Notice2022-02913
Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Proposed Rule Change Concerning the Options Clearing Corporation's Margin Methodology for Incorporating Variations in Implied Volatility
Primary source
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Published
February 11, 2022
Issuing agencies
Securities and Exchange Commission
Full Text
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[Federal Register Volume 87, Number 29 (Friday, February 11, 2022)]
[Notices]
[Pages 8072-8080]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-02913]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-94165; File No. SR-OCC-2022-001]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Concerning the Options
Clearing Corporation's Margin Methodology for Incorporating Variations
in Implied Volatility
February 7, 2022.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on January 24, 2022, the Options Clearing
Corporation (``OCC'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by OCC. The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
This proposed rule change would modify OCC's margin methodology,
the System for Theoretical Analysis and Numerical Simulations
(``STANS''), to simplify the methodology, control procyclicality in
volatility modeling, provide natural offsets for volatility products
with similar characteristics, and build the foundation for a single,
consistent framework to model equity volatility products in margin and
stress testing. Specifically, this proposed rule change would:
(1) Implement a new model for incorporating variations in
implied volatility within STANS for products based on the S&P 500
Index (such index hereinafter referred to as ``S&P 500'' and such
proposed model being the ``S&P 500 Implied Volatility Simulation
Model'') to provide consistent and smooth simulated volatility
scenarios;
(2) implement a new model to calculate the theoretical values of
futures on indexes designed to measure volatilities implied by
prices of options on a particular underlying index (such indexes
being ``volatility indexes''; futures contracts on such volatility
indexes being ``volatility index futures''; and such proposed model
being the ``Volatility Index Futures Model'') to provide consistent
and stable coverage across all maturities; and
(3) replace OCC's model to calculate the theoretical values of
exchange-traded futures contracts based on the expected realized
variance of an underlying interest (such contracts being ``variance
futures,'' and such model being the ``Variance Futures Model'') with
one that provides adequate margin coverage while providing offsets
for hedged positions in the listed options market.
The proposed changes to OCC's STANS Methodology document are
contained in confidential Exhibit 5 of filing SR-OCC-2022-001.
Amendments to the existing text are marked by underlining and material
proposed to be deleted is marked by strikethrough text. The proposed
changes are described in detail in Item 3 below. New sections 2.1.4
(S&P 500 Implied Volatilities Scenarios) and 2.1.8 (Volatility Index
Futures), and the replacement text for section 2.1.7 (Variance
Futures), specific to the proposed models, are presented without
marking. Existing Section 2.1.4 through 2.1.7 have been renumbered to
reflect the addition of the new sections but are otherwise unchanged.
The proposed rule change does not require any changes to the text of
OCC's By-Laws or Rules. All terms with initial capitalization that are
not otherwise defined herein have the same meaning as set forth in the
OCC By-Laws and Rules.\3\
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\3\ OCC's By-Laws and Rules can be found on OCC's public
website: <a href="https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules">https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules</a>.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of these
statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
(1) Purpose
Background
STANS Overview
STANS is OCC's proprietary risk management system for calculating
Clearing Member margin requirements.\4\ The STANS methodology utilizes
large-scale Monte Carlo simulations to forecast price and volatility
movements in determining a Clearing Member's margin requirement.\5\
STANS margin requirements are calculated at the portfolio level of
Clearing Member accounts with positions in marginable securities and
consists of an estimate of two primary components: a base component and
a concentration/dependence stress test add-on component. The base
component is an estimate of a 99% expected shortfall \6\ over a two-day
time horizon. The concentration/dependence stress test add-on is
obtained by considering increases in the expected margin shortfall for
an account that would occur due to (i) market movements that are
especially large and/or in which certain risk factors would exhibit
perfect or zero correlations rather than correlations otherwise
estimated using historical data or (ii) extreme and adverse
idiosyncratic movements for individual risk factors to which the
account is particularly exposed. OCC uses the STANS methodology to
measure the exposure of portfolios of options and futures cleared by
OCC and cash instruments in margin collateral, including volatility
index futures and variance futures.\7\
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\4\ See Exchange Act Release No. 91079 (Feb. 8, 2021), 86 FR
9410 (Feb. 12, 2021) (File No. SR-OCC-2020-016). OCC makes its STANS
Methodology description available to Clearing Members. An overview
of the STANS methodology is on OCC's public website: <a href="https://www.theocc.com/Risk-Management/Margin-Methodology">https://www.theocc.com/Risk-Management/Margin-Methodology</a>.
\5\ See OCC Rule 601.
\6\ The expected shortfall component is established as the
estimated average of potential losses higher than the 99% value at
risk threshold. The term ``value at risk'' or ``VaR'' refers to a
statistical technique that, generally speaking, is used in risk
management to measure the potential risk of loss for a given set of
assets over a particular time horizon.
\7\ Pursuant to OCC Rule 601(e)(1), OCC also calculates initial
margin requirements for segregated futures accounts on a gross basis
using the Standard Portfolio Analysis of Risk Margin Calculation
System (``SPAN''). Commodity Futures Trading Commission (``CFTC'')
Rule 39.13(g)(8), requires, in relevant part, that a derivatives
clearing organization (``DCO'') collect initial margin for customer
segregated futures accounts on a gross basis. While OCC uses SPAN to
calculate initial margin requirements for segregated futures
accounts on a gross basis, OCC believes that margin requirements
calculated on a net basis (i.e., permitting offsets between
different customers' positions held by a Clearing Member in a
segregated futures account using STANS) affords OCC additional
protections at the clearinghouse level against risks associated with
liquidating a Clearing Member's segregated futures account. As a
result, OCC calculates margin requirements for segregated futures
accounts using both SPAN on a gross basis and STANS on a net basis,
and if at any time OCC staff observes a segregated futures account
where initial margin calculated pursuant to STANS on a net basis
exceeds the initial margin calculated pursuant to SPAN on a gross
basis, OCC collateralizes this risk exposure by applying an
additional margin charge in the amount of such difference to the
account. See Exchange Act Release No. 72331 (June 5, 2014), 79 FR
33607 (June 11, 2014) (File No. SR-OCC-2014-13).
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[[Page 8073]]
The models in STANS currently incorporate a number of risk factors.
A ``risk factor'' within OCC's margin system is defined as a product or
attribute whose historical data is used to estimate and simulate the
risk for an associated product. The majority of risk factors utilized
in the STANS methodology are the returns on individual equity
securities; however, a number of other risk factors may be considered,
including, among other things, returns on implied volatility.
