Notice2023-13449
Self-Regulatory Organizations; The Options Clearing Corporation; Order Granting Approval of Proposed Rule Change by The Options Clearing Corporation To Amend and Enhance the Options Clearing Corporation's Model Risk Management Policy
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Published
June 26, 2023
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 88 Issue 121 (Monday, June 26, 2023)</title>
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[Federal Register Volume 88, Number 121 (Monday, June 26, 2023)]
[Notices]
[Pages 41453-41455]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-13449]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-97763; File No. SR-OCC-2023-004]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of Proposed Rule Change by The Options Clearing
Corporation To Amend and Enhance the Options Clearing Corporation's
Model Risk Management Policy
June 20, 2023.
I. Introduction
On April 27, 2023, the Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2023-004 pursuant to Section 19(b) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
\2\ thereunder. The proposed rule change would amend OCC's Model Risk
Management Policy (the ``MRM Policy'' or ``Policy'') to, in part,
broaden the scope of OCC's processes for managing model risk. The
proposed rule change was published for public comment in the Federal
Register on May 17, 2023.\3\ The Commission has received no comments
regarding the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 97484 (May 11, 2023), 88
FR 31549 (May 17, 2023) (File No. SR-OCC-2023-004) (``Notice of
Filing'').
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II. Background <SUP>4</SUP>
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\4\ 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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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 certain
risks arising from its relationships with its members. To manage such
risks, OCC uses quantitative methods to make estimates, forecasts, and
projections in the context of its credit risk models, margin system and
related models, and liquidity risk models (each a ``Risk Model'').\5\
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\5\ See Securities Exchange Act Release No. 82785 (Feb. 27,
2018), 83 FR 9345 (Mar. 5, 2018) (File No. SR-OCC-2017-011)
(approving the formalization of the MRM Policy).
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OCC's use of models inherently exposes OCC to model risk, such as
the risk of losses arising out of decisions based on incorrect or
misused model outputs. For example, a model that is not managed
properly could potentially cause OCC to under-collect the collateral
used to cover credit risk posed by a Clearing Member. OCC's MRM Policy
outlines OCC's framework for managing model risk and defines the roles
and responsibilities throughout the risk model and methodology
lifecycle.
Currently, the Policy applies to the Risk Models that OCC uses to
determine, quantify, or measure actual or potential risk exposures or
risk mitigating actions.\6\ The Policy also describes and outlines the
roles and responsibilities of various groups at OCC with regard to
model risk management.\7\ Further, changes to the Policy are subject to
annual review and approval by the Risk Committee of OCC's Board of
Directors.\8\ As described in more detail below, OCC proposes to expand
the application of the Policy to contemplate methodologies comprising
Risk Models and their related inputs and outputs, rather than only
individual Risk Models. To accommodate the expansion of the Policy's
scope beyond individual Risk Models, OCC proposes to revise the roles
and responsibilities described in the MRM Policy. To further broaden
the Policy, OCC proposes adding a new section regarding the use of
tools with quantitative or mathematical techniques not focused on
credit risk models, margin system and related models, and liquidity
risk models (such tools and techniques referred to as ``Risk
Applications'').\9\
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\6\ See id.
\7\ See id.
\8\ See Notice of Filing, 88 FR at 31552, n. 22.
\9\ OCC also proposes non-material verbiage changes, such as
updating references to internal policies and removing duplicative
definitions. For example, OCC would remove standalone definitions at
the end of the Policy where either the term is defined in the body
of the Policy or is not used in the Policy.
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A. Expanding From Risk Models to Risk Methodologies
As noted above, OCC proposes to expand the scope of its MRM Policy
to encompass not only individual Risk Models, but also the
methodologies such models comprise. Such ``Risk Methodologies'' include
the related inputs and outputs of OCC's Risk Models, which OCC uses to
estimate or
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compute the distinct aspects of OCC's credit (i.e., Clearing Fund and
margin) and liquidity resources. To effectuate this expansion, OCC
proposes to replace references to Risk Models with references to Risk
Methodologies, and to revise the roles and responsibilities of OCC
staff as described below.
B. OCC Internal Roles and Responsibilities
OCC proposes changes to the roles and responsibilities defined in
its MRM Policy to accommodate the shift in focus from Risk Models to
Risk Methodologies. Such changes include the expansion of the Model
Risk Management (``MRM'') department's responsibilities. MRM would
become responsible for validating both Risk Models and Risk
Methodologies no less than annually.\10\ Further, the proposed Policy
would require MRM, in validating OCC's Risk Methodologies, to review
the performance of each methodology and verify the related software
implementation.\11\ Additionally, certain references to a specific
department would be replaced with references to such department's
parent to encompass a broader set of staff and responsibilities. For
example, discussion of OCC's Quantitative Risk Management (``QRM'')
department's role in monitoring the use and performance of individual
Risk Models would be replaced with discussion of OCC's Financial Risk
Management (``FRM'') department, of which QRM is a part. Similarly, OCC
proposes to expand the responsibilities of the Model Risk Working Group
(``MRWG'') in accordance with the expansion of the MRM Policy.\12\
Currently, the MRWG reviews risk model changes and determines which
should be sent to OCC's Management Committee for further consideration.
