended Advance Notice should
provide OCC with the ability to reestablish a matched book, allocate
uncovered losses if necessary, and limit
OCC’s potential exposure to losses from
an extreme loss event, all of which
would be essential to OCC’s ability to
continue to provide its critical clearing
services in the event that an extreme
market event places OCC in a recovery
scenario. In general, OCC maintains
equal and opposite obligations on
cleared positions. In an extreme loss
event caused by a Clearing Member
default, re-establishing this matched
book as quickly as possible is essential
because it would allow OCC to close out
the defaulting Clearing Member’s
portfolio, define the potential scope of
losses, and avoid additional losses to
non-defaulting Clearing Members or
OCC. In addition, allocating uncovered
losses is important in an extreme loss
event because it would allow OCC to
provide further certainty to Clearing
Members, their customers, and other
stakeholders about how it addresses
such losses and avoid a disorderly
resolution to such an event. Thus, taken
together, the Commission believes that,
by providing OCC with these new and
amended tools specific to the context of
extreme loss events that may heighten
the need for recovery, the proposed
changes should improve OCC’s ability
to recover in the event that an extreme
market event places OCC in a recovery
scenario, and therefore are reasonably
designed to enhance OCC’s ability to
address an extreme loss event and
continue to operate in a safe and sound
manner during such an event.
In addition, the Commission believes
that the proposed changes would
provide a reasonable amount of clarity
and specificity to Clearing Members,
their customers, and other stakeholders
about the potential tools that would be
expected to be available to OCC if such
an event occurred, and the
consequences that might arise from
OCC’s application of such tools.
Because of this increased clarity and
specificity, OCC’s Clearing Members,
their customers, and other stakeholders
should have more information regarding
their potential exposure and liability to
OCC in an extreme loss event.
Accordingly, the Commission believes
that the proposed changes should allow
Clearing Members, their customers, and
other stakeholders to better evaluate the
risks and benefits of clearing
transactions at OCC because the
proposed changes result in those parties
having more information and specificity
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regarding the actions that OCC could
take in response to an extreme loss
event. Further, to the extent that
Clearing Members, their customers, and
other stakeholders are able to use this
increased clarity and specificity to
better manage their potential exposure
and liability in clearing transactions at
OCC, such parties should be able to
mitigate the likelihood that such tools
could surprise or otherwise destabilize
them and, by extension, the broader
financial system. For these reasons, the
Commission believes that the proposed
changes are consistent with promoting
robust risk management, promoting
safety and soundness, and supporting
the stability of the broader financial
system.
Second, the Commission believes that
the proposed changes are consistent
with reducing systemic risks and
supporting the stability of the broader
financial system. OCC is the sole
registered clearing agency for the U.S.
listed options markets and a SIFMU. It
is therefore important for OCC to
implement measures that enhance its
ability to address losses and avoid
threatening the stability of the U.S.
listed options markets and the broader
financial system, including measures
reflected in the proposed changes that
are designed to facilitate OCC’s ability
to address risks and obligations arising
in the specific context of extreme loss
events that may heighten the need for
recovery. Therefore, and for the reasons
discussed above with respect to OCC’s
ability to re-establish a matched book,
allocate uncovered losses if necessary,
and limit OCC’s potential exposure to
losses from an extreme loss event, the
Commission believes that, as a result of
the new and amended authority granted
to OCC to implement such measures,
the proposed changes are reasonably
designed to facilitate OCC’s ability to
fully allocate, and ultimately extinguish,
any losses arising from an extreme
market event, thereby enhancing OCC’s
ability to continue to provide its critical
clearing services. Relatedly, the
Commission also believes that the
proposed changes should reduce the
potential risk that OCC’s handling of an
extreme loss event results in additional
financial stress or instability passing on
to Clearing Members, their customers,
other stakeholders and the broader
financial system generally during such
events. As such, the Commission
believes the proposed change is
consistent with reducing systemic risks
and supporting the stability of the
broader financial system.
Third, OCC’s proposed modified
assessment powers would impose a cap
on a Clearing Member’s potential
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liability to replenish the Clearing Fund
following a particular default event and
extend the timeframe during which a
Clearing Member must determine
whether to terminate its membership
and avoid further losses. In addition, the
new authority to seek Voluntary
Payments would provide an additional
tool by which OCC may increase its
financial resources. Taken together, the
Commission believes that these tools are
reasonably designed to provide OCC
with sufficient financial resources to
cover default losses and ensure that
OCC can take timely actions to contain
losses and continue meeting its
obligations in the event of a Clearing
Member default. Similarly, the
Commission believes that these changes
would provide Clearing Members and
their customers with greater certainty
and predictability regarding the amount
of losses they must bear as a result of
a Clearing Member default. For these
reasons, the Commission believes that
these tools should enhance OCC’s
ability to address the issues arising from
a Clearing Member default, thereby
promoting robust risk management and
safety and soundness.
Fourth, OCC’s proposed authority to
conduct tear-ups would provide OCC
with a mechanism for restoring a
matched book and, in the event that
OCC did not have sufficient financial
resources to pay the full Partial Tear-Up
Price, allocate losses to the nondefaulting Clearing Members. The
Commission recognizes that a tear-up
would result in termination of positions
of non-defaulting Clearing Members.
However, because under the proposed
rules OCC would only be able to use its
tear-up authority after it has conducted
an auction pursuant to its Rules and
when OCC has determined that it may
not have sufficient financial resources to
meet its obligations, a tear-up would
only arise in an extreme stress scenario.
Use of tear-up in such circumstances
could potentially return OCC to a
matched book quickly, thereby
containing its losses and avoiding OCC’s
and its Clearing Members’ exposure to
additional losses, as discussed further
above. OCC’s proposal would also
address the determination of the Partial
Tear-Up Price. Specifically, OCC would
determine a Partial Tear-Up Price by
using its discretion, acting in good faith
and a commercially reasonable manner,
to adopt methods of valuation expected
to produce reasonably accurate
substitutes for the values that would
have been obtained from the relevant
market if it were operating normally,
including but not limited to the use of
pricing models that use the market price
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of the underlying interest or the market
prices of its components. The
Commission believes that OCC’s
proposed authority to conduct tear-ups,
and therefore its ability to return to a
matched book quickly and, in an
extreme event, allocate losses, could
facilitate the timely containment of
default losses and liquidity pressures,
thereby helping to prevent OCC from
failing in such an event, and is therefore
consistent with promoting robust risk
management and safety and soundness.
Further, the Commission believes that,
to the extent that OCC’s ability to
conduct tear-ups could limit contagion
to the broader financial system, this
ability is also consistent with
supporting the stability of the broader
financial system.
One commenter states that the Partial
Tear-Up Price should be determined
objectively and not on a discretionary
basis.32 In the OCC Letter, OCC states
that, in the event that it has to
determine a Partial Tear-Up Price, OCC
anticipates that it is likely to use the last
established end-of-day settlement price,
in accordance with its existing practices
concerning pricing and valuation, but
notes that discretion may be necessary
in the circumstances likely to be
associated with an extreme loss event
necessitating a tear-up where the end-ofday closing price may be stale or
unavailable.33 Further, the Commission
notes that, under OCC’s proposed rule,
OCC would not have unfettered
discretion to determine the appropriate
price. Rather, OCC’s discretion would
be limited by two conditions.
Specifically, in the event that OCC uses
its discretion to determine a Partial
Tear-Up Price, it will be required under
OCC’s proposed rule to do so (i) in good
faith and (ii) in a commercially
reasonable manner.34 The Commission
believes that this discretion, as limited
by the two specified conditions, is
appropriate given that it is not possible
to know the precise circumstances
likely to be associated with an extreme
loss event necessitating a tear-up, and,
therefore, the limited discretion
provided for in the proposed rule may
32 See Letter from Jacqueline H. Mesa, Sr. Vice
President of Global Policy, Futures Industry
Association, to Brent Fields, Secretary,
Commission, at 2 available at https://www.sec.gov/
comments/sr-occ-2017-022/occ2017020.htm (Jan.
16, 2018) (‘‘FIA Letter’’).
33 See OCC Letter at 5. According to OCC, a stale
or unavailable closing price could be the result of
a halt on trading in the underlying security, a
corporate action resulting in a cash-out or
conversion of the underlying security (but that has
not yet been finalized), or the result of an ADR
whose underlying security is being impacted by
certain provisions under foreign laws. See id.
34 See also id. at 5.
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be appropriate in such circumstances.
The Commission also notes that, in the
event that OCC is using its authority to
conduct a Partial Tear-Up, OCC would
provide notification to the Commission
and other regulators.35 Accordingly, the
Commission does not believe that this
aspect of the proposal is inconsistent
with the Clearing Supervision Act.
Finally, OCC’s proposal would also
introduce methods of re-allocating
losses after a tear-up. First, the revised
By-Laws would allow OCC discretion to
use remaining Clearing Fund
contributions to re-allocate losses
imposed on non-defaulting Clearing
Members and their customers from a
tear-up. Second, the revised Rules
would provide the Board with the
discretion to re-allocate losses among all
non-defaulting members via a Special
Charge, to the extent that such losses
can be reasonably determined. As such,
the Commission believes that these
tools, and the associated governance, are
reasonably designed to give OCC the
ability to re-allocate the losses in a fair
and equitable manner after an extreme
market event, thereby promoting safety
and soundness and supporting the
stability of the broader financial system.
One commenter states that the power
to impose the Special Charge in
connection with a Partial Tear-Up
potentially could impose costs onto
non-defaulting Clearing Members that
did not have an opposing position from
a defaulting Clearing Member.
