Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Proposed Rule Change Concerning a Proposed Capital Management Policy That Would Support The Options Clearing Corporation's Function as a Systemically Important Financial Market Utility, 44944-44952 [2019-18385]
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Federal Register / Vol. 84, No. 166 / Tuesday, August 27, 2019 / Notices
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Dated: August 22, 2019.
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[FR Doc. 2019–18391 Filed 8–26–19; 8:45 am]
II. Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Proposed Rule Change
BILLING CODE 7036–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–86725; File No. SR–OCC–
2019–007]
Self-Regulatory Organizations; The
Options Clearing Corporation; Notice
of Filing of Proposed Rule Change
Concerning a Proposed Capital
Management Policy That Would
Support The Options Clearing
Corporation’s Function as a
Systemically Important Financial
Market Utility
August 21, 2019.
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Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Exchange Act’’),1 and Rule 19b–4
thereunder,2 notice is hereby given that
on August 9, 2019, the Options Clearing
Corporation (‘‘OCC’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’ or ‘‘SEC) the proposed
rule change as described in Items I, II,
and III below, which Items have been
prepared primarily by OCC. The
Commission is publishing this notice to
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
This proposed rule change by OCC
would adopt a Capital Management
Policy, which includes OCC’s plan to
replenish its capital in the event it falls
close to or below its target capital (as
defined below, ‘‘Replenishment Plan’’).
The Capital Management Policy is
included in confidential Exhibit 5a of
the filing.3 In order to implement
aspects of the new Capital Management
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 The Commission notes that exhibits referenced
herein are included in the filing submitted by OCC
to the Commission, but are not included in this
Notice.
2 17
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Policy, the proposed rule change would
also amend the following governing
documents: OCC’s Rules, which can be
found in Exhibit 5b, and OCC’s
schedule of fees, which can be found in
Exhibit 5c. Material proposed to be
added to OCC’s Rules and schedule of
fees, as currently in effect, is marked by
underlining, and material proposed to
be deleted is marked with strikethrough
text. 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
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
OCC is proposing to adopt a new
Capital Management Policy and to make
amendments to OCC’s Rules and
schedule of fees necessary to implement
the new Capital Management Policy.
The main features of the Capital
Management Policy and the related
changes are: (a) To determine the
amount of Equity sufficient for OCC to
meet its regulatory obligations and to
serve market participants and the public
interest (as defined below, ‘‘Target
Capital Requirement’’), (b) to monitor
Equity 5 and liquid net assets funded by
equity (‘‘LNAFBE’’) 6 levels to help
ensure adequate financial resources are
available to meet general business
obligations; and (c) to manage Equity
levels, including by (i) adjusting OCC’s
fee schedule (as appropriate) and (ii)
establishing a plan for accessing
additional capital should OCC’s Equity
4 OCC’s By-Laws and Rules can be found on
OCC’s public website: https://optionsclearing.com/
about/publications/bylaws.jsp.
5 The Capital Management Policy would define
‘‘Equity’’ as shareholders’ equity as shown on
OCC’s Statement of Financial Condition.
6 The Capital Management Policy would define
‘‘LNAFBE’’ as the level of cash and cash
equivalents, no greater than Equity, less any
approved adjustments (i.e., agency-related liabilities
such as Section 31 fees held by OCC).
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fall below certain thresholds
(‘‘Replenishment Plan’’).
The Replenishment Plan would: (i)
Provide that should OCC’s Equity fall
below 110% of the Target Capital
Requirement (as defined by the Capital
Management Policy, ‘‘Early Warning’’),
Management would recommend to the
Board whether to implement a fee
increase in an amount the Board
determines necessary and appropriate to
raise additional Equity; (ii) provide that
should OCC’s Equity fall below 90% of
the Target Capital Requirement or fall
below the Target Capital Requirement
for a period of 90 consecutive days (as
defined in the Capital Management
Policy, ‘‘Trigger Event’’), OCC would
contribute the funds held under The
Options Clearing Corporation Executive
Deferred Compensation Plan Trust to
the extent that such funds are (x)
deposited on or after January 1, 2020 in
respect of its Executive Deferred
Compensation Plan (‘‘EDCP’’) and (y) in
excess of amounts necessary to pay for
benefits accrued and vested under the
EDCP at such time (such funds are
defined in Chapter 1 of the proposed
changes to OCC’s Rules as the ‘‘EDCP
Unvested Balance’’); and (iii) provide
that should contribution of the EDCP
Unvested Balance fail to cure the
Trigger Event, or if a further Trigger
Event occurs, OCC will charge an
Operational Loss Fee (as defined below)
in equal shares to the Clearing Members.
OCC is also hereby proposing to
create a layer of skin-in-the-game
resources in the event of default losses.
Specifically, OCC is amending Rule
1006 to state that: First, any current or
retained earnings above 110% of the
Target Capital Requirement will be used
to offset default losses after applying a
defaulting Clearing Member’s margin
and Clearing Fund contributions, and
next, any remaining loss will be charged
pro rata to (a) non-defaulting Clearing
Members’ Clearing Fund contributions,
and (b) the aggregate value of the EDCP
Unvested Balance.
Proposed Changes
OCC proposes to adopt a Capital
Management Policy and make
conforming changes to OCC’s Rules and
schedule of fees necessary to implement
the Capital Management Policy, as
described below, to formalize its policy
to identify, monitor, and manage OCC’s
capital needs to promote compliance
SEC Rule 17Ad–22(e)(15).7 In
formulating the Capital Management
Policy, OCC also has considered the
Commodity Futures Trading
Commission’s (‘‘CFTC’’) regulatory
7 17
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CFR 240.17Ad–22(e)(15).
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capital requirements for OCC as a DCO,
as set forth in CFTC Rule 39.11(a)(2).8
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Target Capital Requirement
The proposed Capital Management
Policy would explain how OCC would
annually determine the Target Capital
Requirement. The proposed amendment
to Chapter 1 of OCC’s Rules would
define OCC’s Target Capital
Requirement as the minimum level of
Equity recommended by Management
and approved by the Board to ensure
compliance with applicable regulatory
requirements and to keep such
additional amount the Board may
approve for capital expenditures.
Resources held to meet OCC’s Target
Capital Requirement would be in
addition to OCC’s resources to cover
participant defaults. OCC considers the
LNAFBE it holds, limited to cash and
cash equivalents, to be high quality and
sufficiently liquid to allow OCC to meet
its current and projected operating
expenses under a range of scenarios,
including in adverse market conditions.
The Capital Management Policy would
also explain that, on an annual basis,
OCC’s Chief Financial Officer (‘‘CFO’’)
would recommend a Target Capital
Requirement for the coming year.
Management would review the CFO’s
report and, as appropriate, recommend
the Target Capital Requirement to the
Compensation and Performance
Committee (‘‘CPC’’). The CPC would
review, and as appropriate, recommend
the proposal to the Board of Directors,
which would review, and as
appropriate, approve the Target Capital
Requirement.
SEC Rule 17Ad–22(e)(15)
OCC would set its Target Capital
Requirement at a level sufficient to
maintain LNAFBE at least equal to the
greatest of three amounts: (x) Sixmonths’ current operating expenses; (y)
the amount determined by the Board to
be sufficient to ensure a recovery or
orderly wind-down of critical
operations and services (the ‘‘RWD
Amount’’); and (z) the amount
determined by the Board to be sufficient
for OCC to continue operations and
services as a going concern if general
business losses materialize (the
‘‘Potential Loss Amount’’).
The RWD Amount would be the
amount recommended by Management
on an annual basis in accordance with
OCC’s Capital Management Procedure 9
8 17
CFR 39.11(a)(2).
Capital Management Procedure would be a
cross-department internal procedure that provides
direction on how those departments shall execute
their responsibilities under the proposed Capital
Management Policy. OCC has included a draft of
9 The
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and, as appropriate, approved by the
Board. OCC’s Recovery and Orderly
Wind-Down Plan (‘‘RWD Plan’’)
identifies critical services and the length
of time the Board has determined it
would take to recover or wind-down.10
Pursuant to the Capital Management
Procedure, Management would use the
assumptions in the RWD Plan to
determine the RWD Amount, which is
the cost to maintain those critical
services over the prescribed recovery or
wind-down period, assuming costs
remain at historical levels. The
calculation of the Potential Loss
Amount would be based on
Management’s annual determination,
pursuant to the Capital Management
Procedure, of the amount of capital
required to address OCC’s operational
risks. OCC quantifies the amount of
capital to be held against OCC’s
operational risks by analyzing and
aggregating potential losses from
individual operational risk scenarios,
aggregating the loss events, and
conducting loss modeling at or above
the 99% confidence level.11
CFTC Rule 39.11(a)(2)
The Capital Management Policy
would also specify that when setting the
Target Capital Requirement the Board
will consider OCC’s projected rolling
twelve-months’ operating expenses as
required by CFTC Rule 39.11(a)(2).12
For the avoidance of doubt, the Board is
not required to set the Target Capital
Requirement at the level of twelvemonths’ operating expenses.13 Factors
that OCC would consider when
considering twelve-months’ operating
expenses include, but are not limited to:
(i) OCC’s obligations and
responsibilities as a systemically
important financial utility (‘‘SIFMU’’),
the Capital Management Procedure OCC intends to
implement if the Commission approves the
proposed Capital Management Policy in
confidential Exhibit 3a, for reference. The
documents in Exhibit 3 are being provided as
supplemental information to the filing and would
not constitute part of OCC’s rules, which have been
provided in Exhibit 5.
10 Securities Exchange Act Release No. 83918
(Aug. 23, 2018), 83 FR 44091 (Aug. 29, 2018) (SR–
OCC–2017–021).
11 Pursuant to the Capital Management Procedure,
OCC’s Enterprise Risk Management department
(‘‘ERM’’) would quantify the Potential Loss Amount
on an annual basis and provide that information to
OCC’s Chief Financial Officer (‘‘CFO’’) as an input
to the CFO’s recommendation to Management for
the Target Capital Requirement. OCC has included
ERM’s process and methodology for quantifying the
Potential Loss Amount from 2015 through present
in confidential Exhibit 3b.
12 17 CFR 39.11(a)(2).
13 Financial resources available to meet CFTC
Rule 39.11(a)(2) are not limited to LNAFBE, and
include OCC’s own capital or any other form of
financial resources deemed acceptable by the CFTC.
See 17 CFR 39.11(b)(2).
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(ii) OCC’s obligations as a derivative
clearing organization under CFTC Rule
39.11(a)(2), (iii) the types of financial
resources the CFTC allows OCC to count
towards the twelve-month requirement,
and (iv) any conditions on the use of
those resources the CFTC has imposed.
Excess Equity for Capital Expenditures
In addition, the Capital Management
Policy would provide that OCC may
increase its Target Capital Requirement
by an amount to be retained for capital
expenditures following a
recommendation by Management and
Board approval. From time to time
Management may identify necessary
capital investments in OCC’s
technology, facilities or other business
tangible or intangible assets to enhance
its effectiveness, efficiency or
compliance posture. The Board would
(a) determine if the capital needs are
necessary and appropriate and, if so, (b)
determine whether to increase the
Target Capital Requirement or whether
the amount can be accumulated as an
amount in excess of the Target Capital
Requirement. In case of the latter,
capital in excess of 110% of the Target
Capital Requirement would be available
as skin in the game.14 Factors the Board
would consider in making this
determination include, but are not
limited to, the amount of funding
required, how much Equity is proposed
to be retained, the potential impact of
the investment on OCC’s operation, and
the duration of time over which funds
would be accumulated.
Monitoring Equity
The proposed Capital Management
Policy would describe how Management
reviews periodic analyses of LNAFBE,
including projecting future volume,
expenses, cash flows, capital needs and
other factors to help ensure adequate
financial resources are available to meet
general business obligations. Those
other factors would include, but not be
limited to: (i) The level of existing
prefunded corporate resources, (ii) the
ability to borrow under an existing OCC
line of credit; (iii) the ability to make a
claim under certain insurance policies;
(iv) OCC’s tax rates and liabilities; and
(v) unfunded obligations. The Capital
Management Policy would further
provide that Management would review
an analysis of Equity at least monthly to
identify whether an Early Warning or
Trigger Event had occurred since the
last review or was likely to occur before
14 See OCC Rule 1006(e), as proposed in the
changes attached [sic; the Commission notes that
‘‘attached’’ here means that the SRO included the
relevant document as a confidential exhibit to the
filing] as Exhibit 5b hereto.
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the next review. The Capital
Management Policy would provide that
the Board of Directors is notified
promptly if those triggers are breached.
To the extent OCC suffers a catastrophic
or sizable loss intra-month, and such
loss amount is known or can reasonably
be estimated, Management would
review a forecast of the impact on
Equity and, should that forecast
demonstrate that Equity has fallen
below the Early Warning or Trigger
Event, Management shall promptly
notify the Board.
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Managing Equity
The Capital Management Policy
would describe the actions OCC may
take to manage its current or future
levels of Equity. As described below, the
primary forms of capital management
actions would include: (i) Changes to
OCC’s fees or other tools to change costs
for market participants; (ii) the
Replenishment Plan; and (iii) use of
current and retained earnings greater
than 100% of the Target Capital
Requirement to cover losses caused by
the default of a Clearing Member.
