Notice2024-01748
Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Amendment No. 2 to Advance Notice Relating to The Options Clearing Corporation's Concerning Modifications to the Amended and Restated Stock Options and Futures Settlement Agreement Between The Options Clearing Corporation and the National Securities Clearing Corporation
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
January 30, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 20 (Tuesday, January 30, 2024)</title>
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[Federal Register Volume 89, Number 20 (Tuesday, January 30, 2024)]
[Notices]
[Pages 5953-5970]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-01748]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-99427; File No. SR-OCC-2023-801]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Amendment No. 2 to Advance Notice Relating to The
Options Clearing Corporation's Concerning Modifications to the Amended
and Restated Stock Options and Futures Settlement Agreement Between The
Options Clearing Corporation and the National Securities Clearing
Corporation
January 24, 2024.
Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act, entitled Payment, Clearing
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'')
\1\ and Rule 19b-4(n)(1)(i) \2\ of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act''),\3\ notice is hereby given that on
January 23, 2024, the Options Clearing Corporation (``OCC'') filed with
the Securities and Exchange Commission (``SEC'' or ``Commission'') this
amendment (``Amendment No. 2'') to an advance notice as described in
Items I, II and III below, which Items have been prepared primarily by
OCC. The Commission is publishing this notice to solicit comments on
the advance notice from interested persons.
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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.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
This Amendment No. 2 to the advance notice SR-OCC-2023-801 is
submitted by OCC to: (1) modify the Amended and Restated Stock Options
and Futures Settlement Agreement dated August 5, 2017 between OCC and
National Securities Clearing Corporation (``NSCC,'' and together with
OCC, the ``Clearing Agencies'') (``Existing Accord'') \4\ to permit OCC
to elect to make a cash payment to NSCC following the default of a
common clearing participant that would cause NSCC's central
counterparty trade guaranty to attach to certain obligations of that
participant and to make certain related revisions to OCC By-Laws, OCC
Rules,\5\ OCC's Comprehensive Stress Testing & Clearing Fund
Methodology, and Liquidity Risk Management Description and OCC's
Liquidity Risk Management Framework (``Phase 1'') and (2) to improve
information sharing between the Clearing Agencies to facilitate the
upcoming transition to a T+1 standard securities settlement cycle and
allow OCC, after the compliance date under amended Exchange Act Rule
15c6-1(a), to provide certain assurances to NSCC prior to the default
of a common clearing participant that would enable NSCC to begin
processing E&A/Delivery Transactions (defined below) before the central
counterparty trade guaranty attaches to certain obligations of that
participant (``Phase 2'').\6\ This Amendment No. 2 would amend and
replace the Initial Filing and Amendment No. 1 in their entirety.
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\4\ The Existing Accord was previously approved by the
Commission. See Securities Exchange Act Release Nos. 81266, 81260
(July 31, 2017) (File Nos. SR-NSCC-2017-007; SR-OCC-2017-013), 82 FR
36484 (Aug. 4, 2017).
\5\ OCC By-Laws are available at <a href="https://www.theocc.com/getmedia/3309eceb-56cf-48fc-b3b3-498669a24572/occ_bylaws.pdf">https://www.theocc.com/getmedia/3309eceb-56cf-48fc-b3b3-498669a24572/occ_bylaws.pdf</a> and OCC
Rules are available at <a href="https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf">https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf</a>.
\6\ OCC initially filed an advance notice concerning the
proposed Phase 1 changes on August 10, 2023. See Securities Exchange
Act Release No. 98214 (Aug. 24, 2023), 88 FR 59988 (Aug. 30, 2023)
(File No. SR-OCC-2023-801) (``Initial Filing''). OCC subsequently
submitted a partial amendment (``Amendment No. 1'') to clarify the
proposed implementation plan for the Initial Filing available at
<a href="https://www.theocc.com/getmedia/fb30a875-2438-4b2d-bb79-3ff364b6796b/SR-OCC-2023-801-Partial-Amendment-No-1.pdf">https://www.theocc.com/getmedia/fb30a875-2438-4b2d-bb79-3ff364b6796b/SR-OCC-2023-801-Partial-Amendment-No-1.pdf</a>. NSCC also
has filed a proposed rule change with the Commission in connection
with this proposal. See Securities Exchange Act Release No. 98213
(Aug. 24, 2023), 88 FR 59968 (Aug. 30, 2023) (File No. SR-NSCC-2023-
007); Securities Exchange Act Release No. 98930 (Nov. 14, 2023), 88
FR 80790 (Nov. 20, 2023) (Partial Amendment No. 1 to File No. SR-
NSCC-2023-007).
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The proposed changes are included in Exhibits 5A and 5B and
confidential Exhibits 5C, 5D, and 5E of Amendment No. 2 to File No. SR-
OCC-2023-801. Material proposed to be added is underlined and material
proposed to be deleted is marked in strikethrough text.
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the advance notice and
discussed any comments it received on the advance notice. The text of
these statements may be examined at the places specified in Item IV
below. OCC has prepared summaries, set forth in sections (A) and (B)
below, of the most significant aspects of these statements.
(A) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants or Others
Written comments were not and are not intended to be solicited with
respect to the proposed changes, and none have been received.
(B) Advance Notice Filed Pursuant to Section 806(e) of the Payment,
Clearing, and Settlement Supervision Act
Description of Proposed Change
Background
OCC is filing this advance notice to (1) modify the Existing Accord
between OCC and NSCC to permit OCC to elect to make a cash payment to
NSCC following the default of a common clearing participant that would
cause NSCC's central counterparty trade guaranty to attach to certain
obligations of that participant and to make certain related revisions
to OCC By-Laws, OCC Rules, OCC's Comprehensive Stress
[[Page 5954]]
Testing & Clearing Fund Methodology, and Liquidity Risk Management
Description and OCC's Liquidity Risk Management Framework for Phase 1
and (2) improve information sharing between the Clearing Agencies to
facilitate the upcoming transition to a T+1 standard securities
settlement cycle and allow OCC, after the compliance date under amended
Exchange Act Rule 15c6-1(a), to provide certain assurances to NSCC
prior to the default of a common clearing participant that would enable
NSCC to begin processing E&A/Delivery Transactions before the central
counterparty trade guaranty attaches to certain obligations of that
participant for Phase 2.
i. Executive Summary
NSCC is a clearing agency that provides clearing, settlement, risk
management, and central counterparty services for trades involving
equity securities. OCC is the sole clearing agency for standardized
equity options listed on national securities exchanges registered with
the Commission, including options that contemplate the physical
delivery of equities cleared by NSCC in exchange for cash (``physically
settled'' options).\7\ OCC also clears certain futures contracts that,
at maturity, require the delivery of equity securities cleared by NSCC
in exchange for cash. As a result, the exercise/assignment of certain
options or maturation of certain futures cleared by OCC effectively
results in stock settlement obligations. NSCC and OCC maintain a legal
agreement, generally referred to by the parties as the ``Accord''
agreement, that governs the processing of such physically settled
options and futures cleared by OCC that result in settlement
obligations in underlying equity securities to be cleared by NSCC
(i.e., the Existing Accord). The Existing Accord establishes terms
under which NSCC accepts for clearing certain securities transactions
that result from the exercise and assignment of relevant options
contracts and the maturity of futures contracts that are cleared and
settled by OCC.\8\ It also establishes the time when OCC's settlement
guaranty in respect of those transactions ends and NSCC's settlement
guaranty begins.
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\7\ The term ``physically-settled'' as used throughout the OCC
Rules refers to cleared contracts that settle into their underlying
interest (i.e., options or futures contracts that are not cash-
settled). When a contract settles into its underlying interest,
shares of stock are sent, i.e., delivered, to contract holders who
have the right to receive the shares from contract holders who are
obligated to deliver the shares at the time of exercise/assignment
in the case of an option and maturity in the case of a future.
\8\ Under the Existing Accord, such options and futures are
defined as ``E&A/Delivery Transactions,'' which refers to ``Exercise
& Assignment Delivery Transactions.''
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The Existing Accord allows for a scenario in which NSCC could
choose not to guarantee the settlement of such securities arising out
of E&A/Delivery Transactions. Specifically, NSCC is not obligated to
guarantee settlement until its member has met its collateral
requirements at NSCC. If NSCC chooses not to guarantee settlement, OCC
would engage in an alternate method of settlement outside of NSCC. This
scenario presents two primary problems. First, the cash required for
OCC and its Clearing Members in certain market conditions to facilitate
settlement outside of NSCC could be significantly more than the amount
required if NSCC were to guarantee the relevant transactions. This is
because settlement of the transactions in the underlying equity
securities outside of NSCC would mean that they would no longer receive
the benefit of netting through the facilities of NSCC. In such a
scenario, the additional collateral required from Clearing Members to
support OCC's continuing settlement guarantee would also have to be
sufficiently liquid to properly manage the risks associated with those
transactions being due on the second business day following the option
exercise or the relevant futures contract maturity date.
Based on an analysis of scenarios using historical data where it
was assumed that OCC could not settle transactions through the
facilities of NSCC, the worst-case outcome resulted in extreme
liquidity demands of over $300 billion for OCC to effect settlement via
an alternative method, e.g., by way of gross broker-to-broker
settlement, as discussed in more detail below. OCC Clearing Members, by
way of their contributions to the OCC Clearing Fund, would bear the
brunt of this demand. Furthermore, there is no guarantee that OCC
Clearing Members could fund the entire amount of any similar real-life
scenarios. By contrast, projected Guaranty Substitution Payments,
defined below, identified during the study ranged from approximately
$419 million to over $6 billion, also as discussed in more detail
below.
The second primary problem relates to the significant operational
complexities if settlement occurs outside of NSCC. More specifically,
netting through NSCC reduces the volume and value of settlement
obligations. For example, in 2022 it is estimated that netting through
NSCC's continuous net settlement (``CNS'') accounting system \9\
reduced the value of CNS settlement obligations by approximately 98% or
$510 trillion from $519 trillion to $9 trillion. If settlement occurred
outside of NSCC, on a broker-to-broker basis between OCC Clearing
Members, for example, shares would not be netted and Clearing Members
would have to coordinate directly with each other to settle the
relevant transactions. The operational complexities and uncertainty
associated with alternate means of settlement would impact every market
participant involved in a settlement of OCC-related transactions.
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\9\ See Rule 11 (CNS System) and Procedure VII (CNS Accounting
Operation) of the NSCC Rules. See NSCC's Rules, available at <a href="https://www.dtcc.com/-/media/Files/Downloads/legal/rules/nscc_rules.pdf">https://www.dtcc.com/-/media/Files/Downloads/legal/rules/nscc_rules.pdf</a>.
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To address these problems, the Clearing Agencies are proposing
certain changes as part of Phase 1 to amend and restate the Existing
Accord and make related changes to their respective rules that would
allow OCC to elect to make a cash payment (the ``Guaranty Substitution
Payment'' or ``GSP'') to NSCC following the default of a Common Member
\10\ that would cause NSCC to guarantee settlement of that Common
Member's transactions and, therefore, cause those transactions to be
settled through processing by NSCC. In connection with this proposal,
OCC also would enhance its daily liquidity stress testing processes and
procedures to account for the possibility of OCC making such a payment
to NSCC in the event of a Common Member default. By making these
enhancements to its stress testing, OCC could include the liquid
resources necessary to make the payment in its resource planning. The
Clearing Agencies believe that by NSCC accepting such a payment from
OCC, the operational efficiencies and reduced costs related to the
settlement of transactions through NSCC would limit market disruption
following a Common Member default because settlement through NSCC
following such a default would be less operationally complex and would
be expected to require less liquidity and other collateral from market
participants than the processes available to OCC for closing out
positions. Additionally, proposed enhancements by OCC to its liquidity
stress testing would add assurances that
[[Page 5955]]
OCC could make such a payment in the event of a Common Member default.