According to the commenter, the
Special Charge could, in effect, be
another assessment against all Clearing
Members, which could create
unquantifiable and unmanageable risks
to Clearing Members. Moreover, the
commenter states that the discretion
afforded the Board may result in the
Special Charge being capriciously
applied. For these reasons, the
commenter believes that the costs
associated with a Partial Tear-Up should
not be transferrable to unaffected
Clearing Members.36
Under the terms of the proposed rule,
the Special Charge could only be used
when the losses, costs, and fees imposed
upon non-defaulting Clearing Members
and their customers directly resulting
from a Partial Tear-Up reasonably can
be determined by OCC. Further, if it
were used, the Special Charge would
correspond to each non-defaulting
Clearing Member’s proportionate share
of the Clearing Fund at the time of the
Partial Tear-Up. Thus, the Commission
does not believe that OCC would be
35 See Securities Exchange Act Release No. 83928
(Aug. 23, 2018 at note 19).
36 See FIA Letter at 2.
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44089
permitted under the proposed rule to
engage in unlimited assessments
because the amount of the Special
Charge must be subject to a reasonable
determination, and the Special Charge
would then correspond to the nondefaulting Clearing Member’s
proportionate share of the Clearing
Fund. These aspects of the Special
Charge should help ensure that OCC
does not apply the tool capriciously and
that the Board would use the Special
Charge in these delineated
circumstances, i.e., when the amount of
the losses was reasonably determinable.
For these reasons, the Commission does
not believe that the Special Charge is
inconsistent with the Clearing
Supervision Act.
Accordingly, and for the reasons
stated, the Commission believes the
changes proposed in the Amended
Advance Notice are consistent with
Section 805(b) of the Clearing
Supervision Act.37
B. Consistency With Rule 17Ad0–
22(e)(2)(i), (iii), and (v), Rule 17Ad–
22(e)(4)(viii) and (ix), Rule 17Ad–
22(e)(13), and Rule 17Ad–22(e)(23)(i)
and (ii) Under the Exchange Act
1. Governance
Rule 17Ad–22(e)(2) requires, in
relevant part, that OCC establish,
implement, maintain, and enforce
written policies and procedures
reasonably designed to provide for
governance arrangements that are clear
and transparent; support the public
interest requirements of Section 17A of
the Exchange Act applicable to clearing
agencies, and the objectives of owners
and participants; and specify clear and
direct lines of responsibility.38
The proposal, taken together with
existing OCC Rules, specifies the
governance that would apply to use of
each of the recovery tools. Specifically,
with respect to the modified powers of
assessment, the cooling-off period
would commence automatically upon a
number of events specified in the ByLaws. The use of Voluntary Payments
and either Voluntary or Partial Tear-Up
cannot occur unless OCC has
determined that it may not have
sufficient resources available to satisfy
its obligations after a default. In
addition, the proposal specifies the
applicable decision-making body that
would be responsible for determining
whether to conduct a tear-up.
Specifically, for a Voluntary Tear-Up,
OCC would be able to make that
determination, and for a Partial Tear37 12
38 17
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Up, which is mandatory, Board action is
required. The Risk Committee would be
responsible for determining the scope of
the tear-ups, and any such
determinations must take into account
certain considerations. Only the Board
may elect to impose a Special Charge to
reallocate losses, costs, and fees from a
Partial Tear-Up.
Thus, key decisions by OCC in
connection with the use of its proposed
recovery tools are subject to specific
governance processes. These
requirements include the involvement
of the Risk Committee in determining
the scope and pricing for any Partial
Tear-up and specifically require Board
approval with respect to instituting
Partial Tear-Up and authorizing the
Special Charge. Accordingly, the
Commission believes that the
governance process for using the
recovery tools is clear and transparent
and provides clear and direct lines of
responsibility by addressing decision
making in the use of recovery tools,
thereby supporting the public interest
requirements of Section 17A of the
Exchange Act applicable to clearing
agencies, and the objectives of owners
and participants, and therefore the
Commission believes that the proposed
rule change is consistent with Rule
17Ad–22(e)(2)(i), (iii), and (v).39
2. Allocation of Credit Losses Exceeding
Available Resources
Rule 17Ad–22(e)(4)(viii) requires, in
relevant part, that OCC establish,
implement, maintain, and enforce
written policies and procedures
reasonably designed to address
allocation of credit losses OCC may face
if its collateral and other resources are
insufficient to fully cover its credit
exposures.40 OCC’s proposal includes
three new recovery tools addressing the
allocation of credit losses in the event
that OCC determined that,
notwithstanding the availability of any
remaining resources under the Other
Resource Rules, OCC may not have
sufficient resources to satisfy its
obligations and liabilities following a
default. First, Rule 1009 would provide
a framework for OCC to receive
Voluntary Payments in addition to their
required contribution to the Clearing
Fund to address a shortfall. Second,
Rule 1111 would provide a framework
for Clearing Members and their
customers to participate in a Voluntary
Tear-Up. Third, Rule 1111 would
provide the Board with the discretion to
conduct a mandatory Partial Tear-Up.
This tool could be used, if necessary in
39 17
40 17
CFR 240.17Ad–22(e)(2)(i), (iii), and (v).
CFR 240.17Ad–22(e)(4)(viii).
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the event that OCC determines that its
resources are inadequate to pay the
applicable Partial Tear-Up Price, to
allocate losses by allowing OCC to pay
each relevant Clearing Member a pro
rata amount of the applicable Partial
Tear-Up Price based on the amount of
such resources remaining. In addition,
the modified powers of assessment
would continue to allow OCC to use the
Clearing Fund to address credit losses in
the event of a member default.
Thus, the Commission believes that
these additional recovery tools are
reasonably designed to provide OCC
with means to address allocation of
credit losses that it may face if its
collateral and other resources are
insufficient to fully cover its credit
exposures. Further, the Commission
believes that these tools should address
fully any credit losses that OCC may
face as a result of any individual or
combined default among its Clearing
Members. Therefore, the Commission
believes that these aspects of the
proposed changes are consistent with
Rule 17Ad–22(e)(4)(viii).41
3. Replenishment of Financial
Resources Following a Default
Rule 17Ad–22(e)(4)(ix) requires, in
relevant part, that OCC establish,
implement, maintain, and enforce
written policies and procedures
reasonably designed to describe OCC’s
process to replenish any financial
resources it may use following a default
or other event in which use of resources
is contemplated.42
The proposed changes to OCC’s
assessment powers would include the
addition of a minimum fifteen-day
cooling-off period that would be
automatically triggered by a
proportionate charge to the Clearing
Fund arising from a Clearing Member
default. At the end of the cooling-off
period, a remaining Clearing Member
(i.e., a Clearing Member that did not
choose to terminate its membership
during the cooling-off period) would be
obligated to replenish the Clearing
Fund.
The Commission recognizes that by
placing a cap on its assessment power
during the cooling-off period, these
revisions would effectively limit the
amount of financial resources available
to OCC from its Clearing Fund during
that period. However, the Commission
believes that these proposals would
provide greater certainty and
predictability regarding Clearing
Members’ maximum liability to the
Clearing Fund, which could potentially
41 17
42 17
PO 00000
CFR 240.17Ad–22(e)(4)(viii).
CFR 240.17Ad–22(e)(4)(ix).
Frm 00076
Fmt 4703
Sfmt 4703
limit loss contagion in the broader
financial system. Moreover, in light of
the proposed cap on OCC’s assessment
powers during the cooling-off period,
OCC has authority under Rule 603 to
call for additional initial margin from
Clearing Members to ensure that OCC
maintains sufficient financial resources
to meet its requirements under Rule
17Ad–22(e)(4)(iii). Finally, at the end of
a cooling-off period, a Clearing Member
would be required to replenish the
Clearing Fund in the amount necessary
to meet its then-required contribution.
In light of the foregoing discussion,
the Commission believes that the
provisions related to OCC’s assessment
powers, taken together with the other
components of OCC’s default
management procedures and recovery
rules, which are reasonably designed to
allow OCC to replenish its financial
resources following a default or other
event in which use of such resources is
contemplated, are consistent with Rule
17Ad–22(e)(4)(ix).43
One commenter states that OCC
should provide an explanation of its
determination to set the cap on the
powers of assessment at 200 percent
during a cooling-off period.44 In the
OCC Letter, OCC provided an
explanation of the internal analysis that
it conducted to reach the 200 percent
determination.45 Specifically, OCC
stated that it considered its ability to
have sufficient financial resources
inclusive of its proposed assessment
powers to withstand extreme market
conditions on a ‘‘Cover-2’’ basis under
various scenarios, and that OCC
determined that, under such scenarios,
it would be able to meet its clearing
obligations so long as it was able to use
(1) the financial resources on hand in
the Clearing Fund, and (2) the full
funding of two assessments (i.e., 200
percent) from non-defaulting Clearing
Members.46 Moreover, OCC stated that it
reviewed the caps that other CCPs
impose upon their own assessment
powers and determined that the 200
percent cap is generally aligned with
other assessment caps.47 Based on
review of the analysis provided by OCC
and the caps of other CCPs,48 the
43 17
CFR 240.17Ad–22(e)(4)(ix).
FIA Letter at 1–2.
45 See OCC Letter at 2–3.
46 See id.
47 See id. at 3.
48 See, e.g., Self-Regulatory Organizations; ICE
Clear Credit LLC; Notice of Filing Amendment No.
