Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice, as Modified by Partial Amendment No. 1, Related to The Options Clearing Corporation's Margin Methodology for Incorporating Variations in Implied Volatility, 60541-60545 [2018-25606]

Download as PDF Federal Register / Vol. 83, No. 227 / Monday, November 26, 2018 / Notices SECURITIES AND EXCHANGE COMMISSION [Release No. 34–84626; File No. SR–OCC– 2018–804] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice, as Modified by Partial Amendment No. 1, Related to The Options Clearing Corporation’s Margin Methodology for Incorporating Variations in Implied Volatility November 19, 2018. 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’’ or ‘‘Act’’),3 notice is hereby given that on October 22, 2018, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) an advance notice as described in Items I, II and III below, which Items have been prepared by OCC. On October 30, 2018, OCC filed Partial Amendment No. 1 to the advance notice.4 The Commission is publishing this notice to solicit comments on the advance notice from interested persons. I. Clearing Agency’s Statement of the Terms of Substance of the Advance Notice This advance notice is filed in connection with proposed changes to enhance OCC’s model for incorporating variations in implied volatility within OCC’s margin methodology (‘‘Implied Volatility Model’’), the System for Theoretical Analysis and Numerical Simulations (‘‘STANS’’).5 The proposed changes to OCC’s Margins Methodology document are contained in confidential Exhibit 5 of the filing. Material proposed to be added is marked by underlining and material proposed to be deleted is marked by strikethrough text. The proposed changes are described in detail in Item 10 below. The proposed changes do not require any changes to the text of OCC’s By-Laws or Rules. The advance notice is available on OCC’s website at https://www.theocc.com/ 1 12 U.S.C. 5465(e)(1). CFR 240.19b–4(n)(1)(i). 3 15 U.S.C. 78a et seq. 4 In Partial Amendment No. 1, OCC corrected an error in Exhibit 5 without changing the substance of the advance notice. 5 OCC also has filed a proposed rule change with the Commission in connection with the proposed changes. See SR–OCC–2018–014. 2 17 VerDate Sep<11>2014 17:28 Nov 23, 2018 Jkt 247001 about/publications/bylaws.jsp. All terms with initial capitalization that are not otherwise defined herein have the same meaning as set forth in the OCC By-Laws and Rules.6 II. Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Advance Notice In its filing with the Commission, OCC included statements concerning the purpose of and basis for the advance notice and discussed any comments it received on the advance notice. The text of these statements may be examined at the places specified in Item IV below. OCC has prepared summaries, set forth in sections A and B below, of the most significant aspects of these statements. (A) Clearing Agency’s Statement on Comments on the Advance Notice Received From Members, Participants or Others Written comments were not and are not intended to be solicited with respect to the proposed rule change and none have been received. OCC will notify the Commission of any written comments received by OCC. (B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, Clearing, and Settlement Supervision Act Description of the Proposed Change Background STANS Overview STANS is OCC’s proprietary risk management system for calculating Clearing Member margin requirements.7 The STANS methodology utilizes largescale Monte Carlo simulations to forecast price and volatility movements in determining a Clearing Member’s margin requirement.8 STANS margin requirements are calculated at the portfolio level of Clearing Member accounts with positions in marginable securities and consists of an estimate of two primary components: A base component and a stress test add-on component. The base component is an estimate of a 99% expected shortfall 9 over a two-day time horizon. The 6 OCC’s By-Laws and Rules can be found on OCC’s public website: https://optionsclearing.com/ about/publications/bylaws.jsp. 7 See Securities Exchange Act Release No. 53322 (February 15, 2006), 71 FR 9403 (February 23, 2006) (SR–OCC–2004–20). A detailed description of the STANS methodology is available at https:// optionsclearing.com/risk-management/margins/. 8 See OCC Rule 601. 9 The expected shortfall component is established as the estimated average of potential losses higher than the 99% value at risk threshold. The term ‘‘value at risk’’ or ‘‘VaR’’ refers to a statistical technique that, generally speaking, is used in risk management to measure the potential risk of loss for a given set of assets over a particular time horizon. PO 00000 Frm 00151 Fmt 4703 Sfmt 4703 60541 concentration/dependence stress test charge is obtained by considering increases in the expected margin shortfall for an account that would occur due to (i) market movements that are especially large and/or in which certain risk factors would exhibit perfect or zero correlations rather than correlations otherwise estimated using historical data or (ii) extreme and adverse idiosyncratic movements for individual risk factors to which the account is particularly exposed. The STANS methodology is used to measure the exposure of portfolios of options and futures cleared by OCC and cash instruments in margin collateral.10 The econometric models underlying STANS currently incorporate a number of risk factors. A ‘‘risk factor’’ within OCC’s margin system is defined as a product or attribute whose historical data is used to estimate and simulate the risk for an associated product. The majority of risk factors utilized in the STANS methodology are the returns on individual equity securities; however, a number of other risk factors may be considered, including, among other things, returns on implied volatility risk factors.11 Current Implied Volatility Model in STANS Generally speaking, the implied volatility of an option is a measure of the expected future volatility of the option’s underlying security at expiration, which is reflected in the current option premium in the market. Using the Black-Scholes options pricing model, the implied volatility is the standard deviation of the underlying asset price necessary to arrive at the market price of an option of a given strike, time to maturity, underlying asset price and the current risk-free rate. In effect, the implied volatility is 10 OCC notes that, pursuant to OCC Rule 601(e)(1), OCC also calculates initial margin requirements for segregated futures accounts using the Standard Portfolio Analysis of Risk Margin Calculation System (‘‘SPAN’’). No changes are proposed to OCC’s use of SPAN because the proposed changes do not concern futures. See Securities Exchange Act Release No. 72331 (June 5, 2014), 79 FR 33607 (June 11, 2014) (SR–OCC–2014– 13). 11 In December 2015, the Commission approved a proposed rule change and issued a Notice of No Objection to an advance notice filing by OCC to its modify margin methodology by more broadly incorporating variations in implied volatility within STANS. See Securities Exchange Act Release No. 76781 (December 28, 2015), 81 FR 135 (January 4, 2016) (SR–OCC–2015–016) and Securities Exchange Act Release No. 76548 (December 3, 2015), 80 FR 76602 (December 9, 2015) (SR–OCC–2015–804). As discussed further below, implied volatility risk factors in STANS are a set of chosen volatility pivot points per product, depending on the tenor of the option. E:\FR\FM\26NON1.SGM 26NON1 60542 Federal Register / Vol. 83, No. 227 / Monday, November 26, 2018 / Notices responsible for that portion of the premium that cannot be explained by the then-current intrinsic value of the option (i.e., the difference between the price of the underlying and the exercise price of the option), discounted to reflect its time value. OCC considers variations in implied volatility within STANS to ensure that the anticipated cost of liquidating options positions in an account recognizes the possibility that implied volatility could change during the two-business day liquidation time horizon and lead to corresponding changes in the market prices of the options. OCC models the variations in implied volatility used to re-price options within STANS for substantially all option contracts 12 available to be cleared by OCC that have a residual tenor 13 of less than three years (‘‘Shorter Tenor Options’’).14 To address variations in implied volatility, OCC models a volatility surface 15 for Shorter Tenor Options by incorporating into the econometric models underlying STANS certain risk factors (i.e., implied volatility pivot points) based on a range of tenors and option deltas.16 Currently, these implied volatility pivot points consist of three tenors of one month, three months and one year, and three deltas of 0.25, 0.5, and 0.75, resulting in nine implied volatility risk factors. These pivot points are chosen such that their combination allows the model to capture changes in level, skew, convexity and term structure of the implied volatility surface. OCC uses a 12 OCC’s Implied Volatility Model excludes: (i) Binary options, (ii) options on commodity futures, (iii) options on U.S. Treasury securities, and (iv) Asians and Cliquets. These relatively new products were introduced as the implied volatility margin methodology changes were in the process of being completed by OCC, and OCC had de minimus open interest in those options. OCC therefore did not believe there was a substantive risk if those products were excluded from the implied volatility model. See id. 13 The ‘‘tenor’’ of an option is the amount of time remaining to its expiration. 14 OCC also incorporates variations in implied volatility as risk factors for certain options with residual tenors of at least three years (‘‘Longer Tenor Options’’); however, the proposed changes described herein would not apply to OCC’s model for Longer Tenor Options. See Securities Exchange Act Release Nos. 68434 (December 14, 2012), 77 FR 57602 (December 19, 2012) (SR–OCC–2012–14); 70709 (October 18, 2013), 78 FR 63267 (October 23, 2013) (SR–OCC–2013–16). 15 The term ‘‘volatility surface’’ refers to a threedimensional graphed surface that represents the implied volatility for possible tenors of the option and the implied volatility of the option over those tenors for the possible levels of ‘‘moneyness’’ of the option. The term ‘‘moneyness’’ refers to the relationship between the current market price of the underlying interest and the exercise price. 16 The ‘‘delta’’ of an option represents the sensitivity of the option price with respect to the price of the underlying security. VerDate Sep<11>2014 17:28 Nov 23, 2018 Jkt 247001 GARCH model 17 to forecast the volatility for each implied volatility risk factor at the nine pivot points.18 For each Shorter Tenor Option in the account of a Clearing Member, changes in its implied volatility are simulated using forecasts obtained from daily implied volatility market data according to the corresponding pivot point and the price of the option is computed to determine the amount of profit or loss in the account under the particular STANS price simulation. Additionally, OCC uses simulated closing prices for the assets underlying the options in the account of a Clearing Member that are scheduled to expire within the liquidation time horizon of two business days to compute the options’ intrinsic value and uses those values to help calculate the profit or loss in the account.19 OCC performed a number of analyses of its current Implied Volatility Model and to support development of the proposed model changes, including backtesting and impact analysis of the proposed model enhancements as well as comparison of OCC’s current model performance against certain industry benchmarks.20 OCC’s analysis demonstrated that one attribute of the current model is that the volatility changes forecasted by the GARCH model are extremely sensitive to sudden spikes in volatility, which can at times result in over reactive margin requirements that OCC believes are unreasonable and procyclical.21 For example, on February 5, 2018, the market experienced extreme levels of volatility, with the Cboe Volatility Index (‘‘VIX’’) 22 moving from 17% up to 37%, 17 The acronym ‘‘GARCH’’ refers to an econometric model that can be used to estimate volatility based on historical data. See generally Tim Bollerslev, ‘‘Generalized Autoregressive Conditional Heteroskedasticity,’’ Journal of Econometrics, 31(3), 307–327 (1986). 