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]

Download as PDF Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices All submissions should refer to File Number SR–Phlx–2019–13. 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 (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements 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 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–Phlx–2019–13 and should be submitted on or before May 14, 2019. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.14 Jill M. Peterson, Assistant Secretary. [FR Doc. 2019–08100 Filed 4–22–19; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–85670; File No. SR–OCC– 2019–801] jbell on DSK3GLQ082PROD with NOTICES 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). VerDate Sep<11>2014 17:49 Apr 22, 2019 Jkt 247001 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: http://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 PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 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. E:\FR\FM\23APN1.SGM 23APN1 16916 Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices jbell on DSK3GLQ082PROD with NOTICES 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 http:// 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 VerDate Sep<11>2014 17:49 Apr 22, 2019 Jkt 247001 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). PO 00000 Frm 00081 Fmt 4703 Sfmt 4703 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. E:\FR\FM\23APN1.SGM 23APN1 Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices 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. jbell on DSK3GLQ082PROD with NOTICES 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. VerDate Sep<11>2014 17:49 Apr 22, 2019 Jkt 247001 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. PO 00000 Frm 00082 Fmt 4703 Sfmt 4703 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. E:\FR\FM\23APN1.SGM 23APN1 16918 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 jbell on DSK3GLQ082PROD with NOTICES 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. VerDate Sep<11>2014 17:49 Apr 22, 2019 Jkt 247001 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 PO 00000 Frm 00083 Fmt 4703 Sfmt 4703 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 E:\FR\FM\23APN1.SGM 23APN1 jbell on DSK3GLQ082PROD with NOTICES 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 Jkt 247001 PO 00000 CFR 240.17Ad–22(e)(6)(i), (iii), and (v). Frm 00084 Fmt 4703 Sfmt 4703 16919 37 Id. E:\FR\FM\23APN1.SGM 23APN1 16920 Federal Register / Vol. 84, No. 78 / Tuesday, April 23, 2019 / Notices Electronic Comments • Use the Commission’s internet comment form (http://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 (http://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 http:// 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. E:\FR\FM\23APN1.SGM 23APN1

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]


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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.
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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: http://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\
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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.
    \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 http://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.
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    \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.
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    \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.
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    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
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    \27\ 12 U.S.C. 5464(b).
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    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).
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     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 (http://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 (http://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