Notice2022-15525
Self-Regulatory Organizations; The Options Clearing Corporation; Notice of No Objection to Advance Notice Concerning the Options Clearing Corporation's Margin Methodology for Incorporating Variations in Implied Volatility
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
July 21, 2022
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 87 Issue 139 (Thursday, July 21, 2022)</title>
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[Federal Register Volume 87, Number 139 (Thursday, July 21, 2022)]
[Notices]
[Pages 43581-43586]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-15525]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-95294; File No. SR-OCC-2022-801]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of No Objection to Advance Notice Concerning the Options
Clearing Corporation's Margin Methodology for Incorporating Variations
in Implied Volatility
July 15, 2022.
I. Introduction
On January 24, 2022, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-OCC-2022-801 (``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
[[Page 43582]]
(``Clearing Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) \2\ under
the Securities Exchange Act of 1934 (``Exchange Act'') \3\ to change
quantitative models related to certain volatility products.\4\ The
Advance Notice was published for public comment in the Federal Register
on February 11, 2022,\5\ and the Commission has received comments
regarding the changes proposed in the Advance Notice.\6\
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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 87 FR 8063.
\5\ Securities Exchange Act Release No. 94166 (Feb. 7, 2022), 87
FR 8063 (Feb. 11, 2022) (File No. SR-OCC-2022-801) (``Notice of
Filing''). On January 24, 2022, OCC also filed a related proposed
rule change (SR-OCC-2022-001) 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 February 11, 2022, OCC seeks approval of
proposed changes to its rules necessary to implement the Advance
Notice. Securities Exchange Act Release No. 94165 (Feb. 7, 2022), 87
FR 8072 (Feb. 11, 2022) (File No. SR-OCC-2022-001). The initial
comment period for the related Proposed Rule Change filing closed on
March 4, 2022. 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 June 22, 2022. See Securities Exchange Act Release
No. 94900 (May 12, 2022), 87 FR 30284 (May 18, 2022) (File No. SR-
OCC-2022-001).
\6\ Comments on the Advance Notice are available at <a href="https://www.sec.gov/comments/sr-occ-2022-801/srocc2022801.htm">https://www.sec.gov/comments/sr-occ-2022-801/srocc2022801.htm</a>. 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 <a href="https://www.sec.gov/comments/sr-occ-2022-001/srocc2022001.htm">https://www.sec.gov/comments/sr-occ-2022-001/srocc2022001.htm</a>.
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On March 24, 2022, pursuant to Section 806(e)(1)(H) of the Clearing
Supervision Act,\7\ the Commission extended the review period for the
Advance Notice for an additional 60 days because the Commission found
the issues raised by the Advance Notice to be complex.\8\ Notice of the
extension was published in the Federal Register on March 30, 2022.\9\
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\7\ 12 U.S.C. 5465(e)(1)(H).
\8\ See Securities Exchange Act Release No. 94504 (Mar. 24,
2022), 87 FR 18414 (Mar. 30, 2022) (File No. SR-OCC-2022-801).
\9\ Id.
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On May 24, 2022, 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,\10\ which tolled the
Commission's period of review of the Advance Notices until 120 days
from the date the information required by the Commission was received
by the Commission.\11\ On June 22, 2022, the Commission received OCC's
response to the Commission's request for additional information.\12\
The Commission is hereby providing notice of no objection to the
Advance Notice.
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\10\ 12 U.S.C. 5465(e)(1)(D).
\11\ 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 <a href="https://www.sec.gov/comments/sr-occ-2022-801/srocc2022801-20129507-295740.pdf">https://www.sec.gov/comments/sr-occ-2022-801/srocc2022801-20129507-295740.pdf</a>.
\12\ 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 <a href="https://www.sec.gov/comments/sr-occ-2022-801/srocc2022801-20132694-303185.pdf">https://www.sec.gov/comments/sr-occ-2022-801/srocc2022801-20132694-303185.pdf</a>.