The Clearing Agencies believe that their respective clearing members
and all other participants in the markets for which OCC provides
clearance and settlement would benefit from OCC's ability to choose to
make a cash payment to effect settlement through the facilities of
NSCC. This change would provide more certainty around certain default
scenarios and would blunt the financial and operational burdens market
participants could experience in the case of most clearing member
defaults.\11\
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\10\ A firm that is both an OCC Clearing Member and an NSCC
Member or is an OCC Clearing Member that has designated an NSCC
Member to act on its behalf is referred to herein as a ``Common
Member.'' The term ``Clearing Member'' as used herein has the
meaning provided in OCC's By-Laws. See OCC's By-Laws, supra, note 5.
The term ``Member'' as used herein has the meaning provided in
NSCC's Rules. See NSCC's Rules, supra note 9.
\11\ OCC provided its analysis of the financial impact of
alternate means of settlement as confidential Exhibit 3A to this
filing.
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Finally, the Clearing Agencies are also proposing certain changes
as part of Phase 2 that, if approved, would not be implemented until
after the Commission shortens the standardized settlement cycle under
Exchange Act Rule 15c6-1(a) from two days after the traded date
(``T+2'') to one day after the trade date (``T+1''), which currently is
set for May 28, 2024. The Phase 2 changes would address the operational
realities concerning the Accord that will result from the Commission's
adoption and implementation of a new standard settlement cycle of T+1
pursuant to Rule 15c6-1(a) under the Act. The Phase 2 changes generally
are designed to allow OCC to provide certain assurances with respect to
OCC's ability to make a GSP in the event of a Common Member default to
NSCC that would permit NSCC to begin processing Common Members' E&A/
Delivery Transactions in a shortened settlement cycle prior to Guaranty
Substitution occurring by introducing new or amended terms and setting
out the processes associated therewith.
ii. Background
OCC acts as a central counterparty clearing agency for U.S.-listed
options and futures on a number of underlying financial assets
including common stocks, currencies and stock indices. In connection
with these services, OCC provides the OCC Guaranty pursuant to its By-
Laws and Rules. NSCC acts as a central counterparty clearing agency for
certain equity securities, corporate and municipal debt, exchange
traded funds and unit investment trusts that are eligible for its
services. Eligible trading activity may be processed through NSCC's CNS
system \12\ or through its Balance Order Accounting system,\13\ where
all eligible compared and recorded transactions for a particular
settlement date are netted by issue into one net long (buy), net short
(sell) or flat position. As a result, for each day with activity, each
Member has a single deliver or receive obligation for each issue in
which it has activity at NSCC. In connection with these services, NSCC
also provides the NSCC Guaranty pursuant to Addendum K of the NSCC
Rules.
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\12\ See Rule 11 (CNS System) and Procedure VII (CNS Accounting
Operation) of the NSCC Rules, supra note 9.
\13\ See Rule 8 (Balance Order and Foreign Security Systems) and
Procedure V (Balance Order Accounting Operation) of the NSCC Rules,
supra note 9.
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OCC's Rules provide that delivery of, and payment for, securities
underlying certain exercised stock options and matured single stock
futures that are physically settled are generally effected through the
facilities of NSCC and are not settled through OCC's facilities.\14\
OCC and NSCC executed the Existing Accord to facilitate, via NSCC's
systems, the physical settlement of securities arising out of options
and futures cleared by OCC. OCC Clearing Members that clear and settle
physically settled options and futures transactions through OCC also
are required under OCC's Rules \15\ to be Members of NSCC or to have
appointed or nominated a Member of NSCC to act on its behalf. As noted
above, these firms are referred to as ``Common Members'' in the
Existing Accord.
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\14\ See Chapter IX of OCC's Rules (Delivery of Underlying
Securities and Payment), supra note 5.
\15\ See OCC Rule 901, supra note 5.
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iii. Summary of the Existing Accord
The Existing Accord governs the transfer between OCC and NSCC of
responsibility for settlement obligations that involve a delivery and
receipt of stock in the settlement of physically settled options and
futures that are cleared and settled by OCC and for which the
underlying securities are eligible for clearing through the facilities
of NSCC (``E&A/Delivery Transactions''). It also establishes the time
when OCC's settlement guarantee (the ``OCC Guaranty'') ends and NSCC's
settlement guarantee (the ``NSCC Guaranty'') \16\ begins with respect
to E&A/Delivery Transactions. However, in the case of a Common Member
default \17\ NSCC can reject these settlement obligations, in which
case the settlement guaranty would not transfer from OCC to NSCC and
OCC would not have a right to settle the transactions through the
facilities of NSCC. Instead, OCC would have to engage in alternative
methods of settlement that have the potential to create significant
liquidity and collateral requirements for both OCC and its non-
defaulting Clearing Members.\18\ More specifically, this could involve
broker-to-broker settlement between OCC Clearing Members.\19\ This
settlement method is operationally complex because it requires
bilateral coordination directly between numerous Clearing Members
rather than relying on NSCC to facilitate multilateral netting to
settle the relevant settlement obligations. As described above, it also
potentially could result in significant liquidity and collateral
requirements for both OCC and its non-defaulting Clearing Members
because the transactions would not be netted through the facilities of
NSCC. Alternatively, where NSCC accepts the E&A/Delivery Transactions
from OCC, the OCC Guaranty ends and the NSCC Guaranty takes effect. The
transactions are then netted through NSCC's systems, which allows
settlement obligations for the same settlement date to be netted into a
single deliver or receive obligation. This netting reduces the costs
associated with securities transfers by reducing the number of
securities movements required for settlement and further reduces
operational and market risk. The benefits of such netting by NSCC may
be significant with respect to the large volumes of E&A/Delivery
Transactions processed during monthly options expiry periods.
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\16\ See Addendum K and Procedure III of the NSCC Rules, supra
note 9.
\17\ A Common Member that has been suspended by OCC or for which
NSCC has ceased to act is referred to as a ``Mutually Suspended
Member.''
\18\ For example, OCC evaluated certain Clearing Member default
scenarios in which OCC assumed that NSCC would not accept the
settlement obligations under the Existing Accord, including the
default of a large Clearing Member coinciding with a monthly options
expiration. OCC has estimated that in such a Clearing Member default
scenario, the aggregate liquidity burden on OCC in connection with
obligations having to be settled on a gross broker-to-broker basis
could reach a significantly high level. For example, in January
2022, the largest gross broker-to-broker settlement amount in the
case of a larger Clearing Member default would have resulted in
liquidity needs of approximately $384,635,833,942. OCC provided the
data and analysis as confidential Exhibit 3A to this filing.
\19\ In broker-to-broker settlement, Clearing Member parties are
responsible for coordinating settlement--delivery and payment--among
themselves on a transaction-by-transaction basis. Once transactions
settle, the parties also have an obligation to affirmatively notify
OCC so that OCC can close out the transactions. If either one of or
both of the parties do not notify OCC, the transaction would remain
open on OCC's books indefinitely until the time both parties have
provided notice of settlement to OCC.
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Pursuant to the Existing Accord, on each trading day NSCC delivers
to OCC a file that identifies the securities, including stocks,
exchange-traded funds and exchange-traded notes, that are
[[Page 5956]]
eligible (1) to settle through NSCC and (2) to be delivered in
settlement of (i) exercises and assignments of stock options cleared
and settled by OCC or (ii) delivery obligations from maturing stock
futures cleared and settled by OCC. OCC, in turn, delivers to NSCC a
file identifying securities to be delivered, or received, for physical
settlement in connection with OCC transactions.\20\
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\20\ Each day that both OCC and NSCC are open for accepting
trades for clearing is referred to as an ``Activity Date'' in the
Existing Accord. Securities eligible for settlement at NSCC are
referred to collectively as ``Eligible Securities'' in the Existing
Accord. Eligible securities are settled at NSCC through NSCC's CNS
Accounting Operation or NSCC's Balance Order Accounting Operation.
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After NSCC receives the list of eligible transactions from OCC, and
NSCC has received all required deposits to the NSCC Clearing Fund from
all Common Members taking into consideration amounts required to
physically settle the OCC transactions, the OCC Guaranty would end and
the NSCC Guaranty would begin with respect to physical settlement of
the eligible OCC-related transactions.\21\ At this point, NSCC is
solely responsible for settling the transactions.\22\
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\21\ The term ``NSCC Clearing Fund'' as used herein has the same
meaning as the term ``Clearing Fund'' as provided in the NSCC Rules.
Procedure XV of the NSCC Rules provides that all NSCC Clearing Fund
requirements and other deposits must be made within one hour of
demand, unless NSCC determines otherwise, supra note 9.
\22\ This is referred to in the Existing Accord as the
``Guaranty Substitution Time,'' and the process of the substitution
of the NSCC Guaranty for the OCC Guaranty with respect to E&A/
Delivery Transactions is referred to as ``Guaranty Substitution.''
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Each day, NSCC is required to promptly notify OCC at the time the
NSCC Guaranty takes effect. If NSCC rejects OCC's transactions due to
an improper submission \23\ or if NSCC ``ceases to act'' for a Common
Member,\24\ NSCC's Guaranty would not take effect for the affected
transactions pursuant to the NSCC Rules.
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\23\ Guaranty Substitution by NSCC (discussed further below)
does not occur with respect to an E&A/Delivery Transaction that is
not submitted to NSCC in the proper format or that involves a
security that is not identified as an Eligible Security on the then-
current NSCC Eligibility Master File.
\24\ Under NSCC's Rules, a default would generally be referred
to as a ``cease to act'' and could encompass a number of
circumstances, such as an NSCC Member's failure to make a Required
Fund Deposit in a timely fashion. See NSCC Rule 46 (Restrictions on
Access to Services), supra note 9. An NSCC Member for which it has
ceased to act is referred to in the Existing Accord as a
``Defaulting NSCC Member.'' Transactions associated with a
Defaulting NSCC Member are referred to as ``Defaulted NSCC Member
Transactions'' in the Existing Accord.
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NSCC is required to promptly notify OCC if it ceases to act for a
Common Member. Upon receiving such a notice, OCC would not continue to
submit to NSCC any further unsettled transactions that involve such
Common Member, unless authorized representatives of both OCC and NSCC
otherwise consent. OCC would, however, deliver to NSCC a reversal file
containing a list of all transactions that OCC already submitted to
NSCC and that involve such Common Member. The NSCC Guaranty ordinarily
would not take effect with respect to transactions for a Common Member
for which NSCC has ceased to act, unless both Clearing Agencies agree
otherwise. As such, NSCC does not have any existing contractual
obligation to guarantee such Common Member's transactions. To the
extent the NSCC Guaranty does not take effect, OCC's Guaranty would
continue to apply, and, as described above, OCC would remain
responsible for effecting the settlement of such Common Member's
transactions pursuant to OCC's By-Laws and Rules.
As noted above, the Existing Accord does provide that the Clearing
Agencies may agree to permit additional transactions for a Common
Member default (``Defaulted NSCC Member Transactions'') to be processed
by NSCC while subject to the NSCC Guaranty. This optional feature,
however, creates uncertainty for the Clearing Agencies and market
participants about how Defaulted NSCC Member Transactions may be
processed following a Common Member default and also does not provide
NSCC with the ability to collect collateral from OCC that it may need
to close out these additional transactions. While the optional feature
would remain in the agreement as part of this proposal, the proposed
changes to the Existing Accord, as described below, could significantly
reduce the likelihood that it would be utilized.
