Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving Proposed Rule Change, as Modified by Partial Amendment No. 1, Concerning a Proposed Capital Management Policy That Would Support The Options Clearing Corporation's Function as a Systemically Important Financial Market Utility, 5500-5511 [2020-01643]

Download as PDF 5500 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: • 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– NYSEArca–2020–07 on the subject line. khammond on DSKJM1Z7X2PROD with NOTICES Paper Comments • Send paper comments in triplicate to: Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSEArca–2020–07. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s internet website (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NYSEArca–2020–07 and should be submitted on or before February 20, 2020. CFR 200.30–3(a)(12). VerDate Sep<11>2014 16:56 Jan 29, 2020 [FR Doc. 2020–01645 Filed 1–29–20; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION Electronic Comments 29 17 For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.29 J. Matthew DeLesDernier, Assistant Secretary. Jkt 250001 [Release No. 34–88028; File No. SR– NASDAQ–2019–091] Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Notice of Designation of a Longer Period for Commission Action on a Proposed Rule Change To Adopt a New Rule Permitting Nasdaq To Halt Trading in a Security and Request Information From the Company Regarding the Number of Unrestricted Publicly Held Shares in Certain Circumstances disapproved. The 45th day after publication of the notice for this proposed rule change is January 26, 2020. The Commission is extending this 45-day time period. The Commission finds it 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, the Commission, pursuant to Section 19(b)(2) of the Act,5 designates March 11, 2020 as the date by which the Commission shall either approve or disapprove, or institute proceedings to determine whether to disapprove, the proposed rule change (File No. SR–NASDAQ–2019–091). For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.6 J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2020–01642 Filed 1–29–20; 8:45 am] BILLING CODE 8011–01–P January 24, 2020. On November 22, 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 19b–4 thereunder,2 a proposed rule change to adopt a new rule permitting Nasdaq to halt trading in a security and request information from the company regarding the number of unrestricted publicly held shares when Nasdaq observes unusual trading characteristics in a security or a company announces an event that may cause a contraction in the number of unrestricted publicly held shares. The proposed rule change was published for comment in the Federal Register on December 12, 2019.3 The Commission has 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 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 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–88029; File No. SR–OCC– 2019–007] Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving Proposed Rule Change, as Modified by Partial Amendment No. 1, Concerning a Proposed Capital Management Policy That Would Support The Options Clearing Corporation’s Function as a Systemically Important Financial Market Utility January 24, 2020. I. Introduction On August 9, 2019, the Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change SR–OCC–2019– 007 (‘‘Proposed Rule Change’’) pursuant to Section 19(b) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 1 and Rule 19b–4 2 thereunder to adopt a policy concerning capital management at OCC, which includes OCC’s plan to replenish its capital in the event it falls close to or below target capital levels.3 The Proposed Rule Change was published for public comment in the Federal Register on 1 15 5 Id. 2 17 6 17 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 87677 (Dec. 6, 2019), 84 FR 67974. 4 15 U.S.C. 78s(b)(2). PO 00000 Frm 00134 Fmt 4703 Sfmt 4703 CFR 200.30–3(a)(31). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 See Notice of Filing infra note 4, at 84 FR 44952. 1 15 E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices August 27, 2019.4 The Commission received comments regarding the Proposed Rule Change.5 On September 11, 2019, OCC filed a partial amendment (‘‘Partial Amendment No. 1’’) to modify the Proposed Rule Change.6 On October 8, 2019, the Commission designated a longer period of time for Commission action on the Proposed Rule Change.7 Notice of Partial Amendment No. 1 and of the designation of a longer period of time was published in the Federal Register on October 15, 2019.8 On November 22, 2019, the Commission issued an order to institute proceedings to determine whether to approve or disapprove the Proposed Rule Change.9 This order approves the Proposed Rule Change. khammond on DSKJM1Z7X2PROD with NOTICES II. Background One reason for the Proposed Rule Change is a specific Commission requirement for covered clearing agencies such as OCC. Rule 17Ad– 22(e)(15) under the Exchange Act requires that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to identify, monitor, and manage the covered clearing agency’s general business risk and hold sufficient liquid net assets funded by equity to cover potential general business losses so that the covered clearing agency can continue operations and services as a going concern if those losses materialize, 4 Securities Exchange Act Release No. 86725 (Aug. 21, 2019), 84 FR 44952 (Aug. 27, 2019) (SR– OCC–2019–007) (‘‘Notice of Filing’’). OCC also filed a related advance notice (SR–OCC–2019–805) (‘‘Advance Notice’’) with the Commission pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, entitled the Payment, Clearing, and Settlement Supervision Act of 2010 and Rule 19b–4(n)(1)(i) under the Exchange Act. 12 U.S.C. 5465(e)(1) and 17 CFR 240.19b–4, respectively. The Advance Notice was published in the Federal Register on September 11, 2019. Securities Exchange Act Release No. 86888 (Sep. 5, 2019), 84 FR 47990 (Sep. 11, 2019) (SR–OCC–2019–805). 5 Comments are available at https://www.sec.gov/ comments/sr-occ-2019-007/srocc2019007.htm. 6 See Notice of Extension infra note 8, at 84 FR 55189. In Partial Amendment No. 1, OCC appended an Exhibit 2 to the materials filed on August 9, 2019 regarding File No. SR–OCC–2019–007. The appended Exhibit 2 consists of communications from OCC concerning the proposal dated after OCC filed the proposal on August 9, 2019 and does not change the purpose of or basis for the Proposed Rule Change. References to the Proposed Rule Change from this point forward refer to the Proposed Rule Change, as amended by Partial Amendment No. 1. 7 See Notice of Extension infra note 8, at 84 FR 55189. 8 Securities Exchange Act Release No. 87246 (Oct. 8, 2019), 84 FR 55189 (Oct. 15, 2019) (SR–OCC– 2019–007) (‘‘Notice of Extension’’). 9 Securities Exchange Act Release No. 87603 (Nov. 22, 2019), 84 FR 65858 (Nov. 29, 2019) (SR– OCC–2019–007). VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 including by taking the actions described in Rules 17Ad–22(e)(15)(i)– (iii) under the Exchange Act.10 In adopting Rule 17Ad–22(e), which includes Rule 17Ad–22(e)(15), the Commission noted that ‘‘each registered clearing agency has different organizational and operating structures and clears distinct products that warrant a tailored approach to governance and risk management, respectively.’’ 11 The Commission also noted its belief that Rule 17Ad–22(e) ‘‘achieves the appropriate balance between imposing new requirements on covered clearing agencies and allowing each covered clearing agency, subject to its obligations and responsibilities as an SRO under the Exchange Act, to design its policies and procedures pursuant to Rule 17Ad–22(e).’’12 Rule 17Ad–22(e)(15) was adopted in 2016 as part of the Covered Clearing Agency Standards, with a compliance date of April 11, 2017.13 Anticipating the need to come into compliance with new Rule 17Ad–22(e)(15), in January 2015, OCC filed with the Commission a proposed rule change regarding a plan to increase OCC’s capitalization (the ‘‘Capital Plan’’).14 The Capital Plan was approved by the Commission in February 2016,15 and subsequently implemented by OCC. However, the approval order was vacated by the Court of Appeals for the D.C. Circuit and remanded to the Commission. On February 13, 2019, the Commission issued an order disapproving the Capital Plan on remand.16 In order to come back into compliance with Rule 17Ad– 22(e)(15), among other things, OCC now proposes changes to adopt, as part of its rules, a new policy concerning capital management at OCC (‘‘Capital Management Policy’’). Specifically, the proposed Capital Management Policy would (i) describe how OCC would determine the amount of liquid net assets funded by equity (‘‘LNAFBE’’) necessary to cover OCC’s potential general business losses; (ii) require OCC to hold a minimum amount of 10 17 CFR 240.17Ad–22(e)(15). Exchange Act Release No. 78961 (September 28, 2016), 81 FR 70786, 70797 (October 13, 2016) (S7–03–14) (‘‘Covered Clearing Agency Standards’’). 12 Id. 13 See Covered Clearing Agency Standards, 81 FR at 70786. 14 See Securities Exchange Act Release No. 74136 (Jan. 26, 2015, 80 FR 5171 (Jan. 30, 2015) (File No. SR–OCC–2015–02). 15 Securities Exchange Act Release No. 7112 (Feb. 11, 2016), 81 FR 8294 (Feb. 18, 2016) (File No. SR– OCC–2015–02). 16 See Securities Exchange Act Release No. 85121 (Feb. 13, 2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR–OCC–2015–02). 11 Securities PO 00000 Frm 00135 Fmt 4703 Sfmt 4703 5501 shareholders equity (‘‘Equity’’) sufficient to support the amount of LNAFBE determined to be necessary; 17 and (iii) establish a plan for replenishing OCC’s capital in the event that Equity were to fall below certain thresholds. OCC also proposes to revise its existing rules to support the terms of the proposed Capital Management policy. A. Determining Capital Requirements As noted above, OCC proposes to adopt rules describing the determination of the LNAFBE necessary to cover potential general business losses. As proposed, LNAFBE would be a subset of OCC’s overall Equity—cash and cash equivalents, less any approved adjustments—and therefore, could not, by definition, exceed Equity. OCC proposes to set a ‘‘Target Capital Requirement,’’ which would be based on two components: (i) The amount of LNAFBE determined by OCC to be necessary to ensure compliance with OCC’s regulatory obligations, including Rule 17Ad–22(e)(15) under the Exchange Act; 18 and (ii) any additional amounts determined to be necessary and appropriate for capital expenditures approved by OCC’s Board.19 With respect to the first component of the Target Capital Requirement, to ensure that it is set at a level sufficient to ensure compliance with OCC’s regulatory obligations, OCC proposes to set its Target Capital Requirement, at a minimum, equal to the greater of three amounts: (i) An amount equal to sixmonths of OCC’s current operating expenses; (ii) the amount determined by OCC’s Board to be sufficient to ensure a recovery or orderly wind-down of critical operations and services (‘‘RWD Amount’’); 20 or (iii) the amount determined by OCC’s Board to be sufficient for OCC to continue 17 LNAFBE would mean cash and cash equivalents to the extent that such cash and cash equivalents do not exceed Equity. 18 17 CFR 240.17Ad–22(e)(15). 19 In setting the Target Capital Requirement, OCC would also consider, but not be bound by, its projected rolling twelve-months’ operating expenses pursuant to OCC’s interpretation of Commodity Exchange Act Rule 39.11(a)(2). 17 CFR 39.11(a)(2). Nothing in this Order constitutes an interpretation of Rule 39.11(a)(2) under the Commodity Exchange Act by the Commission or an endorsement of OCC’s interpretation of Rule 39.11(a)(2). 20 Under the proposal, OCC’s Board would approve the RWD Amount annually at a level designed to cover the cost to maintain OCC’s critical services over the recovery or wind-down period. Identification of OCC’s critical services and the length of time necessary to recover or winddown is covered in OCC’s Recovery and WindDown Plan. See Securities Exchange Act Release No. 83918 (Aug. 23, 2018), 83 FR 44091 (Aug. 29, 2018). E:\FR\FM\30JAN1.SGM 30JAN1 5502 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices operations and services as a going concern if general business losses materialize (‘‘Potential Loss Amount’’).21 OCC believes that a minimum Target Capital Requirement sized to cover at least these three amounts would address OCC’s obligations under Exchange Act Rule 17Ad–22(e)(15).22 With respect to the second component of the Target Capital Requirement, the proposal would authorize OCC’s Board to increase the Target Capital Requirement by an amount to be retained for capital expenditures.23 OCC’s Board would be responsible for reviewing and approving the Target Capital Requirement annually. khammond on DSKJM1Z7X2PROD with NOTICES B. Maintaining Capital As noted above, OCC proposes to adopt rules that would require it to hold the minimum amount of Equity necessary to cover the Target Capital Requirement. Specifically, OCC proposes to adopt rules pertaining to the monitoring and management of OCC’s Equity. Under the proposed rules, OCC’s senior management would be responsible for reviewing analyses, including projections of future volume, expenses, cash flows, capital needs and other factors, to help ensure adequate financial resources are available to meet general business obligations. Such analyses would also include a monthly review of whether OCC’s Equity falls close to or below the Target Capital Requirement. Under the proposal, OCC would view Equity less than 110 percent of the Target Capital Requirement as falling close to the Target Capital Requirement.24 OCC would refer to a breach of this 110 percent threshold as an ‘‘Early Warning.’’ Under the proposed rules, OCC’s senior management would be obligated to notify OCC’s Board 21 Under the proposal, OCC’s Board would set the Potential Loss Amount by analyzing and aggregating potential losses from individual operational risk scenarios, aggregating the loss events, and conducting loss modeling at or above the 99 percent confidence level. 22 See Notice of Filing, 84 FR at 44945. 23 Under the proposal, OCC’s Board could determine, in the alternative, to fund capital expenditures out of funds in excess of the Target Capital Requirement. OCC stated that, in making such a determination, its Board would consider factors including, but not limited to, the amount of funding required, the amount of Equity proposed to be retained, the potential impact of the investment on OCC’s operations, and the duration of time over which funds would be accumulated. See id. 24 OCC stated that 10 percent of the Target Capital Requirement represents approximately two months of earnings, and that OCC believes that a two-month window would provide OCC’s senior management and Board sufficient time to respond to a deterioration of OCC’s capital. See Notice of Filing, 84 FR at 44946. VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 promptly if Equity were to fall below the Early Warning threshold and to recommend to the Board whether to implement a fee increase in an amount that the Board determines necessary and appropriate to raise additional Equity. Under the proposal, OCC’s senior management would also, on a quarterly basis, review OCC’s schedule of fees in consideration of projected operating expenses, projected volumes, anticipated cash flows, and capital needs. Based on its review, OCC’s senior management would recommend to OCC’s Board Compensation and Performance Committee whether to issue a fee increase, decrease or fee waiver. Additionally, if Equity were to exceed 110 percent of the Target Capital Requirement plus an amount of excess Equity approved for capital expenditures, OCC’s Board could reduce the cost of clearing by lowering fees, declaring a fee holiday, or issuing refunds. OCC stated that resources held to meet OCC’s Target Capital Requirement would be in addition to OCC’s resources to cover participant defaults.25 OCC proposes, however, to mitigate losses arising out of a Clearing Member default with OCC’s own excess capital. Specifically, OCC proposes to offset default losses remaining after the application of a defaulted Clearing Member’s margin deposits and Clearing Fund contributions with OCC’s capital in excess of 110 percent of the Target Capital Requirement at the time of the default. OCC also proposes to charge losses remaining after the application of OCC’s excess capital to OCC senior management’s deferred compensation as well as non-defaulting Clearing Members.26 The Commission understands these aspects of the proposal to constitute the first instance where a covered clearing agency is seeking Commission consideration of a ‘‘skin-in-the-game’’ component to financial risk management for central clearing. A skin-in-the-game component to financial risk management entails a covered clearing agency (in this instance, OCC), upon the occurrence of a default or series of defaults and application of all available assets of the defaulting participant(s), choosing to apply its own capital contribution to the relevant clearing or guaranty fund in full to satisfy any remaining losses prior to the application of any (a) contributions by non-defaulting 25 See Notice of Filing, 84 FR at 44950. losses would be charged on a pro rata basis to (a) non-defaulting Clearing Members’ Clearing Fund contributions, and (b) the aggregate value of the EDCP Unvested Balance (defined below). 26 Such PO 00000 Frm 00136 Fmt 4703 Sfmt 4703 members to the clearing or guaranty fund, or (b) assessments that the covered clearing agency require non-defaulting participants to contribute following the exhaustion of such participant’s funded contributions to the relevant clearing or guaranty fund.27 C. Replenishing Capital OCC proposes to establish a plan for replenishing its capital in the event that Equity were to fall below certain thresholds (‘‘Replenishment Plan’’). As described above, OCC proposes to establish an Early Warning threshold to define when OCC’s Equity falls close enough to the Target Capital Requirement to require action. OCC also proposes to establish two ‘‘Trigger Event’’ thresholds to identify (i) whether OCC’s Equity were to fall below the Target Capital Requirement; and (ii) the appropriate response based on the severity and speed of capital deterioration. Further, the proposed Capital Management Policy would require that, on an annual basis, OCC’s management recommend that the Board approve or, as appropriate, modify the Replenishment Plan, and that the Board review and, as appropriate, approve Management’s recommendation. Under the proposed rules, a Trigger Event would occur if OCC’s Equity were to remain below 100 percent of the Target Capital Requirement for a period of 90 consecutive calendar days (referred to herein as the ‘‘Moderate Trigger Event’’). OCC believes that the failure of a fee increase resulting from an Early Warning to increase OCC’s Equity above the Target Capital Requirement within 90 days would indicate that corrective action in the form of a fee increase would be insufficient.28 Under the proposed rules, a Trigger Event would also occur if OCC’s Equity were to fall below 90 percent of the Target Capital Requirement at any time (referred to herein as the ‘‘Severe Trigger Event’’). OCC believes that a Severe Trigger Event 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.29 As noted above, OCC’s Board would be authorized to approve fee increases to address the deterioration of OCC’s capital over time. To address the more acute capital replenishment needs posed by the Trigger Events, OCC proposes to authorize the use of two 27 See Covered Clearing Agency Standards, 81 FR at 70806. 28 See Notice of Filing, 84 FR at 44946–47. 29 See Notice of Filing, 84 FR at 44946. E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices khammond on DSKJM1Z7X2PROD with NOTICES additional resources: (i) Funds held under The Options Clearing Corporation Executive Deferred Compensation Plan Trust (‘‘EDCP’’); 30 and (ii) funds obtained by levying a special fee on Clearing Members. In response to a Trigger Event, OCC would be required to replenish its capital first through the contribution of the EDCP Unvested Balance. The amount of the EDCP Unvested Balance contributed would be the lesser of (i) the entire EDCP Unvested Balance or (ii) the amount necessary to raise OCC’s Equity above 110 percent of the Target Capital Requirement. If a contribution of the entire EDCP Unvested balance were necessary, OCC would be required to reevaluate its Equity vis-a`-vis the Target Capital Requirement to determine whether further action would be required following such a contribution. The proposed rules would require that OCC take further action if, after contributing the entire EDCP Unvested Balance, either: (i) Equity were to remain above 90 percent, but below 100 percent, of the Target Capital Requirement for an additional 90-day period; 31 or (ii) Equity were below 90 percent of the Target Capital Requirement. Under the proposal, if OCC were to determine that further action would be necessary to replenish its capital, OCC would be required to levy a special fee on its Clearing Members (‘‘Operational Loss Fee’’), which would be payable within five business days of OCC providing notice to the Clearing Members. Accordingly, OCC proposes to amend its schedule of fees to describe the maximum Operational Loss Fee that it could charge Clearing Members. The maximum Operational Loss Fee would be sized to provide OCC with the RWD Amount after any applicable taxes (‘‘Adjusted RWD Amount’’).32 Under the proposal, OCC would be authorized to charge Clearing Members, collectively, the lesser of (i) the maximum Operational Loss Fee or (ii) the amount necessary to raise OCC’s Equity above 110 percent of the Target Capital Requirement. Under the 30 The EDCP funds available for capital replenishment would be only those funds that are (x) deposited on or after January 1, 2020 in respect of the EDCP and (y) in excess of amounts necessary to pay for benefits accrued and vested under the EDCP at such time (‘‘EDCP Unvested Balance’’). 