Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning a Proposed Capital Management Policy That Would Support the Options Clearing Corporation's Function as a Systemically Important Financial Market Utility, 47990-47998 [2019-19608]

Download as PDF 47990 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices SECURITIES AND EXCHANGE COMMISSION [Release No. 34–86888; File No. SR–OCC– 2019–805] Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning a Proposed Capital Management Policy That Would Support the Options Clearing Corporation’s Function as a Systemically Important Financial Market Utility September 5, 2019. jspears on DSK3GMQ082PROD with NOTICES Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, entitled Payment, Clearing and Settlement Supervision Act of 2010 (‘‘Clearing Supervision Act’’) 1 and Rule 19b–4(n)(1)(i) 2 under the Securities Exchange Act of 1934 (‘‘Exchange Act’’),3 notice is hereby given that on August 9, 2019, the Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’ or ‘‘SEC’’) an advance notice as described in Items I, II and III below, which Items have been prepared by OCC. The Commission is publishing this notice to solicit comments on the advance notice from interested persons. I. Clearing Agency’s Statement of the Terms of Substance of the Proposed Rule Change This advance notice is filed in connection with OCC’s proposal to 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. 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 1 12 U.S.C. 5465(e)(1). CFR 240.19b–4(n)(1)(i). 3 15 U.S.C. 78a et seq. 4 OCC’s By-Laws and Rules can be found on OCC’s public website: https://optionsclearing.com/ about/publications/bylaws.jsp. 2 17 VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 II. Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Advance Notice In its filing with the Commission, OCC included statements concerning the purpose of and basis for the advance notice and discussed any comments it received on the advance notice. The text of these statements may be examined at the places specified in Item IV below. OCC has prepared summaries, set forth in sections A and B below, of the most significant aspects of these statements. (A) Clearing Agency’s Statement on Comments on the Advance Notice Received From Members, Participants or Others Written comments were not and are not intended to be solicited with respect to the proposed change and none have been received. OCC will notify the Commission of any written comments received by OCC. (B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, Clearing, and Settlement Supervision Act Description of the Proposed Change 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’’). 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 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). PO 00000 Frm 00060 Fmt 4703 Sfmt 4703 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 capital requirements for OCC as a DCO, as set forth in CFTC Rule 39.11(a)(2).8 Target Capital Requirement The proposed Capital Management Policy would explain how OCC would annually determine the Target Capital Requirement. The proposed amendment 7 17 8 17 E:\FR\FM\11SEN1.SGM CFR 240.17Ad–22(e)(15). CFR 39.11(a)(2). 11SEN1 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices 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. jspears on DSK3GMQ082PROD with NOTICES 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 and, as appropriate, approved by the Board. OCC’s Recovery and Orderly 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. VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 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’’), (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. 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). PO 00000 Frm 00061 Fmt 4703 Sfmt 4703 47991 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 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 14 See OCC Rule 1006(e), as proposed in the changes attached as Exhibit 5b hereto. E:\FR\FM\11SEN1.SGM 11SEN1 47992 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices demonstrate that Equity has fallen below the Early Warning or Trigger Event, Management shall promptly notify the Board. jspears on DSK3GMQ082PROD with NOTICES 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 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 15 OCC By-Law Art. IX, § 9. VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 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 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 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 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. 