Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving Proposed Rule Change Concerning Collateral Haircuts and Standards for Clearing Banks and Letters of Credit, 55775-55785 [2023-17529]

Download as PDF Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices and analysis 104 to indicate that the spot bitcoin market is ‘‘increasingly efficient,’’ with ‘‘high liquidity’’ and a ‘‘higher degree of consensus among investors regarding the price of [b]itcoin,’’ making it ‘‘less susceptible to manipulation.’’ 105 Do commenters believe the Exchange has shown that the bitcoin market is resistant to price manipulation? 4. The Exchange also states that it will execute a surveillance-sharing agreement with Coinbase that is intended to supplement the Exchange’s market surveillance program. According to the Exchange, the agreement is ‘‘expected to have the hallmarks of a surveillance-sharing agreement between two members of the ISG, which would give the Exchange supplemental access to data regarding spot [b]itcoin trades on Coinbase where the Exchange determines it is necessary as part of its surveillance program for the Commodity-Based Trust Shares.’’ 106 Based on the description of the surveillance-sharing agreement as provided by the Exchange herein, what are commenters’ views of such an agreement if finalized and executed? Do commenters agree with the Exchange’s assertion that such an agreement with Coinbase would be ‘‘helpful in detecting, investigating, and deterring fraud and manipulation in the Commodity-Based Trust Shares’’? 107 IV. Procedure: Request for Written Comments lotter on DSK11XQN23PROD with NOTICES1 The Commission requests that interested persons provide written submissions of their views, data, and arguments with respect to the issues identified above, as well as any other concerns they may have with the proposal. In particular, the Commission invites the written views of interested persons concerning whether the proposal is consistent with section 6(b)(5) or any other provision of the Act, and the rules and regulations thereunder. Although there do not appear to be any issues relevant to approval or disapproval that would be facilitated by an oral presentation of views, data, and arguments, the Commission will consider, pursuant to Rule 19b–4, any request for an 104 See id. id. 106 See id. The Exchange states that ‘‘[t]his means that the Exchange expects to receive market data for orders and trades from Coinbase, which it will utilize in surveillance of the trading of CommodityBased Trust Shares.’’ Id. 107 See id. 105 See VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 opportunity to make an oral presentation.108 Interested persons are invited to submit written data, views, and arguments regarding whether the proposed rule change, as modified by Amendment No. 3, should be approved or disapproved by September 6, 2023. Any person who wishes to file a rebuttal to any other person’s submission must file that rebuttal by September 20, 2023. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include file number SR– CboeBZX–2023–028 on the subject line. Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to file number SR–CboeBZX–2023–028. 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 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. Do not include personal identifiable information in submissions; you should submit only information 108 Section 19(b)(2) of the Act, as amended by the Securities Act Amendments of 1975, Public Law 94–29 (June 4, 1975), grants the Commission flexibility to determine what type of proceeding— either oral or notice and opportunity for written comments—is appropriate for consideration of a particular proposal by a self-regulatory organization. See Securities Act Amendments of 1975, Senate Comm. on Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st Sess. 30 (1975). PO 00000 Frm 00115 Fmt 4703 Sfmt 4703 55775 that you wish to make available publicly. We may redact in part or withhold entirely from publication submitted material that is obscene or subject to copyright protection. All submissions should refer to file number SR–CboeBZX–2023–028 and should be submitted on or before September 6, 2023. Rebuttal comments should be submitted by September 20, 2023. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.109 J. Matthew DeLesDernier, Deputy Secretary. [FR Doc. 2023–17603 Filed 8–15–23; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–98101; File No. SR–OCC– 2022–012] Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving Proposed Rule Change Concerning Collateral Haircuts and Standards for Clearing Banks and Letters of Credit August 10, 2023. I. Introduction On December 19, 2022, the Options Clearing Corporation (‘‘OCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the Proposed Rule Change SR–OCC–2022– 012 (‘‘Proposed Rule Change’’) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 1 and Rule 19b–4 2 thereunder to amend OCC’s rules, policies, and procedures regarding (i) the valuation of Government securities and governmentsponsored enterprise (‘‘GSE’’) debt securities deposited as margin or Clearing Fund collateral; (ii) minimum standards for OCC’s Clearing Bank relationships; and (iii) letters of credit as margin collateral.3 The Proposed Rule Change was published for public comment in the Federal Register on December 23, 2022.4 The Commission received comments regarding the Proposed Rule Change.5 The 109 17 CFR 200.30–3(a)(12); 17 CFR 200.30– 3(a)(57). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 See Notice of Filing infra note 4, 87 FR at 79015. 4 Securities Exchange Act Release No. 96533 (Dec. 19, 2022), 87 FR 79015 (Dec. 23, 2022) (File No. SR– OCC–2022–012) (‘‘Notice of Filing’’). 5 Comments on the proposed rule change are available at https://www.sec.gov/comments/sr-occ2022-012/srocc2022012.htm. E:\FR\FM\16AUN1.SGM 16AUN1 55776 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices Commission designated a longer period within which to take action on the Proposed Rule Change on February 3, 2023, extending the period to March 23, 2023.6 The Commission instituted proceedings to determine whether to approve or disapprove the Proposed Rule Change on March 21, 2023.7 The Commission designated a longer period for Commission action on the proceedings to determine whether to approve or disapprove the Proposed Rule Change on June 20, 2023.8 For the reasons discussed below, the Commission is approving the Proposed Rule Change. lotter on DSK11XQN23PROD with NOTICES1 II. Background 9 OCC is a central counterparty (‘‘CCP’’), which means it interposes itself as the buyer to every seller and seller to every buyer for financial transactions. As the CCP for the listed options markets in the U.S.,10 as well as for certain futures, OCC is exposed to certain risks arising from its relationships with its members as well as the banks that support OCC’s clearance and settlement services. Such risks include credit risk because OCC is obligated to perform on the contracts it clears even where one of its members defaults. OCC manages credit risk by collecting collateral from members (i.e., margin and Clearing Fund resources) sufficient to cover OCC’s credit exposure to Clearing Members under a wide range of stress scenarios. In doing so, OCC requires its Clearing Members to deposit collateral as margin to support obligations on short options, futures contracts, and other obligations arising within the members’ accounts at OCC. OCC also requires its members to deposit collateral serving as Clearing Fund assets to protect OCC, should the margin of a defaulting member be insufficient to address the potential losses from the defaulting member’s positions. OCC imposes a haircut to collateral to address the risk that such collateral may be worth less in the future than at the time it was pledged 6 Securities Exchange Act Release No. 96797 (Feb. 3, 2023), 88 FR 8505 (Feb. 9, 2023) (File No. SR– OCC–2022–012) (‘‘Extension’’). 7 Securities Exchange Act Release No. 97178 (Mar. 21, 2023), 88 FR 18205 (Mar. 27, 2023) (File No. SR–OCC–2022–012). 8 Securities Exchange Act Release No. 97765 (June 20, 2023), 88 FR 41441 (June 26, 2023) (File No. SR–OCC–2022–012). 9 Capitalized terms used but not defined herein have the meanings specified in OCC’s Rules and ByLaws, available at https://www.theocc.com/about/ publications/bylaws.jsp. 10 OCC describes itself as ‘‘the sole clearing agency for standardized equity options listed on a national securities exchange registered with the Commission (‘listed options’).’’ See Notice of Filing supra note 4, 87 FR at 79015. VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 to OCC. With regard to risks posed by the banks that support OCC’s clearance and settlement services, OCC maintains standards for third-party relationships, such as those with banks through which OCC conducts settlement (‘‘Clearing Banks’’), and banks that issue letters of credit that Clearing Members may deposit as margin collateral. As described in more detail below, OCC proposed to revise its rules, including certain policies,11 to make the following three changes related to the management of collateral haircuts and banking relationships: (1) Replace the current processes for applying haircuts to Government and GSE debt securities provided as collateral 12 with a new process for applying fixed collateral haircuts that it would set and adjust from time to time, based on a process defined in OCC’s CRM Policy; (2) Codify internal standards for Clearing Banks and letter-of-credit issuers in OCC’s Rules to provide transparency on minimum standards for banking relationships that are critical to OCC’s clearance and settlement services; and (3) Authorize OCC to set more restrictive concentration limits for letters of credit than those limits currently codified in its Rules. Based on its impact analysis, OCC does not expect changes in collateral haircut valuation processes to have a significant impact on Clearing Members.13 OCC stated that the fixed haircut schedule under the proposed procedures-based approach initially would be the same as currently codified in the Rules.14 Regarding the additional minimum standards for Clearing Banks and letter-of-credit issuers, OCC indicated that the institutions currently approved as such already meet these proposed standards.15 A. Collateral Haircuts for Government Securities and GSE Debt Securities OCC proposed to eliminate the CiM treatment of Government securities and 11 These policies include the Collateral Risk Management Policy (‘‘CRM Policy’’), Margin Policy, and System for Theoretical Analysis and Numerical Simulation (‘‘STANS’’) Methodology Description. Id. 12 Generally, OCC defines, by rule, specific haircuts for Government and GSE debt securities. For margin collateral specifically, OCC currently also has authority to value such securities using Monte Carlo simulations as part of its STANS margin methodology (known as ‘‘Collateral in Margin’’ or ‘‘CiM’’). 13 See Notice of Filing supra note 4, 87 FR at 79015. OCC provided its analysis in a confidential Exhibit 3 to File No. SR–OCC–2022–012. 14 See Notice of Filing supra note 4, 87 FR at 79015. 15 Id. PO 00000 Frm 00116 Fmt 4703 Sfmt 4703 GSE debt securities, as well as to remove the fixed collateral haircuts schedule from its rules in favor of adopting rules that describe OCC’s process for setting and adjusting fixed haircuts from time to time. OCC asserted that such a ‘‘procedure-based approach’’ would allow for more frequent valuation, thus reflecting current market conditions, including periods of stress.16 Under the current structure, OCC accepts Government securities from Clearing Members as contributions to the Clearing Fund.17 Additionally, OCC accepts both Government securities and GSE debt securities as margin collateral.18 Rule 604(b) specifies haircuts for Government securities 19 and GSE debt securities 20 that are contributed as margin collateral, while Rule 1002(a)(ii) 21 specifies haircuts for Government securities that are contributed to the Clearing Fund. (i) Removal of CiM Treatment OCC proposed to remove its authority to value Government securities and GSE debt securities using the STANS margin methodology, which currently is used to calculate haircuts applicable to margin collateral.22 As currently written, Interpretation and Policy (‘‘I&P’’) .06 to Rule 601 and Rule 604(f) grant OCC the authority to determine the collateral value of any Government securities or GSE debt securities pledged by Clearing Members as margin collateral either by: (1) the CiM method of including them in Monte Carlo simulations as part of OCC’s STANS margin methodology; or 16 See Notice of Filing supra note 4, 87 FR at 79016–18. 17 See OCC Rule 1002(a). 18 See OCC Rule 604(b)(1), (2). 19 ‘‘Government securities shall be valued for margin purposes at 99.5% of the current market value for maturities of up to one year; 98% of the current market value for maturities in excess of one year through five years; 96.5% of the current market value for maturities in excess of five years through ten years; and 95% of the current market value for maturities in excess of ten years.’’ See OCC Rule 604(b)(1). 20 ‘‘GSE debt securities shall be valued for margin purposes at (1) 99% of the current market value for maturities of up to one year; (2) 97% of the current market value for maturities in excess of one year through five years; (3) 95% of the current market value for maturities in excess of five years through ten years; and (4) 93% of the current market value for maturities in excess of ten years.’’ See OCC Rule 604(b)(2). 21 ‘‘For purposes of valuing Government securities for calculating contributions to the Clearing Fund, Government securities shall be valued at (1) 99.5% of the current market value for maturities less than one year; (2) 98% of the current market value for maturities between one and five years; (3) 96.5% of the current market value for maturities between five and ten years; and (4) 95% of the current market value for maturities in excess of ten years.’’ See OCC Rule 1002(a)(ii). 22 See Notice of Filing supra note 4, 87 FR at 79016. E:\FR\FM\16AUN1.SGM 16AUN1 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices (2) applying the fixed haircuts that are specified in OCC Rule 604(b). OCC stated, however, that regulatory examination findings and OCC’s model validation analyses have identified certain weaknesses, including that OCC may not adequately consider relevant stressed market conditions for Government securities and GSE debt securities deposited as margin and Clearing Fund collateral.23 OCC proposed to resolve such shortcomings by deleting I&P .06 to Rule 601 and Rule 604(f), and instead subjecting all Government securities and GSE debt securities pledged as margin collateral to a fixed haircut schedule set in accordance with a revised CRM Policy, discussed in more detail below. OCC asserted that the resulting approach would be less procyclical.24 Under the proposed change, OCC would value all such deposits using a fixed haircut schedule.25 OCC stated that this change would prevent spikes in margin requirements during periods of heightened volatility that can occur under the current CiM approach.26 As stated in the Notice of Filing, while the proposed fixed haircut approach may be more conservative in periods of low market volatility, it would prevent spikes in margin requirements during periods of heightened volatility that may take place under the existing CiM approach.27 The proposed changes would result in an average impact of less than one percent of the value of Government securities and GSE debt securities.28 OCC stated that it intends lotter on DSK11XQN23PROD with NOTICES1 23 Id. 24 Id. The Commission has stated that procyclicality typically refers to changes in riskmanagement practices that are positively correlated with market, business, or credit cycle fluctuations that may cause or exacerbate financial stability. Standards for Covered Clearing Agencies, Securities Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70816 n. 318 (Oct. 13, 2016). The Commission stated further that, while changes in collateral values tend to be procyclical, collateral arrangements can increase procyclicality if haircut levels fall during periods of low market stress and increase during periods of high market stress. Id. 25 Additionally, OCC would shift its categorization of Government security and GSE debt security deposits currently valued using STANS from margin balances to collateral balances to align its reporting with the proposed haircut methodology. Specifically, the value of CiM-eligible Government securities and GSE debt securities would no longer be included in margin calculations, and thus would no longer be included on OCC’s margin reports. Following implementation of the proposed changes, the value of the previously CiM-eligible Government securities and GSE debt securities would be found in OCC’s collateral reports. See Notice of Filing supra note 4, 87 FR at 79016 n.10. 26 See Notice of Filing supra note 4, 87 FR at 79016. 27 Id. 28 Id. As noted below, OCC is proposing to replace the fixed haircut schedule in its rules that VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 to provide parallel reporting to its Clearing Members for a period of at least four consecutive weeks prior to implementing the change.29 (ii) Removal of the Fixed Haircut Schedule From OCC’s Rules OCC proposed to eliminate the fixed haircut schedules in its rules for Government securities and GSE debt securities used as margin collateral and Government securities deposited in the Clearing Fund, and instead to adopt new subsections that would grant OCC the authority to specify a schedule of haircuts from time to time based on changing market conditions. Specifically, OCC’s proposal would delete the fixed collateral haircut schedule stated in Rule 604(b)(1)–(2) for Government securities and GSE debt securities used as margin collateral, and in Rule 1002(a)(ii) for Government securities deposited in the Clearing Fund.30 OCC proposed to adopt a new section (e) under Rule 604 and amend language in Rule 1002(a)(ii), to authorize OCC to determine the current value of these types of securities, and generally apply a schedule of haircuts that is specified from time to time upon prior notice to Clearing Members. OCC proposed to describe the new process for valuing such securities in its CRM Policy, as described in greater detail in Section II.A.iii. below. Additionally, the proposed changes to the CRM Policy would require OCC to communicate changes in haircut rates to Clearing Members at least one full day in advance, and to maintain the haircut schedule on OCC’s public website. As noted above, OCC would publish a haircut schedule from time to time on its website, and such schedule would be determined based on the proposed methodology in the CRM Policy. The proposed changes to Rule 604 would also authorize OCC to apply haircuts to Government securities and GSE debt securities that are more conservative than those defined in such haircut schedule, or, in unusual or unforeseen circumstances, to assign partial or no value to such securities. The proposed applies to Government securities deposited in the Clearing Fund. The change would result in a negligible impact to Clearing Fund collateral haircuts. Id. OCC provided supporting data as a confidential Exhibit 3 to File No. SR–OCC–2022– 012. 29 See Notice of Filing supra note 4, 87 FR at 79016. See note 25 supra regarding reporting changes that would be implemented in connection with the proposed change. Further, OCC’s rules require it to provide reporting related to margin and Clearing Fund collateral each day. See OCC Rule 605 and OCC Rule 1007. 30 OCC does not accept GSE debt securities as Clearing Fund collateral. PO 00000 Frm 00117 Fmt 4703 Sfmt 4703 55777 change would authorize OCC to take such action for its protection or the protection of Clearing Members or the general public with prior notice to Clearing Members. OCC also proposed changes to the CRM Policy that would provide additional detail regarding the authority to apply more conservative haircuts or reduce the value attributed to Government securities and GSE debt securities.31 Consistent with the proposed addition to Rule 604, the CRM Policy would require OCC to communicate such actions to Clearing Members prior to implementation. Additionally, OCC proposed to add language to the CRM Policy to enumerate the factors that OCC would consider when determining if such action would be appropriate for its protection or the protection of Clearing Members or the general public, including (i) volatility and liquidity, (ii) elevated sovereign credit risk,32 and (iii) any other factors OCC determines are relevant.33 (iii) A Procedures-Based Approach To Setting Collateral Haircuts As described above, OCC proposed to establish a new process for applying fixed collateral haircuts for Government securities and GSE debt securities that OCC would set and adjust from time to time. OCC proposed to define its new process, which it refers to as a ‘‘procedures-based approach,’’ in the CRM Policy. The proposed proceduresbased approach would replace the processes that OCC proposed removing from its rules (i.e., dynamic haircuts calculated by OCC’s margin methodology and fixed haircuts defined by rule). The proposed procedures-based approach would rely on a financial model to set and assess the adequacy of collateral haircuts. In particular, the proposed amendments to the CRM Policy would provide that OCC’s Pricing and Margins team within its Financial Risk Management (‘‘FRM’’) department 31 The CRM Policy currently authorizes OCC to take additional mitigating actions in the form of reducing the value of such securities and review and approval of such actions by OCC’s Management Committee and/or its delegates. 