31 The 90-calendar day term of a subsequent Moderate Trigger Event would be measured beginning on the date OCC applies the EDCP Unvested Balance. 32 OCC acknowledged that the tax implications of the income represented by the Operational Loss Fee would depend on the extent to which any operational loss giving rise to a Trigger Event would be tax deductible. See Notice of Filing, 84 FR at 44947. VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 proposal, OCC would allocate the Operational Loss Fee equally among the Clearing Members. OCC believes that charging the Operational Loss Fee in equal shares is preferable to other potential allocation methods because it would equally mutualize the risk of operational loss among the firms that use OCC’s services.33 The proposed rules would permit OCC to charge amounts only up to the maximum Operational Loss Fee. If, after charging some amount less than the maximum Operational Loss Fee, OCC were to issue clearing fee refunds to manage excess capital, OCC would issue such refunds in equal shares until the amount of the Operational Loss Fee charged to each Clearing Member had been fully refunded. If OCC were to charge some amount less than the maximum Operational Loss Fee, then the proposed rules would allow OCC to charge another Operational Loss Fee in the future, provided that the sum of all Operational Loss Fees, less amounts refunded, could not exceed the maximum Operational Loss Fee. In the event that OCC were to charge the maximum Operational Loss Fee, OCC would then be required to convene its Board to develop a new replenishment plan. III. Statutory Standards Section 19(b)(2)(C) of the Exchange Act directs the Commission to approve a proposed rule change of a selfregulatory organization if it finds that such proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to such organization.34 The Commission addresses in its review of the Proposed Rule Change the following relevant provisions of the Exchange Act and the rules and regulations thereunder applicable to registered clearing agencies: • Section 17A(b)(3)(F) of the Exchange Act requires, in part, that the rules of a registered clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions, to assure the safeguarding of securities and funds which are in the custody or control of OCC or for which it is responsible, and to protect investors and the public interest.35 • Section 17A(b)(3)(D) of the Exchange Act requires, in part, that the 33 See id. OCC stated that it found no evidence of a correlation between the risk of operational loss and either volume or a Clearing Member’s credit risk profile. See id. 34 15 U.S.C. 78s(b)(2)(C). 35 15 U.S.C. 78q–1(b)(3)(F). PO 00000 Frm 00137 Fmt 4703 Sfmt 4703 5503 rules of a clearing agency provide for the equitable allocation of reasonable dues, fees, and other charges among its participants.36 • Rule 17Ad–22(e)(2) under the Exchange Act requires, in part, that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for governance arrangements that meet a number of criteria.37 • Rule 17Ad–22(e)(15) under the Exchange Act requires, in part, that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to identify, monitor, and manage the covered clearing agency’s general business risk and hold sufficient liquid net assets funded by equity to cover potential general business losses so that the covered clearing agency can continue operations and services as a going concern if those losses materialize, including by taking the actions described in Rules 17Ad–22(e)(15)(i)– (iii) under the Exchange Act.38 IV. Discussion and Commission Findings After considering the entire record, and for the reasons discussed below, the Commission finds the proposal is consistent with Sections 17A(b)(3)(F) and 17A(b)(3)(D) of the Exchange Act,39 as well as Rules 17Ad–22(e)(2) and 17Ad–22(e)(15) thereunder.40 Before addressing the relevant portions of the Exchange Act and the rules and regulations thereunder, however, we address a comment submitted by Susquehanna International Group (‘‘SIG’’). SIG does not comment on the substance of the proposal, but, rather, expresses a generalized concern that the capital accumulated through the proposed Capital Management Policy could ultimately be monetized only or disproportionately for the benefit of the OCC shareholders in the event of a future sale of OCC.41 SIG acknowledges that OCC’s By-Laws currently limit the shareholders of OCC to national securities exchanges or national securities associations.42 SIG states, however, that OCC’s By-Laws leave 36 15 U.S.C. 78q–1(b)(3)(D). CFR 240.17Ad–22(e)(2). 38 17 CFR 240.17Ad–22(e)(15). 39 15 U.S.C. 78q–1(b)(3)(D) and (F). 40 17 CFR 240.17Ad–22(e)(2) and 17 CFR 240.17Ad–22(e)(15). 41 Letter from Brian Sopinsky, General Counsel, Susquehanna International Group, dated October 1, 2019, to Vanessa Countryman, Secretary, Commission (‘‘SIG Letter’’) at 1. 42 SIG Letter at 1. 37 17 E:\FR\FM\30JAN1.SGM 30JAN1 5504 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices khammond on DSKJM1Z7X2PROD with NOTICES open the possibility of one of these organizations acquiring OCC or a future change to OCC’s By-Laws to permit others to acquire OCC.43 The Commission notes that any such future transformative transaction (including any related proposals concerning the Capital Management Policy) would be subject to the filing requirements of Section 19 of the Exchange Act. We would therefore assess the details and potential effects of the transaction at that time, including the treatment of fees collected from Clearing Members. In light of this required review of any such transaction, the Commission does not believe that the concerns raised by SIG about such a future transaction render the Capital Management Policy inconsistent with the Exchange Act. A. Consistency With Section 17A(b)(3)(F) of the Exchange Act Section 17A(b)(3)(F) of the Exchange Act requires, in part, that the rules of OCC be designed to promote the prompt and accurate clearance and settlement of securities transactions and to assure the safeguarding of securities and funds which are in the custody or control of OCC or for which it is responsible.44 Based on its review of the record, the Commission finds the proposal is consistent with Section 17A(b)(3)(F) of the Exchange Act. The Commission believes that the Capital Management Policy as a whole would help to ensure that OCC monitors and maintains its Equity at a level sufficient to either continue operating as a going concern or to wind-down its operations in an orderly manner in the event that OCC incurs potential operational or general business losses. In particular, the Commission believes that the proposed establishment of a Target Capital Requirement in combination with the capital monitoring, management, and replenishment tools described above, including the Operational Loss Fee, would reduce the risk that OCC would be unavailable to clear and settle securities transactions and therefore is consistent with promoting prompt and accurate clearance and settlement of securities transactions. The Commission did not receive any comments on this aspect of the proposal. In addition, as described above, OCC proposes to mitigate losses arising out of a Clearing Member default with OCC’s excess capital (i.e., skin-in-the-game). Further, OCC proposes to charge losses remaining after the application of skinin-the-game to OCC senior management 43 SIG 44 15 Letter at 1. U.S.C. 78q–1(b)(3)(F). VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 as well as Clearing Members through the contribution of the EDCP Unvested Balance. Taken together, these aspects of the Proposed Rule Change could reduce the potential losses charged to the Clearing Fund contributions of nondefaulting Clearing Members in the event of a Clearing Member default, which in turn would help preserve the Clearing Fund contributions of nondefaulting Clearing Members.45 As such, the components of the Proposed Rule Change related to skin-in-the-game are consistent with promoting the safeguarding of securities and funds in OCC’s custody or for which OCC is responsible. Accordingly, the Commission finds that the proposed Capital Management Policy is consistent with the requirements of Section 17A(b)(3)(F) of the Exchange Act.46 B. Consistency With Section 17A(b)(3)(D) of the Exchange Act Section 17A(b)(3)(D) of the Exchange Act requires the rules of a clearing agency to provide for the equitable allocation of reasonable dues, fees, and other charges among its participants.47 As discussed below, based on its review of the record, the Commission finds that OCC’s proposal—as relevant here, the proposal to adopt the Operational Loss Fee—is consistent with Section 17A(b)(3)(D) of the Exchange Act. 1. OCC’s Proposal To Set the Amount of the Operational Loss Fee Is Reasonable As discussed above, the Operational Loss Fee is designed to replenish OCC’s capital following the realization of losses arising out of operational or general business risk exposures (as opposed to losses arising out of the default of a Clearing Member). To that end, OCC proposes to set the maximum amount of the Operational Loss Fee based on the amount determined necessary to either recover and continue operating as a going concern, or winddown its operations in an orderly manner, with adjustments to those amounts to account for the potential tax implications of revenues that would be generated by the fee.48 Additionally, the proposal would not require OCC to charge the maximum amount of the Operational Loss Fee, and would 45 Additional issues relevant to the skin-in-thegame aspects of the proposal, including relevant comments, are discussed below in Section V.C. 46 15 U.S.C. 78q–1(b)(3)(F). 47 15 U.S.C. 78q–1(b)(3)(D). 48 See Notice of Filing, 84 FR at 44947. As discussed in Section V.D.2 herein, the Commission finds that the approach OCC applies to determining such amounts is reasonable and supported by the record. PO 00000 Frm 00138 Fmt 4703 Sfmt 4703 provide OCC the means to repay any Operational Loss Fee charged to Clearing Members through subsequent refunds.49 As noted, the purpose of the Operational Loss Fee is to provide OCC with sufficient replenishment capital following an operational- or general business risk-related loss, such that OCC could either recover its operations and continue operating as a going concern, or wind-down its operations in an orderly manner. The Commission did not receive any comments on the aspects of the proposal related to the sizing of the Operational Loss Fee. Further, as discussed above, the Commission has reviewed the regulatory information available to it related to OCC’s Clearing Members and understands that the maximum Operational Loss Fee would be 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.50 The Commission believes that OCC’s proposal to size the Operational Loss Fee consistent with other Clearing Member obligations while also generating an amount of capital appropriate to recover OCC’s operations and continue as a going concern or wind down its operations in an orderly manner is reasonable and therefore consistent with the requirements of Section 17A(b)(3)(D) of the Exchange Act.51 2. OCC’s Proposal Would Provide for the Equitable Allocation of the Operational Loss Fee If levied, OCC would allocate the Operational Loss Fee equally among all Clearing Members.52 According to OCC, equal allocation is preferable to a proportional allocation based on, for example, Clearing Members’ trade volume or Clearing Fund contributions, because, in OCC’s view, all Clearing Members benefit from equal access to the clearance and settlement services provided by OCC, irrespective of how much a given Clearing Member chooses to use those services.53 Additionally, in developing its proposal to adopt the 49 See id. minimum assessments could equal up to an additional $1 million ($500,000 minimum Clearing Fund requirement, assessed up to two times) on top of a Clearing Member’s existing $500,000 minimum Clearing Fund contribution, for a total contribution of $1.5 million. See, generally, OCC Rule 1006(h), available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf 51 15 U.S.C. 78q–1(b)(3)(D). 52 See Notice of Filing, 84 FR at 44947. 53 See id. 50 Such E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices khammond on DSKJM1Z7X2PROD with NOTICES Operational Loss Fee, OCC considered alternative allocation methods for the Operational Loss Fee, including allocating the Operational Loss Fee proportionally among Clearing Members based on trade volume, risk profile, and other metrics.54 As part of this process, OCC reviewed available data related to different measures of Clearing Members’ use of OCC’s clearance and settlement services, such as trade volume and credit risk profiles, and performed a series of analyses to determine whether there is a potential correlation between and among those metrics and the various operational and general business risks that could give rise to the Operational Loss Fee. The Commission received, and has reviewed, these analyses.55 These analyses did not show a correlation between the operational and general business risks that could give rise to the Operational Loss Fee and contract volume, Clearing Fund contributions, risk profile, or other metrics.56 Based on our review of the record, we conclude that it is consistent with the Exchange Act to allocate the Operational Loss Fee equally among all Clearing Members. One commenter, the FIA, submitted a comment letter noting that the use of the Operational Loss Fee could allocate some amount of non-default losses to OCC’s Clearing Members and stating that non-default losses should not be allocated to Clearing Members. In the FIA’s view, as a CCP, OCC should absorb such losses rather than utilize capital on a discretionary basis.57 Rather than assess the Operational Loss Fee in the event of a Trigger Event, the FIA asserts that OCC should begin accumulating retained earnings now so that it will be in a position to use them instead of the Operational Loss Fee.58 OCC responds that raising additional capital through the accumulation of retained earnings over a number of years would still source the funds from Clearing Members, but would do so in a manner that essentially would prefund the replenishment obligation rather than only impose it if and when 54 See id. Additionally, OCC discussed the equal allocation of the Operational Loss Fee with Clearing Members on May 31, 2019. See Notice of Filing, 84 FR at 44949. 55 See Notice of Filing, 84, FR at 44947 (noting that OCC included as confidential Exhibit 3e a comparison of its quantification of operational risks to contract volume and the amount of Clearing Fund deposits). 56 See Notice of Filing, 84, FR at 44947 (noting that ‘‘OCC has not observed any correlation between the annual quantifications of these risks and contract volume or Clearing Member credit risk.’’). 57 FIA Letter at 3. 58 FIA Letter at 2. VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 doing so became necessary.59 OCC further describes the series of events that would have to occur in the event that its Equity fell at or below different percentages of the Target Capital Requirement, and the different measures OCC would have to take, including potentially raising fees, lowering costs, and using its available skin-in-the-game to cure such losses (and that would have to fail) before OCC would be permitted to charge the Operational Loss Fee.60 OCC’s proposal with respect to the Operational Loss Fee will permit OCC to raise additional equity in the event that its equity falls close to or below the Target Capital Requirement. The Operational Loss Fee represents an appropriate and reasonable allocation of potential contingent costs to Clearing Members. The FIA’s suggested approach would still source the required funds from Clearing Members, but in a manner that essentially pre-funds the maximum potential replenishment obligation without being informed by the specific facts and circumstances that inform OCC’s determination of the actual required amount.61 In contrast, under OCC’s proposal, the Operational Loss Fee would be imposed only if and when OCC’s efforts to set and maintain its capital reserves at a level sufficient to withstand operational and business losses are insufficient, OCC’s capital reserves deteriorate to a significant degree as a result, and the other tools available to OCC are insufficient to return OCC’s capital reserves to a minimum acceptable level. In this respect, the Commission believes that OCC’s approach is both reasonable and consistent with the Exchange Act. Because the Operational Loss Fee is not assessed until a specific but contingent future time, it leaves available to Clearing Members funds and liquidity that may be put to more efficient use as opposed to being held indefinitely at OCC in the form of collected fees. Further, the Proposed Rule Change would allow OCC to charge less than the maximum Operational Loss Fee because, if and when such a fee were to become necessary, OCC would know that actual amount required to achieve replenishment. In the Commission’s view, this approach is more precise, requiring OCC to determine and collect only the amount of the Operational Loss Fee required by OCC under the given circumstances to replenish its resources. Further, as the FIA noted, OCC estimates that the Operational Loss Fee, if assessed now, would be around $1.4 59 OCC Letter at 2. Letter at 4–5. 61 OCC Letter at 2. 60 OCC PO 00000 Frm 00139 Fmt 4703 Sfmt 4703 5505 million per Clearing Member.62 OCC’s rules currently require Clearing Members to maintain net capital of at least $2 million.63 Based on its review of data provided by OCC, as of the time of filing, 98 percent of Clearing Members would be able to absorb the maximum Operational Loss Fee without breaching that requirement.64 Further, a $1.4 million Operational Loss Fee would be roughly similar to the contingent obligations under the OCC Clearing Fund assessment requirements for a Clearing Member operating at the minimum Clearing Fund deposit.65 In the Commission’s view, this helps ensure that any potential liquidity obligations OCC may place on its Clearing Members via the Operational Loss Fee is at a level that is generally consistent with OCC’s existing assessment demands on such Clearing Members. Finally, the FIA’s preferred approach of imposing higher fees now and building up OCC’s capital reserves to the necessary level over time would not provide OCC with an immediately available replenishment plan, and would therefore, not be consistent with OCC’s obligation to comply with Rule 17Ad-22(e)(15)(iii) of the Exchange Act. As such, although the FIA has a general objection to any CCP allocating nondefault losses to Clearing Members, the FIA does not assert that, or otherwise explain how, OCC’s specific proposal to do so in the context of the Operational Loss Fee would render the Proposed Rule Change inconsistent with the Exchange Act. The FIA further expresses the belief that imposing the Operational Loss Fee on Clearing Members without providing a return to Clearing Members is inequitable and that, ideally, OCC’s shareholders should either be required to provide ‘‘similar such commitment or allow for an equity dilution.’’ 66 As explained above, the Commission believes that the record demonstrates that OCC has designed the Operational Loss Fee in a manner that is equitable to the Clearing Members in terms of determining (i) the overall amount of the Operational Loss Fee, and (ii) the relative burdens and obligations Clearing Members must meet in paying the Operational Loss Fee. Moreover, the Commission believes that the 62 FIA Letter at 2. of Filing, 84 FR at 44951–52 (citation omitted). 64 See Notice of Filing, 84, FR at 44952 (stating that OCC included, as confidential Exhibit 3h, financial data reported by Clearing Members). 65 Notice of Filing, 84 FR at 44951; see also supra note 51. 66 FIA Letter at 2. 63 Notice E:\FR\FM\30JAN1.SGM 30JAN1 5506 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices khammond on DSKJM1Z7X2PROD with NOTICES Operational Loss Fee serves a critical purpose for the benefit of Clearing Members, their customers and the broader U.S. equity markets. OCC is the only clearing agency for standardized U.S. securities options listed on SECregistered national securities exchanges (‘‘listed options’’) and provides central counterparty services for the U.S. listedoptions markets.67 OCC’s role as the sole CCP for all listed options contracts in the U.S. makes it an integral part of the national system for clearance and settlement, and the Financial Stability Oversight Council designated OCC as a systemically important financial market utility (‘‘SIFMU’’) in 2012.68 The resilience and ongoing orderly operations of OCC thus broadly benefits Clearing Members, their customers, and the broader U.S. financial system.69 While OCC could have considered or proposed other approaches that might have entailed different obligations and burdens for Clearing Members (including via raising additional capital from the Clearing Members), the failure of OCC to consider or propose such alternative measures does not render the Proposed Rule Change inequitable. A different commenter—LPL Financial (‘‘LPL’’)—expresses the belief that the proposal to allocate the Operational Loss fee in equal shares among OCC’s Clearing Members would be inequitable and suggests that, instead, the Operational Loss Fee should be allocated ‘‘in a manner that corresponds to the extent to which each Clearing Member utilizes (and therefore benefits from) the OCC’s operations.’’ 