Proposed Phase 1 Changes
i. Proposed Changes to the Existing Accord
The proposed changes to the Existing Accord would permit OCC to
make a cash payment, referred to as the ``Guaranty Substitution
Payment'' or ``GSP,'' to NSCC. This cash payment could occur on either
or both of the day that the Common Member becomes a Mutually Suspended
Member and on the next business day. Upon NSCC's receipt of the
Guaranty Substitution Payment from OCC, the NSCC Guaranty would take
effect for the Common Member's transactions, and they would be accepted
by NSCC for clearance and settlement.\25\ OCC could use all Clearing
Member contributions to the OCC Clearing Fund \26\ and certain Margin
Assets \27\ of a defaulted Clearing Member to pay the GSP, as described
in more detail below.
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\25\ Acceptance of such transactions by NSCC would be subject to
NSCC's standard validation criteria for incoming trades. See NSCC
Rule 7, supra note 9.
\26\ The term ``OCC Clearing Fund'' as used herein has the same
meaning as the term ``Clearing Fund'' in OCC's By-Laws, supra note
5.
\27\ The term ``Margin Assets'' as used herein has the same
meaning as provided in OCC's By-Laws, supra note 5.
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NSCC would calculate the Guaranty Substitution Payment as the sum
of the Mutually Suspended Member's unpaid required deposit to the NSCC
Clearing Fund (``Required Fund Deposit'') \28\ and the unpaid
Supplemental Liquidity Deposit \29\ obligation that is attributable to
E&A/Delivery Transactions. The proposed changes to the Existing Accord
define how NSCC would calculate the Guaranty Substitution Payment.
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\28\ The Required Fund Deposit is calculated pursuant to Rule 4
(Clearing Fund) and Procedure XV (Clearing Fund Formula and Other
Matters) of the NSCC Rules, see supra note 9.
\29\ Under the NSCC Rules, NSCC collects additional cash
deposits from those Members who would generate the largest
settlement debits in stressed market conditions, referred to as
``Supplemental Liquidity Deposits'' or ``SLD.'' See Rule 4A of the
NSCC Rules, supra note 9.
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More specifically, NSCC would first determine how much of the
member's unpaid Clearing Fund requirement would be included in the GSP.
NSCC would look at the day-over-day change in gross market value of the
Mutually Suspended Member's positions as well as day-over-day change in
the member's NSCC Clearing Fund requirements. Based on such changes,
NSCC would identify how much of the change in the Clearing Fund
requirement was attributable to E&A/Delivery Transactions coming from
OCC. If 100 percent of the day-over-day change in the NSCC Clearing
Fund requirement is attributable to activity coming from OCC, then the
GSP would include 100 percent of the member's NSCC Clearing Fund
requirement. If less than 100 percent of the change is attributable to
activity coming from OCC, then the GSP would include that percent of
the member's unpaid NSCC Clearing Fund requirement attributable to
activity coming from OCC. NSCC would then determine the portion of the
member's unpaid SLD obligation that is attributable to E&A/Delivery
Transactions. As noted above, the GSP would be the sum of these two
amounts. A member's NSCC Clearing Fund requirement and SLD obligation
at NSCC are designed to address the credit and liquidity risks that a
member poses to NSCC. The GSP calculation is
[[Page 5957]]
intended to assess how much of a member's obligations arise out of
activity coming from OCC so that the amount paid by OCC is commensurate
with the risk to NSCC of guarantying such activity.
To permit OCC to anticipate the potential resources it would need
to pay the GSP for a Mutually Suspended Member, each business day, NSCC
would provide OCC with (1) Required Fund Deposit and Supplemental
Liquidity Deposit obligations, as calculated pursuant to the NSCC
Rules, and (2) the gross market value of the E&A/Delivery Transactions
and the gross market value of total Net Unsettled Positions (as such
term is defined in the NSCC Rules). On options expiry days that fall on
a Friday, NSCC would also provide OCC with information regarding
liquidity needs and resources, and any intraday SLD requirements of
Common Members. Such information would be delivered pursuant to the
ongoing information sharing obligations under the Existing Accord (as
proposed to be amended) and the Service Level Agreement (``SLA'') to
which both NSCC and OCC are a party pursuant to Section 2 of the
Existing Accord.\30\ The SLA addresses specifics regarding the time,
form, and manner of various required notifications and actions
described in the Accord and also includes information applicable under
the Accord.
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\30\ OCC provided a draft of the revised SLA to the Commission
as confidential Exhibit 3C to this filing.
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NSCC and OCC believe the proposed calculation of the Required Fund
Deposit portion of the GSP is appropriate because it is designed to
provide a reasonable proxy for the impact of the Mutually Suspended
Member's E&A/Delivery Transactions on its Required Fund Deposit. While
impact study data did show that the proposed calculation could result
in a GSP that overestimates or underestimates the Required Fund Deposit
attributable to the Mutually Suspended Member's E&A/Delivery
Transactions,\31\ current technology constraints prohibit NSCC from
performing a precise calculation of the GSP on a daily basis for every
Common Member.\32\
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\31\ The impact study was conducted at the Commission's request
to cover a three-day period and reviewed the ten Common Members with
the largest Required Fund Deposits attributable to the Mutually
Suspended Member's E&A/Delivery Transactions. Over the 30 instances
in the study, approximately 15 instances resulted in an
underestimate of the Required Fund Deposit by an average of
approximately $112,900,926, four instances where the proxy
calculation was the same as the Required Fund Deposit, and eleven
instances of an overestimate of the Required Fund Deposit by an
average of approximately $59,654,583. See confidential Exhibit 3D to
this filing for additional detail related to the referenced study.
\32\ OCC and NSCC agreed that performing the necessary
technology build during Phase 1 would delay the implementation of
Phase 1 of this proposal. NSCC will incorporate those technology
updates in connection with Phase 2 of this proposal.
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Implementing the ability for OCC to make the GSP and cause the E&A/
Delivery Transactions to be cleared and settled through NSCC would
promote the ability of OCC and NSCC to be efficient and effective in
meeting the requirements of the markets they serve. This is because
data demonstrates that the expected size of the GSP would be smaller
than the amount of cash that would otherwise be needed by OCC and its
Clearing Members to facilitate settlement outside of NSCC. More
specifically, based on a historical study of alternate means of
settlement available to OCC from September 2021 through September 2022,
in the event that NSCC did not accept E&A/Delivery Transactions, the
worst-case scenario peak liquidity need OCC identified was
$384,635,833,942 for settlement to occur on a gross broker-to-broker
basis. OCC estimates that the corresponding GSP in this scenario would
have been $863,619,056. OCC also analyzed several other large liquidity
demand amounts that were identified during the study if OCC effected
settlement on a gross broker-to-broker basis.\33\ These liquidity
demand amounts and the largest liquidity demand amount OCC observed of
$384,635,833,942 substantially exceed the amount of liquid resources
currently available to OCC.\34\ By contrast, projected GSPs identified
during the study ranged from $419,297,734 to $6,281,228,428. For each
of these projected GSP amounts, OCC observed that the Margin Assets and
OCC Clearing Fund contributions that would have been required of
Clearing Members in these scenarios would have been sufficient to
satisfy the amount of the projected GSPs.
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\33\ See confidential Exhibit 3A to this filing for additional
detail related to the referenced study.
\34\ As of September 30, 2023, OCC held approximately $12.37
billion in qualifying liquid resources. See OCC Quantitative
Disclosure, July-September 2023, available at <a href="https://www.theocc.com/risk-management/pfmi-disclosures">https://www.theocc.com/risk-management/pfmi-disclosures</a>.
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To help address the current technology constraint that prohibits
NSCC from performing a precise calculation of the GSP on a daily basis
for every Common Member, proposed Section 6(b)(i) of the Existing
Accord and related Section 7(d) of the SLA would provide that with
respect to a Mutually Suspended Member, either NSCC or OCC may require
that the Required Fund Deposit portion of the GSP be re-calculated by
calculating the Required Fund Deposit for the Mutually Suspended Member
both before and after the delivery of the E&A/Delivery Transactions and
utilize the precise amount that is attributable to that activity in the
final GSP. If such a recalculation is required, the result would
replace the Required Fund Deposit component of the GSP that was
initially calculated. The SLD component of the GSP would be unchanged
by such recalculation.
As the above demonstrates, the GSP is intended to address the
significant collateral and liquidity requirements that could be
required of OCC Clearing Members in the event of a Common Member
default.
Allowing OCC to make a GSP payment also is intended to allow for
settlement processing to take place through the facilities of NSCC to
retain operational efficiencies associated with the settlement process.
Alternative settlement means such as broker-to-broker settlement add
operational burdens, because transactions would need to be settled
individually on one-off bases. In contrast, NSCC's netting reduces the
volume and value of settlement obligations that would need to be closed
out in the market.\35\ Because the clearance and settlement of
obligations through NSCC's facilities following a Common Member
default, including netting of E&A/Delivery Transactions with a Common
Member's positions at NSCC, would avoid these potentially significant
operational burdens for OCC and its Clearing Members, OCC and NSCC
believe that the proposed changes would limit market disruption
relating to a Common Member default. NSCC netting significantly reduces
the total number of obligations that require the exchange of money for
settlement. Allowing more activity to be processed through NSCC's
netting systems would minimize risk associated with the close out of
those transactions following the default of a Common Member.
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\35\ CNS reduces the value of obligations that require financial
settlement by approximately 98%, where, for example $519 trillion in
trades could be netted down to approximately $9 trillion in net
settlements.
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Amending the Existing Accord to define the terms and conditions
under which Guaranty Substitution may occur, at OCC's election, with
respect to Defaulted NSCC Member Transactions after a Common Member
becomes a Mutually Suspended Member would also provide more certainty
to both the Clearing Agencies and market
[[Page 5958]]
participants generally about how a Mutually Suspended Member's
Defaulted NSCC Member Transactions may be processed.
NSCC and OCC have agreed it is appropriate to limit the
availability of the proposed provision to the day of the Common Member
default and the next business day because, based on historical
simulations of cease to act events involving Common Members, most
activity of a Mutually Suspended Member is closed out on those
days.\36\ Furthermore, the benefits of netting through NSCC's systems
would be reduced for any activity submitted to NSCC after that time.
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\36\ OCC provided data regarding such events in confidential
Exhibit 3B to this filing. The information contained therein
includes the assumptions and timelines leading up to the declaration
of a default for a Common Member and the anticipated timing of OCC's
payment of the GSP.
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To implement the proposed Phase 1 changes to the Existing Accord,
OCC and NSCC propose to make the following changes.
Section 1--Definitions
First, new definitions would be added, and existing definitions
would be amended in Section 1, which is the Definitions section.
The new defined terms would be as follows.
<bullet> The term ``Close Out Transaction'' would be defined to
mean ``the liquidation, termination or acceleration of one or more
exercised or matured Stock Options \37\ or Stock Futures \38\
contracts, securities contracts, commodity contracts, forward
contracts, repurchase agreements, swap agreements, master netting
agreements or similar agreements of a Mutually Suspended Member
pursuant to OCC Rules 901, 1006 and 1101 through 1111 (including but
not limited to Rules 1104 and 1107) and/or NSCC Rule 18.'' This
proposed definition would make it clear that the payment of the
Guaranty Substitution Payment and NSCC's subsequent acceptance of
Defaulted NSCC Member Transactions for clearance and settlement are
intended to fall within the ``safe harbors'' provided in the Bankruptcy
Code,\39\ the Securities Investor Protection Act,\40\ and other similar
laws.
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\37\ The term ``Stock Options'' is defined in the Existing
Accord within the definition of ``Eligible Securities,'' and refers
to options issued by OCC.
\38\ The term ``Stock Futures'' is defined in the Existing
Accord within the definition of ``Eligible Securities,'' and refers
to stock futures contracts cleared by OCC.