1 and Order Granting Accelerated Approval of
Proposed Rule Change to Amend the ICE Clear
Credit Clearing Rules, as Modified by Amendment
No. 1, Relating to Default Management, Clearing
House Recovery and Wind-Down, Exchange Act
Release No. 79750 (Jan. 6, 2017), 82 FR 3831 (Jan.
12, 2017) (SR–ICC–2016–013) (approving a
44 See
E:\FR\FM\29AUN1.SGM
29AUN1
Federal Register / Vol. 83, No. 168 / Wednesday, August 29, 2018 / Notices
Commission believes that the 200
percent cap in the proposed changes is
consistent with Rule 17Ad–22(e)(4)(ix).
sradovich on DSK3GMQ082PROD with NOTICES
5. Authority To Take Timely Action To
Contain Losses and Liquidity Demands
and Continue To Meet Obligations
Rule 17Ad–22(e)(13) requires, in
relevant part, that OCC establish,
implement, maintain, and enforce
written policies and procedures
reasonably designed to ensure that it has
the authority and operational capacity
to take timely action to contain losses
and liquidity demands and continue to
meet its obligations.49 As described
above, OCC’s proposal would provide
OCC with modified assessment powers
and new tools of Voluntary Payments,
Voluntary Tear-Ups, and Partial TearUps.
As discussed above, the Commission
recognizes that a tear-up would result in
termination of positions of nondefaulting Clearing Members. However,
because OCC would only be able to use
its tear-up authority after it has
conducted an auction pursuant to its
Rules and when OCC has determined
that it may not have sufficient financial
resources to meet its obligations, a tearup would only arise in an extreme stress
scenario. Further, use of tear-up in such
circumstances could potentially return
OCC to a matched book quickly, thereby
containing its losses.
The Commission believes that these
tools are designed to provide greater
certainty to Clearing Members seeking
to estimate the potential risks and losses
arising from their use of OCC, while
enabling OCC to promptly return to a
matched book. The Commission
believes that returning to a matched
book pursuant to these provisions in the
context of OCC’s default management
and recovery facilitates OCC’s
operational capacity to timely contain
losses and liquidity demands while
continuing to meet its obligations. Thus,
the Commission believes that the
proposed changes are consistent with
Rule 17Ad–22(e)(13).50
6. Public Disclosure of Key Aspects of
Default Rules
Rules 17Ad–22(e)(23)(i) and (ii)
require, in relevant part, that OCC
establish, implement, maintain, and
enforce written policies and procedures
reasonably designed to provide for the
public disclosure of all relevant rules
and material procedures, including key
aspects of default rules and procedures,
proposed rule change including, among other
things, a 300 percent cap on non-defaulting
participants’ liability during a cooling-off period).
49 17 CFR 240.17Ad–22(e)(13).
50 Id.
VerDate Sep<11>2014
17:04 Aug 28, 2018
Jkt 244001
as well as sufficient information to
enable participants to identify and
evaluate the risks, fees and other
material costs they incur by
participating in OCC.51 The
Commission believes that the proposed
changes address key aspects of OCC’s
default rules and procedures, thereby
providing Clearing Members with a
better understanding of the potential
risks and costs they might face in an
extreme event where OCC may use its
proposed recovery tools, including the
potential use of the Special Charge.
Accordingly, the Commission believes
that OCC has disclosed these key
aspects of its default rules and
procedures, consistent with Rule 17Ad–
22(e)(23)(i) and (ii).52
IV. Conclusion
It is therefore noticed, pursuant to
Section 806(e)(1)(I) of the Clearing
Supervision Act,53 that the Commission
does not object to Advance Notice (SR–
OCC–2017–809), as modified by
Amendment No. 2, and that OCC is
authorized to implement the proposed
change as of the date of this notice or
the date of an order by the Commission
approving proposed rule change SR–
OCC–2017–020, as modified by
Amendment No. 2, whichever is later.
By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018–18655 Filed 8–28–18; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–83918; File No. SR–OCC–
2017–021]
Self-Regulatory Organizations; The
Options Clearing Corporation; Order
Approving Proposed Rule Change, as
Modified by Partial Amendment No. 2,
Concerning Updates to and
Formalization of OCC’s Recovery and
Orderly Wind-Down Plan
August 23, 2018.
I. Introduction
On December 8, 2017, The Options
Clearing Corporation (‘‘OCC’’) filed with
the Securities and Exchange
Commission (‘‘Commission’’) the
proposed rule change SR–OCC–2017–
021 (‘‘Proposed Rule Change’’) pursuant
to Section 19(b) of the Securities
Exchange Act of 1934 (‘‘Exchange
51 17
CFR 240.17Ad–22(e)(23)(i) and (ii).
CFR 240.17Ad–22(e)(23)(i) and (ii).
53 12 U.S.C. 5465(e)(1)(I).
52 17
PO 00000
Frm 00077
Fmt 4703
Sfmt 4703
44091
Act’’),1 and Rule 19b–4 2 thereunder to
propose to formalize and update its
Recovery and Orderly Wind-Down Plan
(‘‘RWD Plan’’).3 The Proposed Rule
Change was published for comment in
the Federal Register on December 26,
2017.4 On January 25, 2018, the
Commission designated a longer period
of time for Commission action on the
Proposed Rule Change.5 On March 22,
2018, the Commission published an
order to institute proceedings to
determine whether to approve or
disapprove the Proposed Rule Change.6
On July 11, 2018, OCC filed Partial
Amendment No. 1 to the Proposed Rule
Change.7 On July 13, 2018, OCC filed
Partial Amendment No. 2 to the
Proposed Rule Change.8 Notice of
Partial Amendments No. 1 and 2 to the
Proposed Rule Change was published
for public comment in the Federal
Register on August 2, 2018,9 and the
Commission has received no comments
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Notice infra note 4, 82 FR 61072.
4 Securities Exchange Act Release No. 82352 (Dec.
19, 2017), 82 FR 61072 (Dec. 26, 2017) (File No. SR–
OCC–2017–021) (‘‘Notice’’). On December 8, 2017,
OCC also filed a related advance notice (SR–OCC–
2017–810) (‘‘Advance Notice’’) with the
Commission pursuant to Section 806(e)(1) of Title
VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled the Payment,
Clearing, and Settlement Supervision Act of 2010
and Rule 19b–4(n)(1)(i) under the Exchange Act. 12
U.S.C. 5465(e)(1) and 17 CFR 240.19b–4(n)(1)(i),
respectively. The Advance Notice was published in
the Federal Register on January 23, 2018. Securities
Exchange Act Release No. 82514 (Jan. 17, 2017), 83
FR 3224 (Jan. 23, 2018) (SR–OCC–2017–810).
The Financial Stability Oversight Council
designated OCC a systemically important financial
market utility on July 18, 2012. See Financial
Stability Oversight Council 2012 Annual Report,
Appendix A, available at https://www.treasury.gov/
initiatives/fsoc/Documents/2012%20Annual
%20Report.pdf. Therefore, OCC is required to
comply with the Payment, Clearing and Settlement
Supervision Act and file advance notices with the
Commission. See 12 U.S.C. 5465(e).
5 Securities Exchange Act Release No. 82586 (Jan.
25, 2018), 83 FR 4527 (Jan. 31, 2018) (File No. SR–
OCC–2017–021).
6 Securities Exchange Act Release No. 82927
(Mar. 22, 2018), 83 FR 13176 (Mar. 27, 2018) (File
No. SR–OCC–2017–021).
7 In Partial Amendment No. 1, OCC made three
modifications to the Notice: (1) Removal of sections
of the RWD Plan concerning OCC’s proposed
authority to require cash settlement of certain
physically delivered options and single stock
futures; (2) updating the list of OCC’s Critical
Support Functions; and (3) making three changes to
the RWD Plan to conform to a change
contemporaneously proposed in Partial
Amendment No. 2 to OCC filing SR–OCC–2017–020
concerning enhanced and new tools for recovery
scenarios.
8 Partial Amendment No. 2 superseded and
replaced Partial Amendment No. 1 in its entirety,
due to technical defects in Partial Amendment No.
1.
9 See Securities Exchange Act Release No. 83732
(Jul. 27, 2018), 83 FR 37864 (Aug. 2, 2018) (‘‘Notice
of Amendment’’).
2 17
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]]>Agencies
[Federal Register Volume 83, Number 168 (Wednesday, August 29, 2018)]
[Notices]
[Pages 44083-44091]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-18655]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-83927; File No. SR-OCC-2017-809]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection to Advance Notice, as Modified by Amendment No.
2, Concerning Enhanced and New Tools for Recovery Scenarios
August 23, 2018.
I. Introduction
On December 8, 2017, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-OCC-2017-809 (``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 (``Clearing Supervision 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 Rules and By-Laws to
enhance OCC's existing tools to address the risks of liquidity
shortfalls and credit losses and to establish new tools by which OCC
could re-establish a matched book and, if necessary, allocate uncovered
losses following a default as well as provide for additional financial
resources. The Advance Notice was published for public comment in the
Federal Register
[[Page 44084]]
on January 23, 2018.\4\ On January 23, 2018, the Commission requested
OCC provide it with additional information regarding the Advance
Notice.\5\ OCC responded to the request, and the Commission received
the information on July 13, 2018.\6\
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\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\ Exchange Act Release No. 82513 (Jan. 17, 2018), 83 FR 3244
(Jan. 23, 2018) (SR-2017-809) (``Notice of Filing''). On December
18, 2017, OCC also filed a related proposed rule change (SR-OCC-
2017-020) 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 December 26, 2017. Exchange Act Release No. 82531 (Dec.
19, 2017), 82 FR 61107 (Dec. 26, 2017).