70 In LPL’s view, such an allocation would ‘‘correctly acknowledge that the extent to which a Clearing Member makes use of the OCC’s clearing and settlement systems does, in some cases, directly correspond to the risk that the OCC will incur certain operational losses.’’ 71 LPL further challenges OCC’s statement that ‘‘there is no correlation between 67 See Securities Exchange Act Release No. 85121 (Feb. 13, 2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR–OCC–2015–02); see id., 84 FR at 5158. 68 See Financial Stability Oversight Council (‘‘FSOC’’) 2012 Annual Report, Appendix A, https://www.treasury.gov/initiatives/fsoc/ Documents/2012%20Annual%20Report.pdf (last visited November 25, 2019). 69 See id. As a registered clearing agency, OCC plays an important role in fostering the proper functioning of financial markets and, by centralizing the clearance and settlement of listed options, allows market participants to reduce costs, increase operational efficiency, and manage risks more effectively. See Covered Clearing Agency Standards, 81 FR at 70860–61. 70 Letter from Steven Morrison, SVP, Associate General Counsel, LPL, dated September 17, 2019 (received September 26, 2019) to Brent J. Fields, Secretary, Commission, (‘‘LPL Letter’’) at 1–2. 71 LPL Letter at 1–2. VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 operational risks, on the one hand, and contract volume, on the other hand,’’ as ‘‘flawed inasmuch as it ignores the fact that a Clearing Member that makes greater use of the OCC’s clearing and settlement system places greater strain on that system and thus exposes the system to greater operational risk.’’72 Based on the Commission’s regulatory and supervisory experience, the Commission does not agree that a Clearing Member that ‘‘makes greater use of OCC’s clearing and settlement system necessarily places greater strain on that system and thus exposes the system to greater operational risk.’’ Contrary to LPL’s assertion that ‘‘each contract introduced to the OCC’s system brings with it a new opportunity for internal fraud and cyber-attack,’’ 73 based on its supervisory and regulatory experience with OCC, the Commission understands that contracts are not submitted to be processed by OCC on a one-by-one basis such that each contract represents an equal potential for operational risk. Further, in the Commission’s experience, a Clearing Member’s ‘‘use’’ of OCC’s services is not necessarily correlated to that Clearing Member’s operational resiliency. OCC has a broad range of geographically diverse Clearing Members, comprised of U.S. brokerdealers, future commission merchants, and foreign securities firms of various sizes, all of which serve diverse markets and engage in diverse strategies and activities on behalf of diverse clients, including professional traders, as well as institutional and retail investors. There is, therefore, no basis to conclude, for example, that a Clearing Member that clears 1,000 contracts in a given month in a particular set of financial products necessarily introduces less operational risk to OCC than a Clearing Member that clears 10,000 contracts in a different set of financial products in that same month. LPL also fails to acknowledge or address the specific operational and business risks that could give rise to the Operational Loss Fee. As noted above, OCC conducted analyses to determine whether it could identify a correlation between various measures of Clearing Members’ use of OCC’s clearance and settlement services and the specific types of operational and general business risks that could give rise to the Operational Loss Fee. These included, among others, internal fraud, external fraud, employment practices, workplace safety, damage to physical assets, business disruption and system failures, 72 LPL 73 LPL PO 00000 Letter at 3. Letter at 3. Frm 00140 Fmt 4703 Sfmt 4703 and execution, delivery, and process management at OCC. The Commission believes that the operational and business risks identified and analyzed by OCC are reasonable in light of the requirements of Rule 17Ad–22(e)(15) discussed above.74 And based on the Commission’s review of the record, we do not believe that there is a positive correlation between these types of risks and a Clearing Member’s ‘‘use of OCC’s clearing and settlement services.’’ For example, OCC’s analyses do not show a correlation between a Clearing Member’s contract volume or credit risk profile, which are reasonable proxies for a Clearing Member’s ‘‘use’’ of OCC’s clearance and settlement services, and the specific operational risk that that Clearing Member poses to OCC. Further, the Commission does not agree with the assertion that Clearing Members that ‘‘use’’ OCC’s clearance and settlement services more derive more benefit from those services, and therefore should be allocated a larger portion of the Operational Loss Fee. As an initial matter, OCC has been designated as a SIFMU and its role as the sole CCP for all listed options contracts in the U.S. makes it an integral part of the national system for clearance and settlement. Clearing Members, their customers, investors, and the markets as a whole derive significant benefit from that national system and the overall market system it supports, regardless of their specific utilization of that system. As such, Clearing Members benefit from OCC’s efforts to ensure that it is and remains well capitalized, that it has sufficient financial resources to withstand operational or general business losses, and that it has a plan in place to replenish those resources in the event that it incurs such losses. The Commission is not aware of evidence demonstrating that those benefits are tied directly or positively correlated to an individual Clearing Member’s rate of utilization of OCC’s clearance and settlement services. Further, as noted, the Commission has reviewed data provided by OCC that demonstrates a lack of correlation between use (as represented by volume) and operational risk.75 Such data is consistent with the Commission’s regulatory and 74 The Commission notes that these operational and business risk metrics correspond to the Basel II Advanced Measurement Approach. See International Convergence of Capital Measurements and Capital Standards: a Revised Framework, Basel Committee on Banking Supervision, 2005, available at https://www.bis.org/publ/bcbs128.pdf. 75 See Notice of Filing, 84, FR at 44947 (noting that OCC included as confidential Exhibit 3e a comparison of its quantification of operational risks to contract volume and the amount of Clearing Fund deposits). E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices khammond on DSKJM1Z7X2PROD with NOTICES supervisory experience, which demonstrates that operational risks can arise from a variety of disparate sources that are represented in different ways and to different degrees among OCC’s diverse membership, such that, as noted above, the level of operational risk presented to OCC by a given Clearing Member does not appear to be positively correlated to the number, type, or volume of contracts that that Clearing Member clears through OCC. Taken together, the Commission believes that OCC’s current proposal to fund replenishment capital through the Operational Loss Fee includes a sizing and allocation methodology that, as discussed above, is reasonably designed to minimize the potential burden of the fee on Clearing Members, as supported by data on the record, and would result in both the reasonable sizing and the equitable allocation of the Operational Loss Fee. Accordingly, for the reasons discussed above, the Commission believes that the proposed allocation method is consistent with the requirement that OCC’s rules provide for the equitable allocation of fees. The Commission finds, therefore, that OCC’s proposal to adopt the Operational Loss Fee is consistent with the requirements of Section 17A(b)(3)(D) of the Exchange Act.76 C. Consistency With Rule 17Ad–22(e)(2) Under the Exchange Act Rule 17Ad–22(e)(2) under the Exchange Act requires, in part, that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for governance arrangements that, among other things, are clear and transparent; clearly prioritize the safety and efficiency of the covered clearing agency; and support the public interest requirements of the Exchange Act.77 Based on its review of the record, the Commission finds the proposal is consistent with Rule 17Ad–22(e)(2) under the Exchange Act. As described in more detail above, under the proposal OCC would introduce a skin-in-the-game component to its existing default waterfall to offset losses in the event of a Clearing Member default. The FIA stated that it is unclear how material these skin-in-the-game contributions would be and whether they would be meaningful enough to result in an alignment of interest from a shareholder perspective.78 The FIA notes that capital expenditures planned 76 15 U.S.C. 78q–1(b)(3)(D). CFR 240.17Ad–22(e)(2). 78 FIA Letter at 1. 77 17 VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 and approved by the OCC Board can be met through amounts in excess of the Target Capital Requirement and, as such, it is unclear how this may tie in with OCC’s plans to contribute skin-inthe-game.79 The FIA also notes that ‘‘capital levels in excess of 110% of threshold could result in OCC revisiting the fee schedule,’’ and that it is ‘‘unclear if/how this may impact the funded level of skin in the game.’’ 80 As such, the FIA seeks ‘‘greater transparency on the size of these resources,’’ states that OCC should have a minimum amount of skin-in-the-game that ‘‘scales with risk and is defined and funded upfront,’’ and urges OCC ‘‘to define a level of [skin-inthe-game] ex ante that would always be readily available in case of a default loss.’’ 81 OCC responds that the Commission has not imposed a skin-in-the-game requirement, but that OCC nevertheless believes it is prudent to align OCC’s incentives with those of the broader industry with respect to the management of risks faced by OCC and, as a result, has determined to propose the skin-in-the-game provisions included in its proposal.82 OCC states that, under the proposed Capital Management Policy, it would provide a layer of skin-in-the-game to be used for both default losses and non-default losses, and that the skin-in-the-game would be a combination of two sources: Current and retained earnings of OCC and available funds in OCC’s EDCP.83 OCC acknowledges that, because it would be determined based on a function of available funds at a specific point in time, the specific amount of skin-in-the-game will be unknown until the time of an operational loss event, but emphasizes its belief that the skinin-the-game component of the proposed Capital Management Policy, particularly with respect to the EDCP funds that would be a direct contribution from OCC management, is sufficient to ensure the alignment of incentives for risk management between OCC and the Clearing Member community.84 We conclude that OCC’s skin-in-thegame proposal is consistent with the Exchange Act and the rules and regulations thereunder. In adopting Rule 17Ad–22(e)(2), the Commission discussed comments it received regarding the concept of skin-in-thegame as a potential tool to align the various incentives of a covered clearing 79 FIA Letter at 2. Letter at 2. 81 FIA Letter at 1–2. 82 OCC Letter at 1. 83 OCC Letter at 1–2. 84 OCC Letter at 2. 80 FIA PO 00000 Frm 00141 Fmt 4703 Sfmt 4703 5507 agency’s stakeholders, including management and clearing members.85 And, while the Commission declined to include a specific skin-in-the-game requirement, it stated its belief that ‘‘the proper alignment of incentives is an important element of a covered clearing agency’s risk management practices,’’ and noted that skin-in-the-game ‘‘may play a role in those risk management practices in many instances.’’ 86 Here, OCC has considered its financial resources, ownership structure, existing risk management framework, and other factors and, in light of these considerations, proposes to add to its current default waterfall two potential sources of skin-in-thegame for offsetting losses associated with Clearing Member defaults: (i) Deferred compensation in the form of the EDCP Unvested Balance (i.e., executive bonuses awarded but not yet paid) and (ii) capital reserves (i.e., Shareholder equity) in excess of 110 percent of the Target Capital Requirement. OCC proposes to modify its current default waterfall such that it would be required to use these skin-inthe-game resources before utilizing nondefaulting members’ Clearing Fund contributions.87 In the Commission’s view, with this aspect of the Proposed Rule Change OCC would be taking an important step toward incorporating a skin-in-the-game component into its existing risk management framework, which in turn should help further align the interests of OCC’s stakeholders, including OCC management and Clearing Members. The direct contribution of the EDCP Unvested Balance in particular would represent a direct contribution of executive compensation by OCC’s senior managers and therefore would help align the incentives of OCC’s 85 Covered Clearing Agency Standards, 81 FR at 70805–06. 86 Covered Clearing Agency Standards, 81 FR at 70806. 87 Specifically, OCC’s current default waterfall, in general, utilizes the following resources in the following order: (i) The defaulting Clearing Member’s margin deposit; (ii) the defaulting Clearing Member’s Clearing Fund contribution; and (iii) non-defaulting Clearing Members’ Clearing Fund contributions. Under the proposal the new default waterfall would require OCC to utilize the following resources in the following order: (i) The defaulting Clearing Member’s margin deposit; (ii) the defaulting Clearing Member’s Clearing Fund contribution; (iii) skin-in-the-game in the form of capital reserves above 110 percent of the Target Capital Requirement at the time of the default; and (iv) skin-in-the-game in the form of the aggregate value of the EDCP Unvested Balance at the time of the default and non-defaulting Clearing Members’ Clearing Fund contributions, both charged on a pro rata basis. In addition, under the proposal, OCC would be permitted (but would not be required) to also utilize capital reserves between 100 percent and 110 percent of the Target Capital Requirement. E:\FR\FM\30JAN1.SGM 30JAN1 khammond on DSKJM1Z7X2PROD with NOTICES 5508 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices senior management with those of the broader industry with respect to the management of risks faced by OCC. Further, the EDCP Unvested Balance would not be affected directly by the issues relating to capital expenditures and revisions to the fee schedule noted by the FIA. Finally, although the size of OCC’s skin-in-the-game resources in absolute terms would not be set unless and until they were utilized, the Proposed Rule Change establishes a clear and transparent methodology for establishing the amount of skin-in-thegame that would be available at the time and in the event of a Clearing Member default. As such, the Commission believes that the skin-in-the-game aspects of the Proposed Rule Change are consistent with Section 17Ad–22(e)(2) of the Exchange Act. In addition to the skin-in-the-game components discussed above, the Proposed Rule Change includes the various components that would govern the sizing and imposition of the Operational Loss Fee. The FIA comment letter expresses the belief that any Board decision that results in the imposition of an Operational Loss Fee should be ‘‘syndicated with’’ Clearing Members and that any resulting feedback from Clearing Members should be ‘‘presented to the Board before any decisions are taken.’’ 88 In response, OCC refers to the requirements of its By-Laws that result in more than two-thirds of OCC’s directors being either Clearing Member directors or public directors.89 Further, OCC expresses its strong belief that part of the viability of a plan to replenish capital is the speed at which that replenishment capital is accessible. We find that the Operational Loss Fee is consistent with Rule 17Ad– 22(e)(2)(iii). That rule requires that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for governance arrangements that support the public interest requirements of Section 17A of the Exchange Act applicable to clearing agencies, and the objectives of owners and participants.90 In adopting Rule 17Ad–22(e)(2), the Commission added paragraph (vi) in response to comments regarding the scope of Rule 17Ad–22(e)(2)(iii).91 Paragraph (vi) of Rule 17Ad–22(e)(2) specifically addresses the consideration of the interests of participants’ customers, securities issuers and 88 FIA Letter at 3. 89 OCC Letter at 3. 90 17 CFR 240.17Ad–22(e)(2)(iii). 91 Covered Clearing Agency Standards, 81 FR at 70803. VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 holders, and other relevant stakeholders of the covered clearing agency.92 In adopting Rule 17Ad–22(e)(2), the Commission noted that the inclusion of independent directors on a clearing agency’s board may be one mechanism for helping to ensure that the relevant views of stakeholders are presented and considered.93 In the context of default management, the Commission has acknowledged that risk exposures can change rapidly during periods of market stress.94 Similarly, the Commission believes that the general business risk exposures, and related losses, may change rapidly during periods of stress, and, in turn, that there is a benefit to a covered clearing agency’s ability to respond to such changes in a timely fashion. The FIA also expresses a concern that OCC’s Board has a fiduciary duty to OCC, and by implication, not to Clearing Members; however, OCC responds that, in furtherance of the Exchange Act requirement that OCC’s rules must assure a fair representation of its shareholders (or members) and participants in the selection of its directors and the administration of its affairs, OCC’s By-Laws ‘‘state that nine of the twenty directorships are reserved for representatives of OCC clearing members,’’ and that, in addition, five of the twenty directorships are reserved for public directors, who are charged with representing the interests of all stakeholders, such that more than twothirds of OCC’s directors are either Clearing Member directors or public directors.95 OCC also describes the formal and informal mechanisms that OCC employs to solicit feedback from Clearing Members and other interested stakeholders, including its Financial Risk Advisory Committee, Operations Roundtable, multiple letters and open calls with Clearing Members and other interested stakeholders, and routine inperson meetings with trade groups and individual firms.96 As such, OCC contends that the Capital Management Policy was constructed with the benefit of the perspective of the Clearing Member community, and any further discussions at the Board will benefit from this same perspective.97 Again, we agree that the proposal is consistent with Rule 17Ad–22(e)(2). In adopting Rule 17Ad–22(e)(2), the Commission noted that the approach a 92 17 CFR 240.17Ad–22(e)(2)(vi). Clearing Agency Standards, 81 FR at 93 Covered 70803. 94 Covered Clearing Agency Standards, 81 FR at 70806. 95 OCC Letter at 3–4. 96 OCC Letter at 4. 97 OCC Letter at 4. PO 00000 Frm 00142 Fmt 4703 Sfmt 4703 covered clearing agency may take in considering the views of stakeholders could vary depending on the ownership structure or organizational form of the covered clearing agency.98 The Commission believes that the governance arrangements currently in existence and proposed by OCC in connection with the Proposed Rule Change, as discussed above, are consistent with the requirement to consider the interests of OCC’s participants, and are therefore consistent with Rule 17Ad–22(e)(2). Accordingly, and for the reasons stated above, the Commission finds the changes proposed in the Proposed Rule Change are consistent with Rule 17Ad– 22(e)(2) under the Exchange Act.99 D. Consistency With Rule 17Ad– 22(e)(15) Under the Exchange Act Rule 17Ad–22(e)(15) under the Exchange Act requires, in part, that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to identify, monitor, and manage the covered clearing agency’s general business risk and hold sufficient liquid net assets funded by equity to cover potential general business losses so that the covered clearing agency can continue operations and services as a going concern if those losses materialize, including by taking the actions described in Rules 17Ad–22(e)(15)(i)– (iii) under the Exchange Act.100 As discussed below, based on its review of the record, the Commission finds that the proposal is consistent with Rule 17Ad–22(e)(15) of the Exchange Act. 1. Rule 17Ad–22(e)(15)(i) Rule 17Ad–22(e)(15)(i) under the Exchange Act requires that the policies and procedures described under Rule 17Ad–22(e)(15) include determining the amount of liquid net assets funded by equity based upon a covered clearing agency’s general business risk profile and the length of time required to achieve a recovery or orderly winddown, as appropriate, of its critical operations and services if such action is taken.101 As described above, OCC proposes to adopt rules governing OCC’s process for determining the amount of Equity required to support the LNAFBE necessary to cover potential general business losses, which would then be 98 Covered Clearing Agency Standards, 81 FR at 70803. 99 17 CFR 240.17Ad–22(e)(2). 100 17 CFR 240.17Ad–22(e)(15). 