Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection To Advance Notice, as Modified by Partial Amendment No. 1 and Amendment No. 2, Concerning Modifications to the Amended and Restated Stock Options and Futures Settlement Agreement Between the Options Clearing Corporation and the National Securities Clearing Corporation, 19629-19634 [2024-05734]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 89, Number 54 (Tuesday, March 19, 2024)]
[Notices]
[Pages 19629-19634]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-05734]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-99731; File No. SR-OCC-2023-801]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of No Objection To Advance Notice, as Modified by Partial 
Amendment No. 1 and Amendment No. 2, Concerning Modifications to the 
Amended and Restated Stock Options and Futures Settlement Agreement 
Between the Options Clearing Corporation and the National Securities 
Clearing Corporation

March 13, 2024.

I. Introduction

    On August 10, 2023, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-OCC-2023-801 (``Advance Notice'') pursuant to Section 
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, entitled Payment, Clearing and Settlement 
Supervision Act of 2010 (``Clearing Supervision Act'') \1\ and Rule 
19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934 
(``Exchange Act'') \3\ to change terms related to the physical 
settlement of equities arising out of certain futures and options 
contracts.\4\ On August 30, 2023, notice of the Advance Notice was 
published in the Federal Register to solicit public comment and to 
extend the review period for the Advance Notice.\5\
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ See Notice of Filing infra note 5, at 88 FR 59988.
    \5\ Securities Exchange Act Release No. 98214 (Aug. 24, 2023), 
88 FR 59988 (Aug. 30, 2023) (File No. SR-OCC-2023-801) (``Notice of 
Filing''). On Aug. 10, 2023, OCC also filed a related proposed rule 
change (SR-OCC-2023-007) with the Commission pursuant to Section 
19(b)(1) of the Exchange Act and Rule 19b-4 thereunder (``Proposed 
Rule Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, 
respectively. In the Proposed Rule Change, which was published in 
the Federal Register on Aug. 30, 2023, OCC seeks approval of 
proposed changes to its rules necessary to implement the Advance 
Notice. Securities Exchange Act Release No. 98215 (Aug. 24, 2023), 
88 FR 59976 (Aug. 30, 2023) (File No. SR-OCC-2023-007). The initial 
comment period for the related Proposed Rule Change filing closed on 
Sept. 20, 2023. The Commission solicited further comment when it 
subsequently instituted proceedings to determine whether to approve 
or disapprove the Proposed Rule Change. The additional comment 
period closed on Dec. 26, 2023. See Securities Exchange Act Release 
No. 98932 (Nov. 14, 2023), 88 FR 80781 (Nov. 20, 2023) (File No. SR-
OCC-2023-007).
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    On November 8, 2023, OCC filed Partial Amendment No. 1 to the 
Advance Notice.\6\ On November 14, 2023, the Commission requested 
additional information for consideration of the Advance Notice from 
OCC, pursuant to Section 806(e)(1)(D) of the Clearing Supervision 
Act,\7\ which tolled the Commission's period of review of the Advance 
Notice until 120 days from the date the information requested by the 
Commission was received by the Commission.\8\ On December 5, 2023, the 
Commission received OCC's response to the Commission's request for 
additional information.\9\ On January 23, 2024, OCC filed Amendment No. 
2 to the Advance Notice, which was published in the Federal Register 
for public comment on January 30, 2024.\10\ The Commission has received 
public comment regarding the changes proposed in the Advance 
Notice.\11\ The Commission is hereby providing notice of no objection 
to the Advance Notice as modified by Partial Amendment No. 1 and 
Amendment No. 2 (hereinafter defined as the ``Advance Notice'').
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    \6\ Partial Amendment No. 1 delays implementation of the 
proposed change. In Partial Amendment No. 1, OCC proposes to 
implement the proposed rule change within 90 days of receiving all 
necessary regulatory approvals and would announce the specific date 
of implementation on its public website at least 14 days prior to 
implementation. The delay is proposed in light of the technical 
system changes that are required to implement the liquidity stress 
testing enhancements and to be able to provide sufficient notice to 
Clearing Members following receipt of approval.
    \7\ 12 U.S.C. 5465(e)(1)(D).
    \8\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); Memorandum from 
the Office of Clearance and Settlement Supervision, Division of 
Trading and Markets, titled ``Commission's Request for Additional 
Information,'' available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-298099-727262.pdf.
    \9\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); Memorandum from 
the Office of Clearance and Settlement Supervision, Division of 
Trading and Markets, titled ``Response to the Commission's Request 
for Additional Information,'' available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-307799-792662.pdf.
    \10\ See Securities Exchange Act Release No. 99427 (Jan. 24, 
2024), 89 FR 5953 (Jan. 30, 2024) (File No. SR-OCC-2023-801) 
(``Notice of Amendment'').
    \11\ Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801.htm. The 
Commission received one comment supporting the proposed changes. See 
comment from John P. Davidson, Principal, Pirnie Advisory (Oct. 4, 
2023), available at https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-268179-645042.htm. Since the proposal contained in the 
Advance Notice was also filed as a proposed rule change, all public 
comments received on the proposal are considered regardless of 
whether the comments are submitted on the Proposed Rule Change or 
the Advance Notice. Comments on the Proposed Rule Change are 
available at https://www.sec.gov/comments/sr-occ-2023-007/srocc2023007.htm. The Commission received comments on the proposed 
rule change that express concerns unrelated to the substance of the 
filing. See, e.g., comment from Gregory Englebert (Feb. 2, 2024) 
(raising concerns about a conflict of interest in the role of 
Financial Risk Management Officers as well as margin calls) comment 
from Curtis H. (Feb. 3, 2024) (referencing short selling and 
margin), and comment from CK Kashyap (Feb. 5, 2024) (referring to 
broker risk management in response to margin).
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II. Background