\5\ See Memorandum from Office of Clearance and Settlement,
Division of Trading and Markets, dated January 23, 2018, available
at https://www.sec.gov/comments/sr-occ-2017-809/occ2017809-2948229-161855.pdf.
\6\ See Memorandum from Office of Clearance and Settlement,
Division of Trading and Markets, dated July 17, 2018, available at
https://www.sec.gov/comments/sr-occ-2017-809/occ2017809-04062512-169148.pdf.
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On July 11, 2018, OCC filed Amendment Nos. 1 and 2 to the Advance
Notice to make certain changes to clarify the use of the recovery tools
and to improve the overall transparency regarding the use of the
recovery tools.\7\ Notice of the Amendments to the Advance Notice was
published for public comment in the Federal Register on August 7,
2018.\8\ Comments received on the proposal contained in the Advance
Notice are discussed below.\9\
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\7\ Amendment No. 2 was filed to supersede and replace Amendment
No. 1 in its entirety due to technical defects in Amendment No. 1.
\8\ See Exchange Act Release No. 83761 (Aug. 1, 2018), 83 FR
38738 (Aug. 7, 2018) (``Notice of Amendment'').
\9\ The letters are available at: https://www.sec.gov/comments/sr-occ-2017-022/occ2017020.htm.
Since the proposal contained in the Advance Notice was also
filed as a proposed rule change, all comments received on the
proposal are considered regardless of whether the comments are
submitted on the proposed rule change or the Advance Notice.
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This publication serves as notice that the Commission does not
object to the changes set forth in the Advance Notice, as amended by
Amendment No. 2 (``Amended Advance Notice'').
II. Background [bds1][bds0]
---------------------------------------------------------------------------
\10\ Capitalized terms used but not defined herein have the
meanings specified in OCC's Rules and By-Laws, available at https://www.theocc.com/about/publications/bylaws.jsp.
---------------------------------------------------------------------------
The Amended Advance Notice concerns proposed changes to OCC's Rules
and By-Laws to enhance OCC's existing tools to address the risks of
liquidity shortfalls and credit losses and to establish new tools by
which OCC could re-establish a matched book and, if necessary, allocate
uncovered losses following the default of a Clearing Member as well as
provide for additional financial resources. Each of the proposed tools
is contemplated to be deployed by OCC in an extreme stress event that
has placed OCC into a recovery or orderly wind-down scenario. The
proposed changes include modifying OCC's powers of assessment,
introducing a framework for requesting voluntary payments to the
Clearing Fund, and establishing OCC's authority to extinguish open
positons (i.e., conduct tear-ups) as well as authorizing OCC's Board to
re-allocate losses from tear-ups.
A. Proposed Changes to OCC's Powers of Assessment
OCC maintains a Clearing Fund comprised of required contributions
from Clearing Members, and OCC has authority to use the Clearing Fund,
by a proportionate charge or otherwise, to cover certain losses
suffered by OCC.\11\ When an amount is paid out of a Clearing Member's
required contribution to the Clearing Fund, the Clearing Member is
generally required to promptly make good any deficiency in its required
contribution to the Clearing Fund from such payment.\12\ Generally,
this requirement to promptly make good on any deficiency arising from
the default of a Clearing Member has been referred to as an
``assessment'' by OCC against a Clearing Member; however, as further
described below, OCC is making clarifying changes to a Clearing
Member's obligation to contribute to the Clearing Fund, including
defining and delineating between a Clearing Member's obligation to
answer ``assessments'' charged by OCC under certain circumstances
described further below and a Clearing Member's obligations where OCC
seeks to effect a ``replenishment'' of the Clearing Fund.
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\11\ See OCC By-Laws, Article VIII. For example, under Section 5
of Article VIII of the OCC By-Laws, when a Clearing Member defaults,
OCC will pay for the resulting losses or expenses by first applying
other funds available to OCC in the accounts of the defaulting
Clearing Member and then applying the defaulting Clearing Member's
required contribution to the Clearing Fund. If the losses and
expenses exceed those amounts, then OCC will charge the amount of
the remaining deficiency on a proportionate basis against all non-
defaulting Clearing Members' required contributions to the Clearing
Fund.
\12\ See OCC By-Laws, Article VIII, Section 6.
---------------------------------------------------------------------------
Currently, a Clearing Member's obligation to make good its required
contribution to the Clearing Fund is not subject to any pre-determined
limit. However, a Clearing Member may limit the amount of its liability
to contribute to the Clearing Fund by winding-down its clearing
activities and terminating its membership. To do so, a Clearing Member
must provide written notice to OCC that it is terminating its
membership by no later than the fifth business day after application of
the proportionate charge.\13\ This termination would limit the Clearing
Member's obligation to meet a future assessment to an additional 100
percent of the amount of its then-required Clearing Fund contribution.
Thus, terminating clearing membership is the only means by which a
Clearing Member can currently limit its liability for amounts due to
the Clearing Fund. OCC proposed three changes to modify its existing
authority to assess proportionate charges against Clearing Members'
required contributions to the Clearing Fund: (1) A cooling-off period
and cap on assessments; (2) termination of clearing membership during a
cooling-off period; and (3) replenishment of resources following a
cooling-off period.
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\13\ In addition to providing the written notice, to effectively
terminate membership, a Clearing Member must satisfy two other
conditions. First, after submitting the written notice, the Clearing
Member cannot submit for clearance any opening purchase transaction
or opening written transaction or initiate a Stock Loan through any
of the Clearing Member's accounts. Second, the Clearing Member has
to close out or transfer all of its open positions with OCC, in each
case as promptly as practicable after giving written notice. See OCC
By-Laws, Article VIII, Section 6.
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1. Cooling-Off Period and Cap on Assessments
The proposal would introduce a minimum fifteen calendar day
``cooling-off'' period that automatically begins when OCC imposes a
proportionate charge related to the default of a Clearing Member
against non-defaulting Clearing Members' Clearing Fund contributions.
During a cooling-off period, the aggregate liability for a Clearing
Member would be capped at 200 percent of its then-required contribution
to the Clearing Fund. The cooling-off period would be extended if one
or more specific events related to the default of a Clearing Member (as
set forth in OCC's By-laws) \14\ occur(s)
[[Page 44085]]
during that fifteen calendar day period and results in one or more
proportionate charges against the Clearing Fund. Such an extension
would run until the earlier of (i) the fifteenth calendar day from the
date of the most recent proportionate charge resulting from that
subsequent event, or (ii) the twentieth day from the date of the
proportionate charge that initiated the cooling-off period.
---------------------------------------------------------------------------
\14\ Specifically, a cooling-off period would automatically
begin after a proportionate charge arises in response to: (i) Any
Clearing Member failure to discharge duly any obligation on or
arising from any confirmed trade accepted by OCC, (ii) any Clearing
Member (including any Appointed Clearing Member) failure to perform
any obligations (including its obligations to the correspondent
clearing corporation) under or arising from any exercised or
assigned option contract or any other contract or obligation issued
or guaranteed by OCC or in respect of which it is otherwise liable,
(iii) any Clearing Member failure to perform any obligation to OCC
in respect of the stock loan and borrow positions of such Clearing
Member, or (iv) OCC suffered any loss or expense upon any
liquidation of a Clearing Member's open positions. See OCC By-Laws,
Article VIII, Section 5(a)(i)-(iv).
---------------------------------------------------------------------------
Once the cooling-off period ends, each remaining Clearing Member
would be required to replenish the Clearing Fund in the amount
necessary to meet its then-required contribution. Any remaining losses
or expenses suffered by OCC as a result of any events that occurred
during that cooling-off period could not be charged against the amounts
Clearing Members have contributed to replenish the Clearing Fund upon
the expiration of the cooling-off period. However, after the end of a
cooling-off period, the occurrence of another specified event that
results in a proportionate charge against the Clearing Fund would
trigger a new cooling-off period.
2. Membership Termination During a Cooling-Off Period
As noted above, to limit its liability to replenish the Clearing
Fund, a Clearing Member currently must provide written notice of its
intent to terminate its clearing membership by no later than the fifth
business day after a proportionate charge. OCC's proposal would extend
the time frame for a Clearing Member to provide such notice of
termination, which would allow the terminating Clearing Member to avoid
liability to replenish the Clearing Fund after the cooling-off period.
Specifically, to terminate its status as a Clearing Member and not be
liable for replenishment at the end of a cooling-off period, a Clearing
Member would be required to: (i) Notify OCC in writing of its intent to
terminate by no later than the last day of the cooling-off period, (ii)
not initiate any opening purchase or opening writing transaction, and,
if the Clearing Member is a Market Loan Clearing Member or a Hedge
Clearing Member, not initiate any Stock Loan transaction through any of
its accounts, and (iii) close-out or transfer all open positions by no
later than the last day of the cooling-off period. If a Clearing Member
fails to satisfy all of these conditions by the end of a cooling-off
period, it would not have completed all of the requirements necessary
to terminate its status as a Clearing Member, and therefore, it would
remain subject to its obligation to replenish the Clearing Fund after
the cooling-off period ends.
Given the products cleared by OCC and the composition of its
clearing membership, OCC determined that a minimum 15-calendar day
cooling-off period, rolling up to a maximum of 20 calendar days, is
likely to be a sufficient amount of time for OCC to manage the ongoing
default(s) and take necessary steps in furtherance of stabilizing the
clearing system. Further, based on its conversations with Clearing
Members, OCC believes that the proposed cooling-off period is likely to
be a sufficient amount of time for Clearing Members (and their
customers) to orderly reduce or rebalance their positions, in an
attempt to mitigate stress losses and exposure to potential initial
margin increases during the stress event.\15\ OCC also believes the
proposed cooling-off period, coupled with the other proposed changes to
OCC's assessment powers, is likely to provide Clearing Members with an
adequate measure of stability and predictability as to the potential
use of Clearing Fund resources, which would, according to OCC, remove
the existing incentive for Clearing Members to withdraw following a
proportionate charge (i.e., to avoid facing potentially unlimited
liability for replenishing the Clearing Fund).