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II. Background <SUP>13</SUP>
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\13\ Capitalized terms used but not defined herein have the
meanings specified in OCC's Rules and By-Laws, available at <a href="https://www.theocc.com/about/publications/bylaws.jsp">https://www.theocc.com/about/publications/bylaws.jsp</a>.
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The System for Theoretical Analysis and Numerical Simulations
(``STANS'') is OCC's methodology for calculating margin.\14\ STANS
includes econometric models that incorporate a number of risk factors.
OCC defines a risk factor in STANS 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 STANS 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.\15\
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\14\ In February 2021, the Commission approved a proposed rule
change by OCC to adopt a new document describing OCC's system for
calculating daily and intraday margin requirements for its Clearing
Members (the ``STANS Methodology Description''). See Securities
Exchange Release No. 91079 (Feb. 8, 2021), 86 FR 9410 (Feb. 12,
2021) (File No. SR-OCC-2020-016) (``STANS Methodology Approval'').
\15\ 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
risk-free rate. In December 2015, the Commission approved a proposed
rule change and issued a Notice of No Objection to an advance notice
filing by OCC to modify its margin methodology by more broadly
incorporating variations in implied volatility within STANS. See
Securities Exchange Act Release No. 76781 (Dec. 28, 2015), 81 FR 135
(Jan. 4, 2016) (File No. SR-OCC-2015-016) and Securities Exchange
Act Release No. 76548 (Dec. 3, 2015), 80 FR 76602 (Dec. 9, 2015)
(File No. SR-OCC-2015-804). In December 2018, the Commission
approved a proposed rule change and issued a Notice of No Objection
to an advance notice filing by OCC to introduce an exponentially
weighted moving average for the daily forecasted volatility of
implied volatility risk factors in STANS. See Securities Exchange
Act Release No. 84879 (Dec. 20, 2018), 83 FR 67392 (Dec. 28, 2018)
(File No. SR-OCC-2018-014) and Securities Exchange Act Release No.
84838 (Dec. 18, 2018), 83 FR 66791 (Dec. 27, 2018) (File No. SR-OCC-
2018-804).
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OCC's STANS Methodology Description includes subsections on (i)
implied volatility risk factors to measure the expected future
volatility of an option's underlying security at expiration, (ii) a
synthetic futures model to price specified products such as volatility
index-based futures, and (iii) a specialized factor model to price
variance futures.\16\ As described below, and in more detail in the
Notice of Filing, OCC proposes the following changes:
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\16\ See STANS Methodology Approval, 86 FR at 9411.
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(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'');
(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''); 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'').
A. S&P 500 Implied Volatility Simulation Model
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 implied volatility could change
during the two-business day liquidation time horizon and lead to
corresponding changes in the market prices of the options. OCC relies
on its Implied Volatilities Scenarios Model to simulate the variations
in implied volatility that OCC uses to re-price options within STANS
for substantially all option contracts \17\ available to be cleared by
OCC that have a residual tenor \18\ of less than three years. As noted
above, OCC now proposes to implement a new model, the S&P 500 Implied
Volatility Simulation Model, for incorporating
[[Page 43583]]
variations in implied volatility within STANS for products based on the
S&P 500 Index.
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\17\ 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.
\18\ The ``tenor'' of an option is the amount of time remaining
to its expiration.
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In the Notice of Filing, OCC stated that its current Implied
Volatilities Scenarios Model is subject to certain limitations and
issues.\19\ Such issues relate to (1) volatility of volatility
forecasting; (2) volatility surface discontinuities; and (3) arbitrage
constraints and cross-product offsets. OCC proposes to replace the
current Implied Volatilities Scenarios Model for the S&P 500 product
group with the proposed S&P 500 Implied Volatility Simulation Model to
address such limitations, which are described below. OCC would continue
to use the current Implied Volatilities Scenarios Model for the
products other than S&P 500-based products.\20\
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\19\ See Notice of Filing, 87 FR at 8065.