    The National Securities Clearing Corporation (``NSCC'') is a 
clearing agency that provides clearing, settlement, risk management, 
and central counterparty services for trades involving equity 
securities. OCC is the sole clearing agency for standardized equity 
options listed on national securities exchanges registered with the 
Commission, including options that contemplate the physical delivery of 
equities cleared by NSCC in exchange for cash (``physically settled'' 
options).\12\ OCC also clears certain futures contracts that, at 
maturity, require the delivery of equity securities cleared by NSCC in 
exchange for cash. As a result, the exercise and assignment of certain 
options or maturation of certain futures cleared by OCC effectively 
results in stock settlement obligations to be cleared by NSCC 
(``Exercise and Assignment Activity'' or ``E&A Activity''). NSCC and 
OCC maintain a legal agreement, generally referred to by the parties as 
the ``Accord,'' that governs the processing of such E&A Activity for 
firms that are members of both OCC and NSCC (``Common Members'').\13\
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    \12\ The term ``physically-settled,'' as used throughout the OCC 
Rulebook, refers to cleared contracts that settle into their 
underlying interest (i.e., options or futures contracts that are not 
cash-settled). When a contract settles into its underlying interest, 
shares of stock are sent (i.e., delivered) to contract holders who 
have the right to receive the shares from contract holders who are 
obligated to deliver the shares at the time of exercise/assignment 
in the case of an option and at the time of maturity in the case of 
a future. 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.
    \13\ Pursuant to OCC Rule 302, outside of certain limited 
exceptions, every Clearing Member that effects transactions in 
physically-settled options or futures must also be a participant of 
NSCC.

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[[Page 19630]]

    Under certain circumstances, the Accord currently allows NSCC not 
to guaranty the settlement of securities arising out of E&A Activity 
for a Common Member for whom NSCC has ceased to act (e.g., due to a 
default by that member). To the extent NSCC chooses not to guaranty 
such transactions of a defaulting Clearing Member, OCC would have to 
engage in an alternate method of settlement outside of NSCC to manage 
the default. This presents two issues. First, based on historical data, 
the cash required for such alternative settlement could be as much as 
$300 billion.\14\ Second, because NSCC's netting process dramatically 
decreases the volume of securities settlement obligations that must be 
addressed, settlement of physically-settled options and futures outside 
of NSCC introduces significant operational complexities. Specifically, 
without NSCC's netting process, OCC would have to coordinate a 
significantly increased number of transactions on a broker-to-broker 
basis rather than through a single central counterparty, and the total 
value of settlement obligations that would need to be processed would 
be significantly higher.\15\
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    \14\ See Notice of Filing, 88 FR at 59989.
    \15\ For example, in 2022 it is estimated that netting through 
NSCC's continuous net settlement (``CNS'') accounting system reduced 
the value of CNS settlement obligations from $519 trillion to $9 
trillion, an approximately 98 percent reduction. See Notice of 
Filing, 88 FR at 59989.
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    OCC proposes to revise the Accord to address these liquidity and 
operational issues. In particular, OCC and NSCC have agreed to modify 
the Accord to require NSCC to accept E&A activity from OCC (i.e., 
guaranty the positions of a defaulting Common Member), provided that 
OCC makes a payment to NSCC called the ``Guaranty Substitution 
Payment,'' or ``GSP.'' The GSP is designed to cover OCC's share of the 
incremental risk to NSCC posed by the defaulting Common Member's 
positions. The total risk posed to NSCC by a defaulting Common Member 
would be the sum of (i) the defaulter's unpaid deposit to the NSCC 
Clearing Fund (``Required Fund Deposit''),\16\ and (ii) the defaulter's 
unpaid Supplemental Liquidity Deposit (``SLD'').\17\ If OCC pays the 
GSP to NSCC, NSCC would be obligated under the amended Accord to accept 
that member's E&A activity from OCC and conduct settlement through 
NSCC's netting process and systems. NSCC would calculate how much of 
the defaulting Common Member's Required Fund Deposit and SLD are 
attributable to the E&A Activity that OCC sends to NSCC, and that 
amount would be the GSP. Based on historical data, OCC's GSP could be 
as much as $6 billion, which is significantly less than the potential 
$300 billion that could be required for alternative settlement outside 
of NSCC.\18\
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    \16\ The Required Fund Deposit is calculated pursuant to Rule 4 
(Clearing Fund) and Procedure XV (Clearing Fund Formula and Other 
Matters) of the NSCC Rules. See Notice of Filing, 88 FR at 59991, 
n.28.
    \17\ Under the NSCC Rules, in certain circumstances, NSCC 
collects the Supplemental Liquidity Deposit, which is an additional 
cash deposit from each of those Members who would generate the 
largest settlement debits in stressed market conditions. See Rule 4A 
of the NSCC Rules. See also Notice of Filing, 88 FR at 59991, n.29.
    \18\ See Notice of Filing, 88 FR at 59989.
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    As noted above, OCC amended the Advance Notice after filing. The 
primary purposes of the Amendment No. 2 were to provide for improved 
information sharing between OCC and NSCC, and ensure that the new 
process and timing for NSCC to calculate the GSP and OCC to pay the GSP 
will be consistent with relevant process and timing requirements 
necessitated by the industry transitions to a T+1 settlement cycle for 
securities.\19\ OCC has labeled the proposed changes included in the 
initial filing to allow OCC to pay the GSP to NSCC and enhance OCC's 
liquidity stress testing as Phase 1 of the proposed changes, and the 
additional changes in the amendment to enhance information sharing and 
facilitate the transition to T+1 as Phase 2.\20\
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    \19\ On Feb. 15, 2023, the Commission adopted rules to shorten 
the standard settlement cycle for most broker-dealer transactions 
from T+2 to T+1. See Securities Exchange Act Release No. 96930 (Feb. 
15, 2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
    \20\ OCC has proposed a two-step implementation based on the 
categorization of changes as part of Phase 1 and Phase 2. See Notice 
of Amendment, 89 FR at 5968.
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    OCC also proposes to make conforming changes throughout its rules 
to accommodate the changes summarized above, as well as a number of 
changes to its rules to facilitate the proposed changes to the Accord 
noted above. For example, OCC proposes to change its rules to permit 
payment of the GSP to NSCC and revise other of its rules related to 
liquidity risk management to account for the potential need to make 
such a cash payment to NSCC.