18 STANS relies on 10,000 price simulation scenarios that are based generally on a historical data period of 500 business days, which are updated daily to keep model results from becoming stale. 19 For such Shorter Tenor Options that are scheduled to expire on the open of the market rather than the close, OCC uses the relevant opening price for the underlying assets. 20 OCC has provided results of these analyses to the Commission in confidential Exhibit 3 of the filing. 21 A quality that is positively correlated with the overall state of the market is deemed to be ‘‘procyclical.’’ For example, procyclicality may be evidenced by increasing margin requirements in times of stressed market conditions and low margin requirements when markets are calm. Hence, antiprocyclical features in a model are measures intended to prevent risk-based models from fluctuating too drastically in response to changing market conditions. 22 The VIX is an index designed to measure the 30-day expected volatility of the Standard & Poor’s 500 index (‘‘SPX’’). PO 00000 Frm 00152 Fmt 4703 Sfmt 4703 representing a relative move of 116% (which is the largest relative daily jump in the history of the index). Under OCC’s current model, OCC observed that the GARCH forecast SPX volatility for at-the-money implied volatility for a one-month tenor was approximately 4 times larger than the comparable market index, the Cboe VVIX Index, which is a volatility of volatility measure in that it represents the expected volatility of the 30-day forward price of the VIX. As a result, aggregated STANS margins jumped more than 80% overnight due to the GARCH model and margins for certain individual Clearing Members increased by a factor of 10.23 In addition, volatility tends to be mean reverting; that is, volatility will quickly return to its long-run mean or average from an elevated level, so it is unlikely that volatility would continue to make big jumps immediately following a drastic increase. For example, based on the VIX history from 1990–2018, VIX levels jumped above 35 (about the level observed on February 5, 2018) for approximately 293 days (i.e., 4% of the sample period). From the level of 35 or higher, the range of daily change on the VIX index was between 27% and -35%. However, the largest daily changes on one-month at-themoney SPX implied volatility forecasted by OCC’s current GARCH model on February 5, 2018, were far in excess of those historical realized amounts, which points to extreme procyclicality issues that need to be addressed in the current model.24 OCC also performed backtesting of the current model and proposed model enhancements to evaluate and compare the performance of each model from a margin coverage perspective. OCC’s backtesting demonstrated that exceedance counts 25 and overall coverage levels over the backtesting period using the proposed model enhancements were substantially similar to the results obtained from the current production model. As a result, OCC believes the current model tends to 23 For example, under the current model the total margin requirement calculated for one particular Clearing Member jumped from $120 million on February 2, 2018, to $1.78 billion on February 5, 2018, representing a 14 times increase in the requirement. 24 For example, OCC’s current model resulted in a maximum variation of 1100% in the one-month at-the-money SPX implied volatility pivot when compared with a maximum 35% move in the VIX for VIX levels greater than 30. Additionally, the model-generated number is significantly higher than 116%, which is the largest realized historical move in the VIX that occurred on February 5, 2018. 25 Exceedance counts here refer to instances where the actual loss on portfolio over the liquidation period of two business days exceeds the margin amounts generated by the model. E:\FR\FM\26NON1.SGM 26NON1 Federal Register / Vol. 83, No. 227 / Monday, November 26, 2018 / Notices be overly conservative/reactive, and the proposed model is more appropriately commensurate with the risks presented by changes in implied volatility. OCC believes that the sudden, extreme and unreasonable increases in margin requirements that may be experienced under its current Implied Volatility Model may stress certain Clearing Members’ ability to obtain sufficient liquidity to meet these significantly increased margin requirements, particularly in periods of sudden, extreme volatility. OCC therefore is proposing changes to its Implied Volatility Model to limit procyclicality and produce margin requirements that OCC believes are more reasonable and are also commensurate with the risks presented by its cleared options products. Proposed Changes OCC proposes to modify its Implied Volatility Model by introducing an exponentially weighted moving average 26 for the daily forecasted volatility for implied volatility risk factors calculated using the GARCH model. Specifically, when forecasting the volatility for each implied volatility risk factor at each of the nine pivot points, OCC would use an exponentially weighted moving average of forecasted volatilities over a specified look-back period rather than using raw daily forecasted volatilities. The exponentially weighted moving average would involve the selection of a lookback period over which the data would be averaged and a decay factor (or weighting factor), which is a positive number between zero and one, that represents the weighting factor for the most recent data point.27 The look-back period and decay factor would be model parameters subject to monthly review,28 along with other model parameters that are reviewed by OCC’s Model Risk Working Group (‘‘MRWG’’) 29 in 26 An exponentially weighted moving average is a statistical method that averages data in a way that gives more weight to the most recent observations using an exponential scheme. 27 The lower the number the more weight is attributed to the more recent data (e.g., if the value is set to one, the exponentially weighted moving average becomes a simple average). 28 OCC initially would use a look-back period of 22 days and an initial decay factor of 0.94 for the exponentially weighted moving average. OCC believes the 22-day look-back is an appropriate initial parameter setting as it would allow for close to monthly updates of the GARCH parameters used in the model. The decay factor value of 0.94 was selected based on the factor initially proposed by JP Morgan’s RiskMetrics methodology (see JPMorgan/Reuters, 1996. ‘‘RiskMetrics—Technical Document’’, Fourth edition). 29 The MRWG is responsible for assisting OCC’s Management Committee in overseeing and governing OCC’s model-related risk issues and VerDate Sep<11>2014 17:28 Nov 23, 2018 Jkt 247001 60543 accordance with OCC’s internal procedure for margin model parameter review and sensitivity analysis, and these parameters would be subject to change upon approval of the MRWG. The proposed changes are intended to reduce the oversensitivity of the current Implied Volatility Model to large, sudden shocks in market volatility and therefore result in margin requirements that are more stable and that remain commensurate with the risks presented during periods of sudden, extreme volatility.30 The proposed changes are expected to produce margin requirements that are very similar to those generated using OCC’s existing model during quiet, less volatile market periods; however, during more volatile periods, the proposed changes would result in a more measured initial response to increases in the volatility of volatility with margin requirements that may remain elevated for a longer period of time after the shock subsides than experienced under OCC’s current model. The proposed changes are intended to reduce procyclicality in OCC’s margin methodology across volatile market periods while continuing to capture changes in implied volatility and produce margin requirements that are commensurate with the risks presented by OCC’s cleared options products. The proposed changes therefore would reduce the risk that a sudden, extreme increase in margin requirements may stress Clearing Members’ ability to obtain liquidity to meet such increased requirements, particularly in periods of extreme volatility. spikes in volatility, which can at times result in over reactive margin requirements that OCC believes are unreasonable and procyclical (for the reasons set forth above). Such sudden, unreasonable increases in margin requirements may stress certain Clearing Members’ ability to obtain liquidity to meet those requirements, particularly in periods of extreme volatility, and could result in a Clearing Member being delayed in meeting, or ultimately failing to meet, its daily settlement obligations to OCC. OCC notes that the proposed changes are expected to produce margin requirements that are very similar to those generated using OCC’s existing model during quiet, less volatile market periods. The proposed changes would, however, result in a more measured initial response to increases in the volatility of volatility with margin requirements that may remain elevated for a longer period after the shock subsides than experienced under OCC’s current model. The proposed changes would therefore reduce the likelihood that OCC’s Implied Volatility Model would produce extreme, over reactive margin requirements that could strain the ability of certain Clearing Members to meet their daily margin requirements at OCC by reducing procyclicality in OCC’s margin methodology and ensuring more stable and appropriate changes in margin requirements across volatile market periods while continuing to capture changes in implied volatility and produce margin requirements that are commensurate with the risks presented. Implementation Timeframe OCC expects to implement the proposed changes within thirty (30) days after the date that OCC receives all necessary regulatory approvals for the proposed changes. OCC will announce the implementation date of the proposed change by an Information Memorandum posted to its public website at least 2 weeks prior to implementation. Consistency With the Payment, Clearing and Settlement Supervision Act Anticipated Effect on, and Management of, Risk The volatility changes forecasted by OCC’s current Implied Volatility Model are extremely sensitive to large, sudden includes representatives from OCC’s Financial Risk Management department, Quantitative Risk Management department, Model Validation Group, and Enterprise Risk Management department. 30 As noted above, OCC has performed analysis of the impact of the proposed changes, and OCC’s backtesting of the proposed model demonstrates comparable exceedance counts and coverage levels to the current model during the most recent volatile period. PO 00000 Frm 00153 Fmt 4703 Sfmt 4703 The stated purpose of the Clearing Supervision Act is to mitigate systemic risk in the financial system and promote financial stability by, among other things, promoting uniform risk management standards for systemically important financial market utilities and strengthening the liquidity of systemically important financial market utilities.31 Section 805(a)(2) of the Clearing Supervision Act 32 also authorizes the Commission to prescribe risk management standards for the payment, clearing and settlement activities of designated clearing entities, like OCC, for which the Commission is the supervisory agency. Section 805(b) of the Clearing Supervision Act 33 states that the objectives and principles for 31 12 U.S.C. 5461(b). U.S.C. 5464(a)(2). 