Fee Schedule
The Capital Management Policy
would provide that clearing fees will be
based on the sum of OCC’s annual
budgeted/forecasted operating expenses,
a defined operating margin and OCC’s
capital needs, divided by forecasted
contract sides. On an annual basis,
Management would review the
operating margin level considering
historical volume variance and other
relevant factors, including but not
limited to variance in interest rates and
OCC’s operating expenses. Management
would recommend to the CPC, to which
the Board has delegated authority for
review and approval of changes to
OCC’s fees pursuant to the CPC’s
charter, whether changes to OCC’s
defined operating margin should be
made.
The Capital Management Policy
would provide that on a quarterly basis,
Management would review its fee
schedule and, considering factors
including, but not limited to projected
operating expenses, projected volumes,
anticipated cash flows, and capital
needs, recommend to the Board, or a
Committee to which the Board
delegated authority, whether a fee
increase, decrease or waiver should be
made in accordance with Article IX,
Section 9 of OCC’s By-Laws.15
The Capital Management Policy
would provide that if OCC’s Equity is
above, in the aggregate, 110% of the
15 OCC
By-Law Art. IX, § 9.
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Target Capital Requirement and any
amount of excess Equity the Board
approves for capital expenditures, the
Board of Directors, or a Committee the
Board has delegated, may use such tools
as it considers appropriate to lower
costs for Clearing Members, providing
the Board believes doing so would
likely not lower OCC’s Equity below the
Early Warning. Such tools would
include lowering fees, a fee holiday or
a refund. The Capital Management
Policy would further provide that if
OCC charges the Operational Loss Fee,
as described below, and its Equity
thereafter returns to a level at which the
Board approves use of such tools, OCC
would first employ tools to lower the
cost of Clearing Member participation in
equal share up to the amount of the
Operational Loss Fee charged. This
provision would help ensure that in the
event OCC must charge an Operational
Loss Fee to Clearing Members in equal
shares, Clearing Members will recover
the amount charged in equal shares up
to the amount charged.
Replenishment Plan
Early Warning
The Capital Management Policy
would provide that in the event OCC’s
Equity breaches the Early Warning
threshold, or 110% of the Target Capital
Requirement, Management would
recommend to the Board whether to
implement a fee increase in an amount
the Board determines necessary and
appropriate to raise additional Equity.16
The recommendation whether to
implement a fee increase would be
informed by several factors including,
but not limited to, (i) the facts,
circumstances and root cause of a
decrease in Equity below the Early
Warning threshold; (ii) the time it
would take to implement a fee increase,
inclusive of securing Board and SEC
approval as required for those actions;
(iii) the anticipated time a fee increase
would take to accumulate the needed
revenue based on projected contract
volume, operational expenses and
interest income over that time period;
and (iv) the potential of a Trigger Event.
The Early Warning is intended to
signal to OCC that its Equity is ‘‘close
to’’ the Target Capital Requirement, as
16 Pursuant to the Capital Management Procedure,
Management’s recommendation would be informed
by the clearing fee amount calculated pursuant to
the Fee Schedule Calculation Procedure, which
provides direction to OCC’s Finance department on
how to calculate the necessary fee level pursuant
to the requirements of the Capital Management
Policy. OCC has included a draft of the Fee
Schedule Calculation Procedure it intends to
implement if the Commission approves the
proposed Capital Management Policy in
confidential Exhibit 3c, for reference.
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directed by Rule 17Ad22(e)(15)(iii). The
Early Warning threshold is set at 110%
because based on an analysis of OCC’s
projected revenue and expenses,17 a
10% premium of the Target Capital
Requirement represents approximately
two months earnings based on current
and projected data,18 which OCC
believes would provide sufficient time
for Management and the Board to
respond. The Capital Management
Policy would provide that to the extent
Management determines, during its
annual review of the Capital
Management Policy, that there is a
change in the estimated length of time
to accumulate approximately 10% of the
Target Capital Requirement,
Management will consider whether to
recommend changes to the Early
Warning and Trigger Event thresholds.
Trigger Event
The Capital Management Policy
would also define a Trigger Event to be
when OCC’s Equity falls below 90% of
the Target Capital Requirement or
remains below the Target Capital
Requirement for ninety consecutive
calendar days. OCC is proposing the
90% threshold based on its analysis
showing that two-months’ earnings
represents approximately a 10%
premium of the Target Capital
Requirement, discussed above. OCC
believes, based on that analysis, that
Equity below the 90% threshold would
be a sign that corrective action more
significant and with a more immediate
impact than increasing fees should be
taken to increase OCC’s Equity Capital.
OCC also set another Trigger Event at a
threshold of Equity above 90% but
below the Target Capital Requirement
for a period of 90 consecutive days
based on the time necessary for a
clearing fee change to have an impact
and to exhaust remedies prior to
charging the Operational Loss Fee. This
timeframe takes into account 30-day
advance notice to Clearing Members to
implement the fee change,
implementation on the first of the
month to accommodate changes to
Clearing Members’ systems, and, as
discussed above, the approximately
two-month period required to
accumulate approximately 10% of the
Target Capital Requirement. Based on
the above-referenced analysis, OCC
believes that, in the event a fee increase
resulting from an Early Warning could
not increase OCC’s Equity above the
17 OCC has included the analysis in confidential
Exhibit 3d.
18 OCC defines earnings for purposes of this
analysis as Operating Income, or revenue less
expenses before taxes. Earnings does not include
interest pass through earned on the cash deposits.
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Target Capital Requirement within 90
days, it would likewise indicate that
corrective action in the form of a fee
increase would be insufficient.
If a Trigger Event occurs, OCC would
first contribute the EDCP Unvested
Balance to cure the loss. OCC believes
that contributing the EDCP Unvested
Balance to cover operational losses
would align Management’s interests
with OCC’s interest in maintaining
required regulatory capital and
operating OCC in a prudent manner. If
application of the EDCP Unvested
Balance brings OCC’s Equity to within
the Early Warning threshold (between
90% and 110% of the Target Capital
Requirement), OCC would act to raise
fees, in accordance with the Capital
Management Policy’s direction for OCC
action in the event of an Early Warning,
as discussed above.
If, however, OCC Equity remains
below 90% of the Target Capital
Requirement after applying the EDCP
Unvested Balance, or if a subsequent
Trigger Event occurs after applying all
of the available EDCP Unvested Balance,
OCC would charge an ‘‘Operational Loss
Fee,’’ up to the maximum Operational
Loss Fee identified in OCC’s schedule of
fees as described below, in equal shares
to each Clearing Member, payable on
five business days’ notice, to raise
additional capital. A further Trigger
Event based on Equity falling below the
Target Capital Requirement for a period
of 90 consecutive calendar days would
be measured beginning on the date OCC
applies the EDCP Unvested Balance.
OCC chose five business days to allow
Clearing Members subject to the fee to
assess its impact on their liquidity and
take appropriate actions. OCC did not
select a shorter period, such as the twoday period in which Clearing Members
must fund Clearing Fund
contributions,19 because that shorter
period is necessary for settlement
obligations, which is not the case for the
Operational Loss Fee.
OCC would calculate the maximum
aggregate Operational Loss Fee based on
the RWD Amount, which would ensure
that OCC would have sufficient capital
to facilitate a recovery or an orderly
wind-down in the event of an
operational loss. In order to account for
OCC’s tax liability for retaining the
Operational Loss Fee as earnings, OCC
may apply a tax gross-up to the RWD
Amount (‘‘Adjusted RWD Amount’’)
depending on whether the operational
loss that caused Equity to fall below the
Trigger Event threshold is tax
deductible. The Capital Management
Policy would provide that, in the event
19 See,
e.g., OCC Rule 1006(h)(A).
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less than the full amount of the
maximum Operational Loss Fee is
needed to bring OCC’s Equity to 110%
of the Target Capital Requirement, only
that amount will be charged. If OCC
charges less than the maximum
Operational Loss Fee, any remaining
amount up to the maximum Operational
Loss Fee will remain available for
subsequent Trigger Events, provided
that the sum of all Operational Loss
Fees that have not been refunded shall
not exceed the maximum Operational
Loss Fee.
In the event that OCC employs a
refund to Clearing Members in equal
shares up to the amount of Operational
Loss Fees previously charged, the
amount of the maximum Operational
Loss Fee available for subsequent
Trigger Events would include the
amount refunded. By allowing OCC to
charge up to the maximum Operational
Loss Fee—less any amounts previously
charged and not refunded—should
subsequent Trigger Events arise, the
proposed Capital Management Policy
would help maintain the continued
ability of OCC to access replenishment
capital should multiple Trigger Events
occur in quick succession before OCC
could implement a new or modified
replenishment plan. In the unlikely
event that the sum of all Operational
Loss Fees charged exhausts the
maximum Operational Loss Fee, the
Board would need to convene to
develop a new replenishment plan,
subject to regulatory approval.
In formulating the Capital
Management Policy OCC considered
other means of allocating the
Operational Loss Fee among OCC’s
Clearing Members, including allocating
the cost to Clearing Members
proportionally based on measures such
as contract volume or risk profile, as
evidenced by a Clearing Member’s
margin or clearing fund contributions.
As part of its analysis for determining
the Potential Loss Amount, OCC has
identified individual operational risk
scenarios that could result in an
operational loss, including such risks as
internal fraud, a cyber-attack on OCC’s
systems, employee lawsuits and damage
to its facilities. The operational risks
OCC identified are separate and distinct
from the credit risk that Clearing
Members present to OCC, which OCC
manages through margin and Clearing
Fund contributions and OCC’s Default
Management Procedures. OCC has not
observed any correlation between the
annual quantification of these risks and
contract volume or Clearing Member
credit risk. OCC has included a
comparison of its quantification of these
risks to contract volume and the amount
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44947
of Clearing Fund deposits in
confidential Exhibit 3e. OCC believes
that charging the Operational Loss Fee
in equal shares is preferable because it
equally mutualizes risk of operational
loss amongst the firms that use OCC’s
services. OCC believes that such
mutualization is preferable because all
Clearing Members benefit from equal
access to the clearance and settlement
services provided by OCC, irrespective
of how much they choose to use it. Such
access provides the benefit of credit and
liquidity risk intermediation and
associated regulatory capital benefits.
To implement the Operational Loss
Fee, OCC is proposing an amendment to
its schedule of fees that would provide
a formula for calculating the maximum
Operational Loss Fee OCC could charge,
attached [sic] to this rule filing as
Exhibit 5c. The amendment to OCC’s fee
schedule would express the Operational
Loss Fee as a fraction, the numerator of
which would be the Adjusted RWD
Amount less the aggregate amount of
Operational Loss Fees that OCC has
previously charged that are not
refunded at the time of calculation, and
the denominator of which would be the
number of Clearing Members at the time
OCC charges the Operational Loss Fee.
OCC would also include in the schedule
of fees the conditions that would trigger
the Operational Loss Fee to be charged.
OCC proposes to amend its schedule of
fees now: (1) To increase transparency
about Clearing Members’ maximum
contingent obligations under the Capital
Management Policy in the unlikely
event OCC’s Equity falls below the
Trigger Event thresholds, (2) to promote
operational efficiency so that OCC can
access replenishment capital
expeditiously if a Trigger Event occurs,
and (3) to reduce the likelihood that
OCC would be required to file an
advance notice or proposed rule change
prior to charging the Operational Loss
Fee, thereby accelerating the time frame
in which OCC could access
replenishment capital if losses
materialize that threaten OCC’s ability
to continue operations and services as a
going concern.
To effectuate the Capital Management
Policy, OCC also proposes to amend
OCC Rule 209 so that the Operational
Loss Fee would be payable within five
business days. OCC Rule 209 currently
provides that all charges and fees owed
by a Clearing Member to OCC shall be
due and payable within five business
days following the end of each calendar
month. The proposed amendment
would add an exception for payment of
the Operational Loss Fee, which would
be due and payable within five business
days following OCC’s notice to the
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Clearing Member that OCC had charged
the Operational Loss Fee. The
amendment to OCC Rule 209 would
ensure that OCC can timely respond to
operational losses that threaten OCC’s
ability to continue operations and
services as a going concern. OCC would
also amend Rule 101 to define
‘‘Operational Loss Fee’’ to mean the fee
that would be charged to Clearing
Members in equal shares, up to the
maximum amount identified in OCC’s
schedule of fees less the aggregate
amount of all such Operational Loss
Fees previously charged and not yet
refunded at the time of calculation, if,
after contributing the entire EDCP
Unvested Balance, Equity remains
below the levels identified in OCC’s
schedule of fees.
Use of Current and Retained Earnings
for Default Losses
The Capital Management Policy
would provide that in the event of a
clearing member default, OCC would
use Equity above 110% of the Target
Capital Requirement to offset any loss
after applying the margin assets and
Clearing Fund contribution of the
defaulting Clearing Member. In
addition, the Capital Management
Policy would provide that OCC would
contribute the EDCP Unvested Balance
on a pro rata basis with non-defaulting
Clearing Member contributions to the
Clearing Fund to satisfy any remaining
balance after applying the margin assets
and Clearing Fund contribution of the
defaulting Clearing Member and any
OCC Equity above 110% of the Target
Capital Requirement.
