Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Proposed Rule Change Related to the Introduction of a New Liquidation Cost Model in The Options Clearing Corporation's Margin Methodology, 19815-19820 [2019-09147]
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Federal Register / Vol. 84, No. 87 / Monday, May 6, 2019 / Notices
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[Release No. 34–85755; File No. SR–OCC–
2019–004]
Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of Filing of Proposed Rule Change
Related to the Introduction of a New
Liquidation Cost Model in The Options
Clearing Corporation’s Margin
Methodology
April 30, 2019.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Exchange Act’’ or ‘‘Act’’),1 and Rule
19b–4 thereunder,2 notice is hereby
given that on April 18, 2019, the
Options Clearing Corporation (‘‘OCC’’)
filed with the Securities and Exchange
Commission (‘‘Commission’’) the
proposed rule change as described in
Items I, II, and III below, which Items
have been prepared by OCC. The
Commission is publishing this notice to
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
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solicit comments on the proposed rule
change from interested persons.
I. Clearing Agency’s Statement of the
Terms of Substance of the Proposed
Rule Change
The proposed rule change is filed in
connection with proposed changes to
OCC’s Margins Methodology, Margin
Policy, and Stress Testing and Clearing
Fund Methodology Description to add a
risk-based liquidation charge based on
bid-ask spreads to adjust the value of
positions to account for the costs of
liquidating a defaulting Clearing
Member’s portfolio.
The proposed changes to OCC’s
Margins Methodology, Margin Policy,
and Stress Testing and Clearing Fund
Methodology Description are contained
in confidential Exhibits 5A–5C 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 a summary of impact analysis
of the proposed model changes in
confidential Exhibit 3. The proposed
changes are described in detail in Item
II below.
The proposed rule change 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.3
II. Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Proposed Rule Change
In its filing with the Commission,
OCC included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item IV below. OCC has prepared
summaries, set forth in sections (A), (B),
and (C) below, of the most significant
aspects of these statements.
(A) Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Proposed Rule Change
(1) Purpose
Background
OCC’s margin methodology, the
System for Theoretical Analysis and
Numerical Simulations (‘‘STANS’’), is
OCC’s proprietary risk management
system that calculates Clearing Member
3 OCC’s By-Laws and Rules can be found on
OCC’s public website: https://optionsclearing.com/
about/publications/bylaws.jsp.
1 15
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margin requirements.4 STANS utilizes
large-scale Monte Carlo simulations to
forecast price and volatility movements
in determining a Clearing Member’s
margin requirement.5 The STANS
margin requirement is calculated at the
portfolio level of Clearing Member legal
entity marginable net positions tier
account (tiers can be customer, firm, or
market marker) and consists of an
estimate of a 99% 2-day expected
shortfall (‘‘99% Expected Shortfall’’)
and an add-on for model risk (the
concentration/dependence stress test
charge). The STANS methodology is
used to measure the exposure of
portfolios of options and futures cleared
by OCC and cash instruments in margin
collateral.
STANS margin requirements are
comprised of the sum of several
components, each reflecting a different
aspect of risk. The base component of
the STANS margin requirement for each
account is obtained using a risk measure
known as 99% Expected Shortfall.
Under the 99% Expected Shortfall
calculation, an account has a base
margin excess (deficit) if its positions in
cleared products, plus all existing
collateral—whether of types included in
the Monte Carlo simulation or of types
subjected to traditional ‘‘haircuts’’—
would have a positive (negative) net
worth after incurring a loss equal to the
average of all losses beyond the 99%
value at risk (or ‘‘VaR’’) point. This base
component is then adjusted by the
addition of a stress test component,
which is obtained from consideration of
the increases in 99% Expected Shortfall
that would arise from market
movements that are especially large
and/or in which various kinds of risk
factors exhibit perfect or zero
correlations in place of their
correlations estimated from historical
data, or from extreme adverse
idiosyncratic movements in individual
risk factors to which the account is
particularly exposed.6 STANS margin
requirements are intended to cover
potential losses due to price movements
over a two-day risk horizon; however,
the base and stress margin components
do not cover the potential liquidation
costs OCC may incur in closing out a
defaulted Clearing Member’s portfolio.7
4 See Securities Exchange Act Release No. 53322
(February 15, 2006), 71 FR 9403 (February 23, 2006)
(SR–OCC–2004–20). A detailed description of the
STANS methodology is available at https://
optionsclearing.com/risk-management/margins/.
5 See OCC Rule 601.
6 STANS margins may also include other add on
charges, which are considerably smaller than the
base and stress test components, and many of
which affect only a minority of accounts.
7 A liquidation cost model was introduced into
STANS in 2012 as part of OCC’s OTC clearing
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Closing out positions in a defaulted
Clearing Member’s portfolio could entail
selling longs at bid price and covering
shorts at ask price. This means that
additional liquidation costs may need to
take into account the bid-ask price
spreads.
Proposed Changes
OCC is proposing to enhance its
margin methodology by introducing a
new model to estimate the liquidation
cost for all options and futures, as well
as the securities in margin collateral. As
noted above, closing out positions of a
defaulted Clearing Member in the open
market could entail selling longs at bid
price and covering shorts at ask price.
These closing-out costs are currently not
taken into account in STANS for all
options (with the exception of longdated SPX index option series, as noted
above).8 Therefore, the purpose of the
proposed change is to add additional
financial resources in the form of
margin, based on liquidation cost grids
calibrated using historical stressed
periods, to guard against potential
shortfalls in margin requirements that
may arise due to the costs of liquidating
Clearing Member portfolios in the event
of a default. The liquidation cost charge
would be applied as an add-on to all
accounts incurring a STANS margin
charge.
The proposed liquidation cost model
calculates liquidation cost based on risk
measures, gross contract volumes and
market bid-ask spreads. In general, the
proposed model would be used to
calculate two risk-based liquidation
costs for a portfolio, Vega 9 liquidation
cost (‘‘Vega LC’’) and Delta liquidation
cost (‘‘Delta LC’’), using ‘‘Liquidation
Grids.’’ 10 Options products will incur
both Vega and Delta LCs while Deltaone 11 products such as futures
initiatives. The model is only applied to long-dated
options on the Standard & Poor’s (‘‘S&P’’) 500 index
(‘‘SPX’’) that have a tenor of three-years or greater.
See Securities Exchange Act Release No. 34–70719
(October 18, 2013), 78 FR 63548 (October 24, 2013)
(SR–OCC–2013–16). The existing liquidation model
for long-dated SPX options would be replaced by
this new model. OCC currently does not have any
open interest in OTC options. OCC does currently
clear similar exchange traded long-dated FLEX SPX
options; however, these options make up less than
0.5% of SPX options open interest.
8 Id.
9 The Delta and Vega of an option represent the
sensitivity of the option price with respect to the
price and volatility of the underlying security,
respectively.
10 ‘‘Liquidation Grids’’ would be comprised
collectively of Vega Liquidation Grids, Vega
Notional Grids, Delta Liquidation Grids, and Delta
Notional Grids. Liquidation Grids are discussed in
more detail below in the Creation and Calibration
of Liquidation Grids section.
11 ‘‘Delta one products’’ refer to products for
which a change in the value of the underlying asset
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contracts, Treasury securities and equity
securities, will have only a Delta charge.
The proposed liquidation cost model
described herein would include: (1) The
decomposition of the defaulter’s
portfolio into sub-portfolios by
underlying security; (2) the creation and
calibration of Liquidation Grids used to
determine liquidation costs; (3) the
calculation of the Vega LC (including a
minimum Vega LC charge) for options
products; (4) the calculation of Delta
LCs for both options and Delta-one
products; (5) the calculation of Vega and
Delta concentration factors; (6) the
calculation of volatility correlations for
Vega LCs; (7) the establishment of a
STANS margin floor based on the
liquidation cost; and (8) conforming
changes to OCC’s Margin Policy and
Stress Testing and Clearing Fund
Methodology Description.