\20\ See Notice of Filing, 87 FR at 8066, n. 32.
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Volatility of volatility forecasting. In the current Implied
Volatilities Scenarios Model, OCC uses a GARCH model \21\ to forecast
the volatility of implied volatility risk factors.\22\ OCC's past
analysis has demonstrated that the volatility changes forecasted by the
GARCH model were extremely sensitive to sudden spikes in volatility,
which at times resulted in margin requirements that OCC believes were
unreasonable.\23\ OCC's current Implied Volatilities Scenarios Model
relies on an exponentially weighted moving average \24\ of forecasted
volatilities over a specified look-back period to reduce the model's
sensitivity to large, sudden shocks in market volatility. OCC stated
that reliance on an exponentially weighted moving average reduces and
delays the impact of large implied volatility spikes, but that it does
so in an artificial way that does not target the limitations and issues
with the model noted above.\25\
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\21\ 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).
\22\ See Notice of Filing, 87 FR at 8064.
\23\ See Notice of Filing, 87 FR at 8065.
\24\ 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. As noted
above, OCC introduced an exponentially weighted moving average for
the daily forecasted volatility of implied volatility risk factors
in STANS in 2018. See supra note 15. OCC found that using unweighted
daily forecasted volatilities of implied volatilities caused jumps
in aggregate margin requirements of up to 80 percent overnight,
which OCC believes were unreasonable. See Securities Exchange Act
Release No. 84879 (Dec. 20, 2018), 83 FR 67392, 67393 (Dec. 28,
2018) (File No. SR-OCC-2018-014) and Securities Exchange Act Release
No. 84838 (Dec. 18, 2018), 83 FR 66791, 66792 (Dec. 27, 2018) (File
No. SR-OCC-2018-804).
\25\ See Notice of Filing, 87 FR at 8065.
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In the proposed S&P 500 Implied Volatility Simulation Model, OCC
would forecast volatility for S&P 500 1-month at-the-money (``ATM'')
implied volatility based on the 30-day VVIX, Cboe's option-implied
volatility-of-volatility index. OCC would further smooth the daily 30-
day VVIX to control for procyclicality. OCC asserted that, based on a
performance analysis, the proposed S&P 500 Implied Volatility
Simulation Model would (1) provide adequate margin coverages for both
upward and downward movements of implied volatility over the margin
risk horizon; and (2) remain stable across both time and low, medium,
and high volatility market conditions.\26\
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\26\ See Notice of Filing, 87 FR at 8068.
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Volatility surface discontinuities. The current Implied
Volatilities Scenarios Model relies on a ``nearest neighbor'' method to
map the implied volatility surface between reference points.\27\ The
reliance on a nearest neighbor method introduces discontinuity in the
implied volatility curve for a given tenor. Further, the current
Implied Volatilities Scenarios Model's use of arithmetic implied
volatility returns can result in near-zero implied volatility in
simulated scenarios, which OCC states is unrealistic.\28\ Additionally,
the current model includes implied volatility scenarios for call and
put options with the same tenor and strike price that are not equal,
which contributes to inconsistencies in the implied volatility
scenarios. OCC now proposes to model the implied volatility surface
directly to generate a surface that would be smooth and continuous in
both term structure and moneyness \29\ dimensions.\30\ Modeling the
implied volatility surface directly rather than mapping the surface
based on a series of reference points would simplify OCC's margin
methodology and help avoid the discontinuities discussed above.
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\27\ The Implied Volatilities Scenarios Model models a
volatility surface by incorporating nine risk factors based on a
range of tenors and option deltas. The ``delta'' of an option
represents the sensitivity of the option price to the price of the
underlying security.
\28\ See Notice of Filing, 87 FR at 8065.
\29\ The term ``moneyness'' refers to the relationship between
the current market price of the underlying interest and the exercise
price. See Notice of Filing, 87 FR at 8064, n. 13.