17 OCC has included the analysis in confidential Exhibit 3d. PO 00000 Frm 00062 Fmt 4703 Sfmt 4703 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% percent 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 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 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. E:\FR\FM\11SEN1.SGM 11SEN1 jspears on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices 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 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 19 See, e.g., OCC Rule 1006(h)(A). VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 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 PO 00000 Frm 00063 Fmt 4703 Sfmt 4703 47993 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 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 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 E:\FR\FM\11SEN1.SGM 11SEN1 47994 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices jspears on DSK3GMQ082PROD with NOTICES ‘‘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 VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 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 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 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. PO 00000 Frm 00064 Fmt 4703 Sfmt 4703 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 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 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. E:\FR\FM\11SEN1.SGM 11SEN1 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices jspears on DSK3GMQ082PROD with NOTICES 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. Anticipated Effect on and Management of Risk OCC believes that the proposed change will reduce OCC’s overall level of risk because it will help ensure that OCC will be able to continue to provide its clearing services even if it suffers significant business losses. Each feature of the Capital Management Policy and associated changes to OCC’s Rules and schedule of fees would help ensure that OCC’s capital is sufficient on an ongoing basis to allow it to withstand business losses, whether resulting from a decline in revenue or otherwise. The Capital Management Policy provides for how OCC would determine the amount of capital necessary to meet its regulatory obligations and to serve market participants and the public interest. The Target Capital Amount is designed to ensure OCC maintains LNAFBE at least equal to the greater of VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 (x) six-months’ current operating expenses, (y) the RWD Amount, and (z) the Potential Loss Amount. By limiting the assets OCC counts towards this LNAFBE requirement to the level of cash and cash equivalents, no greater than Equity, the Capital Management Policy ensures that the assets OCC maintains to satisfy the requirement are 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. The Capital Management Policy further provides for how OCC would monitor its LNAFBE and Equity levels to ensure adequate financial recourses are available to meet general business obligations. The Replenishment Plan would help ensure OCC has access to replenishment capital should OCC’s Equity fall close to or below the Target Capital Requirement to ensure OCC maintains adequate capital levels. In the event of an 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 capital. If a Trigger Event occurs, OCC would charge Clearing Members the Operational Loss Fee in equal shares, after contributing the entire EDCP Unvested Balance, to return OCC’s Equity to 110% of the Target Capital Requirement—up to the maximum Operational Loss Fee provided for in OCC’s schedule of fees. Any Clearing Member’s failure to pay the Operational Loss Fee would have the same consequences as a Clearing Member default, including suspension, liquidation of positions from which OCC may recover any outstanding obligations, and the ability of OCC to use the Clearing Fund to cover any remaining obligations. After a Trigger Event, OCC would maintain the ability to charge an Operational Loss Fee for any subsequent Trigger Event, up to the maximum Operational Loss Fee less the amount of any Operational Loss Fees previously charged and unrefunded. Should OCC’s Equity return to a level at or above 110% of the Target Capital Requirement after a Trigger Event, OCC may replenish the maximum Operational Loss Fee amount it could charge for subsequent Trigger Events by using tools to lower the cost of Clearing Members in equal shares, up to the amount of the Operational Loss Fee or Fees previously charged. Together these features of the Capital Management Policy help ensure that OCC maintains levels of capital sufficient to allow it to absorb substantial business losses and meet its PO 00000 Frm 00065 Fmt 4703 Sfmt 4703 47995 responsibilities as a systemically important financial market utility, which in turn helps reduce OCC’s overall level of risk. OCC also believes that the proposed changes reduce the nature and level of risk presented by OCC by providing for the use of OCC’s capital in excess of 110% of its Target Capital Requirement to cover losses caused by Clearing Member defaults. Using such excess Equity as skin-in-the-game, after applying a defaulting Clearing Member’s margin and Clearing Fund deposits, provides another layer of financial resources available to cover credit