The new liquidation cost model
would cover the following cleared
products in a Clearing Member’s
portfolio: Options on indices, equities,
Exchange Traded Funds (‘‘ETFs’’) and
futures; FLEX options; future contracts;
Treasury securities; and stock loan and
collateral securities. The securities not
included in STANS margin calculations
would not be covered by the new
model.
The proposed approach to calculating
liquidation costs and the conforming
changes to OCC’s Margin Policy are
described in further detail below.
1. Portfolio Decomposition and Creation
of Sub-Portfolios
For a portfolio consisting of many
contracts and underlyings, the proposed
model would first divide (or
decompose) the portfolio into subportfolios by underlying security such
that all contracts with the same
underlying are grouped into the same
sub-portfolio. The Vega LC and Delta LC
are first calculated at a sub-portfolio
level and then aggregated to derive the
final liquidation cost for the total
portfolio. All the option positions with
the same fundamental underlying
would form one sub-portfolio because
they share the same risk characteristics.
The equity index, index future and
index ETFs would all be categorized by
the underlying index that is the basis for
the index, future, and ETF-underlying
securities. The corresponding options
on the index, index future, and ETFs
would therefore fall into the same subportfolio. In addition, FLEX options on
the same underlying would be included
in the same sub-portfolio of the regular
options. Similarly, cash products such
results in a change of the same, or nearly the same,
proportion in the value of the product.
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as equities and futures would be
grouped in the same sub-category based
on their underlying symbols. All
Treasury security positions would form
one sub-portfolio. The calculation of
Vega LC and Delta LC for each subportfolio is summarized in the next
sections.
2. Creation and Calibration of
Liquidation Grids
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A key element of the proposed
liquidation cost model is the
‘‘Liquidation Grids.’’ The calculations of
Vega LC and Delta LC involve a number
of liquidity-related quantities such as
volatility bid-ask spreads, price bid-ask
spreads, Vega notional, and Delta
notional. The collection of these
quantities would be used to create the
following Liquidation Grids.
1. Vega Liquidation Grids (or volatility
grids): The Vega Liquidation Grids
would represent the level of bid-ask
spreads on the implied volatility of
option contracts for a given underlying.
Since the volatility spreads of option
contracts vary by the Delta and tenor of
the option, OCC would divide the
contracts into several Delta buckets by
tenor buckets.12 Each pair (Delta, tenor)
is referred to as a Vega bucket. For each
bucket, an average volatility spread is
estimated and defined as the volatility
grid for the bucket. The size of grid
would essentially represent the cost for
liquidating one unit of Vega risk in the
bucket.
2. Vega Notional Grid: The Vega
Notional Grid of an underlying security
would be the average trading options
volume weighted by the Vega of all
options on the given underlying. The
size of Vega Notional grids would
indicate the average daily trading
volume in terms of dollar Vegas (i.e., the
Vega multiplied by the volume of the
option).
3. Delta Liquidation Grid: The Delta
liquidation grid would represent an
estimated bid-ask price spread (in
percentage) on the underlying.13 It
12 Initially, Vega Liquidation Grids would consist
of 5 Delta buckets by 5 tenor buckets, with a total
of 25 pairs; however, the Vega Liquidation Grids
would be reviewed annually or at a frequency
determined by OCC’s Model Risk Working Group
(‘‘MRWG’’) and updated as needed as determined
by the MRWG. The MRWG is responsible for
assisting OCC’s Management Committee in
overseeing and governing OCC’s model-related risk
issues and includes representatives from OCC’s
Financial Risk Management department,
Quantitative Risk Management department, Model
Validation Group, and Enterprise Risk Management
department.
13 Delta Liquidation Grids are comprised of
several rows representing liquidity categories for
the underlying security (initially 14 rows, subject to
periodic review and modification) and one column
representing the cost of liquidating one dollar unit
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represents the cost of liquidating one
dollar unit of the underlying security.
The Delta liquidation grid for Treasury
securities represents bid-ask yield
spreads, expressed in basis points.
4. Delta Notional Grid: The Delta
Notional grid of an underlying security
would represent the average trading
volume in dollars of the security.14
Vega Notional Grids are calibrated at
the security level; that is, each
individual underlying security would
have its own Vega Notional. The Delta
Notional Grid and both Vega and Delta
Liquidation Grids for all underlying
securities are estimated at the levels of
a fixed number of classes based on their
liquidity level.15 All equity securities
would be divided, based on their
membership in commonly used market
indices (including, but not limited to,
the S&P 100 and 500 index) or other
market liquidity measurements, into
liquidity classes (which may include,
but are not limited to, High Liquid
Equities, Medium Liquid Equities and
Low Liquid Equities). Any new equity
security would generally default to the
lowest liquidity classification unless
otherwise assigned to a higher liquidity
classification when deemed necessary.
Major indices (e.g., SPX or the Cboe
Volatility Index (‘‘VIX’’)) may form their
own index liquidity class, which may
cover indices, index ETFs, and index
futures. In addition, sector ETFs, ETFs
on a major commodity (such as Gold,
Crude/Natural Gas, Metals, and
Electricity), and Treasury ETFs would
generally each form individual classes
of their own, subject to the availability
of liquidation data. Pursuant to the
proposed Margins Methodology, these
liquidity classes would be reviewed
annually or at a frequency determined
by OCC’s MRWG and updated as
needed, taking into consideration such
factors including, but not limited to,
changes in membership of the S&P 100
index and S&P 500 index, listing and
of the underlying security. The Delta Liquidation
Grids would be reviewed annually or at a frequency
determined by OCC’s MRWG and updated as
needed as determined by the MRWG.
14 Delta Notional Grids are comprised of several
rows representing liquidity categories for the
underlying security (initially 14 rows, subject to
periodic review and modification) and one column
representing the average trading volume in dollars
of the underlying security. The Delta Notional Grids
would be reviewed annually or at a frequency
determined by OCC’s MRWG and updated as
needed as determined by the MRWG.
15 Within the same liquidity group, the Vega
Notional can vary dramatically from name to name.
Moreover, Vega risk can be much greater than Delta
risk. As a result, OCC would calculate Vega
Notionals at the security level as opposed to the
liquidity level.
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19817
delisting of securities, and any corporate
actions on the existing securities.
Because the bid-ask spreads can
change daily, the use of spreads from
current market conditions could cause
liquidation costs to fluctuate
dramatically with market volatility,
especially during a stressed market
period. To mitigate this procyclicality
issue, Liquidation Grids would be
calibrated from several historical
stressed periods, which are selected
based on the history of VIX index levels
and would remain unchanged with time
until a new stressed period is selected
and added to the calibrations in
accordance with the requirements of the
proposed Margins Methodology.16
3. Vega Liquidation Cost
Vega Liquidation Cost Calculation
Vega LC is the main component of the
proposed liquidation cost model. For a
simple option contract, the Vega LC
would be its position Vega multiplied
by its respective bucket in the Vega
Liquidation Grid. The result is
approximately equal to one half of the
bid-ask price spread. For a portfolio
consisting of many contracts and
underlyings, the model first divides the
portfolio into sub-portfolios by
underlying security such that all
contracts with the same underlying are
grouped into the same sub-portfolio (as
described above). The Vega LCs for subportfolios are calculated first and then
aggregated to derive the Vega LC for the
total portfolio.
The Vega LC for a sub-portfolio,
which consists of all the contracts with
the same underlying security, would be
calculated in several steps. First, the
Liquidation Grids would be calibrated
for Vega ‘‘buckets’’ that consist of Delta
bins by tenor bins as discussed above.