OCC proposes to expand the MRWG's purview to include review of Risk
Methodologies (not just individual Risk Models).\13\
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\10\ Such validations would be performed both prior to
implementation as well as on an ongoing basis to evaluate the
performance of individual Risk Models. Pursuant to the MRM Policy,
OCC requires MRM to validate its Risk Models annually, which OCC
defines as every ``12 months or 365 days.'' The head of MRM would be
responsible for developing and maintain OCC's Annual Model
Validation Plan. OCC proposes to use the more generic ``head of
MRM'' to accommodate non-material title changes that may occur from
time to time. For example, the head of MRM was previously the
Executive Director of MRM, but is currently the Managing Director,
Model Risk Management.
\11\ Such validations would be governed by two procedures
underlying the MRM Policy (the Methodology and Model Validation
Procedure and the Methodology and Model Performance Monitoring
Procedure), which OCC provided to staff as confidential exhibits to
File No. SR-OCC-2023-004.
\12\ The MRWG assists OCC's Management Committee in overseeing
and governing OCC's model-related risk issues. In addition to the
expansion of responsibilities described here, OCC proposes to
describe the membership of the MRWG more generally in the MRM Policy
than is currently the case. Based on a review of OCC's Model Risk
Working Group Procedure, the Commission understands that the MRM
Policy change will not remove any of the current departments
represented on the MRWG. OCC provided the MRWG Procedure as a
confidential exhibit to File No. SR-OCC-2023-004.
\13\ OCC also proposes non-substantive changes that touch on
roles and responsibilities. For example, OCC's Chief Financial Risk
Officer (``CFRO'') has responsibility for reviewing and approving
Risk Model documentation. Currently, the Policy describes review of
documentation as the responsibility of the CFRO or the CFRO's
delegate. The proposed Policy would instead describe it as the
responsibility of the CFRO pursuant to OCC's Risk Methodology
Documentation Procedure. According to OCC, the change would not
result in any substantive change in the roles and responsibilities.
See Notice of Filing, 88 FR at 31550, n. 10.
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C. New Section on Risk Applications
Lastly, OCC proposes to add a new section regarding the use of Risk
Applications. The current MRM Policy focuses on OCC's financial risk
management (i.e., credit risk models, margin system and related models,
and liquidity risk models).\14\ The Risk Applications are tools with
quantitative or mathematical techniques specifically not focused on
financial risk management. Although the Risk Applications do not affect
OCC's Risk Methodologies (or the underlying Risk Models), the processes
for managing the potential risks are similar, so OCC proposes to
encompass both Risk Methodologies and Risk Applications in its Model
Risk Management Policy going forward.\15\
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\14\ See Securities Exchange Act Release No. 82785 (Feb. 27,
2018), 83 FR 9345 (Mar. 5, 2018) (File No. SR-OCC-2017-011)
(approving the formalization of the MRM Policy).
\15\ The proposed MRM Policy would also note that OCC uses user
developed applications (``UDAs''), which are analytical applications
designed to manipulate and analyze data that are used on a
repetitive basis and might expose OCC to Model Risk, and that the
governance for such UDAs is outlined in OCC's User Developed
Application Management Procedure.
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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.\16\ 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)(F) of the Exchange Act,\17\ Rules 17Ad-22(e)(3),
(e)(4), (e)(6), and (e)(7) \18\ thereunder as described in detail
below.
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\16\ 15 U.S.C. 78s(b)(2)(C).
\17\ 15 U.S.C. 78q-1(b)(3)(F).
\18\ 17 CFR 240.17Ad-22(e)(3), 17 CFR 240.17Ad-22(e)(4), 17 CFR
240.17Ad-22(e)(6), and 17 CFR 240.17Ad-22(e)(7).
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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 a clearing agency's rules are designed to assure the
safeguarding of securities and funds in custody or control of the
clearing agency or for which it is responsible.\19\
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\19\ 15 U.S.C. 78q-1(b)(3)(F).
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The Commission believes that the proposed change supports OCC's
ability to safeguard of securities and funds because the proposed
change builds on the foundation of OCC's current processes to provide a
more complete view of model risk at OCC. The MRM Policy governs OCC's
processes for reducing model risk. Expanding OCC's view of model risk
to encompass Risk Methodologies rather than focusing only on individual
Risk Models in isolation will give OCC a more comprehensive
understanding of model risk. The Commission continues to believe that
reducing model risk may allow OCC to avoid taking non-defaulters'
resources to manage a default by covering losses and shortfalls with a
defaulter's collateral.\20\ Similarly, applying its model risk
management practices to OCC's Risk Applications will reduce the
likelihood of loss arising out of decisions based on those
applications.