101 17 CFR 240.17Ad–22(e)(15)(i). E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices used to help set its Target Capital Requirement.102 In turn, the Target Capital Requirement would be designed to ensure, among other things, that OCC holds sufficient capital to continue operations and services as a going concern if general business losses materialize, which OCC refers to as the Potential Loss Amount.103 To set the Potential Loss Amount, OCC would conduct an annual analysis of its capital requirements by analyzing and aggregating potential losses from individual operational risk scenarios, aggregating the loss events, and conducting loss modeling at or above the 99 percent confidence level.104 The Commission did not receive any comments on this aspect of the proposal. Taken together, the Commission believes the proposal is designed to identify and maintain the resources necessary for OCC to recover or wind-down its critical operations or services as well as to remain a going concern following the realization of losses due to general business risk, and therefore finds that it is consistent with Rule 17Ad–22(e)(15)(i).105 khammond on DSKJM1Z7X2PROD with NOTICES 2. Rule 17Ad–22(e)(15)(ii) Rule 17Ad–22(e)(15)(ii) under the Exchange Act requires that the policies and procedures described under Rule 17Ad–22(e)(15) include holding liquid net assets funded by equity equal to the greater of either (i) six months of the covered clearing agency’s current operating expenses, or (ii) the amount determined by the board of directors to be sufficient to ensure a recovery or orderly wind-down of critical operations and services of the covered clearing agency, as contemplated by the plans established under Rule 17Ad– 22(e)(3)(ii), and which shall be in addition to resources held to cover participant defaults or other risks covered under applicable credit risk and the liquidity risk standards, and shall be of high quality and sufficiently liquid to allow the covered clearing agency to meet its current and projected operating expenses under a range of scenarios, including in adverse market conditions.106 As described above, OCC proposes to adopt rules that would require it to hold at least the minimum amount of Equity necessary to meet the Target Capital Requirement. In turn, the Target Capital Requirement would be set at a level at 102 See supra Section V.A; see also Notice of Filing, 84 FR at 44945. 103 See id. 104 See id.; OCC Letter at 4. 105 17 CFR 240.17Ad–22(e)(15)(i). 106 17 CFR 240.17Ad–22(e)(15)(ii). VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 least sufficient to comply with Rule 17Ad–22(e)(15)(ii) under the Exchange Act. Specifically, the Target Capital Requirement would equal or exceed, at a minimum, the greater of (i) six months of OCC’s current operating expenses; (ii) the RWD Amount (which would equal or exceed the amount determined by the board of directors to be sufficient to ensure a recovery or orderly wind-down of critical operations and services); or (iii) the Potential Loss Amount. Thus, under the proposal, OCC would maintain LNAFBE in an amount that would equal or exceed the amount determined by OCC to correspond to the amounts described in Rule 17Ad– 22(e)(15)(ii). To ensure that OCC continues to hold the amount of LNAFBE required under Rule 17Ad–22(e)(ii), as detailed above, OCC would also, on a monthly basis, monitor its Equity relative to the Target Capital Requirement to determine whether an Early Warning or Trigger Event had occurred. In addition, in response to such monitoring and any associated Early Warnings, OCC would use fee-related tools currently available under its existing Rules (e.g., increases, decreases, refunds, or fee waivers) to manage and maintain its capital levels at or near the Target Capital Requirement. For example, OCC proposes to require OCC Management to notify OCC’s Board promptly if Equity were to fall below the Early Warning threshold and to recommend to the Board whether to implement a fee increase in an amount that the Board determines necessary and appropriate to raise additional Equity. The requirement to notify the Board, and recommend appropriate action, would help to ensure that OCC continues to hold sufficient resources to meet the Target Capital Requirement. As such, the proposal would be designed to ensure that OCC holds Equity sufficient to support the amount of LNAFBE equal to the Target Capital Requirement, which requirement would correspond to the amounts specified under Rule 17Ad– 22(e)(15)(ii). The Capital Management Policy would provide objective, quantifiable metrics and tools that OCC would use to determine its forward six-months operating expenses and RWD Amount (i.e., the cost of recovery or orderly wind-down) and ensure that it holds at least those amounts in LNAFBE at all times.107 Specifically, to determine the 107 OCC has, in prior filings, discussed the quantitative analyses underlying the calculation of operating expenses and potential recovery and wind-down costs. See Securities Exchange Act Release No. 85322 (Mar. 14, 2019), 84 FR 10377, 10378 (Mar. 20, 2019) (File No. SR–OCC–2019–001) PO 00000 Frm 00143 Fmt 4703 Sfmt 4703 5509 RWD Amount, on an annual basis OCC would follow the process and use the assumptions laid out in its Recovery and Wind-Down Plan (‘‘RWD Plan’’), which the Commission previously reviewed and approved.108 Under the RWD Plan, on an annual basis, OCC identifies its critical services and determines the cost to maintain those critical services over the prescribed recovery or wind-down period, assuming costs remain at historical levels.109 As noted above, OCC would also set the Target Capital Requirement at a level designed to cover the Potential Loss Amount, which would be designed to address losses arising out of operational risk. On an annual basis, OCC would quantify 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 percent confidence level.110 The Commission also finds that the proposed rules concerning the form of OCC’s LNAFBE and manner in which it would be held are consistent with the requirements of Rule 17Ad–22(e)(15)(ii). OCC proposes to define LNAFBE such that it would consist of only cash and cash equivalents. OCC’s LNAFBE would, therefore, be liquid by definition. Further, OCC proposes to adopt rules requiring that OCC hold Equity equal to 110 percent of the Target Capital Requirement separate from OCC’s resources to cover participant defaults, which would help ensure that the Equity it holds to comply with Rule 17Ad–22(e)(ii) is in addition to OCC’s resources to cover participant defaults and other risks covered under applicable credit risk and liquidity risk standards. The Commission did not receive any comments opposing OCC’s proposed approach to determining its forward six-months operating expenses and cost of recovery or orderly winddown. For the reasons discussed above, the Commission believes that the (stating that such quantitative assumptions are based on a number of assumptions and projections, including, among other things, (i) projected average daily volumes; (ii) projected expenses and known cash flows; (iii) an operating margin based on historical volumes; and (iv) known capital needs to replace and modernize OCC’s technology infrastructure). 108 See Notice of Filing, 84 FR at 44945. See also Securities Exchange Act Release No. 83918 (Aug. 23, 2018), 83 FR 44091 (Aug. 29, 2018) (File No. SR–OCC–2017–021) (approving OCC’s proposal to formalize and update its Recovery and Orderly Wind-Down Plan). 109 See Notice of Filing, 84 FR at 44945. 110 See Notice of Filing, 84 FR at 44945. E:\FR\FM\30JAN1.SGM 30JAN1 5510 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices proposal is consistent with Rule 17Ad– 22(e)(15)(ii) of the Exchange Act. The Commission did receive one comment regarding the degree of transparency OCC proposes to maintain in respect of the Target Capital Requirement. In its comment letter, the FIA states that the Target Capital Requirement information that OCC would publish on its website quarterly is ‘‘important for transparency purposes’’ and that OCC should ‘‘also provide disclosures on any expenses/ losses that could result in the operational loss fee being charged as this will assist members in their own risk management.’’ 111 Rule 17Ad– 22(e)(15) does not require OCC to publish the information to which the FIA refers, and Clearing Members already receive from OCC a wide range of information to assist with their own risk management and to help them anticipate and satisfy their obligations as Clearing Members of OCC, such as the Daily Position Report,112 Daily Margin Report,113 X–M Margin and Settlement Report,114 Expiration Exercise Report,115 Exercise and Assignment Activity Report,116 and reports listing the current amount and form of a Clearing Member’s required contribution to the Clearing Fund.117 The Commission believes that such information already provides Clearing Members with timely, relevant information that Clearing Members are able to incorporate into their existing risk management efforts. As such, the Commission does not believe that OCC’s failure to propose to provide the type of additional disclosures advocated by the FIA renders the Proposed Rule Change inconsistent with Rule 17Ad– 22(e)(15)(ii) under the Exchange Act. 3. Rule 17Ad–22(e)(15)(iii) Rule 17Ad–22(e)(15)(iii) under the Exchange Act requires that the policies and procedures described under Rule 17Ad–22(e)(15) include maintaining a viable plan, approved by the board of 111 FIA Letter at 4. OCC Rule 501, available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. 113 See OCC Rule 605, available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. 114 See OCC Rule 706, available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. 115 See OCC Rule 805, available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. 116 See OCC Rule 901, available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. 117 See OCC Rule 1007, available at https:// www.theocc.com/components/docs/legal/rules_ and_bylaws/occ_rules.pdf. khammond on DSKJM1Z7X2PROD with NOTICES 112 See VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 directors and updated at least annually, for raising additional equity should a covered clearing agency’s equity fall close to or below the amount required under Rule 17Ad–22(e)(15)(ii).118 As described above, the proposed Replenishment Plan would govern OCC’s process for replenishing its capital in the event that Equity were to fall close to or below the Target Capital Requirement by, among other things, implementing tools that would allow OCC to replenish its capital levels in the event that routine monitoring and management through its existing feerelated tools is insufficient to avoid a Trigger Event, which would only occur if OCC’s Equity fell below 100% of the Target Capital Requirement and stayed there for 90 consecutive days or OCC’s Equity fell below 90% of the Target Capital Requirement at any point in time. The proposed Replenishment Plan would require OCC’s Management to monitor changes in Equity and to notify OCC’s Board of a Trigger Event. If a Trigger Event were to occur, OCC would attempt to replenish its capital levels first through the contribution of the EDCP Unvested Balance. If and only if the entire EDCP Unvested Balance were insufficient to bring OCC’s Equity back to or above 100% of the Target Capital Requirement, OCC would be required to levy the Operational Loss Fee on Clearing Members. The Operational Loss Fee would be sized to the Adjusted RWD Amount, and therefore would be designed to provide OCC with at least enough capital either to continue as a going concern or to wind-down in an orderly fashion. Under the proposal, on an annual basis OCC’s Management would be obligated to recommend that the Board approve or, as appropriate, modify the proposed Replenishment Plan. In turn, OCC’s Board would be obligated annually to approve or, as appropriate, modify the proposed Replenishment Plan based on Management recommendation. To the extent the Operational Loss Fee is levied, the FIA suggests that OCC should clarify the mechanism for returning such resources to Clearing Members.119 In response, OCC states that if an Operational Loss Fee were charged and OCC’s capital subsequently exceeded 110 percent of the Target Capital Requirement such that OCC determined to return to Clearing Members funds received pursuant to the charge, OCC would return the funds to Clearing Members in equal share to each Clearing Member that paid the 118 17 CFR 240.17Ad–22(e)(15)(iii). Letter at 3. 119 FIA PO 00000 Frm 00144 Fmt 4703 Sfmt 4703 Operational Loss Fee until such time as the aggregate amount of the Operational Loss Fee was returned.120 OCC’s comment included an example to further clarify OCC’s explanation.121 This information also is described in the Notice of Filing,122 and is consistent with the Commission’s understanding, based on its review of the record, of the mechanisms that OCC would use to return the Operational Loss Fee in the event that it is levied. Accordingly, the Commission believes that the information provided by OCC in the Notice of Filing and subsequently in its comment letter provides a comprehensive and sufficient response to the FIA’s request for clarification. The FIA also requests clarification regarding OCC’s proposal to charge the Operational Loss Fee in an amount that would return OCC to a capitalization of 110 percent of the Target Capital Requirement, instead of just returning to the target capital levels.123 OCC clarifies that the reason for this 10 percent buffer is ‘‘embedded in the requirement itself: OCC’s replenishment plan is to be used when OCC’s Equity falls ‘close to or below the [Target Capital Requirement],’’’ 124 which OCC interprets as requiring it to maintain capital reserves, at a minimum, above 100 percent of the Target Capital Requirement. In determining how much above 100 percent of the Target Capital Requirement, OCC determined that maintaining capital reserves at or around 110 percent of the Target Capital Requirement was the appropriate amount, in part because 10 percent of the Target Capital Requirement represents approximately two months of earnings, and OCC believes that a twomonth window would provide OCC’s senior management and Board sufficient time to respond to a deterioration of OCC’s capital.125 The Commission has reviewed the analysis provided by OCC 126 and believes that a 110 percent buffer representing approximately two months of earnings is reasonable in light of the requirement set forth in Rule 17Ad–22(e)(15)(iii) that a viable replenishment plan be calibrated to circumstances where a covered clearing agency’s capital level falls below or close to the required capital amount. Accordingly, here as well the 120 OCC Letter at 3. 121 Id. 122 See Notice of Filing, 84 FR at 44946. Letter at 3. 124 OCC Letter at 3 (emphasis in original) (citation omitted). 125 See Notice of Filing, 84, FR at 44946. 126 See Notice of Filing, 84, FR at 44946, n. 17 (stating that OCC included its analysis in confidential exhibit 3d). 123 FIA E:\FR\FM\30JAN1.SGM 30JAN1 Federal Register / Vol. 85, No. 20 / Thursday, January 30, 2020 / Notices Commission believes that the information provided by OCC provides a comprehensive and sufficient response to the FIA’s request for clarification. The Commission believes that OCC’s proposal with respect to the Operational Loss Fee will permit OCC to raise additional equity in the event that its equity falls close to or below the Target Capital Requirement and therefore finds that it is consistent with Rule 17Ad– 22(e)(15)(iii) of the Exchange Act. The Commission finds, therefore, that adoption of these aspects of the proposed Capital Management Policy and supporting rule changes are consistent with Exchange Act Rule 17Ad–22(e)(15).127 V. Conclusion On the basis of the foregoing, the Commission finds that the Proposed Rule Change is consistent with the requirements of the Exchange Act, and in particular, the requirements of Section 17A of the Exchange Act 128 and the rules and regulations thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act,129 that the Proposed Rule Change (SR– OCC–2019–007), as modified by Partial Amendment No. 1, be, and hereby is, approved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.130 J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2020–01643 Filed 1–29–20; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–88033; File No. SR–NYSE– 2020–03] Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change To Add New Rule 46B To Permit the Appointment of Regulatory Trading Officials and Amend Rules 47 and 75 January 24, 2020. khammond on DSKJM1Z7X2PROD with NOTICES Pursuant to Section 19(b)(1) 1 of the Securities Exchange Act of 1934 (‘‘Act’’) 2 and Rule 19b–4 thereunder,3 127 17 CFR 240.17Ad–22(e)(15). approving this Proposed Rule Change, the Commission has considered the proposed rules’ impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 129 15 U.S.C. 78s(b)(2). 130 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 15 U.S.C. 78a. 3 17 CFR 240.19b–4. 128 In VerDate Sep<11>2014 16:56 Jan 29, 2020 Jkt 250001 notice is hereby given that, on January 14, 2020, New York Stock Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the self-regulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes a new Rule 46B to permit the appointment of Regulatory Trading Officials and corresponding amendments to Rules 47 and 75 to permit Regulatory Trading Officials to review whether a bid or offer was verbalized at the point of sale in time to be eligible for inclusion in the Closing Auction. The proposed rule change is available on the Exchange’s website at www.nyse.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the self-regulatory organization included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of those statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant parts of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes a new Rule 46B to permit the appointment of Regulatory Trading Officials and corresponding amendments to Rules 47 and 75 to permit Regulatory Trading Officials to review whether a bid or offer was verbalized at the point of sale in time to be eligible for inclusion in the Closing Auction. Background Rule 46 permits the Exchange to appoint active NYSE members 4 as Floor 4 Rule 2(a) states that the term ‘‘member,’’ when referring to a natural person, means a natural PO 00000 Frm 00145 Fmt 4703 Sfmt 4703 5511 Officials. Rule 46 also permits the Exchange to appoint ‘‘qualified’’ 5 ICE employees to act as Floor Governors, one of the more senior types of Floor Officials (‘‘Staff Governors’’).6 Floor Officials are delegated certain authority from the Board of Directors of the Exchange to supervise and regulate active openings and unusual situations that arise in connection with the making of bids, offers or transactions on the Trading Floor,7 and to review and approve certain trading actions. Currently, only Floor Officials are authorized to act under the Exchange’s rules in connection with certain situations involving bids, offers or transactions on the Trading Floor. Specifically, Rule 75 (Disputes as to Bids and Offers) mandates that disputes arising on bids or offers that are not settled by agreement between the interested members shall be settled by a Floor Official. Under Rule 47 (Floor Officials—Unusual Situations), Floor Officials have the authority to ‘‘supervise and regulate active openings and unusual situations that may arise in connection with the making of bids, offers or transactions on the Floor.’’ Unusual situations may arise that could impede or prevent Floor brokers from representing customer interest before the end of Core Trading Hours.8 In the event of such a potentially unusual situation,9 a Floor broker may person associated with a member organization who has been approved by the Exchange and designated by such member organization to effect transactions on the Exchange Trading Floor or any facility thereof. See also note 7, infra. 5 Supplementary Material .10 defines ‘‘qualified’’ employees as ‘‘employees of ICE or any of its subsidiaries, excluding employees of NYSE Regulation, Inc., who shall have satisfied any applicable testing or qualification required by the NYSE for all Floor Governors.’’ 6 Pursuant to Rules 46 and 46A, Floor Governors are one of several ranks of the broader category of Floor Officials, including, in order of increasing seniority, Floor Officials, Senior Floor Officials, Executive Floor Officials, Floor Governors and Executive Floor Governors. See Securities Exchange Act Release No. 57627 (April 4, 2008), 73 FR 19919 (April 11, 2008) (SR–NYSE–2008–19). 7 The term ‘‘Trading Floor’’ is defined in Rule 6A to mean the restricted-access physical areas designated by the Exchange for the trading of securities, commonly known as the ‘‘Main Room’’ and the ‘‘Buttonwood Room.’’ 8 See NYSE Rule 52. Core Trading Hours are defined in Rule 1.1(d) to mean the hours of 9:30 a.m. ET through 4:00 p.m. ET, or such other hours as may be determined by the Exchange, for example, an early scheduled closing time. 9 Unusual situations may arise, for example, if the Floor broker hand-held device malfunctions or ceases to work or if a Floor broker is physically impeded, as a result of a crowd condition beyond that of normal traffic flow on the Exchange’s trading Floor or some other circumstance beyond the Floor broker’s control, in his or her ability to be present at a post before the DMM closes the security. See E:\FR\FM\30JAN1.SGM Continued 30JAN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 85, Number 20 (Thursday, January 30, 2020)]
[Notices]
[Pages 5500-5511]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01643]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88029; File No. SR-OCC-2019-007]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change, as Modified by Partial Amendment 
No. 1, Concerning a Proposed Capital Management Policy That Would 
Support The Options Clearing Corporation's Function as a Systemically 
Important Financial Market Utility