\39\ 11 U.S.C. 101 et seq., including sections 362(b)(6), (7),
(17), (25) and (27) (exceptions to the automatic stay), sections
546(e)-(g) and (j) (limitations on avoiding powers), and sections
555-556 and 559-562 (contractual right to liquidate, terminate or
accelerate certain contracts).
\40\ 15 U.S.C. 78aaa-lll, including section 78eee(b)(2)(C)
(exceptions to the stay).
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<bullet> The term ``Guaranty Substitution Payment'' would be
defined to mean ``an amount calculated by NSCC in accordance with the
calculations set forth in Appendix A [to the Existing Accord (as
proposed to be amended)], to include two components: (i) a portion of
the Mutually Suspended Member's Required Fund Deposit deficit to NSCC
at the time of the cease to act; and (ii) a portion of the Mutually
Suspended Member's unpaid Supplemental Liquidity Deposit obligation at
the time of the cease to act.''
<bullet> The term ``Mutually Suspended Member'' would mean ``any
OCC Participating Member \41\ that has been suspended by OCC that is
also an NSCC Participating Member \42\ for which NSCC has ceased to
act.''
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\41\ The term ``OCC Participating Member'' is defined in the
Existing Accord to mean ``(i) a Common Member; (ii) an OCC Clearing
Member that is an `Appointing Clearing Member' (as defined in
Article I of OCC's By-Laws) and has appointed an Appointed Clearing
Member that is an NSCC Member to effect settlement of E&A/Delivery
Transactions through NSCC on the Appointing Clearing Member's
behalf; (iii) an OCC Clearing Member that is an Appointed Clearing
Member; or (iv) a Canadian Clearing Member.'' No changes are
proposed to this definition.
\42\ The term ``NSCC Participating Member'' is defined in the
Existing Accord to mean ``(i) a Common Member; (ii) an NSCC Member
that is an `Appointed Clearing Member' (as defined in Article I of
OCC's By-Laws); or (iii) [Canadian Depository for Securities Limited
or ``CDS'']. For the avoidance of doubt, the Clearing Agencies agree
that CDS is an NSCC Member for purposes of this Agreement.'' No
changes are proposed to this definition.
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<bullet> The term ``Required Fund Deposit'' would have the meaning
``provided in Rule 4 of NSCC's Rules and Procedures (or any replacement
or substitute rule), the version of which, with respect to any
transaction or obligation incurred that is the subject of this
Agreement, is in effect at the time of such transaction or incurrence
of obligation.''
<bullet> The term ``Supplemental Liquidity Deposit'' would have the
meaning ``provided in Rule 4A of NSCC's Rules and Procedures (or any
replacement or substitute rule), the version of which, with respect to
any transaction or obligation incurred that is the subject of this
Agreement, is in effect at the time of such transaction or incurrence
of obligation.''
The defined terms that would be amended in Section 1 of the
Existing Accord are as follows.
<bullet> The definition for the term ``E&A/Delivery Transaction''
generally contemplates a transaction that involves a delivery and
receipt of stock in the settlement of physically settled options and
futures that are cleared and settled by OCC and for which the
underlying securities are eligible for clearing through the facilities
of NSCC. The definition would be amended to make clear that it would
apply in respect of a ``Close Out Transaction'' of a ``Mutually
Suspended Member'' as those terms are proposed to be defined (described
above).
<bullet> The definition for the term ``Eligible Securities''
generally contemplates the securities that are eligible to be used for
physical settlement under the Existing Accord. The term would be
modified to clarify that this may include, for example, equities,
exchange-traded funds and exchange-traded notes that are underlying
securities for options issued by OCC.
Section 6--Default by an NSCC Participating Member or OCC Participating
Member
Section 6 of the Existing Accord provides that NSCC is required to
provide certain notice to OCC in circumstances in which NSCC has ceased
to act for a Common Member. Currently, Section 6(a)(ii) of the Existing
Accord also requires NSCC to notify OCC if a Common Member has failed
to satisfy its Clearing Fund obligations to NSCC, but for which NSCC
has not yet ceased to act. In practice, this provision would trigger a
number of obligations (described below) when a Common Member fails to
satisfy its NSCC Clearing Fund obligations for any reason, including
those due to an operational delay. Therefore, OCC and NSCC are
proposing to remove the notification requirement under Section 6(a)(ii)
from the Existing Accord. Under Section 7(d) of the Existing Accord,
NSCC and OCC are required to provide each other with general
surveillance information regarding Common Members, which includes
information regarding any Common Member that is considered by the other
party to be in distress. Therefore, if a Common Member has failed to
satisfy its NSCC Clearing Fund obligations and NSCC believes this
failure is due to, for example, financial distress and not, for
example, due to a known operational delay, and NSCC has not yet ceased
to act for that Common Member, such notification to OCC would still
occur but would be done pursuant to Section 7(d) of the Existing Accord
(as proposed to be amended), and not Section 6(a)(ii). Notifications
under Section 6 of the Existing Accord (as proposed to be amended)
would be limited to instances when NSCC has actually ceased to act
[[Page 5959]]
for a Common Member pursuant to the NSCC Rules.\43\
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\43\ See Rule 46 (Restrictions on Access to Services) of the
NSCC Rules, supra note 9.
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Following notice by NSCC that it has ceased to act for a Common
Member, OCC is obligated in turn to deliver to NSCC a list of all E&A/
Delivery Transactions (excluding certain transactions for which
Guaranty Substitution does not occur) involving the Common Member.\44\
This provision would be amended to clarify that it applies in respect
of such E&A/Delivery Transactions for the Common Member for which the
NSCC Guaranty has not yet attached--meaning that Guaranty Substitution
has not yet occurred.
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\44\ The section of the Existing Accord that addresses
circumstances in which NSCC ceases to act and/or an NSCC Member
defaults is currently part of Section 6(a). It would be re-
designated as Section 6(b) for organizational purposes.
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As described above in the summary of the Existing Accord, where
NSCC has ceased to act for a Common Member, the Existing Accord refers
to the Common Member as the Defaulting NSCC Member and also refers to
the relevant E&A/Delivery Transactions in connection with that
Defaulting NSCC Member for which a Guaranty Substitution has not yet
occurred as Defaulted NSCC Member Transactions.
If the Defaulting NSCC Member is also suspended by OCC, it would be
covered by the proposed definition that is described above for a
Mutually Suspended Member. For such a Mutually Suspended Member, the
proposed changes in Section 6(b) would provide that NSCC, by a time
agreed upon by the parties, would provide OCC with the amount of the
Guaranty Substitution Payment as calculated by NSCC and related
documentation regarding the calculation. The Guaranty Substitution
Payment would be calculated pursuant to NSCC's Rules as that portion of
the unmet Required Fund Deposit \45\ and Supplemental Liquidity Deposit
\46\ obligations of the Mutually Suspended Member attributable to the
Defaulted NSCC Member Transactions. By a time agreed upon by the
parties,\47\ OCC would then be required to either notify NSCC of its
intent to make the full amount of the Guaranty Substitution Payment to
NSCC or notify NSCC that it will not make the Guaranty Substitution
Payment. If OCC makes the full amount of the Guaranty Substitution
Payment, NSCC's guaranty would take effect at the time of NSCC's
receipt of that payment and the OCC Guaranty would end.
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\45\ The Required Fund Deposit is calculated pursuant to Rule 4
(Clearing Fund) and Procedure XV (Clearing Fund Formula and Other
Matters) of the NSCC Rules, see supra note 9.
\46\ The Supplemental Liquidity Deposit is calculated pursuant
to Rule 4A (Supplemental Liquidity Deposits) of the NSCC Rules, see
supra note 9.
\47\ The time by which OCC would be required to notify NSCC of
its intent would be defined in the Service Level Agreement. As of
the time of this filing, the parties intend to set that time as one
hour after OCC's receipt of the calculated Guaranty Substitution
Payment from NSCC.
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The proposed changes would further provide that if OCC does not
suspend the Common Member (such that the Common Member would therefore
not meet the proposed definition of a Mutually Suspended Member) or if
OCC elects to not make the full amount of the Guaranty Substitution
Payment to NSCC, then all of the Defaulted NSCC Member Transactions
would be exited from NSCC's CNS Accounting Operation and/or NSCC's
Balance Order Accounting Operation, as applicable, and Guaranty
Substitution would not occur in respect thereof. Therefore, NSCC would
continue to have no obligation to guarantee or settle the Defaulted
NSCC Member Transactions, and the OCC Guaranty would continue to apply
to them pursuant to OCC's By-Laws and Rules.\48\
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\48\ Under the current and proposed terms of the Existing
Accord, NSCC would be permitted to voluntarily guaranty and settle
the Defaulted NSCC Member Transactions.
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Proposed changes to the Existing Accord would also address the
application of any Guaranty Substitution Payment by NSCC. Specifically,
new Section 6(d) would provide that any Guaranty Substitution Payment
made by OCC may be used by NSCC to satisfy any liability or obligation
of the Mutually Suspended Clearing Member to NSCC on account of
transactions involving the Mutually Suspended Clearing Member for which
the NSCC Guaranty applies and to the extent that any amount of assets
otherwise held by NSCC for the account of the Mutually Suspended Member
(including any Required Fund Deposit or Supplemental Liquidity Deposit)
are insufficient to satisfy its obligations related to transactions for
which the NSCC Guaranty applies. Proposed changes to Section 6(d) would
further provide for the return to OCC of any unused portion of the GSP.
With regard to the portion of the Guaranty Substitution Payment that
corresponds to a member's Supplemental Liquidity Deposit obligation,
NSCC must return any unused amount to OCC within fourteen (14) days
following the conclusion of NSCC's settlement, close-out and/or
liquidation. With regard to the portion of the Guaranty Substitution
Payment that corresponds to a Required Fund Deposit, NSCC must return
any unused amount to OCC under terms agreed to by the parties.\49\
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\49\ Such amounts would be returned to OCC as appropriate and in
accordance with a Netting Contract and Limited Cross-Guaranty, by
and among The Depository Trust Company, Fixed Income Clearing
Corporation, NSCC and OCC, dated as of January 1, 2003, as amended.
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Other Proposed Changes as Part of Phase 1
Certain other technical changes are also proposed to the Existing
Accord to conform it to the proposed changes described above. For
example, the preamble and the ``whereas'' clauses in the Preliminary
Statement would be amended to clarify that the agreement is an amended
and restated agreement and to summarize that the agreement would be
modified to contemplate the Guaranty Substitution Payment structure.
Section 1(c), which addresses the terms in the Existing Accord that are
defined by reference to NSCC's Rules and Procedures and OCC's By-Laws
and Rules would be modified to state that such terms would have the
meaning then in effect at the time of any transaction or obligation
that is covered by the agreement rather than stating that such terms
have the meaning given to them as of the effective date of the
agreement. This change is proposed to help ensure that the meaning of
such terms in the agreement will not become inconsistent with the
meaning in the NSCC Rules and/or OCC By-Laws and Rules, as they may be
modified through proposed rule changes with the Commission.
Technical changes would be made to Sections 3(d) and (e) of the
Existing Accord to provide that those provisions would not apply in the
event new Section 6(b) described above, is triggered. Section 3(d)
generally provides that OCC will no longer submit E&A/Delivery
Transactions to NSCC involving a suspended OCC Participating
Member.\50\ Similarly, Section 3(e) generally provides that OCC will no
longer submit E&A/Delivery Transactions to NSCC involving an NSCC
Participating Member \51\ for which NSCC has ceased to act. A proposed
change would also be made to Section 5 of the Existing Accord to modify
a reference to Section 5 of Article VI of OCC's By-Laws to instead
provide that the updated cross-reference should be to Chapter IV of
OCC's Rules.
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\50\ See supra note 41 defining OCC Participating Member.
\51\ See supra note 42 defining NSCC Participating Member.
