Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to Advance Notice, as Modified by Partial Amendment No. 1, Related to The Options Clearing Corporation's Margin Methodology for Incorporating Variations in Implied Volatility, 66791-66794 [2018-28008]

Download as PDF Federal Register / Vol. 83, No. 247 / Thursday, December 27, 2018 / Notices Commission believes that waiving the 30-day operative delay is consistent with the protection of investors and the public interest because doing so will allow the Pilot Program to continue without interruption in a manner that is consistent with the Commission’s prior approval of the extension and expansion of the Pilot Program.14 Accordingly, the Commission designates the proposed rule change as operative upon filing with the Commission.15 At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. If the Commission takes such action, the Commission shall institute proceedings to determine whether the proposed rule should be approved or disapproved. khammond on DSK30JT082PROD with NOTICES IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change 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 20549–1090 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. 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–NYSEAMER–2018–57 and should be submitted on or before January 17, 2019. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.16 Brent J. Fields, Secretary. 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– NYSEAMER–2018–57 on the subject line. [FR Doc. 2018–27991 Filed 12–26–18; 8:45 am] Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSEAMER–2018–57. 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 Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to Advance Notice, as Modified by Partial Amendment No. 1, Related to The Options Clearing Corporation’s Margin Methodology for Incorporating Variations in Implied Volatility 14 See Securities Exchange Release No. 61061 (November 24, 2009), 74 FR 62857 (December 1, 2009) (SR–NYSEArca–2009–44). 15 For purposes only of waiving the operative delay for this proposal, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). VerDate Sep<11>2014 17:14 Dec 26, 2018 Jkt 247001 BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–84838; File No. SR–OCC– 2018–804] December 19, 2018. I. Introduction On October 22, 2018, The Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) advance notice SR–OCC–2018–804 (‘‘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 16 17 1 12 PO 00000 CFR 200.30–3(a)(12). U.S.C. 5465(e)(1). Frm 00121 Fmt 4703 Sfmt 4703 66791 19b–4(n)(1)(i) 2 under the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 3 to propose changes to OCC’s model for incorporating variations in implied volatility within OCC’s margin methodology, the System for Theoretical Analysis and Numerical Simulations.4 On October 30, 2018, OCC filed a partial amendment (‘‘Partial Amendment No. 1’’) to modify the Advance Notice.5 The Advance Notice, as modified by Partial Amendment No. 1, was published for public comment in the Federal Register on November 26, 2018,6 and the Commission received no comments regarding the proposal contained in the Advance Notice.7 This publication serves as notice of no objection to the Advance Notice. II. Background The System for Theoretical Analysis and Numerical Simulations (‘‘STANS’’) is OCC’s methodology for calculating margin. STANS includes econometric models that incorporate a number of risk factors. OCC defines a risk factor in STANS 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 STANS 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.8 2 17 CFR 240.19b–4(n)(1)(i). U.S.C. 78a et seq. 4 See Notice of Filing infra note 6, at 83 FR 60541. 5 In Partial Amendment No. 1, OCC corrected an error in Exhibit 5 without changing the substance of the Advance Notice. References to the Advance Notice from this point forward refer to the Advance Notice, as amended by Partial Amendment No. 1. 6 Securities Exchange Act Release No. 84626 (November 19, 2018), 83 FR 60541 (November 26, 2018) (SR–OCC–2018–804) (‘‘Notice of Filing’’). On October 22, 2018, OCC also filed a related proposed rule change (SR–OCC–2018–014) 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 November 8, 2018. Securities Exchange Act Release No. 84524 (Nov. 2, 2018), 83 FR 55918 (Nov. 8, 2018) (SR– OCC–2018–014). 7 Since the proposal contained in the Advance Notice was also filed as a proposed rule change, all public comments received on the proposal are considered regardless of whether the comments are submitted on the proposed rule change or the Advance Notice. 