Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Related to the Options Clearing Corporation's Margin Methodology for Volatility Index Futures, 16915-16920 [2019-08083]
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Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices
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Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of Filing of Advance Notice Related to
the Options Clearing Corporation’s
Margin Methodology for Volatility
Index Futures
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 March 18, 2019, the Options Clearing
Corporation (‘‘OCC’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’) an advance notice
(‘‘Advance Notice’’) as described in
Items I, II and III below, which Items
have been prepared by OCC. The
Commission is publishing this notice to
solicit comments on the advance notice
from interested persons.
I. Clearing Agency’s Statement of the
Terms of Substance of the Advance
Notice
This advance notice is in connection
with proposed changes to OCC’s margin
methodology for futures on indexes
designed to measure volatilities implied
by prices of options on a particular
underlying interest (such indexes being
‘‘Volatility Indexes,’’ and futures
contracts on such Volatility Indexes
being ‘‘Volatility Index Futures’’). The
proposed methodology enhancements
for Volatility Index Futures would
include: (1) Introducing ‘‘synthetic’’
futures (discussed below) into the daily
re-estimation of prices and correlations
for Volatility Index Futures; (2) an
enhanced statistical distribution for
modeling price returns of the
‘‘synthetic’’ futures; and (3) a new antiprocyclical floor for variance estimates.
The proposed changes are discussed in
detail in Section II below.
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. OCC also
has included backtesting and impact
analysis of the proposed model changes
in confidential Exhibit 3.
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.4
April 17, 2019.
Pursuant to Section 806(e)(1) of Title
VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act,
entitled Payment, Clearing and
14 17
CFR 200.30–3(a)(12).
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1 12
U.S.C. 5465(e)(1).
CFR 240.19b–4(n)(1)(i).
3 15 U.S.C. 78a et seq.
4 OCC’s By-Laws and Rules can be found on
OCC’s public website: https://optionsclearing.com/
about/publications/bylaws.jsp.
16915
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
The purpose of the proposed changes
is to introduce enhancements to OCC’s
margin methodology for Volatility Index
Futures so that OCC’s margin model
reflects more current market
information for Volatility Index Futures
and allows for more appropriate
modeling of the risk attributes of such
products. Specifically, the proposed
methodology enhancements for
Volatility Index Futures would include:
(1) Introducing ‘‘synthetic’’ futures into
the process for daily re-estimation of
prices and correlations for Volatility
Index Futures; (2) an enhanced
statistical distribution for modeling
price returns for ‘‘synthetic’’ futures;
and (3) a new anti-procyclical floor for
variance estimates. OCC’s current model
for Volatility Index Futures and the
proposed changes thereto are described
in further detail below.
Background
OCC’s margin methodology, the
System for Theoretical Analysis and
Numerical Simulations (‘‘STANS’’),5 is
OCC’s proprietary risk management
system that calculates Clearing Member
margin requirements. STANS utilizes
large-scale Monte Carlo simulations to
forecast price and volatility movements
in determining a Clearing Member’s
margin requirement.6 The STANS
2 17
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5 See Securities Exchange Act Release No. 53322
(February 15, 2006), 71 FR 9403 (February 23, 2006)
(SR–OCC–2004–20).
6 See OCC Rule 601.
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Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices
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margin requirement is calculated at the
portfolio level of Clearing Member
accounts with positions in marginable
securities. The STANS margin
requirement consists of an estimate of a
99% expected shortfall 7 over a two-day
time horizon and an add-on margin
charge for model risk (the
concentration/dependence stress test
charge).8 The STANS methodology is
used to measure the exposure of
portfolios of options, futures and cash
instruments, including the Volatility
Index Futures cleared by OCC.9
Volatility Indexes are indexes
designed to measure the volatility that
is implied by the prices of options on a
particular reference index or asset. For
example, the Cboe Volatility Index
(‘‘VIX’’) is an index designed to measure
the 30-day expected volatility of the
Standard & Poor’s 500 index (‘‘SPX’’).10
7 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.
8 A detailed description of the STANS
methodology is available at https://
optionsclearing.com/risk-management/margins/.
9 Pursuant to OCC Rule 601(e)(1), OCC also
calculates initial margin requirements for
segregated futures accounts on a gross basis using
the Standard Portfolio Analysis of Risk Margin
Calculation System (‘‘SPAN’’). Commodity Futures
Trading Commission (‘‘CFTC’’) Rule 39.13(g)(8),
requires, in relevant part, that derivatives clearing
organizations (‘‘DCOs’’) collect initial margin for
customer segregated futures accounts on a gross
basis. While OCC uses SPAN to calculate initial
margin requirements for segregated futures accounts
on a gross basis, OCC believes that margin
requirements calculated on a net basis (i.e.,
permitting offsets between different customers’
positions held by a Clearing Member in a segregated
futures account using STANS) affords OCC
additional protections at the clearinghouse level
against risks associated with liquidating a Clearing
Member’s segregated futures account. As a result,
OCC calculates margin requirements for segregated
futures accounts using both SPAN on a gross basis
and STANS on a net basis, and if at any time OCC
staff observes a segregated futures account where
initial margin calculated pursuant to STANS on a
net basis exceeds the initial margin calculated
pursuant to SPAN on a gross basis, OCC
collateralizes this risk exposure by applying an
additional margin charge in the amount of such
difference to the account. See Securities Exchange
Act Release No. 72331 (June 5, 2014), 79 FR 33607
(June 11, 2014) (SR–OCC–2014–13).
10 Generally speaking, the implied volatility of an
option is a measure of the expected future volatility
of the value of the option’s annualized standard
deviation of the price of the underlying security,
index, or future at exercise, which is reflected in the
current option premium in the market. Using the
Black-Scholes options pricing model, the implied
volatility is the standard deviation of the
underlying asset price necessary to arrive at the
market price of an option of a given strike, time to
maturity, underlying asset price and given the
current risk-free rate. In effect, the implied volatility
is responsible for that portion of the premium that
cannot be explained by the then-current intrinsic
value (i.e., the difference between the price of the
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OCC currently clears futures contracts
on such Volatility Indexes. These
Volatility Index Futures contracts can
consequently be viewed as an indication
of the market’s future expectations of
the volatility of a given Volatility
Index’s underlying reference index (e.g.,
in the case of the VIX, providing a
snapshot of the expected market
volatility of the underlying over the
term of the options making up the
index).
Current Model for Volatility Index
Futures
Under OCC’s existing margin
methodology, OCC models the potential
final settlement prices of Volatility
Index Futures using the underlying
index as the risk factor.11 Final
settlement prices are simulated under
the assumption that the logarithm of the
values of the risk factor (i.e., the
underlying spot Volatility Index)
follows a mean-reverting 12 random
walk 13 with normally-distributed
steps.14 The model is designed to
calibrate the distribution that defines
this mean-reversion behavior so that the
expected final settlement prices of the
futures match their currently-observed
market prices to ensure that margin
coverage is sufficient to limit credit
exposures to OCC’s participants under
normal market conditions. OCC
recalculates the Monte Carlo scenarios
of the returns of each futures series over
its remaining life so that the standard
deviation of the scenarios matches two
days’ worth of the implied volatility of
near-the-money and contemporaneously
expiring options on the Volatility Index,
where available, in order to align with
OCC’s two-day liquidation period
assumption. Currently, the calibration
for the distribution is performed on a
daily basis.
OCC’s current model for Volatility
Index Futures, which utilizes the
underlying Volatility Index as the sole
risk factor, is subject to certain
limitations, which would be addressed
by the proposed changes described
underlying and the exercise price of the option) of
the option, discounted to reflect its time value.