\30\ Key risk factors driving the implied volatility surface are
explicitly modeled within the model itself. See Notice of Filing, 87
FR at 8067.
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Arbitrage constraints and cross-product offsets. The current
Implied Volatilities Scenarios Model does not impose constraints to
ensure that simulated surfaces are arbitrage-free. Because of this
potential for arbitrage, OCC believes the implied volatilities are not
adequate inputs to price Variance Futures and Volatility Index Futures
accurately, both of which assume an arbitrage-free condition.\31\
Further, the current Implied Volatilities Scenarios Model may not
provide natural offsetting of risks in Clearing Member accounts that
contain combinations of S&P 500 options, variance futures, and/or
volatility index futures because OCC models such options and futures
independent of each other rather than as inherently related components
of a broader system, which could in turn result in unnecessarily large
margin requirements for certain Clearing Members.
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\31\ See Notice of Filing, 87 FR at 8065.
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Under the proposed model, put and call options with the same tenors
and strike prices would have the same implied volatility scenarios.
Imposing such a constraint on arbitrage would be sufficient to allow
OCC to use the output of the proposed model for margining volatility
index futures and variance futures.\32\ Use of the proposed S&P 500
Implied Volatility Simulation Model as an input to margining volatility
index futures and variance futures also would, in turn, support margin
offsets between S&P 500 options, VIX futures, and S&P 500 variance
futures.
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\32\ See Notice of Filing, 87 FR at 8068. OCC intends to rely on
the output from the proposed S&P 500 Implied Volatility Simulation
Model as an input to the proposed Volatility Index Futures Model and
Variance Futures Model described below. See Notice of Filing, 87 FR
at 8067.
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B. Volatility Index Futures Model
To calculate margin for Clearing Member portfolios, OCC currently
relies on its ``Synthetic Futures Model'' to calculate the theoretical
value of volatility index futures, among other products.\33\ As noted
above, OCC now
[[Page 43584]]
proposes to implement its new Volatility Index Futures model, which
would be used to calculate the theoretical values of futures on certain
volatility futures indexes (i.e., indexes designed to measure
volatilities implied by prices of options on a particular underlying
index).\34\
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\33\ See Securities Exchange Act Release No. 85873 (May 16,
2019), 84 FR 23620 (May 22, 2019) (File No. SR-OCC-2019-002)
(approving a proposed rule change regarding the measurement of
volatilities implied by prices of options on a particular underlying
interest). OCC also applies the Synthetic Futures Model to (i)
futures on the American Interbank Offered Rate (``AMERIBOR''); (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 Securities Exchange Act Release No. 89392 (Jul. 24,
2020), 85 FR 45938 (Jul. 30, 2020) (File No. SR-OCC-2020-007)
(application of OCC's Synthetic Futures model to AMERIBOR futures);
Securities Exchange Act Release No. 90139 (Oct. 8, 2020), 85 FR
65886 (Oct. 16, 2020) (File No. SR-OCC-2020-012) (application of
OCC's Synthetic Futures model to Small Treasury Yield Index
Futures); Securities Exchange Act Release No. 91833 (May 10, 2021),
86 FR 26586 (May 14, 2021) (File No. SR-OCC-2021-005) (application
of OCC's Synthetic Futures model to Small Crude Oil Futures).
\34\ 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. See Notice
of Filing, 87 FR at 8065, n. 26.
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In the Notice of Filing, OCC stated that its current Synthetic
Futures Model is subject to certain limitations and issues.\35\ First,
the current Synthetic Futures Model relies on a GARCH variance forecast
that, as noted above, is sensitive to large volatility shocks. OCC
mitigates this sensitivity by imposing a floor for variance estimates
based on the underlying index (e.g., VIX). The proposed Volatility
Index Futures Model would instead rely on a direct link between the
volatility index futures price and the underlying S&P 500 options price
to mitigate the model's sensitivity to large volatility shocks. Such a
link would come from reliance on the output of the proposed S&P 500
Implied Volatility Simulation Model, which does not rely on a GARCH
process and, therefore, the input to the proposed Volatility Index
Futures Model would not have the same sensitivity to large volatility
shocks as the current Synthetic Futures Model.