8 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, 3 15 Continued E:\FR\FM\27DEN1.SGM 27DEN1 66792 Federal Register / Vol. 83, No. 247 / Thursday, December 27, 2018 / Notices khammond on DSK30JT082PROD with NOTICES As a general matter, 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 price of the option.9 Changes in implied volatility, therefore, result in changes to an option’s value. In effect, the implied volatility is responsible for that portion of the premium that cannot be attributed to 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. STANS includes a model that simulates variations in implied volatility for most of the option contracts that OCC clears (‘‘Implied Volatility Model’’).10 The purpose of OCC’s Implied Volatility Model is 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, in turn, uses such anticipated costs to determine and collect the amount of margin necessary to collateralize the exposure that OCC could face in the event of a Clearing Member default. One component of the Implied Volatility Model is a forecast of the volatility of implied volatility. In the process of performing backtesting and impact analyses as well as comparing the Implied Volatility Model to industry benchmarks, OCC determined that its process for forecasting the volatility of implied volatility is extremely sensitive to sudden spikes in volatility, which can at times result in over-reactive margin requirements that OCC believes are unreasonable and procyclical.11 For example, on February 5, 2018, the Cboe Volatility Index (‘‘VIX’’) experienced a large amount of volatility.12 Based on its 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). 9 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. 10 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 products were relatively new products at the time that OCC completed its last implied volatility margin methodology changes, and OCC had de minimus open interest in those options. OCC uses its Implied Volatility Model specifically for options that have a residual tenor of less than three years (‘‘Shorter Tenor Options’’). 11 See Notice of Filing, 83 FR at 60542. 12 The VIX is a measure of the implied volatility of the of Standard & Poor’s 500 index (‘‘SPX’’). VerDate Sep<11>2014 17:14 Dec 26, 2018 Jkt 247001 review and understanding of OCC’s analysis, the Commission understands that OCC’s Implied Volatility Model forecasted an extreme increase in the volatility of implied volatility in response to the increase in the VIX on February 5, 2018.13 Specifically, the Implied Volatility Model forecasted a volatility of implied volatility for an atthe-money, one-month tenor SPX position that was approximately 4 times larger than the comparable market index.14 This forecast caused aggregate margin requirements at OCC to jump more than 80 percent overnight due to the Implied Volatility Model, and margin requirements for certain individual Clearing Members increased by a factor of 10.15 Due in large part to the over-reaction of the Implied Volatility Model’s to the rise in the VIX, a future shock to the VIX during a time of market stress could result in an increase in margin requirements that likely would impose additional stresses on Clearing Members. The Advance Notice proposes to modify OCC’s Implied Volatility Model by introducing an exponentially weighted moving average 16 for the daily forecasted volatility of implied volatility risk factors. Specifically, when forecasting the volatility for each implied volatility risk factor, OCC would use an exponentially weighted moving average of forecasted volatilities over a specified look-back period rather than using unweighted daily forecasted volatilities. The proposal would change the Implied Volatility Model’s sensitivity to large, sudden shocks in market volatility when forecasting the volatility of implied volatility. Specifically, the proposal would result in a more measured initial response to such shocks while producing margin requirements that may remain elevated for a longer period of time following a market shock. Based on its analysis of data provided by OCC, the Commission understands that the margin requirements calculated with the current and proposed models would be very similar during less volatile periods, and that the likelihood that OCC would have sufficient margin to cover its exposures under normal market conditions would not decrease under 13 See Notice of Filing, 83 FR at 60542. Notice of Filing, 83 FR at 60542. 15 See Notice of Filing, 83 FR at 60542. For example, the total margin requirements for one Clearing Member would have increased from $120 million on February 2, 2018 to $1.78 billion on February 5, 2018. See Notice of Filing, 83 FR at 60542, n. 22. 16 An exponentially weighted moving average is a statistical method that averages data in a way that gives more weight to the most recent observations. 14 See PO 00000 Frm 00122 Fmt 4703 Sfmt 4703 the proposed model.17 However, the proposed model would present a more commensurate response to the extreme volatility increases in the market. 