33 12 U.S.C. 5464(b). 32 12 E:\FR\FM\26NON1.SGM 26NON1 60544 Federal Register / Vol. 83, No. 227 / Monday, November 26, 2018 / Notices risk management standards prescribed under Section 805(a) shall be to: • Promote robust risk management; • promote safety and soundness; • reduce systemic risks; and • support the stability of the broader financial system. OCC believes that the proposed changes described herein would enhance its margin methodology in a manner consistent with the objectives and principles of Section 805(b) of the Clearing Supervision Act 34 and the risk management standards adopted by the Commission in Rule 17Ad–22 under the Act for the reasons set forth below.35 OCC believes the proposed changes are consistent with the objectives and principles of Section 805(b) of the Clearing Supervision Act 36 in that they would promote robust risk management and safety and soundness while reducing systemic risks and supporting the stability of the broader financial system. As discussed above, the volatility changes forecasted by OCC’s current Implied Volatility Model are extremely sensitive to large, sudden spikes in volatility, which can at times result in over reactive margin requirements that OCC believes are unreasonable and procyclical. Such sudden, unreasonable increases in margin requirements may stress certain Clearing Members’ ability to obtain liquidity to meet those requirements, particularly in periods of extreme volatility, and could result in a Clearing Member being delayed in meeting, or ultimately failing to meet, its daily settlement obligations to OCC. OCC notes that the proposed changes are expected to produce margin requirements that are very similar to those generated using OCC’s existing model during quiet, less volatile market periods. The proposed changes would, however, result in a more measured initial response to increases in the volatility of volatility with margin requirements that may remain elevated for a longer period after the shock subsides than experienced under OCC’s current model. The proposed changes would therefore reduce the likelihood that OCC’s Implied Volatility Model would produce extreme, over reactive 34 Id. 35 17 CFR 240.17Ad–22. See Securities Exchange Act Release Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7–08–11) (‘‘Clearing Agency Standards’’); 78961 (September 28, 2016), 81 FR 70786 (October 13, 2016) (S7–03–14) (‘‘Standards for Covered Clearing Agencies’’). The Standards for Covered Clearing Agencies became effective on December 12, 2016. OCC is a ‘‘covered clearing agency’’ as defined in Rule 17Ad–22(a)(5) and therefore must comply with the requirements of Rule 17Ad–22(e). 36 12 U.S.C. 5464(b). VerDate Sep<11>2014 17:28 Nov 23, 2018 Jkt 247001 margin requirements by reducing procyclicality in OCC’s margin methodology and ensuring more stable and appropriate changes in margin requirements across volatile market periods while continuing to provide for robust management of the risks presented by the implied volatility of OCC’s cleared options products. Accordingly, OCC believes the proposed changes would promote robust risk management and safety and soundness while reducing systemic risks and supporting the stability of the broader financial system. Rules 17Ad–22(e)(6)(i) and (v) 37 require a covered clearing agency that provides central counterparty services to establish, implement, maintain and enforce written policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that (1) considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market and (2) uses an appropriate method for measuring credit exposure that accounts for relevant product risk factors and portfolio effects across products. As noted above, OCC’s current model for implied volatility demonstrates extreme sensitivity to sudden spikes in volatility, which can at times result in over reactive margin requirements that OCC believes are unreasonable and procyclical. The proposed changes are designed to reduce the oversensitivity of the model and produce margin requirements that are commensurate with the risks presented during periods of sudden, extreme volatility. The proposed model enhancements are expected to produce margin requirements that are very similar to those generated using OCC’s existing model during quiet, less volatile market periods; however, the proposed changes would result in a more measured initial response to increases in the volatility of volatility with margin requirements that may remain elevated for a longer period of time after the shock subsides than experienced under OCC’s current model. The proposed changes are designed to reduce procyclicality in OCC’s margin methodology and ensure more stable changes in margin requirements across volatile market periods while continuing to capture changes in implied volatility and produce margin requirements that are commensurate with the risks presented by OCC’s cleared options. As a result, OCC believes that the proposed changes are reasonably designed to consider, and 37 17 PO 00000 CFR 240.17Ad–2(e)(6)(i) and (v). Frm 00154 Fmt 4703 Sfmt 4703 produce margin levels commensurate with, the risk presented by the implied volatility of OCC’s cleared options and use an appropriate method for measuring credit exposure that accounts for this product risk factor (i.e., implied volatility) in a manner consistent with Rules 17Ad–22(e)(6)(i) and (v).38 III. Date of Effectiveness of the Advance Notice and Timing for Commission Action The proposed change may be implemented if the Commission does not object to the proposed change within 60 days of the later of (i) the date the proposed change was filed with the Commission or (ii) the date any additional information requested by the Commission is received. OCC shall not implement the proposed change if the Commission has any objection to the proposed change. The Commission may extend the period for review by an additional 60 days if the proposed change raises novel or complex issues, subject to the Commission providing the clearing agency with prompt written notice of the extension. A proposed change may be implemented in less than 60 days from the date the advance notice is filed, or the date further information requested by the Commission is received, if the Commission notifies the clearing agency in writing that it does not object to the proposed change and authorizes the clearing agency to implement the proposed change on an earlier date, subject to any conditions imposed by the Commission. OCC shall post notice on its website of proposed changes that are implemented. The proposal shall not take effect until all regulatory actions required with respect to the proposal are completed. IV. Solicitation of Comments Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the advance notice is consistent with the Clearing Supervision Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– OCC–2018–804 on the subject line. 38 Id. E:\FR\FM\26NON1.SGM 26NON1 Federal Register / Vol. 83, No. 227 / Monday, November 26, 2018 / Notices Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. All submissions should refer to File Number SR–OCC–2018–804. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s internet website (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the advance notice that are filed with the Commission, and all written communications relating to the advance notice between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the self-regulatory organization. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–OCC–2018–804 and should be submitted on or before December 17, 2018. By the Commission. Brent J. Fields, Secretary. [FR Doc. 2018–25606 Filed 11–23–18; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–84629; File No. SR– NASDAQ–2018–095] Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Nasdaq Rule 5615(b)(4) To Change the Threshold for Qualifying as a Smaller Reporting Company To Qualify for Certain Exemptions From the Compensation Committee Requirements November 20, 2018. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on November 14, 2018, The Nasdaq Stock Market LLC (‘‘Nasdaq’’ or the ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend Nasdaq Rule 5615(b)(4) to change the threshold for listed companies that are eligible to benefit from the exemptions from the Exchange’s compensation committee requirements applicable to smaller reporting companies so that all companies that qualify for smaller reporting company status under the revised SEC definition will qualify for the Exchange’s exemptions. The text of the proposed rule change is available on the Exchange’s website at https://nasdaq.cchwallstreet.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set 1 15 2 17 VerDate Sep<11>2014 17:28 Nov 23, 2018 Jkt 247001 PO 00000 U.S.C. 78s(b)(1). CFR 240.19b–4. Frm 00155 Fmt 4703 60545 forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The purpose of the proposed rule change is to amend Rule 5615(b)(4) to change the threshold for listed companies that are eligible to benefit from the exemptions from the Exchange’s compensation committee requirements applicable to smaller reporting companies so that all companies that qualify for smaller reporting company status under the revised SEC definition will qualify for the Exchange’s exemptions. The SEC recently adopted 3 amendments to the definition of ‘‘smaller reporting company’’ set forth in Item 10(f)(1) of Regulation S–K,4 Rule 12b–2 under the Act 5 and Rule 405 under the Securities Act of 1933.6 The amendments raise the smaller reporting company cap from less than $75 million in public float to less than $250 million and also include as smaller reporting companies issuers with less than $100 million in annual revenues if they also have either no public float or a public float that is less than $700 million. The amendments became effective on September 10, 2018. As a result of the SEC rule changes, an expanded number of registrants, and hence, of listed companies, will qualify for smaller reporting company status than was previously the case.7 Smaller reporting companies are entitled to avail themselves of certain exemptions from Nasdaq’s compensation committee requirements.8 3 See Release Nos. 33–10513 and 34–83550 (June 28, 2018); 83 FR 31992 (July 10, 2018) (the ‘‘Adopting Release’’). 4 17 CFR 229.10(f)(1). 5 17 CFR 240.12b–2. 6 17 CFR 230.405. 7 See the Adopting Release. 8 Specifically, pursuant to Rule 5605(d)(5), a listed company that satisfies the definition of smaller reporting company is not required to comply with: (i) The additional requirements with respect to the independence of compensation committee members set forth in Rule 5605(d)(2)(A); (ii) the requirements with respect to the specific compensation committee responsibilities and authority set forth in Rule 5605(d)(3) and the requirement to include such responsibilities and authority in its compensation committee charter as set forth in Rule 5605(d)(1)(D); or (iii) the requirement with respect to the compensation committee’s responsibility to review and reassess the adequacy of its compensation committee charter on an annual basis. A listed smaller reporting company must comply with all other applicable Exchange corporate governance requirements, Continued Sfmt 4703 E:\FR\FM\26NON1.SGM 26NON1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 83, Number 227 (Monday, November 26, 2018)]
[Notices]
[Pages 60541-60545]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-25606]