January 24, 2020.

I. Introduction

    On August 9, 2019, the Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2019-007 (``Proposed Rule Change'') 
pursuant to Section 19(b) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to adopt a policy 
concerning capital management at OCC, which includes OCC's plan to 
replenish its capital in the event it falls close to or below target 
capital levels.\3\ The Proposed Rule Change was published for public 
comment in the Federal Register on

[[Page 5501]]

August 27, 2019.\4\ The Commission received comments regarding the 
Proposed Rule Change.\5\ On September 11, 2019, OCC filed a partial 
amendment (``Partial Amendment No. 1'') to modify the Proposed Rule 
Change.\6\ On October 8, 2019, the Commission designated a longer 
period of time for Commission action on the Proposed Rule Change.\7\ 
Notice of Partial Amendment No. 1 and of the designation of a longer 
period of time was published in the Federal Register on October 15, 
2019.\8\ On November 22, 2019, the Commission issued an order to 
institute proceedings to determine whether to approve or disapprove the 
Proposed Rule Change.\9\ This order approves the Proposed Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Notice of Filing infra note 4, at 84 FR 44952.
    \4\ Securities Exchange Act Release No. 86725 (Aug. 21, 2019), 
84 FR 44952 (Aug. 27, 2019) (SR-OCC-2019-007) (``Notice of 
Filing''). OCC also filed a related advance notice (SR-OCC-2019-805) 
(``Advance Notice'') with the Commission pursuant to Section 
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, entitled the Payment, Clearing, and 
Settlement Supervision Act of 2010 and Rule 19b-4(n)(1)(i) under the 
Exchange Act. 12 U.S.C. 5465(e)(1) and 17 CFR 240.19b-4, 
respectively. The Advance Notice was published in the Federal 
Register on September 11, 2019. Securities Exchange Act Release No. 
86888 (Sep. 5, 2019), 84 FR 47990 (Sep. 11, 2019) (SR-OCC-2019-805).
    \5\ Comments are available at https://www.sec.gov/comments/sr-occ-2019-007/srocc2019007.htm.
    \6\ See Notice of Extension infra note 8, at 84 FR 55189. In 
Partial Amendment No. 1, OCC appended an Exhibit 2 to the materials 
filed on August 9, 2019 regarding File No. SR-OCC-2019-007. The 
appended Exhibit 2 consists of communications from OCC concerning 
the proposal dated after OCC filed the proposal on August 9, 2019 
and does not change the purpose of or basis for the Proposed Rule 
Change. References to the Proposed Rule Change from this point 
forward refer to the Proposed Rule Change, as amended by Partial 
Amendment No. 1.
    \7\ See Notice of Extension infra note 8, at 84 FR 55189.
    \8\ Securities Exchange Act Release No. 87246 (Oct. 8, 2019), 84 
FR 55189 (Oct. 15, 2019) (SR-OCC-2019-007) (``Notice of 
Extension'').
    \9\ Securities Exchange Act Release No. 87603 (Nov. 22, 2019), 
84 FR 65858 (Nov. 29, 2019) (SR-OCC-2019-007).
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II. Background

    One reason for the Proposed Rule Change is a specific Commission 
requirement for covered clearing agencies such as OCC. Rule 17Ad-
22(e)(15) under the Exchange Act requires that a covered clearing 
agency establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to identify, monitor, and manage the 
covered clearing agency's general business risk and hold sufficient 
liquid net assets funded by equity to cover potential general business 
losses so that the covered clearing agency can continue operations and 
services as a going concern if those losses materialize, including by 
taking the actions described in Rules 17Ad-22(e)(15)(i)-(iii) under the 
Exchange Act.\10\ In adopting Rule 17Ad-22(e), which includes Rule 
17Ad-22(e)(15), the Commission noted that ``each registered clearing 
agency has different organizational and operating structures and clears 
distinct products that warrant a tailored approach to governance and 
risk management, respectively.'' \11\ The Commission also noted its 
belief that Rule 17Ad-22(e) ``achieves the appropriate balance between 
imposing new requirements on covered clearing agencies and allowing 
each covered clearing agency, subject to its obligations and 
responsibilities as an SRO under the Exchange Act, to design its 
policies and procedures pursuant to Rule 17Ad-22(e).''\12\
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    \10\ 17 CFR 240.17Ad-22(e)(15).
    \11\ Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786, 70797 (October 13, 2016) (S7-03-14) (``Covered 
Clearing Agency Standards'').
    \12\ Id.
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    Rule 17Ad-22(e)(15) was adopted in 2016 as part of the Covered 
Clearing Agency Standards, with a compliance date of April 11, 
2017.\13\ Anticipating the need to come into compliance with new Rule 
17Ad-22(e)(15), in January 2015, OCC filed with the Commission a 
proposed rule change regarding a plan to increase OCC's capitalization 
(the ``Capital Plan'').\14\ The Capital Plan was approved by the 
Commission in February 2016,\15\ and subsequently implemented by OCC. 
However, the approval order was vacated by the Court of Appeals for the 
D.C. Circuit and remanded to the Commission. On February 13, 2019, the 
Commission issued an order disapproving the Capital Plan on remand.\16\ 
In order to come back into compliance with Rule 17Ad-22(e)(15), among 
other things, OCC now proposes changes to adopt, as part of its rules, 
a new policy concerning capital management at OCC (``Capital Management 
Policy''). Specifically, the proposed Capital Management Policy would 
(i) describe how OCC would determine the amount of liquid net assets 
funded by equity (``LNAFBE'') necessary to cover OCC's potential 
general business losses; (ii) require OCC to hold a minimum amount of 
shareholders equity (``Equity'') sufficient to support the amount of 
LNAFBE determined to be necessary; \17\ and (iii) establish a plan for 
replenishing OCC's capital in the event that Equity were to fall below 
certain thresholds. OCC also proposes to revise its existing rules to 
support the terms of the proposed Capital Management policy.
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    \13\ See Covered Clearing Agency Standards, 81 FR at 70786.
    \14\ See Securities Exchange Act Release No. 74136 (Jan. 26, 
2015, 80 FR 5171 (Jan. 30, 2015) (File No. SR-OCC-2015-02).
    \15\ Securities Exchange Act Release No. 7112 (Feb. 11, 2016), 
81 FR 8294 (Feb. 18, 2016) (File No. SR-OCC-2015-02).
    \16\ See Securities Exchange Act Release No. 85121 (Feb. 13, 
2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR-OCC-2015-02).
    \17\ LNAFBE would mean cash and cash equivalents to the extent 
that such cash and cash equivalents do not exceed Equity.
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A. Determining Capital Requirements

    As noted above, OCC proposes to adopt rules describing the 
determination of the LNAFBE necessary to cover potential general 
business losses. As proposed, LNAFBE would be a subset of OCC's overall 
Equity--cash and cash equivalents, less any approved adjustments--and 
therefore, could not, by definition, exceed Equity. OCC proposes to set 
a ``Target Capital Requirement,'' which would be based on two 
components: (i) The amount of LNAFBE determined by OCC to be necessary 
to ensure compliance with OCC's regulatory obligations, including Rule 
17Ad-22(e)(15) under the Exchange Act; \18\ and (ii) any additional 
amounts determined to be necessary and appropriate for capital 
expenditures approved by OCC's Board.\19\
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    \18\ 17 CFR 240.17Ad-22(e)(15).
    \19\ In setting the Target Capital Requirement, OCC would also 
consider, but not be bound by, its projected rolling twelve-months' 
operating expenses pursuant to OCC's interpretation of Commodity 
Exchange Act Rule 39.11(a)(2). 17 CFR 39.11(a)(2). Nothing in this 
Order constitutes an interpretation of Rule 39.11(a)(2) under the 
Commodity Exchange Act by the Commission or an endorsement of OCC's 
interpretation of Rule 39.11(a)(2).
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    With respect to the first component of the Target Capital 
Requirement, to ensure that it is set at a level sufficient to ensure 
compliance with OCC's regulatory obligations, OCC proposes to set its 
Target Capital Requirement, at a minimum, equal to the greater of three 
amounts: (i) An amount equal to six-months of OCC's current operating 
expenses; (ii) the amount determined by OCC's Board to be sufficient to 
ensure a recovery or orderly wind-down of critical operations and 
services (``RWD Amount''); \20\ or (iii) the amount determined by OCC's 
Board to be sufficient for OCC to continue

[[Page 5502]]

operations and services as a going concern if general business losses 
materialize (``Potential Loss Amount'').\21\ OCC believes that a 
minimum Target Capital Requirement sized to cover at least these three 
amounts would address OCC's obligations under Exchange Act Rule 17Ad-
22(e)(15).\22\ With respect to the second component of the Target 
Capital Requirement, the proposal would authorize OCC's Board to 
increase the Target Capital Requirement by an amount to be retained for 
capital expenditures.\23\ OCC's Board would be responsible for 
reviewing and approving the Target Capital Requirement annually.
---------------------------------------------------------------------------

    \20\ Under the proposal, OCC's Board would approve the RWD 
Amount annually at a level designed to cover the cost to maintain 
OCC's critical services over the recovery or wind-down period. 
Identification of OCC's critical services and the length of time 
necessary to recover or wind-down is covered in OCC's Recovery and 
Wind-Down Plan. See Securities Exchange Act Release No. 83918 (Aug. 
23, 2018), 83 FR 44091 (Aug. 29, 2018).
    \21\ Under the proposal, OCC's Board would set the Potential 
Loss Amount by analyzing and aggregating potential losses from 
individual operational risk scenarios, aggregating the loss events, 
and conducting loss modeling at or above the 99 percent confidence 
level.
    \22\ See Notice of Filing, 84 FR at 44945.
    \23\ Under the proposal, OCC's Board could determine, in the 
alternative, to fund capital expenditures out of funds in excess of 
the Target Capital Requirement. OCC stated that, in making such a 
determination, its Board would consider factors including, but not 
limited to, the amount of funding required, the amount of Equity 
proposed to be retained, the potential impact of the investment on 
OCC's operations, and the duration of time over which funds would be 
accumulated. See id.
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B. Maintaining Capital

    As noted above, OCC proposes to adopt rules that would require it 
to hold the minimum amount of Equity necessary to cover the Target 
Capital Requirement. Specifically, OCC proposes to adopt rules 
pertaining to the monitoring and management of OCC's Equity. Under the 
proposed rules, OCC's senior management would be responsible for 
reviewing analyses, including projections of future volume, expenses, 
cash flows, capital needs and other factors, to help ensure adequate 
financial resources are available to meet general business obligations. 
Such analyses would also include a monthly review of whether OCC's 
Equity falls close to or below the Target Capital Requirement. Under 
the proposal, OCC would view Equity less than 110 percent of the Target 
Capital Requirement as falling close to the Target Capital 
Requirement.\24\ OCC would refer to a breach of this 110 percent 
threshold as an ``Early Warning.'' Under the proposed rules, OCC's 
senior management would be obligated to notify OCC's Board promptly if 
Equity were to fall below the Early Warning threshold and to recommend 
to the Board whether to implement a fee increase in an amount that the 
Board determines necessary and appropriate to raise additional Equity.
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    \24\ OCC stated that 10 percent of the Target Capital 
Requirement represents approximately two months of earnings, and 
that OCC believes that a two-month window would provide OCC's senior 
management and Board sufficient time to respond to a deterioration 
of OCC's capital. See Notice of Filing, 84 FR at 44946.
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    Under the proposal, OCC's senior management would also, on a 
quarterly basis, review OCC's schedule of fees in consideration of 
projected operating expenses, projected volumes, anticipated cash 
flows, and capital needs. Based on its review, OCC's senior management 
would recommend to OCC's Board Compensation and Performance Committee 
whether to issue a fee increase, decrease or fee waiver. Additionally, 
if Equity were to exceed 110 percent of the Target Capital Requirement 
plus an amount of excess Equity approved for capital expenditures, 
OCC's Board could reduce the cost of clearing by lowering fees, 
declaring a fee holiday, or issuing refunds.
    OCC stated that resources held to meet OCC's Target Capital 
Requirement would be in addition to OCC's resources to cover 
participant defaults.\25\ OCC proposes, however, to mitigate losses 
arising out of a Clearing Member default with OCC's own excess capital. 
Specifically, OCC proposes to offset default losses remaining after the 
application of a defaulted Clearing Member's margin deposits and 
Clearing Fund contributions with OCC's capital in excess of 110 percent 
of the Target Capital Requirement at the time of the default. OCC also 
proposes to charge losses remaining after the application of OCC's 
excess capital to OCC senior management's deferred compensation as well 
as non-defaulting Clearing Members.\26\ The Commission understands 
these aspects of the proposal to constitute the first instance where a 
covered clearing agency is seeking Commission consideration of a 
``skin-in-the-game'' component to financial risk management for central 
clearing. A skin-in-the-game component to financial risk management 
entails a covered clearing agency (in this instance, OCC), upon the 
occurrence of a default or series of defaults and application of all 
available assets of the defaulting participant(s), choosing to apply 
its own capital contribution to the relevant clearing or guaranty fund 
in full to satisfy any remaining losses prior to the application of any 
(a) contributions by non-defaulting members to the clearing or guaranty 
fund, or (b) assessments that the covered clearing agency require non-
defaulting participants to contribute following the exhaustion of such 
participant's funded contributions to the relevant clearing or guaranty 
fund.\27\
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    \25\ See Notice of Filing, 84 FR at 44950.
    \26\ Such losses would be charged on a pro rata basis to (a) 
non-defaulting Clearing Members' Clearing Fund contributions, and 
(b) the aggregate value of the EDCP Unvested Balance (defined 
below).
    \27\ See Covered Clearing Agency Standards, 81 FR at 70806.
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C. Replenishing Capital

    OCC proposes to establish a plan for replenishing its capital in 
the event that Equity were to fall below certain thresholds 
(``Replenishment Plan''). As described above, OCC proposes to establish 
an Early Warning threshold to define when OCC's Equity falls close 
enough to the Target Capital Requirement to require action. OCC also 
proposes to establish two ``Trigger Event'' thresholds to identify (i) 
whether OCC's Equity were to fall below the Target Capital Requirement; 
and (ii) the appropriate response based on the severity and speed of 
capital deterioration. Further, the proposed Capital Management Policy 
would require that, on an annual basis, OCC's management recommend that 
the Board approve or, as appropriate, modify the Replenishment Plan, 
and that the Board review and, as appropriate, approve Management's 
recommendation.
    Under the proposed rules, a Trigger Event would occur if OCC's 
Equity were to remain below 100 percent of the Target Capital 
Requirement for a period of 90 consecutive calendar days (referred to 
herein as the ``Moderate Trigger Event''). OCC believes that the 
failure of a fee increase resulting from an Early Warning to increase 
OCC's Equity above the Target Capital Requirement within 90 days would 
indicate that corrective action in the form of a fee increase would be 
insufficient.\28\ Under the proposed rules, a Trigger Event would also 
occur if OCC's Equity were to fall below 90 percent of the Target 
Capital Requirement at any time (referred to herein as the ``Severe 
Trigger Event''). OCC believes that a Severe Trigger Event 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.\29\
---------------------------------------------------------------------------

    \28\ See Notice of Filing, 84 FR at 44946-47.
    \29\ See Notice of Filing, 84 FR at 44946.
---------------------------------------------------------------------------

    As noted above, OCC's Board would be authorized to approve fee 
increases to address the deterioration of OCC's capital over time. To 
address the more acute capital replenishment needs posed by the Trigger 
Events, OCC proposes to authorize the use of two

[[Page 5503]]

additional resources: (i) Funds held under The Options Clearing 
Corporation Executive Deferred Compensation Plan Trust (``EDCP''); \30\ 
and (ii) funds obtained by levying a special fee on Clearing Members.
---------------------------------------------------------------------------

    \30\ The EDCP funds available for capital replenishment would be 
only those funds that are (x) deposited on or after January 1, 2020 
in respect of the EDCP and (y) in excess of amounts necessary to pay 
for benefits accrued and vested under the EDCP at such time (``EDCP 
Unvested Balance'').
---------------------------------------------------------------------------

    In response to a Trigger Event, OCC would be required to replenish 
its capital first through the contribution of the EDCP Unvested 
Balance. The amount of the EDCP Unvested Balance contributed would be 
the lesser of (i) the entire EDCP Unvested Balance or (ii) the amount 
necessary to raise OCC's Equity above 110 percent of the Target Capital 
Requirement. If a contribution of the entire EDCP Unvested balance were 
necessary, OCC would be required to reevaluate its Equity vis-[agrave]-
vis the Target Capital Requirement to determine whether further action 
would be required following such a contribution.
    The proposed rules would require that OCC take further action if, 
after contributing the entire EDCP Unvested Balance, either: (i) Equity 
were to remain above 90 percent, but below 100 percent, of the Target 
Capital Requirement for an additional 90-day period; \31\ or (ii) 
Equity were below 90 percent of the Target Capital Requirement. Under 
the proposal, if OCC were to determine that further action would be 
necessary to replenish its capital, OCC would be required to levy a 
special fee on its Clearing Members (``Operational Loss Fee''), which 
would be payable within five business days of OCC providing notice to 
the Clearing Members. Accordingly, OCC proposes to amend its schedule 
of fees to describe the maximum Operational Loss Fee that it could 
charge Clearing Members. The maximum Operational Loss Fee would be 
sized to provide OCC with the RWD Amount after any applicable taxes 
(``Adjusted RWD Amount'').\32\ Under the proposal, OCC would be 
authorized to charge Clearing Members, collectively, the lesser of (i) 
the maximum Operational Loss Fee or (ii) the amount necessary to raise 
OCC's Equity above 110 percent of the Target Capital Requirement. Under 
the proposal, OCC would allocate the Operational Loss Fee equally among 
the Clearing Members. OCC believes that charging the Operational Loss 
Fee in equal shares is preferable to other potential allocation methods 
because it would equally mutualize the risk of operational loss among 
the firms that use OCC's services.\33\
---------------------------------------------------------------------------

    \31\ The 90-calendar day term of a subsequent Moderate Trigger 
Event would be measured beginning on the date OCC applies the EDCP 
Unvested Balance.
    \32\ OCC acknowledged that the tax implications of the income 
represented by the Operational Loss Fee would depend on the extent 
to which any operational loss giving rise to a Trigger Event would 
be tax deductible. See Notice of Filing, 84 FR at 44947.
    \33\ See id. OCC stated that it found no evidence of a 
correlation between the risk of operational loss and either volume 
or a Clearing Member's credit risk profile. See id.
---------------------------------------------------------------------------

    The proposed rules would permit OCC to charge amounts only up to 
the maximum Operational Loss Fee. If, after charging some amount less 
than the maximum Operational Loss Fee, OCC were to issue clearing fee 
refunds to manage excess capital, OCC would issue such refunds in equal 
shares until the amount of the Operational Loss Fee charged to each 
Clearing Member had been fully refunded. If OCC were to charge some 
amount less than the maximum Operational Loss Fee, then the proposed 
rules would allow OCC to charge another Operational Loss Fee in the 
future, provided that the sum of all Operational Loss Fees, less 
amounts refunded, could not exceed the maximum Operational Loss Fee. In 
the event that OCC were to charge the maximum Operational Loss Fee, OCC 
would then be required to convene its Board to develop a new 
replenishment plan.