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.18 Section 805(a)(2) of the Clearing Supervision Act 19 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 20 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 risk-management and default policies and procedures, among others areas.21 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’’).22 The Clearing Agency Rules require, among other things, each covered 17 OCC’s backtesting, which the Commission has reviewed and analyzed, demonstrated that coverage levels using the proposed model were substantially similar to the results obtained from the current model. See Notice, 83 FR at 60542. 18 See 12 U.S.C. 5461(b). 19 12 U.S.C. 5464(a)(2). 20 12 U.S.C. 5464(b). 21 12 U.S.C. 5464(c). 22 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). E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 83, No. 247 / Thursday, December 27, 2018 / Notices khammond on DSK30JT082PROD with NOTICES 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.23 As such, it is appropriate for the Commission to review advance notices against the Clearing Agency Rules and the objectives and principles of these risk management standards as described in Section 805(b) of the Clearing Supervision Act. As discussed below, the Commission believes the proposal in the Advance Notice is consistent with the objectives and principles described in Section 805(b) of the Clearing Supervision Act,24 and in the Clearing Agency Rules, in particular Rule 17Ad– 22(e)(6)(i).25 A. Consistency With Section 805(b) of the Clearing Supervision Act The Commission believes that the proposal contained in the Advance Notice is consistent with the stated objectives and principles of Section 805(b) of the Clearing Supervision Act. OCC manages its credit exposure to Clearing Members, in part, through the collection of collateral based on OCC’s margin methodology. As noted above, however, the imposition of margin requirements resulting from a model that overreacts to increases in implied volatility may impose stresses on OCC’s Clearing Members. Clearing Members, particularly large Clearing Members or their affiliates, are active in various markets. A large, unexpected margin call at OCC could affect a Clearing Member’s ability to meet its obligations to other counterparties, including other SIMFUs. As a consequence, the imposition of margin requirements resulting from a model overreaction could have implications for the broader financial system. As discussed below, the Commission believes that the changes to OCC’s margin methodology proposed in the Advance Notice could enhance OCC’s management of credit risk while reducing potential systemic risk. First, the proposal would change the Implied Volatility Model’s response to sudden, large changes in market volatility. As noted above, the margin requirements produced by the current model appear to be overly responsive to sudden, large shocks. The proposed change would result in a more measured initial response to a sudden, large change in market volatility while maintaining elevated margin 23 17 CFR 240.17Ad–22. 24 12 U.S.C. 5464(b). 25 17 CFR 240.17Ad–22(e)(6)(i). VerDate Sep<11>2014 17:14 Dec 26, 2018 Jkt 247001 requirements following such a shock. Although the initial reduction in sensitivity would result in the collection of less margin than under the current model, backtesting results demonstrate that margin requirements produced under the proposed model would provide as consistent a level of coverage as margin requirements produced under the proposed model. In addition, the proposal would result in margin requirements that remain elevated for a longer period of time following a market shock, which could provide further support for OCC’s ability to cover its potential future exposure to risk. Therefore, the Commission believes that the consistent level of coverage, taken together with the potential for extended elevation of margin requirements after a market shock, is consistent with the promotion of both robust risk management and safety and soundness. Second, the proposal could reduce the likelihood that OCC’s margin requirements impose sudden and excessive stress on Clearing Members during times of broader market stress. As described above, the current Implied Volatility Model could result in dramatic increases in Clearing Member margin requirements in response to a sudden, large shock in market volatility. Based on its review of OCC’s data comparing margin requirements to market data on February 5, 2018, the Commission understands that the size of such an increase would not necessarily be commensurate with the risk of the Clearing Member’s portfolio because, as described above, the volatility of implied volatility forecasted by the current model on that day was 4 times the size of a comparable market index, resulting in margin requirements for some Clearing Members that rose by a factor of 10. Imposing a large, unexpected increase in margin requirements could impose a large, unexpected stress on a Clearing Member during a period of high volatility. The Commission believes that reducing the likelihood of unnecessarily large and unexpected stresses on Clearing Members could help