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\20\ See Securities Exchange Act Release No. 82785 (Feb. 27,
2018), 83 FR 9345, 9346 (Mar. 5, 2018) (File No. SR-OCC-2017-011).
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The Commission believes, therefore, that the proposal is consistent
with the requirements of Section 17A(b)(3)(F) of the Exchange Act.
B. Consistency With Rule 17Ad-22(e)(4), (e)(6), and (e)(7) Under the
Exchange Act
Rules 17Ad-22(e)(4)(vii), (e)(6)(vii) and (e)(7)(vii) under the
Exchange Act require a covered clearing agency to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to, among other things, require the performance of a model
validation for its credit risk models, margin system and related
models, and liquidity risk models not
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less than annually, or more frequently as may be contemplated by the
covered clearing agency's risk management framework established
pursuant to Rule 17Ad-22(e)(3) under the Exchange Act.\21\ The
Commission has stated that a covered clearing agency generally should
consider, in establishing and maintaining policies and procedures for
margin, whether it regularly reviews and validates its margin
system.\22\
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\21\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii) and (e)(7)(vii).
The requirements of Rule 17Ad-22(e)(4) pertain to the effective
identification, measurement, monitoring, and management of credit
exposures. 17 CFR 240.17Ad-22(e)(4). The requirements of Rule 17Ad-
22(e)(6), which apply to a covered clearing agency that performs
central counterparty services, pertain to the covering of a covered
clearing agency's credit exposures to its participants. 17 CFR
240.17Ad-22(e)(6). The requirements of Rule 17Ad-22(e)(7) pertain to
the effective measurement, monitoring, and management of liquidity
risk. 17 CFR 240.17Ad-22(e)(7).
\22\ See Standards for Covered Clearing Agencies, Securities
Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70819
(Oct. 13, 2016).
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The Commission previously found the adoption of the MRM Policy to
be consistent with Rules 17Ad-22(e)(4)(vii), (e)(6)(vii), and
(e)(7)(vii) under the Exchange Act because the MRM Policy requires the
annual validations of the performance, parameters, and assumptions of
OCC's credit risk, margin, and liquidity risk models. As described
above, OCC proposes to broaden the scope of the Policy to contemplate
not only individual Risk Models, but also the Risk Methodologies such
models comprise. The proposal includes governance changes that would
facilitate expansion of the Policy's scope without reducing the current
validation obligations of OCC's MRM department. The Commission believes
that expanding the scope of the MRM Policy to encompass Risk
Methodologies without weakening the arrangements governing the
validation of individual Risk Models would strengthen OCC's validation
of its credit risk models, margin system and related models, and
liquidity risk models.
The Commission believes, therefore, that the proposal is consistent
with the requirements of Rules 17Ad-22(e)(4)(vii), (e)(6)(vii) and
(e)(7)(vii) under the Exchange Act.\23\
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\23\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii) and (e)(7)(vii).
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C. Consistency With Rule 17Ad-22(e)(3) Under the Exchange Act
Rule 17Ad-22(e)(3)(i) requires, among other things, that a covered
clearing agency establish, implement, maintain and enforce written
policies and procedures reasonably designed to maintain a sound risk
management framework for comprehensively managing legal, credit,
liquidity, operational, general business, investment, custody, and
other risks that arise in or are borne by the covered clearing agency,
which includes risk management policies, procedures, and systems
designed to identify, measure, monitor, and manage the range of risks
that arise in or are borne by the covered clearing agency, that are
subject to review on a specified periodic basis and approved by the
board of directors annually.\24\
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\24\ 17 CFR 240.17Ad-22(e)(3)(i).
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Currently, the MRM Policy (and related risk management processes)
applies to Risk Models, which include only credit risk models, margin
system and related models, and liquidity risk models (i.e., financial
risk management models). As proposed, the MRM Policy would apply to
quantitative or mathematical techniques (i.e., the Risk Applications)
that OCC uses outside of financial risk management. As a result, OCC is
proposing to apply a consistent risk management approach to Risk
Methodologies and Risk Applications. The Commission believes that
broadening the application of risk management processes to cover models
that deal with both financial risks and non-financial risks is
consistent with the maintain a sound risk management framework for
comprehensively managing such risks.
The Commission believes, therefore, that the proposal is consistent
with the requirements of Rule 17Ad-22(e)(3)(i) under the Exchange
Act.\25\
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\25\ 17 CFR 240.17Ad-22(e)(3)(i).
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VI. 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 \26\ and the rules and regulations thereunder.
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\26\ 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,\27\ that the proposed rule change (SR-OCC-2022-004) be,
and hereby is, approved.
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\27\ 15 U.S.C. 78s(b)(2).
\28\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\28\
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2023-13449 Filed 6-23-23; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on June 26, 2023.
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