A. Information Sharing and the Guaranty Substitution Payment

    The proposed revisions to the Accord designed to introduce and 
facilitate the new GSP include the following: changes designed to 
facilitate improved information sharing between OCC and NSCC; changes 
that would define the calculation of the GSP; changes that would define 
the process and timing by which guaranty of the E&A Activity would 
transfer from OCC to NSCC; \21\ and additional conforming changes to 
the Accord to support these and the other changes described in more 
detail below.
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    \21\ Here, the ``transfer'' of the guaranty refers to the point 
at which OCC's settlement guaranty with respect to E&A Activity ends 
and NSCC's settlement guaranty begins.
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    Improved Information Sharing. Currently, NSCC sends a file daily to 
OCC defining which securities are eligible to settle through NSCC. OCC 
then delivers to NSCC a file identifying securities to be physically 
settled at NSCC as a result of E&A Activity. This process would 
continue under the proposal, however, as part of Phase 1 NSCC would 
also communicate the GSP daily to OCC.\22\ In Phase 2, NSCC would 
continue to communicate the GSP daily to OCC, but the calculation would 
differ, as described in more detail below.
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    \22\ NSCC would communicate both the total amount of collateral 
required to cover the risk presented by each common clearing member 
and what percentage of that risk is attributable to OCC (i.e., the 
GSP) and therefore OCC would need to pay to require NSCC to guaranty 
the positions of a Common Member for whom NSCC has ceased to act. As 
described further below, OCC proposes to incorporate the total risk 
presented by each common member into its management of liquidity 
risk.
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    Also in Phase 2, OCC and NSCC would share additional information 
beyond the daily exchange of position files and communication of the 
GSP. Specifically, NSCC would communicate to OCC daily the single 
largest GSP observed in the prior 12 months (the ``Historical Peak 
GSP''), which would in turn provide a data point for discussion between 
OCC and NSCC to confirm that OCC will likely be in a position to commit 
to paying the actual GSP in the event of the default of a Common 
Member.\23\ NSCC would also communicate a set of margin and liquidity-
related data to OCC daily (the ``GSP Monitoring Data''). The GSP 
Monitoring Data would be for informational purposes and would 
facilitate OCC's daily assessment of its ability to commit to pay the 
actual GSP

[[Page 19631]]