Current Implied Volatilities Scenarios Model
Generally speaking, the implied volatility of an option is a
measure of the expected future volatility of the option's underlying
security at expiration, which is reflected in the current option
premium in the market. Using the Black-Scholes options pricing model,
the implied volatility is the standard deviation of the underlying
asset price necessary to arrive at the market price of an option of a
given strike, time to maturity, underlying asset price and the current
discount interest rate. In effect, the implied volatility is
responsible for that portion of the premium that cannot be explained by
the current intrinsic value of the option (i.e., the difference between
the price of the underlying and the exercise price of the option),
discounted to reflect its time value. OCC considers variations in
implied volatility within STANS to ensure that the anticipated cost of
liquidating options positions in an account recognizes the possibility
that the implied volatility could change during the two-business day
liquidation time horizon and lead to corresponding changes in the
market prices of the options.
Using its current Implied Volatilities Scenarios Model,\8\ OCC
models the variations in implied volatility used to re-price options
within STANS for substantially all option contracts \9\ available to be
cleared by OCC that have a residual tenor \10\ of less than three years
(``Shorter Tenor Options'').\11\ To address variations in implied
volatility, OCC models a volatility surface \12\ for Shorter Tenor
Options by incorporating certain risk factors (i.e., implied volatility
pivot points) based on a range of tenors and option deltas \13\ into
the models in STANS. Currently, these implied volatility pivot points
consist of three tenors of one month, three months and one year, and
three deltas of 0.25, 0.5, and 0.75, resulting in nine implied
volatility risk factors. These pivot points are chosen such that their
combination allows the model to capture changes in level, skew (i.e.,
strike price), convexity, and term structure of the implied volatility
surface. OCC uses a GARCH model \14\ to forecast the volatility for
each implied volatility risk factor at the nine pivot points.\15\ For
each Shorter Tenor Option in the account of a Clearing Member, changes
in its implied volatility are simulated using forecasts obtained from
daily implied volatility market data according to the corresponding
pivot point and the price of the option is computed to determine the
amount of profit or loss in the account under the particular STANS
price simulation. Additionally, OCC uses simulated closing prices for
the assets underlying the options in the account of a Clearing Member
that are scheduled to expire within the liquidation time horizon of two
business days to compute the options' intrinsic value and uses those
values to help calculate the profit or loss in the account.\16\
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\8\ In December 2015, the Commission approved a proposed rule
change and issued a Notice of No Objection to an advance notice
filed by OCC to modify its margin methodology by more broadly
incorporating variations in implied volatility within STANS. See
Exchange Act Release No. 76781 (Dec. 28, 2015), 81 FR 135 (Jan. 4,
2016) (File No. SR-OCC-2015-016); Exchange Act Release No. 76548
(Dec. 3, 2015), 80 FR 76602 (Dec. 9, 2015) (File No. SR-OCC-2015-
804). Initially named the ``Implied Volatility Model,'' OCC re-
titled the model the ``Implied Volatilities Scenarios Model'' in
2021 as part of the STANS Methodology's broader reorganization of
OCC's Margin Methodology. See Exchange Act Release No. 90763 (Dec.
21, 2020), 85 FR 85788, 85792 (Dec. 29, 2020) (File No. SR-OCC-2020-
016).
\9\ OCC's Implied Volatilities Scenarios Model excludes (i)
binary options, (ii) options on commodity futures, (iii) options on
U.S. Treasury securities, and (iv) Asians and Cliquets.
\10\ The ``tenor'' of an option is the amount of time remaining
to its expiration.
\11\ OCC currently incorporates variations in implied volatility
as risk factors for certain options with residual tenors of at least
three years (``Longer Tenor Options'') by a separate process. See
Exchange Act Release No. 68434 (Dec. 14, 2012), 77 FR 57602 (Dec.
19, 2012) (File No. SR-OCC-2012-14); Exchange Act Release No. 70709
(Oct. 18, 2013), 78 FR 63267 (Oct. 23, 2013) (File No. SR-OCC-2013-
16). Because all Longer Tenor Options are S&P 500-based products,
the proposed S&P 500 Implied Volatility Simulation Model would
eliminate the separate process for Longer Tenor Options with a
single methodology for all S&P 500 options.
\12\ The term ``volatility surface'' refers to a three-
dimensional graphed surface that represents the implied volatility
for possible tenors of the option and the implied volatility of the
option over those tenors for the possible levels of ``moneyness'' of
the option. The term ``moneyness'' refers to the relationship
between the current market price of the underlying interest and the
exercise price.
\13\ The ``delta'' of an option represents the sensitivity of
the option price with respect to the price of the underlying
security.
\14\ The acronym ``GARCH'' refers to an econometric model that
can be used to estimate volatility based on historical data. See
generally Tim Bollerslev, ``Generalized Autoregressive Conditional
Heteroskedasticity,'' Journal of Econometrics, 31(3), 307-327
(1986).
\15\ STANS relies on 10,000 price simulation scenarios that are
based generally on a historical data period of 500 business days,
which are updated daily to keep model results from becoming stale.
\16\ For such Shorter Tenor Options that are scheduled to expire
on the open of the market rather than the close, OCC uses the
relevant opening price for the underlying assets.
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In January 2019,\17\ OCC modified the Implied Volatilities
Scenarios Model after OCC's analyses of the model demonstrated that the
volatility changes forecasted by the GARCH model were extremely
sensitive to sudden spikes in volatility, which at times resulted in
overreactive margin requirements that OCC believed were unreasonable
and procyclical.\18\ To reduce the oversensitivity of the Implied
Volatilities Scenarios Model to large, sudden shocks in market
volatility and therefore result in margin requirements that are more
stable and that remain commensurate with the risks presented during
periods of sudden, extreme volatility, OCC modified the Implied
Volatilities Scenarios Model to use an exponentially weighted moving
average \19\ of forecasted volatilities over a specified look-back
period rather than using raw daily forecasted volatilities. The
exponentially weighted moving average involves the selection of a look-
back period over which the data would be averaged and a decay factor
(or weighting factor), which is a positive number between zero and one,
that represents the weighting factor for the
[[Page 8074]]
most recent data point.\20\ The look-back period and decay factor are
model parameters subject to monthly review, along with other model
parameters that are reviewed by OCC's Model Risk Working Group
(``MRWG'') \21\ in accordance with OCC's internal procedure for margin
model parameter review and sensitivity analysis, and these parameters
are subject to change upon approval of the MRWG.
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\17\ In December 2018, the Commission approved a proposed rule
change and issued a Notice of No Objection to an advance notice
filed by OCC to modify the Implied Volatilities Scenarios Model. See
Exchange Act Release No. 84879 (Dec. 20, 2018), 83 FR 67392 (Dec.
29, 2018) (File No. SR-OCC-2018-014); Exchange Act Release No. 84838
(Dec. 19, 2018), 83 FR 66791 (Dec. 27, 2018) (File No. SR-OCC-2018-
804).
\18\ A quality that is positively correlated with the overall
state of the market is deemed to be ``procyclical.'' While margin
requirements from risk-based margin models normally fluctuate with
market volatility, a margin model can be procyclical if it
overreacts to market conditions, such as generating drastic spikes
in margin requirements in response to jumps in market volatility.
