Notice2022-15771
Self-Regulatory Organizations; The Options Clearing Corporation; Order Granting Approval of Proposed Rule Change Concerning The Options Clearing Corporation's Margin Methodology for Incorporating Variations in Implied Volatility
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Published
July 25, 2022
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 87 Issue 141 (Monday, July 25, 2022)</title>
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[Federal Register Volume 87, Number 141 (Monday, July 25, 2022)]
[Notices]
[Pages 44167-44171]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-15771]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-95319; File No. SR-OCC-2022-001]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of Proposed Rule Change Concerning The Options
Clearing Corporation's Margin Methodology for Incorporating Variations
in Implied Volatility
July 19, 2022.
I. Introduction
On January 24, 2022, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2022-001 (``Proposed Rule Change'')
pursuant to Section 19(b) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to change
quantitative models related to certain volatility products.\3\ The
Proposed Rule Change was published for public comment in the Federal
Register on February 11, 2022.\4\ The Commission has received comments
regarding the Proposed Rule Change.\5\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Notice of Filing infra note 4, at 87 FR 8072.
\4\ Securities Exchange Act Release No. 94165 (Feb. 7, 2022), 87
FR 8072 (Feb. 11, 2022) (File No. SR-OCC-2022-001) (``Notice of
Filing''). OCC also filed a related advance notice (SR-OCC-2022-801)
(``Advance Notice'') with the Commission pursuant to Section
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled the Payment, Clearing, and
Settlement Supervision Act of 2010 and Rule 19b-4(n)(1)(i) under the
Exchange Act. 12 U.S.C. 5465(e)(1). 15 U.S.C. 78s(b)(1) and 17 CFR
240.19b-4, respectively. The Advance Notice was published in the
Federal Register on February 11, 2022. Securities Exchange Act
Release No. 94166 (Feb. 7, 2022), 87 FR 8063 (Feb. 11, 2022) (File
No. SR-OCC-2022-801).
\5\ 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>. Since
the proposal contained in the Proposed Rule Change was also filed as
an advance notice, 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.
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On March 24, 2022, pursuant to Section 19(b)(2) of the Exchange
Act,\6\ the Commission designated a longer period within which to
approve, disapprove, or institute proceedings to determine whether to
approve or disapprove the Proposed Rule Change.\7\ On May 12, 2022, the
Commission instituted proceedings to determine whether to approve or
disapprove the Proposed Rule Change.\8\ This order approves the
Proposed Rule Change.
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\6\ 15 U.S.C. 78s(b)(2).
\7\ Securities Exchange Act Release No. 94165 (Feb. 7, 2022), 87
FR 8072 (Feb. 11, 2022) (File No. SR-OCC-2022-001).
\8\ Securities Exchange Act Release No. 94900 (May 12, 2022), 87
FR 30284 (May 18, 2022) (File No. SR-OCC-2022-001).
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OCC is a central counterparty (``CCP''), which means it interposes
itself as the buyer to every seller and seller to every buyer for
financial transactions. As the CCP for the listed options markets in
the U.S., as well as for certain futures, OCC is exposed to the risk
that one or more of its members may fail to make a payment or to
deliver securities. OCC addresses such exposures, in part, by requiring
its members to provide collateral, including margin collateral. Margin
is the collateral that CCPs, like OCC, collect to cover potential
changes in a member's positions over a set period of time. Typically,
margin is designed to cover such exposures during normal market
conditions, which means that margin collateral should be sufficient to
exposures at least 99 out of 100 days.
Margin requirements may fluctuate from day to day; however, CCPs
seek to reduce fluctuations that could otherwise impose systemic risk.
For example, if a CCP collects too little margin during relatively
stable market conditions, then it would need to collect significantly
more margin during stressed market conditions. Margin requirements that
are strongly reactive to market movements are considered to be
``procyclical.'' By contrast, a CCP may collect slightly more margin
during quiet times to reduce the additional strain it places on members
during times of market stress.
OCC's process for setting margin requirements considers several
distinct risk factors, including volatility. OCC's current models for
estimating the impact of volatility on member positions have a number
of limitations that may result in procyclical margin requirements. OCC
is proposing to change its models to reduce the level of procyclicality
in its margin requirements caused by changes in volatility. The changes
OCC is proposing would also provide for offsets between products based
on the same underlying asset. Based on data provided by OCC, the
proposed model changes would likely increase margin requirements
slightly overall, which, in turn, would reduce the additional
[[Page 44168]]
amount of margin OCC would need to collect during periods of market
stress.
The proposed changes to OCC's models are a continuation of
volatility model changes that OCC has implemented over the past several
years. In 2015, the Commission approved OCC's proposal to more broadly
incorporate variations in implied volatility in OCC's margin
methodology.\9\ In 2018, OCC modified its implied volatility model to
address issues highlighted by large spikes in volatility. The following
sections describe the proposed changes to OCC's models in more detail
as well as the consistency of the proposed changes with applicable law.
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\9\ See Securities Exchange Act Release No. 76781 (Dec. 28,
2015), 81 FR 135 (Jan. 4, 2016) (File No. SR-OCC-2015-016).
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II. Background <SUP>10</SUP>
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\10\ 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.\11\ 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.\12\
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\11\ 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'').
\12\ 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.\13\ As described below, and in more
detail in the Notice of Filing, OCC proposes to change three
quantitative models related to certain volatility products.
Specifically, OCC proposes the following changes:
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\13\ See STANS Methodology Approval, 86 FR at 9411.