losses. By applying such excess Equity prior to charging the Clearing Fund, this feature of the Capital Management Policy helps protect other Clearing Members from losses as a result of a Clearing Member’s default, which in turn helps reduce OCC’s overall level of risk and ensure the prompt and accurate clearance and settlement of its cleared products. For the foregoing reasons, OCC believes that the proposed change would enhance OCC’s management of risk and reduce the nature or level of risk presented to OCC. Consistency With the Payment, Clearing and Settlement Supervision Act The stated purpose of the Clearing Supervision Act is to mitigate systemic risk in the financial system and promote financial stability by, among other things, promoting uniform risk management standards for systemically important financial market utilities and strengthening the liquidity of systemically important financial market utilities.22 Section 805(a)(2) of the Clearing Supervision Act 23 also authorizes the Commission to prescribe risk management standards for the payment, clearing and settlement activities of designated clearing entities, like OCC, for which the Commission is the supervisory agency. Section 805(b) of the Clearing Supervision Act 24 states that the objectives and principles for risk management standards prescribed under Section 805(a) shall be to: • Promote robust risk management; • promote safety and soundness; • reduce systemic risks; and • support the stability of the broader financial system. OCC believes the proposed changes are consistent with the objectives and principles of Section 805(b) of the Clearing Supervision Act.25 As 22 12 U.S.C. 5461(b). U.S.C. 5464(a)(2). 24 12 U.S.C. 5464(b). 25 12 U.S.C. 5464(b). 23 12 E:\FR\FM\11SEN1.SGM 11SEN1 47996 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices described above, 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. 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 Clearing 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 the Clearing Supervision Act The Commission has adopted risk management standards under Section 805(a)(2) of the Clearing Supervision Act and the Act, which include Commission Rules 17Ad–22(e)(15).29 Rule 17Ad–22(e)(15) requires OCC to establish, implement, maintain and enforce written policies and procedures 26 12 U.S.C. 5463. 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 17 CFR 240.17Ad–22. See Securities Exchange Act Release Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7–08–11) (‘‘Clearing Agency Standards’’); 78961 (September 28, 2016), 81 FR 70786 (October 13, 2016) (S7–03–14) (‘‘Standards for Covered Clearing Agencies’’). The Standards for Covered Clearing Agencies became effective on December 12, 2016. OCC is a ‘‘covered clearing agency’’ as defined in Rule 17Ad–22(a)(5) and therefore OCC must comply with section (e) of Rule 17Ad–22. jspears on DSK3GMQ082PROD with NOTICES 27 FSOC VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 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, 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 30 17 31 17 PO 00000 CFR 240.17Ad–22(e)(15). CFR 240.17Ad–22(e)(15)(i). Frm 00066 Fmt 4703 Sfmt 4703 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 32 17 33 17 E:\FR\FM\11SEN1.SGM CFR 240.17Ad–22(e)(15)(ii). CFR 240.17Ad–22(e)(15)(ii)(A). 11SEN1 jspears on DSK3GMQ082PROD with NOTICES Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices 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 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 Rules currently require Clearing Members to maintain net capital of at least $2 million.35 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.36 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. Furthermore, 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.37 Should the assets of the defaulting member be 35 OCC Rule 302. CFR 240.15c3–1. 37 OCC Rule 1108. 36 17 34 17 CFR 240.17Ad–22(e)(15)(ii)(B). VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 PO 00000 Frm 00067 Fmt 4703 Sfmt 4703 47997 insufficient to cover its obligations, OCC may recover the unpaid amount from the Clearing Fund.38 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 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.’’ 39 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.’’ 40 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 proposal 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 38 OCC Rule 1006(a), clause (vi) (failure of any Clearing Member to make any other required payment or render any other required performance). 39 Standards for Covered Clearing Agencies, Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70836 (Oct. 13, 2016). 