Anti-procyclical features in a model are measures intended to
prevent risk-based models from fluctuating too drastically in
response to changing market conditions.
\19\ An exponentially weighted moving average is a statistical
method that averages data in a way that gives more weight to the
most recent observations using an exponential scheme.
\20\ The lower the number the more weight is attributed to the
more recent data (e.g., if the value is set to one, the
exponentially weighted moving average becomes a simple average).
\21\ The MRWG is responsible for assisting OCC's Management
Committee in overseeing OCC's model-related risk and includes
representatives from OCC's Financial Risk Management department,
Quantitative Risk Management department, Model Validation Group, and
Enterprise Risk Management department.
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The current Implied Volatilities Scenarios Model is subject to
certain limitations and issues, which would be addressed by the
proposed changes described herein. While the overlay of an
exponentially weighted moving average reduces and delays the impact of
large implied volatility spikes, it does so in an artificial way that
does not target the primary issues that OCC identified with the GARCH
model. Consequently, the 2019 modifications were intended to be a
temporary solution.
The current model uses the ``nearest neighbor'' method to switch
pivot points in the implied volatility surface, which introduces
discontinuity in the implied volatility curve for a given tenor. In
addition, the implied volatility scenarios for call and put options
with the same tenor and strike price are not equal. These issues
introduce inconsistencies in implied volatility scenarios.\22\ Due to
the use of arithmetic implied volatility returns in the current
model,\23\ it can produce near zero implied volatility, which is
unrealistic, in a few simulated scenarios.
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\22\ The inconsistency arises from the assumption that call
deltas are equivalent to put deltas plus one, which is not well
justified.
\23\ The arithmetic return of an implied volatility over a
single period of any length of time is calculated by dividing the
difference between final value and initial value by the initial
value.
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In addition, the current model does not impose constraints on the
nine pivot points to ensure that simulated surfaces are arbitrage-free
because the pivots are not modeled consistently. As a result, the
simulated implied volatility surfaces often allow arbitrages across
options. Because of the potential for arbitrage, the implied
volatilities are not adequate inputs to price variance futures and
volatility index futures accurately, both of which assume an arbitrage-
free condition.\24\ Furthermore, the current Implied Volatilities
Scenarios Model may not provide natural offsetting of risks in accounts
that contain combinations of S&P 500 options, variance futures, and/or
volatility index futures because the copula utilized in the current
model indirectly captures the correlation effect between S&P 500
options and volatility index futures or variance futures.
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\24\ Currently, the S&P 500 underlying price scenario generated
from the Variance Futures Model is used as input data for variance
futures. For volatility index futures, synthetic VIX futures time
series generated by the Synthetic Futures Model are used as input
data to calibrate model parameters, as discussed below.
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Current Synthetic Futures Model
Volatility indexes are indexes designed to measure the volatility
that is implied by the prices of options on a particular reference
index or asset. For example, Cboe's Volatility Index (``VIX'') is an
index designed to measure the 30-day expected volatility of the S&P
500. Volatility index futures can consequently be viewed as an
indication of the market's future expectations of the volatility of a
given volatility index's underlying reference index (e.g., in the case
of the VIX, providing a snapshot of the expected market volatility of
the S&P 500 over the term of the options making up the index). OCC
clears futures contracts on such volatility indexes.
OCC currently uses the Synthetic Futures Model to calculate the
theoretical value of volatility index futures, among other
products,\25\ for purposes of calculating margin for Clearing Member
portfolios. OCC's current approach for projecting the potential final
settlement prices of volatility index futures models the price
distributions of ``synthetic'' futures on a daily basis based on the
historical returns of futures contracts with approximately the same
tenor.\26\ The Synthetic Futures Model uses synthetic time series of
500 daily proportional returns created from historical futures. Once
futures mature, the synthetic time series roll from the nearer-term
futures to the next further out futures on the day subsequent to the
front-month maturity date. Thus, the front-month synthetic always
contains returns of the front contract; the second synthetic
corresponds to the next month out, and so on. While synthetic time
series contain returns from different contracts, a return on any given
date is constructed from prices of the same contract (e.g., as the
front-month futures contract ``rolls'' from the current month to the
subsequent month, returns on the roll date are constructed by using the
same contract and not by calculating returns across months). The
econometric model currently used in STANS for purposes of modeling
proportionate returns of the synthetic futures is an asymmetric
GARCH(1,1) with an asymmetric Standardized Normal Reciprocal Inverse
Gaussian (or ``NRIG'')-distributed logarithmic returns.\27\ The
correlation between S&P 500 options and VIX futures are controlled by a
copula.
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\25\ OCC also applies the Synthetic Futures Model to (i) futures
on the American Interbank Offered Rate (``AMERIBOR'') disseminated
by the American Financial Exchange, LLC, which is a transaction-
based interest rate benchmark that represents market-based borrowing
costs; (ii) futures products linked to indexes comprised of
continuous yield based on the most recently issued (i.e., ``on-the-
run'') U.S. Treasury notes listed by Small Exchange Inc. (``Small
Treasury Yield Index Futures''); and (iii) futures products linked
to Light Sweet Crude Oil (WTI) listed by Small Exchange (``Small
Crude Oil Futures''). See Exchange Act Release No. 89392 (July 24,
2020), 85 FR 45938 (July 30, 2020) (File No. SR-OCC-2020-007)
(AMERIBOR futures); Exchange Act Release No. 90139 (Oct. 8, 2020),
85 FR 65886 (Oct. 16, 2020) (File No. SR-OCC-2020-012) (Small
Treasury Yield Index Futures); Exchange Act Release No. 91833 (May
10, 2021), 86 FR 26586 (May 14, 2021) (File No. SR-OCC-2021-005)
(Small Crude Oil Futures). Notwithstanding the proposed charges
herein, OCC would continue to use the current Synthetic Futures
Model to model prices for interest rate futures on AMERIBOR, Small
Treasury Yield Index Futures and Small Crude Oil Futures.
\26\ A ``synthetic'' futures time series relates to a uniform
substitute for a time series of daily settlement prices for actual
futures contracts, which persists over many expiration cycles and
thus can be used as a basis for econometric analysis. One feature of
futures contracts is that each contract may have a different
expiration date, and at any one point in time there may be a variety
of futures contracts on the same underlying interest, all with
varying dates of expiration, so that there is no one continuous time
series for those futures. Synthetic futures can be used to generate
a continuous time series of futures contract prices across multiple
expirations. These synthetic futures price return histories are
inputted into the existing Copula simulation process in STANS
alongside the underlying interests of OCC's other cleared and cross-
margin products and collateral. The purpose of this use of synthetic
futures is to allow the margin system to better approximate
correlations between futures contracts of different tenors by
creating more price data points and their margin offsets.