32 OCC explained that while it already has authority under I&P .15 to Rule 604 to make disapprovals of collateral based on similar factors, the proposal is intended to enumerate sovereign credit risk as a factor in the CRM Policy for haircuts on Government securities. See Notice of Filing supra note 4, 87 FR at 79017, n.16. 33 OCC also proposed to include ‘‘any other factors the Corporation determines are relevant’’ for consistency with I&P .15 to OCC Rule 604 and because such a catch-all is designed to capture unforeseen circumstances that might not previously have been considered possible. Id. E:\FR\FM\16AUN1.SGM 16AUN1 55778 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices would monitor the adequacy of the haircuts using a Historical Value-at-Risk approach (‘‘H-VaR’’) with multiple lookback periods (e.g., 2-year, 5-year, and 10-year), updated at least monthly.34 Each look-back period would comprise a synthetic time series of the greatest daily negative return observed for each combination of security type and maturity bucket (e.g., Government securities maturing in more than 10 years). The longest look-back period under the proposed H-VaR approach would include defined periods of market stress.35 The CRM Policy would further require OCC to maintain haircuts at a level at least equal to a 99 percent confidence interval of the look-back period that provides for the most conservative haircuts. Changes to the haircut rate would be communicated to Clearing Members at least one full day in advance and the schedule would be maintained on OCC’s public website. lotter on DSK11XQN23PROD with NOTICES1 (iv) Increased Frequency of Valuations OCC’s proposed addition of Rule 604(e) and amendments to Rule 1002(a)(ii) would resolve an inconsistency between its Rules, which require monthly reviews of collateral haircuts in relation to the Clearing Fund, and its CRM Policy, which requires daily review of all collateral haircuts, including both margin and Clearing Fund collateral. Specifically, under the proposal, OCC would determine the current market value for Government securities and GSE debt securities at such intervals as it may from time to time prescribe, at least daily, based on the quoted bid price supplied by a price source designated by OCC.36 The proposed change also would explicitly remove from the Rules the Risk Committee’s authority for prescribing the interval at which haircuts are set. Rather, the Pricing and Margins business unit would continue to hold this authority, consistent with the current CRM Policy. Under the current CRM Policy, the Pricing and Margins business unit monitors haircuts daily for ‘‘breaches’’ (i.e., an erosion in value exceeding the 34 Upon implementation of the proposed changes, OCC anticipates that the collateral haircuts initially would be identical to those outlined in Rules 604(b) and 1002(a). See Notice of Filing supra note 4, 87 FR at 79017. 35 The delineation of look-back periods, periods of stressed market volatility included in the longestterm look-back period, and the type and maturity buckets would be defined in procedures maintained by OCC’s Pricing and Margins business unit. 36 Additionally, both the current and proposed language in the CRM Policy provide leeway for more frequent valuation, when warranted, and help to ensure that the designation of minimum valuation intervals would not be a limiting factor. See Notice of Filing supra note 4, 87 FR at 79017. VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 relevant haircut) and adequacy, with any issues being promptly reported to appropriate decision-makers at OCC.37 Changes to OCC’s Rules and the CRM Policy, including the minimum valuation interval, would remain subject to Risk Committee approval and the Risk Committee would retain oversight over OCC’s risk management determinations. incorporating stressed market periods in the H-VaR approach for setting and adjusting the haircuts for collateral in the form of Government securities and GSE debt securities used in margin accounts and Government securities in the Clearing Fund, which is comparable to the approach for incorporating stressed markets into the Liquidation Cost Add-on. (v) Conforming Changes to OCC’s Policies Based on the proposed changes to its Rules and policies, OCC also proposed conforming changes to its CRM Policy, Margin Policy, and STANS Methodology Description by: • Establishing the CRM Policy as the relevant OCC policy governing OCC’s process for valuing Government securities and GSE debt securities; • Deleting descriptions that indicate that Government securities and GSE debt securities pledged as margin collateral may be valued using Monte Carlo simulations as part of OCC’s STANS margin methodology; 38 • Conforming capitalization of terms in the CRM Policy with OCC’s By-Laws; • Deleting certain portions of the STANS Methodology Description that exist to support the valuation of Government securities and GSE debt securities using Monte Carlo simulations; • Removing Treasuries (i.e., Government securities) from OCC’s model for generating yield curve distributions to form theoretical price distributions for U.S. Government securities and for modeling Treasury rates within STANS joint distribution of risk factors; 39 • Revising the STANS Methodology Description to reflect the fact that the Liquidation Cost Add-on charge would no longer be assessed to Government security collateral deposits,40 while B. Minimum Standards for Clearing Banks and Letter-of-Credit Issuers 37 OCC believed that Pricing and Margins, as the business unit responsible for such monitoring, is well positioned to make the determination about more frequent valuation intervals consistent with the directive of the CRM Policy approved by the Risk Committee. See Notice of Filing supra note 4, 87 FR at 79018. 38 The Margin Policy currently states that Government securities may be valued using the CiM approach. OCC did not propose to change the description of CiM generally, but rather would maintain it other than the removal of references suggesting that it applies to Government securities and GSE debt securities pledged as margin. See Notice of Filing supra note 4, 87 FR at 79018. 39 As described above, OCC would value such securities as described in the CRM Policy rather than pursuant to STANS. 40 The Liquidation Cost charge is a margin addon charge that is designed to estimate the cost to liquidate a portfolio based on the mid-points of the bid-ask spreads for the financial instruments within the portfolio, and would scale up such liquidation PO 00000 Frm 00118 Fmt 4703 Sfmt 4703 OCC’s proposal would update and codify existing internal minimum standards that OCC uses to establish relationships with Clearing Banks and letter-of-credit issuers. The core of these proposed minimum standards would be the same for both Clearing Banks and letter-of-credit issuers, including requirements for, at a minimum, $500 million in Tier 1 Capital; 41 maintaining certain Tier 1 Capital Ratios; and providing that non-U.S. entities must be domiciled in a country that has a sovereign rating considered to be ‘‘low credit risk.’’ OCC would reserve the right to set other such standards from time to time. OCC stated that these proposed changes would provide transparency on minimum standards for banking relationships that are critical to its clearance and settlement services. Details of proposed amendments to Rule 203 for Clearing Banks and the Interpretations and Policies for Rule 604 relating to letter-of-credit issuers are described below. costs for large or concentrated positions that would likely be more expensive to close out. See Securities Exchange Act Release No. 86119 (June 17, 2019), 84 FR 29267, 29268 (June 21, 2019) (File No. SR–OCC– 2019–004). The Liquidation Cost charge considers the cost of liquidating an underlying security, such as a Government security, during a period of market stress. Id. As described above, OCC now proposes to include defined periods of market stress in its collateral haircuts methodology under the CRM Policy. OCC indicated that the Liquidation Cost charge for such collateral is currently, and is expected to remain, immaterial, based on its analysis of the average daily Liquidation Cost charge across all accounts. See Notice of Filing supra note 4, 87 FR at 79018. 41 Tier 1 Capital is the required regulatory capital that is permanently held by banks to absorb unexpected losses. See generally, Bank for International Settlements, Financial Stability Institute, ‘‘Definition of capital in Basel III— Executive Summary’’ (June 27, 2019), available at https://www.bis.org/fsi/fsisummaries/defcap_ b3.htm#:∼:text=Regulatory%20capital %20under%20Basel%20III,the%20 components%20of%20regulatory%20capital; and The Federal Deposit Insurance Corporation (FDIC), ‘‘Risk Management Manual of Examination Policies,’’ Section 2.1 (Capital), available at https:// www.fdic.gov/regulations/safety/manual/section21.pdf. Tier 1 Capital includes common equity Tier 1 Capital, such as certain bank-issued common stock instruments, and additional Tier 1 Capital. See 12 CFR 217.20. E:\FR\FM\16AUN1.SGM 16AUN1 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices (i) Clearing Banks lotter on DSK11XQN23PROD with NOTICES1 OCC indicated that Clearing Banks play a critical role in its clearance and settlement of options.42 As currently written, Rule 203 requires that every Clearing Member establish and maintain a bank account at a Clearing Bank for each account maintained by it with OCC. However, the sole eligibility requirement for a Clearing Bank expressly delineated in current Rules is that the Clearing Bank be a bank or trust company that has entered into an agreement with OCC in respect of settlement of confirmed trades on behalf of Clearing Members.43 OCC’s By-Laws and Rules are silent on the internal governance process for approving Clearing Bank relationships. Rather, the details as to the financial and operational capability requirements and the governance process for approving Clearing Banks are housed in OCC’s internal procedures, which are not publicly available.44 OCC proposed to amend Rules 101 and 203 to clarify the term ‘‘Clearing Bank’’ and codify minimum capital and operational requirements and the governance process for approving its Clearing Banks.45 OCC believed that expressly listing these requirements in its ByLaws and Rules will provide Clearing Members and other market participants greater clarity and transparency concerning OCC’s Clearing Bank relationships.46 Specifically, Rule 101 would amend the definition of ‘‘Clearing Bank’’ to reflect that such Clearing Bank relationships are approved by the Risk Committee, while leaving the rest of the definition intact. The proposed changes to Rule 203 would codify the following practices for Clearing Banks: • Provide in Rule 203(b) that the Risk Committee may approve a bank or trust company as a Clearing Bank if it meets the minimum requirements; • Require under Rule 203(b)(1) that any Clearing Bank, whether domiciled in the U.S. or outside the U.S., maintain at least $500 million (U.S.) in Tier 1 Capital, rather than the existing $100 million Tier 1 Capital requirement for 42 See Notice of Filing supra note 4, 87 FR at 79018. 43 See OCC Rule 101.C(1). 44 These internal procedures include, for example, a Tier 1 Capital requirement of $100 million for U.S. banks and $200 million for nonU.S. banks, and in effect align with standards for Clearing Banks codified in I&P .01 to OCC Rule 604 with respect to banks or trust companies that OCC may approve to issue letters of credit as margin collateral. 45 See Notice of Filing supra note 4, 87 FR at 79018. 46 Id. VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 letter-of-credit issuers currently required under I&P .01 to OCC Rule 604; • Require under Rules 203(b)(2) and (4) that Clearing Banks maintain (i) common equity Tier 1 Capital (CET1) 47 of 4.5%, (ii) minimum Tier 1 Capital of 6%, (iii) total risk-based capital of 8%, and (iv) a Liquidity Coverage Ratio of at least 100%, unless the Clearing Bank is not required to compute the Liquidity Coverage Ratio; • Provide under Rule 203(b)(3) that non-U.S. Clearing Banks must be domiciled in a country that has a sovereign rating considered to be ‘‘low credit risk’’ (i.e., A- by Standard & Poor’s, A3 by Moody’s, A- by Fitch, or equivalent); • Require under Rule 203(b)(5) that a Clearing Bank must execute an agreement with OCC, including that the Clearing Bank: (A) maintain the ability to utilize the Society for Worldwide Interbank Financial Telecommunication (‘‘SWIFT’’), (B) maintain access to the Federal Reserve Bank’s Fedwire Funds Service, and (C) provide its quarterly and annual financial statements to OCC and promptly notify OCC of material changes to its operations, financial condition, and ownership; • Allow under Rule 203(b)(5)(A) the use of such other messaging protocol, apart from SWIFT, as approved by the Risk Committee; 48 and • Add catchall language in Rule 203(b)(6) to provide that an institution must meet such other standards as OCC may determine from time to time. Language that forms the basis of Rule 203(b)(1)–(3) was taken, in part, from the previously codified standards for letter-of-credit issuers found in I&P .01 to Rule 604. OCC proposed to delete this rule text relating to letter-of-credit issuers and move the essential concepts to Rule 203(b)(1)–(3) concerning Clearing Banks. In doing so, OCC also proposed to adjust certain thresholds related to Tier 1 Capital requirements and sovereign credit ratings. Most notably, the proposed change would increase the Tier 1 Capital minimum requirement from $100 million for U.S. institutions and $200 million for nonU.S. institutions to $500 million for all institutions serving as Clearing Banks or letter-of-credit issuers. Additionally, the proposed change would lower the 47 See Rule 203(c). ‘‘For purposes of this Rule, ‘Tier 1 Capital,’ ‘Common Equity Tier 1 Capital (CET1),’ ‘total risk-based capital,’ and ‘Liquidity Coverage Ratio’ will mean those amounts or ratios reported by a bank or trust company to its regulatory authority.’’ 48 OCC stated that the Risk Committee may elect to temporarily accommodate a Clearing Bank that does not meet these requirements if it is actively implementing such capabilities. See Notice of Filing supra note 4, 87 FR at 79019. PO 00000 Frm 00119 Fmt 4703 Sfmt 4703 55779 sovereign credit risk threshold for institutions domiciled outside of the U.S. from countries rated as AAA to countries that have a rating considered to be low credit risk (A- by Standard & Poor’s, A3 by Moody’s, A- by Fitch, or equivalent). OCC then proposed to incorporate by reference minimum requirements for Clearing Banks in I&P .01 to Rule 604, which applies to letterof-credit issuers, thus aligning standards for Clearing Banks and letter-of-credit issuers and erasing some distinctions between U.S. and non-U.S. institutions. OCC explained that the proposed changes in Rule 203(b) are meant to serve as the articulation of minimum standards for establishing relationships with Clearing Banks, and that OCC is not obligated to enter into any Clearing Bank relationship merely because a bank or trust company meets these enumerated standards.49 In proposing these changes, OCC believed that the Risk Committee is the appropriate governing body to approve such relationships because of the nature of the risks presented by OCC’s Clearing Bank relationships, including the risk that OCC would need to borrow from or satisfy a loss using Clearing Fund assets in order to meet its liquidity needs as a result of the failure of a Clearing Bank to achieve daily settlement.50 Further, in reviewing its existing Clearing Banks, OCC found that a $500 million (U.S.) Tier 1 Capital standard was more representative of these institutions.51 In expanding the definition of ‘‘low credit risk’’ under the proposed Rule 203(b)(3), OCC stated that these ratings better reflect current understanding of countries considered to be ‘‘low credit risk,’’ and that, for example, it would permit OCC to establish relationships with institutions from France with which OCC previously had relationships before France’s sovereign credit rating fell below AAA.52 (ii) Letter-of-Credit Issuers OCC proposed to revise Rule 604 regarding the acceptability of letters of credit as margin collateral. Under the proposal, OCC would align the minimum requirements for letter-ofcredit issuers with some of those for OCC’s other banking relationships, including the above-proposed standards 49 See Notice of Filing supra note 4, 87 FR at 79019. 50 See Notice of Filing supra note 4, 87 FR at 79018. 51 Id. 52 See Notice of Filing supra note 4, 87 FR at 79018–9. E:\FR\FM\16AUN1.SGM 16AUN1 55780 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices lotter on DSK11XQN23PROD with NOTICES1 for Clearing Banks.53 I&P .01 to OCC Rule 604 currently sets forth minimum standards for the types of U.S. and nonU.S. institutions that OCC may approve as an issuer of letters of credit, including minimum Tier 1 Capital requirements, and, for non-U.S. institutions, the ultimate sovereign credit rating for the country where the principal executive office is located, credit ratings for the institution’s commercial paper or other short-term obligations, and standards that apply if there is no credit rating on the institution’s commercial paper or other short-term obligations. OCC proposed to amend I&P .01 to Rule 604 in the following ways: • Combine and restate, without substantive change, the description of which institutions OCC may approve as letter-of-credit issuers; • Replace specific capital and sovereign credit rating requirements with reference to proposed Rule 203(b)(1)–(3) prescribing minimum standards for Clearing Banks; 54 • Remove external credit rating standards for a non-U.S. institution’s commercial paper, other short-term obligations or long-term obligations; 55 and • Add catchall language to provide that an institution must meet such other standards as OCC may determine from time to time. Additionally, OCC proposed conforming changes to better align I&P .03 and .09 to Rule 604, requiring that all letters of credit must be payable at an issuer’s domestic branch.56 Currently, I&P .03 requires any letter of credit issued by a non-U.S. institution be payable at a Federal or State branch or agency thereof, while I&P .09 provides that a letter of credit may be 53 See Notice of Filing supra note 4, 87 FR at 79015. 54 OCC stated that in eliminating I&P .01(b)(3) concerning credit ratings, OCC would remove the subjective process for determining a ‘‘AAA’’ equivalent country based on consultation with entities experienced in international banking and finance matters satisfactory to the Risk Committee, in favor of the more objective standards. See Notice of Filing supra note 4, 87 FR at 79019. 55 OCC stated that it has had to terminate several letter-of-credit issuer relationships pursuant to these external credit rating standards even though the institutions otherwise met OCC’s requirements and were not reporting elevated internal credit risk metrics. By deleting I&P .01(b)(4), OCC would make its Rules consistent with industry best practice, and instead would rely on its Watch Level and Internal Credit Rating surveillance processes under its Third-Party Risk Management Framework to determine creditworthiness of institutions. Id. Proposed I&P .01(c) to OCC’s Rule 604 would provide OCC authority sufficient to determine additional standards for issuers of letters of credit. 56 See Notice of Filing supra note 4, 87 FR at 79020. VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 issued by a Non-U.S. branch of a U.S. institution, as long as it otherwise conforms with Rule 604 and the Interpretations and Policies thereunder and is payable at a U.S. office of such institution. OCC’s proposal would eliminate the text of I&P .09 in its entirety, and instead amend the text of I&P .03 to require letters of credit used as margin collateral to be payable at an issuer’s ‘‘domestic branch,’’ 57 or at the issuer’s Federal or State branch or agency.58 The amended I&P .03 would apply to U.S. and Non-U.S. institutions alike. C. Letter-of-Credit Concentration Limits Lastly, the proposal would allow OCC to set more restrictive concentration limits for accepting letters of credit, while retaining the currently codified concentration limits as thresholds.59 As currently written, I&P .02 to Rule 604 provides that ‘‘[n]o more than 50% of a Clearing Member’s margin on deposit at any given time may include letters of credit in the aggregate, and no more than 20% may include letters of credit issued by any one institution.’’ In addition, I&P .04 to Rule 604 limits the total amount of letters of credit issued for the account of any one Clearing Member by a U.S. or non-U.S. institution to a maximum of 15% of such institution’s Tier 1 Capital. OCC proposed to retain these provisions, while simultaneously deleting the current text of I&P .09 to Rule 604, as described above, and replacing it with language that grants OCC the authority to specify, from time to time, more restrictive limits for the amount of letters of credit a Clearing Member may deposit in the aggregate or from any one institution.60 Such determinations would be made based on market conditions, the financial condition of approved issuers, and any other factors OCC determines are relevant. Any such restrictive limit would apply to all Clearing Members. Under the proposal, the CRM Policy would explicitly state that the responsibility of setting and adjusting more conservative concentration limits for letters of credit would lie with the Credit and Liquidity Risk Working Group (‘‘CLRWG’’), which is a crossfunctional group that comprises representatives from relevant OCC business units including Pricing and Margins, Collateral Services, and Credit 57 As that term is defined in the Federal Deposit Insurance Act. See 12 U.S.C. 1813(o). 58 As those terms are defined in I&P .01 by reference to the International Banking Act of 1978. 59 See Notice of Filing supra note 4, 87 FR at 79015. 60 Id. at 79020. PO 00000 Frm 00120 Fmt 4703 Sfmt 4703 Risk Management. Similar to determinations surrounding collateral haircuts, the CRM Policy would provide that OCC will maintain the concentration limits on its website and will provide prior notice of any changes to the limits. OCC would retain the current requirements under the CRM Policy and the Model Risk Management Policy regarding the CLRWG’s, at a minimum, annual review of the CRM Policy, including concentration limits, and the requirement that any changes to the CRM Policy resulting from the review be presented the Management Committee and, if approved, then the Risk Committee. OCC stated that the anticipated impact of more restrictive concentration limits is low, considering that the use of letters of credit as margin collateral is currently low.61 OCC explained that while utilization of letters of credit is low, it plans to continue to support letters of credit based on their acceptability as collateral under Commodity Futures Trading Commission regulations.62 The final proposed change would amend I&P .08 to Rule 604, which currently provides that OCC will not accept a letter of credit issued pursuant to Rule 604(c) for the account of a Clearing Member in which the issuing institution, a parent, or an affiliate has an equity interest in the amount of 20 percent or more of such Clearing Member’s total capital. The Proposed Rule Change would eliminate the reference to 20 percent, thus resulting in a total prohibition on accepting letters of credit for the account of a Clearing Member in which the issuing institution, a parent, or an affiliate has any equity interest in such Clearing Member’s total capital. III. Discussion and Commission Findings 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.63 After carefully considering the Proposed Rule Change and the comment letters received, the Commission finds that the proposal is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to OCC. More specifically, the Commission 61 Id. 62 Id. 63 15 E:\FR\FM\16AUN1.SGM U.S.C. 78s(b)(2)(C). 16AUN1 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices finds that the proposal is consistent with Section 17A(b)(3)(F) and (I) of the Exchange Act,64 and Rule 17Ad– 22(e)(5),65 Rule 17Ad–22(e)(9),66 Rule 17Ad–22(e)(22),67 and Rule 17Ad– 22(e)(23) 68 thereunder, as described in detail below. lotter on DSK11XQN23PROD with NOTICES1 A. Consistency With Section 17A(b)(3)(F) of the Exchange Act Section 17A(b)(3)(F) 69 of the Exchange Act requires, among other things, that the rules of a clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions and derivative agreements, contracts, and transactions; and to assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible. Based on its review of the record, and for the reasons described below, the Commission believes that the proposed changes to OCC’s rules and procedures regarding collateral haircuts and concentration limits for letters of credit are consistent with promoting the prompt and accurate clearance and settlement of securities and derivatives transactions. As stated above, OCC is exposed to credit risk stemming from its relationships with Clearing Members during the course of fulfilling its core clearing services. One of the ways OCC manages this credit risk is by collecting high-quality collateral for margin accounts and the Clearing Fund, while recognizing that this collateral may decrease in value at a future date. The Commission continues to believe that a clearing agency generally should reduce the need for procyclical adjustments by establishing stable and conservative haircuts that are calibrated to include periods of stressed market conditions, to the extent practicable and prudent.70 Procyclical adjustments (i.e., lower haircuts during periods of low stress followed by increased haircuts during times of high market stress) could exacerbate market stress and contribute to driving down asset prices further, resulting in additional collateral requirements.71 The imposition of more conservative haircuts during normal 64 15 U.S.C. 78q–1(b)(3)(F) and 15 U.S.C. 78q– 1(b)(3)(I). 65 17 CFR 240.17Ad–22(e)(5). 66 17 CFR 240.17Ad–22(e)(9). 67 17 CFR 240.17Ad–22(e)(22). 68 17 CFR 240.17Ad–22(e)(23). 69 15 U.S.C. 78q–1(b)(3)(F). 70 See Standards for Covered Clearing Agencies supra note 24, 81 FR at 70816–17. 71 See Committee on Payment and Settlement Systems, Principles for Financial Market Infrastructures, section 3.5.6 (Apr. 2012); available at https://www.bis.org/publ/cpss101a.pdf. VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 market conditions, therefore, would reduce the amount by which haircuts must be adjusted during times of market stress. Based on the data provided by OCC, the proposed replacement of OCC’s current process for setting collateral haircuts with the proposed HVaR approach would yield more conservative haircuts during times of low market stress, which, in turn, would help reduce spikes in collateral haircuts during heightened market volatility. As noted above, reducing such spikes would reduce the potential for driving down asset prices that could result in the imposition of additional collateral requirements on market participants already faced with increased market stress. The proposed approach also would attempt to address the weaknesses identified in the CiM model in response to regulatory and internal examinations by, for example, incorporating periods of market stress into the look-back period for the model under the proposed H-VaR approach. Further, the proposed changes would add flexibility for OCC to more frequently value collateral haircuts during time of deteriorating market or other conditions while preserving notice requirements to ensure that Clearing Members are aware of risk management changes. Similarly, the proposed changes related to letters of credit (e.g., limits not linked to a specific domicile in order to impose the same requirements on both U.S. and non-U.S. issuers, concentration limits, and a prohibition on affiliated issuers) would support OCC’s ability to manage risks posed by the collateral it accepts from participants. Based on its review of the record, and for the reasons described below, the Commission believes that OCC’s proposed changes to rules and procedures regarding minimum standards for Clearing Banks and letterof-credit issuers are consistent with assuring the safeguarding of securities and funds which are in its custody or control or for which it is responsible. The quality of acceptable custodians is crucial to safeguarding these types of securities and funds, and one of the key ways to measure this quality is by establishing minimum qualifying standards. OCC’s proposed Rule amendments would set more stringent Tier 1 Capital requirements for both Clearing Banks and letter-of-credit issuers, while amending the sovereign credit ratings to reflect current understanding, and requiring Clearing Banks to maintain the ability to use SWIFT, a generally accepted and secure communication method, as a primary messaging protocol. Although the PO 00000 Frm 00121 Fmt 4703 Sfmt 4703 55781 proposal would remove from OCC’s Rules the external credit rating standards for a non-U.S. institution’s commercial paper and related obligations, the ability of these institutions to meet their financial and other obligations to OCC would still be considered under the Third-Party-Risk Management Framework (‘‘TPRMF’’), along with other risk factors.72 Additionally, the proposed changes to the minimum standards for Clearing Banks and letter-of-credit issuers, when viewed as a whole, serve to strengthen OCC’s process for accepting letters of credit, which comprise a fraction of margin,73 come with many related restrictions, and pose minimal risk to OCC. Moreover, the proposal would provide clarity by aligning minimum standards for Clearing Banks and letterof-credit issuers, and would make clear that these rule changes are meant to serve as the articulation of minimum standards for establishing relationships, and OCC would not be obligated to enter into any such relationship merely because an institution meets these enumerated standards. The Commission believes that aligning and codifying such standards in OCC’s rules facilitate OCC’s maintenance of banking and letter-of-credit issuer relationships that support its ability to safeguard securities and funds for which it is responsible or that are in its custody or control. The Commission received comments stating that the proposal to calculate collateral haircuts using the H-VaR model, rather than the current CiM methodology, would ignore long-tail 72 The TPRMF is an OCC rule that requires OCC to evaluate financial institutions such as Clearing Banks and other liquidity providers when they onboard or off-board with OCC, and to continuously monitor such institutions for so long as they maintain a relationship with OCC. It requires OCC to evaluate such financial institutions across a variety of factors, several of which assess the ability of the institution to meet its financial and other obligations to OCC, such as the financial, operational, legal, and regulatory risks faced by the institution. See Securities Exchange Act Release No. 90797 (Dec. 23, 2020), 85 FR 86592 (Dec. 30, 2020) (File No. SR–OCC–2020–014) (approving adoption of OCC’s TPRMF). The TPRMF also provides for Watch List processes and internal escalation procedures in instances of an institution’s deteriorating financial or operational ability to timely meet its future obligations to OCC, including assessing the institution’s operational difficulties, late financial reports, and risk management issues. OCC, ‘‘Third-Party Risk Management Framework’’ (Dec. 22, 2022), available at https:// www.theocc.com/getmedia/68a1ea2d-ddae-4a93a309-100bf70a0f28/Third-Party-Risk-ManagementFramework.pdf. 73 As of Dec. 31, 2022, OCC reported that bank letters of credit accounted for only $130 million out of $152.7 billion of margin at OCC. See OCC 2022 Financials, at 10, available at https:// www.theocc.com/company-information/documentsand-archives/annual-reports. E:\FR\FM\16AUN1.SGM 16AUN1 55782 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices lotter on DSK11XQN23PROD with NOTICES1 risks 74 and historical periods of significant market stress.75 Commenters also stated that fixed collateral haircuts do not accurately reflect the potential fluctuations in asset values, including during times of market stress.76 The Commission has reviewed the proposed H-VaR methodology, including confidential policies, procedures, and related materials.77 The H-VaR model would reflect asset value fluctuations during times of market stress because it specifically includes such periods in the defined lookback periods. With regard 74 The commenters did not elaborate on what was meant by ‘‘long tail risk.’’ See, e.g., Letter from Jean Garcia-Gomez (Feb. 12, 2023), available at https:// www.sec.gov/comments/sr-occ-2022-012/ srocc2022012-325181.htm. Given the related comments and context, the Commission believes this to refer to the risk of loss due to an event that has an extremely low probability of occurring (i.e., an event that is far out in the tail of a distribution of possible events). 75 See, e.g., id. Commenters raised additional concerns regarding sovereign credit ratings, and OCC’s redaction of certain exhibits to the filing. See, e.g., id. Regarding OCC’s redaction of certain exhibits, the Commission notes that OCC asserted that Exhibits 3A–3C and 5B–5D to the filing, which contain internal policies and procedures, internal statistical calculations and descriptions, and confidential regulatory findings, were entitled to confidential treatment because they contained commercial and financial information that is not customarily released to the public and is treated as the private information of OCC. Under Section 23(a)(3) of the Exchange Act, the Commission is not required to make public statements filed with the Commission in connection with a proposed rule change of a self-regulatory organization if the Commission could withhold the statements from the public in accordance with the Freedom of Information Act (‘‘FOIA’’), 5 U.S.C. 552. 15 U.S.C. 78w(a)(3). The Commission has reviewed the documents for which OCC requests confidential treatment and concludes that they could be withheld from the public under the FOIA. FOIA Exemption 4 protects confidential commercial or financial information. 5 U.S.C. 552(b)(4). Under Exemption 4, information is confidential if it ‘‘is both customarily and actually treated as private by its owner and provided to government under an assurance of privacy.’’ Food Marketing Institute v. Argus Leader Media, 139 S. Ct. 2356, 2366 (2019). In its requests for confidential treatment, OCC stated that it has not disclosed the confidential exhibits to the public, and the information is the type that would not customarily be disclosed to the public. In addition, by requesting confidential treatment, OCC had an assurance of privacy because the Commission generally protects information that can be withheld under Exemption 4. Thus, the Commission has determined to accord confidential treatment to the confidential exhibits. 76 Comments on the Proposed Rule Change are available at https://www.sec.gov/comments/sr-occ2022-012/srocc2022012.htm. See, e.g., Letter from Jean Garcia-Gomez (Feb. 12, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/ srocc2022012-325181.htm. 77 See Notice of Filing supra note 4, 87 FR at 79016–79018. OCC provided its policies, procedures, and related documents in confidential Exhibits 3A–3C, and 5B–5D to File No. SR–OCC– 2022–012. Such documents included changes to both high-level policies and detailed technical documentation, as well as an analysis of the impact that changes in the haircut methodology would have on the value of collateral posted by members. VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 to long-tail risk, the proposed rules would require OCC to maintain haircuts at a level at least equal to a 99 percent confidence interval of the look-back period that provides for most conservative haircuts.78 Further, the Commission notes that regulatory and internal examinations showed that the CiM method has previously resulted in inaccuracies in sizing haircuts, and concludes that the use of the H-VaR model in place of the CiM method would improve accuracy of collateral haircuts. Additionally, fixed collateral haircuts are not a fundamentally new approach for OCC. For example, OCC’s Rule 1002 currently applies fixed haircuts to Government securities in the Clearing Fund, and such haircuts are currently subject to review and recalculation based, in part, on market fluctuations.79 Based on its review of the record and having considered the comments described above, the Commission believes that the proposed H-VaR methodology and the continued use of fixed collateral haircuts is consistent with the Exchange Act and the relevant rules thereunder.80 The Commission also received comments stating that lowering or eliminating sovereign credit rating requirements for non-U.S. Clearing Banks and letter-of-credit issuers increases the risk taken on by OCC.81 The Commission has considered the materials submitted by OCC with regard to the Proposed Rule Change.82 OCC’s rules do not currently prescribe acceptable sovereign credit rating for the domicile of any non-U.S. Clearing Bank. OCC is not proposing to weaken minimum standards, but rather to codify the current requirement to allow only those Clearing Banks domiciled in the U.S. or in locations with sovereign rating considered to be low credit risk. The Commission believes the proposed standards (i.e., A¥ by Standard & Poor’s, A3 by Moody’s, A¥ by Fitch, or equivalent, which would include institutions domiciled in countries such 78 See Notice of Filing supra note 4, 87 FR at 79017. 79 Id. 80 Commenters also raised a concern that the proposed rule change would ‘‘cut margin requirements.’’ See, e.g., letter from Daniel Lambden (Feb. 25, 2023), available at https:// www.sec.gov/comments/sr-occ-2022-012/ srocc2022012-326082.htm. Such comments are not relevant to the filing because OCC did not propose changes to how it calculates margin requirements. 81 See note 75, supra. 82 See Notice of Filing supra note 4, 87 FR at 79018–79020. OCC provided its policies, procedures, and related documents in confidential Exhibits 3A–3C, and 5B–5D to File No. SR–OCC– 2022–012. Such documents include changes to policy governing OCC’s management of risk presented by letters of credit. PO 00000 Frm 00122 Fmt 4703 Sfmt 4703 as France) represents a reasonable choice by OCC to identify sovereigns with low credit risk.83 The Commission recognizes that the proposal would change the acceptable ratings for letterof-credit issuers; however, the proposed standard would still require that such banks be domiciled in the United States or in locations with sovereign ratings considered to be low credit risk, as noted above. Moreover, the removal of external credit rating standards for a non-U.S. institution’s commercial paper and related obligations from OCC’s Rules does not mean that creditworthiness will not be considered at all. Rather, the proposal calls for an evaluation of credit risk as part of a broader review of factors, such as financial, operational, legal, and regulatory risks, with regard to Clearing Banks and liquidity providers, such as letters of credit issuers under the TPRMF.84 The sovereign credit rating requirements are part of a broader set of minimum standards for Clearing Banks and letter-of-credit issuers, including the Tier 1 Capital that OCC proposes to increase, thus providing further safeguards that mitigate or eliminate the additional risk to OCC. Based on its review of the record and having considered the comments described above, the Commission believes that the proposed sovereign credit rating requirements are consistent with the Exchange Act and the relevant rules thereunder. The Commission received further comments stating that the proposed changes would reduce or remove external audit, supervision, and credit ratings, contrary to recommendations made in a 2015 paper from the Bank of International Settlements (‘‘BIS’’).85 These comments are not relevant to the proposal being considered here. The Proposed Rule Change is unrelated to and does not address external audit or supervision and, contrary to commenters’ assertions, it would not remove the consideration of credit ratings. Where the proposal addresses credit ratings, it does so in the limited context of sovereign credit ratings 83 OCC acknowledged that the sovereign credit rating requirement historically applied to letter-ofcredit issuers is different than what is currently applied to its Clearing Banks, and that OCC would change the sovereign credit rating requirement for letter-of-credit issuers to conform to that for the Clearing Banks. See Notice of Filing supra note 4, 87 FR at 79018–79019. 84 See note 72, supra. 