to lessen the risk of Clearing Member defaults. Reducing the risk of Clearing Member defaults could also reduce the likelihood of contagion during times of market stress because Clearing Members, particularly large Clearing Members, tend to be active participants in multiple asset markets. Therefore, the Commission believes that the proposed change is consistent with the reduction of systemic risk and supporting the stability of the broader financial system. Accordingly, and for the reasons stated, the Commission believes the PO 00000 Frm 00123 Fmt 4703 Sfmt 4703 66793 changes proposed in the Advance Notice are consistent with Section 805(b) of the Clearing Supervision Act.26 B. Consistency With Rule 17Ad–22(e)(6) Under the Exchange Act Rule 17Ad–22(e)(6)(i) under the Exchange Act requires that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to cover, if the covered clearing agency provides central counterparty services, its credit exposures to its participants by establishing a risk-based margin system that, among other things, considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market.27 The proposed change is designed to better align the margin requirements produced by OCC’s margin methodology with the level of risk posed by changes in market volatility. The component of the current Implied Volatility Model that forecasts the volatility of implied volatility is very sensitive to sudden, large changes in market volatility, as evidenced by the model’s reaction to the large, sudden spike in market volatility observed on February 5, 2018 discussed above which produced dramatic increases in Clearing Member margin requirements. The proposed change to the Implied Volatility Model would reduce the sensitivity of the model to sudden, large changes in market volatility, and, as demonstrated by OCC’s backtesting, would be unlikely to reduce the level of coverage.28 The Commission believes that revising the Implied Volatility Model could produce margin requirements that are more precise and better reflect the risks and particular attributes of the products cleared by OCC. The Commission further believes that such changes could produce margin levels that are commensurate with the risks of the products being cleared. Accordingly, based on the foregoing, the Commission believes that the proposed change to the Implied Volatility Model is consistent with Exchange Act Rule 17Ad– 22(e)(6)(i).29 IV. Conclusion It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Clearing Supervision Act, that the Commission DOES NOT OBJECT to the Advance Notice (SR–OCC–2018–804) and that 26 12 U.S.C. 5464(b). CFR 240.17Ad–22(e)(6)(i). 28 See supra note 17. 29 17 CFR 240.17Ad–22(e)(6). 27 17 E:\FR\FM\27DEN1.SGM 27DEN1 66794 Federal Register / Vol. 83, No. 247 / Thursday, December 27, 2018 / Notices 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–2018–014, as modified by Partial Amendment No. 1, whichever is later. By the Commission. Brent J. Fields, Secretary. [FR Doc. 2018–28008 Filed 12–26–18; 8:45 am] BILLING CODE P SECURITIES AND EXCHANGE COMMISSION A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change [Release No. 34–84853; File No. SR– NYSEArca–2018–91] Self-Regulatory Organizations; NYSE Arca, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Changes Relating to ProShares Ultra Gold, ProShares UltraShort Gold, ProShares Ultra Silver, and ProShares UltraShort Silver December 19, 2018. Pursuant to Section 19(b)(1) 1 of the Securities Exchange Act of 1934 (the ‘‘Act’’) 2 and Rule 19b–4 thereunder,3 notice is hereby given that, on December 6, 2018, NYSE Arca, Inc. (the ‘‘Exchange’’ or ‘‘NYSE Arca’’) filed with the Securities and Exchange Commission (the ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the selfregulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. khammond on DSK30JT082PROD with NOTICES I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to reflect changes to the underlying benchmark, net asset value calculation times, and creation and redemption order cut-off times applicable to the ProShares Ultra Gold, ProShares UltraShort Gold, ProShares Ultra Silver, and ProShares UltraShort Silver. The proposed rule change is available on the Exchange’s website at www.nyse.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. 1 15 U.S.C.78s(b)(1). U.S.C. 78a. 3 17 CFR 240.19b–4. 2 15 VerDate Sep<11>2014 17:14 Dec 26, 2018 Jkt 247001 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 self-regulatory organization 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 those statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant parts of such statements. 1. Purpose The Commission previously approved the listing and trading of the shares (‘‘Shares’’) on the Exchange of the following under Commentary .02 to NYSE Arca Rule 8.200–E,4 which governs the listing and trading of ‘‘Trust Issued Receipts’’ (‘‘TIRs’’) on the Exchange: 5 ProShares Ultra Gold, ProShares UltraShort Gold, ProShares Ultra Silver, and ProShares UltraShort Silver (each a ‘‘Fund’’ and, collectively, the ‘‘Funds’’).6 The Funds are series of ProShares Trust II (‘‘Trust’’). The Bank of New York Mellon Corporation is 4 Commentary .02 to NYSE Arca Rule 8.200–E applies to Trust Issued Receipts that invest in ‘‘Financial Instruments.’’ The term ‘‘Financial Instruments,’’ as defined in Commentary .02(b)(4) to NYSE Arca Rule 8.200–E, means any combination of investments, including cash; securities; options on securities and indices; futures contracts; options on futures contracts; forward contracts; equity caps, collars and floors; and swap agreements. 5 See Securities Exchange Act Release Nos. 58457 (September 3, 2008), (73 FR 52711 (September 10, 2008) (SR–NYSEArca–2008–91) (notice of filing and order granting accelerated approval of proposed rule change regarding listing and trading of shares of 14 funds of the Commodities and Currency Trust (now the ProShares Trust II)); 58162 (July 15, 2008), 73 FR 42391 (July 21, 2008) (SR–NYSEArca–2008– 73) (notice of filing and immediate effectiveness of proposed rule change relating to trading of shares of 14 funds of the Commodities and Currency Trust pursuant to unlisted trading privileges) (‘‘Prior NYSE Arca Notice’’). See also Securities Exchange Act Release Nos. 58161 (July 15, 2008), 73 FR 42380 (July 21, 2008) (SR–Amex–2008–39) (order approving listing and trading on the American Stock Exchange LLC of shares of 14 funds of the Commodities and Currency Trust) (‘‘Prior Amex Order’’); 57932 (June 5, 2008), 73 FR 33467 (June 12, 2008) (notice of proposed rule change regarding listing and trading of shares of 14 funds of the Commodities and Currency Trust) (‘‘Prior Amex Notice’’ and, together with the Prior Amex Order, the ‘‘Prior Amex Releases’’). 6 The ProShares Ultra Gold and ProShares Ultra Silver are referred to herein as ‘‘Ultra Funds’’ and the ProShares UltraShort Gold and ProShares UltraShort Silver are referred to herein as ‘‘UltraShort Funds.’’ PO 00000 Frm 00124 Fmt 4703 Sfmt 4703 custodian for the Trust. SEI Investments Distribution Co. is the distributor for the Funds.7 Shares of the Funds are currently listed and trading on the Exchange. The Exchange is submitting this proposed rule change to reflect a change to the underlying benchmarks, net asset value calculation times, and creation and redemption order cut-off times applicable to the Funds, as described below. Changes to Underlying Benchmarks The Ultra Funds seek daily investment results, before fees and expenses, that correspond to two times (2x) the daily performance of their ‘‘Underlying Benchmark’’ (as described below) If each such Fund is successful in meeting its investment objective, the value of the Shares of each such Fund, on a given day, before fees and expenses, should gain approximately two times as much on a percentage basis as the level of each such Fund’s respective Underlying Benchmark when the price of the Underlying Benchmark rises, and should lose approximately two times as much when such price declines on a given day, before fees and expenses. The Ultra Funds do not seek to achieve their stated objective over a period greater than a single day. A ‘‘single day’’ is measured from the time an Ultra Fund calculates its respective NAV to the time of the Ultra Fund’s next NAV calculation. The UltraShort Funds seek daily investment results, before fees and expenses that correspond to two times the inverse (¥2x) of the daily performance of their Underlying Benchmark. If each such Fund is successful in meeting its objective, the value of the Shares of each such Fund, on a given day, before fees and expenses, should gain approximately two times as much, on a percentage basis, when the level of each such Fund’s respective Underlying Benchmark declines, and should decrease approximately two times as much as the respective Underlying 7 On October 1, 2018, the Trust filed with the Commission, registration statements pursuant to Rule 424(b)(3) under the Securities Act of 1933 (‘‘Securities Act’’) (15 U.S.C. 77a) relating to the Ultra Gold and Ultra Silver Funds (File No. 333– 220688) and the UltraShort Silver and UltraShort Gold Funds (File No. 333–223012). The registration statements filed pursuant to Rule 424(b)(3) are collectively referred to herein as the ‘‘Registration Statements.’’ The description of the operation of the Trust and the Funds herein is based, in part, on the Registration Statements. Share of the Funds are currently listed and traded on the Exchange in compliance with all original and continued listing standards of the Exchange and requirements of the Prior NYSE Arca Order and the Prior Amex Releases. E:\FR\FM\27DEN1.SGM 27DEN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 83, Number 247 (Thursday, December 27, 2018)]
[Notices]
[Pages 66791-66794]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-28008]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-84838; File No. SR-OCC-2018-804]