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Section 5 would also be amended to clarify that Guaranty
Substitution
[[Page 5960]]
occurs when NSCC has received both the Required Fund Deposit and
Supplemental Liquidity Deposit, as calculated by NSCC in its sole
discretion, from Common Members. The addition of the collection of the
Supplemental Liquidity Deposit to the definition of the Guaranty
Substitution Time in this Section 5 would reflect OCC and NSCC's
agreement that both amounts are components of the Guaranty Substitution
Payment (as described above) and would make this definition consistent
with that agreement.
In Section 7 of the Existing Accord, proposed changes would be made
to provide that NSCC would provide to OCC information regarding a
Common Member's Required Fund Deposit and Supplemental Liquidity
Deposit obligations, to include the Supplemental Liquidity Deposit
obligation in this notice requirement, and additionally that NSCC would
provide OCC with information regarding the potential Guaranty
Substitution Payment for the Common Member. On an options expiration
date that is a Friday, NSCC would, by close of business on that day,
also provide to OCC information regarding the intra-day liquidity
requirement, intra-day liquidity resources and intra-day calls for a
Common Member that is subject to a Supplemental Liquidity Deposit at
NSCC.
Finally, Section 14 of the Existing Accord would be modernized to
provide that notices between the parties would be provided by email
rather than by hand, overnight delivery service or first-class mail.
ii. Proposed Changes to OCC By-Laws and Rules as Part of Phase 1
General Description
OCC is also proposing certain changes to its By-Laws and Rules that
are designed to complement the proposed changes described above
regarding the Existing Accord. These proposed changes to the By-Laws
and Rules are described below, and they generally cover the following
four areas. First, the proposed changes would define Guaranty
Substitution Payment. Second, the proposed changes would describe the
circumstances under which OCC could make a Guaranty Substitution
Payment to NSCC. Third, the proposed changes would specify what
financial resources could be used by OCC to make the Guaranty
Substitution Payment.\52\ Fourth, the proposed changes to OCC's
Comprehensive Stress Testing and Clearing Fund Methodology, and
Liquidity Risk Management Description would outline enhanced stress
testing incorporating the GSP and OCC's ability to call for additional
resources from Clearing Members. OCC also is proposing changes to OCC's
Liquidity Risk Management Framework to account for OCC's ability to
make the GSP.
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\52\ OCC would be permitted to borrow from the Clearing Fund and
margin of a suspended Clearing Member, over which OCC has a general
lien, where that Clearing Member is a Mutually Suspended Member. The
change would merely expand the circumstances under which OCC's
current By-Laws and Rules permit OCC to borrow Clearing Fund and
margin. The change would not affect the treatment of such borrowing
under OCC's default waterfall that determines how OCC allocates
losses against available financial resources. The Mutually Suspended
Member's margin and Clearing Fund collateral would remain first in
line to absorb losses.
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Article I--Definitions
OCC proposes to add ``Guaranty Substitution Payment'' as a new
defined term under Article I of OCC's By-Laws, which is the Definitions
section. The term ``Guaranty Substitution Payment'' would be defined to
mean: ``a payment that may be made by [OCC] to [NSCC] under the terms
of an agreement between them, as described in Rule 901, so that [NSCC]
will not reject settlement obligations for CCC-eligible \53\ securities
that are directed by [OCC] for settlement through the facilities of
[NSCC] on account of a Clearing Member that has been suspended, as
described in Rule 1102, and for which [NSCC] has ceased to act.''
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\53\ The term ``CCC-Eligible'' as used herein has the meaning
provided in OCC's By-Laws, supra note 5.
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Chapter IX--Delivery of Underlying Securities and Payment
Certain changes are also proposed to Chapter IX of OCC's Rules. OCC
proposes to add parenthetical language to the Introduction section of
Chapter IX of OCC's Rules. It would specify that a Guaranty
Substitution Payment could be made by OCC to NSCC in connection with
OCC's general policy that to the extent a security to be delivered and
received is CCC-eligible, OCC will direct the delivery and payment
obligations to be settled through the facilities of NSCC where the
obligations are physically-settled and arise out of the exercise of
stock option contracts or the maturity of stock futures contracts.
Next, OCC proposes to delete certain provisions from Rule 901(b)
regarding when a Guaranty Substitution occurs. Specifically, Rule
901(b) currently provides that unless otherwise agreed between OCC and
NSCC, a Guaranty Substitution with respect to settlement obligations
for CCC-eligible securities that settle ``regular way'' under NSCC's
Rules and Procedures will occur if: (i) the applicable settlement
obligations are reported to and are not rejected by NSCC; (ii) NSCC has
not notified OCC that it has ceased to act for the relevant Clearing
Member or Appointed Clearing Member; and (iii) the NSCC Clearing Fund
requirements of the relevant Clearing Member or Appointed Clearing
Member owing to NSCC, as determined in accordance with NSCC's Rules and
Procedures, are received by NSCC. These considerations regarding when a
Guaranty Substitution occurs are addressed under the terms of the
Existing Accord, and they would continue to be relevant considerations
regarding when a Guaranty Substitution occurs under the changes that
OCC and NSCC are proposing to the Existing Accord. However, because
additional considerations would be added to the Guaranty Substitution
process in connection with the proposed ability for OCC in certain
circumstances to make a Guaranty Substitution Payment to NSCC and also
to eliminate the potential for a description of the Guaranty
Substitution process in OCC's Rules to become inconsistent with the
process that OCC and NSCC have agreed to in the Existing Accord, as it
would be amended, OCC is proposing to delete the discussion of these
considerations in Rule 901(b) in favor of instead simply cross
referencing the terms of the agreement.\54\
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\54\ For purposes of the proposed rule change process under
Exchange Act Section 19(b), the agreement is treated as a rule of a
clearing agency under Exchange Act Section 3(a)(27) and therefore
any proposed changes to it by OCC are subject to the related rule
change process and public notice and comment. OCC therefore believes
that addressing the terms in the agreement and cross-referencing the
agreement in OCC Rule 901 would not deprive the Commission or the
public of notice regarding any future proposed changes.
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In addition, OCC proposes to add a new paragraph to the end of Rule
901(b) to provide that pursuant to the proposed changes to the Existing
Accord, OCC would be permitted to make a Guaranty Substitution Payment
to NSCC. The proposed changes would also describe the circumstances in
which OCC may make a Guaranty Substitution Payment in connection with
settlement obligations of a suspended Clearing Member, and that the
amount of the Guaranty Substitution Payment under the terms of the
Existing Accord, as amended, would be the amount required by NSCC to
satisfy its deficit(s) regarding such Clearing Member's ``Required Fund
Deposit'' and ``Supplemental Liquidity Deposit'' as those terms are
defined in NSCC's Rules
[[Page 5961]]
and Procedures.\55\ The changes would provide that any amount of a
Guaranty Substitution Payment that NSCC does not use pursuant to its
Rules and Procedures would subsequently be returned to OCC under such
terms and within such times as are agreed by OCC and NSCC. OCC believes
that it is useful to include this description of the proposed process
for the Guaranty Substitution Payment and the circumstances in which it
may be made so that a user of OCC's publicly available By-Laws and
Rules would have sufficient information to understand the existence of
the Guaranty Substitution Payment mechanism, the general circumstances
in which it may be made and the role that a Guaranty Substitution
Payment would play in causing NSCC to accept obligations for CCC-
eligible securities for clearance and settlement.
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\55\ See NSCC Rules 4 (defining ``Required Fund Deposit'') and
4A (defining ``Supplemental Liquidity Deposit''), supra note 9.
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Chapters X and XI--Clearing Fund Contributions and Suspension of a
Clearing Member
As generally described above, the proposed changes would also
provide that OCC would be permitted to borrow from the OCC Clearing
Fund, and also against certain Margin Assets, of a Clearing Member that
has been suspended by OCC where that Clearing Member is a Mutually
Suspended Member. To implement these changes, OCC is proposing the
following amendments to OCC Rule 1006 and Rule 1104.
OCC Rule 1006 addresses the purpose and permitted uses of the OCC
Clearing Fund. OCC proposes to make amendments to paragraphs (a) and
(f) to permit OCC to utilize assets in the Clearing Fund as a liquidity
resource in connection with making a Guaranty Substitution Payment.
Currently, OCC Rule 1006(a) states the conditions for use of the OCC
Clearing Fund. These provide that the OCC Clearing Fund may be used for
borrowings pursuant to OCC Rule 1006(f) or to make good losses or
expenses suffered by OCC including: (i) as a result of the failure of
any Clearing Member to discharge duly any obligation on or arising from
any confirmed trade accepted by OCC, (ii) as a result of the failure of
any Clearing Member (including any Appointed Clearing Member) or of CDS
(Canada's national securities depository) to perform its obligations
under any contract or obligation issued, undertaken, or guaranteed by
OCC or in respect of which OCC is otherwise liable, (iii) as a result
of the failure of any Clearing Member to perform any of its obligations
to OCC in respect of the stock loan and borrow positions of such
Clearing Member, (iv) in connection with any liquidation of a Clearing
Member's open positions, (v) in connection with protective transactions
effected for the account of OCC pursuant to Chapter XI of OCC's Rules
(delivery of underlying securities and payment), (vi) as a result of
the failure of any Clearing Member to make any other required payment
or render any other required performance or (vii) as a result of the
failure of any bank, securities or commodities clearing organization,
or investment counterparty, to perform its obligations to OCC for
certain specified reasons.\56\
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\56\ The terms ``Clearing Member'' and ``Appointed Clearing
Member'' as used herein have the meanings provided in OCC's By-Laws,
supra note 5.
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OCC proposes to renumber clauses (iii) through (vii) in paragraph
(a) as (iv) through (viii), and to insert as new clause (iii) a
provision that the OCC Clearing Fund may be used ``regarding any
Guaranty Substitution Payment that [OCC] may make to [NSCC] under an
agreement between them, as described in [OCC] Rule 901, so that [NSCC]
will not reject settlement obligations for CCC-eligible securities
involving a Clearing Member for which [NSCC] has ceased to act and that
[OCC] directs to [NSCC] for settlement through its facilities.'' \57\
OCC also proposes to add parenthetical language to paragraphs (f)(1)(A)
and (f)(2)(A)(ii) to further clarify that contributions to the OCC
Clearing Fund may be borrowed by OCC for use in connection with making
a Guaranty Substitution Payment to NSCC. Any borrowing from the OCC
Clearing Fund by OCC to make a Guaranty Substitution Payment to NSCC
would be subject to the existing terms of OCC Rule 1006(f)(3) that
provide that irrespective of how any such borrowings from the OCC
Clearing Fund are applied by OCC, the borrowing for a period not to
exceed thirty (30) days will not be deemed to result in charges against
the OCC Clearing Fund under OCC's default waterfall for allocating
actual losses. For purposes of determining whether a loss resulting
from a Guaranty Substitution Payment has occurred, OCC Rule 1006(f)(3)
would be amended to provide that the Guaranty Substitution Payment is
deemed to be repaid by OCC at such time as under the Accord that it is
NSCC's obligation to return any portion of the Guaranty Substitution
Payment that NSCC does not use pursuant to its rules. If, subsequent to
the borrowing, OCC determines that the borrowing represents an actual
loss or all or any part of the borrowing remains outstanding after
thirty (30) days (or on the first Business Day thereafter if the
thirtieth calendar day is not a Business Day) then the amount of OCC
Clearing Fund assets used in the outstanding borrowing would be an
actual loss that OCC would be required to immediately allocate under
its By-Laws and Rules.\58\ As noted above, losses resulting from the
borrowing of Clearing Fund or Margin Assets as a liquidity resource to
facilitate OCC making a Guaranty Substitution Payment would be
allocated in the same sequence as any other losses charged to the
default waterfall.