(1) implement a new model for incorporating variations in implied
volatility within STANS for products based on the S&P 500 Index (``S&P
500''); such proposed model being the ``S&P 500 Implied Volatility
Simulation Model'');
(2) implement a new model to margin futures on volatility indexes
\14\ (``Volatility Index Futures''); such proposed model being the
``Volatility Index Futures Model''); and
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\14\ A volatility index is an index designed to measure the
volatiles implied by the prices of options on an underlying index.
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(3) replace OCC's model for margining variance futures; \15\ such
model being the ``Variance Futures Model.''
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\15\ A variance future is an exchange-traded futures contract
based on the expected realized variance of an underlying interest.
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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 \16\ available to be cleared by
OCC that have a residual tenor \17\ 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 variations in implied
volatility within STANS for products based on the S&P 500 Index.
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\16\ 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.
\17\ 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.\18\ 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.\19\
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\18\ See Notice of Filing, 87 FR at 8074.
\19\ See Notice of Filing, 87 FR at 8075, n. 31.
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Volatility of volatility forecasting. In the current Implied
Volatilities Scenarios Model, OCC uses a GARCH model \20\ to forecast
the volatility of implied volatility risk factors.\21\ 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.\22\ OCC's current Implied Volatilities Scenarios Model
relies on an exponentially weighted moving average \23\ 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.\24\
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\20\ 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).
\21\ See Notice of Filing, 87 FR at 8073.
\22\ See id.
\23\ 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 12. 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).
\24\ See Notice of Filing, 87 FR at 8074.
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In the proposed S&P 500 Implied Volatility Simulation Model, OCC
[[Page 44169]]
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.\25\
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\25\ See Notice of Filing, 87 FR at 8076.
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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.\26\ 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.\27\ 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 \28\ dimensions.\29\ 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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\26\ 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.
\27\ See Notice of Filing, 87 FR at 8074.
\28\ 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 8073, n. 12.
\29\ Key risk factors driving the implied volatility surface are
explicitly modeled within the model itself. See Notice of Filing, 87
FR at 8076.
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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.\30\
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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\30\ See Notice of Filing, 87 FR at 8074.
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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.\31\ 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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\31\ See Notice of Filing, 87 FR at 8076. 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 8075.
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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.\32\ As noted
above, OCC now 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).\33\
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\32\ 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).
\33\ 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 8074, n. 25.
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In the Notice of Filing, OCC stated that its current Synthetic
Futures Model is subject to certain limitations and issues.\34\ 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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\34\ See Notice of Filing, 87 FR at 8074.
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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.\35\
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\35\ 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
Proposed Rule Change, 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
[[Page 44170]]
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.\36\
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\36\ 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.\37\ 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.\38\ 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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\37\ See Notice of Filing, 87 FR at 8075.
\38\ 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.\39\
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\39\ See Notice of Filing, 87 FR at 8075.
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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
Proposed Rule Change, 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 Commission Findings
Section 19(b)(2)(C) of the Exchange Act directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to such organization.\40\ After carefully
considering the Proposed Rule Change, the Commission finds that the
proposal is consistent with the requirements of the Exchange Act and
the rules and regulations thereunder applicable to OCC. More
specifically, the Commission finds that the proposal is consistent with
Section 17A(b)(3)(A) of the Exchange Act,\41\ and Rule 17Ad-22(e)(6)
\42\ thereunder, as described in detail below.
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\40\ 15 U.S.C. 78s(b)(2)(C).
\41\ 15 U.S.C. 78q-1(b)(3)(A).
\42\ 17 CFR 240.17Ad-22(e)(6).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act
Section 17A(b)(3)(F) of the Exchange Act requires, among other
things, that the rules of a clearing agency be designed to assure the
safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible.\43\
Based on its review of the record, and for the reasons described below,
the Commission believes that allowing OCC to make the proposed model
changes described above is consistent with the safeguarding of
securities and funds which are in its custody or control or for which
it is responsible.
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\43\ 15 U.S.C. 78q-1(b)(3)(F).
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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. Setting margins
that accurately reflect the risks posed by the products OCC clears
could reduce the likelihood that OCC would not have sufficient margin
to address losses arising out of the default of a Clearing Member.
Reducing the likelihood that OCC holds insufficient margin to address
default losses would, in turn, further assure the safeguarding of
surviving Clearing Members' collateral by reducing the likelihood that
OCC would be forced to charge losses to the Clearing Fund.
The Commission believes, therefore, that the proposed model changes
are consistent with the requirements of Section 17A(b)(3)(F) of the
Exchange Act.\44\
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\44\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(6) Under the Exchange Act
Rule 17Ad-22(e)(6) 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 \45\ 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.\46\
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\45\ 17 CFR 240.17Ad-22(e)(6)(i).
\46\ 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.\47\ 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
[[Page 44171]]
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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\47\ 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,\48\ 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.'' \49\ The 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.\50\ 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.\51\
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\48\ See Notice of Filing, at 87 FR 8072.
\49\ 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.
\50\ See supra footnote 47.
\51\ 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.\52\
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\52\ 17 CFR 240.17Ad-22(e)(6).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
Proposed Rule Change is consistent with the requirements of the
Exchange Act, and in particular, the requirements of Section 17A of the
Exchange Act \53\ and the rules and regulations thereunder.
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\53\ In approving this Proposed Rule Change, the Commission has
considered the proposed rules' impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\54\ that the Proposed Rule Change (SR-OCC-2022-001) be,
and hereby is, approved.
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\54\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\55\
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\55\ 17 CFR 200.30-3(a)(12).
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-15771 Filed 7-22-22; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on July 25, 2022.
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