To implement this aspect of the
Capital Management Policy, OCC would
also amend OCC Rule 1006 to adjust the
default waterfall and the allocation of
Clearing Fund losses accordingly. Rule
1006(e), which currently governs use of
retained earnings to cover certain losses
prior to charging those losses to the
Clearing Fund under Rule 1006(b) (i.e.,
losses caused by Clearing Member
defaults) and Rule 1006(c) (i.e., losses
caused by bank and clearing
organization failures to perform
obligations to OCC not recoverable
under Rule 1006(b)), would be divided
into subsections numbed Rule 1006(e)(i)
through (e)(iii). OCC would add Rule
1006(e)(i) to require OCC to charge a
loss or deficiency associated with a
Clearing Member default to OCC’s
current and retained earnings that are
greater than 110% of its Target Capital
Requirement (which would be defined
as above in Rule 101) prior to charging
the Clearing Fund and the EDCP
Unvested Balance under Rule 1006(b),
as discussed below. Rule 1006(e)(ii)
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would contain the current text of the
first two sentences of the current Rule
1006(e), updating the cross-reference
therein to limit the scope to the use of
earnings to cover losses caused by bank
or clearing organization failures before
charging the Clearing Fund under Rule
1006(c). Thus, OCC would retain the
option, but not the obligation, to use
current or retained earnings to cover
such bank or clearing organization
losses, for which the Rules currently
provide. Rule 1006(e)(iii) would contain
the last two sentences of Rule 1006(e)
currently in effect, which concern (1)
the meaning of ‘‘current earnings’’ and
(2) provide for a Clearing Member’s
continuing liability for any deficiencies
in that member’s Clearing Fund
contribution that OCC covers with
OCC’s current and retained earnings.
With respect to the latter, OCC would
amend Rule 1006(e)(iii) to remove
reference to OCC’s ‘‘elect[ion]’’ to charge
the deficiency to current or retained
earnings so that such liability for
Clearing Fund contribution deficiencies
remains if OCC is obligated to charge
current and retained earnings over
110% of the Target Capital Requirement
under proposed Rule 1006(e)(i).
OCC also proposes to amend Rule
1006(b) to provide that OCC would
apply the EDCP Unvested Balance
(which would be defined as above in
Rule 101) on a pro rata basis with the
Clearing Fund contributions of nondefaulting Clearing Members to satisfy
any remaining balance after applying
the defaulting Clearing Member’s
margin and Clearing Fund contribution
and OCC’s current and retained earnings
greater than 110% of its Target Capital
Requirement. By amendment to Rule
1006(b)(iii), the EDCP Unvested
Balance’s proportion of the loss would
be calculated by a fraction, the
numerator of which would be EDCP
Unvested Balance and the denominator
of which would be the sum of the EDCP
Unvested Balance and the balance of all
non-defaulting Clearing Members’
Clearing Fund contributions.20 Pursuant
to proposed amendments to Rule
1006(b) and (e), such contribution of
current and retained earnings would be
20 Because Rule 1006 has separate provisions
addressing use of the Clearing Fund to cover losses
arising from a Clearing Member default (Rule
1006(b)) and losses arising from bank or clearing
organization failures (Rule 1006(c)), certain changes
would be made to the rules to limit the changes for
purposes of effecting the Capital Management
Policy to the use of current and retained earnings
and the EDCP Unvested Balance in the event of a
Clearing Member default. Specifically, the proposed
changes to OCC’s rules would eliminate
Interpretations and Policies .01 and establishes the
respective allocation provisions in Rule 1006(b)(iii)
and (c)(iii). No substantive changes to Rule 1006(c)
are intended.
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made after applying the defaulting
Clearing Member’s margin and Clearing
Fund contribution, but before charging
that loss or deficiency proportionately
to the Clearing Fund.
In addition, a proposed amendment to
Rule 1006(g), concerning, among other
things, the allocation of funds received
under the Limited Cross-Guaranty
Agreement between OCC and certain
other clearing agencies in the event of
the default of a common member, would
provide that any funds received under
that agreement by OCC with respect to
losses incurred by OCC would be
credited in accordance with Rule 1010.
Rule 1010 concerns recovery of losses
charged to non-defaulting Clearing
Members and provides that any
recovery of a loss charged
proportionately against the
contributions of those Clearing Members
shall be paid to each Clearing Member
charged in proportion to the amounts
charged. The amendment to Rule
1006(g) would establish that the nondefaulting Clearing Members whose
Clearing Fund contributions were
charged would recover proportional to
the amount their contributions were
charged up to the amount their Clearing
Fund contributions were charged. The
recovery proportional to the amount
charged to the EDCP Unvested Balance
would be available for return to the
EDCP.
Market Participant Outreach
In developing the proposed plan for
replenishment capital OCC also sought
input from market participants. On May
1, 2019, OCC Management presented to
the SIFMA options committee and the
Securities Traders Association on the
following topics: (1) How OCC will set
fees, (2) how OCC determines its
operating margin, (3) OCC’s proposal to
add a working capital line of credit, (4)
the triggers and thresholds for action,
and (5) the amount that a replenishment
plan would need to raise. A discussion
ensued with participants from the
SIFMA options committee concerning
how OCC would set the Target Capital
Requirement.
On May 28, 2019, OCC provided
Clearing Members with a notice
concerning the details of the Capital
Management Policy.21 OCC has
included a copy of the letter in Exhibit
21 The letter references a ‘‘one-time’’ Operational
Loss Fee, consistent with the proposed Capital
Management Policy as approved by the Board at its
May 13, 2019 meeting. As discussed below, the
Board approved a revision to the proposal at its July
17, 2019 meeting to allow OCC to retain the ability
to charge the Operational Loss Fee for subsequent
Trigger Events up to the maximum Operational Loss
Fee, less any Operational Loss Fees previously
charged and not yet refunded.
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3f. OCC sent the same letter to the
participant exchanges (including the
non-shareholder exchanges). Either calls
or meetings were held with nonshareholder exchanges to discuss the
proposed Capital Management Policy
and allow them to raise questions or
concerns. No such concerns were
expressed.
OCC conducted calls open to all
Clearing Members on May 31, 2019 to
discuss the proposal. The calls were
attended by approximately 140
participants representing 40
organizations. No concerns with the
proposed Capital Management Policy
were expressed. Discussion ensued
about the mechanics of the Operational
Loss Fee, alternatives to equal allocation
of the Operational Loss Fee among
Clearing Members that OCC considered
and the likelihood that OCC would need
to charge the Operational Loss Fee.
Management has also met with
individual Clearing Members and other
market participants to discuss the
proposed Capital Management Policy.
After the Board meeting on July 17,
2019, OCC conducted a call with the
SIFMA options committee to discuss
certain features of the Capital
Management Policy proposal approved
at that meeting, including: (a) If OCC
charges the Operational Loss Fee and its
Equity thereafter returns to a level at
which the Board approves use of tools
to lower the cost of participation for
Clearing Members, OCC would first
employ tools to lower the Clearing
Members’ costs in equal share up to the
amount of the Operational Loss Fee
charged; and (b) if OCC charges the
Operational Loss Fee, OCC would retain
the ability to charge Operational Loss
Fees for subsequent Trigger Events up to
the maximum Operational Loss Fee, less
any Operational Loss Fees previously
charged and not yet refunded.
OCC has included a summary of the
questions raised and Management’s
responses during the above referenced
calls and meetings in Exhibit 3g.
2. Statutory Basis
OCC believes the proposed rule
change is consistent with Section 17A of
the Securities Exchange Act of 1934
(‘‘Exchange Act’’) and the rules and
regulations thereunder. In particular,
OCC believes that the Capital
Management Policy is consistent with
Section 17A(b)(3)(F) of the Exchange
Act 22 and Rule 17Ad–22(e)(15) 23
thereunder for the reasons described
below. In addition, OCC believes adding
the Operational Loss Fee to its schedule
22 15
U.S.C. 78q–1(b)(3)(F).
23 17 CFR 240.17Ad–22(e)(15).
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of fees is consistent with Section
17A(b)(3)(D) of the Exchange Act,24 and
that the changes to OCC’s Rules to
effectuate the use of current and
retained earnings in excess of 110% of
the Target Capital Requirement and the
EDCP Unvested Balance to cover default
losses is consistent with Rule 17Ad–
22(e)(4).25
Section 17A(b)(3)(F) of the Exchange
Act requires, in part, that the rules of
OCC be designed to promote the prompt
and accurate clearance and settlement of
securities transactions and, in general,
to protect investors and the public
interest. The Capital Management Policy
is designed to ensure that OCC holds
sufficient LNAFBE such that it could
continue to promptly and accurately
clear and settle securities transactions
even if it suffered significant operational
losses. In other words, holding
sufficient LNAFBE would help OCC to
absorb such operational losses and
avoid a disruption that could negatively
impact OCC’s prompt and accurate
clearing and settlement of transactions.
By limiting the financial resources OCC
counts toward its LNAFBE to cash and
cash equivalents, the Capital
Management Policy ensures those
resources would be high quality and
sufficiently liquid to allow OCC to meet
its current and projected operating
expenses under a range of scenarios,
including in adverse market conditions.
OCC would protect the interests of
investors and the general public by
establishing the Capital Management
Policy, which is designed to ensure that
such losses would not result in a failure
or disruption of a SIFMU, as OCC is
designated by the Financial Stability
Oversight Council (‘‘FSOC’’) pursuant to
the Payment, Clearing and Settlement
Supervision Act.26 FSOC has concluded
that a failure or disruption at OCC
would negatively affect significant
dollar value and volume transactions in
the options and futures markets, impose
material losses on OCC counterparties
and create liquidity and credit problems
for financial institutions and others that
rely on the markets OCC serves, and that
such credit and liquidity problems
would spread quickly and broadly
among financial institutions and other
markets.27 Accordingly, FSOC
determined that a failure or disruption
at OCC could threaten the stability of
24 15
U.S.C. 78q–1(b)(3)(D).
CFR 240.17Ad–22(e)(4).
26 12 U.S.C. 5463.
27 FSOC Annual Report, Appendix A, at 187
(2012), available at https://www.treasury.gov/
initiatives/fsoc/Documents/2012%20
Appendix%20A%20Designation%20of
%20Systemically%20Important%20
Market%20Utilities.pdf.
25 17
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44949
the U.S. financial system.28 Therefore,
OCC believes that the Capital
Management Policy, which is
reasonably designed to ensure that OCC
has sufficient LNAFBE to continue
operations in the event of an operational
loss, is consistent with the requirements
of Section 17A(b)(3)(F) of the Exchange
Act by protecting investors and the
public interest.29
Rule 17Ad–22(e)(15) under the
Exchange Act requires OCC to establish,
implement, maintain and enforce
written policies and procedures
reasonably designed to identify, monitor
and manage OCC’s general business risk
and hold sufficient LNAFBE to cover
potential general business losses so that
OCC can continue operations and
services as a going concern if those
losses materialize.30 The Capital
Management Policy and amendments to
OCC’s Rules and Fee Schedule are
designed for consistency with the
requirements of Rule 17Ad–22(e)(15) for
the reasons described below.
Rule 17Ad–22(e)(15)(i) requires, in
part, that OCC establish, implement,
maintain and enforce written policies
and procedures reasonably designed to
identify, monitor, and manage OCC’s
general business risk, including by
determining the amount of LNAFBE
based upon OCC’s general business risk
profile and the length of time required
to achieve recovery or orderly winddown, as appropriate, of its critical
operations and services if such action is
taken.31 Pursuant to the Capital
Management Policy, OCC would set its
Target Capital Requirement at a level
sufficient to maintain LNAFBE at least
equal to the greater of (x) six months’ of
OCC’s current operating expenses; (y)
the amount determined by the Board to
be sufficient to ensure a recovery or
orderly wind-down of critical
operations and services, plus any excess
Equity Management recommends, and
the Board approves, to be retained for
capital expenditures; and (z) the amount
determined by the Board to be sufficient
for OCC to continue operations and
services as a going concern if general
business losses materialize. By
providing that OCC would set its Target
Capital Requirement no less than the
greatest of these three amounts, OCC
believes the Capital Management Policy
is consistent with Rule 17Ad–
22(e)(15)(i).
The Capital Management Policy is
also designed to identify, monitor and
manage OCC’s general business risk,
28 Id.
29 15
U.S.C. 78q–1(b)(3)(F).
CFR 240.17Ad–22(e)(15).
31 17 CFR 240.17Ad–22(e)(15)(i).
30 17
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consistent with Rule 17Ad–22(e)(15), by
providing that OCC’s Board would
review and approve the Target Capital
Requirement annually. The Capital
Management Policy is also designed to
monitor OCC’s general business risk by
providing that OCC would perform an
analysis of its Equity on at least a
monthly basis to ensure that OCC’s
Equity has not fallen below the Early
Warning or Trigger Event thresholds
and is not likely to fall below those
thresholds prior to the next review. The
Capital Management Policy’s
requirement that Management report on
the firm’s LNAFBE relative to the Early
Warning and Trigger Event thresholds at
each regularly scheduled Board meeting
is also designed to identify, monitor,
and manage OCC’s general business
risk. The Capital Management Policy’s
requirement that the Board be promptly
notified in the event of an Early
Warning or Trigger Event is also
reasonably designed to ensure that OCC
can act quickly to ensure OCC’s
compliance with the LNAFBE-holding
requirements of Rule 17Ad–22(e)(15).