These Vega buckets are used to
represent the volatility risk at the
different areas on the implied volatility
surface. Next, the Vega of each contract
position in a given sub-portfolio would
be calculated and bucketed into one of
the Vega buckets. The Vegas falling into
the same Vega bucket would then be
netted. The Vega LC for each of the Vega
buckets is calculated as the net Vega
multiplied by the Vega grid of the
buckets. Finally, the total liquidation
cost for the sub-portfolio would be
aggregated from these bucket Vega LCs
by using correlations between the Vega
buckets. Since the sub-portfolios are
formed by the fundamental equity or
index underlying the option, the Vega
LCs of closely related but different
16 The Liquidation Grids will be reviewed
annually or at a frequency determined by the
MRWG.
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underlying securities are allowed to net.
For example, Vega LCs for SPX and
related indices, futures, and ETFs that
are based on the S&P 500 index would
be allowed 100% netting.
The Vega LC for the total portfolio
would be a similar correlation-based
sum of Vega LCs of all the subportfolios, taking into account
correlations between the products’
implied volatility.17
Minimum Liquidation Cost
Because the proposed model allows
risk netting across closely related option
contracts, it is possible that a wellhedged option strategy could result in a
very small or zero liquidation cost. To
prevent this from happening, a
minimum liquidation cost would be
introduced to the Vega liquidation
charges. The minimum liquidation cost
for a sub-portfolio would be calculated
as the gross number of option contracts
multiplied by a minimum cost per
contract value.18 The minimum cost
amount would be calculated for the
entire portfolio and would be used to
floor the final total Vega LC. The
proposal would not apply a minimum
cost for Delta LC due to the immaterial
impact a minimum Delta LC would have
on the overall liquidation cost charge.
4. Delta Liquidation Cost
In addition to Vega risk, the model
also considers the Delta risk presented
in an entire portfolio. If a portfolio has
positions in either options, futures,
equities, or Treasury securities, it will
contain some Delta risk. Under the
proposed model, the liquidation cost
due to Delta risk in a sub-portfolio (as
defined by the underlying) would be
approximated by the net dollar Delta of
the sub-portfolio multiplied by its
respective bucket in the Delta
Liquidation Grid.
The proposed model would allow
netting of Delta LC if the option
contracts, futures, or equity positions
belong to or are related to a top index
(such as SPX or VIX). For example, in
a portfolio, positions in SPX-related
options, options on futures, futures, or
collateral have their Delta LC netted.
Under the proposed model, U.S.
dollar Treasury bonds would form one
sub-portfolio. The Delta or DV01 (i.e.,
dollar value of one basis point) of all the
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17 See
infra, Volatility Correlations section.
minimum cost rate would initially be set
as $2 per contract, unless the position is long and
the net asset value per contract is less than $2. (For
a typical option with a contract size of 100, this
would occur if the option was priced below 0.02.)
This value would be reviewed annually or at a
frequency determined by OCC’s MRWG and
recalibrated as needed over time.
18 The
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bonds would be calculated and
bucketed into six tenor buckets. For
each bucket, the liquidation cost would
be approximated by the absolute value
of the net DV01 of the bucket multiplied
by the Liquidation Grid (in basis points)
in the corresponding tenor bucket. The
total liquidation cost for the Treasury
security sub-portfolio would then be a
sum of the costs over all the buckets.
The Delta LC for the total portfolio
would be simple sum of the Delta LCs
over all sub-portfolios.
5. Concentration Charges
In addition to Vega and Delta LCs, the
proposed model also would incorporate
the potential risks involved in closing
out large or concentrated positions in a
portfolio. The ‘‘largeness’’ of an option
position is typically measured in terms
of Average Daily Volume (‘‘ADV’’). The
Vega volume or notional, defined as
‘‘Vega-weighted ADV,’’ is also a relevant
measure of options trading volume.
Closing out large or concentrated
positions with one or more Vega
notional may either take longer to
liquidate or demand wider spreads, and
therefore could incur additional cost. To
cover this additional risk, the proposed
model would use Vega concentration
factors (‘‘Vega CF’’) to scale the Vega LC
for option positions. The Vega CFs
would be equal to one for small
positions that are less than one Vega
notional, but may be scaled up for large
positions as a function of the size of the
positions. Similar to Vega CF, Delta
concentration factors (‘‘Delta CF’’)
would be used to scale the Delta LC to
account for the concentration risk
associated with large Delta positions.
6. Volatility Correlations
Under the proposed model, the Vega
LC for each underlying sub-portfolio is
calculated using correlations between
the Vega buckets. The correlation matrix
from the most liquid product (SPX)
would be used as the base and would be
scaled for other underlyings based on
their liquidity class. These would be
calibrated from time periods that
overlap the stress periods used to
calculate Liquidation Grids.
To aggregate the liquidation cost at
the portfolio level, the pair-wise
correlations of implied volatilities
between different underlyings are
needed. OCC would use a single
correlation value for all crossunderlying correlations rather than a
correlation matrix for all crossunderlying correlations to simplify the
calibration of the grids. To account for
potential errors that may arise from
using a single correlation value, OCC
would calculate three single correlations
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representing the minimum, average, and
maximum correlation across the
liquidity class to determine three
different Vega LCs. The highest of these
three Vega LCs would be used as the
final Vega LC.
7. STANS Margin Floor
The proposed liquidation costs would
be added to the base and stress margin
components of STANS that are intended
to cover the potential losses due to price
movements over a two-day risk horizon.
In certain cases, well-hedged portfolios
may not experience any loss and the
resultant STANS margin requirement is
close to zero or may even become
positive in some extreme cases. If the
STANS requirement is positive, this
may result in a credit instead of a charge
for the Clearing Member. To account for
the risk of potentially liquidating a
portfolio at current (instead of two-day
ahead) prices, no credit from the margin
would be allowed so that the final
margin requirement would not be lower
than the amount of the liquidation cost.
8. Margin Policy and Stress Testing and
Clearing Fund Methodology Description
OCC also would make conforming
changes to its Margin Policy and Stress
Testing and Clearing Fund Methodology
Description to reflect the inclusion of
the new liquidation cost charge as an
add-on charge to the base STANS
margin and how the liquidation cost
charge add-on would be incorporated in
Clearing Fund shortfall calculations.19
Clearing Member Outreach
To inform Clearing Members of the
proposed change, OCC has provided
overviews of its proposed liquidation
cost model to the Financial Risk
Advisory Council (‘‘FRAC’’), a working
group comprised of exchanges, Clearing
Members and indirect participants of
OCC, and the OCC Roundtable, which
was established to bring Clearing
Members, exchanges and OCC together
to discuss industry and operational
issues,20 during 2016 and 2017. OCC
19 The Stress Testing and Clearing Fund
Methodology Description would be revised to note
that the shortfall of a portfolio is calculated by
offsetting its profit and loss (‘‘PnL’’) in a stress
scenario with its STANS margin assets, which
include base margin (i.e., 99% Expected Shortfall),
excess net asset value related to long option
premium, any non-collateral-in-margins haircut
amounts, and various other Add-On Charges such
as the proposed liquidation cost charges. Since the
cost of liquidation is not considered in stress
scenario PnL, a charge for liquidation costs using
the same values as calculated for margins is
included in shortfall calculations to ensure that the
liquidation cost charge is part of the required total
credit financial resources.
20 The OCC Roundtable is comprised of
representatives of the senior OCC staff, participant
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has also published Information Memos
to all Clearing Members discussing the
proposed change.
Under the proposed liquidation cost
model, each Clearing Member/account
would independently observe different
levels of impact based on the
composition of their cleared portfolios.
Based on OCC’s analysis to-date,
directional portfolios containing more
outright positions, which are more
typically associated with customer
accounts, are most likely to see the
largest impact from the proposed
liquidation cost charges, while more
well-hedged portfolios, such as market
maker accounts, would be less impacted
(and are more likely to incur the
minimum liquidation cost charge). In
the aggregate, OCC expects the proposed
liquidation cost charges to make up
approximately 5–8% of total risk margin
charges, with customer accounts
accounting for roughly 60% of the
proposed liquidation cost charges, and
proprietary accounts and market
markers generating approximately 25%
and 15% of the proposed liquidation
cost charges, respectively.