in the event of the default of a Common Member.
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    \23\ NSCC would provide the Historical Peak GSP to OCC daily, 
and OCC would communicate to NSCC whether OCC has Clearing Fund cash 
in excess of the Historical Peak GSP. If OCC does not have 
sufficient cash in the Clearing Fund, this would allow OCC and NSCC 
to escalate discussion of whether OCC will likely be in a position 
to commit to paying the actual GSP (e.g., what other resources OCC 
has, whether the actual GSP is likely to be as large as the 
historical peak). The comparison of OCC's resources to the 
Historical Peak GSP would not affect whether OCC is permitted to 
send E&A Activity to NSCC.
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    The Guaranty Substitution Payment. As described above, NSCC would 
communicate to OCC the GSP amount each day. In the event of a Common 
Member default, this is the amount OCC would need to pay to require 
NSCC to guaranty the positions of the defaulting Common Member. Under 
both Phases 1 and 2, the GSP for a given member would be the amount 
necessary to cover the risk posed by the member's E&A Activity, and 
would be calculated by determining the portion of the defaulting 
Clearing Member's Required Fund Deposit and SLD that the member owes to 
NSCC that is attributable to the member's E&A Activity at OCC. The 
calculation of OCC's portion of the Required Fund Deposit obligation 
would differ between Phases 1 and 2, with a precise calculation in 
Phase 2 replacing a proxy from Phase 1.
    In Phase 1, NSCC would approximate the percentage of the member's 
Required Fund Deposit attributable to E&A Activity by referencing the 
day-over-day change in gross market value of the Common Member's 
positions at NSCC. OCC acknowledges that this gross market value proxy 
methodology overestimates or underestimates the Required Fund Deposit 
attributable to a Common Member's E&A Activity, but states that current 
technology constraints prohibit NSCC from performing a precise 
calculation of the GSP on a daily basis for every Common Member. The 
Phase 2 changes to the Accord would introduce a more precise allocation 
of the Required Fund Deposit portion of the GSP, which would help 
eliminate the potential over- or under-estimation of OCC's portion of 
the Required Fund Deposit.\24\ Specifically, in Phase 2, NSCC would 
calculate OCC's portion of the Required Fund Deposit as a difference 
between the Required Fund Deposit of the Common Member's entire 
portfolio and the Required Fund Deposit of the Common Member's 
portfolio prior to the submission of E&A Activity. This more precise 
calculation would completely replace the Phase 1 gross market value 
proxy. Under both Phases 1 and 2, the SLD portion of the GSP would be 
the Common Member's unpaid SLD associated with any E&A Activity.
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    \24\ See Notice of Amendment, 89 FR at 5964-65. OCC and NSCC 
agreed that performing the necessary technology build during Phase 1 
would delay the implementation of the proposal. NSCC will 
incorporate those technology updates in connection with Phase 2 of 
this proposal. See Notice of Amendment, 89 FR at 5957, n.32.
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    Guaranty Transfer. As described above, the purpose of the proposed 
changes is to increase the circumstances under which NSCC must assume 
the obligation to guaranty E&A Activity. Currently, the guaranty for 
such transactions transfers from OCC to NSCC after NSCC has received 
Required Fund Deposits from the Common Members. The guaranty would not 
transfer if a member fails to satisfy its obligations to NSCC. Under 
the proposed changes, the guaranty would transfer after NSCC has 
received Required Fund Deposits from the Common Members or at such time 
that OCC pays the GSP if a Common Member fails to satisfy its 
obligations to NSCC.

B. Liquidity Risk Management

    The changes to the Accord regarding the GSP and transfer of the 
guaranty are designed to resolve a potential gap in OCC's liquidity 
risk management. As noted above, the potential liquidity exposure to 
OCC posed by E&A Activity would be dramatically reduced by the proposed 
changes because it would go through NSCC's netting process. However, 
that reduction would only occur if OCC has sufficient liquid resources 
to pay the GSP. The potential payment of the GSP is, therefore, a 
liquidity demand that OCC must manage.
    OCC's Liquidity Risk Management Framework (``LRMF'') sets forth a 
comprehensive overview of OCC's liquidity risk management practices and 
governs OCC's policies and procedures as they relate to liquidity risk 
management.\25\ OCC proposes changes to the LRMF as well as to OCC's 
Comprehensive Stress Testing & Clearing Fund Methodology, and Liquidity 
Risk Management Description \26\ to incorporate the GSP into OCC's 
liquidity stress testing practices by treating the GSP as a potential 
liquidity demand.\27\
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    \25\ See Securities Exchange Act Release No. 89014 (June 4, 
2020), 85 FR 35446 (June 10, 2020) (File No. SR-OCC-2020-003).
    \26\ OCC provided a marked version of the Comprehensive Stress 
Testing & Clearing Fund Methodology, and Liquidity Risk Management 
Description to the Commission as exhibit 5D to File No. SR-OCC-2023-
801.
    \27\ OCC would incorporate this potential liquidity demand at 
the level of a group of affiliated members.
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    To implement this change, OCC would add an amount representing the 
potential GSP to each member account on each day on which options 
expire. The amount would be based on historical data. Specifically, OCC 
would add the peak GSP observed in the prior 12 months for the member 
to the potential liquidity risk posed by the member.\28\ The reliance 
on the peak GSP observed in a 12-month lookback, however, raises two 
issues that OCC proposes to address in its management of liquidity 
risk.
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    \28\ OCC states that the one-year lookback allows for the best 
like-to-like application of a historical GSP as there is a cyclical 
nature to option standard expirations with quarterly (i.e., Mar., 
June, Sept., and Dec.) and Jan. generally being more impactful than 
non-quarterly expirations. See Notice of Filing, 88 FR at 59998. OCC 
states further that the one-year lookback allows behavior changes of 
a Clearing Member to be recognized within an annual cycle. See id.
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    First, future liquidity exposures may exceed past exposures, so 
holding enough liquidity to meet historical demands does not ensure 
that OCC will hold enough to meet future exposures. To address this 
issue, OCC proposes to incorporate a member's total Required Fund 
Deposit and SLD obligations to NSCC (not just the portion represented 
in the GSP), into its liquidity risk management. As with most risk 
management, there is no guaranty that a future GSP could not exceed 
OCC's stress test exposures, but the proposed change increases the 
likelihood that OCC would have sufficient cash to pay the GSP.\29\
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    \29\ For example, assume the largest member obligation to NSCC 
would have been $100, but the largest GSP (representing the amount 
attributable to E&A Activity) would only have been $75. Rather than 
hold $75 and hope that the future exposures do not exceed past 
demands, OCC would hold $100 to cover a future GSP.
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    Second, the more E&A Activity that OCC sends to NSCC, the larger 
the amount of Required Fund Deposit and SLD attributable to E&A 
Activity. However, the level of E&A Activity varies predictably based 
on the expiration cycle of options such that different expiration 
cycles consistently present different volumes. Put simply, different 
expiration cycles are likely to pose different levels of liquidity risk 
to OCC in the form of the potential size of the GSP. Based on its 
analysis, OCC proposes to separate expirations into five 
categories.\30\ For each day, OCC proposes to apply the peak obligation 
observed over the prior 12 months within the relevant expiration 
category for that day.\31\ The five categories that