Rule 17Ad–22(e)(15) further requires,
in part, that OCC establish, implement,
maintain and enforce written policies
and procedures reasonably designed to
hold sufficient LNAFBE to cover
potential general business losses so that
OCC can continue operations and
services as a going concern if those
losses materialize, including by holding
LNAFBE equal to the greater of either
(x) six months of OCC’s current
operating expenses, or (y) the amount
determined by the Board to be sufficient
to ensure a recovery or orderly winddown of critical operations and
services.32 As described above, the
Capital Management Policy would
provide that OCC sets its Target Capital
Requirement at a level sufficient to
maintain LNAFBE in an amount that is
the greatest of three amounts, which
include six months’ operating expenses,
an amount determined by the Board to
be sufficient to ensure recovery or
orderly wind-down, and an amount
determined by the Board to be sufficient
for OCC to continue operations and
services as a going concern if general
business losses materialize. Therefore,
the Capital Management Policy is
designed to ensure that OCC maintains,
at a minimum, LNAFBE equal to the
greater of the two amounts required by
Rule 17Ad–22(e)(15)(ii). By also
including an amount determined by the
Board to be sufficient to meet general
business losses should they materialize,
the Capital Management Policy is
designed to ensure OCC maintains
LNAFBE at an amount necessary to
satisfy Rule 17Ad–22(e)(15)’s broader
requirement that OCC hold sufficient
LNAFBE to cover potential general
business losses so that OCC can
continue operations and services as a
going concern if those losses
materialize.
Rule 17Ad–22(e)(15)(ii) further
requires, in part, that LNAFBE held by
OCC pursuant to Rule 17Ad–
22(e)(15)(ii) shall be (A) in addition to
resources held to cover participant
defaults or other credit or liquidity
risks,33 and (B) of high quality and
sufficiently liquid to allow OCC to meet
its current and projected operating
expenses under a range of scenarios,
including in adverse market
conditions.34 The Capital Management
Policy is designed to satisfy Rule 17Ad–
22(e)(15)(ii)(A) by providing that the
resources held to meet OCC’s Target
Capital Requirement are in addition to
OCC’s resources to cover participant
defaults and liquidity shortfalls. While
the Capital Management Policy and
proposed changes to OCC’s Rules
provide for the use of capital to cover
credit losses in the event of a Clearing
Member default, the proposed changes
limit the amount of current and retained
earnings available to cover such losses
to the amount above 110% of the Target
Capital Requirement. The Capital
Management Policy is also designed to
satisfy Rule 17Ad–22(e)(15)(ii)(B) by
providing that the resources held to
meet OCC’s Target Capital Requirement
be high quality and sufficiently liquid.
As a result, OCC believes the Capital
Management Policy is designed to
comply with Rule 17Ad–22(e)(15)(ii)(A)
and (B).
Rule 17Ad–22(e)(15)(iii) requires that
OCC establish, implement, maintain and
enforce written policies and procedures
reasonably designed to identify,
monitor, and manage OCC’s general
business risk, including by maintaining
a viable plan, approved by the Board
and updated at least annually, for
raising additional equity should its
equity fall close to or below the amount
required under Rule 17Ad–22(e)(15)(ii).
The Capital Management Policy and
amendments to OCC’s Rules and
schedule of fees are reasonably designed
to establish a viable plan to raise
additional capital in an amount up to
the amount the Board determines
annually to be sufficient to ensure
recovery or orderly wind-down should
OCC’s Equity fall close to or below its
Target Capital Requirement. By setting
the threshold triggers by reference to the
CFR 240.17Ad–22(e)(15)(ii).
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34 17
Jkt 247001
35 OCC
Rule 1108.
Rule 1006(a), clause (vi) (failure of any
Clearing Member to make any other required
payment or render any other required performance).
36 OCC
33 17
32 17
Target Capital Requirement, OCC’s plan
for replenishment capital is designed to
require OCC to act to raise capital
should its LNAFBE fall close to or
below the amounts required under Rule
17Ad–22(e)(15)(ii). In addition, by
providing that the Target Capital
Requirement must be the greater of
those amounts or the amount
determined by the Board to be sufficient
to cover potential general business
losses so that OCC can continue
operations and services as a going
concern if those losses materialize, the
Capital Management Policy is also
reasonably designed to ensure that OCC
has a viable plan to raise the capital
necessary to comply with Rule 17Ad–
22(e)(15) as a whole. Furthermore, the
Capital Management Policy provides
that Management shall on an annual
basis recommend the Board approve or,
as appropriate, modify the
Replenishment Plan. The Board would
review and, as appropriate, approve
Management’s recommendation. Should
OCC charge the full amount of the
Operational Loss Fee, Management
would recommend a new or modified
replenishment plan, subject to
regulatory approval. The Board would
review and, as appropriate, approve
Management’s recommendation.
OCC’s proposed addition of an
Operational Loss Fee as part of its
Replenishment Plan is also reasonably
designed to establish a viable plan to
raise additional capital. OCC’s By-Laws
and Rules serve as a contract between
OCC and its Clearing Members. Thus,
OCC believes the Operational Loss Fee
is no less reliable than any other
potential replenishment plan that does
not involve accumulating replenishment
capital in advance of any operational
loss. Failure of a Clearing Member to
pay the Operational Loss Fee if charged
will have the same impact as failure to
meet a margin call or clearing fund
assessment, and thus may have
significant consequences. Any Clearing
Member in default of its obligations to
OCC is subject to suspension and
liquidation of the defaulting member’s
positions, from which OCC may collect
all unpaid obligations to OCC.35 Should
the assets of the defaulting member be
insufficient to cover its obligations, OCC
may recover the unpaid amount from
the Clearing Fund.36
While Rule 17Ad–22(e)(15)(iii) does
not by its terms specify the amount of
additional equity a clearing agency’s
plan for replenishment capital must be
PO 00000
CFR 240.17Ad–22(e)(15)(ii)(A).
CFR 240.17Ad–22(e)(15)(ii)(B).
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designed to raise, the SEC’s adopting
release states that ‘‘a viable plan
generally should enable the covered
clearing agency to hold sufficient liquid
net assets to achieve recovery or orderly
wind-down.’’ 37 OCC believes that the
Capital Management Policy and
Operational Loss Fee is consistent with
the SEC’s adopting release for Rule
17Ad–22(e)(15)(iii) because OCC sets
the maximum Operational Loss Fee at
an amount sufficient to raise, on a posttax basis, the amount determined
annually by the Board to be sufficient to
ensure recovery or orderly wind-down
pursuant to the Board’s annual approval
of the RWD Plan.
In its adopting release, the SEC also
states that in developing its policies and
procedures, a covered clearing agency
‘‘generally should consider and account
for circumstances that may require a
certain length of time before any plan
can be implemented.’’ 38 In the case of
an Early Warning, a fee increase would
require Board approval, which could be
obtained in a special meeting of the
Board on an expedited basis. OCC
would file the fee increase with the SEC
for immediate effectiveness, thereby
minimizing the amount of time needed
to implement the new fee. In the case of
a Trigger Event, the Operational Loss
Fee added to the fee schedule would not
require further Board approval to
implement, and would likely not
require further regulatory approval to
implement because this proposed rule
change would add the fee to OCC’s
schedule of fees. By allowing OCC to
charge up to the maximum Operational
Loss Fee, less any Operational Loss Fees
previously charged and not yet
refunded, the Capital Management
Policy would help OCC maintain its
ability to access replenishment capital
during the time it would take to
implement a new or revised
Replenishment Plan. The Operational
Loss Fee and amendment to Rule 209(a)
further account for the length of time to
implement OCC’s plan for
replenishment capital by requiring
payment within five business days.
Therefore, OCC believes the proposed
Capital Management Policy, Operational
Loss Fee, and amendments to OCC’s
Rules are consistent with the SEC’s
adopting release for Rule 17Ad–
22(e)(15)(iii).
OCC also believes the Operational
Loss Fee is consistent with Section
17A(b)(3)(D) of the Exchange Act, which
requires that the rules of a clearing
37 Standards for Covered Clearing Agencies,
Exchange Act Release No. 78961 (Sept. 28, 2016),
81 FR 70786, 70836 (Oct. 13, 2016).
38 Id.
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agency provide for the equitable
allocation of reasonable dues, fees and
other charges among its participants.
OCC believes the proposed Operational
Loss Fee is reasonable because it is
designed to accumulate additional
capital to ensure that OCC can continue
to meet its obligations as a SIFMU to
Clearing Members and the general
public. OCC believes that the proposed
Operational Loss Fee is reasonable also
because it is designed as a viable plan
for replenishing OCC’s LNAFBE in the
event OCC’s Equity falls below certain
thresholds that are themselves designed
to ensure that OCC act to raise
additional capital before OCC’s Equity
reaches the amounts required by Rule
17Ad–22(e)(15)(ii). And as discussed
above, by providing that the
Replenishment Amount be sufficient to
ensure OCC has sufficient capital to
cover the amount the Board determines
sufficient to ensure a recovery or orderly
wind-down, OCC believes the
Operational Loss Fee is consistent with
Rule 17Ad–22(e)(15)(iii). OCC also
believes that the proposed Operational
Loss Fee would result in an equitable
allocation of fees among its participants
because it would equally mutualize risk
of operational loss amongst the firms
that use OCC’s services. The Clearing
Members’ equal access to the clearance
and settlement services provided by
OCC, which provide the benefit of credit
and liquidity risk intermediation and
associated regulatory capital benefits, is
of equal benefit to all Clearing Members
irrespective of how much they choose to
use it. In addition, the Capital
Management Policy provides that if
OCC charges the Operational Loss Fee
and its Equity thereafter returns to a
level at which the Board approves use
of tools to lower the cost of Clearing
Member participation to return Equity
in excess of 110% of its Target Capital
Requirement, such as a refund, OCC
will employ such tools to lower costs for
Clearing Members in equal shares, up to
the amount of the Operational Loss Fee
charged. Thus, Clearing Members will
share both the cost and recovery of the
Operational Loss Fee equally. As a
result, OCC believes that the proposed
Operational Loss Fee provides for the
equitable allocation of reasonable fees in
accordance with Section 17A(b)(3)(D) of
the Exchange Act.39
OCC also believes the amendments to
its Rules for use of current and retained
earnings and the EDCP Unvested
Balance to cover default losses are
consistent with Rule 17Ad–22(e)(4),
which provides, in part, that OCC
establish, implement, maintain and
enforce written policies and procedures
reasonably designed to effectively
identify, measure, monitor and manage
its credit exposures to participants and
those arising from its payment, clearing
and settlement processes, including by
maintaining sufficient financial
resources to cover its credit exposure to
each participant fully with a high degree
of confidence.40 By providing that OCC
shall use current and retained earnings
in excess of 110% of its Target Capital
Requirement, as well as contributing the
EDCP Unvested Balance on a pro rata
basis with Clearing Member’s Clearing
Fund contributions, OCC is providing
for additional financial resources
available to cover losses in the event of
a Clearing Member default, and
reducing the amount OCC would charge
the Clearing Fund contributions of nondefaulting Clearing Members. Therefore,
OCC believes the amendments to its
Rules are consistent with Rule 17Ad–
22(e)(4).
B. Clearing Agency’s Statement on
Burden on Competition
Section 17A(b)(3)(I) of the Exchange
Act 41 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
the Capital Management Policy and
amendments to OCC’s Rules and
schedule of fees would not have any
impact, or impose any burden, on
competition that is not necessary or
appropriate in furtherance of the
purposes of the Exchange Act. As
discussed above, the Capital
Management Policy describes how OCC
would measure, monitor and manage its
capital needs to ensure appropriate
financial resiliency for a SIFMU and
comply with applicable financial
regulations, including requirements
about the amount of LNAFBE it must
hold. The Capital Management Policy is
designed for OCC to maintain Equity at
a level necessary to meet the
requirements of Rule 17Ad–22(e)(15)
and serve its Clearing Members and the
public interest.
While the proposed Operational Loss
Fee, in the unlikely event it is charged,
would have an effect on the amount of
fees that Clearing Members pay for
OCC’s services, the proposed rule
change is designed to allocate those fees
on an equal basis to all Clearing
Members. OCC’s Rules currently require
Clearing Members to maintain net
40 17
39 15
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44952
Federal Register / Vol. 84, No. 166 / Tuesday, August 27, 2019 / Notices
capital of at least $2 million.42 Based on
the most recent financial information
reported by Clearing Members, which
OCC has included in confidential
Exhibit 3h, OCC believes that 98% of
Clearing Members could absorb the
maximum amount of the Operational
Loss Fee without breaching their
minimum net capital requirements or
the SEC’s ‘‘early warning’’ threshold.43
OCC is comfortable with Clearing
Members’ ability to pay the Operational
Loss Fee because the amount of the
maximum Operational Loss Fee that
would be charged per Clearing Member
is approximately the same as the
contingent obligations under the OCC
clearing fund assessment requirements
for a Clearing Member operating at the
minimum clearing fund deposit—$1
million. Consequently, OCC does not
believe the Operational Loss Fee
obligation poses a significant barrier to
entry for smaller Clearing Members. By
adding the Operational Loss Fee to
OCC’s schedule of fees, the fee would be
a transparent obligation of membership
based upon which Clearing Members
can independently assess their rights
and obligations.
In addition, the Capital Management
Policy would help address the relative
impact that charging the Operational
Loss Fee in equal shares would have on
smaller Clearing Members by providing
that should OCC charge the fee and
thereafter return to a position where the
Board may approve tools to lower costs
for Clearing Members, such as refunds,
OCC would employ such tools to lower
costs for Clearing Members on an equal
basis, up to the amount of the
Operational Loss Fee charged. Thus, all
Clearing Members shall share equally in
the cost and recovery of the Operational
Loss Fee amounts charged.