11 A ‘‘risk factor’’ within OCC’s margin system
may be defined as a product or attribute whose
historical data is used to estimate and simulate the
risk for an associated product.
12 In finance, the term ‘‘mean reversion’’ describes
a financial time series in which returns can be very
unstable in the short run but very stable in the long
run.
13 A random walk is a continuous process with
random increments drawn independently from a
particular distribution.
14 This is known as a Gaussian OrnsteinUhlenbeck process. See Uhlenbeck, G.E. and L.S.
Ornstein, ‘‘On the Theory of Brownian Motion,’’
Physical Review, 36, 823–841 (1930) (explaining the
Gaussian Ornstein-Uhlenbeck process).
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herein. Volatility Indexes, unlike futures
contracts, are not investible (i.e., they
cannot be replicated by static portfolios
of traded contracts). In addition, the
futures market has a term structure that
cannot be modeled using just the
underlying index. Finally, futures on a
Volatility Index are less volatile and less
fat-tailed 15 than the index itself, and
these features are term-dependent. The
current model was developed before
sufficient data on the futures was
available, so a model based on
‘‘synthetic’’ futures,16 as proposed
herein, was not an option at the time.
Also, the current model does not
account for certain strategies Clearing
Members might employ involving
spreads between delivery dates, which
may result in under-margining of those
positions.
In recent years, OCC has seen
significant growth in trading volume for
Volatility Index Futures. As a result,
OCC is proposing a number of
enhancements to its margin
methodology designed to provide for
more accurate and responsive margin
requirements for Volatility Index
Futures.
Proposed Changes
The purpose of the proposed changes
is to introduce enhancements to OCC’s
margin methodology so that OCC’s
margin models reflect more current
market information for Volatility Index
Futures, introduce asymmetry into the
statistical distribution used to model
price returns of the ‘‘synthetic’’ futures,
and reduce procyclicality 17 in the
model.
The proposed changes would
specifically include: (1) The daily reestimation of prices and correlations
using ‘‘synthetic’’ futures; (2) an
enhanced statistical distribution for
modeling price returns for ‘‘synthetic’’
futures; and (3) a new anti-procyclical
15 A data set with a ‘‘fat tail’’ is one in which
extreme price returns have a higher probability of
occurrence than would be the case in a normal
distribution.
16 As discussed in further detail below, a
‘‘synthetic’’ futures time series, for the intended
purposes of OCC, relates to a uniform substitute for
a time series of daily settlement prices for actual
futures contracts, which persists over many
expiration cycles and thus can be used as a basis
for econometric analysis.
17 A quality that is positively correlated with the
overall state of the market is deemed to be
‘‘procyclical.’’ For example, procyclicality may be
evidenced by increasing margin or Clearing Fund
requirements in times of stressed market conditions
and low margin or Clearing Fund requirements
when markets are calm. Hence, anti-procyclical
features in a model are measures intended to
prevent risk-based models from fluctuating too
drastically in response to changing market
conditions.
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floor for variance estimates.18 The main
feature of the proposed model, relative
to the current model, is the replacement
of the underlying Volatility Index itself
as a risk factor by risk factors that are
based on observed futures prices (i.e.,
the ‘‘synthetic’’ futures contracts). The
proposed change would introduce a
new set of risk factors and method for
generating scenarios for those risk
factors, and hence Volatility Index
Futures settlement prices, to be
incorporated into the STANS margin
calculations. OCC believes its proposed
methodology would provide for more
accurate and responsive margin
requirements and that the imposition of
a floor for variance estimates would
mitigate procyclicality in OCC’s margin
methodology for Volatility Index
Futures. The proposed changes are
described in further detail below.
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1. Daily Re-Estimations Using Synthetic
Futures
As noted above, OCC currently
models the potential final settlement
prices of Volatility Index Futures based
on the underlying index itself. OCC
proposes to modify its modeling
approach for Volatility Index Futures by
modeling the price distributions of
‘‘synthetic’’ futures on a daily basis
based on the historical returns of futures
contracts with approximately the same
tenor (as opposed to OCC’s current
approach of calibrating the distribution
based on the Volatility Index itself). A
‘‘synthetic’’ futures time series for the
intended purposes of OCC relates to a
uniform substitute for a time series of
daily settlement prices for actual futures
contracts, which persists over many
expiration cycles and thus can be used
as a basis for econometric analysis. One
feature of futures contracts is that each
contract may have a different expiration
date, and at any one point in time there
may be a variety of futures contracts on
the same underlying interest, all with
varying dates of expiry, so that there is
no one continuous time series for those
futures. ‘‘Synthetic’’ futures can be used
to generate a continuous time series of
futures contract prices across multiple
expirations. These ‘‘synthetic’’ futures
price return histories would be inputted
into the existing Copula simulation
process in STANS alongside the
underlying interests of OCC’s other
cleared and cross-margin products and
collateral. The purpose of this use of
‘‘synthetic’’ futures is to allow the
margin system to better approximate
18 OCC would also make a number of conforming
changes throughout it Margins Methodology so that
the document arcuately reflects the adoption of the
new model.
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correlations between futures contracts of
different tenors by creating more price
data points and their margin offsets.
Under the proposal, the historical
‘‘synthetic’’ time series for these
Volatility Indexes would be updated
daily and mapped to their
corresponding futures contracts. By
construction, the first ‘‘synthetic’’ time
series would always contain returns of
the front contract (i.e., the contract
closest to maturity, on any given day),
the second, which would correspond to
the next month out, and the remaining
series would follow the same pattern.
Following the expiration date of the
front contract, each contract within a
time series would be replaced with a
contract maturing one month later.
While ‘‘synthetic’’ time series contain
returns from different contracts, a return
on any given date is constructed from
prices of the same contract (e.g., as the
front month futures contract ‘‘rolls’’
from the current month to the
subsequent month, returns on the roll
date would be constructed by using the
same contract and not by calculating
returns across months). The marginal
probability distribution parameters for
the ‘‘synthetic’’ time series (i.e.,
marginal probabilities of various values
of the variables in the distribution
without reference to the values of the
other variables) would be estimated
daily using recent historical
observations.19 In cases in which the
GARCH variance 20 forecast falls below
the sample variance, in addition to
being floored by the sample variance,
the ‘‘synthetic’’ time series would
additionally be ‘‘scaled up’’ through the
introduction of a new floor on variance
estimates based on the corresponding
underlying index in order to reduce
procyclicality in the model (as
discussed in further detail below).
OCC believes that using synthetic
futures in its daily re-estimation process
would allow OCC’s econometric model
for Volatility Index Futures to reflect
more current market information and
achieve better coverage across the term
19 However, for any tenor extension or new
contract that does not have enough historical data
for the associated ‘‘synthetic’’ security, the
scenarios for the longest tenor ‘‘synthetic’’ with
enough history would be used as a proxy for
generating futures theoretical price scenarios. In
this case, the long run floor (discussed below)
would be borrowed from the proxy ‘‘synthetic.’’
20 See generally Tim Bollerslev, ‘‘Generalized
Autoregressive Conditional Heteroskedasticity,’’
Journal of Econometrics, 31(3), 307–327 (1986). The
acronym ‘‘GARCH’’ refers to an econometric model
that can be used to estimate volatility based on
historical data. The general distinction between the
‘‘GARCH variance’’ and the ‘‘sample variance’’ for
a given time series is that the GARCH variance uses
the underlying time series data to forecast volatility.