[[Page 19632]]

OCC proposes to employ are the following:
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    \30\ OCC provided its analysis supporting the specific 
categories to the Commission in confidential Exhibit 3E to File No. 
SR-OCC-2023-007. The confidential Exhibit 3E sets forth data related 
to OCC's liquidity stress testing for Sufficiency and Adequacy 
scenarios with and without the inclusion of the GSP, including 
Available Liquidity Resources, Minimum Cash Requirement thresholds, 
and liquidity breaches.
    \31\ For example, for a standard monthly expiration, which is 
typically the third Friday of the month, OCC would look at the peak 
obligation observed across all standard monthly expirations in the 
preceding 12 months.
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     Standard Monthly Expiration: typically the third Friday of 
each month;
     End of Week Expirations: the last business day of the 
week, excluding the third Friday of each month;
     End of Month Expirations: the last trading day of the 
month;
     Bank Holiday Expirations: days where banks are closed but 
the markets are open; \32\
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    \32\ The Bank Holiday category recognizes that for Veterans Day 
and Columbus Day, the equity and equity derivative markets are open 
for trading, but the banking system is closed. Because of this, 
settlement at NSCC encompasses two days of equity trading and E&A 
Activity. This creates the possibility of a significant outlying GSP 
requirement due to the settlement of two days of activity 
simultaneously. In OCC's view this necessitates the ability to 
separately risk manage such occurrences through the creation of the 
Bank Holiday category. Additional supporting data in support of the 
creation of the Bank Holiday Expiration category is included as 
Exhibit 3E to File No. SR-OCC-2023-007.
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     Daily Expirations: all other days with an expiration that 
do not fall into any of the categories above (typically most Mondays 
through Thursdays).
    Notwithstanding this categorization and the underlying analysis, 
OCC proposes to impose two floors to certain expirations. First, the 
peak obligation applied in the End of Week, End of Month, and Bank 
Holiday categories cannot be lower than the peak obligation observed in 
the Daily Expirations category. Second, the obligation applied in the 
Standard Monthly Expiration category cannot be lower than the peak 
obligation observed in either the End of Week, End of Month, or Daily 
Expiration category. As discussed below, the imposition of the floors 
would help OCC control for the possibility of an unusually large 
liquidity demand that is not related to the different expiration 
cycles.
    The liquidity risk management changes described above are part of 
Phase 1. Additionally, OCC proposes changes to its Rules and By-Laws to 
allow OCC to pay the GSP out of its liquid resources.\33\ Under Phase 
2, OCC proposes to make further clarifying and definitional changes in 
the LRMF, but the substance of the Phase 1 changes would persist in 
Phase 2.
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    \33\ For example, OCC proposes changes to its rules to allow OCC 
to borrow funds from the Clearing Fund to pay the GSP, which is 
consistent with OCC's use of the Clearing Fund to address other 
liquidity needs such as to cover losses resulting from a member's 
failure to satisfy an obligation on a confirmed trade accepted by 
OCC. See OCC Rule 1006(a)(i).
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C. Transition to T+1