Given the magnitude of expected
changes in margins, OCC expects to
conduct an extended parallel
implementation for Clearing Members
prior to implementation. Additionally,
OCC will perform additional outreach to
the FRAC upon submission of its
regulatory filings to remind Clearing
Members of the pending changes and
direct outreach with those Clearing
Members that would be most impacted
by the proposed change and would
work closely with such Clearing
Members to coordinate the
implementation and associated funding
for such Clearing Members resulting
from the proposed change.21
Implementation Timeframe
jbell on DSK3GLQ082PROD with NOTICES
OCC expects to implement the
proposed changes no sooner than thirty
(30) days and no later than one hundred
eighty (180) days from the date that OCC
receives all necessary regulatory
approvals for the filings. OCC will
announce the implementation date of
the proposed change by an Information
Memo posted to its public website at
least two (2) weeks prior to
implementation.
exchanges and Clearing Members, representing the
diversity of OCC’s membership in industry
segments, OCC-cleared volume, business type,
operational structure and geography.
21 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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(2) Statutory Basis
OCC believes the proposed rule
change is consistent with Section 17A of
the Act 22 and the regulations
thereunder. Section 17A(b)(3)(F) of the
Act,23 requires, among other things, that
the rules of a clearing agency be
designed to promote the prompt and
accurate clearance and settlement of
securities transactions and, to the extent
applicable, derivative agreements,
contracts, and transactions, to assure the
safeguarding of securities and funds
which are in the custody or control of
the clearing or agency or for which it is
responsible, and, in general, to protect
investors and the public interest. As
described above, STANS margin
requirements are comprised of the sum
of several components, each reflecting a
different aspect of risk. These margins
are intended to cover the potential
losses due to price movements over a
two-day risk horizon; however, the base
and stress margin components do not
cover the potential liquidation cost OCC
may incur in closing out a defaulted
Clearing Member’s portfolio. Closing out
positions in a defaulted portfolio could
entail selling longs at bid price and
covering shorts at ask price. This means
that additional liquidation costs may
need to take into account the bid-ask
price spreads. The proposed liquidation
cost model would calculate liquidation
costs for OCC’s cleared products based
on risk measures, gross contract
volumes and market bid-ask spreads.
The proposed model is designed to
provide additional financial resources
in the form of margin, based on
liquidation costs and current market
prices, to guard against potential
shortfalls in margin requirements that
may arise due to the costs of liquidating
Clearing Member portfolios. OCC uses
the margin it collects from a defaulting
Clearing Member to protect other
Clearing Members from losses they
cannot anticipate or control as a result
of such a default. As a result, OCC
believes the proposed changes would
reduce the overall level of risk to OCC,
its Clearing Members, and the markets
served by OCC. OCC believes that the
proposed rule change is therefore
designed, in general, to promote the
prompt and accurate clearance and
settlement of securities and derivatives
transactions, assure the safeguarding of
securities and funds which are in the
custody or control of OCC or for which
it is responsible, and protect investors
and the public interest in accordance
with Section 17A(b)(3)(F) of the Act.24
Rule 17Ad–22(b)(2) 25 requires, in
part, that a registered clearing agency
that performs central counterparty
services establish, implement, maintain
and enforce written policies and
procedures reasonably designed to 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 described above, the
proposed liquidation cost model is a
risk-based model that calculates
liquidation cost based on risk measures,
gross contract volumes, and market bidask spreads. The proposed model is
designed to provide additional financial
resources in the form of margin, based
on liquidation costs and current market
prices, to guard against potential
shortfalls in margin requirements that
may arise due to the costs of liquidating
Clearing Member portfolios, which
currently are not taken into account in
STANS for all of OCC’s cleared
products. Accordingly, the proposed
risk-based model would 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).26
Rule 17Ad–22(e)(6)(i) 27 further
requires a covered clearing agency that
provides central counterparty services
to establish, implement, maintain and
enforce written policies and procedures
reasonably designed to cover its credit
exposures to its participants by
establishing a risk-based margin system
that considers, and produces margin
levels commensurate with, the risks and
particular attributes of each relevant
product, portfolio, and market. The
proposed liquidation cost model is a
risk-based model that would calculate
additional margin charges designed to
account for potential shortfalls in
margin requirements that may arise due
to the costs of liquidating Clearing
Member portfolios by taking into
consideration the risks and attributes
associated with relevant products and
portfolios cleared by OCC (e.g.,
volatility bid-ask spreads, price bid-ask
spreads, Vega notional, and Delta
notional). Accordingly, OCC believes
the proposed changes are consistent
with Rule 17Ad–22(e)(6)(i).28
The proposed rule changes are not
inconsistent with the existing rules of
24 Id.
25 17
CFR 240.17Ad–22(b)(2).
26 Id.
22 17
23 17
PO 00000
U.S.C. 78q–1.
U.S.C. 78q–1(b)(3)(F).
Frm 00067
Fmt 4703
Sfmt 4703
19819
27 17
CFR 240.17Ad–22(e)(6)(i).
28 Id.
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OCC, including any other rules
proposed to be amended.
(B) Clearing Agency’s Statement on
Burden on Competition
Section 17A(b)(3)(I) of the Act 29
requires that the rules of a clearing
agency not impose any burden on
competition not necessary or
appropriate in furtherance of the
purposes of the Act. OCC believes that
while the proposed rule change may
have differing impacts on its Clearing
Members, it would not impose a burden
on competition. Moreover, OCC believes
that any competitive impact imposed by
the proposed liquidation cost model
would be necessary and appropriate in
furtherance of the purposes of Act.30 As
noted above, under the proposed
liquidation cost model, each Clearing
Member/account would independently
observe different levels of impact based
on the composition of their cleared
portfolios. Based on OCC’s analysis todate, directional portfolios containing
more outright positions, which are more
typically associated with customer
accounts, are most likely to see the
largest impact from the proposed
liquidation cost charges, while more
well-hedged portfolios, such as market
maker accounts, would be less impacted
(and are more likely to incur the
minimum liquidation cost charge). In
the aggregate, OCC expects the proposed
liquidation cost charges to make up
approximately 5–8% of total risk margin
charges, with customer accounts
accounting for roughly 60% of the
proposed liquidation cost charges, and
proprietary accounts and market
markers generating approximately 25%
and 15% of the proposed liquidation
cost charges, respectively.
The proposed changes are primarily
designed to allow OCC to determine
margin requirements that more
accurately represent the risk presented
by the extra cost in liquidating a
portfolio due to the bid-ask spread.
While the individual impact of the
proposed changes will vary and depend
on the composition of the portfolio in
question, the proposed risk model
enhancements are intended apply to all
Clearing Members to address potential
liquidation costs that OCC may incur in
closing out a defaulted Clearing
Member’s portfolio. OCC does not
believe that the proposed rule change
would unfairly inhibit access to OCC’s
services or disadvantage or favor any
particular user in relationship to
another user. Accordingly, OCC believes
that any competitive impact would be
29 15
U.S.C. 78q–1(b)(3)(I).
30 Id.
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19:35 May 03, 2019
Jkt 247001
necessary and appropriate in
furtherance of the prompt and accurate
clearance and settlement of securities
transactions, the safeguarding of
securities and funds which are in the
custody or control of OCC or for which
it is responsible, and in general, the
protection of investors and the public
interest.