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16917
curve.21 As a result, OCC believes the
proposed changes would result more
accurate margin requirements for
Clearing Members under the current
market conditions.
2. Enhancements to Statistical
Distribution for Volatility Index Futures
In addition to using a ‘‘synthetic’’
futures price return history in the
process for daily re-estimation of model
parameters, OCC is proposing additional
enhancements to its margin
methodology for Volatility Index
Futures to introduce asymmetry into the
statistical distribution used to model
price returns of the ‘‘synthetic’’ futures.
The econometric model currently used
in STANS for all price risk factors is an
asymmetric GARCH(1,1) with
symmetric Standardized Normal
Reciprocal Inverse Gaussian (or
‘‘NRIG’’)-distributed logarithmic
returns.22 OCC proposes to move to an
asymmetric NRIG distribution for
purposes of modeling proportionate
returns of the ‘‘synthetic’’ futures. OCC
believes the asymmetric NRIG
distribution has a better ‘‘goodness of
fit’’ 23 to the historical data and allows
for more appropriate modeling of
observed asymmetry of the distribution.
As a result, OCC believes that the
proposed change would lead to more
consistent treatment of returns both on
the upside as well as downside of the
distribution. Accordingly, OCC believes
that the proposed changes would result
in margin requirements for Volatility
Index Futures that respond more
appropriately to changes in market
volatility and therefore are more
accurate.
3. Introduction of Anti-Procyclical Floor
for Variance Estimates
OCC also proposes to introduce a new
floor for variance estimates of the
Volatility Index Futures that would be
21 In 2018, the Commission approved, and issued
a Notice of No-Objection to, proposed changes to
OCC’s margin methodology designed to enable OCC
to: (1) Obtain daily price data for equity products
for use in the daily estimation of econometric
model parameters; (2) enhance OCC’s econometric
model for updating statistical parameters for all risk
factors that reflect the most recent data obtained; (3)
improve the sensitivity and stability of correlation
estimates across risk factors by using de-volatized
returns; and (4) improve OCC’s methodology related
to the treatment of defaulting securities. See
Securities Exchange Act Release No. 83326 (May
24, 2018), 83 FR 25081 (May 31, 2018) (SR–OCC–
2017–022) and Securities Exchange Act Release No.
83305 (May 23, 2018), 83 FR 24536 (May 29, 2018)
(SR–OCC–2017–811). Under the proposal,
correlation updates for ‘‘synthetic’’ futures would
be done daily with a one-day lag.
22 See id.
23 The goodness of fit of a statistical model
describes the extent to which observed data match
the values generated by the model.
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Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices
modeled under the newly proposed
approach to mitigate procyclicality in
OCC’s margin model. In order to
incorporate a variance level implied by
a longer time series of data, OCC would
calculate a floor for variance estimates
based on the underlying index (e.g.,
VIX) which is expected to have a longer
history that is more reflective of the
long-run variance level that cannot be
otherwise captured using the
‘‘synthetic’’ futures data. The floor
would therefore reduce the impact of a
sudden increase in margin requirements
from a low level and therefore mitigate
procyclicality in the model.
Clearing Member Outreach
In order to inform Clearing Members
of the proposed change, OCC has
provided updates to members at OCC
Roundtable 24 and Financial Risk
Advisory Council (or ‘‘FRAC’’) 25
meetings and will provide additional
reminders about the proposed changes
at its next FRAC meeting. In addition,
OCC will publish an Information Memo
to all Clearing Members describing the
proposed changes and will provide
additional periodic Information Memo
updates prior to the implementation
date. Additionally, OCC will perform
targeted and direct outreach with
Clearing Members that would be most
impacted by the proposed change, and
OCC would work closely with such
Clearing Members to coordinate the
implementation and to discuss the
impact and timing of any required
collateral deposits that may result from
the proposed change.26
Implementation Timeframe
OCC plans to implement the proposed
changes on May 20, 2019, provided that
all necessary regulatory approvals are
received by that date. If all regulatory
approvals are not received by May 20,
2019, or if implementation on that date
becomes otherwise impractical, OCC
will 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 any alternative
implementation date of the proposed
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24 The
OCC Roundtable was established to bring
Clearing Members, exchanges and OCC together to
discuss industry and operational issues. It is
comprised of representatives of senior OCC staff,
participant exchanges and Clearing Members,
representing the diversity of OCC’s membership in
industry segments, OCC-cleared volume, business
type, operational structure and geography.
25 The Financial Risk Advisory Council is a
working group comprised of exchanges, Clearing
Members and indirect participants of OCC.
26 Specifically, OCC will discuss with those
Clearing Members how they plan to satisfy any
increase in their margin requirements associated
with the proposed change.
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changes by an Information Memo posted
to its public website at least one week
prior to implementation.
Anticipated Effect on and Management
of Risk
OCC believes that the proposed
changes would reduce the nature and
level of risk presented by OCC because
it would introduce enhancements to
OCC’s margin methodology so that
OCC’s margin models reflect more
current market information for Volatility
Index Futures; use a statistical
distribution for modeling proportionate
returns of the ‘‘synthetic’’ futures,
which OCC believes has a better
‘‘goodness of fit’’ to the historical data
and allows for more appropriate
modeling of observed asymmetry of the
distribution; and reduce procyclicality
in the model.
The main feature of the proposed
model, relative to the current model, is
the replacement of the underlying
Volatility Index itself as a risk factor by
risk factors that are based on observed
futures prices (i.e., the ‘‘synthetic’’
futures contracts). OCC believes that
using ‘‘synthetic’’ futures in its daily reestimation process would allow OCC’s
econometric model for Volatility Index
Futures to reflect more current market
information and achieve better coverage
across the term curve. As a result, OCC
believes the proposed changes would
result more accurate margin
requirements for Clearing Members
under the current market conditions
that respond more appropriately to
changes in market volatility. In
addition, OCC believes that the
proposed change to an asymmetrical
NRIG statistical distribution would lead
to more consistent treatment of returns
both on the upside as well as downside
of the distribution and therefore result
in margin requirements for Volatility
Index Futures that respond more
appropriately to changes in market
volatility and therefore are more
accurate. Finally, the proposed changes
would enhance OCC’s approach for
modeling Volatility Index Futures by
introducing a floor on variance
estimates in the model to mitigate
procyclicality.
The proposed model would be used
by OCC to calculate margin
requirements designed to limit its credit
exposures to participants, and OCC uses
the margin it collects from a defaulting
Clearing Member to protect other
Clearing Members from losses as a result
of the default and ensure that OCC is
able to continue the prompt and
accurate clearance and settlement of its
cleared products. Accordingly, OCC
believes the proposed changes would
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promote robust risk management for
Volatility Index futures and promote
safety and soundness consistent with
the objectives and principles of Section
805(b) of the Clearing Supervision
Act.27
For the foregoing reasons, OCC
believes that the proposed change
would enhance OCC’s management of
risk and reduce the nature or level of
risk presented to OCC.
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.28 Section 805(a)(2) of the
Clearing Supervision Act 29 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 30 states
that the objectives and principles for
risk management standards prescribed
under Section 805(a) shall be to:
• Promote robust risk management;
• promote safety and soundness;
• reduce systemic risks; and
• support the stability of the broader
financial system.
The Commission has adopted risk
management standards under Section
805(a)(2) of the Clearing Supervision
Act and the Act, which include
Commission Rules 17Ad–22(b)(1), (b)(2)
and (e)(6).31
Rule 17Ad–22(b)(1) 32 requires that a
registered clearing agency that performs
central counterparty services establish,
implement, maintain and enforce
written policies and procedures
reasonably designed to measure its
credit exposures to its participants at
least once a day and limit its exposures
27 12
U.S.C. 5464(b).