III. Statutory Standards

    Section 19(b)(2)(C) of the Exchange Act directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to such organization.\34\ The Commission 
addresses in its review of the Proposed Rule Change the following 
relevant provisions of the Exchange Act and the rules and regulations 
thereunder applicable to registered clearing agencies:
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78s(b)(2)(C).
---------------------------------------------------------------------------

     Section 17A(b)(3)(F) of the Exchange Act requires, in 
part, that the rules of a registered clearing agency be designed to 
promote the prompt and accurate clearance and settlement of securities 
transactions, to assure the safeguarding of securities and funds which 
are in the custody or control of OCC or for which it is responsible, 
and to protect investors and the public interest.\35\
---------------------------------------------------------------------------

    \35\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

     Section 17A(b)(3)(D) of the Exchange Act requires, in 
part, that the rules of a clearing agency provide for the equitable 
allocation of reasonable dues, fees, and other charges among its 
participants.\36\
---------------------------------------------------------------------------

    \36\ 15 U.S.C. 78q-1(b)(3)(D).
---------------------------------------------------------------------------

     Rule 17Ad-22(e)(2) under the Exchange Act requires, in 
part, that a covered clearing agency establish, implement, maintain, 
and enforce written policies and procedures reasonably designed to 
provide for governance arrangements that meet a number of criteria.\37\
---------------------------------------------------------------------------

    \37\ 17 CFR 240.17Ad-22(e)(2).
---------------------------------------------------------------------------

     Rule 17Ad-22(e)(15) under the Exchange Act requires, in 
part, that a covered clearing agency establish, implement, maintain, 
and enforce written policies and procedures reasonably designed to 
identify, monitor, and manage the covered clearing agency's general 
business risk and hold sufficient liquid net assets funded by equity to 
cover potential general business losses so that the covered clearing 
agency can continue operations and services as a going concern if those 
losses materialize, including by taking the actions described in Rules 
17Ad-22(e)(15)(i)-(iii) under the Exchange Act.\38\
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    \38\ 17 CFR 240.17Ad-22(e)(15).
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    After considering the entire record, and for the reasons discussed 
below, the Commission finds the proposal is consistent with Sections 
17A(b)(3)(F) and 17A(b)(3)(D) of the Exchange Act,\39\ as well as Rules 
17Ad-22(e)(2) and 17Ad-22(e)(15) thereunder.\40\
---------------------------------------------------------------------------

    \39\ 15 U.S.C. 78q-1(b)(3)(D) and (F).
    \40\ 17 CFR 240.17Ad-22(e)(2) and 17 CFR 240.17Ad-22(e)(15).
---------------------------------------------------------------------------

    Before addressing the relevant portions of the Exchange Act and the 
rules and regulations thereunder, however, we address a comment 
submitted by Susquehanna International Group (``SIG''). SIG does not 
comment on the substance of the proposal, but, rather, expresses a 
generalized concern that the capital accumulated through the proposed 
Capital Management Policy could ultimately be monetized only or 
disproportionately for the benefit of the OCC shareholders in the event 
of a future sale of OCC.\41\ SIG acknowledges that OCC's By-Laws 
currently limit the shareholders of OCC to national securities 
exchanges or national securities associations.\42\ SIG states, however, 
that OCC's By-Laws leave

[[Page 5504]]

open the possibility of one of these organizations acquiring OCC or a 
future change to OCC's By-Laws to permit others to acquire OCC.\43\ The 
Commission notes that any such future transformative transaction 
(including any related proposals concerning the Capital Management 
Policy) would be subject to the filing requirements of Section 19 of 
the Exchange Act. We would therefore assess the details and potential 
effects of the transaction at that time, including the treatment of 
fees collected from Clearing Members. In light of this required review 
of any such transaction, the Commission does not believe that the 
concerns raised by SIG about such a future transaction render the 
Capital Management Policy inconsistent with the Exchange Act.
---------------------------------------------------------------------------

    \41\ Letter from Brian Sopinsky, General Counsel, Susquehanna 
International Group, dated October 1, 2019, to Vanessa Countryman, 
Secretary, Commission (``SIG Letter'') at 1.
    \42\ SIG Letter at 1.
    \43\ SIG Letter at 1.
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act

    Section 17A(b)(3)(F) of the Exchange Act requires, in part, that 
the rules of OCC be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and to assure the 
safeguarding of securities and funds which are in the custody or 
control of OCC or for which it is responsible.\44\ Based on its review 
of the record, the Commission finds the proposal is consistent with 
Section 17A(b)(3)(F) of the Exchange Act.
---------------------------------------------------------------------------

    \44\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    The Commission believes that the Capital Management Policy as a 
whole would help to ensure that OCC monitors and maintains its Equity 
at a level sufficient to either continue operating as a going concern 
or to wind-down its operations in an orderly manner in the event that 
OCC incurs potential operational or general business losses. In 
particular, the Commission believes that the proposed establishment of 
a Target Capital Requirement in combination with the capital 
monitoring, management, and replenishment tools described above, 
including the Operational Loss Fee, would reduce the risk that OCC 
would be unavailable to clear and settle securities transactions and 
therefore is consistent with promoting prompt and accurate clearance 
and settlement of securities transactions. The Commission did not 
receive any comments on this aspect of the proposal.
    In addition, as described above, OCC proposes to mitigate losses 
arising out of a Clearing Member default with OCC's excess capital 
(i.e., skin-in-the-game). Further, OCC proposes to charge losses 
remaining after the application of skin-in-the-game to OCC senior 
management as well as Clearing Members through the contribution of the 
EDCP Unvested Balance. Taken together, these aspects of the Proposed 
Rule Change could reduce the potential losses charged to the Clearing 
Fund contributions of non-defaulting Clearing Members in the event of a 
Clearing Member default, which in turn would help preserve the Clearing 
Fund contributions of non-defaulting Clearing Members.\45\ As such, the 
components of the Proposed Rule Change related to skin-in-the-game are 
consistent with promoting the safeguarding of securities and funds in 
OCC's custody or for which OCC is responsible.
---------------------------------------------------------------------------

    \45\ Additional issues relevant to the skin-in-the-game aspects 
of the proposal, including relevant comments, are discussed below in 
Section V.C.
---------------------------------------------------------------------------

    Accordingly, the Commission finds that the proposed Capital 
Management Policy is consistent with the requirements of Section 
17A(b)(3)(F) of the Exchange Act.\46\
---------------------------------------------------------------------------

    \46\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

B. Consistency With Section 17A(b)(3)(D) of the Exchange Act

    Section 17A(b)(3)(D) of the Exchange Act requires the rules of a 
clearing agency to provide for the equitable allocation of reasonable 
dues, fees, and other charges among its participants.\47\ As discussed 
below, based on its review of the record, the Commission finds that 
OCC's proposal--as relevant here, the proposal to adopt the Operational 
Loss Fee--is consistent with Section 17A(b)(3)(D) of the Exchange Act.
---------------------------------------------------------------------------

    \47\ 15 U.S.C. 78q-1(b)(3)(D).
---------------------------------------------------------------------------

1. OCC's Proposal To Set the Amount of the Operational Loss Fee Is 
Reasonable
    As discussed above, the Operational Loss Fee is designed to 
replenish OCC's capital following the realization of losses arising out 
of operational or general business risk exposures (as opposed to losses 
arising out of the default of a Clearing Member). To that end, OCC 
proposes to set the maximum amount of the Operational Loss Fee based on 
the amount determined necessary to either recover and continue 
operating as a going concern, or wind-down its operations in an orderly 
manner, with adjustments to those amounts to account for the potential 
tax implications of revenues that would be generated by the fee.\48\ 
Additionally, the proposal would not require OCC to charge the maximum 
amount of the Operational Loss Fee, and would provide OCC the means to 
repay any Operational Loss Fee charged to Clearing Members through 
subsequent refunds.\49\
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    \48\ See Notice of Filing, 84 FR at 44947. As discussed in 
Section V.D.2 herein, the Commission finds that the approach OCC 
applies to determining such amounts is reasonable and supported by 
the record.
    \49\ See id.
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    As noted, the purpose of the Operational Loss Fee is to provide OCC 
with sufficient replenishment capital following an operational- or 
general business risk-related loss, such that OCC could either recover 
its operations and continue operating as a going concern, or wind-down 
its operations in an orderly manner. The Commission did not receive any 
comments on the aspects of the proposal related to the sizing of the 
Operational Loss Fee. Further, as discussed above, the Commission has 
reviewed the regulatory information available to it related to OCC's 
Clearing Members and understands that the maximum Operational Loss Fee 
would be 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.\50\ The Commission 
believes that OCC's proposal to size the Operational Loss Fee 
consistent with other Clearing Member obligations while also generating 
an amount of capital appropriate to recover OCC's operations and 
continue as a going concern or wind down its operations in an orderly 
manner is reasonable and therefore consistent with the requirements of 
Section 17A(b)(3)(D) of the Exchange Act.\51\
---------------------------------------------------------------------------

    \50\ Such minimum assessments could equal up to an additional $1 
million ($500,000 minimum Clearing Fund requirement, assessed up to 
two times) on top of a Clearing Member's existing $500,000 minimum 
Clearing Fund contribution, for a total contribution of $1.5 
million. See, generally, OCC Rule 1006(h), available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf
    \51\ 15 U.S.C. 78q-1(b)(3)(D).
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2. OCC's Proposal Would Provide for the Equitable Allocation of the 
Operational Loss Fee
    If levied, OCC would allocate the Operational Loss Fee equally 
among all Clearing Members.\52\ According to OCC, equal allocation is 
preferable to a proportional allocation based on, for example, Clearing 
Members' trade volume or Clearing Fund contributions, because, in OCC's 
view, all Clearing Members benefit from equal access to the clearance 
and settlement services provided by OCC, irrespective of how much a 
given Clearing Member chooses to use those services.\53\ Additionally, 
in developing its proposal to adopt the

[[Page 5505]]

Operational Loss Fee, OCC considered alternative allocation methods for 
the Operational Loss Fee, including allocating the Operational Loss Fee 
proportionally among Clearing Members based on trade volume, risk 
profile, and other metrics.\54\ As part of this process, OCC reviewed 
available data related to different measures of Clearing Members' use 
of OCC's clearance and settlement services, such as trade volume and 
credit risk profiles, and performed a series of analyses to determine 
whether there is a potential correlation between and among those 
metrics and the various operational and general business risks that 
could give rise to the Operational Loss Fee.
---------------------------------------------------------------------------

    \52\ See Notice of Filing, 84 FR at 44947.
    \53\ See id.
    \54\ See id. Additionally, OCC discussed the equal allocation of 
the Operational Loss Fee with Clearing Members on May 31, 2019. See 
Notice of Filing, 84 FR at 44949.
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    The Commission received, and has reviewed, these analyses.\55\ 
These analyses did not show a correlation between the operational and 
general business risks that could give rise to the Operational Loss Fee 
and contract volume, Clearing Fund contributions, risk profile, or 
other metrics.\56\ Based on our review of the record, we conclude that 
it is consistent with the Exchange Act to allocate the Operational Loss 
Fee equally among all Clearing Members.
---------------------------------------------------------------------------

    \55\ See Notice of Filing, 84, FR at 44947 (noting that OCC 
included as confidential Exhibit 3e a comparison of its 
quantification of operational risks to contract volume and the 
amount of Clearing Fund deposits).
    \56\ See Notice of Filing, 84, FR at 44947 (noting that ``OCC 
has not observed any correlation between the annual quantifications 
of these risks and contract volume or Clearing Member credit 
risk.'').
---------------------------------------------------------------------------

    One commenter, the FIA, submitted a comment letter noting that the 
use of the Operational Loss Fee could allocate some amount of non-
default losses to OCC's Clearing Members and stating that non-default 
losses should not be allocated to Clearing Members. In the FIA's view, 
as a CCP, OCC should absorb such losses rather than utilize capital on 
a discretionary basis.\57\ Rather than assess the Operational Loss Fee 
in the event of a Trigger Event, the FIA asserts that OCC should begin 
accumulating retained earnings now so that it will be in a position to 
use them instead of the Operational Loss Fee.\58\ OCC responds that 
raising additional capital through the accumulation of retained 
earnings over a number of years would still source the funds from 
Clearing Members, but would do so in a manner that essentially would 
pre-fund the replenishment obligation rather than only impose it if and 
when doing so became necessary.\59\ OCC further describes the series of 
events that would have to occur in the event that its Equity fell at or 
below different percentages of the Target Capital Requirement, and the 
different measures OCC would have to take, including potentially 
raising fees, lowering costs, and using its available skin-in-the-game 
to cure such losses (and that would have to fail) before OCC would be 
permitted to charge the Operational Loss Fee.\60\
---------------------------------------------------------------------------

    \57\ FIA Letter at 3.
    \58\ FIA Letter at 2.
    \59\ OCC Letter at 2.
    \60\ OCC Letter at 4-5.
---------------------------------------------------------------------------

    OCC's proposal with respect to the Operational Loss Fee will permit 
OCC to raise additional equity in the event that its equity falls close 
to or below the Target Capital Requirement. The Operational Loss Fee 
represents an appropriate and reasonable allocation of potential 
contingent costs to Clearing Members. The FIA's suggested approach 
would still source the required funds from Clearing Members, but in a 
manner that essentially pre-funds the maximum potential replenishment 
obligation without being informed by the specific facts and 
circumstances that inform OCC's determination of the actual required 
amount.\61\ In contrast, under OCC's proposal, the Operational Loss Fee 
would be imposed only if and when OCC's efforts to set and maintain its 
capital reserves at a level sufficient to withstand operational and 
business losses are insufficient, OCC's capital reserves deteriorate to 
a significant degree as a result, and the other tools available to OCC 
are insufficient to return OCC's capital reserves to a minimum 
acceptable level. In this respect, the Commission believes that OCC's 
approach is both reasonable and consistent with the Exchange Act. 
Because the Operational Loss Fee is not assessed until a specific but 
contingent future time, it leaves available to Clearing Members funds 
and liquidity that may be put to more efficient use as opposed to being 
held indefinitely at OCC in the form of collected fees. Further, the 
Proposed Rule Change would allow OCC to charge less than the maximum 
Operational Loss Fee because, if and when such a fee were to become 
necessary, OCC would know that actual amount required to achieve 
replenishment. In the Commission's view, this approach is more precise, 
requiring OCC to determine and collect only the amount of the 
Operational Loss Fee required by OCC under the given circumstances to 
replenish its resources.
---------------------------------------------------------------------------

    \61\ OCC Letter at 2.
---------------------------------------------------------------------------

    Further, as the FIA noted, OCC estimates that the Operational Loss 
Fee, if assessed now, would be around $1.4 million per Clearing 
Member.\62\ OCC's rules currently require Clearing Members to maintain 
net capital of at least $2 million.\63\ Based on its review of data 
provided by OCC, as of the time of filing, 98 percent of Clearing 
Members would be able to absorb the maximum Operational Loss Fee 
without breaching that requirement.\64\ Further, a $1.4 million 
Operational Loss Fee would be roughly similar to the contingent 
obligations under the OCC Clearing Fund assessment requirements for a 
Clearing Member operating at the minimum Clearing Fund deposit.\65\ In 
the Commission's view, this helps ensure that any potential liquidity 
obligations OCC may place on its Clearing Members via the Operational 
Loss Fee is at a level that is generally consistent with OCC's existing 
assessment demands on such Clearing Members.
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    \62\ FIA Letter at 2.
    \63\ Notice of Filing, 84 FR at 44951-52 (citation omitted).
    \64\ See Notice of Filing, 84, FR at 44952 (stating that OCC 
included, as confidential Exhibit 3h, financial data reported by 
Clearing Members).
    \65\ Notice of Filing, 84 FR at 44951; see also supra note 51.
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    Finally, the FIA's preferred approach of imposing higher fees now 
and building up OCC's capital reserves to the necessary level over time 
would not provide OCC with an immediately available replenishment plan, 
and would therefore, not be consistent with OCC's obligation to comply 
with Rule 17Ad-22(e)(15)(iii) of the Exchange Act. As such, although 
the FIA has a general objection to any CCP allocating non-default 
losses to Clearing Members, the FIA does not assert that, or otherwise 
explain how, OCC's specific proposal to do so in the context of the 
Operational Loss Fee would render the Proposed Rule Change inconsistent 
with the Exchange Act.
    The FIA further expresses the belief that imposing the Operational 
Loss Fee on Clearing Members without providing a return to Clearing 
Members is inequitable and that, ideally, OCC's shareholders should 
either be required to provide ``similar such commitment or allow for an 
equity dilution.'' \66\
---------------------------------------------------------------------------

    \66\ FIA Letter at 2.
---------------------------------------------------------------------------