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\57\ In connection with these amendments, the reference in Rule
1006(b) to ``clauses (i) through (vi) of paragraph (a)'' would be
changed to ``clauses (i) through (vii) of paragraph (a).''
\58\ If the defaulting OCC Clearing Member's Margin Assets and
OCC Clearing Fund contribution were insufficient to cover the
associated losses, OCC would next look to certain OCC financial
resources that are available for that purpose (e.g., OCC's corporate
contribution and Clearing Fund contributions of non-defaulting OCC
Clearing Members).
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Consistent with these changes to permit OCC to use the OCC Clearing
Fund as a borrowing resource to make a Guaranty Substitution Payment to
NSCC, OCC is also proposing similar changes to OCC Rule 1104 that would
permit OCC to borrow certain Margin Assets of a Clearing Member that
has been suspended by OCC where that Clearing Member is a Mutually
Suspended Member and OCC has a general lien \59\ over the Margin
Assets.
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\59\ Article I, Section 1.G.(1) of OCC's By-Laws states that the
``term `general lien' means a security interest of [OCC] in all or
specified assets in a Clearing Member account as security for all of
the Clearing Member's obligations to [OCC] regardless of the source
or nature of such obligations.'' See OCC By-Laws, supra note 5.
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Specifically, OCC proposes to add a new paragraph (g) to OCC Rule
1104 that would provide that OCC may use specified Margin Assets of a
suspended Clearing Member as a borrowing in order to use such borrowed
Margin Assets to make a Guaranty Substitution Payment to NSCC. OCC
would be permitted to use Margin Assets from the following accounts of
a suspended Common Member: firm lien account and firm non-lien account;
separate Market-Maker's account; combined Market-Maker's account; and
JBO Participants' account.\60\ OCC is not proposing at this time to
have authority to borrow Margin Assets from other types of accounts
over
[[Page 5962]]
which OCC has a restricted lien \61\ and for which the Margin Assets
are security for the particular restricted lien accounts because of
additional complexity that OCC believes would be associated with
tracking NSCC's use of Margin Assets associated with those accounts and
also due to certain regulatory requirements under Commission Rule 15c3-
3 that apply to broker-dealer Clearing Members and prohibit the use of
customer property of the broker-dealer to support non-customer
activities.\62\
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\60\ The Clearing Member accounts referenced herein are
described in subparagraphs (a), (b), (c) and (h) of Article VI,
Section 3 of OCC's By-Laws. See OCC's By-Laws, supra note 5.
\61\ Article I, Section 1.R.(8) of OCC's By-Laws states that the
``term `restricted lien' means a security interest of [OCC] in
specified assets (including any proceeds thereof) in an account of a
Clearing Member with [OCC] as security for the Clearing Member's
obligations to [OCC] arising from such account or, to the extent so
provided in the By-Laws or Rules, a specified group of accounts that
includes such account including, without limitation, obligations in
respect of all confirmed trades effected through such account or
group of accounts, and exercise notices assigned to such account or
group of accounts.'' See OCC's By-Laws, supra note 5.
\62\ For example, under the broker-dealer customer reserve
account formula to SEC Rule 15c3-3 the broker-dealer takes a debit
in the formula under Item 13 for margin that is ``required and on
deposit with OCC for all option contracts written or purchased in
customer accounts.'' This means that such margin in turn can be used
by the broker-dealer Clearing Member as Margin Assets to support the
securities customers' account at OCC.
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As with the terms that currently apply to any borrowing from the
OCC Clearing Fund pursuant to OCC Rule 1006(f), new paragraph (g) in
OCC Rule 1104 would further provide that Margin Assets borrowed by OCC
to make a Guaranty Substitution Payment to NSCC would not be deemed to
be charges against the margin assets for the relevant account(s) for up
to thirty (30) days; however, if all or a part of such borrowing were
to be determined by OCC, in its discretion, to represent an actual
loss, or if all or a part of the borrowing were to remain outstanding
after such thirty (30)-day period, OCC would consider the amount of
margin assets used to support OCC's obligations under the outstanding
borrowing or transaction as an actual loss and immediately allocate the
loss in accordance with OCC's By-Laws and Rules.
OCC anticipates that in a scenario in which it would be permitted
make a Guaranty Substitution Payment to NSCC under the proposed changes
to the Existing Accord and OCC's By-Laws and Rules, OCC would generally
expect to borrow from the Clearing Fund as a primary liquidity
resource. OCC could also borrow Margin Assets of the suspended Clearing
Member that is a Common Member under the proposed terms described
above. OCC is not proposing changes that would require a specific
borrowing sequence because OCC believes that it is more appropriate to
preserve flexibility to borrow from the available OCC Clearing Fund or
Margin Assets as OCC determines appropriate under the circumstances.
In addition, OCC proposes to specify in OCC Rule 1107(a)(1) that
exercised option contracts and matured, physically-settled stock
futures to which the suspended Clearing Member is a party may be
settled in accordance with the terms of any agreement between OCC and
NSCC governing the settlement of exercised option contracts and
matured, physically-settled stock futures of a suspended Clearing
Member. In such an event, settlement will be governed by and subject to
the agreement between OCC and NSCC and the rules of NSCC.
The purpose of the proposed changes to create the Guaranty
Substitution Payment mechanism is to provide OCC and NSCC with an
additional default management tool to help manage liquidity and
settlement risks that OCC believes would be presented to each covered
clearing agency in connection with a Mutually Suspended Member. OCC
believes that having the ability to make a Guaranty Substitution
Payment to NSCC in regard to any unmet Required Fund Deposit or
Supplemental Liquidity Deposit obligations of a Mutually Suspended
Member would promote prompt and accurate clearance and settlement in
the national system for the settlement of securities transactions by
causing NSCC to guarantee certain securities settlement obligations
that result from exercised options and matured futures contracts that
are cleared and settled by OCC. In the following ways, OCC believes
that this would be beneficial to and protective of OCC, NSCC, their
participants, and the markets they serve.
First, OCC's ability to make the Guaranty Substitution Payment
would ensure that the relevant securities settlement obligations would
be accepted by NSCC for clearance and settlement and therefore the size
of the related settlement obligations could be decreased from netting
through NSCC's CNS Accounting Operation and/or NSCC's Balance Order
Accounting Operation. Second, this outcome would avoid a scenario in
which OCC's Guaranty would continue to apply and the settlement
obligations would be settled on a broker-to-broker basis between OCC
Clearing Members pursuant to the applicable provisions in Chapter IX of
OCC's Rules. As noted above, OCC believes that such a broker-to-broker
settlement scenario could result in substantial collateral and
liquidity requirements for OCC Clearing Members. OCC believes that
these potential collateral and liquidity consequences would be due to
the lost benefit of netting of the settlement obligations through
NSCC's facilities and also due to the short time (i.e., the T+2
standard settlement cycle) between a rejection by NSCC of the
settlement obligations for clearing and the associated settlement date
on which settlement would be otherwise required to be made bilaterally
by OCC Clearing Members. This scenario also raises the potential for
procyclical liquidity demands on OCC Clearing Members and participants
during stressed market conditions. Third, OCC will plan to size its
liquidity resource requirements to reasonable expectations with a high
probability of making a Guaranty Substitution Payment in order to
facilitate the settlement of a Mutually Suspended Member's obligations
through NSCC. Accounting for net liquidity demands from a Mutually
Suspended Member's settlement obligations at the central counterparty-
level enhances liquidity in the financial system and promotes the
efficient use of capital by reducing the demand for liquidity
associated with gross settlement of obligations and enabling the
application of resources at both clearing agencies to satisfy the
Member's obligation. Fourth, OCC believes that the potential for the
size of the settlement obligations to be comparatively larger than the
Guaranty Substitution Payment coupled with the short time remaining to
settlement could also increase the risk of default by the affected OCC
Clearing Members at a time when a Common Member has already been
suspended. Therefore, OCC believes that the proposed changes to
implement the ability for OCC to make a Guaranty Substitution Payment
to NSCC would allow OCC to avoid these risks by causing NSCC to accept
the relevant obligations arising from exercised options and matured
futures cleared and settled by OCC, as it ordinarily would, and
guarantee their settlement, upon OCC making a Guaranty Substitution
Payment to NSCC in accordance with the revised Accord.
[[Page 5963]]
iii. Proposed Changes to Comprehensive Stress Testing & Clearing Fund
Methodology, and Liquidity Risk Management Description and Liquidity
Risk Management Framework as Part of Phase 1
Comprehensive Stress Testing & Clearing Fund Methodology, and Liquidity
Risk Management Description
OCC proposes to revise the OCC Comprehensive Stress Testing &
Clearing Fund Methodology, and Liquidity Risk Management Description to
include the GSP in its liquidity risk management practices. Overall,
the proposed changes would reflect that the GSP functions as an
additional liquidity demand type at the Clearing Member Organization
(``CMO'') Group level.\63\
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\63\ A Clearing Member Group is composed of a set of affiliated
OCC Clearing Members.
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OCC would include additional specifics to address the potential
increased demand that the inclusion of the GSP may cause in its
liquidity risk management practices in the Liquidity Risk Management
section of the Comprehensive Stress Testing & Clearing Fund
Methodology, and Liquidity Risk Management Description. Specifically,
OCC proposes to amend the Liquidity Demand for Positions Rejected by
NSCC subsection, which describes the Existing Accord, including the
scenario in which NSCC could choose not to guaranty certain securities
settlement obligations arising out of transactions cleared by OCC. This
subsection would be retitled as the Liquidity Demand Associated with
NSCC Performance of Physical Settlement Activities subsection to more
clearly describe its content and incorporate the GSP, as further
detailed below. Consistent with the changes to the Existing Accord
described above, OCC proposes to clarify that the Accord allows NSCC to
reject such obligations if OCC elects to not make a GSP.
OCC proposes a new subsection, titled the Liquidity Demand GSP, to
describe the GSP, which NSCC would calculate as defined in the proposed
amendments to the Existing Accord. OCC would describe a GSP as a firm
specific liquidity demand (i.e., the amount of cash OCC needs to pay
NSCC on behalf of the defaulting Common Member). OCC would describe the
components of the GSP under the Accord. OCC would explain how it
accounts for the liquidity demand associated with a potential GSP.
Specifically, OCC would apply an amount to account for a potential GSP
obligation for every day on which option expirations occur. This amount
would be based on peak GSP amounts from the prior 12 months in a given
expiration category for the specific CMO Group for each forecasted
liquidity demand calculation. OCC will use a one-year lookback time
period to determine the appropriate GSP amount to apply. The one-year
lookback allows for the best like-to-like application of a historical
GSP as there is a cyclical nature to option standard expirations with
quarterly (i.e., March, June, September, and December) and January
generally being more impactful than non-quarterly expirations. The one-
year lookback also allows behavior changes of a Clearing Member to be
recognized within an annual cycle. OCC proposes to utilize a historical
GSP based on current system capabilities and data that will be supplied
by NSCC.
OCC would use the total amount of Clearing Fund and SLD deficits at
NSCC in its calculation to account for its obligation. However, in the
event of a default, OCC would be responsible for a proportionate share
of both NSCC Clearing Fund deficits (which are analogous to OCC margin
deficits) and SLDs that are attributable to OCC E&A activity
transmitted to NSCC for settlement, whereas NSCC will be responsible
for the portion of the Clearing Fund and SLD deficits associated with
activity that NSCC clears that is not transmitted by OCC.