Moreover, any barrier to entry that the
Operational Loss Fee may impose is not
unnecessary in furtherance of the
Exchange Act, and the rules the SEC has
promulgated thereunder. Pursuant to
those rules, OCC must hold minimum
LNAFBE and have a viable plan to
replenish equity should OCC’s equity
fall close to or below those minimums.
It is entirely appropriate that the
Clearing Members that benefit equally
from OCC’s services share the burden
equally should OCC experience an
operational loss that threatens its ability
to continue providing those services and
comply with its regulatory obligations.
42 OCC
Rule 302.
43 17 CFR 240.15c3–1.
VerDate Sep<11>2014
19:12 Aug 26, 2019
Jkt 247001
C. Clearing Agency’s Statement on
Comments on the Proposed Rule
Change 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.
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–2019–007 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–2019–007. 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
PO 00000
Frm 00111
Fmt 4703
Sfmt 4703
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–2019–007 and should
be submitted on or before September 17,
2019.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.44
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019–18385 Filed 8–26–19; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–86722; File No. SR–LTSE–
2019–01]
Self-Regulatory Organizations; LongTerm Stock Exchange, Inc.; Order
Approving Proposed Rule Change To
Adopt Rule 14.425, Which Would
Require Companies Listed on the
Exchange To Develop and Publish
Certain Long-Term Policies
August 21, 2019.
I. Introduction
On June 25, 2019, the Long-Term
Stock Exchange, Inc. (‘‘LTSE’’ or
‘‘Exchange’’) filed with the Securities
and Exchange Commission
(‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act
of 1934 (‘‘Act’’) 1 and Rule 19b–4
thereunder,2 a proposed rule change to
adopt new Rule 14.425 (Long-Term
Policies), which would require
companies listed on the Exchange to
develop and publish certain policies
that the Exchange believes will facilitate
long-term focus and value creation. The
proposed rule change was published for
44 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 166 (Tuesday, August 27, 2019)]
[Notices]
[Pages 44944-44952]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-18385]
=======================================================================
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-86725; File No. SR-OCC-2019-007]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Concerning a Proposed Capital
Management Policy That Would Support The Options Clearing Corporation's
Function as a Systemically Important Financial Market Utility
August 21, 2019.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby
given that on August 9, 2019, the Options Clearing Corporation
(``OCC'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC) the proposed rule change as described in
Items I, II, and III below, which Items have been prepared primarily by
OCC. The Commission is publishing this notice to solicit comments on
the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
This proposed rule change by OCC would adopt a Capital Management
Policy, which includes OCC's plan to replenish its capital in the event
it falls close to or below its target capital (as defined below,
``Replenishment Plan''). The Capital Management Policy is included in
confidential Exhibit 5a of the filing.\3\ In order to implement aspects
of the new Capital Management Policy, the proposed rule change would
also amend the following governing documents: OCC's Rules, which can be
found in Exhibit 5b, and OCC's schedule of fees, which can be found in
Exhibit 5c. Material proposed to be added to OCC's Rules and schedule
of fees, as currently in effect, is marked by underlining, and material
proposed to be deleted is marked with strikethrough text. 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\
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\3\ The Commission notes that exhibits referenced herein are
included in the filing submitted by OCC to the Commission, but are
not included in this Notice.
\4\ OCC's By-Laws and Rules can be found on OCC's public
website: https://optionsclearing.com/about/publications/bylaws.jsp.
---------------------------------------------------------------------------
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the 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
OCC is proposing to adopt a new Capital Management Policy and to
make amendments to OCC's Rules and schedule of fees necessary to
implement the new Capital Management Policy. The main features of the
Capital Management Policy and the related changes are: (a) To determine
the amount of Equity sufficient for OCC to meet its regulatory
obligations and to serve market participants and the public interest
(as defined below, ``Target Capital Requirement''), (b) to monitor
Equity \5\ and liquid net assets funded by equity (``LNAFBE'') \6\
levels to help ensure adequate financial resources are available to
meet general business obligations; and (c) to manage Equity levels,
including by (i) adjusting OCC's fee schedule (as appropriate) and (ii)
establishing a plan for accessing additional capital should OCC's
Equity fall below certain thresholds (``Replenishment Plan'').
---------------------------------------------------------------------------
\5\ The Capital Management Policy would define ``Equity'' as
shareholders' equity as shown on OCC's Statement of Financial
Condition.
\6\ The Capital Management Policy would define ``LNAFBE'' as the
level of cash and cash equivalents, no greater than Equity, less any
approved adjustments (i.e., agency-related liabilities such as
Section 31 fees held by OCC).
---------------------------------------------------------------------------
The Replenishment Plan would: (i) Provide that should OCC's Equity
fall below 110% of the Target Capital Requirement (as defined by the
Capital Management Policy, ``Early Warning''), Management would
recommend to the Board whether to implement a fee increase in an amount
the Board determines necessary and appropriate to raise additional
Equity; (ii) provide that should OCC's Equity fall below 90% of the
Target Capital Requirement or fall below the Target Capital Requirement
for a period of 90 consecutive days (as defined in the Capital
Management Policy, ``Trigger Event''), OCC would contribute the funds
held under The Options Clearing Corporation Executive Deferred
Compensation Plan Trust to the extent that such funds are (x) deposited
on or after January 1, 2020 in respect of its Executive Deferred
Compensation Plan (``EDCP'') and (y) in excess of amounts necessary to
pay for benefits accrued and vested under the EDCP at such time (such
funds are defined in Chapter 1 of the proposed changes to OCC's Rules
as the ``EDCP Unvested Balance''); and (iii) provide that should
contribution of the EDCP Unvested Balance fail to cure the Trigger
Event, or if a further Trigger Event occurs, OCC will charge an
Operational Loss Fee (as defined below) in equal shares to the Clearing
Members.
OCC is also hereby proposing to create a layer of skin-in-the-game
resources in the event of default losses. Specifically, OCC is amending
Rule 1006 to state that: First, any current or retained earnings above
110% of the Target Capital Requirement will be used to offset default
losses after applying a defaulting Clearing Member's margin and
Clearing Fund contributions, and next, any remaining loss will be
charged pro rata to (a) non-defaulting Clearing Members' Clearing Fund
contributions, and (b) the aggregate value of the EDCP Unvested
Balance.
Proposed Changes
OCC proposes to adopt a Capital Management Policy and make
conforming changes to OCC's Rules and schedule of fees necessary to
implement the Capital Management Policy, as described below, to
formalize its policy to identify, monitor, and manage OCC's capital
needs to promote compliance SEC Rule 17Ad-22(e)(15).\7\ In formulating
the Capital Management Policy, OCC also has considered the Commodity
Futures Trading Commission's (``CFTC'') regulatory
[[Page 44945]]
capital requirements for OCC as a DCO, as set forth in CFTC Rule
39.11(a)(2).\8\
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\7\ 17 CFR 240.17Ad-22(e)(15).
\8\ 17 CFR 39.11(a)(2).
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Target Capital Requirement
The proposed Capital Management Policy would explain how OCC would
annually determine the Target Capital Requirement. The proposed
amendment to Chapter 1 of OCC's Rules would define OCC's Target Capital
Requirement as the minimum level of Equity recommended by Management
and approved by the Board to ensure compliance with applicable
regulatory requirements and to keep such additional amount the Board
may approve for capital expenditures. Resources held to meet OCC's
Target Capital Requirement would be in addition to OCC's resources to
cover participant defaults. OCC considers the LNAFBE it holds, limited
to cash and cash equivalents, to be high quality and sufficiently
liquid to allow OCC to meet its current and projected operating
expenses under a range of scenarios, including in adverse market
conditions. The Capital Management Policy would also explain that, on
an annual basis, OCC's Chief Financial Officer (``CFO'') would
recommend a Target Capital Requirement for the coming year. Management
would review the CFO's report and, as appropriate, recommend the Target
Capital Requirement to the Compensation and Performance Committee
(``CPC''). The CPC would review, and as appropriate, recommend the
proposal to the Board of Directors, which would review, and as
appropriate, approve the Target Capital Requirement.
SEC Rule 17Ad-22(e)(15)
OCC would set its Target Capital Requirement at a level sufficient
to maintain LNAFBE at least equal to the greatest of three amounts: (x)
Six-months' current operating expenses; (y) the amount determined by
the Board to be sufficient to ensure a recovery or orderly wind-down of
critical operations and services (the ``RWD Amount''); and (z) the
amount determined by the Board to be sufficient for OCC to continue
operations and services as a going concern if general business losses
materialize (the ``Potential Loss Amount'').
The RWD Amount would be the amount recommended by Management on an
annual basis in accordance with OCC's Capital Management Procedure \9\
and, as appropriate, approved by the Board. OCC's Recovery and Orderly
Wind-Down Plan (``RWD Plan'') identifies critical services and the
length of time the Board has determined it would take to recover or
wind-down.\10\ Pursuant to the Capital Management Procedure, Management
would use the assumptions in the RWD Plan to determine the RWD Amount,
which is the cost to maintain those critical services over the
prescribed recovery or wind-down period, assuming costs remain at
historical levels. The calculation of the Potential Loss Amount would
be based on Management's annual determination, pursuant to the Capital
Management Procedure, of the amount of capital required to address
OCC's operational risks. OCC quantifies the amount of capital to be
held against OCC's operational risks by analyzing and aggregating
potential losses from individual operational risk scenarios,
aggregating the loss events, and conducting loss modeling at or above
the 99% confidence level.\11\
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\9\ The Capital Management Procedure would be a cross-department
internal procedure that provides direction on how those departments
shall execute their responsibilities under the proposed Capital
Management Policy. OCC has included a draft of the Capital
Management Procedure OCC intends to implement if the Commission
approves the proposed Capital Management Policy in confidential
Exhibit 3a, for reference. The documents in Exhibit 3 are being
provided as supplemental information to the filing and would not
constitute part of OCC's rules, which have been provided in Exhibit
5.
\10\ Securities Exchange Act Release No. 83918 (Aug. 23, 2018),
83 FR 44091 (Aug. 29, 2018) (SR-OCC-2017-021).
\11\ Pursuant to the Capital Management Procedure, OCC's
Enterprise Risk Management department (``ERM'') would quantify the
Potential Loss Amount on an annual basis and provide that
information to OCC's Chief Financial Officer (``CFO'') as an input
to the CFO's recommendation to Management for the Target Capital
Requirement. OCC has included ERM's process and methodology for
quantifying the Potential Loss Amount from 2015 through present in
confidential Exhibit 3b.
---------------------------------------------------------------------------
CFTC Rule 39.11(a)(2)
The Capital Management Policy would also specify that when setting
the Target Capital Requirement the Board will consider OCC's projected
rolling twelve-months' operating expenses as required by CFTC Rule
39.11(a)(2).\12\ For the avoidance of doubt, the Board is not required
to set the Target Capital Requirement at the level of twelve-months'
operating expenses.\13\ Factors that OCC would consider when
considering twelve-months' operating expenses include, but are not
limited to: (i) OCC's obligations and responsibilities as a
systemically important financial utility (``SIFMU''), (ii) OCC's
obligations as a derivative clearing organization under CFTC Rule
39.11(a)(2), (iii) the types of financial resources the CFTC allows OCC
to count towards the twelve-month requirement, and (iv) any conditions
on the use of those resources the CFTC has imposed.
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\12\ 17 CFR 39.11(a)(2).
\13\ Financial resources available to meet CFTC Rule 39.11(a)(2)
are not limited to LNAFBE, and include OCC's own capital or any
other form of financial resources deemed acceptable by the CFTC. See
17 CFR 39.11(b)(2).
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Excess Equity for Capital Expenditures
In addition, the Capital Management Policy would provide that OCC
may increase its Target Capital Requirement by an amount to be retained
for capital expenditures following a recommendation by Management and
Board approval. From time to time Management may identify necessary
capital investments in OCC's technology, facilities or other business
tangible or intangible assets to enhance its effectiveness, efficiency
or compliance posture. The Board would (a) determine if the capital
needs are necessary and appropriate and, if so, (b) determine whether
to increase the Target Capital Requirement or whether the amount can be
accumulated as an amount in excess of the Target Capital Requirement.
In case of the latter, capital in excess of 110% of the Target Capital
Requirement would be available as skin in the game.\14\ Factors the
Board would consider in making this determination include, but are not
limited to, the amount of funding required, how much Equity is proposed
to be retained, the potential impact of the investment on OCC's
operation, and the duration of time over which funds would be
accumulated.
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\14\ See OCC Rule 1006(e), as proposed in the changes attached
[sic; the Commission notes that ``attached'' here means that the SRO
included the relevant document as a confidential exhibit to the
filing] as Exhibit 5b hereto.
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Monitoring Equity
The proposed Capital Management Policy would describe how
Management reviews periodic analyses of LNAFBE, including projecting
future volume, expenses, cash flows, capital needs and other factors to
help ensure adequate financial resources are available to meet general
business obligations. Those other factors would include, but not be
limited to: (i) The level of existing prefunded corporate resources,
(ii) the ability to borrow under an existing OCC line of credit; (iii)
the ability to make a claim under certain insurance policies; (iv)
OCC's tax rates and liabilities; and (v) unfunded obligations. The
Capital Management Policy would further provide that Management would
review an analysis of Equity at least monthly to identify whether an
Early Warning or Trigger Event had occurred since the last review or
was likely to occur before
[[Page 44946]]
the next review. The Capital Management Policy would provide that the
Board of Directors is notified promptly if those triggers are breached.