[[Page 60541]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-84626; File No. SR-OCC-2018-804]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Advance Notice, as Modified by Partial Amendment 
No. 1, Related to The Options Clearing Corporation's Margin Methodology 
for Incorporating Variations in Implied Volatility

November 19, 2018.
    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'' or ``Act''),\3\ notice is hereby given that on 
October 22, 2018, The Options Clearing Corporation (``OCC'') filed with 
the Securities and Exchange Commission (``Commission'') an advance 
notice as described in Items I, II and III below, which Items have been 
prepared by OCC. On October 30, 2018, OCC filed Partial Amendment No. 1 
to the advance notice.\4\ The Commission is publishing this notice to 
solicit comments on the advance notice from interested persons.
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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\ In Partial Amendment No. 1, OCC corrected an error in 
Exhibit 5 without changing the substance of the advance notice.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This advance notice is filed in connection with proposed changes to 
enhance OCC's model for incorporating variations in implied volatility 
within OCC's margin methodology (``Implied Volatility Model''), the 
System for Theoretical Analysis and Numerical Simulations 
(``STANS'').\5\ The proposed changes to OCC's Margins Methodology 
document are contained in confidential Exhibit 5 of the filing. 
Material proposed to be added is marked by underlining and material 
proposed to be deleted is marked by strikethrough text. The proposed 
changes are described in detail in Item 10 below. The proposed changes 
do not require any changes to the text of OCC's By-Laws or Rules. The 
advance notice is available on OCC's website at https://www.theocc.com/about/publications/bylaws.jsp. All terms with initial capitalization 
that are not otherwise defined herein have the same meaning as set 
forth in the OCC By-Laws and Rules.\6\
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    \5\ OCC also has filed a proposed rule change with the 
Commission in connection with the proposed changes. See SR-OCC-2018-
014.
    \6\ OCC's By-Laws and Rules can be found on OCC's public 
website: https://optionsclearing.com/about/publications/bylaws.jsp.
---------------------------------------------------------------------------