85 Isabella Arndorfer, Bank of International Settlements, and Andrea Minto, Utrecht University, Occasional Paper No. 11, ‘‘The ‘four lines of defence model’ for financial institutions,’’ Financial Stability Institute ((Dec. 23, 2015), available at https://www.bis.org/fsi/fsipapers11.pdf. (‘‘BIS paper’’). E:\FR\FM\16AUN1.SGM 16AUN1 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices considered to be of low credit risk, transferring the rules regarding consideration of creditworthiness of Clearing Banks and liquidity providers from the OCC rulebook to the TPRMF, and as part of a broader set of minimum requirements for Clearing Banks and letter-of-credit issuers. The BIS paper discusses, among other things, how interactions among internal lines of defense and external controls can enhance governance at financial institutions.86 These issues are not relevant to the Proposed Rule Change. Further, unlike the commenters suggest, the BIS paper does not discuss credit ratings at all. Additionally, even though the proposal would adjust the required sovereign credit rating, and transfer the rules regarding consideration of creditworthiness of Clearing Banks and liquidity providers from the OCC rulebook to the TPRMF, it would still only allow for countries with low credit risk and institutions that are able to meet obligations to OCC, and these requirements are part of a larger set of minimum standards, such as more stringent Tier 1 Capital requirements and the requirement for Clearing Banks to maintain the ability to use SWIFT, that serve to enhance OCC’s banking and letter-of-credit relationships. As such, after having considered the comments relating to the BIS paper, the Commission continues to believe that the proposal is consistent with the Exchange Act and the relevant rules thereunder. Therefore, the Commission finds that, taken together, the proposed changes described above are consistent with the requirements of Section 17A(b)(3)(F) of the Exchange Act.87 B. Consistency With Section 17A(b)(3)(I) of the Exchange Act Section 17A(b)(3)(I) of the Exchange Act requires that the rules of a clearing agency do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.88 In response to the Notice of Filing,89 the Commission received a comment 90 opposing the proposal stating that the ‘‘increase to the current Tier 1 Capital 86 Id. 87 15 U.S.C. 78q–1(b)(3)(F). U.S.C. 78q–1(b)(3)(I). 89 See Notice of Filing supra note 4, 87 FR at 79015. 90 Letter from Lakeside Bank dated January 26, 2023 (‘‘Lakeside Ltr’’), available at https:// www.sec.gov/comments/sr-occ-2022-012/ srocc2022012.htm. See also Letter from Lakeside Bank dated March 15, 2023 (‘‘Lakeside Ltr 2’’), available at https://www.sec.gov/comments/sr-occ2022-012/srocc2022012-328270.htm. Lakeside Ltr 2 did not present novel comments. lotter on DSK11XQN23PROD with NOTICES1 88 15 VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 requirement will have a negative effect by eliminating [Lakeside Bank] as a member Clearing Bank’’ and that such elimination ‘‘will reduce competition.’’ 91 The commenter, Lakeside, states further that large Clearing Banks ‘‘tend to not provide service for small and mid-sized Clearing Brokers,’’ which appears to suggest that the proposed change could reduce direct access to clearing for OCC’s current membership.92 Finally, the commenter states that the ‘‘proposed Tier 1 Capital rule change to $500 million is arbitrary and capricious and not explained other than the OCC’s belief the new requirement reduces the risk of a Clearing Banks failure to achieve their daily settlement obligations.’’ 93 In a subsequent comment letter, OCC responded to the concerns raised by Lakeside.94 OCC stated that its proposal would not impose a burden on competition 95 because Clearing Members of various sizes ‘‘currently have established relationships with OCC-approved Clearing Banks that meet the proposed standards.’’ 96 Further, OCC stated that ‘‘Lakeside Bank does not currently provide settlement banking services as a Clearing Bank for any OCC Clearing Member.’’ 97 Moreover, OCC stated that its ‘‘current rules do not obligate OCC to enter into a Clearing Bank relationship with a bank simply because the bank meets its present standards.’’ 98 OCC stated that obligating it to enter into Clearing Bank relationships simply because an institution meets the minimum standards and without further due diligence ‘‘would not be consistent with sound third-party risk management practices.’’ 99 On the contrary, ‘‘OCC believes that strengthening OCC standards for entering into Clearing Bank arrangements is necessary and appropriate to ensure the overall safety 91 Lakeside Ltr at 1. 92 Id. The Commission also received a comment stating that the proposed increase to capital requirements would impact smaller members. Letter from Kevin Lau (Feb. 14, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/ srocc2022012-325669.htm. 93 Lakeside Ltr at 2. 94 Letter from Megan Cohen, Managing Director, OCC, to Vanessa Countryman, Secretary, Commission, dated February 2, 2023 (‘‘OCC Ltr’’), available at https://www.sec.gov/comments/sr-occ2022-012/srocc2022012.htm. 95 The Exchange Act requires that the rules of the clearing agency do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. See 15 U.S.C. 78q–1(b)(3)(I). 96 OCC Ltr at 3. 97 Id. at 1. 98 Id. at 2. 99 Id. at 2. PO 00000 Frm 00123 Fmt 4703 Sfmt 4703 55783 and soundness of the markets OCC serves.’’ 100 OCC stated further that it ‘‘determined the proposed Tier 1 Capital requirement to align with the Tier 1 Capital held by the Clearing Banks that have demonstrated records of performance, including the resources to devote to and meet OCC’s operational expectations for providing such critical services.’’ 101 Based on the information provided, the Commission believes that the proposal would not impose a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act. All of OCC’s current members maintain relationships with Clearing Banks that meet the proposed standards. The Commission did not receive comments raising concerns from current or prospective OCC participants. With regard to monitoring, managing, and limiting the credit and liquidity risk arising from commercial settlement banks, the Commission has provided guidance that a clearing agency generally should consider establishing and monitoring adherence to strict criteria for its settlement banks that take account of, among other things, their capitalization.102 The Commission believes, therefore, that strengthening capital requirements for settlement banks, such as OCC’s Clearing Banks, can serve an important risk management purpose. The Commission acknowledges the concerns raised by Lakeside with regard to competition among settlement banks and access to central clearing at OCC.103 As noted above, the proposal does not limit access to current OCC members, and, even if the proposed changes were not approved, OCC’s current rules would not necessarily obligate OCC to 100 Id. at 3. As OCC additionally explained, ‘‘If a Clearing Bank is unable to timely make incoming payments on behalf of one or more Clearing Members, OCC may face liquidity challenges requiring it to draw on resources that could impose unexpected costs or other adverse consequences for its Clearing Members and, ultimately, market participants.’’ Id. 101 Id. 102 See Standards for Covered Clearing Agencies supra note 24, 81 FR at 70826. 103 Lakeside also raised concerns regarding potential future rule changes at the Chicago Mercantile Exchange (‘‘CME’’) and the Depository Trust and Clearing Corporation (‘‘DTCC’’). See Lakeside Ltr at 2. Such concerns are not ripe for consideration here because (1) CME is not currently registered as a clearing agency with the Commission, and (2) there are no proposed changes related to this matter pending with the Commission from the Depository Trust Company, Fixed Income Clearing Corporation, or National Securities Clearing Corporation (i.e., the three registered clearing agencies whose parent is DTCC). E:\FR\FM\16AUN1.SGM 16AUN1 55784 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices lotter on DSK11XQN23PROD with NOTICES1 maintain a Clearing Bank relationship with Lakeside or a similar institution. Therefore, the Commission finds that the proposed changes described above are consistent with the requirements of Section 17A(b)(3)(I) of the Exchange Act.104 C. Consistency With Rule 17Ad–22(e)(5) Under the Exchange Act Rule 17Ad–22(e)(5) 105 under the Exchange Act requires each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures reasonably designed to set and enforce appropriately conservative haircuts and concentration limits if the covered clearing agency requires collateral to manage its or its participants’ credit exposures; and require a review of the sufficiency of its collateral haircuts and concentration limits to be performed not less than annually. In adopting Rule 17Ad– 22(e)(5), the Commission provided guidance that ‘‘to reduce the need for procyclical adjustments, a covered clearing agency generally should consider establishing stable and conservative haircuts that are calibrated to include periods of stressed market conditions, to the extent practical and prudent.’’ 106 Based on the information and data provided by OCC, the Commission believes that OCC’s proposed H–VaR approach would help reduce spikes during heightened market volatility by yielding more conservative haircuts during normal market conditions. The proposed approach also would attempt to address the weaknesses identified in the CiM model in response to regulatory and internal examinations by, for example, incorporating periods of market stress into the look-back period for the model. Additionally, OCC’s proposal to amend its internal CRM Policy to list specific factors, such as volatility and liquidity, and elevated sovereign credit risk when determining the value of GSE debt securities and Government securities used as margin or Clearing Fund collateral, would provide guideposts to set and enforce appropriately conservative haircuts. OCC’s proposed changes also would grant it new authority to set and adjust more restrictive concentration limits for accepting letters of credit, as well as expressly list the factors for making such determinations, and establish a prohibition on accepting letters of credit for the account of a Clearing Member 104 15 U.S.C. 78q–1(b)(3)(I). CFR 240.17Ad–22(e)(5). 106 See Standards for Covered Clearing Agencies supra note 24, 81 FR at 70816–17. 105 17 VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 where the issuing institution, a parent, or an affiliate has any equity interest in such Clearing Member’s total capital. Thus, the Commission believes that OCC’s proposed changes to letter-ofcredit concentration limits, when reviewed in combination with the proposed minimum standards for Clearing Banks and letter-of-credit issuers, would be appropriately conservative and may help eliminate wrong-way risk found in some Clearing Members’ relationships with such issuers.107 Finally, the Commission believes that reviews at regular intervals of collateral haircuts and concentration limits proposed in the CRM Policy and Rules would be consistent with the requirement for, at a minimum, an annual review. Accordingly, the Commission finds that the proposed changes are consistent with Rule 17Ad–22(e)(5) 108 under the Exchange Act. D. Consistency With Rule 17Ad–22(e)(9) Under the Exchange Act Rule 17Ad–22(e)(9) 109 under the Exchange Act requires each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures reasonably designed to, among other things, minimize and manage credit and liquidity risk arising from conducting its money settlements in commercial bank money if central bank money is not used by the covered clearing agency. The Commission believes that including OCC’s minimum standards for Clearing Banks in its rules would support OCC’s ability to monitor its relationships with Clearing Banks and manage the financial and operational risks inherent in such relationships. The Commission also believes that the requirements for Clearing Banks, taken as a whole, as well as the mandatory approval of any new Clearing Bank by the Risk Committee prior to onboarding, would help reduce credit and liquidity risk arising from conducting its money settlements in commercial bank money. Accordingly, the Commission finds that the proposed changes are consistent 107 Wrong-way risk can be either general or specific. General wrong-way risk arises at a central counterparty (‘‘CCP’’) when the potential losses of either a participant’s portfolio or a participant’s collateral is correlated with the default probability of that participant. Specific wrong-way risk arises at a CCP when an exposure to a participant is highly likely to increase when the creditworthiness of that participant is deteriorating. See Standards for Covered Clearing Agencies supra note 24, 81 FR at 70816, n.317. 108 17 CFR 240.17Ad–22(e)(5). 109 17 CFR 240.17Ad–22(e)(9). PO 00000 Frm 00124 Fmt 4703 Sfmt 4703 with Rule 17Ad–22(e)(9) 110 under the Exchange Act. E. Consistency With Rule 17Ad– 22(e)(22) Under the Exchange Act Rule 17Ad–22(e)(22) 111 under the Exchange Act requires each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures reasonably designed to use, or at a minimum accommodate, relevant internationally accepted communication procedures and standards in order to facilitate efficient payment, clearing, and settlement. As described above, OCC proposed codifying its requirement that its Clearing Banks maintain the ability to utilize SWIFT, whenever possible. The proposed change would codify the process that OCC proposed in 2017.112 Previously, the Commission did not to object to the process, in part, based on the belief that the proposal to expand the usage of SWIFT as a standard for OCC’s Clearing Banks is consistent with Rule 17Ad–22(e)(22).113 The Commission believes that codifying the requirement would further support OCC’s existing process and use of SWIFT to facilitate efficient payment, clearing, and settlement. Accordingly, the Commission finds that the proposed changes are consistent with Rule 17Ad– 22(e)(22) 114 under the Exchange Act. F. Consistency With Rule 17Ad– 22(e)(23) Under the Exchange Act Rule 17Ad–22(e)(23)(i) and (ii) 115 under the Exchange Act requires each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures reasonably designed to, among other things, publicly disclose all relevant rules and material procedures; and provide sufficient information to enable participants to identify and evaluate the risks, fees, and other material costs they incur by participating in the covered clearing agency. Based on its review of the record, and for the reasons described below, the Commission finds that the proposed changes, taken together, are consistent with the requirements of Rule 17Ad–22(e)(23)(i) and (ii).116 By adopting rules that require OCC to provide prior notice through public 110 Id. 111 17 CFR 240.17Ad–22(e)(22). Securities Exchange Act Release No. 82055 (Nov. 13, 2017), 82 FR 54448 (Nov. 17, 2017) (File No. SR–OCC–2017–805). 113 See Securities Exchange Act Release No. 82221 (Dec. 5, 2017), 82 FR 58230, 58232 (Dec. 11, 2017) (File No. SR–OCC–2017–805). 114 17 CFR 240.17Ad–22(e)(22). 115 17 CFR 240.17Ad–22(e)(23)(i) and (ii). 116 Id. 112 See E:\FR\FM\16AUN1.SGM 16AUN1 Federal Register / Vol. 88, No. 157 / Wednesday, August 16, 2023 / Notices disclosures on its website relating to information on collateral haircuts for Government securities and GSE debt securities, and concentration limits for letters of credit, the Commission believes that OCC’s rules would support the communication of information that Clearing Members may use to identify and evaluate the haircuts and concentration limits resulting from OCC’s valuation processes. Additionally, the Commission believes that codifying minimum standards for Clearing Banks and letter-of-credit issuers in OCC’s public rules would provide increased clarity and transparency to Clearing Members and market participants, while preserving OCC’s flexibility and authority in disapproving specific relationships based on individual facts and circumstances. As such, the Commission believes that the proposed rule and policy revisions are consistent with publicly disclosing all relevant rules and material procedures; and providing sufficient information to enable participants to identify and evaluate the risks, fees, and other material costs incurred with participation in the covered clearing agency. The Commission finds, therefore, that OCC’s proposals, described above, are consistent with the requirements of Rule 17Ad–22(e)(23)(i) and (ii) under the Exchange Act.117 IV. 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 118 and the rules and regulations thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act,119 that the Proposed Rule Change (SR– OCC–2022–012), be, and hereby is, approved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.120 Sherry R. Haywood, Assistant Secretary. [FR Doc. 2023–17529 Filed 8–15–23; 8:45 am] lotter on DSK11XQN23PROD with NOTICES1 BILLING CODE 8011–01–P 117 Id. 118 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). 119 15 U.S.C. 78s(b)(2). 120 17 CFR 200.30–3(a)(12). VerDate Sep<11>2014 19:39 Aug 15, 2023 Jkt 259001 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–98115; File No. SR– NYSEARCA–2023–50] Self-Regulatory Organizations; NYSE Arca, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Amend the NYSE Arca Equities Fees and Charges To Adopt a Fee for Directed Orders Routed Directly by the Exchange to an Alternative Trading System August 11, 2023. Pursuant to section 19(b)(1) 1 of the Securities Exchange Act of 1934 (‘‘Act’’),2 and Rule 19b–4 thereunder,3 notice is hereby given that, on July 31, 2023, NYSE Arca, Inc. (‘‘NYSE Arca’’ or the ‘‘Exchange’’) filed with the Securities and Exchange Commission (the ‘‘Commission’’) the proposed rule change as described in Items I, II, and III 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 to amend the NYSE Arca Equities Fees and Charges (‘‘Fee Schedule’’) to adopt a fee for Directed Orders routed by the Exchange to an alternative trading system (‘‘ATS’’). 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. 1 15 U.S.C. 78s(b)(1). U.S.C. 78a. 3 17 CFR 240.19b–4. 2 15 PO 00000 Frm 00125 Fmt 4703 Sfmt 4703 55785 A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to amend the Fee Schedule to adopt a fee for Directed Orders routed by the Exchange to an ATS. The Exchange proposes to implement the fee change effective August 1, 2023. Background The Exchange operates in a highly competitive market. The Securities and Exchange Commission (‘‘Commission’’) has repeatedly expressed its preference for competition over regulatory intervention in determining prices, products, and services in the securities markets. In Regulation NMS, the Commission highlighted the importance of market forces in determining prices and SRO revenues and, also, recognized that current regulation of the market system ‘‘has been remarkably successful in promoting market competition in its broader forms that are most important to investors and listed companies.’’ 4 While Regulation NMS has enhanced competition, it has also fostered a ‘‘fragmented’’ market structure where trading in a single stock can occur across multiple trading centers. When multiple trading centers compete for order flow in the same stock, the Commission has recognized that ‘‘such competition can lead to the fragmentation of order flow in that stock.’’ 5 Indeed, equity trading is currently dispersed across 16 exchanges,6 numerous alternative trading systems,7 and broker-dealer internalizers and wholesalers, all competing for order flow. Based on publicly available information, no single exchange currently has more than 17% market share.8 Therefore, no exchange possesses significant pricing power in the execution of equity order flow. More 4 See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37499 (June 29, 2005) (File No. S7–10–04) (Final Rule) (‘‘Regulation NMS’’). 5 See Securities Exchange Act Release No. 61358, 75 FR 3594, 3597 (January 21, 2010) (File No. S7– 02–10) (Concept Release on Equity Market Structure). 6 See Cboe U.S Equities Market Volume Summary, available at https://markets.cboe.com/us/ equities/market_share. See generally https:// www.sec.gov/fast-answers/divisionsmarket regmrexchangesshtml.html. 7 See FINRA ATS Transparency Data, available at https://otctransparency.finra.org/otctransparency/ AtsIssueData. A list of alternative trading systems registered with the Commission is available at https://www.sec.gov/foia/docs/atslist.htm. 8 See Cboe Global Markets U.S. Equities Market Volume Summary, available at https:// markets.cboe.com/us/equities/market_share/. E:\FR\FM\16AUN1.SGM 16AUN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 88, Number 157 (Wednesday, August 16, 2023)]
[Notices]
[Pages 55775-55785]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-17529]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98101; File No. SR-OCC-2022-012]

Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving Proposed Rule Change Concerning Collateral Haircuts and
Standards for Clearing Banks and Letters of Credit

August 10, 2023.

I. Introduction

On December 19, 2022, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') the
Proposed Rule Change SR-OCC-2022-012 (``Proposed Rule Change'')
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to amend OCC's
rules, policies, and procedures regarding (i) the valuation of
Government securities and government-sponsored enterprise (``GSE'')
debt securities deposited as margin or Clearing Fund collateral; (ii)
minimum standards for OCC's Clearing Bank relationships; and (iii)
letters of credit as margin collateral.\3\ The Proposed Rule Change was
published for public comment in the Federal Register on December 23,
2022.\4\ The Commission received comments regarding the Proposed Rule
Change.\5\ The

[[Page 55776]]

Commission designated a longer period within which to take action on
the Proposed Rule Change on February 3, 2023, extending the period to
March 23, 2023.\6\ The Commission instituted proceedings to determine
whether to approve or disapprove the Proposed Rule Change on March 21,
2023.\7\ The Commission designated a longer period for Commission
action on the proceedings to determine whether to approve or disapprove
the Proposed Rule Change on June 20, 2023.\8\ For the reasons discussed
below, the Commission is approving 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, 87 FR at 79015.
\4\ Securities Exchange Act Release No. 96533 (Dec. 19, 2022),
87 FR 79015 (Dec. 23, 2022) (File No. SR-OCC-2022-012) (``Notice of
Filing'').
\5\ Comments on the proposed rule change are available at
https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm.
\6\ Securities Exchange Act Release No. 96797 (Feb. 3, 2023), 88
FR 8505 (Feb. 9, 2023) (File No. SR-OCC-2022-012) (``Extension'').
\7\ Securities Exchange Act Release No. 97178 (Mar. 21, 2023),
88 FR 18205 (Mar. 27, 2023) (File No. SR-OCC-2022-012).
\8\ Securities Exchange Act Release No. 97765 (June 20, 2023),
88 FR 41441 (June 26, 2023) (File No. SR-OCC-2022-012).
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II. Background ⁹
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\9\ Capitalized terms used but not defined herein have the
meanings specified in OCC's Rules and By-Laws, available at https://www.theocc.com/about/publications/bylaws.jsp.
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OCC is a central counterparty (``CCP''), which means it interposes
itself as the buyer to every seller and seller to every buyer for
financial transactions. As the CCP for the listed options markets in
the U.S.,\10\ as well as for certain futures, OCC is exposed to certain
risks arising from its relationships with its members as well as the
banks that support OCC's clearance and settlement services. Such risks
include credit risk because OCC is obligated to perform on the
contracts it clears even where one of its members defaults. OCC manages
credit risk by collecting collateral from members (i.e., margin and
Clearing Fund resources) sufficient to cover OCC's credit exposure to
Clearing Members under a wide range of stress scenarios. In doing so,
OCC requires its Clearing Members to deposit collateral as margin to
support obligations on short options, futures contracts, and other
obligations arising within the members' accounts at OCC. OCC also
requires its members to deposit collateral serving as Clearing Fund
assets to protect OCC, should the margin of a defaulting member be
insufficient to address the potential losses from the defaulting
member's positions. OCC imposes a haircut to collateral to address the
risk that such collateral may be worth less in the future than at the
time it was pledged to OCC. With regard to risks posed by the banks
that support OCC's clearance and settlement services, OCC maintains
standards for third-party relationships, such as those with banks
through which OCC conducts settlement (``Clearing Banks''), and banks
that issue letters of credit that Clearing Members may deposit as
margin collateral.
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\10\ OCC describes itself as ``the sole clearing agency for
standardized equity options listed on a national securities exchange
registered with the Commission (`listed options').'' See Notice of
Filing supra note 4, 87 FR at 79015.
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As described in more detail below, OCC proposed to revise its
rules, including certain policies,\11\ to make the following three
changes related to the management of collateral haircuts and banking
relationships:
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\11\ These policies include the Collateral Risk Management
Policy (``CRM Policy''), Margin Policy, and System for Theoretical
Analysis and Numerical Simulation (``STANS'') Methodology
Description. Id.
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(1) Replace the current processes for applying haircuts to
Government and GSE debt securities provided as collateral \12\ with a
new process for applying fixed collateral haircuts that it would set
and adjust from time to time, based on a process defined in OCC's CRM
Policy;
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\12\ Generally, OCC defines, by rule, specific haircuts for
Government and GSE debt securities. For margin collateral
specifically, OCC currently also has authority to value such
securities using Monte Carlo simulations as part of its STANS margin
methodology (known as ``Collateral in Margin'' or ``CiM'').
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(2) Codify internal standards for Clearing Banks and letter-of-
credit issuers in OCC's Rules to provide transparency on minimum
standards for banking relationships that are critical to OCC's
clearance and settlement services; and
(3) Authorize OCC to set more restrictive concentration limits for
letters of credit than those limits currently codified in its Rules.
Based on its impact analysis, OCC does not expect changes in
collateral haircut valuation processes to have a significant impact on
Clearing Members.\13\ OCC stated that the fixed haircut schedule under
the proposed procedures-based approach initially would be the same as
currently codified in the Rules.\14\ Regarding the additional minimum
standards for Clearing Banks and letter-of-credit issuers, OCC
indicated that the institutions currently approved as such already meet
these proposed standards.\15\
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\13\ See Notice of Filing supra note 4, 87 FR at 79015. OCC
provided its analysis in a confidential Exhibit 3 to File No. SR-
OCC-2022-012.
\14\ See Notice of Filing supra note 4, 87 FR at 79015.
\15\ Id.
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A. Collateral Haircuts for Government Securities and GSE Debt
Securities

OCC proposed to eliminate the CiM treatment of Government
securities and GSE debt securities, as well as to remove the fixed
collateral haircuts schedule from its rules in favor of adopting rules
that describe OCC's process for setting and adjusting fixed haircuts
from time to time. OCC asserted that such a ``procedure-based
approach'' would allow for more frequent valuation, thus reflecting
current market conditions, including periods of stress.\16\ Under the
current structure, OCC accepts Government securities from Clearing
Members as contributions to the Clearing Fund.\17\ Additionally, OCC
accepts both Government securities and GSE debt securities as margin
collateral.\18\ Rule 604(b) specifies haircuts for Government
securities \19\ and GSE debt securities \20\ that are contributed as
margin collateral, while Rule 1002(a)(ii) \21\ specifies haircuts for
Government securities that are contributed to the Clearing Fund.
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\16\ See Notice of Filing supra note 4, 87 FR at 79016-18.
\17\ See OCC Rule 1002(a).
\18\ See OCC Rule 604(b)(1), (2).
\19\ ``Government securities shall be valued for margin purposes
at 99.5% of the current market value for maturities of up to one
year; 98% of the current market value for maturities in excess of
one year through five years; 96.5% of the current market value for
maturities in excess of five years through ten years; and 95% of the
current market value for maturities in excess of ten years.'' See
OCC Rule 604(b)(1).
\20\ ``GSE debt securities shall be valued for margin purposes
at (1) 99% of the current market value for maturities of up to one
year; (2) 97% of the current market value for maturities in excess
of one year through five years; (3) 95% of the current market value
for maturities in excess of five years through ten years; and (4)
93% of the current market value for maturities in excess of ten
years.'' See OCC Rule 604(b)(2).
\21\ ``For purposes of valuing Government securities for
calculating contributions to the Clearing Fund, Government
securities shall be valued at (1) 99.5% of the current market value
for maturities less than one year; (2) 98% of the current market
value for maturities between one and five years; (3) 96.5% of the
current market value for maturities between five and ten years; and
(4) 95% of the current market value for maturities in excess of ten
years.'' See OCC Rule 1002(a)(ii).
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(i) Removal of CiM Treatment
OCC proposed to remove its authority to value Government securities
and GSE debt securities using the STANS margin methodology, which
currently is used to calculate haircuts applicable to margin
collateral.\22\ As currently written, Interpretation and Policy
(``I&P'') .06 to Rule 601 and Rule 604(f) grant OCC the authority to
determine the collateral value of any Government securities or GSE debt
securities pledged by Clearing Members as margin collateral either by:
(1) the CiM method of including them in Monte Carlo simulations as part
of OCC's STANS margin methodology; or

[[Page 55777]]

(2) applying the fixed haircuts that are specified in OCC Rule 604(b).
OCC stated, however, that regulatory examination findings and OCC's
model validation analyses have identified certain weaknesses, including
that OCC may not adequately consider relevant stressed market
conditions for Government securities and GSE debt securities deposited
as margin and Clearing Fund collateral.\23\ OCC proposed to resolve
such shortcomings by deleting I&P .06 to Rule 601 and Rule 604(f), and
instead subjecting all Government securities and GSE debt securities
pledged as margin collateral to a fixed haircut schedule set in
accordance with a revised CRM Policy, discussed in more detail below.
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\22\ See Notice of Filing supra note 4, 87 FR at 79016.
\23\ Id.
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OCC asserted that the resulting approach would be less
procyclical.\24\ Under the proposed change, OCC would value all such
deposits using a fixed haircut schedule.\25\ OCC stated that this
change would prevent spikes in margin requirements during periods of
heightened volatility that can occur under the current CiM
approach.\26\ As stated in the Notice of Filing, while the proposed
fixed haircut approach may be more conservative in periods of low
market volatility, it would prevent spikes in margin requirements
during periods of heightened volatility that may take place under the
existing CiM approach.\27\ The proposed changes would result in an
average impact of less than one percent of the value of Government
securities and GSE debt securities.\28\ OCC stated that it intends to
provide parallel reporting to its Clearing Members for a period of at
least four consecutive weeks prior to implementing the change.\29\
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\24\ Id. The Commission has stated that procyclicality typically
refers to changes in risk-management practices that are positively
correlated with market, business, or credit cycle fluctuations that
may cause or exacerbate financial stability. Standards for Covered
Clearing Agencies, Securities Exchange Act Release No. 78961 (Sept.
28, 2016), 81 FR 70786, 70816 n. 318 (Oct. 13, 2016). The Commission
stated further that, while changes in collateral values tend to be
procyclical, collateral arrangements can increase procyclicality if
haircut levels fall during periods of low market stress and increase
during periods of high market stress. Id.
\25\ Additionally, OCC would shift its categorization of
Government security and GSE debt security deposits currently valued
using STANS from margin balances to collateral balances to align its
reporting with the proposed haircut methodology. Specifically, the
value of CiM-eligible Government securities and GSE debt securities
would no longer be included in margin calculations, and thus would
no longer be included on OCC's margin reports. Following
implementation of the proposed changes, the value of the previously
CiM-eligible Government securities and GSE debt securities would be
found in OCC's collateral reports. See Notice of Filing supra note
4, 87 FR at 79016 n.10.
\26\ See Notice of Filing supra note 4, 87 FR at 79016.
\27\ Id.
\28\ Id. As noted below, OCC is proposing to replace the fixed
haircut schedule in its rules that applies to Government securities
deposited in the Clearing Fund. The change would result in a
negligible impact to Clearing Fund collateral haircuts. Id. OCC
provided supporting data as a confidential Exhibit 3 to File No. SR-
OCC-2022-012.
\29\ See Notice of Filing supra note 4, 87 FR at 79016. See note
25 supra regarding reporting changes that would be implemented in
connection with the proposed change. Further, OCC's rules require it
to provide reporting related to margin and Clearing Fund collateral
each day. See OCC Rule 605 and OCC Rule 1007.
---------------------------------------------------------------------------

(ii) Removal of the Fixed Haircut Schedule From OCC's Rules
OCC proposed to eliminate the fixed haircut schedules in its rules
for Government securities and GSE debt securities used as margin
collateral and Government securities deposited in the Clearing Fund,
and instead to adopt new subsections that would grant OCC the authority
to specify a schedule of haircuts from time to time based on changing
market conditions. Specifically, OCC's proposal would delete the fixed
collateral haircut schedule stated in Rule 604(b)(1)-(2) for Government
securities and GSE debt securities used as margin collateral, and in
Rule 1002(a)(ii) for Government securities deposited in the Clearing
Fund.\30\ OCC proposed to adopt a new section (e) under Rule 604 and
amend language in Rule 1002(a)(ii), to authorize OCC to determine the
current value of these types of securities, and generally apply a
schedule of haircuts that is specified from time to time upon prior
notice to Clearing Members. OCC proposed to describe the new process
for valuing such securities in its CRM Policy, as described in greater
detail in Section II.A.iii. below. Additionally, the proposed changes
to the CRM Policy would require OCC to communicate changes in haircut
rates to Clearing Members at least one full day in advance, and to
maintain the haircut schedule on OCC's public website.
---------------------------------------------------------------------------

\30\ OCC does not accept GSE debt securities as Clearing Fund
collateral.
---------------------------------------------------------------------------

As noted above, OCC would publish a haircut schedule from time to
time on its website, and such schedule would be determined based on the
proposed methodology in the CRM Policy. The proposed changes to Rule
604 would also authorize OCC to apply haircuts to Government securities
and GSE debt securities that are more conservative than those defined
in such haircut schedule, or, in unusual or unforeseen circumstances,
to assign partial or no value to such securities. The proposed change
would authorize OCC to take such action for its protection or the
protection of Clearing Members or the general public with prior notice
to Clearing Members.
OCC also proposed changes to the CRM Policy that would provide
additional detail regarding the authority to apply more conservative
haircuts or reduce the value attributed to Government securities and
GSE debt securities.\31\ Consistent with the proposed addition to Rule
604, the CRM Policy would require OCC to communicate such actions to
Clearing Members prior to implementation. Additionally, OCC proposed to
add language to the CRM Policy to enumerate the factors that OCC would
consider when determining if such action would be appropriate for its
protection or the protection of Clearing Members or the general public,
including (i) volatility and liquidity, (ii) elevated sovereign credit
risk,\32\ and (iii) any other factors OCC determines are relevant.\33\
---------------------------------------------------------------------------

\31\ The CRM Policy currently authorizes OCC to take additional
mitigating actions in the form of reducing the value of such
securities and review and approval of such actions by OCC's
Management Committee and/or its delegates.
\32\ OCC explained that while it already has authority under I&P
.15 to Rule 604 to make disapprovals of collateral based on similar
factors, the proposal is intended to enumerate sovereign credit risk
as a factor in the CRM Policy for haircuts on Government securities.
See Notice of Filing supra note 4, 87 FR at 79017, n.16.
\33\ OCC also proposed to include ``any other factors the
Corporation determines are relevant'' for consistency with I&P .15
to OCC Rule 604 and because such a catch-all is designed to capture
unforeseen circumstances that might not previously have been
considered possible. Id.
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(iii) A Procedures-Based Approach To Setting Collateral Haircuts
As described above, OCC proposed to establish a new process for
applying fixed collateral haircuts for Government securities and GSE
debt securities that OCC would set and adjust from time to time. OCC
proposed to define its new process, which it refers to as a
``procedures-based approach,'' in the CRM Policy. The proposed
procedures-based approach would replace the processes that OCC proposed
removing from its rules (i.e., dynamic haircuts calculated by OCC's
margin methodology and fixed haircuts defined by rule).
The proposed procedures-based approach would rely on a financial
model to set and assess the adequacy of collateral haircuts. In
particular, the proposed amendments to the CRM Policy would provide
that OCC's Pricing and Margins team within its Financial Risk
Management (``FRM'') department