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\35\ See Notice of Filing, 87 FR at 8066.
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Second, the current Synthetic Futures Model makes the rolling
volatility futures contracts take on different variances from
calibration at futures roll dates, which could translate to jumps in
margin. The proposed Volatility Index Futures Model would be based on
an entirely different approach that would not incorporate the same
potential jumps in margin. Specifically, OCC proposes to adopt 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.\36\
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\36\ See Cboe, VIX White Paper (2019), available at <a href="https://www.cboe.com/micro/vix/vixwhite.pdf">https://www.cboe.com/micro/vix/vixwhite.pdf</a>.
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As described in the confidential exhibits OCC submitted with the
Advance Notice, the proposed Volatility Index Futures Model would
provide more consistent margin coverage across the term structure when
compared to the current Synthetic Futures Model. Based on OCC's
testing, the proposed model would continue to provide adequate margin
coverage during periods of low and high volatility as well as for
short-term futures. Further, the proposed model would provide for more
efficient margin coverage for VIX futures portfolios hedged with S&P
500 options.
C. Variance Futures Model
Variance futures are commodity futures for which the underlying
interest is a variance. OCC's current model for calculating the
theoretical value of variance futures, adopted in 2007, 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 now proposes to replace its current model for margining variance
futures with the proposed Variance Futures Model, which would be based
on a replication technique using the log-contract to price variance
futures similar to the proposed Volatility Index Futures Model.\37\
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\37\ 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>.
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OCC believes that its current model for margining variance futures
has several disadvantages.\38\ First, OCC currently models variance
futures by simulating a final settlement price rather than a near-term
variance futures price, which is not consistent with OCC's two-day
liquidation horizon.\39\ The proposed Variance Futures Model would
simulate a near-term variance futures price rather than a final
settlement price, consistent with OCC's two-day liquidation assumption.
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\38\ See Notice of Filing, 87 FR at 8066.
\39\ OCC's processes for managing the default of a Clearing
Member assume that OCC can close out the defaulter's portfolio
within two days of default.
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Second, similar to the Implied Volatilities Scenarios Model and
Synthetic Futures Model, OCC's current model for margining variance
futures relies on a GARCH model that OCC believes: (1) does not provide
appropriate risk offsets with other instruments inherently related to
the S&P 500 implied volatility and (2) does not generate margin
requirements that are sufficiently conservative for short positions and
aggressive for long positions to avoid causing model backtesting
failures.\40\
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\40\ See Notice of Filing, 87 FR at 8066.
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Instead of relying on a GARCH variance forecast, the proposed
Variance Futures Model would approximate the implied component of
variance futures (i.e., the unrealized variance) based on option prices
generated using the proposed S&P 500 Implied Volatility Simulation
Model. As described in the confidential exhibits OCC submitted with the
Advance Notice, this would significantly reduce long-side coverage
exceedances relative to the current model while maintaining coverage
for periods of low and high volatility. It would also offer offsets for
variance futures with the options of the same underlying security.
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 SIFMUs and
strengthening the liquidity of SIFMUs.\41\
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\41\ 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.\42\ 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): \43\
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\42\ 12 U.S.C. 5464(a)(2).
\43\ 12 U.S.C. 5464(b).
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<bullet> to promote robust risk management;
<bullet> to promote safety and soundness;
<bullet> to reduce systemic risks; and
<bullet> 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.\44\
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\44\ 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 Act (the ``Clearing Agency Rules'').\45\ The Clearing Agency
Rules require, among other things, each covered clearing agency to
establish, implement, maintain, and enforce written policies
[[Page 43585]]
and procedures that are reasonably designed to meet certain minimum
requirements for its operations and risk management practices on an
ongoing basis.\46\ 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,\47\ and in
the Clearing Agency Rules, in particular Rule 17Ad-22(e)(6).\48\
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\45\ 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 Covered Clearing Agency Standards, 81 FR 70786. OCC is a
``covered clearing agency'' as defined in Rule 17Ad-22(a)(5).