\27\ See Exchange Act Release No. 85873 (May 16, 2019), 84 FR
23620 (May 22, 2019) (File No. SR-OCC-2019-002); Exchange Act
Release No. 85870 (May 15, 2019), 84 FR 23096 (May 21, 2019) (File
No. SR-OCC-2019-801).
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The current synthetic modeling approach suffers from limitations
and issues similar to the current Implied Volatilities Scenarios Model.
For one, the current synthetic model relies on the GARCH variance
forecast, which, as described above, is prone to volatility shocks. To
address this, the Synthetic Futures Model employs an anti-procyclical
floor for variance
[[Page 8075]]
estimates.\28\ Secondly, the current synthetic model makes the rolling
volatility futures contracts take on different variances from
calibration at futures roll dates, which could translate to jumps in
margin.
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\28\ In order to incorporate a variance level implied by a
longer time series of data, OCC calculates a floor for variance
estimates based on the underlying index (e.g., VIX) which is
expected to have a longer history that is more reflective of the
long-run variance level that cannot be otherwise captured using the
synthetic futures data. The floor therefore reduces the impact of a
sudden increase in margin requirements from a low level and
therefore mitigates procyclicality in the model.
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Current Model for Variance Futures
Variance futures are commodity futures for which the underlying
interest is a variance.\29\ Variance futures differ from volatility
index futures in that the underlying variance is calculated using only
historical daily closing values of the reference variable while an
underlying volatility index represents the implied volatility component
of bid and ask premium quotations for options on a reference variable.
When a variance futures contract is listed, it defines the initial
variance strike. This initial variance strike represents the estimated
future variance at contract expiration. The final settlement value is
determined based on a standardized formula for calculating the realized
variance of the S&P 500 measured from the time of initial listing until
expiration of the contract. At maturity, the buyer of the contract pays
the amount of predefined strike to the seller and the seller pays the
realized variances. Therefore, the buyer profits if the realized
variance at maturity exceeds the predefined variance strike. S&P 500
variance futures are exchange-traded futures contracts based on the
realized variance of the S&P 500.
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\29\ A variance is a statistical measure of the variability of
price returns relative to an average (mean) price return.
Accordingly, OCC believes that an underlying variance is a
``commodity'' within the definition of Section 1a(4) of the
Commodity Exchange Act (``CEA''), which defines ``commodity'' to
include ``all . . . rights, and interests in which contracts for
future delivery are presently or in the future dealt in.'' 7 U.S.C.
1a(9). OCC believes a variance is neither a ``security'' nor a
``narrow-based security index'' as defined in Section 3(a)(10) and
Section 3(a)(55)(A) of the Exchange Act, respectively, and therefore
is within the exclusive jurisdiction of the CFTC. OCC clears this
product in its capacity as a DCO registered under Section 5b of the
CEA. See Exchange Act Release No. 49925 (June 28, 2004), 69 FR 40447
(July 2, 2004) (File No. SR-OCC-2004-08).
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OCC uses the current Variance Futures Model to calculate the
theoretical value of variance futures for purposes of calculating
margin for Clearing Member portfolios. OCC's current Variance Futures
Model was introduced in 2007 and is an econometric model designed to
capture long- and short-term conditional variance of the underlying S&P
500 to generate variance futures prices. OCC's current approach to
modeling variance futures has several disadvantages. OCC currently
models variance futures by simulating a final settlement price rather
than a near-term variance futures price. This approach is not
consistent with OCC's two-day liquidation horizon. In addition, the
current Variance Futures Model is based on an econometric model that
assumes the S&P 500 return variance can be described by the GARCH(1,1)
model and that the long-term variation follows and Ornstein-Uhlenbeck
process.\30\ As with the use of GARCH for the Implied Volatilities
Scenarios Model, this approach has several limitations, including (1)
the current approach does not provide appropriate risk offsets with
other instruments closely related to the S&P 500 implied volatility,
such as VIX futures; and (2) the margin rates it generates are too
conservative for short positions and too aggressive for long positions,
which causes model backtesting to fail.
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\30\ See Uhlenbeck, G. E. and L.S. Ornstein, ``On the Theory of
Brownian Motion,'' Physical Review, 36, 823-841 (1930) (explaining
the Gaussian Ornstein-Uhlenbeck process).
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Proposed Change
OCC is proposing to replace the Implied Volatilities Scenarios
Model for S&P 500-based products, the Synthetic Futures Model for
volatility index-based products, and the Variance Future Model for
variance futures with new models that would simplify the STANS
methodology, control procyclicality in volatility modeling, provide
natural offsets for volatility products with similar characteristics,
and build the foundation for a single, consistent framework to model
equity volatility products in margin and stress testing.
Proposed Changes to the Implied Volatilities Scenarios Model for S&P
500-Based Products
OCC proposes to replace the current Implied Volatilities Scenarios
Model with the proposed S&P 500 Implied Volatility Simulation Model for
the S&P 500 product group.\31\ The purpose of the proposed S&P 500
Implied Volatility Simulation Model is to establish a consistent and
robust framework for implied volatility simulation, provide appropriate
control for procyclicality in S&P 500 implied volatility modeling, and
provide natural offsets for volatility products with similar
characteristics to S&P 500 implied volatility (e.g., VIX futures and
options). The output of the S&P 500 Implied Volatility Simulation Model
would be used by OCC's options pricing model, as well as the proposed
Volatility Index Futures Model and Variance Futures Model.
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\31\ The S&P 500 Implied Volatility Model has been designed to
model implied volatility dynamics for options written on the S&P 500
and related indexes, such as S&P 500 index options (``SPX'') and S&P
500 Exchange Traded Funds (``SPY'') options, options on S&P 500
futures, and related implied volatility derivatives such as VIX
futures and Miax's SPIKES Volatility Index (``SPIKES''). While OCC
would continue to use the current Implied Volatilities Scenarios
Model for the products other than S&P 500-based products to which
the model currently applies, the S&P 500 Implied Volatility
Simulation Model is intended to provide a foundation upon which OCC
can build a single consistent framework to model single-name and
index/futures equity volatility products for margin and stress
testing.
---------------------------------------------------------------------------
Proposed S&P 500 Implied Volatility Simulation Model Description
The proposed S&P 500 Implied Volatility Simulation Model is a Monte
Carlo simulation model that captures the risk dynamics in S&P 500
implied volatility surface including its term structure and skew. This
proposed model aims to provide enhanced treatment for simulating the
dynamics of S&P 500 options and replace the nine-pivot approach in
STANS, to provide appropriate control for procyclicality in S&P 500
implied volatility modeling, and to provide natural offsets for
volatility products with similar characteristics of S&P 500 implied
volatility (e.g., VIX futures and options).