U.S.C. 5461(b).
29 12 U.S.C. 5464(a)(2).
30 12 U.S.C. 5464(b).
31 17 CFR 240.17Ad–22. See Securities Exchange
Act Release Nos. 68080 (October 22, 2012), 77 FR
66220 (November 2, 2012) (S7–08–11) (‘‘Clearing
Agency Standards’’); 78961 (September 28, 2016, 81
FR 70786 (October 13, 2016) (S7–03–14)
(‘‘Standards for Covered Clearing Agencies’’). The
Standards for Covered Clearing Agencies became
effective on December 12, 2016. OCC is a ‘‘covered
clearing agency’’ as defined in Rule 17Ad–22(a)(5)
and therefore OCC must comply with new section
(e) of Rule 17Ad–22.
32 17 CFR 240.17Ad–22(b)(1).
28 12
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Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices
to potential losses from defaults by its
participants under normal market
conditions so that the operations of the
clearing agency would not be disrupted
and non-defaulting participants would
not be exposed to losses that they
cannot anticipate or control. As
described above, the proposed changes
would introduce new model
enhancements for OCC’s cleared
Volatility Index Futures. OCC would
use the risk-based model enhancements
described herein to measure its credit
exposures to its participants on a daily
basis and determine margin
requirements based on such
calculations. OCC believes that the
proposed enhancements would result in
more accurate and responsive margin
requirements by ensuring that OCC’s
margin models reflect more current
market information for Volatility Index
Futures and using an asymmetric
distribution in its model that has a
better ‘‘goodness of fit’’ to the historical
data and allows for more appropriate
modeling of observed asymmetry of the
distribution. The proposed changes
would also introduce a new floor on
variance estimates in the model to
mitigate procyclicality. OCC believes
the proposed changes are therefore
designed to ensure that OCC sets margin
requirements that would serve to limit
OCC’s exposures to potential losses
from defaults by its participants under
normal market conditions so that the
operations of OCC would not be
disrupted, and non-defaulting
participants would not be exposed to
losses that they cannot anticipate or
control. Accordingly, OCC believes the
proposed changes are consistent with
Rule 17Ad–22(b)(1).33
Rule 17Ad–22(b)(2) 34 further
requires, in part, that a registered
clearing agency that performs central
counterparty services establish,
implement, maintain and enforce
written policies and procedures
reasonably designed use margin
requirements to limit its credit
exposures to participants under normal
market conditions and use risk-based
models and parameters to set margin
requirements. As noted above, OCC
would use the proposed model
enhancements to calculate margin
requirements for Volatility Index
Futures in a manner designed to limit
its credit exposures to participants
under normal market conditions.
Moreover, OCC believes that the
proposed risk-based model
enhancements for Volatility Index
Futures would result in more accurate
33 Id.
34 17
and responsive margin requirements for
OCC’s Clearing Members and would
introduce an asymmetric distribution
into its model that has a better
‘‘goodness of fit’’ to the historical data
and allows for more appropriate
modeling of observed asymmetry of the
distribution. The proposed floor on
variance estimates would also help to
reduce procyclicality in margin
requirements for Volatility Index
Futures. The risk-based model would
therefore be used to calculate margin
requirements designed to limit OCC’s
credit exposures to participants under
normal market conditions in a manner
consistent with Rule 17Ad–22(b)(2).35
Rules 17Ad–22(e)(6)(i), (iii), and (v) 36
further require that a covered clearing
agency establish, implement, maintain
and enforce written policies and
procedures reasonably designed to cover
its credit exposures to its participants by
establishing a risk-based margin system
that, among other things: (1) Considers,
and produces margin levels
commensurate with, the risks and
particular attributes of each relevant
product, portfolio, and market; (2)
calculates margin sufficient to cover its
potential future exposure to participants
in the interval between the last margin
collection and the close out of positions
following a participant default; and (3)
uses an appropriate method for
measuring credit exposure that accounts
for relevant product risk factors and
portfolio effects across products.
As described in detail above, OCC
believes that the proposed model
enhancements would result in more
accurate, more responsive, and less
procyclical margin requirements for
OCC’s Clearing Members clearing
Volatility Index Futures, with such
margin serving to protect other Clearing
Members from losses arising as a result
of a Clearing Member default. The
proposed changes are intended to
ensure that OCC’s margin models reflect
more current market information for
Volatility Index Futures and would
introduce an asymmetric distribution
into its model that has a better
‘‘goodness of fit’’ to the historical data
and allows for more appropriate
modeling of the observed asymmetry of
the distribution. Additionally, OCC
would introduce a floor on variance
estimates in the model to limit
procyclicality. OCC therefore believes
the proposed changes are reasonably
designed to consider and produce
margin levels commensurate with the
risks and particular attributes of OCC’s
cleared Volatility Index Futures,
calculate margin sufficient to cover its
potential future exposure to participants
in the interval between the last margin
collection and the close out of positions
following a participant default, and
apply an appropriate method for
measuring credit exposure that accounts
for risk factors and portfolio effects of
Volatility Index Futures in a manner
consistent with Rules 17Ad–22(e)(6)(i),
(iii), and (v).37
The changes are not inconsistent with
the existing rules of OCC, including any
other rules proposed to be amended.
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:
35 Id.
CFR 240.17Ad–22(b)(2).
VerDate Sep<11>2014
17:49 Apr 22, 2019
36 17
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37 Id.
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Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices
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–2019–801 on the subject line.
Paper Comments
All submissions should refer to File
Number SR–OCC–2019–801. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the advance notice that
are filed with the Commission, and all
written communications relating to the
advance notice between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549 on official
business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of the
filing also will be available for
inspection and copying at the principal
office of 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–2019–801 and should
be submitted on or before May 7, 2019.
jbell on DSK3GLQ082PROD with NOTICES
By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019–08083 Filed 4–22–19; 8:45 am]
BILLING CODE 8011–01–P
17:49 Apr 22, 2019
[Investment Company Act Release No.
33449; File No. 812–14970]
Putnam Managed Municipal Income
Trust, et al.
April 17, 2019.
Securities and Exchange
Commission (‘‘Commission’’).
ACTION: Notice.
AGENCY:
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549.
VerDate Sep<11>2014
SECURITIES AND EXCHANGE
COMMISSION
Jkt 247001
Notice of an application under section
6(c) of the Investment Company Act of
1940 (‘‘Act’’) for an exemption from
section 19(b) of the Act and rule 19b–
1 under the Act to permit registered
closed-end investment companies to
make periodic distributions of long-term
capital gains more frequently than
permitted by section 19(b) or rule 19b–
1.