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

December 19, 2018.

I. Introduction

    On October 22, 2018, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-OCC-2018-804 (``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 model for 
incorporating variations in implied volatility within OCC's margin 
methodology, the System for Theoretical Analysis and Numerical 
Simulations.\4\
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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\ See Notice of Filing infra note 6, at 83 FR 60541.
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    On October 30, 2018, OCC filed a partial amendment (``Partial 
Amendment No. 1'') to modify the Advance Notice.\5\ The Advance Notice, 
as modified by Partial Amendment No. 1, was published for public 
comment in the Federal Register on November 26, 2018,\6\ and the 
Commission received no comments regarding the proposal contained in the 
Advance Notice.\7\ This publication serves as notice of no objection to 
the Advance Notice.
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    \5\ In Partial Amendment No. 1, OCC corrected an error in 
Exhibit 5 without changing the substance of the Advance Notice. 
References to the Advance Notice from this point forward refer to 
the Advance Notice, as amended by Partial Amendment No. 1.
    \6\ Securities Exchange Act Release No. 84626 (November 19, 
2018), 83 FR 60541 (November 26, 2018) (SR-OCC-2018-804) (``Notice 
of Filing''). On October 22, 2018, OCC also filed a related proposed 
rule change (SR-OCC-2018-014) 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 November 8, 2018. Securities 
Exchange Act Release No. 84524 (Nov. 2, 2018), 83 FR 55918 (Nov. 8, 
2018) (SR-OCC-2018-014).
    \7\ Since the proposal contained in the Advance Notice was also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the proposed rule change or the Advance Notice.
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II. Background

    The System for Theoretical Analysis and Numerical Simulations 
(``STANS'') is OCC's methodology for calculating margin. STANS includes 
econometric models that incorporate a number of risk factors. OCC 
defines a risk factor in STANS 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 STANS 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.\8\
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    \8\ 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).

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[[Page 66792]]