    As explained above, the Commission believes that the record 
demonstrates that OCC has designed the Operational Loss Fee in a manner 
that is equitable to the Clearing Members in terms of determining (i) 
the overall amount of the Operational Loss Fee, and (ii) the relative 
burdens and obligations Clearing Members must meet in paying the 
Operational Loss Fee. Moreover, the Commission believes that the

[[Page 5506]]

Operational Loss Fee serves a critical purpose for the benefit of 
Clearing Members, their customers and the broader U.S. equity markets. 
OCC is the only clearing agency for standardized U.S. securities 
options listed on SEC-registered national securities exchanges 
(``listed options'') and provides central counterparty services for the 
U.S. listed-options markets.\67\ OCC's role as the sole CCP for all 
listed options contracts in the U.S. makes it an integral part of the 
national system for clearance and settlement, and the Financial 
Stability Oversight Council designated OCC as a systemically important 
financial market utility (``SIFMU'') in 2012.\68\ The resilience and 
ongoing orderly operations of OCC thus broadly benefits Clearing 
Members, their customers, and the broader U.S. financial system.\69\ 
While OCC could have considered or proposed other approaches that might 
have entailed different obligations and burdens for Clearing Members 
(including via raising additional capital from the Clearing Members), 
the failure of OCC to consider or propose such alternative measures 
does not render the Proposed Rule Change inequitable.
---------------------------------------------------------------------------

    \67\ See Securities Exchange Act Release No. 85121 (Feb. 13, 
2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR-OCC-2015-02); see 
id., 84 FR at 5158.
    \68\ See Financial Stability Oversight Council (``FSOC'') 2012 
Annual Report, Appendix A, https://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf (last visited November 25, 
2019).
    \69\ See id. As a registered clearing agency, OCC plays an 
important role in fostering the proper functioning of financial 
markets and, by centralizing the clearance and settlement of listed 
options, allows market participants to reduce costs, increase 
operational efficiency, and manage risks more effectively. See 
Covered Clearing Agency Standards, 81 FR at 70860-61.
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    A different commenter--LPL Financial (``LPL'')--expresses the 
belief that the proposal to allocate the Operational Loss fee in equal 
shares among OCC's Clearing Members would be inequitable and suggests 
that, instead, the Operational Loss Fee should be allocated ``in a 
manner that corresponds to the extent to which each Clearing Member 
utilizes (and therefore benefits from) the OCC's operations.'' \70\ In 
LPL's view, such an allocation would ``correctly acknowledge that the 
extent to which a Clearing Member makes use of the OCC's clearing and 
settlement systems does, in some cases, directly correspond to the risk 
that the OCC will incur certain operational losses.'' \71\ LPL further 
challenges OCC's statement that ``there is no correlation between 
operational risks, on the one hand, and contract volume, on the other 
hand,'' as ``flawed inasmuch as it ignores the fact that a Clearing 
Member that makes greater use of the OCC's clearing and settlement 
system places greater strain on that system and thus exposes the system 
to greater operational risk.''\72\
---------------------------------------------------------------------------

    \70\ Letter from Steven Morrison, SVP, Associate General 
Counsel, LPL, dated September 17, 2019 (received September 26, 2019) 
to Brent J. Fields, Secretary, Commission, (``LPL Letter'') at 1-2.
    \71\ LPL Letter at 1-2.
    \72\ LPL Letter at 3.
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    Based on the Commission's regulatory and supervisory experience, 
the Commission does not agree that a Clearing Member that ``makes 
greater use of OCC's clearing and settlement system necessarily places 
greater strain on that system and thus exposes the system to greater 
operational risk.'' Contrary to LPL's assertion that ``each contract 
introduced to the OCC's system brings with it a new opportunity for 
internal fraud and cyber-attack,'' \73\ based on its supervisory and 
regulatory experience with OCC, the Commission understands that 
contracts are not submitted to be processed by OCC on a one-by-one 
basis such that each contract represents an equal potential for 
operational risk.
---------------------------------------------------------------------------

    \73\ LPL Letter at 3.
---------------------------------------------------------------------------

    Further, in the Commission's experience, a Clearing Member's 
``use'' of OCC's services is not necessarily correlated to that 
Clearing Member's operational resiliency. OCC has a broad range of 
geographically diverse Clearing Members, comprised of U.S. broker-
dealers, future commission merchants, and foreign securities firms of 
various sizes, all of which serve diverse markets and engage in diverse 
strategies and activities on behalf of diverse clients, including 
professional traders, as well as institutional and retail investors. 
There is, therefore, no basis to conclude, for example, that a Clearing 
Member that clears 1,000 contracts in a given month in a particular set 
of financial products necessarily introduces less operational risk to 
OCC than a Clearing Member that clears 10,000 contracts in a different 
set of financial products in that same month.
    LPL also fails to acknowledge or address the specific operational 
and business risks that could give rise to the Operational Loss Fee. As 
noted above, OCC conducted analyses to determine whether it could 
identify a correlation between various measures of Clearing Members' 
use of OCC's clearance and settlement services and the specific types 
of operational and general business risks that could give rise to the 
Operational Loss Fee. These included, among others, internal fraud, 
external fraud, employment practices, workplace safety, damage to 
physical assets, business disruption and system failures, and 
execution, delivery, and process management at OCC. The Commission 
believes that the operational and business risks identified and 
analyzed by OCC are reasonable in light of the requirements of Rule 
17Ad-22(e)(15) discussed above.\74\ And based on the Commission's 
review of the record, we do not believe that there is a positive 
correlation between these types of risks and a Clearing Member's ``use 
of OCC's clearing and settlement services.'' For example, OCC's 
analyses do not show a correlation between a Clearing Member's contract 
volume or credit risk profile, which are reasonable proxies for a 
Clearing Member's ``use'' of OCC's clearance and settlement services, 
and the specific operational risk that that Clearing Member poses to 
OCC.
---------------------------------------------------------------------------

    \74\ The Commission notes that these operational and business 
risk metrics correspond to the Basel II Advanced Measurement 
Approach. See International Convergence of Capital Measurements and 
Capital Standards: a Revised Framework, Basel Committee on Banking 
Supervision, 2005, available at https://www.bis.org/publ/bcbs128.pdf.
---------------------------------------------------------------------------

    Further, the Commission does not agree with the assertion that 
Clearing Members that ``use'' OCC's clearance and settlement services 
more derive more benefit from those services, and therefore should be 
allocated a larger portion of the Operational Loss Fee. As an initial 
matter, OCC has been designated as a SIFMU and its role as the sole CCP 
for all listed options contracts in the U.S. makes it an integral part 
of the national system for clearance and settlement. Clearing Members, 
their customers, investors, and the markets as a whole derive 
significant benefit from that national system and the overall market 
system it supports, regardless of their specific utilization of that 
system. As such, Clearing Members benefit from OCC's efforts to ensure 
that it is and remains well capitalized, that it has sufficient 
financial resources to withstand operational or general business 
losses, and that it has a plan in place to replenish those resources in 
the event that it incurs such losses. The Commission is not aware of 
evidence demonstrating that those benefits are tied directly or 
positively correlated to an individual Clearing Member's rate of 
utilization of OCC's clearance and settlement services. Further, as 
noted, the Commission has reviewed data provided by OCC that 
demonstrates a lack of correlation between use (as represented by 
volume) and operational risk.\75\ Such data is consistent with the 
Commission's regulatory and

[[Page 5507]]

supervisory experience, which demonstrates that operational risks can 
arise from a variety of disparate sources that are represented in 
different ways and to different degrees among OCC's diverse membership, 
such that, as noted above, the level of operational risk presented to 
OCC by a given Clearing Member does not appear to be positively 
correlated to the number, type, or volume of contracts that that 
Clearing Member clears through OCC.
---------------------------------------------------------------------------

    \75\ See Notice of Filing, 84, FR at 44947 (noting that OCC 
included as confidential Exhibit 3e a comparison of its 
quantification of operational risks to contract volume and the 
amount of Clearing Fund deposits).
---------------------------------------------------------------------------

    Taken together, the Commission believes that OCC's current proposal 
to fund replenishment capital through the Operational Loss Fee includes 
a sizing and allocation methodology that, as discussed above, is 
reasonably designed to minimize the potential burden of the fee on 
Clearing Members, as supported by data on the record, and would result 
in both the reasonable sizing and the equitable allocation of the 
Operational Loss Fee. Accordingly, for the reasons discussed above, the 
Commission believes that the proposed allocation method is consistent 
with the requirement that OCC's rules provide for the equitable 
allocation of fees. The Commission finds, therefore, that OCC's 
proposal to adopt the Operational Loss Fee is consistent with the 
requirements of Section 17A(b)(3)(D) of the Exchange Act.\76\
---------------------------------------------------------------------------

    \76\ 15 U.S.C. 78q-1(b)(3)(D).
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(2) Under the Exchange Act

    Rule 17Ad-22(e)(2) under the Exchange Act requires, in part, that a 
covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to provide for 
governance arrangements that, among other things, are clear and 
transparent; clearly prioritize the safety and efficiency of the 
covered clearing agency; and support the public interest requirements 
of the Exchange Act.\77\ Based on its review of the record, the 
Commission finds the proposal is consistent with Rule 17Ad-22(e)(2) 
under the Exchange Act.
---------------------------------------------------------------------------

    \77\ 17 CFR 240.17Ad-22(e)(2).
---------------------------------------------------------------------------

    As described in more detail above, under the proposal OCC would 
introduce a skin-in-the-game component to its existing default 
waterfall to offset losses in the event of a Clearing Member default. 
The FIA stated that it is unclear how material these skin-in-the-game 
contributions would be and whether they would be meaningful enough to 
result in an alignment of interest from a shareholder perspective.\78\ 
The FIA notes that capital expenditures planned and approved by the OCC 
Board can be met through amounts in excess of the Target Capital 
Requirement and, as such, it is unclear how this may tie in with OCC's 
plans to contribute skin-in-the-game.\79\ The FIA also notes that 
``capital levels in excess of 110% of threshold could result in OCC 
revisiting the fee schedule,'' and that it is ``unclear if/how this may 
impact the funded level of skin in the game.'' \80\ As such, the FIA 
seeks ``greater transparency on the size of these resources,'' states 
that OCC should have a minimum amount of skin-in-the-game that ``scales 
with risk and is defined and funded upfront,'' and urges OCC ``to 
define a level of [skin-in-the-game] ex ante that would always be 
readily available in case of a default loss.'' \81\
---------------------------------------------------------------------------

    \78\ FIA Letter at 1.
    \79\ FIA Letter at 2.
    \80\ FIA Letter at 2.
    \81\ FIA Letter at 1-2.
---------------------------------------------------------------------------

    OCC responds that the Commission has not imposed a skin-in-the-game 
requirement, but that OCC nevertheless believes it is prudent to align 
OCC's incentives with those of the broader industry with respect to the 
management of risks faced by OCC and, as a result, has determined to 
propose the skin-in-the-game provisions included in its proposal.\82\ 
OCC states that, under the proposed Capital Management Policy, it would 
provide a layer of skin-in-the-game to be used for both default losses 
and non-default losses, and that the skin-in-the-game would be a 
combination of two sources: Current and retained earnings of OCC and 
available funds in OCC's EDCP.\83\ OCC acknowledges that, because it 
would be determined based on a function of available funds at a 
specific point in time, the specific amount of skin-in-the-game will be 
unknown until the time of an operational loss event, but emphasizes its 
belief that the skin-in-the-game component of the proposed Capital 
Management Policy, particularly with respect to the EDCP funds that 
would be a direct contribution from OCC management, is sufficient to 
ensure the alignment of incentives for risk management between OCC and 
the Clearing Member community.\84\
---------------------------------------------------------------------------

    \82\ OCC Letter at 1.
    \83\ OCC Letter at 1-2.
    \84\ OCC Letter at 2.
---------------------------------------------------------------------------

    We conclude that OCC's skin-in-the-game proposal is consistent with 
the Exchange Act and the rules and regulations thereunder. In adopting 
Rule 17Ad-22(e)(2), the Commission discussed comments it received 
regarding the concept of skin-in-the-game as a potential tool to align 
the various incentives of a covered clearing agency's stakeholders, 
including management and clearing members.\85\ And, while the 
Commission declined to include a specific skin-in-the-game requirement, 
it stated its belief that ``the proper alignment of incentives is an 
important element of a covered clearing agency's risk management 
practices,'' and noted that skin-in-the-game ``may play a role in those 
risk management practices in many instances.'' \86\
---------------------------------------------------------------------------

    \85\ Covered Clearing Agency Standards, 81 FR at 70805-06.
    \86\ Covered Clearing Agency Standards, 81 FR at 70806.
---------------------------------------------------------------------------

    Here, OCC has considered its financial resources, ownership 
structure, existing risk management framework, and other factors and, 
in light of these considerations, proposes to add to its current 
default waterfall two potential sources of skin-in-the-game for 
offsetting losses associated with Clearing Member defaults: (i) 
Deferred compensation in the form of the EDCP Unvested Balance (i.e., 
executive bonuses awarded but not yet paid) and (ii) capital reserves 
(i.e., Shareholder equity) in excess of 110 percent of the Target 
Capital Requirement. OCC proposes to modify its current default 
waterfall such that it would be required to use these skin-in-the-game 
resources before utilizing non-defaulting members' Clearing Fund 
contributions.\87\
---------------------------------------------------------------------------

    \87\ Specifically, OCC's current default waterfall, in general, 
utilizes the following resources in the following order: (i) The 
defaulting Clearing Member's margin deposit; (ii) the defaulting 
Clearing Member's Clearing Fund contribution; and (iii) non-
defaulting Clearing Members' Clearing Fund contributions. Under the 
proposal the new default waterfall would require OCC to utilize the 
following resources in the following order: (i) The defaulting 
Clearing Member's margin deposit; (ii) the defaulting Clearing 
Member's Clearing Fund contribution; (iii) skin-in-the-game in the 
form of capital reserves above 110 percent of the Target Capital 
Requirement at the time of the default; and (iv) skin-in-the-game in 
the form of the aggregate value of the EDCP Unvested Balance at the 
time of the default and non-defaulting Clearing Members' Clearing 
Fund contributions, both charged on a pro rata basis. In addition, 
under the proposal, OCC would be permitted (but would not be 
required) to also utilize capital reserves between 100 percent and 
110 percent of the Target Capital Requirement.
---------------------------------------------------------------------------

    In the Commission's view, with this aspect of the Proposed Rule 
Change OCC would be taking an important step toward incorporating a 
skin-in-the-game component into its existing risk management framework, 
which in turn should help further align the interests of OCC's 
stakeholders, including OCC management and Clearing Members. The direct 
contribution of the EDCP Unvested Balance in particular would represent 
a direct contribution of executive compensation by OCC's senior 
managers and therefore would help align the incentives of OCC's

[[Page 5508]]

senior management with those of the broader industry with respect to 
the management of risks faced by OCC. Further, the EDCP Unvested 
Balance would not be affected directly by the issues relating to 
capital expenditures and revisions to the fee schedule noted by the 
FIA. Finally, although the size of OCC's skin-in-the-game resources in 
absolute terms would not be set unless and until they were utilized, 
the Proposed Rule Change establishes a clear and transparent 
methodology for establishing the amount of skin-in-the-game that would 
be available at the time and in the event of a Clearing Member default. 
As such, the Commission believes that the skin-in-the-game aspects of 
the Proposed Rule Change are consistent with Section 17Ad-22(e)(2) of 
the Exchange Act.
    In addition to the skin-in-the-game components discussed above, the 
Proposed Rule Change includes the various components that would govern 
the sizing and imposition of the Operational Loss Fee. The FIA comment 
letter expresses the belief that any Board decision that results in the 
imposition of an Operational Loss Fee should be ``syndicated with'' 
Clearing Members and that any resulting feedback from Clearing Members 
should be ``presented to the Board before any decisions are taken.'' 
\88\ In response, OCC refers to the requirements of its By-Laws that 
result in more than two-thirds of OCC's directors being either Clearing 
Member directors or public directors.\89\ Further, OCC expresses its 
strong belief that part of the viability of a plan to replenish capital 
is the speed at which that replenishment capital is accessible.
---------------------------------------------------------------------------

    \88\ FIA Letter at 3.
    \89\ OCC Letter at 3.
---------------------------------------------------------------------------

    We find that the Operational Loss Fee is consistent with Rule 17Ad-
22(e)(2)(iii). That rule requires that a covered clearing agency 
establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to provide for governance arrangements 
that support the public interest requirements of Section 17A of the 
Exchange Act applicable to clearing agencies, and the objectives of 
owners and participants.\90\ In adopting Rule 17Ad-22(e)(2), the 
Commission added paragraph (vi) in response to comments regarding the 
scope of Rule 17Ad-22(e)(2)(iii).\91\ Paragraph (vi) of Rule 17Ad-
22(e)(2) specifically addresses the consideration of the interests of 
participants' customers, securities issuers and holders, and other 
relevant stakeholders of the covered clearing agency.\92\ In adopting 
Rule 17Ad-22(e)(2), the Commission noted that the inclusion of 
independent directors on a clearing agency's board may be one mechanism 
for helping to ensure that the relevant views of stakeholders are 
presented and considered.\93\ In the context of default management, the 
Commission has acknowledged that risk exposures can change rapidly 
during periods of market stress.\94\ Similarly, the Commission believes 
that the general business risk exposures, and related losses, may 
change rapidly during periods of stress, and, in turn, that there is a 
benefit to a covered clearing agency's ability to respond to such 
changes in a timely fashion.
---------------------------------------------------------------------------

    \90\ 17 CFR 240.17Ad-22(e)(2)(iii).
    \91\ Covered Clearing Agency Standards, 81 FR at 70803.
    \92\ 17 CFR 240.17Ad-22(e)(2)(vi).
    \93\ Covered Clearing Agency Standards, 81 FR at 70803.
    \94\ Covered Clearing Agency Standards, 81 FR at 70806.
---------------------------------------------------------------------------