Applicants: Putnam Managed
Municipal Income Trust (‘‘PMM’’), a
diversified closed-end investment
company registered under the Act and
organized as a Massachusetts business
trust; Putnam Master Intermediate
Income Trust (‘‘PIM’’), a diversified
closed-end investment company
registered under the Act and organized
as a Massachusetts business trust;
Putnam Municipal Opportunities Trust
(‘‘PMO’’), a non-diversified closed-end
investment company registered under
the Act and organized as a
Massachusetts business trust; Putnam
Premier Income Trust (‘‘PPT,’’ and
together with PMM, PIM, and PMO, the
‘‘Funds’’), a non-diversified closed-end
investment company registered under
the Act and organized as a
Massachusetts business trust; Putnam
Investment Management, LLC (‘‘Putnam
Management’’), a limited liability
company organized under the laws of
Massachusetts; and Putnam Investments
Limited (‘‘Putnam Investments,’’ and
together with Putnam Management, the
‘‘Advisers’’), a private limited company
organized under the laws of the United
Kingdom, each of Putnam Management
and Putnam Investments registered
under the Investment Advisers Act of
1940, and serving as investment adviser
and sub-adviser to the Funds,
respectively (the Advisers, together with
the Funds, the ‘‘Applicants’’).1
1 Applicants request that the order also apply to
each other registered closed-end investment
company advised or to be advised in the future by
Putnam Management, Putnam Investments, or by an
entity controlling, controlled by, or under common
control (within the meaning of section 2(a)(9) of the
Act) with Putnam Management or Putnam
Investments (including any successor in interest)
(each such entity, including the Advisers, also the
‘‘Adviser’’) that in the future seeks to rely on the
order (such investment companies, together with
PO 00000
Frm 00085
Fmt 4703
Sfmt 4703
Filing Dates: The application was
filed on November 6, 2018, and
amended on March 18, 2019.
Hearing or Notification of Hearing: An
order granting the application will be
issued unless the Commission orders a
hearing. Interested persons may request
a hearing by writing to the
Commission’s Secretary and serving
applicants with a copy of the request,
personally or by mail. Hearing requests
should be received by the Commission
by 5:30 p.m. on May 13, 2019, and
should be accompanied by proof of
service on applicants, in the form of an
affidavit or, for lawyers, a certificate of
service. Pursuant to Rule 0–5 under the
Act, hearing requests should state the
nature of the writer’s interest, any facts
bearing upon the desirability of a
hearing on the matter, the reason for the
request, and the issues contested.
Persons who wish to be notified of a
hearing may request notification by
writing to the Commission’s Secretary.
ADDRESSES: The Commission: Secretary,
U.S. Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090.
Applicants: Bryan Chegwidden, Esq.,
Ropes & Gray LLP, 1211 Avenue of the
Americas, New York, New York 10036
and Robert T. Burns, Vice President,
Putnam Investment Management, LLC,
100 Federal Street, Boston,
Massachusetts 02110.
FOR FURTHER INFORMATION CONTACT: Jill
Ehrlich, Senior Counsel at (202) 551–
6819, or Andrea Ottomanelli Magovern,
Branch Chief, at (202) 551–6821
(Division of Investment Management,
Chief Counsel’s Office).
SUPPLEMENTARY INFORMATION: The
following is a summary of the
application. The complete application
may be obtained via the Commission’s
website by searching for the file
number, or for an applicant using the
Company name box, at https://
www.sec.gov/search/search.htm, or by
calling (202) 551–8090.
Summary of the Application
1. Section 19(b) of the Act generally
makes it unlawful for any registered
investment company to make long-term
capital gains distributions more than
once every twelve months. Rule 19b–1
under the Act limits to one the number
of capital gain dividends, as defined in
section 852(b)(3)(C) of the Internal
Revenue Code of 1986 (‘‘Code,’’ and
such dividends, ‘‘distributions’’), that a
the Funds, are collectively the ‘‘Funds’’ and,
individually, a ‘‘Fund’’). A successor in interest is
limited to entities that result from a reorganization
into another jurisdiction or a change in the type of
business organization.
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]]>Agencies
[Federal Register Volume 84, Number 78 (Tuesday, April 23, 2019)]
[Notices]
[Pages 16915-16920]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-08083]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-85670; File No. SR-OCC-2019-801]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Advance Notice Related to the Options Clearing
Corporation's Margin Methodology for Volatility Index Futures
April 17, 2019.
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
March 18, 2019, the Options Clearing Corporation (``OCC'') filed with
the Securities and Exchange Commission (``Commission'') an advance
notice (``Advance Notice'') as described in Items I, II and III below,
which Items have been prepared by OCC. The Commission is publishing
this notice to solicit comments on the advance notice from interested
persons.
---------------------------------------------------------------------------
\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ 15 U.S.C. 78a et seq.
---------------------------------------------------------------------------
I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
This advance notice is in connection with proposed changes to OCC's
margin methodology for futures on indexes designed to measure
volatilities implied by prices of options on a particular underlying
interest (such indexes being ``Volatility Indexes,'' and futures
contracts on such Volatility Indexes being ``Volatility Index
Futures''). The proposed methodology enhancements for Volatility Index
Futures would include: (1) Introducing ``synthetic'' futures (discussed
below) into the daily re-estimation of prices and correlations for
Volatility Index Futures; (2) an enhanced statistical distribution for
modeling price returns of the ``synthetic'' futures; and (3) a new
anti-procyclical floor for variance estimates. The proposed changes are
discussed in detail in Section II below.
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. OCC also has included backtesting and
impact analysis of the proposed model changes in confidential Exhibit
3.
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.\4\
---------------------------------------------------------------------------
\4\ 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
The purpose of the proposed changes is to introduce enhancements to
OCC's margin methodology for Volatility Index Futures so that OCC's
margin model reflects more current market information for Volatility
Index Futures and allows for more appropriate modeling of the risk
attributes of such products. Specifically, the proposed methodology
enhancements for Volatility Index Futures would include: (1)
Introducing ``synthetic'' futures into the process for daily re-
estimation of prices and correlations for Volatility Index Futures; (2)
an enhanced statistical distribution for modeling price returns for
``synthetic'' futures; and (3) a new anti-procyclical floor for
variance estimates. OCC's current model for Volatility Index Futures
and the proposed changes thereto are described in further detail below.
Background
OCC's margin methodology, the System for Theoretical Analysis and
Numerical Simulations (``STANS''),\5\ is OCC's proprietary risk
management system that calculates Clearing Member margin requirements.
STANS utilizes large-scale Monte Carlo simulations to forecast price
and volatility movements in determining a Clearing Member's margin
requirement.\6\ The STANS
[[Page 16916]]
margin requirement is calculated at the portfolio level of Clearing
Member accounts with positions in marginable securities. The STANS
margin requirement consists of an estimate of a 99% expected shortfall
\7\ over a two-day time horizon and an add-on margin charge for model
risk (the concentration/dependence stress test charge).\8\ The STANS
methodology is used to measure the exposure of portfolios of options,
futures and cash instruments, including the Volatility Index Futures
cleared by OCC.\9\
---------------------------------------------------------------------------
\5\ See Securities Exchange Act Release No. 53322 (February 15,
2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-20).
\6\ See OCC Rule 601.
\7\ 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.
\8\ A detailed description of the STANS methodology is available
at https://optionsclearing.com/risk-management/margins/.
\9\ Pursuant to OCC Rule 601(e)(1), OCC also calculates initial
margin requirements for segregated futures accounts on a gross basis
using the Standard Portfolio Analysis of Risk Margin Calculation
System (``SPAN''). Commodity Futures Trading Commission (``CFTC'')
Rule 39.13(g)(8), requires, in relevant part, that derivatives
clearing organizations (``DCOs'') collect initial margin for
customer segregated futures accounts on a gross basis. While OCC
uses SPAN to calculate initial margin requirements for segregated
futures accounts on a gross basis, OCC believes that margin
requirements calculated on a net basis (i.e., permitting offsets
between different customers' positions held by a Clearing Member in
a segregated futures account using STANS) affords OCC additional
protections at the clearinghouse level against risks associated with
liquidating a Clearing Member's segregated futures account. As a
result, OCC calculates margin requirements for segregated futures
accounts using both SPAN on a gross basis and STANS on a net basis,
and if at any time OCC staff observes a segregated futures account
where initial margin calculated pursuant to STANS on a net basis
exceeds the initial margin calculated pursuant to SPAN on a gross
basis, OCC collateralizes this risk exposure by applying an
additional margin charge in the amount of such difference to the
account. See Securities Exchange Act Release No. 72331 (June 5,
2014), 79 FR 33607 (June 11, 2014) (SR-OCC-2014-13).