To the extent OCC suffers a catastrophic or sizable loss intra-month,
and such loss amount is known or can reasonably be estimated,
Management would review a forecast of the impact on Equity and, should
that forecast demonstrate that Equity has fallen below the Early
Warning or Trigger Event, Management shall promptly notify the Board.
Managing Equity
The Capital Management Policy would describe the actions OCC may
take to manage its current or future levels of Equity. As described
below, the primary forms of capital management actions would include:
(i) Changes to OCC's fees or other tools to change costs for market
participants; (ii) the Replenishment Plan; and (iii) use of current and
retained earnings greater than 100% of the Target Capital Requirement
to cover losses caused by the default of a Clearing Member.
Fee Schedule
The Capital Management Policy would provide that clearing fees will
be based on the sum of OCC's annual budgeted/forecasted operating
expenses, a defined operating margin and OCC's capital needs, divided
by forecasted contract sides. On an annual basis, Management would
review the operating margin level considering historical volume
variance and other relevant factors, including but not limited to
variance in interest rates and OCC's operating expenses. Management
would recommend to the CPC, to which the Board has delegated authority
for review and approval of changes to OCC's fees pursuant to the CPC's
charter, whether changes to OCC's defined operating margin should be
made.
The Capital Management Policy would provide that on a quarterly
basis, Management would review its fee schedule and, considering
factors including, but not limited to projected operating expenses,
projected volumes, anticipated cash flows, and capital needs, recommend
to the Board, or a Committee to which the Board delegated authority,
whether a fee increase, decrease or waiver should be made in accordance
with Article IX, Section 9 of OCC's By-Laws.\15\
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\15\ OCC By-Law Art. IX, Sec. 9.
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The Capital Management Policy would provide that if OCC's Equity is
above, in the aggregate, 110% of the Target Capital Requirement and any
amount of excess Equity the Board approves for capital expenditures,
the Board of Directors, or a Committee the Board has delegated, may use
such tools as it considers appropriate to lower costs for Clearing
Members, providing the Board believes doing so would likely not lower
OCC's Equity below the Early Warning. Such tools would include lowering
fees, a fee holiday or a refund. The Capital Management Policy would
further provide that if OCC charges the Operational Loss Fee, as
described below, and its Equity thereafter returns to a level at which
the Board approves use of such tools, OCC would first employ tools to
lower the cost of Clearing Member participation in equal share up to
the amount of the Operational Loss Fee charged. This provision would
help ensure that in the event OCC must charge an Operational Loss Fee
to Clearing Members in equal shares, Clearing Members will recover the
amount charged in equal shares up to the amount charged.
Replenishment Plan
Early Warning
The Capital Management Policy would provide that in the event OCC's
Equity breaches the Early Warning threshold, or 110% of the Target
Capital Requirement, Management would recommend to the Board whether to
implement a fee increase in an amount the Board determines necessary
and appropriate to raise additional Equity.\16\ The recommendation
whether to implement a fee increase would be informed by several
factors including, but not limited to, (i) the facts, circumstances and
root cause of a decrease in Equity below the Early Warning threshold;
(ii) the time it would take to implement a fee increase, inclusive of
securing Board and SEC approval as required for those actions; (iii)
the anticipated time a fee increase would take to accumulate the needed
revenue based on projected contract volume, operational expenses and
interest income over that time period; and (iv) the potential of a
Trigger Event.
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\16\ Pursuant to the Capital Management Procedure, Management's
recommendation would be informed by the clearing fee amount
calculated pursuant to the Fee Schedule Calculation Procedure, which
provides direction to OCC's Finance department on how to calculate
the necessary fee level pursuant to the requirements of the Capital
Management Policy. OCC has included a draft of the Fee Schedule
Calculation Procedure it intends to implement if the Commission
approves the proposed Capital Management Policy in confidential
Exhibit 3c, for reference.
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The Early Warning is intended to signal to OCC that its Equity is
``close to'' the Target Capital Requirement, as directed by Rule
17Ad22(e)(15)(iii). The Early Warning threshold is set at 110% because
based on an analysis of OCC's projected revenue and expenses,\17\ a 10%
premium of the Target Capital Requirement represents approximately two
months earnings based on current and projected data,\18\ which OCC
believes would provide sufficient time for Management and the Board to
respond. The Capital Management Policy would provide that to the extent
Management determines, during its annual review of the Capital
Management Policy, that there is a change in the estimated length of
time to accumulate approximately 10% of the Target Capital Requirement,
Management will consider whether to recommend changes to the Early
Warning and Trigger Event thresholds.
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\17\ OCC has included the analysis in confidential Exhibit 3d.
\18\ OCC defines earnings for purposes of this analysis as
Operating Income, or revenue less expenses before taxes. Earnings
does not include interest pass through earned on the cash deposits.
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Trigger Event
The Capital Management Policy would also define a Trigger Event to
be when OCC's Equity falls below 90% of the Target Capital Requirement
or remains below the Target Capital Requirement for ninety consecutive
calendar days. OCC is proposing the 90% threshold based on its analysis
showing that two-months' earnings represents approximately a 10%
premium of the Target Capital Requirement, discussed above. OCC
believes, based on that analysis, that Equity below the 90% threshold
would be a sign that corrective action more significant and with a more
immediate impact than increasing fees should be taken to increase OCC's
Equity Capital. OCC also set another Trigger Event at a threshold of
Equity above 90% but below the Target Capital Requirement for a period
of 90 consecutive days based on the time necessary for a clearing fee
change to have an impact and to exhaust remedies prior to charging the
Operational Loss Fee. This timeframe takes into account 30-day advance
notice to Clearing Members to implement the fee change, implementation
on the first of the month to accommodate changes to Clearing Members'
systems, and, as discussed above, the approximately two-month period
required to accumulate approximately 10% of the Target Capital
Requirement. Based on the above-referenced analysis, OCC believes that,
in the event a fee increase resulting from an Early Warning could not
increase OCC's Equity above the
[[Page 44947]]
Target Capital Requirement within 90 days, it would likewise indicate
that corrective action in the form of a fee increase would be
insufficient.
If a Trigger Event occurs, OCC would first contribute the EDCP
Unvested Balance to cure the loss. OCC believes that contributing the
EDCP Unvested Balance to cover operational losses would align
Management's interests with OCC's interest in maintaining required
regulatory capital and operating OCC in a prudent manner. If
application of the EDCP Unvested Balance brings OCC's Equity to within
the Early Warning threshold (between 90% and 110% of the Target Capital
Requirement), OCC would act to raise fees, in accordance with the
Capital Management Policy's direction for OCC action in the event of an
Early Warning, as discussed above.
If, however, OCC Equity remains below 90% of the Target Capital
Requirement after applying the EDCP Unvested Balance, or if a
subsequent Trigger Event occurs after applying all of the available
EDCP Unvested Balance, OCC would charge an ``Operational Loss Fee,'' up
to the maximum Operational Loss Fee identified in OCC's schedule of
fees as described below, in equal shares to each Clearing Member,
payable on five business days' notice, to raise additional capital. A
further Trigger Event based on Equity falling below the Target Capital
Requirement for a period of 90 consecutive calendar days would be
measured beginning on the date OCC applies the EDCP Unvested Balance.
OCC chose five business days to allow Clearing Members subject to the
fee to assess its impact on their liquidity and take appropriate
actions. OCC did not select a shorter period, such as the two-day
period in which Clearing Members must fund Clearing Fund
contributions,\19\ because that shorter period is necessary for
settlement obligations, which is not the case for the Operational Loss
Fee.
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\19\ See, e.g., OCC Rule 1006(h)(A).
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OCC would calculate the maximum aggregate Operational Loss Fee
based on the RWD Amount, which would ensure that OCC would have
sufficient capital to facilitate a recovery or an orderly wind-down in
the event of an operational loss. In order to account for OCC's tax
liability for retaining the Operational Loss Fee as earnings, OCC may
apply a tax gross-up to the RWD Amount (``Adjusted RWD Amount'')
depending on whether the operational loss that caused Equity to fall
below the Trigger Event threshold is tax deductible. The Capital
Management Policy would provide that, in the event less than the full
amount of the maximum Operational Loss Fee is needed to bring OCC's
Equity to 110% of the Target Capital Requirement, only that amount will
be charged. If OCC charges less than the maximum Operational Loss Fee,
any remaining amount up to the maximum Operational Loss Fee will remain
available for subsequent Trigger Events, provided that the sum of all
Operational Loss Fees that have not been refunded shall not exceed the
maximum Operational Loss Fee.
In the event that OCC employs a refund to Clearing Members in equal
shares up to the amount of Operational Loss Fees previously charged,
the amount of the maximum Operational Loss Fee available for subsequent
Trigger Events would include the amount refunded. By allowing OCC to
charge up to the maximum Operational Loss Fee--less any amounts
previously charged and not refunded--should subsequent Trigger Events
arise, the proposed Capital Management Policy would help maintain the
continued ability of OCC to access replenishment capital should
multiple Trigger Events occur in quick succession before OCC could
implement a new or modified replenishment plan. In the unlikely event
that the sum of all Operational Loss Fees charged exhausts the maximum
Operational Loss Fee, the Board would need to convene to develop a new
replenishment plan, subject to regulatory approval.
In formulating the Capital Management Policy OCC considered other
means of allocating the Operational Loss Fee among OCC's Clearing
Members, including allocating the cost to Clearing Members
proportionally based on measures such as contract volume or risk
profile, as evidenced by a Clearing Member's margin or clearing fund
contributions. As part of its analysis for determining the Potential
Loss Amount, OCC has identified individual operational risk scenarios
that could result in an operational loss, including such risks as
internal fraud, a cyber-attack on OCC's systems, employee lawsuits and
damage to its facilities. The operational risks OCC identified are
separate and distinct from the credit risk that Clearing Members
present to OCC, which OCC manages through margin and Clearing Fund
contributions and OCC's Default Management Procedures. OCC has not
observed any correlation between the annual quantification of these
risks and contract volume or Clearing Member credit risk. OCC has
included a comparison of its quantification of these risks to contract
volume and the amount of Clearing Fund deposits in confidential Exhibit
3e. OCC believes that charging the Operational Loss Fee in equal shares
is preferable because it equally mutualizes risk of operational loss
amongst the firms that use OCC's services. OCC believes that such
mutualization is preferable because all Clearing Members benefit from
equal access to the clearance and settlement services provided by OCC,
irrespective of how much they choose to use it. Such access provides
the benefit of credit and liquidity risk intermediation and associated
regulatory capital benefits.
To implement the Operational Loss Fee, OCC is proposing an
amendment to its schedule of fees that would provide a formula for
calculating the maximum Operational Loss Fee OCC could charge, attached
[sic] to this rule filing as Exhibit 5c. The amendment to OCC's fee
schedule would express the Operational Loss Fee as a fraction, the
numerator of which would be the Adjusted RWD Amount less the aggregate
amount of Operational Loss Fees that OCC has previously charged that
are not refunded at the time of calculation, and the denominator of
which would be the number of Clearing Members at the time OCC charges
the Operational Loss Fee. OCC would also include in the schedule of
fees the conditions that would trigger the Operational Loss Fee to be
charged. OCC proposes to amend its schedule of fees now: (1) To
increase transparency about Clearing Members' maximum contingent
obligations under the Capital Management Policy in the unlikely event
OCC's Equity falls below the Trigger Event thresholds, (2) to promote
operational efficiency so that OCC can access replenishment capital
expeditiously if a Trigger Event occurs, and (3) to reduce the
likelihood that OCC would be required to file an advance notice or
proposed rule change prior to charging the Operational Loss Fee,
thereby accelerating the time frame in which OCC could access
replenishment capital if losses materialize that threaten OCC's ability
to continue operations and services as a going concern.
To effectuate the Capital Management Policy, OCC also proposes to
amend OCC Rule 209 so that the Operational Loss Fee would be payable
within five business days. OCC Rule 209 currently provides that all
charges and fees owed by a Clearing Member to OCC shall be due and
payable within five business days following the end of each calendar
month. The proposed amendment would add an exception for payment of the
Operational Loss Fee, which would be due and payable within five
business days following OCC's notice to the
[[Page 44948]]
Clearing Member that OCC had charged the Operational Loss Fee. The
amendment to OCC Rule 209 would ensure that OCC can timely respond to
operational losses that threaten OCC's ability to continue operations
and services as a going concern. OCC would also amend Rule 101 to
define ``Operational Loss Fee'' to mean the fee that would be charged
to Clearing Members in equal shares, up to the maximum amount
identified in OCC's schedule of fees less the aggregate amount of all
such Operational Loss Fees previously charged and not yet refunded at
the time of calculation, if, after contributing the entire EDCP
Unvested Balance, Equity remains below the levels identified in OCC's
schedule of fees.
Use of Current and Retained Earnings for Default Losses
The Capital Management Policy would provide that in the event of a
clearing member default, OCC would use Equity above 110% of the Target
Capital Requirement to offset any loss after applying the margin assets
and Clearing Fund contribution of the defaulting Clearing Member. In
addition, the Capital Management Policy would provide that OCC would
contribute the EDCP Unvested Balance on a pro rata basis with non-
defaulting Clearing Member contributions to the Clearing Fund to
satisfy any remaining balance after applying the margin assets and
Clearing Fund contribution of the defaulting Clearing Member and any
OCC Equity above 110% of the Target Capital Requirement.