The amount of notional activity sent by OCC to NSCC informs the
likelihood of a GSP. Namely, the potential amount of NSCC Clearing Fund
and SLD deficits that are allocable to OCC increases as the amount of
activity OCC sends to NSCC increases. Since not all types of
expirations are the same with respect to the notional amount of
activity sent by OCC to NSCC, OCC proposes to use five separate
categories of expirations with potentially different GSP amounts to
apply. Each day on which expirations occur would fall into one of five
categories as follows:
<bullet> Standard Monthly Expiration: typically the third Friday of
each month from the previous twelve months;
<bullet> Non-Standard Monthly Expiration Fridays (``End of Week
Expirations''): the last business day of every week, typically a
Friday, excluding the third Friday of each month from the previous
twelve months;
<bullet> End of Month Expirations: the last trading day of every
month from the previous twelve months;
<bullet> Expirations falling on Bank Holidays where Markets Are
Open (``Bank Holiday Expirations''): days where banks are closed but
the markets are open from the previous twelve months; \64\
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\64\ The Bank Holiday category recognizes that for Veterans Day
and Columbus Day, the equity and equity derivative markets are open
for trading, but the banking system is closed for the day. Since the
banking system is closed while the aforementioned markets are open,
settlement at NSCC encompasses two days of equity trading and equity
derivative E&A activity. As OCC is using NSCC deficit numbers
without regard for allocation, there is a possibility of a
significant outlying GSP requirement due to the settlement of two
days of activity simultaneously. Prudence dictates retaining the
capability to risk manage a day with such disparate characteristics
differently. Additional supporting data in support of the creation
of the Bank Holiday Expiration category is included as confidential
Exhibit 3E to this filing.
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<bullet> Remaining Expiration Days (``Daily Expirations''): All
other days with an expiration from the previous twelve months that do
not fall into any of the categories above (typically most Mondays
through Thursdays) from the previous twelve months.
OCC believes these five categories are appropriate after an
analysis of notional activity sent to NSCC by OCC.\65\ More
specifically, the standard Friday monthly expiration far exceeds the
needs associated with any other category.\66\ The remaining categories
are intended to capture like time periods that will appropriately
account for the GSP.
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\65\ OCC provided its analysis of notional activity sent to NSCC
by OCC in support of the creation of the five categories as
confidential Exhibit 3E to this filing. This Exhibit 3E sets forth
data related to OCC's liquidity stress testing, including Available
Liquidity Resources, Minimum Cash Requirement thresholds, and/or
liquidity breaches, for Sufficiency and Adequacy scenarios with and
without the inclusion of the GSP.
\66\ For example, the average notional transfer for Remaining
Expiration Days is approximately 10% the size of Standard
Expiration.
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OCC would apply the peak GSP amounts from the prior twelve months
in a given expiration category for the specific CMO Group for each
forecasted liquidity demand calculation by adding the GSP amounts to
the CMO Group's other forecasted liquidity demands for the relevant
expiration day.\67\ If a Clearing Member defaults, OCC may have to pay
a GSP to NSCC on two successive days to facilitate the close-out of the
defaulted Clearing Member's positions. To account for this possibility
in its liquidity risk management process, OCC contemplates the payment
of a GSP on expirations that result in settlements on the first and
second days of the default management process. As described above, this
GSP amount may
[[Page 5964]]
serve to only increase liquidity demands.\68\
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\67\ As an example, if the applicable GSP is $100 and the
(current) stressed liquidity demand is $150 for a Clearing Member
Group, the result after the application of the GSP for that Clearing
Member Group would be a combined liquidity requirement of $250
versus $150 currently.
\68\ OCC provided its analysis of the impact of the GSP,
including with respect to calls for collateral and liquidity demands
as confidential Exhibit 3E to this filing.
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Furthermore, as stated in the new Liquidity Demand GSP subsection,
OCC would apply a floor to certain expirations. At a minimum, the GSPs
applied to the End of Week, End of Month, and Bank Holiday Expirations
will be no lower than the peak of the Daily Expirations category. If a
GSP pertaining to the End of Week, End of Month, and Bank Holiday
Expiration category is higher than the peak of the Daily Expirations
category, then OCC will apply that higher GSP. Standard Monthly
Expirations will be floored by End of Week, End of Month, and Daily
Expirations. If a GSP pertaining to any of these categories is higher
than the Standard Monthly Expiration category, then OCC will apply that
higher GSP. OCC would set out formulas representing the floors for the
Standard Monthly, End of Week, End of Month, and Bank Holiday
Expirations. Finally, OCC also proposes a minor change to clarify that
it would attempt to effect alternative settlement if OCC elected not to
make a GSP.\69\
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\69\ This clarification would maintain OCC's current process for
settling transactions not processed through NSCC and does not
represent the adoption of a new process or settlement method.
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Liquidity Risk Management Framework
OCC proposes changes to the Liquidity Risk Management Framework to
incorporate the GSP. In the Liquidity Risk Identification section, OCC
would specify that, in the situation where a member defaults
immediately preceding, or during the expiration, of physically-settled
E&A activity, OCC may elect to make a GSP to NSCC to compel NSCC to
accept and process the E&A activity. If OCC elects to not make a GSP,
OCC would complete settlement of the defaulted Clearing Member's E&A
transactions through its current process. Relatedly, OCC would include
a minor clarification to a footnote in this section to note that NSCC
is not acting on behalf of a defaulting Clearing Member ``in this
situation.''
Proposed Phase 2 Changes
On February 15, 2023, the Commission adopted amendments to Rule
15c6-1(a) under the Act \70\ to shorten the standard settlement cycle
for most broker-dealer transactions in securities from T+2 to T+1. In
doing so, the Commission stated that a shorter settlement cycle ``can
promote investor protection, reduce risk, and increase operational and
capital efficiency.'' \71\ Moreover, the Commission stated that
delaying the move to a shorter settlement cycle would ``allow undue
risk to continue to exist in the U.S. clearance and settlement system''
\72\ and that it ``believes that the May 28, 2024, compliance date will
help ensure that market participants have sufficient time to implement
the changes necessary to reduce risk, such as risks associated with the
potential for increases in settlement fails.'' \73\ The Phase 2 changes
proposed herein serve those risk reduction objectives related to
securities settlements by endeavoring to limit market disruption
following a Common Member default. The proposed changes would allow OCC
to provide certain assurances with respect to its ability to make a GSP
in the event of a Common Member default to NSCC in a shortened
settlement cycle, which would permit NSCC to begin processing E&A/
Delivery Transactions prior to Guaranty Substitution occurring. This,
in turn, would promote settlement through NSCC that is less
operationally complex and would be expected to require less collateral
and liquidity from market participants than if OCC engaged in the
alternative settlement processes discussed above.
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\70\ 17 CFR 240.15c6-1.
\71\ Securities Exchange Act Release No. 96930 (Feb. 15, 2023),
88 FR 13872, 13873 (Mar. 6, 2023).
\72\ Id. at 13881.
\73\ Id. at 13917.
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To address the operational realities concerning the Accord that
will result from the Commission's adoption and implementation of a new
standard settlement cycle of T+1 pursuant to Rule 15c6-1(a) under the
Act, OCC and NSCC are proposing Phase 2 changes to further modify the
Accord after the T+1 settlement cycle becomes effective. As described
in greater detail below, the Phase 2 changes would allow the GSP and
other changes that are part of the Phase 1 changes to continue to
function appropriately and efficiently in the new T+1 settlement
environment. Because of the phased approach, a separate mark-up is
provided in confidential Exhibit 5C to this filing of the Phase 2
changes against the Accord as modified through the Phase 1 changes.
As described in more detail below, shortening the settlement cycle
to T+1 will require NSCC to process stock settlement obligations
arising from E&A Delivery Transactions one day earlier, i.e., on the
day after the trade date, than is currently the case. Moving processing
times ahead by a full day will require processing to occur before the
guaranty transfers from OCC to NSCC.\74\ In this new T+1 processing
environment, the Phase 2 changes would limit market disruption
following a Common Member default because the Phase 2 changes would
allow OCC to provide certain assurances with respect to its ability to
make a GSP in the event of a Common Member default to NSCC that would
permit NSCC to begin processing the defaulting Common Member's E&A/
Delivery Transactions prior to Guaranty Substitution occurring. This,
in turn, will promote settlement through NSCC that is less
operationally complex and would be expected to require less collateral
and liquidity from market participants than if OCC engaged in
alternative settlement processes. The specific changes included in
Phase 2 are described below. The changes would facilitate the continued
ability of the GSP to function in an environment with a shorter
settlement cycle. These changes are generally designed to allow OCC to
provide certain assurances with respect to its ability to make a GSP in
the event of a Common Member default to NSCC that would permit NSCC to
begin processing E&A/Delivery Transactions prior to Guaranty
Substitution occurring by introducing new or amended terms and setting
out the processes associated therewith. All of the descriptions below
explain the changes to the Accord as they would be made after the
Accord has already been modified through prior implementation of the
proposed Phase 1 changes.
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\74\ Given the reduction in the settlement cycle and existing
processes that must be completed for settlement, it is OCC's
understanding that the NSCC would not be able to safely compress its
processing times further to allow processing to occur after the
guaranty transfers from OCC to NSCC. OCC provided proposed
processing timelines in confidential Exhibit 3G to this filing.
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Section 1--Definitions
First, new definitions would be added, and existing definitions
would be amended or removed in Section 1.
The new defined terms would be as follows.
<bullet> The term ``GSP Monitoring Data'' would be defined to mean
a set of margin and liquidity-related data points provided by NSCC on
each Activity Date prior to the submission of E&A/Delivery Transactions
by OCC to be used for informational purposes at OCC and NSCC.
<bullet> The term ``Final Guaranty Substitution Payment'' would be
defined to mean an amount calculated by NSCC for each Settlement Date
in accordance with Appendix A to the Accord, to include two components:
(i) a portion of the NSCC Participating
[[Page 5965]]
Member's \75\ Required Fund Deposit deficit to NSCC calculated as a
difference between the Required Fund Deposit deficit calculated on the
NSCC Participating Member's entire portfolio and the Required Fund
Deposit deficit calculated on the NSCC Participating Member's portfolio
prior to submission of the E&A/Delivery Transactions; and (ii) the
portion of the NSCC Participating Member's unpaid Supplemental
Liquidity Deposit obligation attributable to the additional activity to
be guaranteed.
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\75\ See supra note 42.
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<bullet> The term ``Historical Peak Guaranty Substitution Payment''
would be defined to mean the largest Final Guaranty Substitution
Payment for an NSCC Participating Member and its affiliates that are
also NSCC Participating Members over the 12 months immediately
preceding the Activity Date, to include two components: (i) the
Required Fund Deposit deficits associated with E&A/Delivery
Transactions based on peak historical observations of the largest NSCC
Participating Member and its affiliates that are also NSCC
Participating Members; and (ii) the Supplemental Liquidity Deposit
obligations associated with E&A/Delivery Transactions based on peak
historical observations as calculated in accordance with applicable
NSCC or OCC Rules and procedures.
<bullet> The term ``Qualifying Liquid Resources'' would be defined
to have the meaning provided by Rule 17Ad-22(a)(14) of the Exchange
Act, 17 CFR 240.17Ad-22(a)(14), or any successor Rule under the
Exchange Act.
<bullet> The term ``Settlement Date'' would be defined to mean the
date on which an E&A/Delivery Transaction is designated to be settled
through payment for, and delivery of, the Eligible Securities
underlying the exercised Stock Option \76\ or matured Stock Future,\77\
as the case may be.
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\76\ See supra note 37.
\77\ See supra note 38.
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<bullet> The term ``Weekday Expiration'' would be defined to mean
any expiration for which the options expiration date occurs on a date
other than a Friday or for which the Settlement Date is any date other
than the first business date following a weekend.
<bullet> The term ``Weekend Expiration'' would be defined to mean
any expiration for which the options expiration date occurs on a Friday
or for which the Settlement Date is the first business date following a
weekend.
The defined term that would be removed in Section 1 is as follows.