    The FIA also expresses a concern that OCC's Board has a fiduciary 
duty to OCC, and by implication, not to Clearing Members; however, OCC 
responds that, in furtherance of the Exchange Act requirement that 
OCC's rules must assure a fair representation of its shareholders (or 
members) and participants in the selection of its directors and the 
administration of its affairs, OCC's By-Laws ``state that nine of the 
twenty directorships are reserved for representatives of OCC clearing 
members,'' and that, in addition, five of the twenty directorships are 
reserved for public directors, who are charged with representing the 
interests of all stakeholders, such that more than two-thirds of OCC's 
directors are either Clearing Member directors or public directors.\95\ 
OCC also describes the formal and informal mechanisms that OCC employs 
to solicit feedback from Clearing Members and other interested 
stakeholders, including its Financial Risk Advisory Committee, 
Operations Roundtable, multiple letters and open calls with Clearing 
Members and other interested stakeholders, and routine in-person 
meetings with trade groups and individual firms.\96\ As such, OCC 
contends that the Capital Management Policy was constructed with the 
benefit of the perspective of the Clearing Member community, and any 
further discussions at the Board will benefit from this same 
perspective.\97\
---------------------------------------------------------------------------

    \95\ OCC Letter at 3-4.
    \96\ OCC Letter at 4.
    \97\ OCC Letter at 4.
---------------------------------------------------------------------------

    Again, we agree that the proposal is consistent with Rule 17Ad-
22(e)(2). In adopting Rule 17Ad-22(e)(2), the Commission noted that the 
approach a covered clearing agency may take in considering the views of 
stakeholders could vary depending on the ownership structure or 
organizational form of the covered clearing agency.\98\ The Commission 
believes that the governance arrangements currently in existence and 
proposed by OCC in connection with the Proposed Rule Change, as 
discussed above, are consistent with the requirement to consider the 
interests of OCC's participants, and are therefore consistent with Rule 
17Ad-22(e)(2).
---------------------------------------------------------------------------

    \98\ Covered Clearing Agency Standards, 81 FR at 70803.
---------------------------------------------------------------------------

    Accordingly, and for the reasons stated above, the Commission finds 
the changes proposed in the Proposed Rule Change are consistent with 
Rule 17Ad-22(e)(2) under the Exchange Act.\99\
---------------------------------------------------------------------------

    \99\ 17 CFR 240.17Ad-22(e)(2).
---------------------------------------------------------------------------

D. Consistency With Rule 17Ad-22(e)(15) Under the Exchange Act

    Rule 17Ad-22(e)(15) under the Exchange Act requires, in part, that 
a covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to identify, 
monitor, and manage the covered clearing agency's general business risk 
and hold sufficient liquid net assets funded by equity to cover 
potential general business losses so that the covered clearing agency 
can continue operations and services as a going concern if those losses 
materialize, including by taking the actions described in Rules 17Ad-
22(e)(15)(i)-(iii) under the Exchange Act.\100\ As discussed below, 
based on its review of the record, the Commission finds that the 
proposal is consistent with Rule 17Ad-22(e)(15) of the Exchange Act.
---------------------------------------------------------------------------

    \100\ 17 CFR 240.17Ad-22(e)(15).
---------------------------------------------------------------------------

1. Rule 17Ad-22(e)(15)(i)
    Rule 17Ad-22(e)(15)(i) under the Exchange Act requires that the 
policies and procedures described under Rule 17Ad-22(e)(15) include 
determining the amount of liquid net assets funded by equity based upon 
a covered clearing agency's general business risk profile and the 
length of time required to achieve a recovery or orderly wind-down, as 
appropriate, of its critical operations and services if such action is 
taken.\101\
---------------------------------------------------------------------------

    \101\ 17 CFR 240.17Ad-22(e)(15)(i).
---------------------------------------------------------------------------

    As described above, OCC proposes to adopt rules governing OCC's 
process for determining the amount of Equity required to support the 
LNAFBE necessary to cover potential general business losses, which 
would then be

[[Page 5509]]

used to help set its Target Capital Requirement.\102\ In turn, the 
Target Capital Requirement would be designed to ensure, among other 
things, that OCC holds sufficient capital to continue operations and 
services as a going concern if general business losses materialize, 
which OCC refers to as the Potential Loss Amount.\103\ To set the 
Potential Loss Amount, OCC would conduct an annual analysis of its 
capital requirements by analyzing and aggregating potential losses from 
individual operational risk scenarios, aggregating the loss events, and 
conducting loss modeling at or above the 99 percent confidence 
level.\104\ The Commission did not receive any comments on this aspect 
of the proposal. Taken together, the Commission believes the proposal 
is designed to identify and maintain the resources necessary for OCC to 
recover or wind-down its critical operations or services as well as to 
remain a going concern following the realization of losses due to 
general business risk, and therefore finds that it is consistent with 
Rule 17Ad-22(e)(15)(i).\105\
---------------------------------------------------------------------------

    \102\ See supra Section V.A; see also Notice of Filing, 84 FR at 
44945.
    \103\ See id.
    \104\ See id.; OCC Letter at 4.
    \105\ 17 CFR 240.17Ad-22(e)(15)(i).
---------------------------------------------------------------------------

2. Rule 17Ad-22(e)(15)(ii)
    Rule 17Ad-22(e)(15)(ii) under the Exchange Act requires that the 
policies and procedures described under Rule 17Ad-22(e)(15) include 
holding liquid net assets funded by equity equal to the greater of 
either (i) six months of the covered clearing agency's current 
operating expenses, or (ii) the amount determined by the board of 
directors to be sufficient to ensure a recovery or orderly wind-down of 
critical operations and services of the covered clearing agency, as 
contemplated by the plans established under Rule 17Ad-22(e)(3)(ii), and 
which shall be in addition to resources held to cover participant 
defaults or other risks covered under applicable credit risk and the 
liquidity risk standards, and shall be of high quality and sufficiently 
liquid to allow the covered clearing agency to meet its current and 
projected operating expenses under a range of scenarios, including in 
adverse market conditions.\106\
---------------------------------------------------------------------------

    \106\ 17 CFR 240.17Ad-22(e)(15)(ii).
---------------------------------------------------------------------------

    As described above, OCC proposes to adopt rules that would require 
it to hold at least the minimum amount of Equity necessary to meet the 
Target Capital Requirement. In turn, the Target Capital Requirement 
would be set at a level at least sufficient to comply with Rule 17Ad-
22(e)(15)(ii) under the Exchange Act. Specifically, the Target Capital 
Requirement would equal or exceed, at a minimum, the greater of (i) six 
months of OCC's current operating expenses; (ii) the RWD Amount (which 
would equal or exceed the amount determined by the board of directors 
to be sufficient to ensure a recovery or orderly wind-down of critical 
operations and services); or (iii) the Potential Loss Amount. Thus, 
under the proposal, OCC would maintain LNAFBE in an amount that would 
equal or exceed the amount determined by OCC to correspond to the 
amounts described in Rule 17Ad-22(e)(15)(ii).
    To ensure that OCC continues to hold the amount of LNAFBE required 
under Rule 17Ad-22(e)(ii), as detailed above, OCC would also, on a 
monthly basis, monitor its Equity relative to the Target Capital 
Requirement to determine whether an Early Warning or Trigger Event had 
occurred. In addition, in response to such monitoring and any 
associated Early Warnings, OCC would use fee-related tools currently 
available under its existing Rules (e.g., increases, decreases, 
refunds, or fee waivers) to manage and maintain its capital levels at 
or near the Target Capital Requirement. For example, OCC proposes to 
require OCC Management to notify OCC's Board promptly if Equity were to 
fall below the Early Warning threshold and to recommend to the Board 
whether to implement a fee increase in an amount that the Board 
determines necessary and appropriate to raise additional Equity. The 
requirement to notify the Board, and recommend appropriate action, 
would help to ensure that OCC continues to hold sufficient resources to 
meet the Target Capital Requirement. As such, the proposal would be 
designed to ensure that OCC holds Equity sufficient to support the 
amount of LNAFBE equal to the Target Capital Requirement, which 
requirement would correspond to the amounts specified under Rule 17Ad-
22(e)(15)(ii).
    The Capital Management Policy would provide objective, quantifiable 
metrics and tools that OCC would use to determine its forward six-
months operating expenses and RWD Amount (i.e., the cost of recovery or 
orderly wind-down) and ensure that it holds at least those amounts in 
LNAFBE at all times.\107\ Specifically, to determine the RWD Amount, on 
an annual basis OCC would follow the process and use the assumptions 
laid out in its Recovery and Wind-Down Plan (``RWD Plan''), which the 
Commission previously reviewed and approved.\108\ Under the RWD Plan, 
on an annual basis, OCC identifies its critical services and determines 
the cost to maintain those critical services over the prescribed 
recovery or wind-down period, assuming costs remain at historical 
levels.\109\ As noted above, OCC would also set the Target Capital 
Requirement at a level designed to cover the Potential Loss Amount, 
which would be designed to address losses arising out of operational 
risk. On an annual basis, OCC would quantify 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 percent confidence level.\110\
---------------------------------------------------------------------------

    \107\ OCC has, in prior filings, discussed the quantitative 
analyses underlying the calculation of operating expenses and 
potential recovery and wind-down costs. See Securities Exchange Act 
Release No. 85322 (Mar. 14, 2019), 84 FR 10377, 10378 (Mar. 20, 
2019) (File No. SR-OCC-2019-001) (stating that such quantitative 
assumptions are based on a number of assumptions and projections, 
including, among other things, (i) projected average daily volumes; 
(ii) projected expenses and known cash flows; (iii) an operating 
margin based on historical volumes; and (iv) known capital needs to 
replace and modernize OCC's technology infrastructure).
    \108\ See Notice of Filing, 84 FR at 44945. See also Securities 
Exchange Act Release No. 83918 (Aug. 23, 2018), 83 FR 44091 (Aug. 
29, 2018) (File No. SR-OCC-2017-021) (approving OCC's proposal to 
formalize and update its Recovery and Orderly Wind-Down Plan).
    \109\ See Notice of Filing, 84 FR at 44945.
    \110\ See Notice of Filing, 84 FR at 44945.
---------------------------------------------------------------------------

    The Commission also finds that the proposed rules concerning the 
form of OCC's LNAFBE and manner in which it would be held are 
consistent with the requirements of Rule 17Ad-22(e)(15)(ii). OCC 
proposes to define LNAFBE such that it would consist of only cash and 
cash equivalents. OCC's LNAFBE would, therefore, be liquid by 
definition. Further, OCC proposes to adopt rules requiring that OCC 
hold Equity equal to 110 percent of the Target Capital Requirement 
separate from OCC's resources to cover participant defaults, which 
would help ensure that the Equity it holds to comply with Rule 17Ad-
22(e)(ii) is in addition to OCC's resources to cover participant 
defaults and other risks covered under applicable credit risk and 
liquidity risk standards. The Commission did not receive any comments 
opposing OCC's proposed approach to determining its forward six-months 
operating expenses and cost of recovery or orderly wind-down. For the 
reasons discussed above, the Commission believes that the

[[Page 5510]]

proposal is consistent with Rule 17Ad-22(e)(15)(ii) of the Exchange 
Act.
    The Commission did receive one comment regarding the degree of 
transparency OCC proposes to maintain in respect of the Target Capital 
Requirement. In its comment letter, the FIA states that the Target 
Capital Requirement information that OCC would publish on its website 
quarterly is ``important for transparency purposes'' and that OCC 
should ``also provide disclosures on any expenses/losses that could 
result in the operational loss fee being charged as this will assist 
members in their own risk management.'' \111\ Rule 17Ad-22(e)(15) does 
not require OCC to publish the information to which the FIA refers, and 
Clearing Members already receive from OCC a wide range of information 
to assist with their own risk management and to help them anticipate 
and satisfy their obligations as Clearing Members of OCC, such as the 
Daily Position Report,\112\ Daily Margin Report,\113\ X-M Margin and 
Settlement Report,\114\ Expiration Exercise Report,\115\ Exercise and 
Assignment Activity Report,\116\ and reports listing the current amount 
and form of a Clearing Member's required contribution to the Clearing 
Fund.\117\ The Commission believes that such information already 
provides Clearing Members with timely, relevant information that 
Clearing Members are able to incorporate into their existing risk 
management efforts. As such, the Commission does not believe that OCC's 
failure to propose to provide the type of additional disclosures 
advocated by the FIA renders the Proposed Rule Change inconsistent with 
Rule 17Ad-22(e)(15)(ii) under the Exchange Act.
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    \111\ FIA Letter at 4.
    \112\ See OCC Rule 501, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \113\ See OCC Rule 605, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \114\ See OCC Rule 706, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \115\ See OCC Rule 805, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \116\ See OCC Rule 901, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
    \117\ See OCC Rule 1007, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
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3. Rule 17Ad-22(e)(15)(iii)
    Rule 17Ad-22(e)(15)(iii) under the Exchange Act requires that the 
policies and procedures described under Rule 17Ad-22(e)(15) include 
maintaining a viable plan, approved by the board of directors and 
updated at least annually, for raising additional equity should a 
covered clearing agency's equity fall close to or below the amount 
required under Rule 17Ad-22(e)(15)(ii).\118\
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    \118\ 17 CFR 240.17Ad-22(e)(15)(iii).
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    As described above, the proposed Replenishment Plan would govern 
OCC's process for replenishing its capital in the event that Equity 
were to fall close to or below the Target Capital Requirement by, among 
other things, implementing tools that would allow OCC to replenish its 
capital levels in the event that routine monitoring and management 
through its existing fee-related tools is insufficient to avoid a 
Trigger Event, which would only occur if OCC's Equity fell below 100% 
of the Target Capital Requirement and stayed there for 90 consecutive 
days or OCC's Equity fell below 90% of the Target Capital Requirement 
at any point in time. The proposed Replenishment Plan would require 
OCC's Management to monitor changes in Equity and to notify OCC's Board 
of a Trigger Event. If a Trigger Event were to occur, OCC would attempt 
to replenish its capital levels first through the contribution of the 
EDCP Unvested Balance. If and only if the entire EDCP Unvested Balance 
were insufficient to bring OCC's Equity back to or above 100% of the 
Target Capital Requirement, OCC would be required to levy the 
Operational Loss Fee on Clearing Members. The Operational Loss Fee 
would be sized to the Adjusted RWD Amount, and therefore would be 
designed to provide OCC with at least enough capital either to continue 
as a going concern or to wind-down in an orderly fashion.
    Under the proposal, on an annual basis OCC's Management would be 
obligated to recommend that the Board approve or, as appropriate, 
modify the proposed Replenishment Plan. In turn, OCC's Board would be 
obligated annually to approve or, as appropriate, modify the proposed 
Replenishment Plan based on Management recommendation.
    To the extent the Operational Loss Fee is levied, the FIA suggests 
that OCC should clarify the mechanism for returning such resources to 
Clearing Members.\119\ In response, OCC states that if an Operational 
Loss Fee were charged and OCC's capital subsequently exceeded 110 
percent of the Target Capital Requirement such that OCC determined to 
return to Clearing Members funds received pursuant to the charge, OCC 
would return the funds to Clearing Members in equal share to each 
Clearing Member that paid the Operational Loss Fee until such time as 
the aggregate amount of the Operational Loss Fee was returned.\120\ 
OCC's comment included an example to further clarify OCC's 
explanation.\121\ This information also is described in the Notice of 
Filing,\122\ and is consistent with the Commission's understanding, 
based on its review of the record, of the mechanisms that OCC would use 
to return the Operational Loss Fee in the event that it is levied. 
Accordingly, the Commission believes that the information provided by 
OCC in the Notice of Filing and subsequently in its comment letter 
provides a comprehensive and sufficient response to the FIA's request 
for clarification.
---------------------------------------------------------------------------

    \119\ FIA Letter at 3.
    \120\ OCC Letter at 3.
    \121\ Id.
    \122\ See Notice of Filing, 84 FR at 44946.
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    The FIA also requests clarification regarding OCC's proposal to 
charge the Operational Loss Fee in an amount that would return OCC to a 
capitalization of 110 percent of the Target Capital Requirement, 
instead of just returning to the target capital levels.\123\ OCC 
clarifies that the reason for this 10 percent buffer is ``embedded in 
the requirement itself: OCC's replenishment plan is to be used when 
OCC's Equity falls `close to or below the [Target Capital 
Requirement],''' \124\ which OCC interprets as requiring it to maintain 
capital reserves, at a minimum, above 100 percent of the Target Capital 
Requirement. In determining how much above 100 percent of the Target 
Capital Requirement, OCC determined that maintaining capital reserves 
at or around 110 percent of the Target Capital Requirement was the 
appropriate amount, in part because 10 percent of the Target Capital 
Requirement represents approximately two months of earnings, and OCC 
believes that a two-month window would provide OCC's senior management 
and Board sufficient time to respond to a deterioration of OCC's 
capital.\125\ The Commission has reviewed the analysis provided by OCC 
\126\ and believes that a 110 percent buffer representing approximately 
two months of earnings is reasonable in light of the requirement set 
forth in Rule 17Ad-22(e)(15)(iii) that a viable replenishment plan be 
calibrated to circumstances where a covered clearing agency's capital 
level falls below or close to the required capital amount. Accordingly, 
here as well the

[[Page 5511]]

Commission believes that the information provided by OCC provides a 
comprehensive and sufficient response to the FIA's request for 
clarification.
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    \123\ FIA Letter at 3.
    \124\ OCC Letter at 3 (emphasis in original) (citation omitted).
    \125\ See Notice of Filing, 84, FR at 44946.
    \126\ See Notice of Filing, 84, FR at 44946, n. 17 (stating that 
OCC included its analysis in confidential exhibit 3d).
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    The Commission believes that OCC's proposal with respect to the 
Operational Loss Fee will permit OCC to raise additional equity in the 
event that its equity falls close to or below the Target Capital 
Requirement and therefore finds that it is consistent with Rule 17Ad-
22(e)(15)(iii) of the Exchange Act. The Commission finds, therefore, 
that adoption of these aspects of the proposed Capital Management 
Policy and supporting rule changes are consistent with Exchange Act 
Rule 17Ad-22(e)(15).\127\
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    \127\ 17 CFR 240.17Ad-22(e)(15).
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V. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the 
Exchange Act, and in particular, the requirements of Section 17A of the 
Exchange Act \128\ and the rules and regulations thereunder.
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    \128\ In approving this Proposed Rule Change, the Commission has 
considered the proposed rules' impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\129\ that the Proposed Rule Change (SR-OCC-2019-007), as 
modified by Partial Amendment No. 1, be, and hereby is, approved.
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    \129\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\130\
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    \130\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-01643 Filed 1-29-20; 8:45 am]
 BILLING CODE 8011-01-P

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