[[Page 55778]]

would monitor the adequacy of the haircuts using a Historical Value-at-
Risk approach (``H-VaR'') with multiple look-back periods (e.g., 2-
year, 5-year, and 10-year), updated at least monthly.\34\ Each look-
back period would comprise a synthetic time series of the greatest
daily negative return observed for each combination of security type
and maturity bucket (e.g., Government securities maturing in more than
10 years). The longest look-back period under the proposed H-VaR
approach would include defined periods of market stress.\35\ The CRM
Policy would further require OCC to maintain haircuts at a level at
least equal to a 99 percent confidence interval of the look-back period
that provides for the most conservative haircuts. Changes to the
haircut rate would be communicated to Clearing Members at least one
full day in advance and the schedule would be maintained on OCC's
public website.
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\34\ Upon implementation of the proposed changes, OCC
anticipates that the collateral haircuts initially would be
identical to those outlined in Rules 604(b) and 1002(a). See Notice
of Filing supra note 4, 87 FR at 79017.
\35\ The delineation of look-back periods, periods of stressed
market volatility included in the longest-term look-back period, and
the type and maturity buckets would be defined in procedures
maintained by OCC's Pricing and Margins business unit.
---------------------------------------------------------------------------

(iv) Increased Frequency of Valuations
OCC's proposed addition of Rule 604(e) and amendments to Rule
1002(a)(ii) would resolve an inconsistency between its Rules, which
require monthly reviews of collateral haircuts in relation to the
Clearing Fund, and its CRM Policy, which requires daily review of all
collateral haircuts, including both margin and Clearing Fund
collateral. Specifically, under the proposal, OCC would determine the
current market value for Government securities and GSE debt securities
at such intervals as it may from time to time prescribe, at least
daily, based on the quoted bid price supplied by a price source
designated by OCC.\36\ The proposed change also would explicitly remove
from the Rules the Risk Committee's authority for prescribing the
interval at which haircuts are set. Rather, the Pricing and Margins
business unit would continue to hold this authority, consistent with
the current CRM Policy.
---------------------------------------------------------------------------

\36\ Additionally, both the current and proposed language in the
CRM Policy provide leeway for more frequent valuation, when
warranted, and help to ensure that the designation of minimum
valuation intervals would not be a limiting factor. See Notice of
Filing supra note 4, 87 FR at 79017.
---------------------------------------------------------------------------

Under the current CRM Policy, the Pricing and Margins business unit
monitors haircuts daily for ``breaches'' (i.e., an erosion in value
exceeding the relevant haircut) and adequacy, with any issues being
promptly reported to appropriate decision-makers at OCC.\37\ Changes to
OCC's Rules and the CRM Policy, including the minimum valuation
interval, would remain subject to Risk Committee approval and the Risk
Committee would retain oversight over OCC's risk management
determinations.
---------------------------------------------------------------------------

\37\ OCC believed that Pricing and Margins, as the business unit
responsible for such monitoring, is well positioned to make the
determination about more frequent valuation intervals consistent
with the directive of the CRM Policy approved by the Risk Committee.
See Notice of Filing supra note 4, 87 FR at 79018.
---------------------------------------------------------------------------

(v) Conforming Changes to OCC's Policies
Based on the proposed changes to its Rules and policies, OCC also
proposed conforming changes to its CRM Policy, Margin Policy, and STANS
Methodology Description by:
Establishing the CRM Policy as the relevant OCC policy
governing OCC's process for valuing Government securities and GSE debt
securities;
Deleting descriptions that indicate that Government
securities and GSE debt securities pledged as margin collateral may be
valued using Monte Carlo simulations as part of OCC's STANS margin
methodology; \38\
---------------------------------------------------------------------------

\38\ The Margin Policy currently states that Government
securities may be valued using the CiM approach. OCC did not propose
to change the description of CiM generally, but rather would
maintain it other than the removal of references suggesting that it
applies to Government securities and GSE debt securities pledged as
margin. See Notice of Filing supra note 4, 87 FR at 79018.
---------------------------------------------------------------------------

Conforming capitalization of terms in the CRM Policy with
OCC's By-Laws;
Deleting certain portions of the STANS Methodology
Description that exist to support the valuation of Government
securities and GSE debt securities using Monte Carlo simulations;
Removing Treasuries (i.e., Government securities) from
OCC's model for generating yield curve distributions to form
theoretical price distributions for U.S. Government securities and for
modeling Treasury rates within STANS joint distribution of risk
factors; \39\
---------------------------------------------------------------------------

\39\ As described above, OCC would value such securities as
described in the CRM Policy rather than pursuant to STANS.
---------------------------------------------------------------------------

Revising the STANS Methodology Description to reflect the
fact that the Liquidation Cost Add-on charge would no longer be
assessed to Government security collateral deposits,\40\ while
incorporating stressed market periods in the H-VaR approach for setting
and adjusting the haircuts for collateral in the form of Government
securities and GSE debt securities used in margin accounts and
Government securities in the Clearing Fund, which is comparable to the
approach for incorporating stressed markets into the Liquidation Cost
Add-on.
---------------------------------------------------------------------------

\40\ The Liquidation Cost charge is a margin add-on charge that
is designed to estimate the cost to liquidate a portfolio based on
the mid-points of the bid-ask spreads for the financial instruments
within the portfolio, and would scale up such liquidation costs for
large or concentrated positions that would likely be more expensive
to close out. See Securities Exchange Act Release No. 86119 (June
17, 2019), 84 FR 29267, 29268 (June 21, 2019) (File No. SR-OCC-2019-
004). The Liquidation Cost charge considers the cost of liquidating
an underlying security, such as a Government security, during a
period of market stress. Id. As described above, OCC now proposes to
include defined periods of market stress in its collateral haircuts
methodology under the CRM Policy. OCC indicated that the Liquidation
Cost charge for such collateral is currently, and is expected to
remain, immaterial, based on its analysis of the average daily
Liquidation Cost charge across all accounts. See Notice of Filing
supra note 4, 87 FR at 79018.
---------------------------------------------------------------------------

B. Minimum Standards for Clearing Banks and Letter-of-Credit Issuers

OCC's proposal would update and codify existing internal minimum
standards that OCC uses to establish relationships with Clearing Banks
and letter-of-credit issuers. The core of these proposed minimum
standards would be the same for both Clearing Banks and letter-of-
credit issuers, including requirements for, at a minimum, $500 million
in Tier 1 Capital; \41\ maintaining certain Tier 1 Capital Ratios; and
providing that non-U.S. entities must be domiciled in a country that
has a sovereign rating considered to be ``low credit risk.'' OCC would
reserve the right to set other such standards from time to time. OCC
stated that these proposed changes would provide transparency on
minimum standards for banking relationships that are critical to its
clearance and settlement services. Details of proposed amendments to
Rule 203 for Clearing Banks and the Interpretations and Policies for
Rule 604 relating to letter-of-credit issuers are described below.
---------------------------------------------------------------------------

\41\ Tier 1 Capital is the required regulatory capital that is
permanently held by banks to absorb unexpected losses. See
generally, Bank for International Settlements, Financial Stability
Institute, ``Definition of capital in Basel III--Executive Summary''
(June 27, 2019), available at https://www.bis.org/fsi/fsisummaries/
defcap_b3.htm#:~:text=Regulatory%20capital%20under%20Basel%20III,the%
20components%20of%20regulatory%20capital; and The Federal Deposit
Insurance Corporation (FDIC), ``Risk Management Manual of
Examination Policies,'' Section 2.1 (Capital), available at https://www.fdic.gov/regulations/safety/manual/section2-1.pdf. Tier 1
Capital includes common equity Tier 1 Capital, such as certain bank-
issued common stock instruments, and additional Tier 1 Capital. See
12 CFR 217.20.

---------------------------------------------------------------------------

[[Page 55779]]

(i) Clearing Banks
OCC indicated that Clearing Banks play a critical role in its
clearance and settlement of options.\42\ As currently written, Rule 203
requires that every Clearing Member establish and maintain a bank
account at a Clearing Bank for each account maintained by it with OCC.
However, the sole eligibility requirement for a Clearing Bank expressly
delineated in current Rules is that the Clearing Bank be a bank or
trust company that has entered into an agreement with OCC in respect of
settlement of confirmed trades on behalf of Clearing Members.\43\ OCC's
By-Laws and Rules are silent on the internal governance process for
approving Clearing Bank relationships. Rather, the details as to the
financial and operational capability requirements and the governance
process for approving Clearing Banks are housed in OCC's internal
procedures, which are not publicly available.\44\ OCC proposed to amend
Rules 101 and 203 to clarify the term ``Clearing Bank'' and codify
minimum capital and operational requirements and the governance process
for approving its Clearing Banks.\45\ OCC believed that expressly
listing these requirements in its By-Laws and Rules will provide
Clearing Members and other market participants greater clarity and
transparency concerning OCC's Clearing Bank relationships.\46\
Specifically, Rule 101 would amend the definition of ``Clearing Bank''
to reflect that such Clearing Bank relationships are approved by the
Risk Committee, while leaving the rest of the definition intact. The
proposed changes to Rule 203 would codify the following practices for
Clearing Banks:
---------------------------------------------------------------------------

\42\ See Notice of Filing supra note 4, 87 FR at 79018.
\43\ See OCC Rule 101.C(1).
\44\ These internal procedures include, for example, a Tier 1
Capital requirement of $100 million for U.S. banks and $200 million
for non-U.S. banks, and in effect align with standards for Clearing
Banks codified in I&P .01 to OCC Rule 604 with respect to banks or
trust companies that OCC may approve to issue letters of credit as
margin collateral.
\45\ See Notice of Filing supra note 4, 87 FR at 79018.
\46\ Id.
---------------------------------------------------------------------------

Provide in Rule 203(b) that the Risk Committee may approve
a bank or trust company as a Clearing Bank if it meets the minimum
requirements;
Require under Rule 203(b)(1) that any Clearing Bank,
whether domiciled in the U.S. or outside the U.S., maintain at least
$500 million (U.S.) in Tier 1 Capital, rather than the existing $100
million Tier 1 Capital requirement for letter-of-credit issuers
currently required under I&P .01 to OCC Rule 604;
Require under Rules 203(b)(2) and (4) that Clearing Banks
maintain (i) common equity Tier 1 Capital (CET1) \47\ of 4.5%, (ii)
minimum Tier 1 Capital of 6%, (iii) total risk-based capital of 8%, and
(iv) a Liquidity Coverage Ratio of at least 100%, unless the Clearing
Bank is not required to compute the Liquidity Coverage Ratio;
---------------------------------------------------------------------------

\47\ See Rule 203(c). ``For purposes of this Rule, `Tier 1
Capital,' `Common Equity Tier 1 Capital (CET1),' `total risk-based
capital,' and `Liquidity Coverage Ratio' will mean those amounts or
ratios reported by a bank or trust company to its regulatory
authority.''
---------------------------------------------------------------------------

Provide under Rule 203(b)(3) that non-U.S. Clearing Banks
must be domiciled in a country that has a sovereign rating considered
to be ``low credit risk'' (i.e., A- by Standard & Poor's, A3 by
Moody's, A- by Fitch, or equivalent);
Require under Rule 203(b)(5) that a Clearing Bank must
execute an agreement with OCC, including that the Clearing Bank: (A)
maintain the ability to utilize the Society for Worldwide Interbank
Financial Telecommunication (``SWIFT''), (B) maintain access to the
Federal Reserve Bank's Fedwire Funds Service, and (C) provide its
quarterly and annual financial statements to OCC and promptly notify
OCC of material changes to its operations, financial condition, and
ownership;
Allow under Rule 203(b)(5)(A) the use of such other
messaging protocol, apart from SWIFT, as approved by the Risk
Committee; \48\ and
---------------------------------------------------------------------------

\48\ OCC stated that the Risk Committee may elect to temporarily
accommodate a Clearing Bank that does not meet these requirements if
it is actively implementing such capabilities. See Notice of Filing
supra note 4, 87 FR at 79019.
---------------------------------------------------------------------------

Add catchall language in Rule 203(b)(6) to provide that an
institution must meet such other standards as OCC may determine from
time to time.
Language that forms the basis of Rule 203(b)(1)-(3) was taken, in
part, from the previously codified standards for letter-of-credit
issuers found in I&P .01 to Rule 604. OCC proposed to delete this rule
text relating to letter-of-credit issuers and move the essential
concepts to Rule 203(b)(1)-(3) concerning Clearing Banks. In doing so,
OCC also proposed to adjust certain thresholds related to Tier 1
Capital requirements and sovereign credit ratings. Most notably, the
proposed change would increase the Tier 1 Capital minimum requirement
from $100 million for U.S. institutions and $200 million for non-U.S.
institutions to $500 million for all institutions serving as Clearing
Banks or letter-of-credit issuers. Additionally, the proposed change
would lower the sovereign credit risk threshold for institutions
domiciled outside of the U.S. from countries rated as AAA to countries
that have a rating considered to be low credit risk (A- by Standard &
Poor's, A3 by Moody's, A- by Fitch, or equivalent). OCC then proposed
to incorporate by reference minimum requirements for Clearing Banks in
I&P .01 to Rule 604, which applies to letter-of-credit issuers, thus
aligning standards for Clearing Banks and letter-of-credit issuers and
erasing some distinctions between U.S. and non-U.S. institutions.
OCC explained that the proposed changes in Rule 203(b) are meant to
serve as the articulation of minimum standards for establishing
relationships with Clearing Banks, and that OCC is not obligated to
enter into any Clearing Bank relationship merely because a bank or
trust company meets these enumerated standards.\49\ In proposing these
changes, OCC believed that the Risk Committee is the appropriate
governing body to approve such relationships because of the nature of
the risks presented by OCC's Clearing Bank relationships, including the
risk that OCC would need to borrow from or satisfy a loss using
Clearing Fund assets in order to meet its liquidity needs as a result
of the failure of a Clearing Bank to achieve daily settlement.\50\
Further, in reviewing its existing Clearing Banks, OCC found that a
$500 million (U.S.) Tier 1 Capital standard was more representative of
these institutions.\51\ In expanding the definition of ``low credit
risk'' under the proposed Rule 203(b)(3), OCC stated that these ratings
better reflect current understanding of countries considered to be
``low credit risk,'' and that, for example, it would permit OCC to
establish relationships with institutions from France with which OCC
previously had relationships before France's sovereign credit rating
fell below AAA.\52\
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\49\ See Notice of Filing supra note 4, 87 FR at 79019.
\50\ See Notice of Filing supra note 4, 87 FR at 79018.
\51\ Id.
\52\ See Notice of Filing supra note 4, 87 FR at 79018-9.
---------------------------------------------------------------------------

(ii) Letter-of-Credit Issuers
OCC proposed to revise Rule 604 regarding the acceptability of
letters of credit as margin collateral. Under the proposal, OCC would
align the minimum requirements for letter-of-credit issuers with some
of those for OCC's other banking relationships, including the above-
proposed standards

[[Page 55780]]

for Clearing Banks.\53\ I&P .01 to OCC Rule 604 currently sets forth
minimum standards for the types of U.S. and non-U.S. institutions that
OCC may approve as an issuer of letters of credit, including minimum
Tier 1 Capital requirements, and, for non-U.S. institutions, the
ultimate sovereign credit rating for the country where the principal
executive office is located, credit ratings for the institution's
commercial paper or other short-term obligations, and standards that
apply if there is no credit rating on the institution's commercial
paper or other short-term obligations. OCC proposed to amend I&P .01 to
Rule 604 in the following ways:
---------------------------------------------------------------------------

\53\ See Notice of Filing supra note 4, 87 FR at 79015.
---------------------------------------------------------------------------

Combine and restate, without substantive change, the
description of which institutions OCC may approve as letter-of-credit
issuers;
Replace specific capital and sovereign credit rating
requirements with reference to proposed Rule 203(b)(1)-(3) prescribing
minimum standards for Clearing Banks; \54\
---------------------------------------------------------------------------

\54\ OCC stated that in eliminating I&P .01(b)(3) concerning
credit ratings, OCC would remove the subjective process for
determining a ``AAA'' equivalent country based on consultation with
entities experienced in international banking and finance matters
satisfactory to the Risk Committee, in favor of the more objective
standards. See Notice of Filing supra note 4, 87 FR at 79019.
---------------------------------------------------------------------------

Remove external credit rating standards for a non-U.S.
institution's commercial paper, other short-term obligations or long-
term obligations; \55\ and
---------------------------------------------------------------------------

\55\ OCC stated that it has had to terminate several letter-of-
credit issuer relationships pursuant to these external credit rating
standards even though the institutions otherwise met OCC's
requirements and were not reporting elevated internal credit risk
metrics. By deleting I&P .01(b)(4), OCC would make its Rules
consistent with industry best practice, and instead would rely on
its Watch Level and Internal Credit Rating surveillance processes
under its Third-Party Risk Management Framework to determine
creditworthiness of institutions. Id. Proposed I&P .01(c) to OCC's
Rule 604 would provide OCC authority sufficient to determine
additional standards for issuers of letters of credit.
---------------------------------------------------------------------------