---------------------------------------------------------------------------
\15\ See Notice of Amendment, 83 FR at 38746.
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3. Replenishment and Assessment
The proposal would clarify the distinction between
``replenishment'' of the Clearing Fund and a Clearing Member's
obligation to answer ``assessments'' charged by OCC. In this context,
the term ``replenish'' (and its variations) would refer to a Clearing
Member's standing duty, following any proportionate charge against the
Clearing Fund, to return its Clearing Fund contribution to the amount
required from such Clearing Member for the month in question. The term
``assessment'' (and its variations) would refer to the amount, during
any cooling-off period, that a Clearing Member would be required to
contribute to the Clearing Fund in excess of the amount of the Clearing
Member's pre-funded required Clearing Fund contribution.
B. Proposed Authority To Request Voluntary Payments
OCC proposed new Rule 1011 to provide a framework for receipt of
voluntary payments in a circumstance where a Clearing Member has
defaulted and OCC has determined that it may not have sufficient
resources to satisfy its obligations and liabilities resulting from
such default.\16\ OCC would initiate a call for voluntary payments by
issuing a notice inviting all non-defaulting Clearing Members to make
payments to the Clearing Fund in addition to any amounts they are
otherwise required to contribute pursuant to Rule 1001 (``Voluntary
Payment Notice''). The Voluntary Payment Notice would specify the terms
applicable to any voluntary payment, including but not limited to, that
any voluntary payment may not be withdrawn once made, that no Clearing
Member shall be obligated to make a voluntary payment, and that OCC
shall retain full discretion to accept or reject any voluntary payment.
---------------------------------------------------------------------------
\16\ OCC's determination would be made notwithstanding
availability of remaining resources under Rules 707 (addressing the
treatment of funds in a Clearing Member's X-M accounts); 1001
(addressing the size of OCC's Clearing Fund and the amount of a
Clearing Member's contribution); 1104-1107 (concerning the treatment
of the portfolio of a defaulted Clearing Member); and 2210 and 2211
(concerning the treatment of Stock Loan positions of a defaulted
Clearing Member).
---------------------------------------------------------------------------
In the event that OCC eventually obtains additional financial
resources from the defaulting Clearing Member, OCC would give priority
to repayment of Clearing Members that made Voluntary Payments.
Specifically, if OCC subsequently recovers from the defaulted Clearing
Member or the estate of the defaulted Clearing Member, OCC would seek
to first compensate all non-defaulting Clearing Members that made
voluntary payments.\17\ If the amount recovered from the defaulted
Clearing Member were less than the aggregate amount of voluntary
payments, non-defaulting Clearing Members that made voluntary payments
each would receive a percentage of the amount recovered that
corresponds to that Clearing Member's percentage of the total amount of
voluntary payments received.
---------------------------------------------------------------------------
\17\ As discussed further in Section II.C.1 below, OCC's
proposed authority with respect to Voluntary Payments and Voluntary
Payments would work together to establish a hierarchy of repayment
in the event that OCC subsequently recovers from the defaulted
Clearing Member. Under proposed rules 1011(b) and 1111(a)(ii), OCC
would first seek to compensate those non-defaulting Clearing Members
who had submitted Voluntary Payments and, thereafter, to the extent
funds remained, OCC would then seek to compensation those non-
defaulting Clearing Members who had participated in the Voluntary
Tear-Up.
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C. Proposed Authority To Conduct Voluntary Tear-Ups and Partial Tear-
Ups
OCC proposed new Rule 1111 to establish a framework to extinguish
positions of a suspended or defaulted Clearing Member on a voluntary
basis (``Voluntary Tear-Up'') or on a mandatory basis (``Partial-Tear
Up'') and, in certain extreme circumstances, to allocate any uncovered
losses in the event that OCC does not have sufficient financial
resources to conduct the tear-
[[Page 44086]]
up. A Voluntary Tear-Up, if provided, would precede a Partial-Tear Up,
and any Partial Tear-Up would take into account any positions
extinguished as part of a Voluntary Tear-Up. Further, Rule 1111(h)
would provide that no action or omission by OCC pursuant to, and in
accordance with, Rule 1111 shall constitute a default by OCC, provided
that Rule 1111(h) would not apply in the event that OCC pays Clearing
Members a pro rata amount of the applicable Tear-Up price because OCC
does not have adequate resources to pay the full Tear-Up price.
OCC's use of both Voluntary and Partial Tear-Up would be subject to
certain prerequisites. First, any tear-up would occur after one or more
failed auctions pursuant to Rule 1104 or 1106. Second, any tear-up
would occur after OCC has determined that it may not have sufficient
resources to satisfy its obligations and liabilities resulting from
such default.\18\
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\18\ As with Voluntary Payments, this determination would be
made notwithstanding availability of remaining resources under Rules
707, 1001, 1104-1107, 2210, and 2211. See note 16 supra.
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OCC represented that it would initiate its tear-up process on a
date sufficiently in advance of the exhaustion of its financial
resources such that OCC would expect to have adequate remaining
resources to cover the amount it must pay to extinguish the positions
of Clearing Members and customers.\19\ The holders of torn-up positions
would be assigned a price, and OCC would draw on its remaining
financial resources to extinguish the torn-up positions at the assigned
price. Although OCC does not intend, in the first instance, for its
tear-up process to serve as a means of loss allocation, OCC recognizes
that circumstances may arise such that, despite its best efforts, OCC
may not have adequate remaining financial resources to extinguish torn-
up positions at the full assigned price, resulting in the allocation of
uncovered losses by the tear-up process. As further described below, a
Clearing Member allocated an uncovered loss would then have an
unsecured claim against OCC for the value of the difference between the
pro rata amount paid to the Clearing Member and the full amount the
Clearing Member should have received.
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\19\ Specifically, OCC stated that it anticipated that it would
determine the date on which to initiate Partial Tear-Ups by
monitoring its remaining financial resources against the potential
exposure of the remaining unauctioned positions from the
portfolio(s) of the defaulted Clearing Member(s).
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1. Voluntary Tear-Up
As noted above, a Voluntary Tear-Up would provide an opportunity to
holders of certain positions opposite a defaulting Clearing Member to
voluntarily extinguish those positions. Although the Risk Committee of
OCC's Board of Directors (``Risk Committee'') approval is not necessary
to commence a Voluntary Tear-Up, the Risk Committee would be
responsible for determining the scope of a Voluntary Tear-Up. Proposed
Rule 1111(c) would provide discretion to the Risk Committee when
determining the appropriate scope, but the discretion would be subject
to, and limited by, certain conditions, i.e., that the determination
should be: (i) Based on then-existing facts and circumstances; (ii) be
in furtherance of the integrity of OCC and the stability of the
financial system; and (iii) take into consideration the legitimate
interests of Clearing Members and market participants.
Once the Risk Committee has determined the scope, OCC would
initiate the call for Voluntary Tear-Ups by issuing a notice
(``Voluntary Tear-Up Notice'') to inform all non-defaulting Clearing
Members of the opportunity to participate in a Voluntary Tear-Up.\20\
The Voluntary Tear-Up Notice would specify the terms applicable to any
Voluntary Tear-Up, including, but not limited to, that no Clearing
Member or customers of a Clearing Member shall be obligated to
participate in a Voluntary Tear-Up, and that OCC shall retain full
discretion to accept or reject any Voluntary Tear-Up.
---------------------------------------------------------------------------
\20\ Because OCC does not know the identities of Clearing
Members' customers, OCC would depend on each Clearing Member to
notify its customers with positions in scope of the Voluntary Tear-
Up of the opportunity to participate in such tear-up.
---------------------------------------------------------------------------
Clearing Members and their customers that participated in a
Voluntary Tear-Up and incurred losses would have a claim to amounts
subsequently recovered from a defaulted Clearing Member (or the estate
of the defaulted Clearing Member). The claim would be junior to
Clearing Members who made a voluntary payment to the Clearing Fund, and
OCC would satisfy the claims on a pro-rata basis.
2. Partial Tear-Up
Under proposed Rule 1111(b), OCC's Board would be responsible for
the decision to conduct a mandatory Partial Tear-Up. The Risk Committee
would then be responsible for determining the appropriate scope of the
Partial Tear-Up, subject to the conditions in Rule 1111(c) discussed
above.
The proposed rule would also provide the Board with the discretion
to conduct a mandatory Partial Tear-Up to extinguish the remaining open
positions of any defaulted Clearing Member or customer of such
defaulted Clearing Member(s) (``Remaining Open Positions'') and/or any
related open positions necessary to mitigate further disruptions to the
markets affected by the Remaining Open Positions (``Related Open
Positions''). The open positions subject to tear-up opposite to the
Remaining Open Positions and the Related Open Positions would be
designated in accordance with the methodology in Rule 1111(e).
Specifically, for Remaining Open Positions, the aggregate amount in the
identical Cleared Contracts and Cleared Securities would be designated
on a pro-rata basis to non-defaulting Clearing Members that have an
open position in such Cleared Contract or Cleared Security. For
Remaining Open Positions, all open positions in Cleared Contracts and
Cleared Securities identified in the scope of the Partial Tear-Up would
be extinguished.