(C) Clearing Agency’s Statement on
Comments on the Proposed Rule
Change Received From Members,
Participants or Others
Written comments on the proposed
rule change were not and are not
intended to be solicited with respect to
the proposed rule change and none have
been received.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of
publication of this notice in the Federal
Register or within such longer period
up to 90 days (i) as the Commission may
designate if it finds such longer period
to be appropriate and publishes its
reasons for so finding or (ii) as to which
the self- regulatory organization
consents, the Commission will:
(A) By order approve or disapprove
the proposed rule change, or
(B) institute proceedings to determine
whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Exchange
Act. Comments may be submitted by
any of the following methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
OCC–2019–004 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number SR–OCC–2019–004. 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/
PO 00000
Frm 00068
Fmt 4703
Sfmt 4703
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 such
filing also will be available for
inspection and copying at the principal
office of OCC and on OCC’s website at
https://www.theocc.com/about/
publications/bylaws.jsp.
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–2019–004 and should
be submitted on or before May 28, 2019.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.31
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019–09147 Filed 5–3–19; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–85752; File No. SR–MSRB–
2019–09]
Self-Regulatory Organizations;
Municipal Securities Rulemaking
Board; Notice of Filing and Immediate
Effectiveness of a Proposed Rule
Change To Eliminate MSRB Rule G–29,
on Availability of Board Rules
April 30, 2019.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (‘‘Act’’
or ‘‘Exchange Act’’) 1 and Rule 19b–4
thereunder,2 notice is hereby given that
on April 19, 2019 the Municipal
Securities Rulemaking Board (‘‘MSRB’’)
filed with the Securities and Exchange
Commission (‘‘SEC’’ or ‘‘Commission’’)
the proposed rule change as described
31 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
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]]>Agencies
[Federal Register Volume 84, Number 87 (Monday, May 6, 2019)]
[Notices]
[Pages 19815-19820]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-09147]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-85755; File No. SR-OCC-2019-004]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Related to the Introduction of
a New Liquidation Cost Model in The Options Clearing Corporation's
Margin Methodology
April 30, 2019.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on April 18, 2019, the Options Clearing
Corporation (``OCC'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change 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 proposed rule change
from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
The proposed rule change is filed in connection with proposed
changes to OCC's Margins Methodology, Margin Policy, and Stress Testing
and Clearing Fund Methodology Description to add a risk-based
liquidation charge based on bid-ask spreads to adjust the value of
positions to account for the costs of liquidating a defaulting Clearing
Member's portfolio.
The proposed changes to OCC's Margins Methodology, Margin Policy,
and Stress Testing and Clearing Fund Methodology Description are
contained in confidential Exhibits 5A-5C 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 a
summary of impact analysis of the proposed model changes in
confidential Exhibit 3. The proposed changes are described in detail in
Item II below.
The proposed rule change 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.\3\
---------------------------------------------------------------------------
\3\ 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 Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of these
statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
(1) Purpose
Background
OCC's margin methodology, the System for Theoretical Analysis and
Numerical Simulations (``STANS''), is OCC's proprietary risk management
system that calculates Clearing Member
[[Page 19816]]
margin requirements.\4\ STANS utilizes large-scale Monte Carlo
simulations to forecast price and volatility movements in determining a
Clearing Member's margin requirement.\5\ The STANS margin requirement
is calculated at the portfolio level of Clearing Member legal entity
marginable net positions tier account (tiers can be customer, firm, or
market marker) and consists of an estimate of a 99% 2-day expected
shortfall (``99% Expected Shortfall'') and an add-on for model risk
(the concentration/dependence stress test charge). The STANS
methodology is used to measure the exposure of portfolios of options
and futures cleared by OCC and cash instruments in margin collateral.
---------------------------------------------------------------------------
\4\ See Securities Exchange Act Release No. 53322 (February 15,
2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-20). A detailed
description of the STANS methodology is available at https://optionsclearing.com/risk-management/margins/.
\5\ See OCC Rule 601.
---------------------------------------------------------------------------
STANS margin requirements are comprised of the sum of several
components, each reflecting a different aspect of risk. The base
component of the STANS margin requirement for each account is obtained
using a risk measure known as 99% Expected Shortfall. Under the 99%
Expected Shortfall calculation, an account has a base margin excess
(deficit) if its positions in cleared products, plus all existing
collateral--whether of types included in the Monte Carlo simulation or
of types subjected to traditional ``haircuts''--would have a positive
(negative) net worth after incurring a loss equal to the average of all
losses beyond the 99% value at risk (or ``VaR'') point. This base
component is then adjusted by the addition of a stress test component,
which is obtained from consideration of the increases in 99% Expected
Shortfall that would arise from market movements that are especially
large and/or in which various kinds of risk factors exhibit perfect or
zero correlations in place of their correlations estimated from
historical data, or from extreme adverse idiosyncratic movements in
individual risk factors to which the account is particularly
exposed.\6\ STANS margin requirements are intended to cover potential
losses due to price movements over a two-day risk horizon; however, the
base and stress margin components do not cover the potential
liquidation costs OCC may incur in closing out a defaulted Clearing
Member's portfolio.\7\ Closing out positions in a defaulted Clearing
Member's portfolio could entail selling longs at bid price and covering
shorts at ask price. This means that additional liquidation costs may
need to take into account the bid-ask price spreads.
---------------------------------------------------------------------------
\6\ STANS margins may also include other add on charges, which
are considerably smaller than the base and stress test components,
and many of which affect only a minority of accounts.
\7\ A liquidation cost model was introduced into STANS in 2012
as part of OCC's OTC clearing initiatives. The model is only applied
to long-dated options on the Standard & Poor's (``S&P'') 500 index
(``SPX'') that have a tenor of three-years or greater. See
Securities Exchange Act Release No. 34-70719 (October 18, 2013), 78
FR 63548 (October 24, 2013) (SR-OCC-2013-16). The existing
liquidation model for long-dated SPX options would be replaced by
this new model. OCC currently does not have any open interest in OTC
options. OCC does currently clear similar exchange traded long-dated
FLEX SPX options; however, these options make up less than 0.5% of
SPX options open interest.
---------------------------------------------------------------------------
Proposed Changes
OCC is proposing to enhance its margin methodology by introducing a
new model to estimate the liquidation cost for all options and futures,
as well as the securities in margin collateral. As noted above, closing
out positions of a defaulted Clearing Member in the open market could
entail selling longs at bid price and covering shorts at ask price.
These closing-out costs are currently not taken into account in STANS
for all options (with the exception of long-dated SPX index option
series, as noted above).\8\ Therefore, the purpose of the proposed
change is to add additional financial resources in the form of margin,
based on liquidation cost grids calibrated using historical stressed
periods, to guard against potential shortfalls in margin requirements
that may arise due to the costs of liquidating Clearing Member
portfolios in the event of a default. The liquidation cost charge would
be applied as an add-on to all accounts incurring a STANS margin
charge.
---------------------------------------------------------------------------
\8\ Id.
---------------------------------------------------------------------------
The proposed liquidation cost model calculates liquidation cost
based on risk measures, gross contract volumes and market bid-ask
spreads. In general, the proposed model would be used to calculate two
risk-based liquidation costs for a portfolio, Vega \9\ liquidation cost
(``Vega LC'') and Delta liquidation cost (``Delta LC''), using
``Liquidation Grids.'' \10\ Options products will incur both Vega and
Delta LCs while Delta-one \11\ products such as futures contracts,
Treasury securities and equity securities, will have only a Delta
charge.
---------------------------------------------------------------------------
\9\ The Delta and Vega of an option represent the sensitivity of
the option price with respect to the price and volatility of the
underlying security, respectively.
\10\ ``Liquidation Grids'' would be comprised collectively of
Vega Liquidation Grids, Vega Notional Grids, Delta Liquidation
Grids, and Delta Notional Grids. Liquidation Grids are discussed in
more detail below in the Creation and Calibration of Liquidation
Grids section.
\11\ ``Delta one products'' refer to products for which a change
in the value of the underlying asset results in a change of the
same, or nearly the same, proportion in the value of the product.