Add catchall language to provide that an institution must
meet such other standards as OCC may determine from time to time.
Additionally, OCC proposed conforming changes to better align I&P
.03 and .09 to Rule 604, requiring that all letters of credit must be
payable at an issuer's domestic branch.\56\ Currently, I&P .03 requires
any letter of credit issued by a non-U.S. institution be payable at a
Federal or State branch or agency thereof, while I&P .09 provides that
a letter of credit may be issued by a Non-U.S. branch of a U.S.
institution, as long as it otherwise conforms with Rule 604 and the
Interpretations and Policies thereunder and is payable at a U.S. office
of such institution. OCC's proposal would eliminate the text of I&P .09
in its entirety, and instead amend the text of I&P .03 to require
letters of credit used as margin collateral to be payable at an
issuer's ``domestic branch,'' \57\ or at the issuer's Federal or State
branch or agency.\58\ The amended I&P .03 would apply to U.S. and Non-
U.S. institutions alike.
---------------------------------------------------------------------------

\56\ See Notice of Filing supra note 4, 87 FR at 79020.
\57\ As that term is defined in the Federal Deposit Insurance
Act. See 12 U.S.C. 1813(o).
\58\ As those terms are defined in I&P .01 by reference to the
International Banking Act of 1978.
---------------------------------------------------------------------------

C. Letter-of-Credit Concentration Limits

Lastly, the proposal would allow OCC to set more restrictive
concentration limits for accepting letters of credit, while retaining
the currently codified concentration limits as thresholds.\59\ As
currently written, I&P .02 to Rule 604 provides that ``[n]o more than
50% of a Clearing Member's margin on deposit at any given time may
include letters of credit in the aggregate, and no more than 20% may
include letters of credit issued by any one institution.'' In addition,
I&P .04 to Rule 604 limits the total amount of letters of credit issued
for the account of any one Clearing Member by a U.S. or non-U.S.
institution to a maximum of 15% of such institution's Tier 1 Capital.
OCC proposed to retain these provisions, while simultaneously deleting
the current text of I&P .09 to Rule 604, as described above, and
replacing it with language that grants OCC the authority to specify,
from time to time, more restrictive limits for the amount of letters of
credit a Clearing Member may deposit in the aggregate or from any one
institution.\60\ Such determinations would be made based on market
conditions, the financial condition of approved issuers, and any other
factors OCC determines are relevant. Any such restrictive limit would
apply to all Clearing Members.
---------------------------------------------------------------------------

\59\ See Notice of Filing supra note 4, 87 FR at 79015.
\60\ Id. at 79020.
---------------------------------------------------------------------------

Under the proposal, the CRM Policy would explicitly state that the
responsibility of setting and adjusting more conservative concentration
limits for letters of credit would lie with the Credit and Liquidity
Risk Working Group (``CLRWG''), which is a cross-functional group that
comprises representatives from relevant OCC business units including
Pricing and Margins, Collateral Services, and Credit Risk Management.
Similar to determinations surrounding collateral haircuts, the CRM
Policy would provide that OCC will maintain the concentration limits on
its website and will provide prior notice of any changes to the limits.
OCC would retain the current requirements under the CRM Policy and the
Model Risk Management Policy regarding the CLRWG's, at a minimum,
annual review of the CRM Policy, including concentration limits, and
the requirement that any changes to the CRM Policy resulting from the
review be presented the Management Committee and, if approved, then the
Risk Committee.
OCC stated that the anticipated impact of more restrictive
concentration limits is low, considering that the use of letters of
credit as margin collateral is currently low.\61\ OCC explained that
while utilization of letters of credit is low, it plans to continue to
support letters of credit based on their acceptability as collateral
under Commodity Futures Trading Commission regulations.\62\
---------------------------------------------------------------------------

\61\ Id.
\62\ Id.
---------------------------------------------------------------------------

The final proposed change would amend I&P .08 to Rule 604, which
currently provides that OCC will not accept a letter of credit issued
pursuant to Rule 604(c) for the account of a Clearing Member in which
the issuing institution, a parent, or an affiliate has an equity
interest in the amount of 20 percent or more of such Clearing Member's
total capital. The Proposed Rule Change would eliminate the reference
to 20 percent, thus resulting in a total prohibition on accepting
letters of credit for the account of a Clearing Member in which the
issuing institution, a parent, or an affiliate has any equity interest
in such Clearing Member's total capital.

III. Discussion and Commission Findings

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.\63\ After carefully
considering the Proposed Rule Change and the comment letters received,
the Commission finds that the proposal is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to OCC. More specifically, the Commission

[[Page 55781]]

finds that the proposal is consistent with Section 17A(b)(3)(F) and (I)
of the Exchange Act,\64\ and Rule 17Ad-22(e)(5),\65\ Rule 17Ad-
22(e)(9),\66\ Rule 17Ad-22(e)(22),\67\ and Rule 17Ad-22(e)(23) \68\
thereunder, as described in detail below.
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\63\ 15 U.S.C. 78s(b)(2)(C).
\64\ 15 U.S.C. 78q-1(b)(3)(F) and 15 U.S.C. 78q-1(b)(3)(I).
\65\ 17 CFR 240.17Ad-22(e)(5).
\66\ 17 CFR 240.17Ad-22(e)(9).
\67\ 17 CFR 240.17Ad-22(e)(22).
\68\ 17 CFR 240.17Ad-22(e)(23).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act

Section 17A(b)(3)(F) \69\ of the Exchange Act requires, among other
things, that the rules of a clearing agency be designed to promote the
prompt and accurate clearance and settlement of securities transactions
and derivative agreements, contracts, and transactions; and to assure
the safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible.
---------------------------------------------------------------------------

\69\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

Based on its review of the record, and for the reasons described
below, the Commission believes that the proposed changes to OCC's rules
and procedures regarding collateral haircuts and concentration limits
for letters of credit are consistent with promoting the prompt and
accurate clearance and settlement of securities and derivatives
transactions. As stated above, OCC is exposed to credit risk stemming
from its relationships with Clearing Members during the course of
fulfilling its core clearing services. One of the ways OCC manages this
credit risk is by collecting high-quality collateral for margin
accounts and the Clearing Fund, while recognizing that this collateral
may decrease in value at a future date. The Commission continues to
believe that a clearing agency generally should reduce the need for
procyclical adjustments by establishing stable and conservative
haircuts that are calibrated to include periods of stressed market
conditions, to the extent practicable and prudent.\70\ Procyclical
adjustments (i.e., lower haircuts during periods of low stress followed
by increased haircuts during times of high market stress) could
exacerbate market stress and contribute to driving down asset prices
further, resulting in additional collateral requirements.\71\ The
imposition of more conservative haircuts during normal market
conditions, therefore, would reduce the amount by which haircuts must
be adjusted during times of market stress. Based on the data provided
by OCC, the proposed replacement of OCC's current process for setting
collateral haircuts with the proposed H-VaR approach would yield more
conservative haircuts during times of low market stress, which, in
turn, would help reduce spikes in collateral haircuts during heightened
market volatility. As noted above, reducing such spikes would reduce
the potential for driving down asset prices that could result in the
imposition of additional collateral requirements on market participants
already faced with increased market stress.
---------------------------------------------------------------------------

\70\ See Standards for Covered Clearing Agencies supra note 24,
81 FR at 70816-17.
\71\ See Committee on Payment and Settlement Systems, Principles
for Financial Market Infrastructures, section 3.5.6 (Apr. 2012);
available at https://www.bis.org/publ/cpss101a.pdf.
---------------------------------------------------------------------------

The proposed approach also would attempt to address the weaknesses
identified in the CiM model in response to regulatory and internal
examinations by, for example, incorporating periods of market stress
into the look-back period for the model under the proposed H-VaR
approach. Further, the proposed changes would add flexibility for OCC
to more frequently value collateral haircuts during time of
deteriorating market or other conditions while preserving notice
requirements to ensure that Clearing Members are aware of risk
management changes. Similarly, the proposed changes related to letters
of credit (e.g., limits not linked to a specific domicile in order to
impose the same requirements on both U.S. and non-U.S. issuers,
concentration limits, and a prohibition on affiliated issuers) would
support OCC's ability to manage risks posed by the collateral it
accepts from participants.
Based on its review of the record, and for the reasons described
below, the Commission believes that OCC's proposed changes to rules and
procedures regarding minimum standards for Clearing Banks and letter-
of-credit issuers are consistent with assuring the safeguarding of
securities and funds which are in its custody or control or for which
it is responsible. The quality of acceptable custodians is crucial to
safeguarding these types of securities and funds, and one of the key
ways to measure this quality is by establishing minimum qualifying
standards. OCC's proposed Rule amendments would set more stringent Tier
1 Capital requirements for both Clearing Banks and letter-of-credit
issuers, while amending the sovereign credit ratings to reflect current
understanding, and requiring Clearing Banks to maintain the ability to
use SWIFT, a generally accepted and secure communication method, as a
primary messaging protocol. Although the proposal would remove from
OCC's Rules the external credit rating standards for a non-U.S.
institution's commercial paper and related obligations, the ability of
these institutions to meet their financial and other obligations to OCC
would still be considered under the Third-Party-Risk Management
Framework (``TPRMF''), along with other risk factors.\72\ Additionally,
the proposed changes to the minimum standards for Clearing Banks and
letter-of-credit issuers, when viewed as a whole, serve to strengthen
OCC's process for accepting letters of credit, which comprise a
fraction of margin,\73\ come with many related restrictions, and pose
minimal risk to OCC. Moreover, the proposal would provide clarity by
aligning minimum standards for Clearing Banks and letter-of-credit
issuers, and would make clear that these rule changes are meant to
serve as the articulation of minimum standards for establishing
relationships, and OCC would not be obligated to enter into any such
relationship merely because an institution meets these enumerated
standards. The Commission believes that aligning and codifying such
standards in OCC's rules facilitate OCC's maintenance of banking and
letter-of-credit issuer relationships that support its ability to
safeguard securities and funds for which it is responsible or that are
in its custody or control.
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\72\ The TPRMF is an OCC rule that requires OCC to evaluate
financial institutions such as Clearing Banks and other liquidity
providers when they on-board or off-board with OCC, and to
continuously monitor such institutions for so long as they maintain
a relationship with OCC. It requires OCC to evaluate such financial
institutions across a variety of factors, several of which assess
the ability of the institution to meet its financial and other
obligations to OCC, such as the financial, operational, legal, and
regulatory risks faced by the institution. See Securities Exchange
Act Release No. 90797 (Dec. 23, 2020), 85 FR 86592 (Dec. 30, 2020)
(File No. SR-OCC-2020-014) (approving adoption of OCC's TPRMF). The
TPRMF also provides for Watch List processes and internal escalation
procedures in instances of an institution's deteriorating financial
or operational ability to timely meet its future obligations to OCC,
including assessing the institution's operational difficulties, late
financial reports, and risk management issues. OCC, ``Third-Party
Risk Management Framework'' (Dec. 22, 2022), available at https://www.theocc.com/getmedia/68a1ea2d-ddae-4a93-a309-100bf70a0f28/Third-Party-Risk-Management-Framework.pdf.
\73\ As of Dec. 31, 2022, OCC reported that bank letters of
credit accounted for only $130 million out of $152.7 billion of
margin at OCC. See OCC 2022 Financials, at 10, available at https://www.theocc.com/company-information/documents-and-archives/annual-reports.
---------------------------------------------------------------------------

The Commission received comments stating that the proposal to
calculate collateral haircuts using the H-VaR model, rather than the
current CiM methodology, would ignore long-tail

[[Page 55782]]

risks \74\ and historical periods of significant market stress.\75\
Commenters also stated that fixed collateral haircuts do not accurately
reflect the potential fluctuations in asset values, including during
times of market stress.\76\ The Commission has reviewed the proposed H-
VaR methodology, including confidential policies, procedures, and
related materials.\77\ The H-VaR model would reflect asset value
fluctuations during times of market stress because it specifically
includes such periods in the defined lookback periods. With regard to
long-tail risk, the proposed rules would require OCC to maintain
haircuts at a level at least equal to a 99 percent confidence interval
of the look-back period that provides for most conservative
haircuts.\78\ Further, the Commission notes that regulatory and
internal examinations showed that the CiM method has previously
resulted in inaccuracies in sizing haircuts, and concludes that the use
of the H-VaR model in place of the CiM method would improve accuracy of
collateral haircuts. Additionally, fixed collateral haircuts are not a
fundamentally new approach for OCC. For example, OCC's Rule 1002
currently applies fixed haircuts to Government securities in the
Clearing Fund, and such haircuts are currently subject to review and
recalculation based, in part, on market fluctuations.\79\ Based on its
review of the record and having considered the comments described
above, the Commission believes that the proposed H-VaR methodology and
the continued use of fixed collateral haircuts is consistent with the
Exchange Act and the relevant rules thereunder.\80\
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\74\ The commenters did not elaborate on what was meant by
``long tail risk.'' See, e.g., Letter from Jean Garcia-Gomez (Feb.
12, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-325181.htm. Given the related comments and context,
the Commission believes this to refer to the risk of loss due to an
event that has an extremely low probability of occurring (i.e., an
event that is far out in the tail of a distribution of possible
events).
\75\ See, e.g., id. Commenters raised additional concerns
regarding sovereign credit ratings, and OCC's redaction of certain
exhibits to the filing. See, e.g., id. Regarding OCC's redaction of
certain exhibits, the Commission notes that OCC asserted that
Exhibits 3A-3C and 5B-5D to the filing, which contain internal
policies and procedures, internal statistical calculations and
descriptions, and confidential regulatory findings, were entitled to
confidential treatment because they contained commercial and
financial information that is not customarily released to the public
and is treated as the private information of OCC. Under Section
23(a)(3) of the Exchange Act, the Commission is not required to make
public statements filed with the Commission in connection with a
proposed rule change of a self-regulatory organization if the
Commission could withhold the statements from the public in
accordance with the Freedom of Information Act (``FOIA''), 5 U.S.C.
552. 15 U.S.C. 78w(a)(3). The Commission has reviewed the documents
for which OCC requests confidential treatment and concludes that
they could be withheld from the public under the FOIA. FOIA
Exemption 4 protects confidential commercial or financial
information. 5 U.S.C. 552(b)(4). Under Exemption 4, information is
confidential if it ``is both customarily and actually treated as
private by its owner and provided to government under an assurance
of privacy.'' Food Marketing Institute v. Argus Leader Media, 139 S.
Ct. 2356, 2366 (2019). In its requests for confidential treatment,
OCC stated that it has not disclosed the confidential exhibits to
the public, and the information is the type that would not
customarily be disclosed to the public. In addition, by requesting
confidential treatment, OCC had an assurance of privacy because the
Commission generally protects information that can be withheld under
Exemption 4. Thus, the Commission has determined to accord
confidential treatment to the confidential exhibits.
\76\ Comments on the Proposed Rule Change are available at
https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm. See,
e.g., Letter from Jean Garcia-Gomez (Feb. 12, 2023), available at
https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-325181.htm.
\77\ See Notice of Filing supra note 4, 87 FR at 79016-79018.
OCC provided its policies, procedures, and related documents in
confidential Exhibits 3A-3C, and 5B-5D to File No. SR-OCC-2022-012.
Such documents included changes to both high-level policies and
detailed technical documentation, as well as an analysis of the
impact that changes in the haircut methodology would have on the
value of collateral posted by members.
\78\ See Notice of Filing supra note 4, 87 FR at 79017.
\79\ Id.
\80\ Commenters also raised a concern that the proposed rule
change would ``cut margin requirements.'' See, e.g., letter from
Daniel Lambden (Feb. 25, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-326082.htm. Such comments are
not relevant to the filing because OCC did not propose changes to
how it calculates margin requirements.
---------------------------------------------------------------------------

The Commission also received comments stating that lowering or
eliminating sovereign credit rating requirements for non-U.S. Clearing
Banks and letter-of-credit issuers increases the risk taken on by
OCC.\81\ The Commission has considered the materials submitted by OCC
with regard to the Proposed Rule Change.\82\ OCC's rules do not
currently prescribe acceptable sovereign credit rating for the domicile
of any non-U.S. Clearing Bank. OCC is not proposing to weaken minimum
standards, but rather to codify the current requirement to allow only
those Clearing Banks domiciled in the U.S. or in locations with
sovereign rating considered to be low credit risk. The Commission
believes the proposed standards (i.e., A- by Standard & Poor's, A3 by
Moody's, A- by Fitch, or equivalent, which would include institutions
domiciled in countries such as France) represents a reasonable choice
by OCC to identify sovereigns with low credit risk.\83\ The Commission
recognizes that the proposal would change the acceptable ratings for
letter-of-credit issuers; however, the proposed standard would still
require that such banks be domiciled in the United States or in
locations with sovereign ratings considered to be low credit risk, as
noted above. Moreover, the removal of external credit rating standards
for a non-U.S. institution's commercial paper and related obligations
from OCC's Rules does not mean that creditworthiness will not be
considered at all. Rather, the proposal calls for an evaluation of
credit risk as part of a broader review of factors, such as financial,
operational, legal, and regulatory risks, with regard to Clearing Banks
and liquidity providers, such as letters of credit issuers under the
TPRMF.\84\ The sovereign credit rating requirements are part of a
broader set of minimum standards for Clearing Banks and letter-of-
credit issuers, including the Tier 1 Capital that OCC proposes to
increase, thus providing further safeguards that mitigate or eliminate
the additional risk to OCC. Based on its review of the record and
having considered the comments described above, the Commission believes
that the proposed sovereign credit rating requirements are consistent
with the Exchange Act and the relevant rules thereunder.
---------------------------------------------------------------------------