After the scope of the Partial Tear-Up is determined, OCC would
initiate the Partial Tear-Up process by issuing a notice (``Partial
Tear-Up Notice''). The Partial Tear-Up Notice would: (i) Identify the
Remaining Open Positions and Related Open Positions designated for
tear-up; (ii) identify the Tear-Up Positions; (iii) specify the
termination price (``Partial Tear-Up Price'') for each position to be
torn-up; and (iv) list the date and time, as determined by the Risk
Committee, that the Partial Tear-Up will occur (``Partial Tear-Up
Time'').
Rule 1111(f) would provide that, to determine the Partial Tear-Up
Price, OCC would use its discretion, acting in good faith and in a
commercially reasonable manner, to adopt methods of valuation expected
to produce reasonably accurate substitutes for the values that would
have been obtained from the relevant market if it were operating
normally, including but not limited to the use of pricing models that
use the market price of the underlying interest or the market prices of
its components. Rule 1111(f) further specifies that OCC may consider
the same information set forth in subpart (c) of Section 27, Article VI
of OCC's By-Laws.\21\ OCC stated that it is likely to
[[Page 44087]]
use the last established end-of-day settlement price, in accordance
with its existing practices concerning pricing and valuation. However,
given that it is not possible to know in advance the precise
circumstances that would cause OCC to conduct a tear-up, Rule 1111(f)
would allow OCC to exercise discretion, if necessary, in establishing
the Partial Tear-Up Price by some means other than its existing
practices concerning pricing and valuation. For example, OCC
represented that it has observed certain rare circumstances in which a
closing price for an underlying security of an option may be stale or
unavailable. A stale or unavailable closing price could be the result
of a halt on trading in the underlying security, a corporate action
resulting in a cash-out or conversion of the underlying security (but
that has not yet been finalized), or the result of an ADR whose
underlying security is being impacted by certain provisions under
foreign laws. OCC stated it would consider these circumstances in
determining whether use of the discretion that would be afforded under
proposed Rule 1111(f) might be warranted.\22\
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\21\ Section 27, Article VI addresses the valuation of positions
that may be subject to close-out netting in the event of OCC's
insolvency or default. Specifically, it states that in determining a
close-out amount, OCC may consider any information that it deems
relevant, including, but not limited to, any of the following
factors: (i) Prices for underlying interests in recent transactions,
as reported by the market or markets for such interests; (ii)
quotations from leading dealers in the underlying interest, setting
forth the price (which may be a dealing price or an indicative
price) that the quoting dealer would charge or pay for a specified
quantity of the underlying interest; (iii) relevant historical and
current market data for the relevant market, provided by reputable
outside sources or generated internally; and (iv) values derived
from theoretical pricing models using available prices for the
underlying interest or a related interest and other relevant data.
\22\ See Letter from Joseph P. Kamnik, Sr. Vice President and
CRO, OCC, to Brent Fields, Secretary, Commission, at 5 (Jul. 9,
2018) (``OCC Letter'').
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Every Partial Tear-Up position would be automatically terminated at
the Partial Tear-Up Time, without the need for any further step by any
party to the position. Upon termination, either OCC or the relevant
Clearing Member would be obligated to pay to the other party the
applicable Partial Tear-Up Price. The corresponding open position would
be deemed terminated at the Partial Tear-Up Price. In the event that,
given the amount of remaining resources, OCC would not be able to pay
the full Partial Tear-Up Price, OCC would pay each torn-up Clearing
Member a pro-rata amount of the applicable Partial Tear-Up Price based
on the amounts of such resources remaining. Those Clearing Members
would then have an unsecured claim against OCC for the value of the
difference between the pro rata amount and the Partial Tear-Up Price.
3. Re-Allocating Losses From Tear-Up
The proposed changes would provide OCC with means to re-allocate
losses, costs, and expenses associated with the tear-up process. First,
the proposal would amend Article VIII of the By-Laws to provide OCC
discretion to use remaining Clearing Fund contributions to re-allocate
losses imposed on non-defaulting Clearing Members and customers from a
tear-up. Second, in connection with a Partial Tear-Up, proposed Rule
1111(g) would provide the Board with discretion to re-allocate losses,
costs, and fees imposed upon non-defaulting Clearing Members and their
customers among all non-defaulting Clearing Members to the extent that
such losses, costs, and fees can be reasonably determined by OCC
(``Special Charge''). The Special Charge would correspond to each non-
defaulting Clearing Member's proportionate share of the variable amount
of the Clearing Fund at the time of the Partial Tear-Up. The Special
Charge would be distinct and separate from a Clearing Member's
obligation to satisfy Clearing Fund assessments during a cooling-off
period and, therefore, not subject to the cap on assessments.
III. Discussion and Commission Findings
Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, the stated purpose of the Clearing
Supervision 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 systemically
important financial market utilities (``SIFMUs'') and strengthening the
liquidity of SIFMUs.\23\
---------------------------------------------------------------------------
\23\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------
Section 805(a)(2) of the Clearing Supervision Act \24\ 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
Clearing Supervision Act \25\ provides the following objectives and
principles for the Commission's risk-management standards prescribed
under Section 805(a):
---------------------------------------------------------------------------
\24\ 12 U.S.C. 5464(a)(2).
\25\ 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.\26\
---------------------------------------------------------------------------
\26\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------
The Commission has adopted risk-management standards under Section
805(a)(2) of the Clearing Supervision Act and Section 17A of the
Exchange Act (the ``Clearing Agency Rules'').\27\ 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.\28\ As such, it is appropriate for the Commission to
review advance notices against the objectives and principles of these
risk management standards as described in Section 805(b) of the
Clearing Supervision Act and the Clearing Agency Rules. As discussed
below, the Commission believes the proposal in the Amended Advance
Notice is consistent with the objectives and principles described in
Section 805(b) of the Clearing Supervision Act,\29\ and in the Clearing
Agency Rules, in particular Rules 17Ad-22(e)(2)(i), (iii), and (v),
(e)(4)(viii) and (ix), (e)(13), and (e)(23)(i) and (ii).\30\
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\27\ 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).
\28\ 17 CFR 240.17Ad-22.
\29\ 12 U.S.C. 5464(b).
\30\ 17 CFR 240.17Ad-22(e)(2)(i), (iii), and (v), (e)(4)(viii)
and (ix), (e)(13), and (e)(23)(i) and (ii).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
The Commission believes that the proposal contained in OCC's
Amended Advance Notice is consistent with the stated objectives and
principles of Section 805(b) of the Clearing Supervision Act.
Specifically, as discussed below, the Commission believes that the
changes proposed in the Amended 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.\31\
---------------------------------------------------------------------------
\31\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
First, the proposed rule changes would provide OCC with additional
tools to address risks it may confront in an extreme stress event that
places OCC in a recovery scenario. The Commission
[[Page 44088]]
believes that the new and amended authority granted to OCC and
described in the Amended Advance Notice should provide OCC with the
ability to re-establish a matched book, allocate uncovered losses if
necessary, and limit OCC's potential exposure to losses from an extreme
loss event, all of which would be essential to OCC's ability to
continue to provide its critical clearing services in the event that an
extreme market event places OCC in a recovery scenario. In general, OCC
maintains equal and opposite obligations on cleared positions. In an
extreme loss event caused by a Clearing Member default, re-establishing
this matched book as quickly as possible is essential because it would
allow OCC to close out the defaulting Clearing Member's portfolio,
define the potential scope of losses, and avoid additional losses to
non-defaulting Clearing Members or OCC. In addition, allocating
uncovered losses is important in an extreme loss event because it would
allow OCC to provide further certainty to Clearing Members, their
customers, and other stakeholders about how it addresses such losses
and avoid a disorderly resolution to such an event. Thus, taken
together, the Commission believes that, by providing OCC with these new
and amended tools specific to the context of extreme loss events that
may heighten the need for recovery, the proposed changes should improve
OCC's ability to recover in the event that an extreme market event
places OCC in a recovery scenario, and therefore are reasonably
designed to enhance OCC's ability to address an extreme loss event and
continue to operate in a safe and sound manner during such an event.
In addition, the Commission believes that the proposed changes
would provide a reasonable amount of clarity and specificity to
Clearing Members, their customers, and other stakeholders about the
potential tools that would be expected to be available to OCC if such
an event occurred, and the consequences that might arise from OCC's
application of such tools. Because of this increased clarity and
specificity, OCC's Clearing Members, their customers, and other
stakeholders should have more information regarding their potential
exposure and liability to OCC in an extreme loss event. Accordingly,
the Commission believes that the proposed changes should allow Clearing
Members, their customers, and other stakeholders to better evaluate the
risks and benefits of clearing transactions at OCC because the proposed
changes result in those parties having more information and specificity
regarding the actions that OCC could take in response to an extreme
loss event. Further, to the extent that Clearing Members, their
customers, and other stakeholders are able to use this increased
clarity and specificity to better manage their potential exposure and
liability in clearing transactions at OCC, such parties should be able
to mitigate the likelihood that such tools could surprise or otherwise
destabilize them and, by extension, the broader financial system. For
these reasons, the Commission believes that the proposed changes are
consistent with promoting robust risk management, promoting safety and
soundness, and supporting the stability of the broader financial
system.
Second, the Commission believes that the proposed changes are
consistent with reducing systemic risks and supporting the stability of
the broader financial system. OCC is the sole registered clearing
agency for the U.S. listed options markets and a SIFMU. It is therefore
important for OCC to implement measures that enhance its ability to
address losses and avoid threatening the stability of the U.S. listed
options markets and the broader financial system, including measures
reflected in the proposed changes that are designed to facilitate OCC's
ability to address risks and obligations arising in the specific
context of extreme loss events that may heighten the need for recovery.