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

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

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants or Others

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

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, 
Clearing, and Settlement Supervision Act

Description of the Proposed Change
Background
STANS Overview
    STANS is OCC's proprietary risk management system for calculating 
Clearing Member margin requirements.\7\ The STANS methodology utilizes 
large-scale Monte Carlo simulations to forecast price and volatility 
movements in determining a Clearing Member's margin requirement.\8\ 
STANS margin requirements are calculated at the portfolio level of 
Clearing Member accounts with positions in marginable securities and 
consists of an estimate of two primary components: A base component and 
a stress test add-on component. The base component is an estimate of a 
99% expected shortfall \9\ over a two-day time horizon. The 
concentration/dependence stress test charge is obtained by considering 
increases in the expected margin shortfall for an account that would 
occur due to (i) market movements that are especially large and/or in 
which certain risk factors would exhibit perfect or zero correlations 
rather than correlations otherwise estimated using historical data or 
(ii) extreme and adverse idiosyncratic movements for individual risk 
factors to which the account is particularly exposed. The STANS 
methodology is used to measure the exposure of portfolios of options 
and futures cleared by OCC and cash instruments in margin 
collateral.\10\
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    \7\ See Securities Exchange Act Release No. 53322 (February 15, 
2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-20). A detailed 
description of the STANS methodology is available at https://optionsclearing.com/risk-management/margins/.
    \8\ See OCC Rule 601.
    \9\ The expected shortfall component is established as the 
estimated average of potential losses higher than the 99% value at 
risk threshold. The term ``value at risk'' or ``VaR'' refers to a 
statistical technique that, generally speaking, is used in risk 
management to measure the potential risk of loss for a given set of 
assets over a particular time horizon.
    \10\ OCC notes that, pursuant to OCC Rule 601(e)(1), OCC also 
calculates initial margin requirements for segregated futures 
accounts using the Standard Portfolio Analysis of Risk Margin 
Calculation System (``SPAN''). No changes are proposed to OCC's use 
of SPAN because the proposed changes do not concern futures. See 
Securities Exchange Act Release No. 72331 (June 5, 2014), 79 FR 
33607 (June 11, 2014) (SR-OCC-2014-13).
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    The econometric models underlying STANS currently incorporate a 
number of risk factors. A ``risk factor'' within OCC's margin system is 
defined as a product or attribute whose historical data is used to 
estimate and simulate the risk for an associated product. The majority 
of risk factors utilized in the STANS methodology are the returns on 
individual equity securities; however, a number of other risk factors 
may be considered, including, among other things, returns on implied 
volatility risk factors.\11\
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    \11\ In December 2015, the Commission approved a proposed rule 
change and issued a Notice of No Objection to an advance notice 
filing by OCC to its modify margin methodology by more broadly 
incorporating variations in implied volatility within STANS. See 
Securities Exchange Act Release No. 76781 (December 28, 2015), 81 FR 
135 (January 4, 2016) (SR-OCC-2015-016) and Securities Exchange Act 
Release No. 76548 (December 3, 2015), 80 FR 76602 (December 9, 2015) 
(SR-OCC-2015-804). As discussed further below, implied volatility 
risk factors in STANS are a set of chosen volatility pivot points 
per product, depending on the tenor of the option.
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Current Implied Volatility Model in STANS
    Generally speaking, the implied volatility of an option is a 
measure of the expected future volatility of the option's underlying 
security at expiration, which is reflected in the current option 
premium in the market. Using the Black-Scholes options pricing model, 
the implied volatility is the standard deviation of the underlying 
asset price necessary to arrive at the market price of an option of a 
given strike, time to maturity, underlying asset price and the current 
risk-free rate. In effect, the implied volatility is