---------------------------------------------------------------------------
The proposed liquidation cost model described herein would include:
(1) The decomposition of the defaulter's portfolio into sub-portfolios
by underlying security; (2) the creation and calibration of Liquidation
Grids used to determine liquidation costs; (3) the calculation of the
Vega LC (including a minimum Vega LC charge) for options products; (4)
the calculation of Delta LCs for both options and Delta-one products;
(5) the calculation of Vega and Delta concentration factors; (6) the
calculation of volatility correlations for Vega LCs; (7) the
establishment of a STANS margin floor based on the liquidation cost;
and (8) conforming changes to OCC's Margin Policy and Stress Testing
and Clearing Fund Methodology Description.
The new liquidation cost model would cover the following cleared
products in a Clearing Member's portfolio: Options on indices,
equities, Exchange Traded Funds (``ETFs'') and futures; FLEX options;
future contracts; Treasury securities; and stock loan and collateral
securities. The securities not included in STANS margin calculations
would not be covered by the new model.
The proposed approach to calculating liquidation costs and the
conforming changes to OCC's Margin Policy are described in further
detail below.
1. Portfolio Decomposition and Creation of Sub-Portfolios
For a portfolio consisting of many contracts and underlyings, the
proposed model would first divide (or decompose) the portfolio into
sub-portfolios by underlying security such that all contracts with the
same underlying are grouped into the same sub-portfolio. The Vega LC
and Delta LC are first calculated at a sub-portfolio level and then
aggregated to derive the final liquidation cost for the total
portfolio. All the option positions with the same fundamental
underlying would form one sub-portfolio because they share the same
risk characteristics. The equity index, index future and index ETFs
would all be categorized by the underlying index that is the basis for
the index, future, and ETF-underlying securities. The corresponding
options on the index, index future, and ETFs would therefore fall into
the same sub-portfolio. In addition, FLEX options on the same
underlying would be included in the same sub-portfolio of the regular
options. Similarly, cash products such
[[Page 19817]]
as equities and futures would be grouped in the same sub-category based
on their underlying symbols. All Treasury security positions would form
one sub-portfolio. The calculation of Vega LC and Delta LC for each
sub-portfolio is summarized in the next sections.
2. Creation and Calibration of Liquidation Grids
A key element of the proposed liquidation cost model is the
``Liquidation Grids.'' The calculations of Vega LC and Delta LC involve
a number of liquidity-related quantities such as volatility bid-ask
spreads, price bid-ask spreads, Vega notional, and Delta notional. The
collection of these quantities would be used to create the following
Liquidation Grids.
1. Vega Liquidation Grids (or volatility grids): The Vega
Liquidation Grids would represent the level of bid-ask spreads on the
implied volatility of option contracts for a given underlying. Since
the volatility spreads of option contracts vary by the Delta and tenor
of the option, OCC would divide the contracts into several Delta
buckets by tenor buckets.\12\ Each pair (Delta, tenor) is referred to
as a Vega bucket. For each bucket, an average volatility spread is
estimated and defined as the volatility grid for the bucket. The size
of grid would essentially represent the cost for liquidating one unit
of Vega risk in the bucket.
---------------------------------------------------------------------------
\12\ Initially, Vega Liquidation Grids would consist of 5 Delta
buckets by 5 tenor buckets, with a total of 25 pairs; however, the
Vega Liquidation Grids would be reviewed annually or at a frequency
determined by OCC's Model Risk Working Group (``MRWG'') and updated
as needed as determined by the MRWG. The MRWG is responsible for
assisting OCC's Management Committee in overseeing and governing
OCC's model-related risk issues and includes representatives from
OCC's Financial Risk Management department, Quantitative Risk
Management department, Model Validation Group, and Enterprise Risk
Management department.
---------------------------------------------------------------------------
2. Vega Notional Grid: The Vega Notional Grid of an underlying
security would be the average trading options volume weighted by the
Vega of all options on the given underlying. The size of Vega Notional
grids would indicate the average daily trading volume in terms of
dollar Vegas (i.e., the Vega multiplied by the volume of the option).
3. Delta Liquidation Grid: The Delta liquidation grid would
represent an estimated bid-ask price spread (in percentage) on the
underlying.\13\ It represents the cost of liquidating one dollar unit
of the underlying security. The Delta liquidation grid for Treasury
securities represents bid-ask yield spreads, expressed in basis points.
---------------------------------------------------------------------------
\13\ Delta Liquidation Grids are comprised of several rows
representing liquidity categories for the underlying security
(initially 14 rows, subject to periodic review and modification) and
one column representing the cost of liquidating one dollar unit of
the underlying security. The Delta Liquidation Grids would be
reviewed annually or at a frequency determined by OCC's MRWG and
updated as needed as determined by the MRWG.
---------------------------------------------------------------------------
4. Delta Notional Grid: The Delta Notional grid of an underlying
security would represent the average trading volume in dollars of the
security.\14\
---------------------------------------------------------------------------
\14\ Delta Notional Grids are comprised of several rows
representing liquidity categories for the underlying security
(initially 14 rows, subject to periodic review and modification) and
one column representing the average trading volume in dollars of the
underlying security. The Delta Notional Grids would be reviewed
annually or at a frequency determined by OCC's MRWG and updated as
needed as determined by the MRWG.
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Vega Notional Grids are calibrated at the security level; that is,
each individual underlying security would have its own Vega Notional.
The Delta Notional Grid and both Vega and Delta Liquidation Grids for
all underlying securities are estimated at the levels of a fixed number
of classes based on their liquidity level.\15\ All equity securities
would be divided, based on their membership in commonly used market
indices (including, but not limited to, the S&P 100 and 500 index) or
other market liquidity measurements, into liquidity classes (which may
include, but are not limited to, High Liquid Equities, Medium Liquid
Equities and Low Liquid Equities). Any new equity security would
generally default to the lowest liquidity classification unless
otherwise assigned to a higher liquidity classification when deemed
necessary. Major indices (e.g., SPX or the Cboe Volatility Index
(``VIX'')) may form their own index liquidity class, which may cover
indices, index ETFs, and index futures. In addition, sector ETFs, ETFs
on a major commodity (such as Gold, Crude/Natural Gas, Metals, and
Electricity), and Treasury ETFs would generally each form individual
classes of their own, subject to the availability of liquidation data.
Pursuant to the proposed Margins Methodology, these liquidity classes
would be reviewed annually or at a frequency determined by OCC's MRWG
and updated as needed, taking into consideration such factors
including, but not limited to, changes in membership of the S&P 100
index and S&P 500 index, listing and delisting of securities, and any
corporate actions on the existing securities.
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\15\ Within the same liquidity group, the Vega Notional can vary
dramatically from name to name. Moreover, Vega risk can be much
greater than Delta risk. As a result, OCC would calculate Vega
Notionals at the security level as opposed to the liquidity level.
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Because the bid-ask spreads can change daily, the use of spreads
from current market conditions could cause liquidation costs to
fluctuate dramatically with market volatility, especially during a
stressed market period. To mitigate this procyclicality issue,
Liquidation Grids would be calibrated from several historical stressed
periods, which are selected based on the history of VIX index levels
and would remain unchanged with time until a new stressed period is
selected and added to the calibrations in accordance with the
requirements of the proposed Margins Methodology.\16\
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\16\ The Liquidation Grids will be reviewed annually or at a
frequency determined by the MRWG.
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3. Vega Liquidation Cost
Vega Liquidation Cost Calculation
Vega LC is the main component of the proposed liquidation cost
model. For a simple option contract, the Vega LC would be its position
Vega multiplied by its respective bucket in the Vega Liquidation Grid.