The proposed approach would model the implied volatility surface in
the space of standardized log-moneyness and tenor. Based on the
approximation of the Bergomi-Guyon expansion,\32\ the dynamics of S&P
500 implied volatility surface would be characterized by an affine
model. In the model, the dynamics of S&P 500 at-the-money (``ATM'')
implied volatility would be specified precisely in the form of
stochastic differential equations \33\ for a fixed number of key
tenors. The changes of S&P 500 ATM implied volatility across different
tenors would be characterized by the volatility-of-volatility of the
anchor tenor with a power law decay term structure and a residual term-
specific random process. The power law decay parameter would be modeled
as a function of S&P 500
[[Page 8076]]
1-month ATM implied volatility. For any arbitrary tenors within the key
tenor range, the term-specific correlation structure would be given by
a linear interpolation across the nearest two key tenors. For any
arbitrary tenors outside the key tenor range, the term-specific
correlation structure would be determined by the shortest or longest
key tenor, respectively.
---------------------------------------------------------------------------
\32\ See Bergomi, Lorenzo, and Julien Guyon, ``Stochastic
volatility's orderly smiles,'' Risk 25.5 (2012): 60.
\33\ A stochastic differential equation is a differential
equation in which one or more of the terms is a stochastic process,
resulting in a solution which is also a stochastic process.
---------------------------------------------------------------------------
OCC assumes changes of skew (i.e., skew shock) evolve
proportionally across different standardized log-moneyness and also
follow a power law decay term structure. OCC would model the S&P 500 1-
month implied volatility skew shock via a linear regression approach
conditional on the changes of S&P 500 1-month ATM implied volatility
and an idiosyncratic term.
OCC would generate the simulated scenarios of S&P 500 implied
volatility surface by first applying shocks across term structure and
then skew shock across moneyness to the initial S&P 500 implied
volatility surface (obtained through OCC's smoothing algorithm).\34\
Along with other risk factors in STANS, the standard uniform draws of
the S&P 500 1-month ATM implied volatility risk factor is generated
from Copula. First, the log-return scenarios of S&P 500 1-month ATM
implied volatility would be simulated from a Hansen's skewed t
distribution with pre-determined degrees-of-freedom and skewness
parameters. The forecasted volatility-of-volatility for S&P 500 1-month
ATM implied volatility would be estimated based on the 30-day VVIX,
Cboe's option-implied volatility-of-volatility index. An equal-weighted
look-back moving average would be applied to smooth the daily 30-day
VVIX. To control for procyclicality, a dynamic scaling factor would be
applied to the smoothed 30-day VVIX. The log-return scenarios of S&P
500 ATM implied volatility for a given listed tenor would be generated
based on the log-return scenarios of the 1-month ATM implied volatility
with a power law decay and the term-specific residuals for tenors
longer than 1 month. The random variables for the term-specific
residual diffusion process would be drawn from a multivariate Student's
t distribution with common degrees-of-freedom.
---------------------------------------------------------------------------
\34\ The smoothing algorithm is the process that OCC uses to
estimate fair values for plain vanilla listed options based on
closing bid and ask price quotes. See Exchange Act Release No. 86731
(Aug. 22, 2019), 84 FR 45188, 45189 (Aug. 28, 2019) (File No. SR-
OCC-2019-005).
---------------------------------------------------------------------------
Secondly, OCC would simulate the S&P 500 1-month implied volatility
skew shock conditional on the log-return scenarios of S&P 500 1-month
ATM implied volatility and an idiosyncratic term. OCC would generate
the skew shock scenarios for listed options with arbitrary tenors and
standardized log-moneyness by applying the power law decay and scaling
by the stylized standardized log-moneyness scenarios. Finally, OCC
would add the skew shock scenario to the shocked S&P 500 ATM implied
volatility scenario to obtain the final S&P 500 implied volatility
scenario for an arbitrary tenor and standardized log-moneyness. OCC
would use the simulated S&P 500 implied volatility scenarios to
generate option prices used in margin estimation and stress testing.
Proposed S&P 500 Implied Volatility Simulation Model Performance
The proposed S&P 500 Implied Volatility Simulation Model simplifies
the STANS methodology by minimizing the number of implied volatility
risk factors. Under the current model, the nine implied volatility
pivots used to simulate volatility scenarios have significantly
increased the dimension of the Student's t copula by adding nine risk
factors to every index or security that has listed options. The
proposed S&P 500 Implied Volatility Simulation Model would employ a
simpler approach to model the S&P 500 implied volatility surface so
that key risk factors driving the implied volatility surface are
explicitly modeled within the model itself. By modeling the implied
volatility surface directly, instead of using the nine-pivot approach,
the simulated implied volatility surface would be smooth and continuous
in both term structure and moneyness dimensions. In addition, put and
call options with the same tenors and strike prices would have the same
implied volatility scenarios under the proposed model. Thus, the S&P
500 Implied Volatility Simulation Model would address issues with the
current model's implied volatility surface and scenarios as discussed
above.
To compensate for the procyclicality in the GARCH process, the
current model employs an exponentially weighted moving average overlay
to reduce and delay the impact of large implied volatility spikes. In
the proposed S&P 500 Implied Volatility Simulation Model, the
forecasted variance of the S&P 500 1-Month ATM implied volatility would
be simulated using the smoothed 30-day VVIX, which is a proxy of the
option-implied volatility-of-volatility, scaled by a dynamic factor to
control for procyclicality. OCC believes the proposed model would be a
better and sounder method to produce consistent and smooth simulated
implied volatility scenarios in both term structure and skew dimensions
for S&P 500 and to control the procyclicality in margin requirements.
As borne out by observations on the performance of the proposed model
discussed below, OCC believes that these proposed changes also reduce
the oversensitivity observed with the GARCH process under the current
Implied Volatilities Scenarios Model to large, sudden shocks in market
volatility and produce margin requirements that are more stable and
that remain commensurate with the risks presented during stressed
periods.
Based on its analysis of the S&P 500 Implied Volatility Simulation
Model's performance, OCC concludes that the proposed model accurately
recovers the correlation structure of the S&P 500 ATM implied
volatilities as well as the VIX futures across different tenors, which
benefits margin coverage of portfolios containing S&P 500 options, VIX
futures, and S&P 500 options and VIX futures. Moreover, the proposed
model provides adequate margin coverages for both upward and downward
movements of implied volatility over the margin risk horizon. The
margin coverage is stable across time and low, medium, and high
volatility market conditions. The model parameters would periodically
be recalibrated to incorporate more recent data and backtesting
performance.
In addition, the implied volatility scenarios generated by the
proposed model observed fewer arbitrage violations and tighter
consistency between VIX and S&P 500 option price scenarios.\35\ The
proposed methodology's mitigation of arbitrage is sufficient to allow
OCC to use S&P 500 Implied Volatility Simulation model in pricing
volatility index futures and variance futures, which assume an
arbitrage-free condition. In this way, the proposed changes support
enhanced margin offsetting between S&P 500 options, VIX futures, and
S&P 500 variance futures, which is naturally captured by the proposed
models.