\81\ See note 75, supra.
\82\ See Notice of Filing supra note 4, 87 FR at 79018-79020.
OCC provided its policies, procedures, and related documents in
confidential Exhibits 3A-3C, and 5B-5D to File No. SR-OCC-2022-012.
Such documents include changes to policy governing OCC's management
of risk presented by letters of credit.
\83\ OCC acknowledged that the sovereign credit rating
requirement historically applied to letter-of-credit issuers is
different than what is currently applied to its Clearing Banks, and
that OCC would change the sovereign credit rating requirement for
letter-of-credit issuers to conform to that for the Clearing Banks.
See Notice of Filing supra note 4, 87 FR at 79018-79019.
\84\ See note 72, supra.
---------------------------------------------------------------------------

The Commission received further comments stating that the proposed
changes would reduce or remove external audit, supervision, and credit
ratings, contrary to recommendations made in a 2015 paper from the Bank
of International Settlements (``BIS'').\85\ These comments are not
relevant to the proposal being considered here. The Proposed Rule
Change is unrelated to and does not address external audit or
supervision and, contrary to commenters' assertions, it would not
remove the consideration of credit ratings. Where the proposal
addresses credit ratings, it does so in the limited context of
sovereign credit ratings

[[Page 55783]]

considered to be of low credit risk, transferring the rules regarding
consideration of creditworthiness of Clearing Banks and liquidity
providers from the OCC rulebook to the TPRMF, and as part of a broader
set of minimum requirements for Clearing Banks and letter-of-credit
issuers. The BIS paper discusses, among other things, how interactions
among internal lines of defense and external controls can enhance
governance at financial institutions.\86\ These issues are not relevant
to the Proposed Rule Change. Further, unlike the commenters suggest,
the BIS paper does not discuss credit ratings at all. Additionally,
even though the proposal would adjust the required sovereign credit
rating, and transfer the rules regarding consideration of
creditworthiness of Clearing Banks and liquidity providers from the OCC
rulebook to the TPRMF, it would still only allow for countries with low
credit risk and institutions that are able to meet obligations to OCC,
and these requirements are part of a larger set of minimum standards,
such as more stringent Tier 1 Capital requirements and the requirement
for Clearing Banks to maintain the ability to use SWIFT, that serve to
enhance OCC's banking and letter-of-credit relationships. As such,
after having considered the comments relating to the BIS paper, the
Commission continues to believe that the proposal is consistent with
the Exchange Act and the relevant rules thereunder.
---------------------------------------------------------------------------

\85\ Isabella Arndorfer, Bank of International Settlements, and
Andrea Minto, Utrecht University, Occasional Paper No. 11, ``The
`four lines of defence model' for financial institutions,''
Financial Stability Institute ((Dec. 23, 2015), available at https://www.bis.org/fsi/fsipapers11.pdf. (``BIS paper'').
\86\ Id.
---------------------------------------------------------------------------

Therefore, the Commission finds that, taken together, the proposed
changes described above are consistent with the requirements of Section
17A(b)(3)(F) of the Exchange Act.\87\
---------------------------------------------------------------------------

\87\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

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

Section 17A(b)(3)(I) of the Exchange Act requires that the rules of
a clearing agency do not impose any burden on competition not necessary
or appropriate in furtherance of the purposes of the Exchange Act.\88\
---------------------------------------------------------------------------

\88\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

In response to the Notice of Filing,\89\ the Commission received a
comment \90\ opposing the proposal stating that the ``increase to the
current Tier 1 Capital requirement will have a negative effect by
eliminating [Lakeside Bank] as a member Clearing Bank'' and that such
elimination ``will reduce competition.'' \91\ The commenter, Lakeside,
states further that large Clearing Banks ``tend to not provide service
for small and mid-sized Clearing Brokers,'' which appears to suggest
that the proposed change could reduce direct access to clearing for
OCC's current membership.\92\ Finally, the commenter states that the
``proposed Tier 1 Capital rule change to $500 million is arbitrary and
capricious and not explained other than the OCC's belief the new
requirement reduces the risk of a Clearing Banks failure to achieve
their daily settlement obligations.'' \93\
---------------------------------------------------------------------------

\89\ See Notice of Filing supra note 4, 87 FR at 79015.
\90\ Letter from Lakeside Bank dated January 26, 2023
(``Lakeside Ltr''), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm. See also Letter from Lakeside Bank
dated March 15, 2023 (``Lakeside Ltr 2''), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-328270.htm.
Lakeside Ltr 2 did not present novel comments.
\91\ Lakeside Ltr at 1.
\92\ Id. The Commission also received a comment stating that the
proposed increase to capital requirements would impact smaller
members. Letter from Kevin Lau (Feb. 14, 2023), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012-325669.htm.
\93\ Lakeside Ltr at 2.
---------------------------------------------------------------------------

In a subsequent comment letter, OCC responded to the concerns
raised by Lakeside.\94\ OCC stated that its proposal would not impose a
burden on competition \95\ because Clearing Members of various sizes
``currently have established relationships with OCC-approved Clearing
Banks that meet the proposed standards.'' \96\ Further, OCC stated that
``Lakeside Bank does not currently provide settlement banking services
as a Clearing Bank for any OCC Clearing Member.'' \97\ Moreover, OCC
stated that its ``current rules do not obligate OCC to enter into a
Clearing Bank relationship with a bank simply because the bank meets
its present standards.'' \98\ OCC stated that obligating it to enter
into Clearing Bank relationships simply because an institution meets
the minimum standards and without further due diligence ``would not be
consistent with sound third-party risk management practices.'' \99\ On
the contrary, ``OCC believes that strengthening OCC standards for
entering into Clearing Bank arrangements is necessary and appropriate
to ensure the overall safety and soundness of the markets OCC serves.''
\100\ OCC stated further that it ``determined the proposed Tier 1
Capital requirement to align with the Tier 1 Capital held by the
Clearing Banks that have demonstrated records of performance, including
the resources to devote to and meet OCC's operational expectations for
providing such critical services.'' \101\
---------------------------------------------------------------------------

\94\ Letter from Megan Cohen, Managing Director, OCC, to Vanessa
Countryman, Secretary, Commission, dated February 2, 2023 (``OCC
Ltr''), available at https://www.sec.gov/comments/sr-occ-2022-012/srocc2022012.htm.
\95\ The Exchange Act requires that the rules of the clearing
agency do not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. See
15 U.S.C. 78q-1(b)(3)(I).
\96\ OCC Ltr at 3.
\97\ Id. at 1.
\98\ Id. at 2.
\99\ Id. at 2.
\100\ Id. at 3. As OCC additionally explained, ``If a Clearing
Bank is unable to timely make incoming payments on behalf of one or
more Clearing Members, OCC may face liquidity challenges requiring
it to draw on resources that could impose unexpected costs or other
adverse consequences for its Clearing Members and, ultimately,
market participants.'' Id.
\101\ Id.
---------------------------------------------------------------------------

Based on the information provided, the Commission believes that the
proposal would not impose a burden on competition that is not necessary
or appropriate in furtherance of the purposes of the Exchange Act. All
of OCC's current members maintain relationships with Clearing Banks
that meet the proposed standards. The Commission did not receive
comments raising concerns from current or prospective OCC participants.
With regard to monitoring, managing, and limiting the credit and
liquidity risk arising from commercial settlement banks, the Commission
has provided guidance that a clearing agency generally should consider
establishing and monitoring adherence to strict criteria for its
settlement banks that take account of, among other things, their
capitalization.\102\ The Commission believes, therefore, that
strengthening capital requirements for settlement banks, such as OCC's
Clearing Banks, can serve an important risk management purpose. The
Commission acknowledges the concerns raised by Lakeside with regard to
competition among settlement banks and access to central clearing at
OCC.\103\ As noted above, the proposal does not limit access to current
OCC members, and, even if the proposed changes were not approved, OCC's
current rules would not necessarily obligate OCC to

[[Page 55784]]

maintain a Clearing Bank relationship with Lakeside or a similar
institution.
---------------------------------------------------------------------------

\102\ See Standards for Covered Clearing Agencies supra note 24,
81 FR at 70826.
\103\ Lakeside also raised concerns regarding potential future
rule changes at the Chicago Mercantile Exchange (``CME'') and the
Depository Trust and Clearing Corporation (``DTCC''). See Lakeside
Ltr at 2. Such concerns are not ripe for consideration here because
(1) CME is not currently registered as a clearing agency with the
Commission, and (2) there are no proposed changes related to this
matter pending with the Commission from the Depository Trust
Company, Fixed Income Clearing Corporation, or National Securities
Clearing Corporation (i.e., the three registered clearing agencies
whose parent is DTCC).
---------------------------------------------------------------------------

Therefore, the Commission finds that the proposed changes described
above are consistent with the requirements of Section 17A(b)(3)(I) of
the Exchange Act.\104\
---------------------------------------------------------------------------

\104\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(5) Under the Exchange Act

Rule 17Ad-22(e)(5) \105\ under the Exchange Act requires each
covered clearing agency to establish, implement, maintain, and enforce
written policies and procedures reasonably designed to set and enforce
appropriately conservative haircuts and concentration limits if the
covered clearing agency requires collateral to manage its or its
participants' credit exposures; and require a review of the sufficiency
of its collateral haircuts and concentration limits to be performed not
less than annually. In adopting Rule 17Ad-22(e)(5), the Commission
provided guidance that ``to reduce the need for procyclical
adjustments, a covered clearing agency generally should consider
establishing stable and conservative haircuts that are calibrated to
include periods of stressed market conditions, to the extent practical
and prudent.'' \106\
---------------------------------------------------------------------------

\105\ 17 CFR 240.17Ad-22(e)(5).
\106\ See Standards for Covered Clearing Agencies supra note 24,
81 FR at 70816-17.
---------------------------------------------------------------------------

Based on the information and data provided by OCC, the Commission
believes that OCC's proposed H-VaR approach would help reduce spikes
during heightened market volatility by yielding more conservative
haircuts during normal market conditions. The proposed approach also
would attempt to address the weaknesses identified in the CiM model in
response to regulatory and internal examinations by, for example,
incorporating periods of market stress into the look-back period for
the model. Additionally, OCC's proposal to amend its internal CRM
Policy to list specific factors, such as volatility and liquidity, and
elevated sovereign credit risk when determining the value of GSE debt
securities and Government securities used as margin or Clearing Fund
collateral, would provide guideposts to set and enforce appropriately
conservative haircuts. OCC's proposed changes also would grant it new
authority to set and adjust more restrictive concentration limits for
accepting letters of credit, as well as expressly list the factors for
making such determinations, and establish a prohibition on accepting
letters of credit for the account of a Clearing Member where the
issuing institution, a parent, or an affiliate has any equity interest
in such Clearing Member's total capital. Thus, the Commission believes
that OCC's proposed changes to letter-of-credit concentration limits,
when reviewed in combination with the proposed minimum standards for
Clearing Banks and letter-of-credit issuers, would be appropriately
conservative and may help eliminate wrong-way risk found in some
Clearing Members' relationships with such issuers.\107\ Finally, the
Commission believes that reviews at regular intervals of collateral
haircuts and concentration limits proposed in the CRM Policy and Rules
would be consistent with the requirement for, at a minimum, an annual
review.
---------------------------------------------------------------------------

\107\ Wrong-way risk can be either general or specific. General
wrong-way risk arises at a central counterparty (``CCP'') when the
potential losses of either a participant's portfolio or a
participant's collateral is correlated with the default probability
of that participant. Specific wrong-way risk arises at a CCP when an
exposure to a participant is highly likely to increase when the
creditworthiness of that participant is deteriorating. See Standards
for Covered Clearing Agencies supra note 24, 81 FR at 70816, n.317.
---------------------------------------------------------------------------

Accordingly, the Commission finds that the proposed changes are
consistent with Rule 17Ad-22(e)(5) \108\ under the Exchange Act.
---------------------------------------------------------------------------

\108\ 17 CFR 240.17Ad-22(e)(5).
---------------------------------------------------------------------------

D. Consistency With Rule 17Ad-22(e)(9) Under the Exchange Act

Rule 17Ad-22(e)(9) \109\ under the Exchange Act requires each
covered clearing agency to establish, implement, maintain, and enforce
written policies and procedures reasonably designed to, among other
things, minimize and manage credit and liquidity risk arising from
conducting its money settlements in commercial bank money if central
bank money is not used by the covered clearing agency. The Commission
believes that including OCC's minimum standards for Clearing Banks in
its rules would support OCC's ability to monitor its relationships with
Clearing Banks and manage the financial and operational risks inherent
in such relationships. The Commission also believes that the
requirements for Clearing Banks, taken as a whole, as well as the
mandatory approval of any new Clearing Bank by the Risk Committee prior
to onboarding, would help reduce credit and liquidity risk arising from
conducting its money settlements in commercial bank money. Accordingly,
the Commission finds that the proposed changes are consistent with Rule
17Ad-22(e)(9) \110\ under the Exchange Act.
---------------------------------------------------------------------------

\109\ 17 CFR 240.17Ad-22(e)(9).
\110\ Id.
---------------------------------------------------------------------------

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

Rule 17Ad-22(e)(22) \111\ under the Exchange Act requires each
covered clearing agency to establish, implement, maintain, and enforce
written policies and procedures reasonably designed to use, or at a
minimum accommodate, relevant internationally accepted communication
procedures and standards in order to facilitate efficient payment,
clearing, and settlement. As described above, OCC proposed codifying
its requirement that its Clearing Banks maintain the ability to utilize
SWIFT, whenever possible. The proposed change would codify the process
that OCC proposed in 2017.\112\ Previously, the Commission did not to
object to the process, in part, based on the belief that the proposal
to expand the usage of SWIFT as a standard for OCC's Clearing Banks is
consistent with Rule 17Ad-22(e)(22).\113\ The Commission believes that
codifying the requirement would further support OCC's existing process
and use of SWIFT to facilitate efficient payment, clearing, and
settlement. Accordingly, the Commission finds that the proposed changes
are consistent with Rule 17Ad-22(e)(22) \114\ under the Exchange Act.
---------------------------------------------------------------------------

\111\ 17 CFR 240.17Ad-22(e)(22).
\112\ See Securities Exchange Act Release No. 82055 (Nov. 13,
2017), 82 FR 54448 (Nov. 17, 2017) (File No. SR-OCC-2017-805).
\113\ See Securities Exchange Act Release No. 82221 (Dec. 5,
2017), 82 FR 58230, 58232 (Dec. 11, 2017) (File No. SR-OCC-2017-
805).
\114\ 17 CFR 240.17Ad-22(e)(22).
---------------------------------------------------------------------------

F. Consistency With Rule 17Ad-22(e)(23) Under the Exchange Act

Rule 17Ad-22(e)(23)(i) and (ii) \115\ under the Exchange Act
requires each covered clearing agency to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to, among other things, publicly disclose all relevant rules
and material procedures; and provide sufficient information to enable
participants to identify and evaluate the risks, fees, and other
material costs they incur by participating in the covered clearing
agency. Based on its review of the record, and for the reasons
described below, the Commission finds that the proposed changes, taken
together, are consistent with the requirements of Rule 17Ad-
22(e)(23)(i) and (ii).\116\
---------------------------------------------------------------------------

\115\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
\116\ Id.
---------------------------------------------------------------------------

By adopting rules that require OCC to provide prior notice through
public

[[Page 55785]]

disclosures on its website relating to information on collateral
haircuts for Government securities and GSE debt securities, and
concentration limits for letters of credit, the Commission believes
that OCC's rules would support the communication of information that
Clearing Members may use to identify and evaluate the haircuts and
concentration limits resulting from OCC's valuation processes.
Additionally, the Commission believes that codifying minimum standards
for Clearing Banks and letter-of-credit issuers in OCC's public rules
would provide increased clarity and transparency to Clearing Members
and market participants, while preserving OCC's flexibility and
authority in disapproving specific relationships based on individual
facts and circumstances. As such, the Commission believes that the
proposed rule and policy revisions are consistent with publicly
disclosing all relevant rules and material procedures; and providing
sufficient information to enable participants to identify and evaluate
the risks, fees, and other material costs incurred with participation
in the covered clearing agency.
The Commission finds, therefore, that OCC's proposals, described
above, are consistent with the requirements of Rule 17Ad-22(e)(23)(i)
and (ii) under the Exchange Act.\117\
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\117\ Id.
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IV. 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 \118\ and the rules and regulations thereunder.
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\118\ 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,\119\ that the Proposed Rule Change (SR-OCC-2022-012), be,
and hereby is, approved.
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\119\ 15 U.S.C. 78s(b)(2).

For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\120\
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\120\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-17529 Filed 8-15-23; 8:45 am]
BILLING CODE 8011-01-P

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