The result is approximately equal to one half of the bid-ask price
spread. For a portfolio consisting of many contracts and underlyings,
the model first divides the portfolio into sub-portfolios by underlying
security such that all contracts with the same underlying are grouped
into the same sub-portfolio (as described above). The Vega LCs for sub-
portfolios are calculated first and then aggregated to derive the Vega
LC for the total portfolio.
The Vega LC for a sub-portfolio, which consists of all the
contracts with the same underlying security, would be calculated in
several steps. First, the Liquidation Grids would be calibrated for
Vega ``buckets'' that consist of Delta bins by tenor bins as discussed
above. These Vega buckets are used to represent the volatility risk at
the different areas on the implied volatility surface. Next, the Vega
of each contract position in a given sub-portfolio would be calculated
and bucketed into one of the Vega buckets. The Vegas falling into the
same Vega bucket would then be netted. The Vega LC for each of the Vega
buckets is calculated as the net Vega multiplied by the Vega grid of
the buckets. Finally, the total liquidation cost for the sub-portfolio
would be aggregated from these bucket Vega LCs by using correlations
between the Vega buckets. Since the sub-portfolios are formed by the
fundamental equity or index underlying the option, the Vega LCs of
closely related but different
[[Page 19818]]
underlying securities are allowed to net. For example, Vega LCs for SPX
and related indices, futures, and ETFs that are based on the S&P 500
index would be allowed 100% netting.
The Vega LC for the total portfolio would be a similar correlation-
based sum of Vega LCs of all the sub-portfolios, taking into account
correlations between the products' implied volatility.\17\
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\17\ See infra, Volatility Correlations section.
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Minimum Liquidation Cost
Because the proposed model allows risk netting across closely
related option contracts, it is possible that a well-hedged option
strategy could result in a very small or zero liquidation cost. To
prevent this from happening, a minimum liquidation cost would be
introduced to the Vega liquidation charges. The minimum liquidation
cost for a sub-portfolio would be calculated as the gross number of
option contracts multiplied by a minimum cost per contract value.\18\
The minimum cost amount would be calculated for the entire portfolio
and would be used to floor the final total Vega LC. The proposal would
not apply a minimum cost for Delta LC due to the immaterial impact a
minimum Delta LC would have on the overall liquidation cost charge.
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\18\ The minimum cost rate would initially be set as $2 per
contract, unless the position is long and the net asset value per
contract is less than $2. (For a typical option with a contract size
of 100, this would occur if the option was priced below 0.02.) This
value would be reviewed annually or at a frequency determined by
OCC's MRWG and recalibrated as needed over time.
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4. Delta Liquidation Cost
In addition to Vega risk, the model also considers the Delta risk
presented in an entire portfolio. If a portfolio has positions in
either options, futures, equities, or Treasury securities, it will
contain some Delta risk. Under the proposed model, the liquidation cost
due to Delta risk in a sub-portfolio (as defined by the underlying)
would be approximated by the net dollar Delta of the sub-portfolio
multiplied by its respective bucket in the Delta Liquidation Grid.
The proposed model would allow netting of Delta LC if the option
contracts, futures, or equity positions belong to or are related to a
top index (such as SPX or VIX). For example, in a portfolio, positions
in SPX-related options, options on futures, futures, or collateral have
their Delta LC netted.
Under the proposed model, U.S. dollar Treasury bonds would form one
sub-portfolio. The Delta or DV01 (i.e., dollar value of one basis
point) of all the bonds would be calculated and bucketed into six tenor
buckets. For each bucket, the liquidation cost would be approximated by
the absolute value of the net DV01 of the bucket multiplied by the
Liquidation Grid (in basis points) in the corresponding tenor bucket.
The total liquidation cost for the Treasury security sub-portfolio
would then be a sum of the costs over all the buckets.
The Delta LC for the total portfolio would be simple sum of the
Delta LCs over all sub-portfolios.
5. Concentration Charges
In addition to Vega and Delta LCs, the proposed model also would
incorporate the potential risks involved in closing out large or
concentrated positions in a portfolio. The ``largeness'' of an option
position is typically measured in terms of Average Daily Volume
(``ADV''). The Vega volume or notional, defined as ``Vega-weighted
ADV,'' is also a relevant measure of options trading volume. Closing
out large or concentrated positions with one or more Vega notional may
either take longer to liquidate or demand wider spreads, and therefore
could incur additional cost. To cover this additional risk, the
proposed model would use Vega concentration factors (``Vega CF'') to
scale the Vega LC for option positions. The Vega CFs would be equal to
one for small positions that are less than one Vega notional, but may
be scaled up for large positions as a function of the size of the
positions. Similar to Vega CF, Delta concentration factors (``Delta
CF'') would be used to scale the Delta LC to account for the
concentration risk associated with large Delta positions.
6. Volatility Correlations
Under the proposed model, the Vega LC for each underlying sub-
portfolio is calculated using correlations between the Vega buckets.
The correlation matrix from the most liquid product (SPX) would be used
as the base and would be scaled for other underlyings based on their
liquidity class. These would be calibrated from time periods that
overlap the stress periods used to calculate Liquidation Grids.
To aggregate the liquidation cost at the portfolio level, the pair-
wise correlations of implied volatilities between different underlyings
are needed. OCC would use a single correlation value for all cross-
underlying correlations rather than a correlation matrix for all cross-
underlying correlations to simplify the calibration of the grids. To
account for potential errors that may arise from using a single
correlation value, OCC would calculate three single correlations
representing the minimum, average, and maximum correlation across the
liquidity class to determine three different Vega LCs. The highest of
these three Vega LCs would be used as the final Vega LC.
7. STANS Margin Floor
The proposed liquidation costs would be added to the base and
stress margin components of STANS that are intended to cover the
potential losses due to price movements over a two-day risk horizon. In
certain cases, well-hedged portfolios may not experience any loss and
the resultant STANS margin requirement is close to zero or may even
become positive in some extreme cases. If the STANS requirement is
positive, this may result in a credit instead of a charge for the
Clearing Member. To account for the risk of potentially liquidating a
portfolio at current (instead of two-day ahead) prices, no credit from
the margin would be allowed so that the final margin requirement would
not be lower than the amount of the liquidation cost.
8. Margin Policy and Stress Testing and Clearing Fund Methodology
Description
OCC also would make conforming changes to its Margin Policy and
Stress Testing and Clearing Fund Methodology Description to reflect the
inclusion of the new liquidation cost charge as an add-on charge to the
base STANS margin and how the liquidation cost charge add-on would be
incorporated in Clearing Fund shortfall calculations.\19\
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\19\ The Stress Testing and Clearing Fund Methodology
Description would be revised to note that the shortfall of a
portfolio is calculated by offsetting its profit and loss (``PnL'')
in a stress scenario with its STANS margin assets, which include
base margin (i.e., 99% Expected Shortfall), excess net asset value
related to long option premium, any non-collateral-in-margins
haircut amounts, and various other Add-On Charges such as the
proposed liquidation cost charges. Since the cost of liquidation is
not considered in stress scenario PnL, a charge for liquidation
costs using the same values as calculated for margins is included in
shortfall calculations to ensure that the liquidation cost charge is
part of the required total credit financial resources.
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Clearing Member Outreach
To inform Clearing Members of the proposed change, OCC has provided
overviews of its proposed liquidation cost model to the Financial Risk
Advisory Council (``FRAC''), a working group comprised of exchanges,
Clearing Members and indirect participants of OCC, and the OCC
Roundtable, which was established to bring Clearing Members, exchanges
and OCC together to discuss industry and operational issues,\20\ during
2016 and 2017. OCC
[[Page 19819]]
has also published Information Memos to all Clearing Members discussing
the proposed change.
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\20\ The OCC Roundtable is comprised of representatives of the
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.