    As a general matter, 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 price of the 
option.\9\ Changes in implied volatility, therefore, result in changes 
to an option's value. In effect, the implied volatility is responsible 
for that portion of the premium that cannot be attributed to 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.
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    \9\ 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.
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    STANS includes a model that simulates variations in implied 
volatility for most of the option contracts that OCC clears (``Implied 
Volatility Model'').\10\ The purpose of OCC's Implied Volatility Model 
is 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, in 
turn, uses such anticipated costs to determine and collect the amount 
of margin necessary to collateralize the exposure that OCC could face 
in the event of a Clearing Member default.
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    \10\ 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 products 
were relatively new products at the time that OCC completed its last 
implied volatility margin methodology changes, and OCC had de 
minimus open interest in those options. OCC uses its Implied 
Volatility Model specifically for options that have a residual tenor 
of less than three years (``Shorter Tenor Options'').
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    One component of the Implied Volatility Model is a forecast of the 
volatility of implied volatility. In the process of performing 
backtesting and impact analyses as well as comparing the Implied 
Volatility Model to industry benchmarks, OCC determined that its 
process for forecasting the volatility of implied volatility is 
extremely sensitive to sudden spikes in volatility, which can at times 
result in over-reactive margin requirements that OCC believes are 
unreasonable and procyclical.\11\ For example, on February 5, 2018, the 
Cboe Volatility Index (``VIX'') experienced a large amount of 
volatility.\12\ Based on its review and understanding of OCC's 
analysis, the Commission understands that OCC's Implied Volatility 
Model forecasted an extreme increase in the volatility of implied 
volatility in response to the increase in the VIX on February 5, 
2018.\13\ Specifically, the Implied Volatility Model forecasted a 
volatility of implied volatility for an at-the-money, one-month tenor 
SPX position that was approximately 4 times larger than the comparable 
market index.\14\ This forecast caused aggregate margin requirements at 
OCC to jump more than 80 percent overnight due to the Implied 
Volatility Model, and margin requirements for certain individual 
Clearing Members increased by a factor of 10.\15\ Due in large part to 
the over-reaction of the Implied Volatility Model's to the rise in the 
VIX, a future shock to the VIX during a time of market stress could 
result in an increase in margin requirements that likely would impose 
additional stresses on Clearing Members.
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    \11\ See Notice of Filing, 83 FR at 60542.
    \12\ The VIX is a measure of the implied volatility of the of 
Standard & Poor's 500 index (``SPX'').
    \13\ See Notice of Filing, 83 FR at 60542.
    \14\ See Notice of Filing, 83 FR at 60542.
    \15\ See Notice of Filing, 83 FR at 60542. For example, the 
total margin requirements for one Clearing Member would have 
increased from $120 million on February 2, 2018 to $1.78 billion on 
February 5, 2018. See Notice of Filing, 83 FR at 60542, n. 22.
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    The Advance Notice proposes to modify OCC's Implied Volatility 
Model by introducing an exponentially weighted moving average \16\ for 
the daily forecasted volatility of implied volatility risk factors. 
Specifically, when forecasting the volatility for each implied 
volatility risk factor, OCC would use an exponentially weighted moving 
average of forecasted volatilities over a specified look-back period 
rather than using unweighted daily forecasted volatilities. The 
proposal would change the Implied Volatility Model's sensitivity to 
large, sudden shocks in market volatility when forecasting the 
volatility of implied volatility. Specifically, the proposal would 
result in a more measured initial response to such shocks while 
producing margin requirements that may remain elevated for a longer 
period of time following a market shock. Based on its analysis of data 
provided by OCC, the Commission understands that the margin 
requirements calculated with the current and proposed models would be 
very similar during less volatile periods, and that the likelihood that 
OCC would have sufficient margin to cover its exposures under normal 
market conditions would not decrease under the proposed model.\17\ 
However, the proposed model would present a more commensurate response 
to the extreme volatility increases in the market.
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    \16\ An exponentially weighted moving average is a statistical 
method that averages data in a way that gives more weight to the 
most recent observations.
    \17\ OCC's backtesting, which the Commission has reviewed and 
analyzed, demonstrated that coverage levels using the proposed model 
were substantially similar to the results obtained from the current 
model. See Notice, 83 FR at 60542.
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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.\18\
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    \18\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act \19\ 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 \20\ provides the following objectives and 
principles for the Commission's risk-management standards prescribed 
under Section 805(a):
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    \19\ 12 U.S.C. 5464(a)(2).
    \20\ 12 U.S.C. 5464(b).
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     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.\21\
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    \21\ 12 U.S.C. 5464(c).
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    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'').\22\ The Clearing Agency 
Rules require, among other things, each covered

[[Page 66793]]