---------------------------------------------------------------------------
Volatility Indexes are indexes designed to measure the volatility
that is implied by the prices of options on a particular reference
index or asset. For example, the Cboe Volatility Index (``VIX'') is an
index designed to measure the 30-day expected volatility of the
Standard & Poor's 500 index (``SPX'').\10\ OCC currently clears futures
contracts on such Volatility Indexes. These Volatility Index Futures
contracts can consequently be viewed as an indication of the market's
future expectations of the volatility of a given Volatility Index's
underlying reference index (e.g., in the case of the VIX, providing a
snapshot of the expected market volatility of the underlying over the
term of the options making up the index).
---------------------------------------------------------------------------
\10\ Generally speaking, the implied volatility of an option is
a measure of the expected future volatility of the value of the
option's annualized standard deviation of the price of the
underlying security, index, or future at exercise, which is
reflected in the current option premium in the market. Using the
Black-Scholes options pricing model, the implied volatility is the
standard deviation of the underlying asset price necessary to arrive
at the market price of an option of a given strike, time to
maturity, underlying asset price and given the current risk-free
rate. In effect, the implied volatility is responsible for that
portion of the premium that cannot be explained by the then-current
intrinsic value (i.e., the difference between the price of the
underlying and the exercise price of the option) of the option,
discounted to reflect its time value.
---------------------------------------------------------------------------
Current Model for Volatility Index Futures
Under OCC's existing margin methodology, OCC models the potential
final settlement prices of Volatility Index Futures using the
underlying index as the risk factor.\11\ Final settlement prices are
simulated under the assumption that the logarithm of the values of the
risk factor (i.e., the underlying spot Volatility Index) follows a
mean-reverting \12\ random walk \13\ with normally-distributed
steps.\14\ The model is designed to calibrate the distribution that
defines this mean-reversion behavior so that the expected final
settlement prices of the futures match their currently-observed market
prices to ensure that margin coverage is sufficient to limit credit
exposures to OCC's participants under normal market conditions. OCC
recalculates the Monte Carlo scenarios of the returns of each futures
series over its remaining life so that the standard deviation of the
scenarios matches two days' worth of the implied volatility of near-
the-money and contemporaneously expiring options on the Volatility
Index, where available, in order to align with OCC's two-day
liquidation period assumption. Currently, the calibration for the
distribution is performed on a daily basis.
---------------------------------------------------------------------------
\11\ A ``risk factor'' within OCC's margin system may be defined
as a product or attribute whose historical data is used to estimate
and simulate the risk for an associated product.
\12\ In finance, the term ``mean reversion'' describes a
financial time series in which returns can be very unstable in the
short run but very stable in the long run.
\13\ A random walk is a continuous process with random
increments drawn independently from a particular distribution.
\14\ This is known as a Gaussian Ornstein-Uhlenbeck process. See
Uhlenbeck, G.E. and L.S. Ornstein, ``On the Theory of Brownian
Motion,'' Physical Review, 36, 823-841 (1930) (explaining the
Gaussian Ornstein-Uhlenbeck process).
---------------------------------------------------------------------------
OCC's current model for Volatility Index Futures, which utilizes
the underlying Volatility Index as the sole risk factor, is subject to
certain limitations, which would be addressed by the proposed changes
described herein. Volatility Indexes, unlike futures contracts, are not
investible (i.e., they cannot be replicated by static portfolios of
traded contracts). In addition, the futures market has a term structure
that cannot be modeled using just the underlying index. Finally,
futures on a Volatility Index are less volatile and less fat-tailed
\15\ than the index itself, and these features are term-dependent. The
current model was developed before sufficient data on the futures was
available, so a model based on ``synthetic'' futures,\16\ as proposed
herein, was not an option at the time. Also, the current model does not
account for certain strategies Clearing Members might employ involving
spreads between delivery dates, which may result in under-margining of
those positions.
---------------------------------------------------------------------------
\15\ A data set with a ``fat tail'' is one in which extreme
price returns have a higher probability of occurrence than would be
the case in a normal distribution.
\16\ As discussed in further detail below, a ``synthetic''
futures time series, for the intended purposes of OCC, relates to a
uniform substitute for a time series of daily settlement prices for
actual futures contracts, which persists over many expiration cycles
and thus can be used as a basis for econometric analysis.
---------------------------------------------------------------------------
In recent years, OCC has seen significant growth in trading volume
for Volatility Index Futures. As a result, OCC is proposing a number of
enhancements to its margin methodology designed to provide for more
accurate and responsive margin requirements for Volatility Index
Futures.
Proposed Changes
The purpose of the proposed changes is to introduce enhancements to
OCC's margin methodology so that OCC's margin models reflect more
current market information for Volatility Index Futures, introduce
asymmetry into the statistical distribution used to model price returns
of the ``synthetic'' futures, and reduce procyclicality \17\ in the
model.
---------------------------------------------------------------------------
\17\ A quality that is positively correlated with the overall
state of the market is deemed to be ``procyclical.'' For example,
procyclicality may be evidenced by increasing margin or Clearing
Fund requirements in times of stressed market conditions and low
margin or Clearing Fund requirements when markets are calm. Hence,
anti-procyclical features in a model are measures intended to
prevent risk-based models from fluctuating too drastically in
response to changing market conditions.
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The proposed changes would specifically include: (1) The daily re-
estimation of prices and correlations using ``synthetic'' futures; (2)
an enhanced statistical distribution for modeling price returns for
``synthetic'' futures; and (3) a new anti-procyclical
[[Page 16917]]
floor for variance estimates.\18\ The main feature of the proposed
model, relative to the current model, is the replacement of the
underlying Volatility Index itself as a risk factor by risk factors
that are based on observed futures prices (i.e., the ``synthetic''
futures contracts). The proposed change would introduce a new set of
risk factors and method for generating scenarios for those risk
factors, and hence Volatility Index Futures settlement prices, to be
incorporated into the STANS margin calculations. OCC believes its
proposed methodology would provide for more accurate and responsive
margin requirements and that the imposition of a floor for variance
estimates would mitigate procyclicality in OCC's margin methodology for
Volatility Index Futures. The proposed changes are described in further
detail below.
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\18\ OCC would also make a number of conforming changes
throughout it Margins Methodology so that the document arcuately
reflects the adoption of the new model.
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1. Daily Re-Estimations Using Synthetic Futures
As noted above, OCC currently models the potential final settlement
prices of Volatility Index Futures based on the underlying index
itself. OCC proposes to modify its modeling approach for Volatility
Index Futures by modeling the price distributions of ``synthetic''
futures on a daily basis based on the historical returns of futures
contracts with approximately the same tenor (as opposed to OCC's
current approach of calibrating the distribution based on the
Volatility Index itself). A ``synthetic'' futures time series for the
intended purposes of OCC relates to a uniform substitute for a time
series of daily settlement prices for actual futures contracts, which
persists over many expiration cycles and thus can be used as a basis
for econometric analysis. One feature of futures contracts is that each
contract may have a different expiration date, and at any one point in
time there may be a variety of futures contracts on the same underlying
interest, all with varying dates of expiry, so that there is no one
continuous time series for those futures. ``Synthetic'' futures can be
used to generate a continuous time series of futures contract prices
across multiple expirations. These ``synthetic'' futures price return
histories would be inputted into the existing Copula simulation process
in STANS alongside the underlying interests of OCC's other cleared and
cross-margin products and collateral. The purpose of this use of
``synthetic'' futures is to allow the margin system to better
approximate correlations between futures contracts of different tenors
by creating more price data points and their margin offsets.