---------------------------------------------------------------------------
\35\ OCC believes that the proposed model's improvements to the
number of arbitrage violations is explained by two factors: (i)
Replacing the current model's approximate delta-based function for
the volatility curve--which leads to arbitrage prices between call
and put options of the same strike and expiration--with the proposed
model's standardized log-moneyness approach, and (ii) replacing the
current model's nine pivot points method with a methodology that
produces an implied volatility surface that is continuous in strike
and time space.
---------------------------------------------------------------------------
OCC has performed backtesting of the current models and proposed
models, including the proposed Volatility Index Futures Model, to
compare and evaluate
[[Page 8077]]
the performance of each model from a margin coverage perspective.
Overall, the proposed models, when tested along with other models in
STANS, provided adequate margin coverage under different market
conditions over the backtesting period. Moreover, compared to the
current models, the margin coverage from the proposed model is more
stable and less procyclical, especially under stressed market
conditions.
Proposed Changes to the Synthetic Futures Model for Volatility Index-
Based Products
OCC proposes to use the Volatility Index Futures Model, rather than
the current Synthetic Futures Model, to derive the theoretical fair
values of volatility index futures.\36\ OCC would also use the
Volatility Index Futures Model to calculate the implied forward price
for options on volatility indexes, including options on VIX and
SPIKES.\37\ The purpose of the proposed change is to replace the
current method for pricing volatility index futures with an industry-
standard method based on Cboe's option replication formula augmented
with a convexity correction. As discussed below, OCC believes that the
proposed model will produce more accurate and stable results than the
current Synthetic Futures Model, which suffers from the limitations
discussed above, including that (i) the Synthetic Futures Model
produces results that are not strongly correlated with S&P 500 option
prices and volatility and are more susceptible to volatility shocks due
to the sensitivity of the GARCH process; and (ii) the Synthetic Futures
Model depends on the historical calibration for various parameters,
which can create artifacts due to the roll dates of VIX futures.
---------------------------------------------------------------------------
\36\ In addition to the VIX index, Cboe calculates several other
volatility indexes including the Cboe Short Term Volatility Index
(VXST), which reflects the 9-day expected volatility of the S&P 500,
as well as the Cboe Nasdaq-100 Volatility Index (VXN), Cboe DJIA
Volatility Index (VXD), Cboe Russell 2000 Volatility Index (RVX) and
Cboe S&P 500 3-Month Volatility Index (VXV) and the Cboe S&P 500 6-
Month Volatility Index (VXMT). The Volatility Index Futures Model
may apply to futures contracts written on these and other volatility
indexes if and when such futures contracts are listed, depending on
OCC's assessment of whether those futures contracts meet the model
assumptions and subject to OCC obtaining all necessary regulatory
approval to apply the Volatility Index Futures Model to such futures
contracts.
\37\ OCC calculates the implied forward price for options on
indexes using the basis futures price. See Exchange Act Release No.
86296 (July 3, 2019), 84 FR 32821 (July 9, 2019) (File No. SR-OCC-
2019-005) (enhancing OCC's smoothing algorithm).
---------------------------------------------------------------------------
Proposed Volatility Index Futures Model Description
The proposed Volatility Index Futures Model would alleviate the
issues observed with the current Synthetic Futures Model by adopting a
parameter-free approach based on the replication of log-contract, which
measures the expected realized volatility using S&P 500 options, as
discussed in Cboe's VIX white paper.\38\ The proposed model would
derive the theoretical fair value of volatility index futures via
replication through a portfolio of vanilla S&P 500 options \39\ using
the proposed S&P 500 Implied Volatility Simulation Model and convexity
adjustments, which reflect the concavity of the square root function
used to convert variance into volatility. A basis adjustment would be
computed to reflect the difference between the market price and the
theoretical value at the base level and then applied to the simulated
volatility index futures prices at the scenario level to align the
simulation to the market. The output from the Volatility Index Futures
Model would be an input to the options pricing model, which treats the
volatility index Futures as the underlying of the options contract. By
providing a direct link between the volatility index futures price and
the underlying S&P 500 options price, OCC believes that the Volatility
Index Futures Model would result in more sensible margin charges
compared to the current model.
---------------------------------------------------------------------------
\38\ See Cboe, VIX White Paper (2021), available at <a href="https://cdn.cboe.com/resources/vix/vixwhite.pdf">https://cdn.cboe.com/resources/vix/vixwhite.pdf</a>.
\39\ In some cases with limited listed strikes, additional
strikes will be interpolated or extrapolated to provide more robust
results.
---------------------------------------------------------------------------
Proposed Volatility Index Futures Model Performance
Based on its analysis of the Volatility Index Futures Model's
performance,\40\ OCC has concluded the proposed model would provide
more consistent and better-behaved margin coverage across the term
structure when compared to the current Synthetic Futures Model. The
Volatility Index Futures Model demonstrates desirable anti-
procyclicality properties, providing adequate margin coverage during
periods of high volatility without being too conservative in periods of
low volatility. Furthermore, the propose model generates adequate
margin coverage for short-term futures which is manifested in the
pronounced Samuelson effect.\41\ OCC believes three reasons account for
the improved performance of the Volatility Index Futures Model: (1) The
proposed model provides a direct link between the futures price and the
underlying option prices via replication; (2) the margin coverage of
VIX futures is closely coupled with the S&P 500 Implied Volatility
Simulation Model with procyclicality control, whereas the Synthetic
Futures Model relies on the GARCH variance forecast process, which is
prone to overreaction to shocks; and (3) unlike the Synthetic Futures
Model, the Volatility Index Futures Model is not subject to the
calibration artifact due to the 500-day lookback window, nor does it
require the rolling VIX futures contracts to take on different
variances from calibration at futures roll dates, which translate to
discontinuities in margin under the current method.
---------------------------------------------------------------------------
\40\ See Confidential Exhibit 3 to File No. SR-OCC-2022-001.
\41\ The Samuelson effect refers to a decrease in volatility
with increasing time to maturity.
---------------------------------------------------------------------------
For VIX futures portfolios \42\ hedged with S&P 500 options, the
proposed models provide more efficient margin coverage.\43\ The
improvement in margin coverage can be attributed to the direct coupling
between VIX futures and S&P 500 options, which gives rise to risk-
offsetting effect from the volatility. This result demonstrates that
the replication method in conjunction with the S&P 500 Implied
Volatility Simulation Model is better able to capture the correlations
between VIX futures and S&P 500 options and produce cross-hedging
benefits for Clearing Members.