Therefore, and for the reasons discussed above with respect to OCC's
ability to re-establish a matched book, allocate uncovered losses if
necessary, and limit OCC's potential exposure to losses from an extreme
loss event, the Commission believes that, as a result of the new and
amended authority granted to OCC to implement such measures, the
proposed changes are reasonably designed to facilitate OCC's ability to
fully allocate, and ultimately extinguish, any losses arising from an
extreme market event, thereby enhancing OCC's ability to continue to
provide its critical clearing services. Relatedly, the Commission also
believes that the proposed changes should reduce the potential risk
that OCC's handling of an extreme loss event results in additional
financial stress or instability passing on to Clearing Members, their
customers, other stakeholders and the broader financial system
generally during such events. As such, the Commission believes the
proposed change is consistent with reducing systemic risks and
supporting the stability of the broader financial system.
Third, OCC's proposed modified assessment powers would impose a cap
on a Clearing Member's potential liability to replenish the Clearing
Fund following a particular default event and extend the timeframe
during which a Clearing Member must determine whether to terminate its
membership and avoid further losses. In addition, the new authority to
seek Voluntary Payments would provide an additional tool by which OCC
may increase its financial resources. Taken together, the Commission
believes that these tools are reasonably designed to provide OCC with
sufficient financial resources to cover default losses and ensure that
OCC can take timely actions to contain losses and continue meeting its
obligations in the event of a Clearing Member default. Similarly, the
Commission believes that these changes would provide Clearing Members
and their customers with greater certainty and predictability regarding
the amount of losses they must bear as a result of a Clearing Member
default. For these reasons, the Commission believes that these tools
should enhance OCC's ability to address the issues arising from a
Clearing Member default, thereby promoting robust risk management and
safety and soundness.
Fourth, OCC's proposed authority to conduct tear-ups would provide
OCC with a mechanism for restoring a matched book and, in the event
that OCC did not have sufficient financial resources to pay the full
Partial Tear-Up Price, allocate losses to the non-defaulting Clearing
Members. The Commission recognizes that a tear-up would result in
termination of positions of non-defaulting Clearing Members. However,
because under the proposed rules OCC would only be able to use its
tear-up authority after it has conducted an auction pursuant to its
Rules and when OCC has determined that it may not have sufficient
financial resources to meet its obligations, a tear-up would only arise
in an extreme stress scenario. Use of tear-up in such circumstances
could potentially return OCC to a matched book quickly, thereby
containing its losses and avoiding OCC's and its Clearing Members'
exposure to additional losses, as discussed further above. OCC's
proposal would also address the determination of the Partial Tear-Up
Price. Specifically, OCC would determine a Partial Tear-Up Price by
using its discretion, acting in good faith and a commercially
reasonable manner, to adopt methods of valuation expected to produce
reasonably accurate substitutes for the values that would have been
obtained from the relevant market if it were operating normally,
including but not limited to the use of pricing models that use the
market price
[[Page 44089]]
of the underlying interest or the market prices of its components. The
Commission believes that OCC's proposed authority to conduct tear-ups,
and therefore its ability to return to a matched book quickly and, in
an extreme event, allocate losses, could facilitate the timely
containment of default losses and liquidity pressures, thereby helping
to prevent OCC from failing in such an event, and is therefore
consistent with promoting robust risk management and safety and
soundness. Further, the Commission believes that, to the extent that
OCC's ability to conduct tear-ups could limit contagion to the broader
financial system, this ability is also consistent with supporting the
stability of the broader financial system.
One commenter states that the Partial Tear-Up Price should be
determined objectively and not on a discretionary basis.\32\ In the OCC
Letter, OCC states that, in the event that it has to determine a
Partial Tear-Up Price, OCC anticipates that it is likely to use the
last established end-of-day settlement price, in accordance with its
existing practices concerning pricing and valuation, but notes that
discretion may be necessary in the circumstances likely to be
associated with an extreme loss event necessitating a tear-up where the
end-of-day closing price may be stale or unavailable.\33\ Further, the
Commission notes that, under OCC's proposed rule, OCC would not have
unfettered discretion to determine the appropriate price. Rather, OCC's
discretion would be limited by two conditions. Specifically, in the
event that OCC uses its discretion to determine a Partial Tear-Up
Price, it will be required under OCC's proposed rule to do so (i) in
good faith and (ii) in a commercially reasonable manner.\34\ The
Commission believes that this discretion, as limited by the two
specified conditions, is appropriate given that it is not possible to
know the precise circumstances likely to be associated with an extreme
loss event necessitating a tear-up, and, therefore, the limited
discretion provided for in the proposed rule may be appropriate in such
circumstances. The Commission also notes that, in the event that OCC is
using its authority to conduct a Partial Tear-Up, OCC would provide
notification to the Commission and other regulators.\35\ Accordingly,
the Commission does not believe that this aspect of the proposal is
inconsistent with the Clearing Supervision Act.
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\32\ See Letter from Jacqueline H. Mesa, Sr. Vice President of
Global Policy, Futures Industry Association, to Brent Fields,
Secretary, Commission, at 2 available at https://www.sec.gov/comments/sr-occ-2017-022/occ2017020.htm (Jan. 16, 2018) (``FIA
Letter'').
\33\ See OCC Letter at 5. According to OCC, a stale or
unavailable closing price could be the result of a halt on trading
in the underlying security, a corporate action resulting in a cash-
out or conversion of the underlying security (but that has not yet
been finalized), or the result of an ADR whose underlying security
is being impacted by certain provisions under foreign laws. See id.
\34\ See also id. at 5.
\35\ See Securities Exchange Act Release No. 83928 (Aug. 23,
2018 at note 19).
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Finally, OCC's proposal would also introduce methods of re-
allocating losses after a tear-up. First, the revised By-Laws would
allow OCC discretion to use remaining Clearing Fund contributions to
re-allocate losses imposed on non-defaulting Clearing Members and their
customers from a tear-up. Second, the revised Rules would provide the
Board with the discretion to re-allocate losses among all non-
defaulting members via a Special Charge, to the extent that such losses
can be reasonably determined. As such, the Commission believes that
these tools, and the associated governance, are reasonably designed to
give OCC the ability to re-allocate the losses in a fair and equitable
manner after an extreme market event, thereby promoting safety and
soundness and supporting the stability of the broader financial system.
One commenter states that the power to impose the Special Charge in
connection with a Partial Tear-Up potentially could impose costs onto
non-defaulting Clearing Members that did not have an opposing position
from a defaulting Clearing Member. According to the commenter, the
Special Charge could, in effect, be another assessment against all
Clearing Members, which could create unquantifiable and unmanageable
risks to Clearing Members. Moreover, the commenter states that the
discretion afforded the Board may result in the Special Charge being
capriciously applied. For these reasons, the commenter believes that
the costs associated with a Partial Tear-Up should not be transferrable
to unaffected Clearing Members.\36\
---------------------------------------------------------------------------
\36\ See FIA Letter at 2.
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Under the terms of the proposed rule, the Special Charge could only
be used when the losses, costs, and fees imposed upon non-defaulting
Clearing Members and their customers directly resulting from a Partial
Tear-Up reasonably can be determined by OCC. Further, if it were used,
the Special Charge would correspond to each non-defaulting Clearing
Member's proportionate share of the Clearing Fund at the time of the
Partial Tear-Up. Thus, the Commission does not believe that OCC would
be permitted under the proposed rule to engage in unlimited assessments
because the amount of the Special Charge must be subject to a
reasonable determination, and the Special Charge would then correspond
to the non-defaulting Clearing Member's proportionate share of the
Clearing Fund. These aspects of the Special Charge should help ensure
that OCC does not apply the tool capriciously and that the Board would
use the Special Charge in these delineated circumstances, i.e., when
the amount of the losses was reasonably determinable. For these
reasons, the Commission does not believe that the Special Charge is
inconsistent with the Clearing Supervision Act.
Accordingly, and for the reasons stated, the Commission believes
the changes proposed in the Amended Advance Notice are consistent with
Section 805(b) of the Clearing Supervision Act.\37\
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\37\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
B. Consistency With Rule 17Ad0-22(e)(2)(i), (iii), and (v), Rule 17Ad-
22(e)(4)(viii) and (ix), Rule 17Ad-22(e)(13), and Rule 17Ad-
22(e)(23)(i) and (ii) Under the Exchange Act
1. Governance
Rule 17Ad-22(e)(2) requires, in relevant part, that OCC establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to provide for governance arrangements that are
clear and transparent; support the public interest requirements of
Section 17A of the Exchange Act applicable to clearing agencies, and
the objectives of owners and participants; and specify clear and direct
lines of responsibility.\38\
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\38\ 17 CFR 240.17Ad-22(e)(2)(i), (iii), and (v).
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The proposal, taken together with existing OCC Rules, specifies the
governance that would apply to use of each of the recovery tools.
Specifically, with respect to the modified powers of assessment, the
cooling-off period would commence automatically upon a number of events
specified in the By-Laws. The use of Voluntary Payments and either
Voluntary or Partial Tear-Up cannot occur unless OCC has determined
that it may not have sufficient resources available to satisfy its
obligations after a default. In addition, the proposal specifies the
applicable decision-making body that would be responsible for
determining whether to conduct a tear-up. Specifically, for a Voluntary
Tear-Up, OCC would be able to make that determination, and for a
Partial Tear-
[[Page 44090]]
Up, which is mandatory, Board action is required. The Risk Committee
would be responsible for determining the scope of the tear-ups, and any
such determinations must take into account certain considerations. Only
the Board may elect to impose a Special Charge to reallocate losses,
costs, and fees from a Partial Tear-Up.