    Phase 1 of the proposed changes are primarily designed to provide 
OCC the right to require NSCC to accept and guaranty the E&A Activity 
of a Common Member even if that member has not met its obligations to 
NSCC. The mechanism by which OCC would exercise that right would be the 
payment of the GSP to NSCC, and OCC would account for such payment as a 
potential liquidity demand that it must manage. Phase 1 does not, 
however, materially change the time at which OCC would cease (and NSCC 
would start) to guaranty the E&A Activity.\34\
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    \34\ The Commission described the current timing and process 
under which OCC's guaranty ceases and NSCC's guaranty attaches in a 
prior order. See Securities Exchange Act Release No. 81266 (July 31, 
2017), 82 FR 36484, 36486-87 (Aug. 4, 2017) (File No. SR-OCC-2017-
013).
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    Under the current Accord, NSCC's guaranty attaches (and OCC's 
ceases) when NSCC has received all Required Fund Deposits taking into 
account the E&A Activity.\35\ Currently, NSCC's guaranty would not 
attach if a Common Member defaults on its obligations to NSCC. Under 
Phase 1 of the proposed changes, however, OCC would have the 
opportunity to pay the GSP to NSCC as an effective substitution for the 
defaulted member's obligations with respect to the E&A Activity. Phase 
1, therefore, allows for a change in who pays NSCC, but does not alter 
the timing of payment.
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    \35\ See id. at 36487.
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    Phase 2 will alter the timing of payment, primarily to accommodate 
the transition from a T+2 settlement cycle to a T+1 settlement 
cycle.\36\ Under the current process, which takes place in a T+2 
settlement cycle, there is sufficient time after expiration for NSCC 
and OCC to determine whether a member has defaulted before NSCC begins 
to process settlement of the E&A Activity. However, in a T+1 settlement 
cycle, settlement processing could begin before NSCC or OCC become 
aware of a member default. Thus, in a T+1 environment, the timing and 
process by which OCC's guaranty would cease (and NSCC's would attach) 
would need to shift.
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    \36\ See Securities Exchange Act Release No. 96930 (Feb. 15, 
2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
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    Specifically, under Phase 2, OCC would commit to payment of the GSP 
(regardless of whether a member has defaulted) prior to NSCC's 
acceptance of E&A Activity. If OCC is unable to commit to pay the GSP, 
NSCC would be permitted, but not required, to reject the E&A Activity. 
The process would vary slightly between expirations occurring on a 
Friday and expirations occurring Monday through Thursday. For a Friday 
expiration, NSCC would communicate the GSP to OCC and OCC would 
subsequently commit to pay the GSP on Saturday morning. For Monday 
through Thursday expirations, OCC's transmission of the E&A Activity 
itself to NSCC would constitute a commitment by OCC to pay the GSP 
related to that E&A Activity.\37\ For all expirations, OCC would send 
the E&A Activity to NSCC by 1 a.m. the morning after expiration (e.g., 
1 a.m. Saturday for a Friday expiration). This would help ensure that, 
in a T+1 settlement environment, NSCC has OCC's commitment to pay the 
GSP before NSCC must begin processing any E&A Activity from OCC.
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    \37\ The requirement to commit prior to calculation of the final 
GSP for E&A Activity arising Monday through Thursday highlights the 
importance of the improved information sharing described above.
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III. Discussion and Notice of No Objection

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, the stated purpose of the Clearing 
Supervision Act is instructive: to mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for systemically 
important financial market utilities (``SIFMUs'') and strengthening the 
liquidity of SIFMUs.\38\
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    \38\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe regulations containing risk management 
standards for the payment, clearing, and settlement activities of 
designated clearing entities engaged in designated activities for which 
the Commission is the supervisory agency.\39\ Section 805(b) of the 
Clearing Supervision Act provides the following objectives and 
principles for the Commission's risk management standards prescribed 
under Section 805(a):\40\
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    \39\ 12 U.S.C. 5464(a)(2).
    \40\ 12 U.S.C. 5464(b).
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     To promote robust risk management;
     To promote safety and soundness;
     To reduce systemic risks; and
     To support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among other areas.\41\
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    \41\ 12 U.S.C. 5464(c).
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    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange

[[Page 19633]]