---------------------------------------------------------------------------
\42\ VIX futures are commonly incorporated into a large S&P 500
portfolio as hedging instruments for volatility risk. For example,
one could gain pure exposure to underlying spot movements of the S&P
500 by buying/selling VIX futures to hedge the vega risk (i.e., risk
of changes in implied volatility) of S&P 500 options.
\43\ See Confidential Exhibit 3 to File No. SR-OCC-2022-001.
---------------------------------------------------------------------------
Proposed Changes to the Variance Futures Model
OCC proposes to replace the current Variance Futures Model in its
entirety. As discussed above, OCC uses the current Variance Futures
Model to derive the theoretical fair values of variance futures for
calculating margin and clearing fund requirements based on Clearing
Member portfolios. Like the proposed Volatility Index Futures Model,
the proposed Variance Futures Model would employ an industry-standard
fundamental replication technique using the log-contract to price
variance futures.\44\ OCC expects that this approach would not only
provide more
[[Page 8078]]
accurate prices, but also offer natural risk offsets with the options
of the same underlying security. In addition, the proposed Variance
Futures Model would no longer be reliant on a GARCH variance forecast
process, thereby addressing the sensitivity and procyclicality of that
process to volatility shocks observed with the current model.
Furthermore, the proposed method would simulate a near-term variance
futures price rather than a final settlement price, consistent with
OCC's two-day liquidation assumption.
---------------------------------------------------------------------------
\44\ This approach is based on Cboe's published method for
pricing S&P 500 variance futures. See Cboe, S&P 500 Variance Futures
Contract Specification (Dec. 10, 2012), available at <a href="http://www.cboe.com/products/futures/va-s-p-500-variance-futures/contract-specifications">http://www.cboe.com/products/futures/va-s-p-500-variance-futures/contract-specifications</a>.
---------------------------------------------------------------------------
Proposed Variance Futures Model Description
The theoretical variances produced by the proposed Variance Futures
Models would be comprised of two components. The first component, as
under the current Variance Futures Model, would be the realized
variance calculated by the realized daily returns of S&P 500 option
prices.\45\ The second component captures the unrealized variance,
which OCC would approximate using a portfolio of out of the money
(``OTM'') call and put European options. The proposed model would
calculate the implied component of variance futures via replication
through a portfolio of OTM option prices generated using the proposed
S&P 500 Implied Volatility Simulation Model.
---------------------------------------------------------------------------
\45\ Additional strikes may be interpolated or extrapolated from
listed strikes to provide more robust results.
---------------------------------------------------------------------------
Proposed Variance Futures Model Performance
Based on its analysis of the current and proposed Variance Futures
Model,\46\ the proposed model shows significant improvement in margin
coverage. The proposed model naturally captures the correlations
between S&P 500 options, variance futures, and VIX. Compared to the
current model, the proposed model provides adequate long and short
coverage for periods of high volatility and reasonable levels for
periods of low volatility. In particular, the proposed model
significantly reduces long-side coverage exceedances. The proposed
model produces higher correlation for neighboring variance futures and
adequate coverage without being overly conservative on the short side.
OCC expects that any changes to the overall margins of Clearing Member
accounts would be limited; over the twelve-month period between May
2019 and April 2020, only four margin accounts held variance futures
positions and the total risk from variance futures positions was less
than one percent of the total risk of all the positions for each of
those accounts.
---------------------------------------------------------------------------
\46\ See Confidential Exhibit 3 to File No. SR-OCC-2022-001.
---------------------------------------------------------------------------
Implementation Timeframe
OCC expects to operate the proposed model in parallel with the
current model for a period of at least thirty (30) days before
implementing the proposed model into production to give Clearing
Members an opportunity to understand the practical effects of the
proposed changes. OCC further expects to implement the proposed changes
within sixty (60) days after the date that OCC receives all necessary
regulatory approvals for the proposed changes. OCC will announce the
implementation date of the proposed change by an Information Memorandum
posted to its public website at least 2 weeks prior to implementation.
(2) Statutory Basis
OCC believes that the proposed rule change is consistent with
Section 17A of the Exchange Act \47\ and the rules and regulations
thereunder applicable to OCC. Section 17A(b)(3)(F) of the Act \48\
requires, in part, that the rules of a clearing agency be designed to
promote the prompt and accurate clearance and settlement of securities
transactions, and in general, to protect investors and the public
interest. As described above, the volatility changes forecasted by
OCC's current Implied Volatilities Scenarios Model are sensitive to
large, sudden spikes in volatility, which can at times result in
overreactive margin requirements that OCC believes are unreasonable and
procyclical (for the reasons set forth above). Such sudden,
unreasonable increases in margin requirements may stress certain
Clearing Members' ability to obtain liquidity to meet those
requirements, particularly in periods of extreme volatility, and could
result in a Clearing Member being delayed in meeting, or ultimately
failing to meet, its daily settlement obligations to OCC. A Clearing
Member's failure to meet its daily settlement obligations could, in
turn, cause the suspension of such Clearing Member and the liquidation
of its portfolio, which could harm investors. While the current Implied
Volatilities Scenarios Model addresses this issue with an exponentially
weighted moving average that reduces and delays the impact of large
implied volatility spikes, it does so in an artificial way that does
not target the primary issues with the GARCH process that OCC has
identified. By modeling implied volatility in a more direct, coherent
manner, the proposed S&P 500 Implied Volatility Simulation Model would
therefore reduce the likelihood that OCC's models would produce
extreme, overreactive margin requirements that could strain the ability
of certain Clearing Members to meet their daily margin requirements at
OCC by controlling procyclicality in OCC's margin methodology and
ensuring more stable and appropriate changes in margin requirements
across volatile market periods while continuing to capture changes in
implied volatility and produce margin requirements that are
commensurate with the risks presented. The proposed model would be used
by OCC to calculate margin requirements designed to limit its credit
exposures to participants, and OCC uses the margin it collects from a
defaulting Clearing Member to protect other Clearing Members and their
customers from losses as a result of the default and ensure that OCC is
able to continue the prompt and accurate clearance and settlement of
its cleared products. As a result, OCC believes the S&P 500 Implied
Volatility Simulation Model is designed to promote the prompt and
accurate clearance and settlement of securities transactions, and,
thereby, to protect investors and the public interest in accordance
with Section 17A(b)(3)(F) of the Exchange Act.\49\
---------------------------------------------------------------------------
\47\ 15 U.S.C. 78q-1.
\48\ 15 U.S.C. 78q-1(b)(3)(F).