\46\ 17 CFR 240.17Ad-22.
\47\ 12 U.S.C. 5464(b).
\48\ 17 CFR 240.17Ad-22(e)(6).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
The Commission believes that 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. Specifically, as
discussed below, the Commission believes that the changes proposed in
the Advance Notice are consistent with promoting robust risk
management, promoting safety and soundness, reducing systemic risks,
and supporting the stability of the broader financial system.\49\
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\49\ 12 U.S.C. 5464(b).
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The Commission believes that the Advance Notice is consistent with
promoting robust risk management as well as safety and soundness
because, based on the confidential information provided by OCC and
reviewed by the Commission, the proposed models provide for margin
coverage levels that are consistent with, and in certain instances
(e.g., long-side variance futures coverage) better than, the current
models. The proposed models would also simplify OCC's methodology for
simulating variations in implied volatilities while simultaneously
supporting offsets for products with the same underlying (e.g.,
volatility and variance products based on the S&P 500). The Commission
believes that providing for such offsets would more accurately
represent the relationship between the products OCC clears. Ensuring
that OCC's margin models accurately reflect the relationships between
the products OCC clears would, in turn, facilitate OCC's ability to set
margins that more accurately reflect the risks posed by such products.
Additionally, providing for such offsets could reduce the likelihood
that Clearing Members would be required to provide additional financial
resources unnecessarily, which, in turn, could reduce the strain on
such members during stress market conditions.
Further, the Commission believes that, to the extent the proposed
changes are consistent with promoting OCC's safety and soundness, they
are also consistent with 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.\50\ The Commission believes that 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 Clearing 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.
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\50\ See Financial Stability Oversight Council (``FSOC'') 2012
Annual Report, Appendix A, <a href="https://home.treasury.gov/system/files/261/here.pdf">https://home.treasury.gov/system/files/261/here.pdf</a> (last visited Feb. 17, 2022).
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Accordingly, and for the reasons stated above, the Commission
believes the changes proposed in the Advance Notice are consistent with
Section 805(b) of the Clearing Supervision Act.\51\
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\51\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(6) Under the Exchange Act
Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to cover, if the
covered clearing agency provides central counterparty services, its
credit exposures to its participants by establishing a risk-based
margin system that, among other things, (1) considers, and produces
margin levels commensurate with, the risks and particular attributes of
each relevant product, portfolio, and market \52\ and (2) calculates
sufficient margin 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.\53\
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\52\ 17 CFR 240.17Ad-22(e)(6)(i).
\53\ 17 CFR 240.17Ad-22(e)(6)(iii).
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As described above, the proposed models would remove the reliance
on GARCH models that have demonstrated extreme sensitivity to sudden
spikes in volatility. The Commission believes that such reactivity can
produce instability and in certain instances over or underestimation of
margin requirements.\54\ The proposed models would also replace the
modeling techniques that currently allow for discontinuities and jumps
in margin (e.g., simulating scenarios with near-zero implied
volatility). Such discontinuities and jumps in margin may, in turn,
lead to disparate margin requirements for instruments with similar risk
profiles. Further, OCC's proposed reliance on output from the proposed
S&P 500 Implied Volatility Simulation Model as an input to the
Volatility Index Futures model and Variance Futures model would capture
the natural risk offsets between inherently related products. Providing
for such offsets would more accurately represent the relationship
between the products OCC clears. Ensuring that OCC's margin models
accurately reflect the relationships between the products OCC clears
would, in turn, facilitate OCC's ability to set margins that more
accurately reflect the risks posed by such products. Further, providing
for such offsets could reduce the likelihood that Clearing Members
would be required to provide additional financial resources
unnecessarily, which, in turn, could reduce the strain on such members
during stress market conditions. Additionally, the proposed Variance
Futures model would simulate a near-term variance futures price rather
than a final settlement price, which is consistent with the risks OCC
would face in the event of a Clearing Member default.