Act (the ``Clearing Agency Rules'').\42\ The Clearing Agency Rules 
require, among other things, each covered clearing agency to establish, 
implement, maintain, and enforce written policies and procedures that 
are reasonably designed to meet certain minimum requirements for its 
operations and risk management practices on an ongoing basis.\43\ As 
such, it is appropriate for the Commission to review advance notices 
against the Clearing Agency Rules and the objectives and principles of 
these risk management standards as described in Section 805(b) of the 
Clearing Supervision Act. As discussed below, the Commission believes 
the changes proposed in the Advance Notice are consistent with the 
objectives and principles described in Section 805(b) of the Clearing 
Supervision Act,\44\ and in the Clearing Agency Rules, in particular 
Rules 17Ad-22(e)(1), (e)(7), and (e)(20).\45\
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    \42\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (Oct. 22, 2012), 77 FR 66220 (Nov. 2, 2012) (S7-08-11). See 
also Securities Exchange Act Release No. 78961 (Sept. 28, 2016), 81 
FR 70786 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing Agency 
Standards''). OCC is a ``covered clearing agency'' as defined in 
Rule 17Ad-22(a)(5). See 17 CFR 240.17Ad-22(a)(5).
    \43\ 17 CFR 240.17Ad-22.
    \44\ 12 U.S.C. 5464(b).
    \45\ 17 CFR 240.17Ad-22(e)(1); 17 CFR 240.17Ad-22(e)(7); and 17 
CFR 240.17Ad-22(e)(20).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    The proposal contained in OCC's Advance Notice is consistent with 
the stated objectives and principles of Section 805(b) of the Clearing 
Supervision Act. In particular, the proposal is consistent with 
promoting robust risk management, promoting safety and soundness, 
reducing systemic risks, and supporting the stability of the broader 
financial system.\46\
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    \46\ 12 U.S.C. 5464(b).
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    The Advance Notice is consistent with promoting robust risk 
management, specifically liquidity risk management, as well as safety 
and soundness primarily because the introduction of the GSP would allow 
OCC to require NSCC to accept E&A Activity in the event of a Common 
Member default, so long as OCC pays the GSP to NSCC. Processing E&A 
Activity through NSCC's netting system would significantly reduce the 
risk posed by such E&A Activity by reducing the volume and value of 
settlement obligations.\47\ It would also reduce OCC's potential 
liquidity demands as a result of the E&A Activity from an amount that 
could exceed its available liquid resources to an amount that would 
fall well within its current liquid resources. Reducing OCC's liquidity 
risk in this manner is consistent with both sound risk management 
practices and safety and soundness more broadly. The information 
sharing contemplated under the proposed changes is also consistent with 
promoting robust risk management because it will allow OCC to better 
understand and monitor its exposures and provide for more dialogue 
between NSCC and OCC, which could, in turn, allow them to better manage 
the risks posed by the E&A Activity.
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    \47\ As noted above, it is estimated that, in 2022, netting 
through NSCC's CNS accounting system reduced the value of CNS 
settlement obligations by approximately 98% or $510 trillion from 
$519 trillion to $9 trillion. See Notice of Filing, 88 FR at 59977.
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    To the extent the proposed changes are consistent with promoting 
OCC's safety and soundness, they are also consistent with reducing 
systemic risks and supporting the stability of the broader financial 
system. OCC has been designated as a SIFMU, in part, because its 
failure or disruption could increase the risk of significant liquidity 
or credit problems spreading among financial institutions or 
markets.\48\ The proposed changes would support OCC's ability to 
continue providing services to the options markets by addressing losses 
and shortfalls arising out of the default of a Common Member. OCC's 
continued operations would, in turn, help support the stability of the 
financial system by reducing the risk of significant liquidity or 
credit problems spreading among market participants that rely on OCC's 
central role in the options market. Further, Phase 2 is consistent with 
supporting the stability of the broader financial system because the 
proposed changes in Phase 2 are designed to support the shortening of 
the standard settlement cycle for most broker-dealer transactions from 
T+2 to T+1.
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    \48\ See Financial Stability Oversight Council (``FSOC'') 2012 
Annual Report, Appendix A, https://home.treasury.gov/system/files/261/here.pdf (last visited Feb. 17, 2022).
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    Accordingly, and for the reasons stated above, the changes proposed 
in the Advance Notice are consistent with Section 805(b) of the 
Clearing Supervision Act.\49\
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    \49\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(1) Under the Exchange Act

    Rule 17Ad-22(e)(1) under the Exchange Act requires, in part, that a 
covered clearing agency establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to provide for a 
well-founded, clear, transparent, and enforceable legal basis for each 
aspect of its activities in all relevant jurisdictions.\50\ In adopting 
Rule 17Ad-22(e)(1), the Commission provided guidance that a covered 
clearing agency generally should consider in establishing and 
maintaining policies and procedures that address legal risk.\51\ The 
Commission stated that a covered clearing agency should consider, inter 
alia, whether its contracts are consistent with relevant laws and 
regulations.\52\
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    \50\ 17 CFR 240.17Ad-22(e)(1).
    \51\ See Covered Clearing Agency Standards, 81 FR at 70802.
    \52\ See id.
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    On February 15, 2023, the Commission adopted a final rule to 
shorten the standard settlement cycle for most broker-dealer 
transactions from two business days after the trade date to one 
business day after the trade date.\53\ Currently, and under Phase 1, 
the terms of the Accord are designed for consistency with a T+2 
settlement cycle. As described above, the terms of the Accord under 
Phase 2, which OCC intends to implement on the T+1 compliance date 
established by the Commission,\54\ would be designed for consistency 
with a T+1 settlement cycle.
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    \53\ See Securities Exchange Act Release No. 96930 (Feb. 15, 
2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
    \54\ See Notice of Amendment, 89 FR at 5968.
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    Accordingly, the proposal to amend the Accord to conform to a T+1 
settlement cycle is consistent with Rule 17Ad-22(e)(1) under the 
Exchange Act.\55\
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    \55\ 17 CFR 240.17Ad-22(e)(1).
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C. Consistency With Rule 17Ad-22(e)(7) Under the Exchange Act

    Rule 17Ad-22(e)(7) under the Exchange Act requires that a covered 
clearing agency establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to effectively measure, 
monitor, and manage the liquidity risk that arises in or is borne by 
the covered clearing agency, including measuring, monitoring, and 
managing its settlement and funding flows on an ongoing and timely 
basis, and its use of intraday liquidity.\56\ In adopting Rule 17Ad-
22(e)(7), the Commission provided guidance that a covered clearing 
agency generally should consider in establishing and maintaining 
policies and procedures that address liquidity risk.\57\ The Commission 
stated that a covered clearing agency should consider, inter alia, 
whether it maintains sufficient liquid resources in all relevant 
currencies to settle securities-related payments and meet