\49\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
In addition, OCC believes the proposed changes to establish the
Volatility Index Futures Model and replace the Variance Futures Model
are consistent with Section 17A(b)(3)(F) of the Act.\50\ Both the
Volatility Index Futures Model and the Variance Futures Model exhibit
procyclicality issues as a result of their reliance on the GARCH
variance forecast process, which is prone to volatility shocks. The
proposed Volatility Index Futures Model and Variance Futures Model
would address these issues by adopting a fundamental replication
technique using the log-contract to price volatility index futures and
variance futures. In addition to providing a consistent modeling
approach to modeling equity volatility products that provides accurate
prices, this approach also offers natural risk offsets with the options
of the same underlying security. This model is also expected to
alleviate concerns around high margin requirements for S&P 500 variance
futures generated by current STANS systems. As discussed above,
collecting margins that are commensurate with risk helps to avoid
[[Page 8079]]
collection of excessive margin that may stress certain Clearing
Members' ability to obtain liquidity to meet those requirements,
particularly in periods of extreme volatility, and could result in
Clearing Member defaults that could harm investors and other Clearing
Members. These changes would also provide natural offsets between S&P
500 options, volatility index Futures and variance futures. The
proposed models would be used by OCC to calculate margin requirements
designed to limit its credit exposures to participants. OCC uses the
margin it collects from a defaulting Clearing Member to protect other
Clearing Members from losses as a result of the default and ensure that
OCC is able to continue the prompt and accurate clearance and
settlement of its cleared products. Accordingly, OCC believes these
proposed rule changes are designed to promote the prompt and accurate
clearance and settlement of securities and derivatives transactions and
to protect investors and the public interest in accordance in
accordance with Section 17A(b)(3)(F) of the Exchange Act.\51\
---------------------------------------------------------------------------
\50\ Id.
\51\ Id.
---------------------------------------------------------------------------
OCC also believes that the proposed changes are consistent with
Rule 17Ad-22(e)(6).\52\ In particular, paragraphs (i), (iii), and (v)
of Rule 17Ad-22(e)(6) \53\ require a covered clearing agency that
provides central counterparty services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to cover its credit exposures to its participants by
establishing a risk-based margin system that (1) considers, and
produces margin levels commensurate with, the risks and particular
attributes of each relevant product, portfolio, and market; (2)
calculates margin sufficient to cover its potential future exposure to
participants in the interval between the last margin collection and the
close out of positions following a participant default; and (3) uses an
appropriate method for measuring credit exposure that accounts for
relevant product risk factors and portfolio effects across products. As
noted above, OCC's current models for implied volatility and pricing
volatility index futures and variance futures demonstrate sensitivity
to sudden spikes in volatility, which can at times result in
overreactive margin requirements that OCC believes are unreasonable and
procyclical. The proposed changes are designed to reduce the
oversensitivity of the model and produce margin requirements that are
commensurate with the risks presented during periods of sudden, extreme
volatility. The proposed changes are designed to reduce procyclicality
in OCC's margin methodology and ensure more stable changes in margin
requirements across volatile market periods while continuing to capture
changes in implied volatility and produce margin requirements that are
commensurate with the risks presented by OCC's cleared options. As a
result, OCC believes that the proposed changes are reasonably designed
to consider, and produce margin levels commensurate with, the risk
presented by the implied volatility of OCC's cleared options, as well
as the risk presented by volatility index futures and variance futures;
calculate margin sufficient to cover its potential future exposure to
participants in the interval between the last margin collection and the
close out of positions following a participant default; and use an
appropriate method for measuring credit exposure that accounts for this
product risk factor (i.e., implied volatility) and for these products
(i.e., volatility index futures and variance futures) in a manner
consistent with Rules 17Ad-22(e)(6)(i), (iii) and (v).\54\
---------------------------------------------------------------------------
\52\ 17 CFR 240.17Ad-2(e)(6).
\53\ 17 CFR 240.17Ad-2(e)(6)(i), (iii), (v).
\54\ Id.
---------------------------------------------------------------------------
(B) Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) 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 Act.\55\ The proposed S&P 500 Implied
Volatility Simulation Model would be used to incorporate variations in
implied volatility within STANS for S&P 500-based products for all
Clearing Members. The Volatility Index Futures Model and Variance
Futures Model would be used to calculate the theoretical values of
volatility index futures and variance futures, respectively, for all
Clearing Members. Accordingly, OCC does not believe that the proposed
rule change would unfairly inhibit access to OCC's services.
---------------------------------------------------------------------------
\55\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
While the proposed rule change may impact different accounts to a
greater or lesser degree depending on the composition of positions in
each account, OCC does not believe that the proposed rule change would
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act. As discussed above,
OCC is obligated under the Exchange Act and the regulations thereunder
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to cover its credit exposures to its
participants by establishing a risk-based margin system that, among
other things, considers, and produces margin levels commensurate with,
the risks and particular attributes of each relevant product,
portfolio, and market.\56\ Overall, the impact analysis shows that at
the account level, margin coverage generated by the proposed models is
comparable to that generated using OCC's existing models for accounts
dominated by S&P 500 options. While margin charges resulting from the
proposed changes may be higher or lower than under the current models
due to compositions of positions in each account, OCC believes that
margin coverage under the proposed models will be more commensurate
with the risks presented by its members' activity because the proposed
models employ a more consistent and sounder approach to modeling
implied volatility, as discussed above. For accounts dominated by
volatility index futures and variance futures, the proposed models are,
in general, expected to produce more accurate margin requirement
because by using S&P 500 options to calculate the price for such
products, the proposed models provide natural offsets for volatility
products with similar characteristics. In addition, the proposed models
are expected to produce margin requirements that are more stable across
time, especially during stressed market conditions--thereby addressing
known issues with the current GARCH-based models. As such, OCC believes
the proposed changes would result in margin requirements commensurate
with the vega risk presented by Clearing Members' portfolios,
consistent with OCC's obligations under the Exchange Act and
regulations thereunder. Accordingly, OCC believes that the proposed
rule change would not impose any burden or impact on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act.
---------------------------------------------------------------------------
\56\ See 17 CFR 240.17Ad-2(e)(6)(i).
---------------------------------------------------------------------------
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments on the proposed rule change were not and are not
intended to be solicited with respect to the proposed rule change and
none have been received.
[[Page 8080]]
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
OCC shall post notice on its website of proposed changes that are
implemented. The proposal shall not take effect until all regulatory
actions required with respect to the proposal are completed.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#86f4f3eae3abe5e9ebebe3e8f2f5c6f5e3e5a8e1e9f0"><span class="__cf_email__" data-cfemail="2e5c5b424b034d4143434b405a5d6e5d4b4d00494158">[email protected]</span></a>. Please include
File Number SR-OCC-2022-001 on the subject line.
Paper Comments
<bullet> Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-OCC-2022-001. 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 (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filing also will be available for inspection
and copying at the principal office of OCC and on OCC's website at
<a href="https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules">https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules</a>.
All comments received will be posted without change. Persons
submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
All submissions should refer to File Number SR-OCC-2022-001 and
should be submitted on or before March 4, 2022.
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\57\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\57\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-02913 Filed 2-10-22; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on February 11, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.