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\54\ For example, OCC's current model would have increased
aggregate margin requirements by 80 percent overnight in response to
the increased volatility observed on February 5, 2018. See
Securities Exchange Act Release No. 84879 (Dec. 20, 2018), 83 FR
67392, 67393 (Dec. 28, 2018).
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In response to the Notice of Filing,\55\ the Commission received a
comment opposing the proposal on the basis that the change would reduce
margins to a level that could ensure some Clearing Members would fail,
with expenses borne by ``direct investors.'' \56\ The
[[Page 43586]]
commenter's assertions, however, are inconsistent with the confidential
performance data provided by OCC. The confidential information provided
by OCC includes backtesting data demonstrating how the proposed models
would have performed had they been in production at OCC from February
2018 through February 2021. This backtesting period includes the period
of increased volatility observed on February 5, 2018 that demonstrated
the reactivity of OCC's current models.\57\ The confidential
information provided by OCC and reviewed by the Commission demonstrates
that, overall, the proposed models perform better than OCC's current
models with regard to setting margin requirements to cover exposures
presented by Clearing Member portfolios.\58\
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\55\ See Notice of Filing, at 87 FR 8063.
\56\ Comment from Mary (Feb. 7, 2022), available at <a href="https://www.sec.gov/comments/sr-occ-2022-001/srocc2022001-20114809-267072.htm">https://www.sec.gov/comments/sr-occ-2022-001/srocc2022001-20114809-267072.htm</a>. The commenter also raised a concern regarding the
confidentiality of certain exhibits. Id. OCC asserted that the
exhibits to the filing were entitled to confidential treatment
because they contained commercial and financial information that is
not customarily released to the public and is treated as the private
information of OCC. Under Section 23(a)(3) of the Exchange Act, the
Commission is not required to make public statements filed with the
Commission in connection with a proposed rule change of a self-
regulatory organization if the Commission could withhold the
statements from the public in accordance with the Freedom of
Information Act (``FOIA''), 5 U.S.C. 552. 15 U.S.C. 78w(a)(3). The
Commission has reviewed the documents for which OCC requests
confidential treatment and concludes that they could be withheld
from the public under the FOIA. FOIA Exemption 4 protects
confidential commercial or financial information. 5 U.S.C.
552(b)(4). Under Exemption 4, information is confidential if it ``is
both customarily and actually treated as private by its owner and
provided to government under an assurance of privacy.'' Food
Marketing Institute v. Argus Leader Media, 139 S. Ct. 2356, 2366
(2019). In its requests for confidential treatment, OCC stated that
it has not disclosed the confidential exhibits to the public, and
the information is the type that would not customarily be disclosed
to the public. In addition, by requesting confidential treatment,
OCC had an assurance of privacy because the Commission generally
protects information that can be withheld under Exemption 4. Thus,
the Commission has determined to accord confidential treatment to
the confidential exhibits.
\57\ See supra footnote 54.
\58\ The Commission received other comments generally asserting
that the proposal would reduce margin at the expense of retail
investors and that there is a need to ``lower the amount of leverage
in the system.'' As described above, the backtesting data provided
by OCC demonstrates that the proposed models would set margin
requirements that more effectively cover exposures presented by
Clearing Member portfolios, which include customer positions.
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Accordingly, the Commission believes that the proposed model
changes are consistent with Rule 17Ad-22(e)(6) under the Exchange
Act.\59\
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\59\ 17 CFR 240.17Ad-22(e)(6).
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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-2022-801) and that OCC is authorized to
implement the proposed change as of the date of this notice or the date
of an order by the Commission approving proposed rule change SR-OCC-
2022-001, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-15525 Filed 7-20-22; 8:45 am]
BILLING CODE 8011-01-P
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