40 Id. E:\FR\FM\11SEN1.SGM 11SEN1 47998 Federal Register / Vol. 84, No. 176 / Wednesday, September 11, 2019 / Notices Loss Fee, and amendments to OCC’s Rules are consistent with the SEC’s adopting release for Rule 17Ad– 22(e)(15)(iii). III. Date of Effectiveness of the Advance Notice and Timing for Commission Action The proposed change may be implemented if the Commission does not object to the proposed change within 60 days of the later of (i) the date the proposed change was filed with the Commission or (ii) the date any additional information requested by the Commission is received. OCC shall not implement the proposed change if the Commission has any objection to the proposed change. The Commission may extend the period for review by an additional 60 days if the proposed change raises novel or complex issues, subject to the Commission providing the clearing agency with prompt written notice of the extension. A proposed change may be implemented in less than 60 days from the date the advance notice is filed, or the date further information requested by the Commission is received, if the Commission notifies the clearing agency in writing that it does not object to the proposed change and authorizes the clearing agency to implement the proposed change on an earlier date, subject to any conditions imposed by the Commission. OCC shall post notice on its website of proposed changes that are implemented. The proposal shall not take effect until all regulatory actions required with respect to the proposal are completed. By the Commission. Jill M. Peterson, Assistant Secretary. I. Solicitation of Comments [FR Doc. 2019–19608 Filed 9–10–19; 8:45 am] Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the advance notice is consistent with the Clearing Supervision Act. Comments may be submitted by any of the following methods: Electronic Comments jspears on DSK3GMQ082PROD with NOTICES All submissions should refer to File Number SR–OCC–2019–805. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s internet website (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the advance notice that are filed with the Commission, and all written communications relating to the advance notice between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the self-regulatory organization. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–OCC–2019–805 and should be submitted on or before September 26, 2019. • 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–2019–805 on the subject line. Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. VerDate Sep<11>2014 17:44 Sep 10, 2019 Jkt 247001 BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–86875; File No. SR– NASDAQ–2019–057] Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Notice of Designation of Longer Period for Commission Action on a Proposed Rule Change To Amend Rule 4121 19b–4 thereunder,2 a proposed rule change to amend Nasdaq Rule 4121 (Trading Halts Due to Extraordinary Market Volatility) to enhance the reopening auction process for Nasdaqlisted securities following trading halts due to extraordinary market volatility. The proposed rule change was published for comment in the Federal Register on July 25, 2019.3 The Commission received no comment letters on the proposed rule change. Section 19(b)(2) of the Act 4 provides that, within 45 days of the publication of the notice of the filing of a proposed rule change, or within such longer period up to 90 days as the Commission may designate if it finds such longer period to be appropriate and publishes its reasons for so finding or as to which the self-regulatory organization consents, the Commission shall either approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether the proposed rule change should be disapproved. The 45th day after publication of the notice for this proposed rule change is September 8, 2019. The Commission is extending the 45day time period for Commission action on the proposed rule change. The Commission finds that it is appropriate to designate a longer period within which to take action on the proposed rule change so that it has sufficient time to consider the proposed rule change. Accordingly, pursuant to Section 19(b)(2) of the Act,5 the Commission designates October 23, 2019 as the date by which the Commission shall either approve, disapprove, or institute proceedings to determine whether to disapprove, the proposed rule change (File No. SR–NASDAQ–2019–057). For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.6 Jill M. Peterson, Assistant Secretary. [FR Doc. 2019–19609 Filed 9–10–19; 8:45 am] BILLING CODE 8011–01–P SMALL BUSINESS ADMINISTRATION Reporting and Recordkeeping Requirements Under OMB Review Small Business Administration. 30-Day notice. September 5, 2019. AGENCY: On July 16, 2019, The Nasdaq Stock Market LLC (‘‘Nasdaq’’ 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 ACTION: 1 15 PO 00000 U.S.C. 78s(b)(1). Frm 00068 Fmt 4703 Sfmt 4703 2 17 CFR 240.19b–4. Securities Exchange Act Release No. 86412 (July 19, 2019), 84 FR 35900. 4 15 U.S.C. 78s(b)(2). 5 15 U.S.C. 78s(b)(2)(A)(ii)(I). 6 17 CFR 200.30–3(a)(31). 3 See E:\FR\FM\11SEN1.SGM 11SEN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 84, Number 176 (Wednesday, September 11, 2019)]
[Notices]
[Pages 47990-47998]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-19608]