Thus, key decisions by OCC in connection with the use of its
proposed recovery tools are subject to specific governance processes.
These requirements include the involvement of the Risk Committee in
determining the scope and pricing for any Partial Tear-up and
specifically require Board approval with respect to instituting Partial
Tear-Up and authorizing the Special Charge. Accordingly, the Commission
believes that the governance process for using the recovery tools is
clear and transparent and provides clear and direct lines of
responsibility by addressing decision making in the use of recovery
tools, thereby supporting the public interest requirements of Section
17A of the Exchange Act applicable to clearing agencies, and the
objectives of owners and participants, and therefore the Commission
believes that the proposed rule change is consistent with Rule 17Ad-
22(e)(2)(i), (iii), and (v).\39\
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\39\ 17 CFR 240.17Ad-22(e)(2)(i), (iii), and (v).
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2. Allocation of Credit Losses Exceeding Available Resources
Rule 17Ad-22(e)(4)(viii) requires, in relevant part, that OCC
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to address allocation of credit losses
OCC may face if its collateral and other resources are insufficient to
fully cover its credit exposures.\40\ OCC's proposal includes three new
recovery tools addressing the allocation of credit losses in the event
that OCC determined that, notwithstanding the availability of any
remaining resources under the Other Resource Rules, OCC may not have
sufficient resources to satisfy its obligations and liabilities
following a default. First, Rule 1009 would provide a framework for OCC
to receive Voluntary Payments in addition to their required
contribution to the Clearing Fund to address a shortfall. Second, Rule
1111 would provide a framework for Clearing Members and their customers
to participate in a Voluntary Tear-Up. Third, Rule 1111 would provide
the Board with the discretion to conduct a mandatory Partial Tear-Up.
This tool could be used, if necessary in the event that OCC determines
that its resources are inadequate to pay the applicable Partial Tear-Up
Price, to allocate losses by allowing OCC to pay each relevant Clearing
Member a pro rata amount of the applicable Partial Tear-Up Price based
on the amount of such resources remaining. In addition, the modified
powers of assessment would continue to allow OCC to use the Clearing
Fund to address credit losses in the event of a member default.
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\40\ 17 CFR 240.17Ad-22(e)(4)(viii).
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Thus, the Commission believes that these additional recovery tools
are reasonably designed to provide OCC with means to address allocation
of credit losses that it may face if its collateral and other resources
are insufficient to fully cover its credit exposures. Further, the
Commission believes that these tools should address fully any credit
losses that OCC may face as a result of any individual or combined
default among its Clearing Members. Therefore, the Commission believes
that these aspects of the proposed changes are consistent with Rule
17Ad-22(e)(4)(viii).\41\
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\41\ 17 CFR 240.17Ad-22(e)(4)(viii).
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3. Replenishment of Financial Resources Following a Default
Rule 17Ad-22(e)(4)(ix) requires, in relevant part, that OCC
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to describe OCC's process to replenish
any financial resources it may use following a default or other event
in which use of resources is contemplated.\42\
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\42\ 17 CFR 240.17Ad-22(e)(4)(ix).
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The proposed changes to OCC's assessment powers would include the
addition of a minimum fifteen-day cooling-off period that would be
automatically triggered by a proportionate charge to the Clearing Fund
arising from a Clearing Member default. At the end of the cooling-off
period, a remaining Clearing Member (i.e., a Clearing Member that did
not choose to terminate its membership during the cooling-off period)
would be obligated to replenish the Clearing Fund.
The Commission recognizes that by placing a cap on its assessment
power during the cooling-off period, these revisions would effectively
limit the amount of financial resources available to OCC from its
Clearing Fund during that period. However, the Commission believes that
these proposals would provide greater certainty and predictability
regarding Clearing Members' maximum liability to the Clearing Fund,
which could potentially limit loss contagion in the broader financial
system. Moreover, in light of the proposed cap on OCC's assessment
powers during the cooling-off period, OCC has authority under Rule 603
to call for additional initial margin from Clearing Members to ensure
that OCC maintains sufficient financial resources to meet its
requirements under Rule 17Ad-22(e)(4)(iii). Finally, at the end of a
cooling-off period, a Clearing Member would be required to replenish
the Clearing Fund in the amount necessary to meet its then-required
contribution.
In light of the foregoing discussion, the Commission believes that
the provisions related to OCC's assessment powers, taken together with
the other components of OCC's default management procedures and
recovery rules, which are reasonably designed to allow OCC to replenish
its financial resources following a default or other event in which use
of such resources is contemplated, are consistent with Rule 17Ad-
22(e)(4)(ix).\43\
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\43\ 17 CFR 240.17Ad-22(e)(4)(ix).
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One commenter states that OCC should provide an explanation of its
determination to set the cap on the powers of assessment at 200 percent
during a cooling-off period.\44\ In the OCC Letter, OCC provided an
explanation of the internal analysis that it conducted to reach the 200
percent determination.\45\ Specifically, OCC stated that it considered
its ability to have sufficient financial resources inclusive of its
proposed assessment powers to withstand extreme market conditions on a
``Cover-2'' basis under various scenarios, and that OCC determined
that, under such scenarios, it would be able to meet its clearing
obligations so long as it was able to use (1) the financial resources
on hand in the Clearing Fund, and (2) the full funding of two
assessments (i.e., 200 percent) from non-defaulting Clearing
Members.\46\ Moreover, OCC stated that it reviewed the caps that other
CCPs impose upon their own assessment powers and determined that the
200 percent cap is generally aligned with other assessment caps.\47\
Based on review of the analysis provided by OCC and the caps of other
CCPs,\48\ the
[[Page 44091]]
Commission believes that the 200 percent cap in the proposed changes is
consistent with Rule 17Ad-22(e)(4)(ix).
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\44\ See FIA Letter at 1-2.
\45\ See OCC Letter at 2-3.
\46\ See id.
\47\ See id. at 3.
\48\ See, e.g., Self-Regulatory Organizations; ICE Clear Credit
LLC; Notice of Filing Amendment No. 1 and Order Granting Accelerated
Approval of Proposed Rule Change to Amend the ICE Clear Credit
Clearing Rules, as Modified by Amendment No. 1, Relating to Default
Management, Clearing House Recovery and Wind-Down, Exchange Act
Release No. 79750 (Jan. 6, 2017), 82 FR 3831 (Jan. 12, 2017) (SR-
ICC-2016-013) (approving a proposed rule change including, among
other things, a 300 percent cap on non-defaulting participants'
liability during a cooling-off period).
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5. Authority To Take Timely Action To Contain Losses and Liquidity
Demands and Continue To Meet Obligations
Rule 17Ad-22(e)(13) requires, in relevant part, that OCC establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to ensure that it has the authority and operational
capacity to take timely action to contain losses and liquidity demands
and continue to meet its obligations.\49\ As described above, OCC's
proposal would provide OCC with modified assessment powers and new
tools of Voluntary Payments, Voluntary Tear-Ups, and Partial Tear-Ups.
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\49\ 17 CFR 240.17Ad-22(e)(13).
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As discussed above, the Commission recognizes that a tear-up would
result in termination of positions of non-defaulting Clearing Members.
However, because OCC would only be able to use its tear-up authority
after it has conducted an auction pursuant to its Rules and when OCC
has determined that it may not have sufficient financial resources to
meet its obligations, a tear-up would only arise in an extreme stress
scenario. Further, use of tear-up in such circumstances could
potentially return OCC to a matched book quickly, thereby containing
its losses.
The Commission believes that these tools are designed to provide
greater certainty to Clearing Members seeking to estimate the potential
risks and losses arising from their use of OCC, while enabling OCC to
promptly return to a matched book. The Commission believes that
returning to a matched book pursuant to these provisions in the context
of OCC's default management and recovery facilitates OCC's operational
capacity to timely contain losses and liquidity demands while
continuing to meet its obligations. Thus, the Commission believes that
the proposed changes are consistent with Rule 17Ad-22(e)(13).\50\
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\50\ Id.
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6. Public Disclosure of Key Aspects of Default Rules
Rules 17Ad-22(e)(23)(i) and (ii) require, in relevant part, that
OCC establish, implement, maintain, and enforce written policies and
procedures reasonably designed to provide for the public disclosure of
all relevant rules and material procedures, including key aspects of
default rules and procedures, as well as sufficient information to
enable participants to identify and evaluate the risks, fees and other
material costs they incur by participating in OCC.\51\ The Commission
believes that the proposed changes address key aspects of OCC's default
rules and procedures, thereby providing Clearing Members with a better
understanding of the potential risks and costs they might face in an
extreme event where OCC may use its proposed recovery tools, including
the potential use of the Special Charge. Accordingly, the Commission
believes that OCC has disclosed these key aspects of its default rules
and procedures, consistent with Rule 17Ad-22(e)(23)(i) and (ii).\52\
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\51\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
\52\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
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IV. Conclusion
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Clearing Supervision Act,\53\ that the Commission does not object to
Advance Notice (SR-OCC-2017-809), as modified by Amendment No. 2, and
that OCC is authorized to implement the proposed change as of the date
of this notice or the date of an order by the Commission approving
proposed rule change SR-OCC-2017-020, as modified by Amendment No. 2,
whichever is later.
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\53\ 12 U.S.C. 5465(e)(1)(I).
By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-18655 Filed 8-28-18; 8:45 am]
BILLING CODE 8011-01-P