Under the proposal, the historical ``synthetic'' time series for
these Volatility Indexes would be updated daily and mapped to their
corresponding futures contracts. By construction, the first
``synthetic'' time series would always contain returns of the front
contract (i.e., the contract closest to maturity, on any given day),
the second, which would correspond to the next month out, and the
remaining series would follow the same pattern. Following the
expiration date of the front contract, each contract within a time
series would be replaced with a contract maturing one month later.
While ``synthetic'' time series contain returns from different
contracts, a return on any given date is constructed from prices of the
same contract (e.g., as the front month futures contract ``rolls'' from
the current month to the subsequent month, returns on the roll date
would be constructed by using the same contract and not by calculating
returns across months). The marginal probability distribution
parameters for the ``synthetic'' time series (i.e., marginal
probabilities of various values of the variables in the distribution
without reference to the values of the other variables) would be
estimated daily using recent historical observations.\19\ In cases in
which the GARCH variance \20\ forecast falls below the sample variance,
in addition to being floored by the sample variance, the ``synthetic''
time series would additionally be ``scaled up'' through the
introduction of a new floor on variance estimates based on the
corresponding underlying index in order to reduce procyclicality in the
model (as discussed in further detail below).
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\19\ However, for any tenor extension or new contract that does
not have enough historical data for the associated ``synthetic''
security, the scenarios for the longest tenor ``synthetic'' with
enough history would be used as a proxy for generating futures
theoretical price scenarios. In this case, the long run floor
(discussed below) would be borrowed from the proxy ``synthetic.''
\20\ See generally Tim Bollerslev, ``Generalized Autoregressive
Conditional Heteroskedasticity,'' Journal of Econometrics, 31(3),
307-327 (1986). The acronym ``GARCH'' refers to an econometric model
that can be used to estimate volatility based on historical data.
The general distinction between the ``GARCH variance'' and the
``sample variance'' for a given time series is that the GARCH
variance uses the underlying time series data to forecast
volatility.
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OCC believes that using synthetic futures in its daily re-
estimation process would allow OCC's econometric model for Volatility
Index Futures to reflect more current market information and achieve
better coverage across the term curve.\21\ As a result, OCC believes
the proposed changes would result more accurate margin requirements for
Clearing Members under the current market conditions.
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\21\ In 2018, the Commission approved, and issued a Notice of
No-Objection to, proposed changes to OCC's margin methodology
designed to enable OCC to: (1) Obtain daily price data for equity
products for use in the daily estimation of econometric model
parameters; (2) enhance OCC's econometric model for updating
statistical parameters for all risk factors that reflect the most
recent data obtained; (3) improve the sensitivity and stability of
correlation estimates across risk factors by using de-volatized
returns; and (4) improve OCC's methodology related to the treatment
of defaulting securities. See Securities Exchange Act Release No.
83326 (May 24, 2018), 83 FR 25081 (May 31, 2018) (SR-OCC-2017-022)
and Securities Exchange Act Release No. 83305 (May 23, 2018), 83 FR
24536 (May 29, 2018) (SR-OCC-2017-811). Under the proposal,
correlation updates for ``synthetic'' futures would be done daily
with a one-day lag.
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2. Enhancements to Statistical Distribution for Volatility Index
Futures
In addition to using a ``synthetic'' futures price return history
in the process for daily re-estimation of model parameters, OCC is
proposing additional enhancements to its margin methodology for
Volatility Index Futures to introduce asymmetry into the statistical
distribution used to model price returns of the ``synthetic'' futures.
The econometric model currently used in STANS for all price risk
factors is an asymmetric GARCH(1,1) with symmetric Standardized Normal
Reciprocal Inverse Gaussian (or ``NRIG'')-distributed logarithmic
returns.\22\ OCC proposes to move to an asymmetric NRIG distribution
for purposes of modeling proportionate returns of the ``synthetic''
futures. OCC believes the asymmetric NRIG distribution has a better
``goodness of fit'' \23\ to the historical data and allows for more
appropriate modeling of observed asymmetry of the distribution. As a
result, OCC believes that the proposed change would lead to more
consistent treatment of returns both on the upside as well as downside
of the distribution. Accordingly, OCC believes that the proposed
changes would result in margin requirements for Volatility Index
Futures that respond more appropriately to changes in market volatility
and therefore are more accurate.
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\22\ See id.
\23\ The goodness of fit of a statistical model describes the
extent to which observed data match the values generated by the
model.
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3. Introduction of Anti-Procyclical Floor for Variance Estimates
OCC also proposes to introduce a new floor for variance estimates
of the Volatility Index Futures that would be
[[Page 16918]]
modeled under the newly proposed approach to mitigate procyclicality in
OCC's margin model. In order to incorporate a variance level implied by
a longer time series of data, OCC would calculate a floor for variance
estimates based on the underlying index (e.g., VIX) which is expected
to have a longer history that is more reflective of the long-run
variance level that cannot be otherwise captured using the
``synthetic'' futures data. The floor would therefore reduce the impact
of a sudden increase in margin requirements from a low level and
therefore mitigate procyclicality in the model.
Clearing Member Outreach
In order to inform Clearing Members of the proposed change, OCC has
provided updates to members at OCC Roundtable \24\ and Financial Risk
Advisory Council (or ``FRAC'') \25\ meetings and will provide
additional reminders about the proposed changes at its next FRAC
meeting. In addition, OCC will publish an Information Memo to all
Clearing Members describing the proposed changes and will provide
additional periodic Information Memo updates prior to the
implementation date. Additionally, OCC will perform targeted and direct
outreach with Clearing Members that would be most impacted by the
proposed change, and OCC would work closely with such Clearing Members
to coordinate the implementation and to discuss the impact and timing
of any required collateral deposits that may result from the proposed
change.\26\
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\24\ The OCC Roundtable was established to bring Clearing
Members, exchanges and OCC together to discuss industry and
operational issues. It is comprised of representatives of senior OCC
staff, participant exchanges and Clearing Members, representing the
diversity of OCC's membership in industry segments, OCC-cleared
volume, business type, operational structure and geography.
\25\ The Financial Risk Advisory Council is a working group
comprised of exchanges, Clearing Members and indirect participants
of OCC.
\26\ Specifically, OCC will discuss with those Clearing Members
how they plan to satisfy any increase in their margin requirements
associated with the proposed change.
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Implementation Timeframe
OCC plans to implement the proposed changes on May 20, 2019,
provided that all necessary regulatory approvals are received by that
date. If all regulatory approvals are not received by May 20, 2019, or
if implementation on that date becomes otherwise impractical, OCC will
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 any alternative implementation date of the
proposed changes by an Information Memo posted to its public website at
least one week prior to implementation.
Anticipated Effect on and Management of Risk
OCC believes that the proposed changes would reduce the nature and
level of risk presented by OCC because it would introduce enhancements
to OCC's margin methodology so that OCC's margin models reflect more
current market information for Volatility Index Futures; use a
statistical distribution for modeling proportionate returns of the
``synthetic'' futures, which OCC believes has a better ``goodness of
fit'' to the historical data and allows for more appropriate modeling
of observed asymmetry of the distribution; and reduce procyclicality in
the model.