[[Page 47990]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-86888; File No. SR-OCC-2019-805]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Advance Notice Concerning a Proposed Capital 
Management Policy That Would Support the Options Clearing Corporation's 
Function as a Systemically Important Financial Market Utility

September 5, 2019.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, entitled Payment, Clearing 
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'') 
\1\ and Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 
1934 (``Exchange Act''),\3\ notice is hereby given that on August 9, 
2019, the Options Clearing Corporation (``OCC'') filed with the 
Securities and Exchange Commission (``Commission'' or ``SEC'') an 
advance notice as described in Items I, II and III below, which Items 
have been prepared by OCC. The Commission is publishing this notice to 
solicit comments on the advance notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    This advance notice is filed in connection with OCC's proposal to 
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. 
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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    \4\ OCC's By-Laws and Rules can be found on OCC's public 
website: https://optionsclearing.com/about/publications/bylaws.jsp.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the advance notice and 
discussed any comments it received on the advance notice. The text of 
these statements may be examined at the places specified in Item IV 
below. OCC has prepared summaries, set forth in sections A and B below, 
of the most significant aspects of these statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants or Others

    Written comments were not and are not intended to be solicited with 
respect to the proposed change and none have been received. OCC will 
notify the Commission of any written comments received by OCC.

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, 
Clearing, and Settlement Supervision Act

Description of the Proposed Change
    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'').
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    \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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    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 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

[[Page 47991]]

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.
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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 
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 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

[[Page 47992]]

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

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% 
percent 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 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

[[Page 47993]]

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).
---------------------------------------------------------------------------

    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 
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 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

[[Page 47994]]

``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 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

[[Page 47995]]

concerns. No such concerns were expressed.
---------------------------------------------------------------------------

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

    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.
Anticipated Effect on and Management of Risk
    OCC believes that the proposed change will reduce OCC's overall 
level of risk because it will help ensure that OCC will be able to 
continue to provide its clearing services even if it suffers 
significant business losses. Each feature of the Capital Management 
Policy and associated changes to OCC's Rules and schedule of fees would 
help ensure that OCC's capital is sufficient on an ongoing basis to 
allow it to withstand business losses, whether resulting from a decline 
in revenue or otherwise.
    The Capital Management Policy provides for how OCC would determine 
the amount of capital necessary to meet its regulatory obligations and 
to serve market participants and the public interest. The Target 
Capital Amount is designed to ensure OCC maintains LNAFBE at least 
equal to the greater of (x) six-months' current operating expenses, (y) 
the RWD Amount, and (z) the Potential Loss Amount. By limiting the 
assets OCC counts towards this LNAFBE requirement to the level of cash 
and cash equivalents, no greater than Equity, the Capital Management 
Policy ensures that the assets OCC maintains to satisfy the requirement 
are 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. The Capital Management Policy 
further provides for how OCC would monitor its LNAFBE and Equity levels 
to ensure adequate financial recourses are available to meet general 
business obligations.
    The Replenishment Plan would help ensure OCC has access to 
replenishment capital should OCC's Equity fall close to or below the 
Target Capital Requirement to ensure OCC maintains adequate capital 
levels. In the event of an 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 capital. If a 
Trigger Event occurs, OCC would charge Clearing Members the Operational 
Loss Fee in equal shares, after contributing the entire EDCP Unvested 
Balance, to return OCC's Equity to 110% of the Target Capital 
Requirement--up to the maximum Operational Loss Fee provided for in 
OCC's schedule of fees. Any Clearing Member's failure to pay the 
Operational Loss Fee would have the same consequences as a Clearing 
Member default, including suspension, liquidation of positions from 
which OCC may recover any outstanding obligations, and the ability of 
OCC to use the Clearing Fund to cover any remaining obligations. After 
a Trigger Event, OCC would maintain the ability to charge an 
Operational Loss Fee for any subsequent Trigger Event, up to the 
maximum Operational Loss Fee less the amount of any Operational Loss 
Fees previously charged and unrefunded. Should OCC's Equity return to a 
level at or above 110% of the Target Capital Requirement after a 
Trigger Event, OCC may replenish the maximum Operational Loss Fee 
amount it could charge for subsequent Trigger Events by using tools to 
lower the cost of Clearing Members in equal shares, up to the amount of 
the Operational Loss Fee or Fees previously charged.
    Together these features of the Capital Management Policy help 
ensure that OCC maintains levels of capital sufficient to allow it to 
absorb substantial business losses and meet its responsibilities as a 
systemically important financial market utility, which in turn helps 
reduce OCC's overall level of risk.
    OCC also believes that the proposed changes reduce the nature and 
level of risk presented by OCC by providing for the use of OCC's 
capital in excess of 110% of its Target Capital Requirement to cover 
losses caused by Clearing Member defaults. Using such excess Equity as 
skin-in-the-game, after applying a defaulting Clearing Member's margin 
and Clearing Fund deposits, provides another layer of financial 
resources available to cover credit losses. By applying such excess 
Equity prior to charging the Clearing Fund, this feature of the Capital 
Management Policy helps protect other Clearing Members from losses as a 
result of a Clearing Member's default, which in turn helps reduce OCC's 
overall level of risk and ensure the prompt and accurate clearance and 
settlement of its cleared products.
    For the foregoing reasons, OCC believes that the proposed change 
would enhance OCC's management of risk and reduce the nature or level 
of risk presented to OCC.
Consistency With the Payment, Clearing and Settlement Supervision Act
    The stated purpose of the Clearing Supervision Act is to mitigate 
systemic risk in the financial system and promote financial stability 
by, among other things, promoting uniform risk management standards for 
systemically important financial market utilities and strengthening the 
liquidity of systemically important financial market utilities.\22\ 
Section 805(a)(2) of the Clearing Supervision Act \23\ also authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like OCC, for which the Commission is the supervisory agency. Section 
805(b) of the Clearing Supervision Act \24\ states that the objectives 
and principles for risk management standards prescribed under Section 
805(a) shall be to:
---------------------------------------------------------------------------