[[Page 60542]]

responsible for that portion of the premium that cannot be explained by 
the then-current intrinsic value of the option (i.e., the difference 
between the price of the underlying and the exercise price of the 
option), discounted to reflect its time value. OCC considers variations 
in implied volatility within STANS to ensure that the anticipated cost 
of liquidating options positions in an account recognizes the 
possibility that implied volatility could change during the two-
business day liquidation time horizon and lead to corresponding changes 
in the market prices of the options.
    OCC models the variations in implied volatility used to re-price 
options within STANS for substantially all option contracts \12\ 
available to be cleared by OCC that have a residual tenor \13\ of less 
than three years (``Shorter Tenor Options'').\14\ To address variations 
in implied volatility, OCC models a volatility surface \15\ for Shorter 
Tenor Options by incorporating into the econometric models underlying 
STANS certain risk factors (i.e., implied volatility pivot points) 
based on a range of tenors and option deltas.\16\ Currently, these 
implied volatility pivot points consist of three tenors of one month, 
three months and one year, and three deltas of 0.25, 0.5, and 0.75, 
resulting in nine implied volatility risk factors. These pivot points 
are chosen such that their combination allows the model to capture 
changes in level, skew, convexity and term structure of the implied 
volatility surface. OCC uses a GARCH model \17\ to forecast the 
volatility for each implied volatility risk factor at the nine pivot 
points.\18\ For each Shorter Tenor Option in the account of a Clearing 
Member, changes in its implied volatility are simulated using forecasts 
obtained from daily implied volatility market data according to the 
corresponding pivot point and the price of the option is computed to 
determine the amount of profit or loss in the account under the 
particular STANS price simulation. Additionally, OCC uses simulated 
closing prices for the assets underlying the options in the account of 
a Clearing Member that are scheduled to expire within the liquidation 
time horizon of two business days to compute the options' intrinsic 
value and uses those values to help calculate the profit or loss in the 
account.\19\
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    \12\ OCC's Implied Volatility Model excludes: (i) Binary 
options, (ii) options on commodity futures, (iii) options on U.S. 
Treasury securities, and (iv) Asians and Cliquets. These relatively 
new products were introduced as the implied volatility margin 
methodology changes were in the process of being completed by OCC, 
and OCC had de minimus open interest in those options. OCC therefore 
did not believe there was a substantive risk if those products were 
excluded from the implied volatility model. See id.
    \13\ The ``tenor'' of an option is the amount of time remaining 
to its expiration.
    \14\ OCC also incorporates variations in implied volatility as 
risk factors for certain options with residual tenors of at least 
three years (``Longer Tenor Options''); however, the proposed 
changes described herein would not apply to OCC's model for Longer 
Tenor Options. See Securities Exchange Act Release Nos. 68434 
(December 14, 2012), 77 FR 57602 (December 19, 2012) (SR-OCC-2012-
14); 70709 (October 18, 2013), 78 FR 63267 (October 23, 2013) (SR-
OCC-2013-16).
    \15\ The term ``volatility surface'' refers to a three-
dimensional graphed surface that represents the implied volatility 
for possible tenors of the option and the implied volatility of the 
option over those tenors for the possible levels of ``moneyness'' of 
the option. The term ``moneyness'' refers to the relationship 
between the current market price of the underlying interest and the 
exercise price.
    \16\ The ``delta'' of an option represents the sensitivity of 
the option price with respect to the price of the underlying 
security.
    \17\ The acronym ``GARCH'' refers to an econometric model that 
can be used to estimate volatility based on historical data. See 
generally Tim Bollerslev, ``Generalized Autoregressive Conditional 
Heteroskedasticity,'' Journal of Econometrics, 31(3), 307-327 
(1986).
    \18\ STANS relies on 10,000 price simulation scenarios that are 
based generally on a historical data period of 500 business days, 
which are updated daily to keep model results from becoming stale.
    \19\ For such Shorter Tenor Options that are scheduled to expire 
on the open of the market rather than the close, OCC uses the 
relevant opening price for the underlying assets.
---------------------------------------------------------------------------

    OCC performed a number of analyses of its current Implied 
Volatility Model and to support development of the proposed model 
changes, including backtesting and impact analysis of the proposed 
model enhancements as well as comparison of OCC's current model 
performance against certain industry benchmarks.\20\ OCC's analysis 
demonstrated that one attribute of the current model is that the 
volatility changes forecasted by the GARCH model are extremely 
sensitive to sudden spikes in volatility, which can at times result in 
over reactive margin requirements that OCC believes are unreasonable 
and procyclical.\21\
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    \20\ OCC has provided results of these analyses to the 
Commission in confidential Exhibit 3 of the filing.
    \21\ A quality that is positively correlated with the overall 
state of the market is deemed to be ``procyclical.'' For example, 
procyclicality may be evidenced by increasing margin requirements in 
times of stressed market conditions and low margin requirements when 
markets are calm. Hence, anti-procyclical features in a model are 
measures intended to prevent risk-based models from fluctuating too 
drastically in response to changing market conditions.
---------------------------------------------------------------------------

    For example, on February 5, 2018, the market experienced extreme 
levels of volatility, with the Cboe Volatility Index (``VIX'') \22\ 
moving from 17% up to 37%, representing a relative move of 116% (which 
is the largest relative daily jump in the history of the index). Under 
OCC's current model, OCC observed that the GARCH forecast SPX 
volatility for at-the-money implied volatility for a one-month tenor 
was approximately 4 times larger than the comparable market index, the 
Cboe VVIX Index, which is a volatility of volatility measure in that it 
represents the expected volatility of the 30-day forward price of the 
VIX. As a result, aggregated STANS margins jumped more than 80% 
overnight due to the GARCH model and margins for certain individual 
Clearing Members increased by a factor of 10.\23\
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    \22\ The VIX is an index designed to measure the 30-day expected 
volatility of the Standard & Poor's 500 index (``SPX'').
    \23\ For example, under the current model the total margin 
requirement calculated for one particular Clearing Member jumped 
from $120 million on February 2, 2018, to $1.78 billion on February 
5, 2018, representing a 14 times increase in the requirement.
---------------------------------------------------------------------------