To implement this aspect of the Capital Management Policy, OCC
would also amend OCC Rule 1006 to adjust the default waterfall and the
allocation of Clearing Fund losses accordingly. Rule 1006(e), which
currently governs use of retained earnings to cover certain losses
prior to charging those losses to the Clearing Fund under Rule 1006(b)
(i.e., losses caused by Clearing Member defaults) and Rule 1006(c)
(i.e., losses caused by bank and clearing organization failures to
perform obligations to OCC not recoverable under Rule 1006(b)), would
be divided into subsections numbed Rule 1006(e)(i) through (e)(iii).
OCC would add Rule 1006(e)(i) to require OCC to charge a loss or
deficiency associated with a Clearing Member default to OCC's current
and retained earnings that are greater than 110% of its Target Capital
Requirement (which would be defined as above in Rule 101) prior to
charging the Clearing Fund and the EDCP Unvested Balance under Rule
1006(b), as discussed below. Rule 1006(e)(ii) would contain the current
text of the first two sentences of the current Rule 1006(e), updating
the cross-reference therein to limit the scope to the use of earnings
to cover losses caused by bank or clearing organization failures before
charging the Clearing Fund under Rule 1006(c). Thus, OCC would retain
the option, but not the obligation, to use current or retained earnings
to cover such bank or clearing organization losses, for which the Rules
currently provide. Rule 1006(e)(iii) would contain the last two
sentences of Rule 1006(e) currently in effect, which concern (1) the
meaning of ``current earnings'' and (2) provide for a Clearing Member's
continuing liability for any deficiencies in that member's Clearing
Fund contribution that OCC covers with OCC's current and retained
earnings. With respect to the latter, OCC would amend Rule 1006(e)(iii)
to remove reference to OCC's ``elect[ion]'' to charge the deficiency to
current or retained earnings so that such liability for Clearing Fund
contribution deficiencies remains if OCC is obligated to charge current
and retained earnings over 110% of the Target Capital Requirement under
proposed Rule 1006(e)(i).
OCC also proposes to amend Rule 1006(b) to provide that OCC would
apply the EDCP Unvested Balance (which would be defined as above in
Rule 101) on a pro rata basis with the Clearing Fund contributions of
non-defaulting Clearing Members to satisfy any remaining balance after
applying the defaulting Clearing Member's margin and Clearing Fund
contribution and OCC's current and retained earnings greater than 110%
of its Target Capital Requirement. By amendment to Rule 1006(b)(iii),
the EDCP Unvested Balance's proportion of the loss would be calculated
by a fraction, the numerator of which would be EDCP Unvested Balance
and the denominator of which would be the sum of the EDCP Unvested
Balance and the balance of all non-defaulting Clearing Members'
Clearing Fund contributions.\20\ Pursuant to proposed amendments to
Rule 1006(b) and (e), such contribution of current and retained
earnings would be made after applying the defaulting Clearing Member's
margin and Clearing Fund contribution, but before charging that loss or
deficiency proportionately to the Clearing Fund.
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\20\ Because Rule 1006 has separate provisions addressing use of
the Clearing Fund to cover losses arising from a Clearing Member
default (Rule 1006(b)) and losses arising from bank or clearing
organization failures (Rule 1006(c)), certain changes would be made
to the rules to limit the changes for purposes of effecting the
Capital Management Policy to the use of current and retained
earnings and the EDCP Unvested Balance in the event of a Clearing
Member default. Specifically, the proposed changes to OCC's rules
would eliminate Interpretations and Policies .01 and establishes the
respective allocation provisions in Rule 1006(b)(iii) and (c)(iii).
No substantive changes to Rule 1006(c) are intended.
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In addition, a proposed amendment to Rule 1006(g), concerning,
among other things, the allocation of funds received under the Limited
Cross-Guaranty Agreement between OCC and certain other clearing
agencies in the event of the default of a common member, would provide
that any funds received under that agreement by OCC with respect to
losses incurred by OCC would be credited in accordance with Rule 1010.
Rule 1010 concerns recovery of losses charged to non-defaulting
Clearing Members and provides that any recovery of a loss charged
proportionately against the contributions of those Clearing Members
shall be paid to each Clearing Member charged in proportion to the
amounts charged. The amendment to Rule 1006(g) would establish that the
non-defaulting Clearing Members whose Clearing Fund contributions were
charged would recover proportional to the amount their contributions
were charged up to the amount their Clearing Fund contributions were
charged. The recovery proportional to the amount charged to the EDCP
Unvested Balance would be available for return to the EDCP.
Market Participant Outreach
In developing the proposed plan for replenishment capital OCC also
sought input from market participants. On May 1, 2019, OCC Management
presented to the SIFMA options committee and the Securities Traders
Association on the following topics: (1) How OCC will set fees, (2) how
OCC determines its operating margin, (3) OCC's proposal to add a
working capital line of credit, (4) the triggers and thresholds for
action, and (5) the amount that a replenishment plan would need to
raise. A discussion ensued with participants from the SIFMA options
committee concerning how OCC would set the Target Capital Requirement.
On May 28, 2019, OCC provided Clearing Members with a notice
concerning the details of the Capital Management Policy.\21\ OCC has
included a copy of the letter in Exhibit
[[Page 44949]]
3f. OCC sent the same letter to the participant exchanges (including
the non-shareholder exchanges). Either calls or meetings were held with
non-shareholder exchanges to discuss the proposed Capital Management
Policy and allow them to raise questions or concerns. No such concerns
were expressed.
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\21\ The letter references a ``one-time'' Operational Loss Fee,
consistent with the proposed Capital Management Policy as approved
by the Board at its May 13, 2019 meeting. As discussed below, the
Board approved a revision to the proposal at its July 17, 2019
meeting to allow OCC to retain the ability to charge the Operational
Loss Fee for subsequent Trigger Events up to the maximum Operational
Loss Fee, less any Operational Loss Fees previously charged and not
yet refunded.
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OCC conducted calls open to all Clearing Members on May 31, 2019 to
discuss the proposal. The calls were attended by approximately 140
participants representing 40 organizations. No concerns with the
proposed Capital Management Policy were expressed. Discussion ensued
about the mechanics of the Operational Loss Fee, alternatives to equal
allocation of the Operational Loss Fee among Clearing Members that OCC
considered and the likelihood that OCC would need to charge the
Operational Loss Fee. Management has also met with individual Clearing
Members and other market participants to discuss the proposed Capital
Management Policy.
After the Board meeting on July 17, 2019, OCC conducted a call with
the SIFMA options committee to discuss certain features of the Capital
Management Policy proposal approved at that meeting, including: (a) If
OCC charges the Operational Loss Fee and its Equity thereafter returns
to a level at which the Board approves use of tools to lower the cost
of participation for Clearing Members, OCC would first employ tools to
lower the Clearing Members' costs in equal share up to the amount of
the Operational Loss Fee charged; and (b) if OCC charges the
Operational Loss Fee, OCC would retain the ability to charge
Operational Loss Fees for subsequent Trigger Events up to the maximum
Operational Loss Fee, less any Operational Loss Fees previously charged
and not yet refunded.
OCC has included a summary of the questions raised and Management's
responses during the above referenced calls and meetings in Exhibit 3g.
2. Statutory Basis
OCC believes the proposed rule change is consistent with Section
17A of the Securities Exchange Act of 1934 (``Exchange Act'') and the
rules and regulations thereunder. In particular, OCC believes that the
Capital Management Policy is consistent with Section 17A(b)(3)(F) of
the Exchange Act \22\ and Rule 17Ad-22(e)(15) \23\ thereunder for the
reasons described below. In addition, OCC believes adding the
Operational Loss Fee to its schedule of fees is consistent with Section
17A(b)(3)(D) of the Exchange Act,\24\ and that the changes to OCC's
Rules to effectuate the use of current and retained earnings in excess
of 110% of the Target Capital Requirement and the EDCP Unvested Balance
to cover default losses is consistent with Rule 17Ad-22(e)(4).\25\
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\22\ 15 U.S.C. 78q-1(b)(3)(F).
\23\ 17 CFR 240.17Ad-22(e)(15).
\24\ 15 U.S.C. 78q-1(b)(3)(D).
\25\ 17 CFR 240.17Ad-22(e)(4).
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Section 17A(b)(3)(F) of the Exchange Act requires, in part, that
the rules of OCC be designed to promote the prompt and accurate
clearance and settlement of securities transactions and, in general, to
protect investors and the public interest. The Capital Management
Policy is designed to ensure that OCC holds sufficient LNAFBE such that
it could continue to promptly and accurately clear and settle
securities transactions even if it suffered significant operational
losses. In other words, holding sufficient LNAFBE would help OCC to
absorb such operational losses and avoid a disruption that could
negatively impact OCC's prompt and accurate clearing and settlement of
transactions. By limiting the financial resources OCC counts toward its
LNAFBE to cash and cash equivalents, the Capital Management Policy
ensures those resources would be high quality and sufficiently liquid
to allow OCC to meet its current and projected operating expenses under
a range of scenarios, including in adverse market conditions. OCC would
protect the interests of investors and the general public by
establishing the Capital Management Policy, which is designed to ensure
that such losses would not result in a failure or disruption of a
SIFMU, as OCC is designated by the Financial Stability Oversight
Council (``FSOC'') pursuant to the Payment, Clearing and Settlement
Supervision Act.\26\ FSOC has concluded that a failure or disruption at
OCC would negatively affect significant dollar value and volume
transactions in the options and futures markets, impose material losses
on OCC counterparties and create liquidity and credit problems for
financial institutions and others that rely on the markets OCC serves,
and that such credit and liquidity problems would spread quickly and
broadly among financial institutions and other markets.\27\
Accordingly, FSOC determined that a failure or disruption at OCC could
threaten the stability of the U.S. financial system.\28\ Therefore, OCC
believes that the Capital Management Policy, which is reasonably
designed to ensure that OCC has sufficient LNAFBE to continue
operations in the event of an operational loss, is consistent with the
requirements of Section 17A(b)(3)(F) of the Exchange Act by protecting
investors and the public interest.\29\
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\26\ 12 U.S.C. 5463.
\27\ FSOC Annual Report, Appendix A, at 187 (2012), available at
https://www.treasury.gov/initiatives/fsoc/Documents/2012%20Appendix%20A%20Designation%20of%20Systemically%20Important%20Market%20Utilities.pdf.
\28\ Id.
\29\ 15 U.S.C. 78q-1(b)(3)(F).
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Rule 17Ad-22(e)(15) under the Exchange Act requires OCC to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to identify, monitor and manage OCC's
general business risk and hold sufficient LNAFBE to cover potential
general business losses so that OCC can continue operations and
services as a going concern if those losses materialize.\30\ The
Capital Management Policy and amendments to OCC's Rules and Fee
Schedule are designed for consistency with the requirements of Rule
17Ad-22(e)(15) for the reasons described below.
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\30\ 17 CFR 240.17Ad-22(e)(15).
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Rule 17Ad-22(e)(15)(i) requires, in part, that OCC establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify, monitor, and manage OCC's general
business risk, including by determining the amount of LNAFBE based upon
OCC's general business risk profile and the length of time required to
achieve recovery or orderly wind-down, as appropriate, of its critical
operations and services if such action is taken.\31\ Pursuant to the
Capital Management Policy, OCC would set its Target Capital Requirement
at a level sufficient to maintain LNAFBE at least equal to the greater
of (x) six months' of OCC's current operating expenses; (y) the amount
determined by the Board to be sufficient to ensure a recovery or
orderly wind-down of critical operations and services, plus any excess
Equity Management recommends, and the Board approves, to be retained
for capital expenditures; and (z) the amount determined by the Board to
be sufficient for OCC to continue operations and services as a going
concern if general business losses materialize. By providing that OCC
would set its Target Capital Requirement no less than the greatest of
these three amounts, OCC believes the Capital Management Policy is
consistent with Rule 17Ad-22(e)(15)(i).
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\31\ 17 CFR 240.17Ad-22(e)(15)(i).
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The Capital Management Policy is also designed to identify, monitor
and manage OCC's general business risk,
[[Page 44950]]
consistent with Rule 17Ad-22(e)(15), by providing that OCC's Board
would review and approve the Target Capital Requirement annually. The
Capital Management Policy is also designed to monitor OCC's general
business risk by providing that OCC would perform an analysis of its
Equity on at least a monthly basis to ensure that OCC's Equity has not
fallen below the Early Warning or Trigger Event thresholds and is not
likely to fall below those thresholds prior to the next review. The
Capital Management Policy's requirement that Management report on the
firm's LNAFBE relative to the Early Warning and Trigger Event
thresholds at each regularly scheduled Board meeting is also designed
to identify, monitor, and manage OCC's general business risk. The
Capital Management Policy's requirement that the Board be promptly
notified in the event of an Early Warning or Trigger Event is also
reasonably designed to ensure that OCC can act quickly to ensure OCC's
compliance with the LNAFBE-holding requirements of Rule 17Ad-22(e)(15).