[[Page 19634]]

other payment obligations on time with a high degree of confidence 
under a wide range of stress scenarios.\58\
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    \56\ 17 CFR 240.17Ad-22(e)(7).
    \57\ See Covered Clearing Agency Standards, 81 FR at 70823.
    \58\ See id.
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    OCC's LRMF sets forth a comprehensive overview of OCC's liquidity 
risk management practices and governs OCC's policies and procedures as 
they relate to liquidity risk management. As described above, the 
potential cash necessary to manage a member default without utilizing 
NSCC's settlement process could exceed OCC's available liquid 
resources. The proposed changes to the Accord would allow OCC to send 
E&A Activity to NSCC even in the event of a Common Member default, 
which, based on an analysis of historical data, would reduce OCC's 
potential liquidity to an amount that is within the scope of its 
current resources.
    To take advantage of the proposed changes to the Accord, OCC must 
be prepared to make a cash payment to NSCC (i.e., the GSP). OCC 
proposes to recognize that potential payment obligation as an input to 
OCC's liquidity risk processes. In particular, OCC proposes to consider 
the full amount of a Common Member's past obligations to NSCC rather 
than consider only the portion of such obligation attributable to E&A 
Activity. OCC's reliance on historical data would allow it to 
approximate, but not predict potential future exposures. Reliance 
solely on past GSP requirements would not position OCC to cover a 
future peak GSP. The incorporation of the full amount of a Common 
Member's past obligations, however, would provide a buffer to increase 
the likelihood that OCC would be in a position to pay a future GSP that 
exceeds historical GSP requirements. OCC also proposes to align its 
measurement of the potential obligation to pay NSCC with the cyclical 
nature of the products that OCC clears,\59\ and to increase its 
information sharing with NSCC, which would allow OCC to better monitor 
the potential liquidity need posed by the GSP.
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    \59\ Alignment with the cyclical nature of the products would be 
achieved, as described above, through the use of expiration 
categories when incorporating collateral requirements into OCC's 
stress testing. To balance this process, however, OCC would also 
impose floors across expiration categories that would help control 
for the possibility for an unusually large liquidity demand that is 
not related to the different expiration cycles.
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    Accordingly, the proposed changes to the Accord regarding the GSP 
and to OCC's internal liquidity risk management rules are consistent 
with Rule 17Ad-22(e)(7) under the Exchange Act.\60\
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    \60\ 17 CFR 240.17Ad-22(e)(7).
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D. Consistency With Rule 17Ad-22(e)(20) Under the Exchange Act

    Rule 17Ad-22(e)(20) under the Exchange Act requires that a covered 
clearing agency establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to identify, monitor, and 
manage risks related to any link the covered clearing agency 
establishes with one or more other clearing agencies, financial market 
utilities, or trading markets.\61\ For the purposes of Rule 17Ad-
22(e)(20), ``link'' means, among other things, a set of contractual and 
operational arrangements between two or more clearing agencies, 
financial market utilities, or trading markets that connect them 
directly or indirectly for the purpose of participating in 
settlement.\62\
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    \61\ 17 CFR 240.17Ad-22(e)(20).
    \62\ 17 CFR 240.17Ad-22(a)(8).
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    In adopting Rule 17Ad-22(e)(20), the Commission provided guidance 
that a covered clearing agency generally should consider in 
establishing and maintaining policies and procedures that address 
links.\63\ Notably, the Commission stated that a covered clearing 
agency should consider whether a link has a well-founded legal basis, 
in all relevant jurisdictions, that supports its design and provides 
adequate protection to the covered clearing agencies involved in the 
link.\64\
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    \63\ See Covered Clearing Agency Standards, 81 FR at 70841.
    \64\ Id.
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    As described above, the Accord is a contractual arrangement between 
NSCC and OCC that governs the processing of E&A Activity, which 
consists of settlement obligations arising out of certain products 
cleared by OCC. The Accord, therefore, is a link for the purposes of 
Rule 17Ad-22(e)(20). The specific legal basis for the Accord to conform 
to a T+1 settlement cycle was discussed above in section III.B. 
Likewise, Section III.C. discussed the ways the Accord provides 
adequate protection to both OCC and NSCC by introducing the GSP, 
enhancing information sharing between OCC and NSCC, and ensuring that 
OCC and NSCC have the tools and information they need to monitor the 
potential liquidity need posed by the GSP.
    For the reasons discussed in those sections, the Accord between OCC 
and NSCC has a well-founded legal basis that supports its design and 
provides adequate protection to the covered clearing agencies involved 
in the Accord. Accordingly, the proposed changes to the Accord are 
consistent with Rule 17Ad-22(e)(20) under the Exchange Act.\65\
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    \65\ 17 CFR 240.17Ad-22(e)(20).
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IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission DOES NOT OBJECT to 
Advance Notice (SR-OCC-2023-801) as modified by Partial Amendment No. 1 
and Amendment No. 2, and that OCC is AUTHORIZED to implement the 
proposed changes as of the date of this notice or the date of an order 
by the Commission approving proposed rule change SR-OCC-2023-007, 
whichever is later.

    By the Commission.

Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-05734 Filed 3-18-24; 8:45 am]
BILLING CODE 8011-01-P