    In addition, volatility tends to be mean reverting; that is, 
volatility will quickly return to its long-run mean or average from an 
elevated level, so it is unlikely that volatility would continue to 
make big jumps immediately following a drastic increase. For example, 
based on the VIX history from 1990-2018, VIX levels jumped above 35 
(about the level observed on February 5, 2018) for approximately 293 
days (i.e., 4% of the sample period). From the level of 35 or higher, 
the range of daily change on the VIX index was between 27% and -35%. 
However, the largest daily changes on one-month at-the-money SPX 
implied volatility forecasted by OCC's current GARCH model on February 
5, 2018, were far in excess of those historical realized amounts, which 
points to extreme procyclicality issues that need to be addressed in 
the current model.\24\
---------------------------------------------------------------------------

    \24\ For example, OCC's current model resulted in a maximum 
variation of 1100% in the one-month at-the-money SPX implied 
volatility pivot when compared with a maximum 35% move in the VIX 
for VIX levels greater than 30. Additionally, the model-generated 
number is significantly higher than 116%, which is the largest 
realized historical move in the VIX that occurred on February 5, 
2018.
---------------------------------------------------------------------------

    OCC also performed backtesting of the current model and proposed 
model enhancements to evaluate and compare the performance of each 
model from a margin coverage perspective. OCC's backtesting 
demonstrated that exceedance counts \25\ and overall coverage levels 
over the backtesting period using the proposed model enhancements were 
substantially similar to the results obtained from the current 
production model. As a result, OCC believes the current model tends to

[[Page 60543]]

be overly conservative/reactive, and the proposed model is more 
appropriately commensurate with the risks presented by changes in 
implied volatility.
---------------------------------------------------------------------------

    \25\ Exceedance counts here refer to instances where the actual 
loss on portfolio over the liquidation period of two business days 
exceeds the margin amounts generated by the model.
---------------------------------------------------------------------------

    OCC believes that the sudden, extreme and unreasonable increases in 
margin requirements that may be experienced under its current Implied 
Volatility Model may stress certain Clearing Members' ability to obtain 
sufficient liquidity to meet these significantly increased margin 
requirements, particularly in periods of sudden, extreme volatility. 
OCC therefore is proposing changes to its Implied Volatility Model to 
limit procyclicality and produce margin requirements that OCC believes 
are more reasonable and are also commensurate with the risks presented 
by its cleared options products.
Proposed Changes
    OCC proposes to modify its Implied Volatility Model by introducing 
an exponentially weighted moving average \26\ for the daily forecasted 
volatility for implied volatility risk factors calculated using the 
GARCH model. Specifically, when forecasting the volatility for each 
implied volatility risk factor at each of the nine pivot points, OCC 
would use an exponentially weighted moving average of forecasted 
volatilities over a specified look-back period rather than using raw 
daily forecasted volatilities. The exponentially weighted moving 
average would involve the selection of a look-back period over which 
the data would be averaged and a decay factor (or weighting factor), 
which is a positive number between zero and one, that represents the 
weighting factor for the most recent data point.\27\ The look-back 
period and decay factor would be model parameters subject to monthly 
review,\28\ along with other model parameters that are reviewed by 
OCC's Model Risk Working Group (``MRWG'') \29\ in accordance with OCC's 
internal procedure for margin model parameter review and sensitivity 
analysis, and these parameters would be subject to change upon approval 
of the MRWG.
---------------------------------------------------------------------------

    \26\ An exponentially weighted moving average is a statistical 
method that averages data in a way that gives more weight to the 
most recent observations using an exponential scheme.
    \27\ The lower the number the more weight is attributed to the 
more recent data (e.g., if the value is set to one, the 
exponentially weighted moving average becomes a simple average).
    \28\ OCC initially would use a look-back period of 22 days and 
an initial decay factor of 0.94 for the exponentially weighted 
moving average. OCC believes the 22-day look-back is an appropriate 
initial parameter setting as it would allow for close to monthly 
updates of the GARCH parameters used in the model. The decay factor 
value of 0.94 was selected based on the factor initially proposed by 
JP Morgan's RiskMetrics methodology (see JPMorgan/Reuters, 1996. 
``RiskMetrics--Technical Document'', Fourth edition).
    \29\ The MRWG is responsible for assisting OCC's Management 
Committee in overseeing and governing OCC's model-related risk 
issues and includes representatives from OCC's Financial Risk 
Management department, Quantitative Risk Management department, 
Model Validation Group, and Enterprise Risk Management department.
---------------------------------------------------------------------------

    The proposed changes are intended to reduce the oversensitivity of 
the current Implied Volatility Model to large, sudden shocks in market 
volatility and therefore result in margin requirements that are more 
stable and that remain commensurate with the risks presented during 
periods of sudden, extreme volatility.\30\ The proposed changes are 
expected to produce margin requirements that are very similar to those 
generated using OCC's existing model during quiet, less volatile market 
periods; however, during more volatile periods, the proposed changes 
would result in a more measured initial response to increases in the 
volatility of volatility with margin requirements that may remain 
elevated for a longer period of time after the shock subsides than 
experienced under OCC's current model. The proposed changes are 
intended to reduce procyclicality in OCC's margin methodology across 
volatile market periods while continuing to capture changes in implied 
volatility and produce margin requirements that are commensurate with 
the risks presented by OCC's cleared options products. The proposed 
changes therefore would reduce the risk that a sudden, extreme increase 
in margin requirements may stress Clearing Members' ability to obtain 
liquidity to meet such increased requirements, particularly in periods 
of extreme volatility.
---------------------------------------------------------------------------

    \30\ As noted above, OCC has performed analysis of the impact of 
the proposed changes, and OCC's backtesting of the proposed model 
demonstrates comparable exceedance counts and coverage levels to the 
current model during the most recent volatile period.
---------------------------------------------------------------------------

Implementation Timeframe

    OCC expects to implement the proposed changes within thirty (30) 
days after the date that OCC receives all necessary regulatory 
approvals for the proposed changes. OCC will announce the 
implementation date of the proposed change by an Information Memorandum 
posted to its public website at least 2 weeks prior to implementation.