Rule 17Ad-22(e)(15) further requires, in part, that OCC establish,
implement, maintain and enforce written policies and procedures
reasonably designed to hold sufficient LNAFBE to cover potential
general business losses so that OCC can continue operations and
services as a going concern if those losses materialize, including by
holding LNAFBE equal to the greater of either (x) six months of OCC's
current operating expenses, or (y) the amount determined by the Board
to be sufficient to ensure a recovery or orderly wind-down of critical
operations and services.\32\ As described above, the Capital Management
Policy would provide that OCC sets its Target Capital Requirement at a
level sufficient to maintain LNAFBE in an amount that is the greatest
of three amounts, which include six months' operating expenses, an
amount determined by the Board to be sufficient to ensure recovery or
orderly wind-down, and an amount determined by the Board to be
sufficient for OCC to continue operations and services as a going
concern if general business losses materialize. Therefore, the Capital
Management Policy is designed to ensure that OCC maintains, at a
minimum, LNAFBE equal to the greater of the two amounts required by
Rule 17Ad-22(e)(15)(ii). By also including an amount determined by the
Board to be sufficient to meet general business losses should they
materialize, the Capital Management Policy is designed to ensure OCC
maintains LNAFBE at an amount necessary to satisfy Rule 17Ad-
22(e)(15)'s broader requirement that OCC hold sufficient LNAFBE to
cover potential general business losses so that OCC can continue
operations and services as a going concern if those losses materialize.
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\32\ 17 CFR 240.17Ad-22(e)(15)(ii).
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Rule 17Ad-22(e)(15)(ii) further requires, in part, that LNAFBE held
by OCC pursuant to Rule 17Ad-22(e)(15)(ii) shall be (A) in addition to
resources held to cover participant defaults or other credit or
liquidity risks,\33\ and (B) of high quality and sufficiently liquid to
allow OCC to meet its current and projected operating expenses under a
range of scenarios, including in adverse market conditions.\34\ The
Capital Management Policy is designed to satisfy Rule 17Ad-
22(e)(15)(ii)(A) by providing that the resources held to meet OCC's
Target Capital Requirement are in addition to OCC's resources to cover
participant defaults and liquidity shortfalls. While the Capital
Management Policy and proposed changes to OCC's Rules provide for the
use of capital to cover credit losses in the event of a Clearing Member
default, the proposed changes limit the amount of current and retained
earnings available to cover such losses to the amount above 110% of the
Target Capital Requirement. The Capital Management Policy is also
designed to satisfy Rule 17Ad-22(e)(15)(ii)(B) by providing that the
resources held to meet OCC's Target Capital Requirement be high quality
and sufficiently liquid. As a result, OCC believes the Capital
Management Policy is designed to comply with Rule 17Ad-22(e)(15)(ii)(A)
and (B).
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\33\ 17 CFR 240.17Ad-22(e)(15)(ii)(A).
\34\ 17 CFR 240.17Ad-22(e)(15)(ii)(B).
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Rule 17Ad-22(e)(15)(iii) requires that OCC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to identify, monitor, and manage OCC's general business risk,
including by maintaining a viable plan, approved by the Board and
updated at least annually, for raising additional equity should its
equity fall close to or below the amount required under Rule 17Ad-
22(e)(15)(ii). The Capital Management Policy and amendments to OCC's
Rules and schedule of fees are reasonably designed to establish a
viable plan to raise additional capital in an amount up to the amount
the Board determines annually to be sufficient to ensure recovery or
orderly wind-down should OCC's Equity fall close to or below its Target
Capital Requirement. By setting the threshold triggers by reference to
the Target Capital Requirement, OCC's plan for replenishment capital is
designed to require OCC to act to raise capital should its LNAFBE fall
close to or below the amounts required under Rule 17Ad-22(e)(15)(ii).
In addition, by providing that the Target Capital Requirement must be
the greater of those amounts or the amount determined by the Board to
be sufficient to cover potential general business losses so that OCC
can continue operations and services as a going concern if those losses
materialize, the Capital Management Policy is also reasonably designed
to ensure that OCC has a viable plan to raise the capital necessary to
comply with Rule 17Ad-22(e)(15) as a whole. Furthermore, the Capital
Management Policy provides that Management shall on an annual basis
recommend the Board approve or, as appropriate, modify the
Replenishment Plan. The Board would review and, as appropriate, approve
Management's recommendation. Should OCC charge the full amount of the
Operational Loss Fee, Management would recommend a new or modified
replenishment plan, subject to regulatory approval. The Board would
review and, as appropriate, approve Management's recommendation.
OCC's proposed addition of an Operational Loss Fee as part of its
Replenishment Plan is also reasonably designed to establish a viable
plan to raise additional capital. OCC's By-Laws and Rules serve as a
contract between OCC and its Clearing Members. Thus, OCC believes the
Operational Loss Fee is no less reliable than any other potential
replenishment plan that does not involve accumulating replenishment
capital in advance of any operational loss. Failure of a Clearing
Member to pay the Operational Loss Fee if charged will have the same
impact as failure to meet a margin call or clearing fund assessment,
and thus may have significant consequences. Any Clearing Member in
default of its obligations to OCC is subject to suspension and
liquidation of the defaulting member's positions, from which OCC may
collect all unpaid obligations to OCC.\35\ Should the assets of the
defaulting member be insufficient to cover its obligations, OCC may
recover the unpaid amount from the Clearing Fund.\36\
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\35\ OCC Rule 1108.
\36\ OCC Rule 1006(a), clause (vi) (failure of any Clearing
Member to make any other required payment or render any other
required performance).
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While Rule 17Ad-22(e)(15)(iii) does not by its terms specify the
amount of additional equity a clearing agency's plan for replenishment
capital must be
[[Page 44951]]
designed to raise, the SEC's adopting release states that ``a viable
plan generally should enable the covered clearing agency to hold
sufficient liquid net assets to achieve recovery or orderly wind-
down.'' \37\ OCC believes that the Capital Management Policy and
Operational Loss Fee is consistent with the SEC's adopting release for
Rule 17Ad-22(e)(15)(iii) because OCC sets the maximum Operational Loss
Fee at an amount sufficient to raise, on a post-tax basis, the amount
determined annually by the Board to be sufficient to ensure recovery or
orderly wind-down pursuant to the Board's annual approval of the RWD
Plan.
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\37\ Standards for Covered Clearing Agencies, Exchange Act
Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70836 (Oct. 13,
2016).
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In its adopting release, the SEC also states that in developing its
policies and procedures, a covered clearing agency ``generally should
consider and account for circumstances that may require a certain
length of time before any plan can be implemented.'' \38\ In the case
of an Early Warning, a fee increase would require Board approval, which
could be obtained in a special meeting of the Board on an expedited
basis. OCC would file the fee increase with the SEC for immediate
effectiveness, thereby minimizing the amount of time needed to
implement the new fee. In the case of a Trigger Event, the Operational
Loss Fee added to the fee schedule would not require further Board
approval to implement, and would likely not require further regulatory
approval to implement because this proposed rule change would add the
fee to OCC's schedule of fees. By allowing OCC to charge up to the
maximum Operational Loss Fee, less any Operational Loss Fees previously
charged and not yet refunded, the Capital Management Policy would help
OCC maintain its ability to access replenishment capital during the
time it would take to implement a new or revised Replenishment Plan.
The Operational Loss Fee and amendment to Rule 209(a) further account
for the length of time to implement OCC's plan for replenishment
capital by requiring payment within five business days. Therefore, OCC
believes the proposed Capital Management Policy, Operational Loss Fee,
and amendments to OCC's Rules are consistent with the SEC's adopting
release for Rule 17Ad-22(e)(15)(iii).
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\38\ Id.
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OCC also believes the Operational Loss Fee is consistent with
Section 17A(b)(3)(D) of the Exchange Act, which requires that the rules
of a clearing agency provide for the equitable allocation of reasonable
dues, fees and other charges among its participants. OCC believes the
proposed Operational Loss Fee is reasonable because it is designed to
accumulate additional capital to ensure that OCC can continue to meet
its obligations as a SIFMU to Clearing Members and the general public.
OCC believes that the proposed Operational Loss Fee is reasonable also
because it is designed as a viable plan for replenishing OCC's LNAFBE
in the event OCC's Equity falls below certain thresholds that are
themselves designed to ensure that OCC act to raise additional capital
before OCC's Equity reaches the amounts required by Rule 17Ad-
22(e)(15)(ii). And as discussed above, by providing that the
Replenishment Amount be sufficient to ensure OCC has sufficient capital
to cover the amount the Board determines sufficient to ensure a
recovery or orderly wind-down, OCC believes the Operational Loss Fee is
consistent with Rule 17Ad-22(e)(15)(iii). OCC also believes that the
proposed Operational Loss Fee would result in an equitable allocation
of fees among its participants because it would equally mutualize risk
of operational loss amongst the firms that use OCC's services. The
Clearing Members' equal access to the clearance and settlement services
provided by OCC, which provide the benefit of credit and liquidity risk
intermediation and associated regulatory capital benefits, is of equal
benefit to all Clearing Members irrespective of how much they choose to
use it. In addition, the Capital Management Policy provides that if OCC
charges the Operational Loss Fee and its Equity thereafter returns to a
level at which the Board approves use of tools to lower the cost of
Clearing Member participation to return Equity in excess of 110% of its
Target Capital Requirement, such as a refund, OCC will employ such
tools to lower costs for Clearing Members in equal shares, up to the
amount of the Operational Loss Fee charged. Thus, Clearing Members will
share both the cost and recovery of the Operational Loss Fee equally.
As a result, OCC believes that the proposed Operational Loss Fee
provides for the equitable allocation of reasonable fees in accordance
with Section 17A(b)(3)(D) of the Exchange Act.\39\
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\39\ 15 U.S.C. 78q-1(b)(3)(D).
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OCC also believes the amendments to its Rules for use of current
and retained earnings and the EDCP Unvested Balance to cover default
losses are consistent with Rule 17Ad-22(e)(4), which provides, in part,
that OCC establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively identify, measure,
monitor and manage its credit exposures to participants and those
arising from its payment, clearing and settlement processes, including
by maintaining sufficient financial resources to cover its credit
exposure to each participant fully with a high degree of
confidence.\40\ By providing that OCC shall use current and retained
earnings in excess of 110% of its Target Capital Requirement, as well
as contributing the EDCP Unvested Balance on a pro rata basis with
Clearing Member's Clearing Fund contributions, OCC is providing for
additional financial resources available to cover losses in the event
of a Clearing Member default, and reducing the amount OCC would charge
the Clearing Fund contributions of non-defaulting Clearing Members.
Therefore, OCC believes the amendments to its Rules are consistent with
Rule 17Ad-22(e)(4).
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\40\ 17 CFR 240.17Ad-22(e)(4)(i).
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B. Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) of the Exchange Act \41\ 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 the Capital Management Policy and amendments to OCC's
Rules and schedule of fees would not have any impact, or impose any
burden, on competition that is not necessary or appropriate in
furtherance of the purposes of the Exchange Act. As discussed above,
the Capital Management Policy describes how OCC would measure, monitor
and manage its capital needs to ensure appropriate financial resiliency
for a SIFMU and comply with applicable financial regulations, including
requirements about the amount of LNAFBE it must hold. The Capital
Management Policy is designed for OCC to maintain Equity at a level
necessary to meet the requirements of Rule 17Ad-22(e)(15) and serve its
Clearing Members and the public interest.
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\41\ 15 U.S.C. 78q-1(b)(3)(I).
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While the proposed Operational Loss Fee, in the unlikely event it
is charged, would have an effect on the amount of fees that Clearing
Members pay for OCC's services, the proposed rule change is designed to
allocate those fees on an equal basis to all Clearing Members. OCC's
Rules currently require Clearing Members to maintain net
[[Page 44952]]
capital of at least $2 million.\42\ Based on the most recent financial
information reported by Clearing Members, which OCC has included in
confidential Exhibit 3h, OCC believes that 98% of Clearing Members
could absorb the maximum amount of the Operational Loss Fee without
breaching their minimum net capital requirements or the SEC's ``early
warning'' threshold.\43\ OCC is comfortable with Clearing Members'
ability to pay the Operational Loss Fee because the amount of the
maximum Operational Loss Fee that would be charged per Clearing Member
is approximately the same as the contingent obligations under the OCC
clearing fund assessment requirements for a Clearing Member operating
at the minimum clearing fund deposit--$1 million. Consequently, OCC
does not believe the Operational Loss Fee obligation poses a
significant barrier to entry for smaller Clearing Members. By adding
the Operational Loss Fee to OCC's schedule of fees, the fee would be a
transparent obligation of membership based upon which Clearing Members
can independently assess their rights and obligations.
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\42\ OCC Rule 302.
\43\ 17 CFR 240.15c3-1.
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In addition, the Capital Management Policy would help address the
relative impact that charging the Operational Loss Fee in equal shares
would have on smaller Clearing Members by providing that should OCC
charge the fee and thereafter return to a position where the Board may
approve tools to lower costs for Clearing Members, such as refunds, OCC
would employ such tools to lower costs for Clearing Members on an equal
basis, up to the amount of the Operational Loss Fee charged. Thus, all
Clearing Members shall share equally in the cost and recovery of the
Operational Loss Fee amounts charged.
Moreover, any barrier to entry that the Operational Loss Fee may
impose is not unnecessary in furtherance of the Exchange Act, and the
rules the SEC has promulgated thereunder. Pursuant to those rules, OCC
must hold minimum LNAFBE and have a viable plan to replenish equity
should OCC's equity fall close to or below those minimums. It is
entirely appropriate that the Clearing Members that benefit equally
from OCC's services share the burden equally should OCC experience an
operational loss that threatens its ability to continue providing those
services and comply with its regulatory obligations.
C. Clearing Agency's Statement on Comments on the Proposed Rule Change
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.
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-2019-007 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-2019-007. 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-2019-007 and
should be submitted on or before September 17, 2019.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\44\
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\44\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-18385 Filed 8-26-19; 8:45 am]
BILLING CODE 8011-01-P