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.\23\ As such, it is appropriate for the Commission 
to review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act. As 
discussed below, the Commission believes the proposal in the Advance 
Notice is consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act,\24\ and in the Clearing 
Agency Rules, in particular Rule 17Ad-22(e)(6)(i).\25\
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    \22\ 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).
    \23\ 17 CFR 240.17Ad-22.
    \24\ 12 U.S.C. 5464(b).
    \25\ 17 CFR 240.17Ad-22(e)(6)(i).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the proposal contained in the Advance 
Notice is consistent with the stated objectives and principles of 
Section 805(b) of the Clearing Supervision Act. OCC manages its credit 
exposure to Clearing Members, in part, through the collection of 
collateral based on OCC's margin methodology. As noted above, however, 
the imposition of margin requirements resulting from a model that 
overreacts to increases in implied volatility may impose stresses on 
OCC's Clearing Members. Clearing Members, particularly large Clearing 
Members or their affiliates, are active in various markets. A large, 
unexpected margin call at OCC could affect a Clearing Member's ability 
to meet its obligations to other counterparties, including other 
SIMFUs. As a consequence, the imposition of margin requirements 
resulting from a model overreaction could have implications for the 
broader financial system. As discussed below, the Commission believes 
that the changes to OCC's margin methodology proposed in the Advance 
Notice could enhance OCC's management of credit risk while reducing 
potential systemic risk.
    First, the proposal would change the Implied Volatility Model's 
response to sudden, large changes in market volatility. As noted above, 
the margin requirements produced by the current model appear to be 
overly responsive to sudden, large shocks. The proposed change would 
result in a more measured initial response to a sudden, large change in 
market volatility while maintaining elevated margin requirements 
following such a shock. Although the initial reduction in sensitivity 
would result in the collection of less margin than under the current 
model, backtesting results demonstrate that margin requirements 
produced under the proposed model would provide as consistent a level 
of coverage as margin requirements produced under the proposed model. 
In addition, the proposal would result in margin requirements that 
remain elevated for a longer period of time following a market shock, 
which could provide further support for OCC's ability to cover its 
potential future exposure to risk. Therefore, the Commission believes 
that the consistent level of coverage, taken together with the 
potential for extended elevation of margin requirements after a market 
shock, is consistent with the promotion of both robust risk management 
and safety and soundness.
    Second, the proposal could reduce the likelihood that OCC's margin 
requirements impose sudden and excessive stress on Clearing Members 
during times of broader market stress. As described above, the current 
Implied Volatility Model could result in dramatic increases in Clearing 
Member margin requirements in response to a sudden, large shock in 
market volatility. Based on its review of OCC's data comparing margin 
requirements to market data on February 5, 2018, the Commission 
understands that the size of such an increase would not necessarily be 
commensurate with the risk of the Clearing Member's portfolio because, 
as described above, the volatility of implied volatility forecasted by 
the current model on that day was 4 times the size of a comparable 
market index, resulting in margin requirements for some Clearing 
Members that rose by a factor of 10. Imposing a large, unexpected 
increase in margin requirements could impose a large, unexpected stress 
on a Clearing Member during a period of high volatility. The Commission 
believes that reducing the likelihood of unnecessarily large and 
unexpected stresses on Clearing Members could help to lessen the risk 
of Clearing Member defaults. Reducing the risk of Clearing Member 
defaults could also reduce the likelihood of contagion during times of 
market stress because Clearing Members, particularly large Clearing 
Members, tend to be active participants in multiple asset markets. 
Therefore, the Commission believes that the proposed change is 
consistent with the reduction of systemic risk and supporting the 
stability of the broader financial system.
    Accordingly, and for the reasons stated, the Commission believes 
the changes proposed in the Advance Notice are consistent with Section 
805(b) of the Clearing Supervision Act.\26\
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    \26\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(6) Under the Exchange Act

    Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that a 
covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to cover, if the 
covered clearing agency provides central counterparty services, its 
credit exposures to its participants by establishing a risk-based 
margin system that, among other things, considers, and produces margin 
levels commensurate with, the risks and particular attributes of each 
relevant product, portfolio, and market.\27\
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    \27\ 17 CFR 240.17Ad-22(e)(6)(i).
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    The proposed change is designed to better align the margin 
requirements produced by OCC's margin methodology with the level of 
risk posed by changes in market volatility. The component of the 
current Implied Volatility Model that forecasts the volatility of 
implied volatility is very sensitive to sudden, large changes in market 
volatility, as evidenced by the model's reaction to the large, sudden 
spike in market volatility observed on February 5, 2018 discussed above 
which produced dramatic increases in Clearing Member margin 
requirements. The proposed change to the Implied Volatility Model would 
reduce the sensitivity of the model to sudden, large changes in market 
volatility, and, as demonstrated by OCC's backtesting, would be 
unlikely to reduce the level of coverage.\28\
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    \28\ See supra note 17.
---------------------------------------------------------------------------

    The Commission believes that revising the Implied Volatility Model 
could produce margin requirements that are more precise and better 
reflect the risks and particular attributes of the products cleared by 
OCC. The Commission further believes that such changes could produce 
margin levels that are commensurate with the risks of the products 
being cleared. Accordingly, based on the foregoing, the Commission 
believes that the proposed change to the Implied Volatility Model is 
consistent with Exchange Act Rule 17Ad-22(e)(6)(i).\29\
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    \29\ 17 CFR 240.17Ad-22(e)(6).
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IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission DOES NOT OBJECT to the 
Advance Notice (SR-OCC-2018-804) and that

[[Page 66794]]

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-2018-014, as modified by Partial Amendment 
No. 1, whichever is later.

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2018-28008 Filed 12-26-18; 8:45 am]
 BILLING CODE P

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