Anticipated Effect on, and Management of, Risk

    The volatility changes forecasted by OCC's current Implied 
Volatility Model are extremely sensitive to large, sudden spikes in 
volatility, which can at times result in over reactive margin 
requirements that OCC believes are unreasonable and procyclical (for 
the reasons set forth above). Such sudden, unreasonable increases in 
margin requirements may stress certain Clearing Members' ability to 
obtain liquidity to meet those requirements, particularly in periods of 
extreme volatility, and could result in a Clearing Member being delayed 
in meeting, or ultimately failing to meet, its daily settlement 
obligations to OCC. OCC notes that the proposed changes are expected to 
produce margin requirements that are very similar to those generated 
using OCC's existing model during quiet, less volatile market periods. 
The proposed changes would, however, result in a more measured initial 
response to increases in the volatility of volatility with margin 
requirements that may remain elevated for a longer period after the 
shock subsides than experienced under OCC's current model. The proposed 
changes would therefore reduce the likelihood that OCC's Implied 
Volatility Model would produce extreme, over reactive margin 
requirements that could strain the ability of certain Clearing Members 
to meet their daily margin requirements at OCC by reducing 
procyclicality in OCC's margin methodology and ensuring more stable and 
appropriate changes in margin requirements across volatile market 
periods while continuing to capture changes in implied volatility and 
produce margin requirements that are commensurate with the risks 
presented.

Consistency With the Payment, Clearing and Settlement Supervision Act

    The stated purpose of the Clearing Supervision Act is to mitigate 
systemic risk in the financial system and promote financial stability 
by, among other things, promoting uniform risk management standards for 
systemically important financial market utilities and strengthening the 
liquidity of systemically important financial market utilities.\31\ 
Section 805(a)(2) of the Clearing Supervision Act \32\ also authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like OCC, for which the Commission is the supervisory agency. Section 
805(b) of the Clearing Supervision Act \33\ states that the objectives 
and principles for

[[Page 60544]]

risk management standards prescribed under Section 805(a) shall be to:
---------------------------------------------------------------------------

    \31\ 12 U.S.C. 5461(b).
    \32\ 12 U.S.C. 5464(a)(2).
    \33\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    OCC believes that the proposed changes described herein would 
enhance its margin methodology in a manner consistent with the 
objectives and principles of Section 805(b) of the Clearing Supervision 
Act \34\ and the risk management standards adopted by the Commission in 
Rule 17Ad-22 under the Act for the reasons set forth below.\35\
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    \34\ Id.
    \35\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release 
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016), 
81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards for Covered 
Clearing Agencies''). The Standards for Covered Clearing Agencies 
became effective on December 12, 2016. OCC is a ``covered clearing 
agency'' as defined in Rule 17Ad-22(a)(5) and therefore must comply 
with the requirements of Rule 17Ad-22(e).
---------------------------------------------------------------------------

    OCC believes the proposed changes are consistent with the 
objectives and principles of Section 805(b) of the Clearing Supervision 
Act \36\ in that they would promote robust risk management and safety 
and soundness while reducing systemic risks and supporting the 
stability of the broader financial system. As discussed above, the 
volatility changes forecasted by OCC's current Implied Volatility Model 
are extremely sensitive to large, sudden spikes in volatility, which 
can at times result in over reactive margin requirements that OCC 
believes are unreasonable and procyclical. Such sudden, unreasonable 
increases in margin requirements may stress certain Clearing Members' 
ability to obtain liquidity to meet those requirements, particularly in 
periods of extreme volatility, and could result in a Clearing Member 
being delayed in meeting, or ultimately failing to meet, its daily 
settlement obligations to OCC. OCC notes that the proposed changes are 
expected to produce margin requirements that are very similar to those 
generated using OCC's existing model during quiet, less volatile market 
periods. The proposed changes would, however, result in a more measured 
initial response to increases in the volatility of volatility with 
margin requirements that may remain elevated for a longer period after 
the shock subsides than experienced under OCC's current model. The 
proposed changes would therefore reduce the likelihood that OCC's 
Implied Volatility Model would produce extreme, over reactive margin 
requirements by reducing procyclicality in OCC's margin methodology and 
ensuring more stable and appropriate changes in margin requirements 
across volatile market periods while continuing to provide for robust 
management of the risks presented by the implied volatility of OCC's 
cleared options products. Accordingly, OCC believes the proposed 
changes would promote robust risk management and safety and soundness 
while reducing systemic risks and supporting the stability of the 
broader financial system.
---------------------------------------------------------------------------

    \36\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    Rules 17Ad-22(e)(6)(i) and (v) \37\ require a covered clearing 
agency that provides central counterparty services to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to cover its credit exposures to its participants 
by establishing a risk-based margin system that (1) considers, and 
produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market and (2) uses 
an appropriate method for measuring credit exposure that accounts for 
relevant product risk factors and portfolio effects across products. As 
noted above, OCC's current model for implied volatility demonstrates 
extreme sensitivity to sudden spikes in volatility, which can at times 
result in over reactive margin requirements that OCC believes are 
unreasonable and procyclical. The proposed changes are designed to 
reduce the oversensitivity of the model and produce margin requirements 
that are commensurate with the risks presented during periods of 
sudden, extreme volatility. The proposed model enhancements are 
expected to produce margin requirements that are very similar to those 
generated using OCC's existing model during quiet, less volatile market 
periods; however, the proposed changes would result in a more measured 
initial response to increases in the volatility of volatility with 
margin requirements that may remain elevated for a longer period of 
time after the shock subsides than experienced under OCC's current 
model. The proposed changes are designed to reduce procyclicality in 
OCC's margin methodology and ensure more stable changes in margin 
requirements across volatile market periods while continuing to capture 
changes in implied volatility and produce margin requirements that are 
commensurate with the risks presented by OCC's cleared options. As a 
result, OCC believes that the proposed changes are reasonably designed 
to consider, and produce margin levels commensurate with, the risk 
presented by the implied volatility of OCC's cleared options and use an 
appropriate method for measuring credit exposure that accounts for this 
product risk factor (i.e., implied volatility) in a manner consistent 
with Rules 17Ad-22(e)(6)(i) and (v).\38\
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    \37\ 17 CFR 240.17Ad-2(e)(6)(i) and (v).
    \38\ Id.
---------------------------------------------------------------------------

III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date the proposed change was filed with the Commission or (ii) the date 
any additional information requested by the Commission is received. OCC 
shall not implement the proposed change if the Commission has any 
objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    OCC shall post notice on its website of proposed changes that are 
implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the advance 
notice is consistent with the Clearing Supervision Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-OCC-2018-804 on the subject line.

[[Page 60545]]

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549.

All submissions should refer to File Number SR-OCC-2018-804. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (https://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the advance notice that are filed with the 
Commission, and all written communications relating to the advance 
notice between the Commission and any person, other than those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549 on official business days between the hours of 10 a.m. and 3 p.m. 
Copies of the filing also will be available for inspection and copying 
at the principal office of the self-regulatory organization.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly.
    All submissions should refer to File Number SR-OCC-2018-804 and 
should be submitted on or before December 17, 2018.

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2018-25606 Filed 11-23-18; 8:45 am]
 BILLING CODE 8011-01-P

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