The main feature of the proposed model, relative to the current
model, is the replacement of the underlying Volatility Index itself as
a risk factor by risk factors that are based on observed futures prices
(i.e., the ``synthetic'' futures contracts). OCC believes that using
``synthetic'' futures in its daily re-estimation process would allow
OCC's econometric model for Volatility Index Futures to reflect more
current market information and achieve better coverage across the term
curve. As a result, OCC believes the proposed changes would result more
accurate margin requirements for Clearing Members under the current
market conditions that respond more appropriately to changes in market
volatility. In addition, OCC believes that the proposed change to an
asymmetrical NRIG statistical distribution would lead to more
consistent treatment of returns both on the upside as well as downside
of the distribution and therefore result in margin requirements for
Volatility Index Futures that respond more appropriately to changes in
market volatility and therefore are more accurate. Finally, the
proposed changes would enhance OCC's approach for modeling Volatility
Index Futures by introducing a floor on variance estimates in the model
to mitigate procyclicality.
The proposed model would be used by OCC to calculate margin
requirements designed to limit its credit exposures to participants,
and OCC uses the margin it collects from a defaulting Clearing Member
to protect other Clearing Members from losses as a result of the
default and ensure that OCC is able to continue the prompt and accurate
clearance and settlement of its cleared products. Accordingly, OCC
believes the proposed changes would promote robust risk management for
Volatility Index futures and promote safety and soundness consistent
with the objectives and principles of Section 805(b) of the Clearing
Supervision Act.\27\
---------------------------------------------------------------------------
\27\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
For the foregoing reasons, OCC believes that the proposed change
would enhance OCC's management of risk and reduce the nature or level
of risk presented to OCC.
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.\28\
Section 805(a)(2) of the Clearing Supervision Act \29\ 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 \30\ states that the objectives
and principles for risk management standards prescribed under Section
805(a) shall be to:
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\28\ 12 U.S.C. 5461(b).
\29\ 12 U.S.C. 5464(a)(2).
\30\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
Promote robust risk management;
promote safety and soundness;
reduce systemic risks; and
support the stability of the broader financial system.
The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and the Act, which include
Commission Rules 17Ad-22(b)(1), (b)(2) and (e)(6).\31\
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\31\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016,
81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards for Covered
Clearing Agencies''). The Standards for Covered Clearing Agencies
became effective on December 12, 2016. OCC is a ``covered clearing
agency'' as defined in Rule 17Ad-22(a)(5) and therefore OCC must
comply with new section (e) of Rule 17Ad-22.
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Rule 17Ad-22(b)(1) \32\ requires that a registered clearing agency
that performs central counterparty services establish, implement,
maintain and enforce written policies and procedures reasonably
designed to measure its credit exposures to its participants at least
once a day and limit its exposures
[[Page 16919]]
to potential losses from defaults by its participants under normal
market conditions so that the operations of the clearing agency would
not be disrupted and non-defaulting participants would not be exposed
to losses that they cannot anticipate or control. As described above,
the proposed changes would introduce new model enhancements for OCC's
cleared Volatility Index Futures. OCC would use the risk-based model
enhancements described herein to measure its credit exposures to its
participants on a daily basis and determine margin requirements based
on such calculations. OCC believes that the proposed enhancements would
result in more accurate and responsive margin requirements by ensuring
that OCC's margin models reflect more current market information for
Volatility Index Futures and using an asymmetric distribution in its
model that has a better ``goodness of fit'' to the historical data and
allows for more appropriate modeling of observed asymmetry of the
distribution. The proposed changes would also introduce a new floor on
variance estimates in the model to mitigate procyclicality. OCC
believes the proposed changes are therefore designed to ensure that OCC
sets margin requirements that would serve to limit OCC's exposures to
potential losses from defaults by its participants under normal market
conditions so that the operations of OCC would not be disrupted, and
non-defaulting participants would not be exposed to losses that they
cannot anticipate or control. Accordingly, OCC believes the proposed
changes are consistent with Rule 17Ad-22(b)(1).\33\
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\32\ 17 CFR 240.17Ad-22(b)(1).
\33\ Id.
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Rule 17Ad-22(b)(2) \34\ further requires, in part, that a
registered clearing agency that performs central counterparty services
establish, implement, maintain and enforce written policies and
procedures reasonably designed use margin requirements to limit its
credit exposures to participants under normal market conditions and use
risk-based models and parameters to set margin requirements. As noted
above, OCC would use the proposed model enhancements to calculate
margin requirements for Volatility Index Futures in a manner designed
to limit its credit exposures to participants under normal market
conditions. Moreover, OCC believes that the proposed risk-based model
enhancements for Volatility Index Futures would result in more accurate
and responsive margin requirements for OCC's Clearing Members and would
introduce an asymmetric distribution into its model that has a better
``goodness of fit'' to the historical data and allows for more
appropriate modeling of observed asymmetry of the distribution. The
proposed floor on variance estimates would also help to reduce
procyclicality in margin requirements for Volatility Index Futures. The
risk-based model would therefore be used to calculate margin
requirements designed to limit OCC's credit exposures to participants
under normal market conditions in a manner consistent with Rule 17Ad-
22(b)(2).\35\
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\34\ 17 CFR 240.17Ad-22(b)(2).
\35\ Id.
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Rules 17Ad-22(e)(6)(i), (iii), and (v) \36\ further require that a
covered clearing agency establish, implement, maintain and enforce
written policies and procedures reasonably designed to cover its credit
exposures to its participants by establishing a risk-based margin
system that, among other things: (1) Considers, and produces margin
levels commensurate with, the risks and particular attributes of each
relevant product, portfolio, and market; (2) calculates margin
sufficient to cover its potential future exposure to participants in
the interval between the last margin collection and the close out of
positions following a participant default; and (3) uses an appropriate
method for measuring credit exposure that accounts for relevant product
risk factors and portfolio effects across products.
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\36\ 17 CFR 240.17Ad-22(e)(6)(i), (iii), and (v).
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As described in detail above, OCC believes that the proposed model
enhancements would result in more accurate, more responsive, and less
procyclical margin requirements for OCC's Clearing Members clearing
Volatility Index Futures, with such margin serving to protect other
Clearing Members from losses arising as a result of a Clearing Member
default. The proposed changes are intended to ensure that OCC's margin
models reflect more current market information for Volatility Index
Futures and would introduce an asymmetric distribution into its model
that has a better ``goodness of fit'' to the historical data and allows
for more appropriate modeling of the observed asymmetry of the
distribution. Additionally, OCC would introduce a floor on variance
estimates in the model to limit procyclicality. OCC therefore believes
the proposed changes are reasonably designed to consider and produce
margin levels commensurate with the risks and particular attributes of
OCC's cleared Volatility Index Futures, calculate margin sufficient to
cover its potential future exposure to participants in the interval
between the last margin collection and the close out of positions
following a participant default, and apply an appropriate method for
measuring credit exposure that accounts for risk factors and portfolio
effects of Volatility Index Futures in a manner consistent with Rules
17Ad-22(e)(6)(i), (iii), and (v).\37\
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\37\ Id.
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The changes are not inconsistent with the existing rules of OCC,
including any other rules proposed to be amended.
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:
[[Page 16920]]
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-2019-801 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-OCC-2019-801. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (https://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the advance notice that are filed with the
Commission, and all written communications relating to the advance
notice between the Commission and any person, other than those that may
be withheld from the public in accordance with the provisions of 5
U.S.C. 552, will be available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of 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-2019-801 and
should be submitted on or before May 7, 2019.
By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-08083 Filed 4-22-19; 8:45 am]
BILLING CODE 8011-01-P