    \22\ 12 U.S.C. 5461(b).
    \23\ 12 U.S.C. 5464(a)(2).
    \24\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    OCC believes the proposed changes are consistent with the 
objectives and principles of Section 805(b) of the Clearing Supervision 
Act.\25\ As

[[Page 47996]]

described above, 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. 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 Clearing 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 the Clearing Supervision Act
---------------------------------------------------------------------------

    \25\ 12 U.S.C. 5464(b).
    \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.
---------------------------------------------------------------------------

    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and the Act, which include 
Commission Rules 17Ad-22(e)(15).\29\ Rule 17Ad-22(e)(15) 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.
---------------------------------------------------------------------------

    \29\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release 
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016), 
81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards for Covered 
Clearing Agencies''). The Standards for Covered Clearing Agencies 
became effective on December 12, 2016. OCC is a ``covered clearing 
agency'' as defined in Rule 17Ad-22(a)(5) and therefore OCC must 
comply with section (e) of Rule 17Ad-22.
    \30\ 17 CFR 240.17Ad-22(e)(15).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \31\ 17 CFR 240.17Ad-22(e)(15)(i).
---------------------------------------------------------------------------

    The Capital Management Policy is also designed to identify, monitor 
and manage OCC's general business risk, 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.
---------------------------------------------------------------------------

    \32\ 17 CFR 240.17Ad-22(e)(15)(ii).
---------------------------------------------------------------------------

    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

[[Page 47997]]

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).
---------------------------------------------------------------------------

    \33\ 17 CFR 240.17Ad-22(e)(15)(ii)(A).
    \34\ 17 CFR 240.17Ad-22(e)(15)(ii)(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 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 Rules currently require 
Clearing Members to maintain net capital of at least $2 million.\35\ 
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.\36\ 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.
---------------------------------------------------------------------------

    \35\ OCC Rule 302.
    \36\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    Furthermore, 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.\37\ Should the assets of the defaulting member be 
insufficient to cover its obligations, OCC may recover the unpaid 
amount from the Clearing Fund.\38\
---------------------------------------------------------------------------

    \37\ OCC Rule 1108.
    \38\ OCC Rule 1006(a), clause (vi) (failure of any Clearing 
Member to make any other required payment or render any other 
required performance).
---------------------------------------------------------------------------

    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 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.'' \39\ 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.
---------------------------------------------------------------------------

    \39\ Standards for Covered Clearing Agencies, Exchange Act 
Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70836 (Oct. 13, 
2016).
---------------------------------------------------------------------------

    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.'' \40\ 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 proposal 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

[[Page 47998]]

Loss Fee, and amendments to OCC's Rules are consistent with the SEC's 
adopting release for Rule 17Ad-22(e)(15)(iii).
---------------------------------------------------------------------------

    \40\ Id.
---------------------------------------------------------------------------

III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date the proposed change was filed with the Commission or (ii) the date 
any additional information requested by the Commission is received. OCC 
shall not implement the proposed change if the Commission has any 
objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    OCC shall post notice on its website of proposed changes that are 
implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

I. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the advance 
notice is consistent with the Clearing Supervision Act. Comments may be 
submitted by any of the following methods:

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-2019-805 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549.

All submissions should refer to File Number SR-OCC-2019-805. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (https://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the advance notice that are filed with the 
Commission, and all written communications relating to the advance 
notice between the Commission and any person, other than those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of the self-regulatory 
organization.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly.
    All submissions should refer to File Number SR-OCC-2019-805 and 
should be submitted on or before September 26, 2019.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-19608 Filed 9-10-19; 8:45 am]
 BILLING CODE 8011-01-P

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