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Under the proposed liquidation cost model, each Clearing Member/
account would independently observe different levels of impact based on
the composition of their cleared portfolios. Based on OCC's analysis
to-date, directional portfolios containing more outright positions,
which are more typically associated with customer accounts, are most
likely to see the largest impact from the proposed liquidation cost
charges, while more well-hedged portfolios, such as market maker
accounts, would be less impacted (and are more likely to incur the
minimum liquidation cost charge). In the aggregate, OCC expects the
proposed liquidation cost charges to make up approximately 5-8% of
total risk margin charges, with customer accounts accounting for
roughly 60% of the proposed liquidation cost charges, and proprietary
accounts and market markers generating approximately 25% and 15% of the
proposed liquidation cost charges, respectively.
Given the magnitude of expected changes in margins, OCC expects to
conduct an extended parallel implementation for Clearing Members prior
to implementation. Additionally, OCC will perform additional outreach
to the FRAC upon submission of its regulatory filings to remind
Clearing Members of the pending changes and direct outreach with those
Clearing Members that would be most impacted by the proposed change and
would work closely with such Clearing Members to coordinate the
implementation and associated funding for such Clearing Members
resulting from the proposed change.\21\
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\21\ 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 expects to implement the proposed changes no sooner than thirty
(30) days and no later than one hundred eighty (180) days from the date
that OCC receives all necessary regulatory approvals for the filings.
OCC will announce the implementation date of the proposed change by an
Information Memo posted to its public website at least two (2) weeks
prior to implementation.
(2) Statutory Basis
OCC believes the proposed rule change is consistent with Section
17A of the Act \22\ and the regulations thereunder. Section
17A(b)(3)(F) of the Act,\23\ requires, among other things, that the
rules of a clearing agency be designed to promote the prompt and
accurate clearance and settlement of securities transactions and, to
the extent applicable, derivative agreements, contracts, and
transactions, to assure the safeguarding of securities and funds which
are in the custody or control of the clearing or agency or for which it
is responsible, and, in general, to protect investors and the public
interest. As described above, STANS margin requirements are comprised
of the sum of several components, each reflecting a different aspect of
risk. These margins are intended to cover the potential losses due to
price movements over a two-day risk horizon; however, the base and
stress margin components do not cover the potential liquidation cost
OCC may incur in closing out a defaulted Clearing Member's portfolio.
Closing out positions in a defaulted portfolio could entail selling
longs at bid price and covering shorts at ask price. This means that
additional liquidation costs may need to take into account the bid-ask
price spreads. The proposed liquidation cost model would calculate
liquidation costs for OCC's cleared products based on risk measures,
gross contract volumes and market bid-ask spreads. The proposed model
is designed to provide additional financial resources in the form of
margin, based on liquidation costs and current market prices, to guard
against potential shortfalls in margin requirements that may arise due
to the costs of liquidating Clearing Member portfolios. OCC uses the
margin it collects from a defaulting Clearing Member to protect other
Clearing Members from losses they cannot anticipate or control as a
result of such a default. As a result, OCC believes the proposed
changes would reduce the overall level of risk to OCC, its Clearing
Members, and the markets served by OCC. OCC believes that the proposed
rule change is therefore designed, in general, to promote the prompt
and accurate clearance and settlement of securities and derivatives
transactions, assure the safeguarding of securities and funds which are
in the custody or control of OCC or for which it is responsible, and
protect investors and the public interest in accordance with Section
17A(b)(3)(F) of the Act.\24\
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\22\ 17 U.S.C. 78q-1.
\23\ 17 U.S.C. 78q-1(b)(3)(F).
\24\ Id.
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Rule 17Ad-22(b)(2) \25\ requires, in part, that a registered
clearing agency that performs central counterparty services establish,
implement, maintain and enforce written policies and procedures
reasonably designed to 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 described
above, the proposed liquidation cost model is a risk-based model that
calculates liquidation cost based on risk measures, gross contract
volumes, and market bid-ask spreads. The proposed model is designed to
provide additional financial resources in the form of margin, based on
liquidation costs and current market prices, to guard against potential
shortfalls in margin requirements that may arise due to the costs of
liquidating Clearing Member portfolios, which currently are not taken
into account in STANS for all of OCC's cleared products. Accordingly,
the proposed risk-based model would 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).\26\
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\25\ 17 CFR 240.17Ad-22(b)(2).
\26\ Id.
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Rule 17Ad-22(e)(6)(i) \27\ further requires a covered clearing
agency that provides central counterparty services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to cover its credit exposures to its participants
by establishing a risk-based margin system that considers, and produces
margin levels commensurate with, the risks and particular attributes of
each relevant product, portfolio, and market. The proposed liquidation
cost model is a risk-based model that would calculate additional margin
charges designed to account for potential shortfalls in margin
requirements that may arise due to the costs of liquidating Clearing
Member portfolios by taking into consideration the risks and attributes
associated with relevant products and portfolios cleared by OCC (e.g.,
volatility bid-ask spreads, price bid-ask spreads, Vega notional, and
Delta notional). Accordingly, OCC believes the proposed changes are
consistent with Rule 17Ad-22(e)(6)(i).\28\
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\27\ 17 CFR 240.17Ad-22(e)(6)(i).
\28\ Id.
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The proposed rule changes are not inconsistent with the existing
rules of
[[Page 19820]]
OCC, including any other rules proposed to be amended.
(B) Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) of the Act \29\ requires that the rules of a
clearing agency not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act. OCC believes
that while the proposed rule change may have differing impacts on its
Clearing Members, it would not impose a burden on competition.
Moreover, OCC believes that any competitive impact imposed by the
proposed liquidation cost model would be necessary and appropriate in
furtherance of the purposes of Act.\30\ As noted above, under the
proposed liquidation cost model, each Clearing Member/account would
independently observe different levels of impact based on the
composition of their cleared portfolios. Based on OCC's analysis to-
date, directional portfolios containing more outright positions, which
are more typically associated with customer accounts, are most likely
to see the largest impact from the proposed liquidation cost charges,
while more well-hedged portfolios, such as market maker accounts, would
be less impacted (and are more likely to incur the minimum liquidation
cost charge). In the aggregate, OCC expects the proposed liquidation
cost charges to make up approximately 5-8% of total risk margin
charges, with customer accounts accounting for roughly 60% of the
proposed liquidation cost charges, and proprietary accounts and market
markers generating approximately 25% and 15% of the proposed
liquidation cost charges, respectively.
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\29\ 15 U.S.C. 78q-1(b)(3)(I).
\30\ Id.
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The proposed changes are primarily designed to allow OCC to
determine margin requirements that more accurately represent the risk
presented by the extra cost in liquidating a portfolio due to the bid-
ask spread. While the individual impact of the proposed changes will
vary and depend on the composition of the portfolio in question, the
proposed risk model enhancements are intended apply to all Clearing
Members to address potential liquidation costs that OCC may incur in
closing out a defaulted Clearing Member's portfolio. OCC does not
believe that the proposed rule change would unfairly inhibit access to
OCC's services or disadvantage or favor any particular user in
relationship to another user. Accordingly, OCC believes that any
competitive impact would be necessary and appropriate in furtherance of
the prompt and accurate clearance and settlement of securities
transactions, the safeguarding of securities and funds which are in the
custody or control of OCC or for which it is responsible, and in
general, the protection of investors and the public interest.
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments on the proposed rule change were not and are not
intended to be solicited with respect to the proposed rule change and
none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self- regulatory organization consents, the Commission will:
(A) By order approve or disapprove the proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Exchange Act. Comments may be submitted
by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-OCC-2019-004 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-OCC-2019-004. 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 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 such filing also will be available for inspection
and copying at the principal office of OCC and on OCC's website at
https://www.theocc.com/about/publications/bylaws.jsp.
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-2019-004 and
should be submitted on or before May 28, 2019.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\31\
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\31\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-09147 Filed 5-3-19; 8:45 am]
BILLING CODE 8011-01-P