<bullet> ``Guaranty Substitution Payment,'' which would be replaced
by the new defined terms ``Final Guaranty Substitution Payment'' and
``Historical Peak Guaranty Substitution Payment.''
The defined terms that would be amended in Section 1 are as
follows.
<bullet> The definition for the term ``Eligible Securities''
generally contemplates the securities that are eligible to be used for
physical settlement under the Existing Accord. In Phase 2, the term
will be modified to exclude any transactions settled through NSCC's
Balance Order System and any security undergoing a voluntary corporate
action that is being supported by NSCC's CNS system. This is because
the processing of E&A/Delivery Transactions and potential reversals of
such transactions under the Phase 2 changes would not be feasible under
the anticipated operation of NSCC's CNS and Balance Order Accounting
Operations under the shortened T+1 settlement cycle.
Section 3--Historical Peak Guaranty Substitution Payment
A new Section 3 would be added to describe the process by which OCC
would send to NSCC evidence of sufficient funds to cover the Historical
Peak Guaranty Substitution Payment. In particular, Section 3(a) would
provide that on each Activity Date, at or before a time agreed upon by
the Clearing Agencies (which may be modified on any given Activity Date
with the consent of an authorized representative of OCC), NSCC will
communicate to OCC the amount of the Historical Peak Guaranty
Substitution Payment amount and the GSP Monitoring Data, which are to
be used for informational purposes at OCC. The Historical Peak Guaranty
Substitution Payment would reflect the largest GSP of the NSCC
Participating Member and its affiliates over the prior twelve months
and would be calculated based on the sum of the Required Fund Deposit
deficits and Supplemental Liquidity Deposit associated with E&A/
Delivery Transactions. Section 3(b) would provide that OCC would then
submit to NSCC an acknowledgement of the Historical Peak Guaranty
Substitution Payment amount and evidence that OCC has sufficient cash
resources in the OCC Clearing Fund to cover the Historical Peak
Guaranty Substitution Payment.
Section 3(c) would provide that if OCC does not provide NSCC with
evidence within the designated time period that it has sufficient cash
resources in the OCC Clearing Fund to cover the Historical Peak
Guaranty Substitution Payment on the Activity Date, OCC will
immediately contact NSCC to escalate discussions to discuss potential
exposures and determine, among other things, whether OCC has other
qualifying liquidity resources available to satisfy such amount.
As described above, the Historical Peak Guaranty Substitution
Payment is designed to serve as a reasonable proxy for the largest
potential Final Guaranty Substitution Payment. Its purpose is to allow
OCC to provide evidence that it likely will be able to satisfy the
Final Guaranty Substitution Payment in the event of a Common Member
default, which will provide NSCC with reasonable assurances such that
NSCC can begin processing E&A/Delivery Transactions upon receipt and
prior to the Guaranty Substitution occurring, which will minimize the
probability of reversals in a default event in light of the shortened
settlement cycle. The Historical Peak Guaranty Substitution Payment
amount also will provide OCC with information that will allow OCC to
include the amount of a potential GSP in its liquidity resource
planning.
Section 6--Final Guaranty Substitution Payment; OCC's Commitment
A new Section 6 would be added to provide the process by which NSCC
would communicate the amount of, and OCC would commit to pay, the Final
Guaranty Substitution Payment. In particular, Section 6(a) would
provide that on each Settlement Date (or each Saturday for Weekend
Expirations), by no later than the time(s) agreed upon by NSCC and OCC,
NSCC will communicate to OCC the Final Guaranty Substitution Payment
for each Common Member calculated by NSCC. NSCC would make such
calculation according to a calculation methodology described in a new
Appendix A to the Accord. This calculation would represent the sum of
the Required Fund Deposit \78\ and the Supplemental Liquidity Deposit
\79\ for the Common Member. As with the Phase 1 Accord, payment of the
Final Guaranty Substitution Payment would be contingent on the mutual
[[Page 5966]]
suspension of the Common Member and payment of the Final Guaranty
Substitution Payment would continue to be the means by which Guaranty
Substitution may occur.
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\78\ The Required Fund Deposit is the portion of the defaulted
Common Member's Required Fund Deposit deficit to NSCC, calculated as
a difference between the Required Fund Deposit deficit calculated on
the entire portfolio and the Required Fund Deposit deficit
calculated on the Common Member's portfolio prior to the submission
of E&A/Delivery Transactions. The Phase 2 changes would refine the
existing calculation methodology for the Required Fund Deposit in
order to provide for a more accurate amount.
\79\ If NSCC calculates a liquidity shortfall with respect to a
defaulted Common Member, the Supplemental Liquidity Deposit is the
portion of that shortfall that is attributable to the additional
activity to be guaranteed.
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Section 6(b) would provide that, following NSCC's communication of
the Final Guaranty Substitution Payment for each Common Member to OCC,
and by no later than the agreed upon time, OCC must either (i) commit
to NSCC that it will pay the Final Guaranty Substitution Payment in the
event of a mutual suspension of a Common Member,\80\ or (ii) notify
NSCC that it will not have sufficient cash resources to pay the largest
Final Guaranty Substitution Payment calculated for every Common Member.
Section 6(b)(i) would further provide that for Weekday Expirations,
OCC's submission of E&A/Delivery Transactions to NSCC would constitute
OCC's commitment to pay the Final Guaranty Substitution Payment on the
Settlement Date in the event of a mutual suspension of a Common Member.
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\80\ If OCC does not have sufficient cash to pay the Final GSP,
then it must confirm for NSCC the availability of other qualifying
liquid resources and the expected timeline for converting such
resources to cash.
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Section 6(c) would provide that if OCC notifies NSCC that it will
not have sufficient cash resources to pay the Final Guaranty
Substitution Payment, NSCC may, in its sole discretion (i) reject or
reverse all E&A/Delivery Transactions, or (ii) voluntarily accept E&A/
Delivery Transactions subject to certain terms and conditions mutually
agreed upon by NSCC and OCC.\81\ Section 6(c) would also provide that
any necessary reversals of E&A/Delivery Transactions shall be delivered
by NSCC to OCC at such time and in such form as the Clearing Agencies
agree.
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\81\ Such terms and conditions may include, but would not be
limited to, OCC's agreement to (i) pay NSCC available cash resources
in partial satisfaction of the Final Guaranty Substitution Payment;
(ii) collect or otherwise source additional resources that would
constitute NSCC Qualifying Liquid Resources to pay the full Final
Guaranty Substitution Payment amount; and/or (iii) reimburse NSCC
for any losses associated with closing out such E&A/Delivery
Transactions.
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Section 6(d) would provide that if, at any time after OCC has
acknowledged the Historical Peak Guaranty Substitution Payment in
accordance with proposed Section 3(b) of the Accord or committed to pay
the Final Guaranty Substitution Payment in accordance with proposed
Section 6(b) of the Accord, OCC has a reasonable basis to believe it
will be unable to pay the Final Guaranty Substitution Payment, OCC will
immediately notify NSCC.
Section 8--Default by an NSCC Participating Member or OCC Participating
Member
Section 6(b)(i), which would be renumbered as Section 8(b)(i),
would be amended to reflect the modified use of the Final Guaranty
Substitution Payment in the event of a mutual suspension of a Common
Member. Section 8(b)(i) would also be revised to remove the ability for
OCC or NSCC to require that the Guaranty Substitution Payment be re-
calculated in accordance with an alternative methodology. This will not
be necessary under the calculation methodology used in the Phase 2
changes because the proposed methodology would result in a more
accurate calculation. Section 8(b)(i) would further amend the Accord by
providing NSCC with discretion to voluntarily accept Defaulted NSCC
Member Transactions and assume the guaranty for such transactions,
subject to certain terms and conditions mutually agreed upon by NSCC
and OCC. The only remaining change to the Guaranty Substitution process
from its operation under the Accord would be the shortened time
duration under which OCC would elect (by way of its commitment) to make
the Final Guaranty Substitution Payment and the timing under which the
Guaranty Substitution will be processed in order to function in a T+1
environment.
In particular, Section 8(b)(i) would provide that, with respect to
a Mutually Suspended Member, if OCC has committed to make the Final
Guaranty Substitution Payment, it will make such cash payment in full
by no later than the agreed upon time(s). Upon NSCC's receipt of the
full amount of the Final Guaranty Substitution Payment, NSCC's Guaranty
would attach (and OCC's Guaranty will no longer apply) to the Defaulted
NSCC Member Transactions. NSCC would have no obligation to accept a
Final Guaranty Substitution Payment and attach the NSCC Guaranty to any
Defaulted NSCC Member Transactions for more than the Activity Date on
which it has ceased to act for that Mutually Suspended Member and one
subsequent Activity Date. If NSCC does not receive the full amount of
the Final Guaranty Substitution Payment in cash by the agreed upon
time, the Guaranty Substitution Time would not occur with respect to
the Defaulted NSCC Member Transactions and Section 8(b)(ii), described
below, would apply. NSCC would, however, have discretion to voluntarily
accept Defaulted NSCC Member Transactions and assume the guaranty for
such transactions, subject to certain terms and conditions mutually
agreed upon by NSCC and OCC.
Section 6(b)(ii), which would be renumbered as Section 8(b)(ii),
would also be amended to reflect the modified use of the Final Guaranty
Substitution Payment in the event OCC continues to perform or does not
make the Final Guaranty Substitution Payment. In particular, Section
8(b)(ii) would add an additional criterion of OCC not satisfying any
alternative agreed upon terms for Guaranty Substitution to reflect this
as an additional option under the Phase 2 changes. As amended, Section
8(b)(ii) would provide that if OCC does not suspend an OCC
Participating Member for which NSCC has ceased to act, OCC does not
commit to make the Final Guaranty Substitution Payment, NSCC does not
receive the full amount of the Final Guaranty Substitution Payment in
cash by the agreed upon time, or OCC does not satisfy any alternative
agreed upon terms for Guaranty Substitution, Guaranty Substitution with
respect to all Defaulted NSCC Member Transactions for that Activity
Date will not occur, all Defaulted NSCC Member Transactions for that
Activity Date will be reversed and exited from NSCC's CNS accounting
system, and NSCC will have no obligation to guaranty or settle such
Defaulted NSCC Member Transactions. NSCC may, however, exercise its
discretion to voluntarily accept the Defaulted NSCC Member
Transactions, and assume the guaranty for such transactions, subject to
certain agreed upon terms and conditions.
Section 8(b) would also be modified to provide for escalated
discussion between the Clearing Agencies in the event of an intraday
NSCC Cease to Act and/or NSCC Participating Member Default,
particularly to confirm that OCC has sufficient qualifying liquid
resources to pay the projected Final Guaranty Substitution Payment for
the Defaulting NSCC Member's projected E&A/Delivery Transactions based
on information provided in GSP Monitoring Data for such Defaulting NSCC
Member.
Conforming changes would also be made to Section 8(d) to reflect
the use of the new defined term ``Final Guaranty Substitution
Payment.''
Other Proposed Changes as Part of Phase 2
Certain other technical changes are also proposed as part of the
Phase 2 changes, including to conform the Accord to the proposed
changes described above. For example, Section 9(c) would be revised
regarding information sharing to reflect the
[[Page 5967]]
introduction of the Historical Peak and Final Guaranty Substitution
Payments and the GSP Monitoring Data; Section 4(c)(ix) would be
conformed to reflect the addition of ``Settlement Date'' as a defined
term in Section 1; various sections would be renumbered and internal
cross-references would be adjusted to reflect the addition of new
sections proposed herein; correct current references throughout the
Accord to ``NSCC Rules and Procedures'' would be changed to simply read
``the NSCC Rules;'' and various non-substantive textual changes would
be made to increase clarity.
Section 4(a) would also be modified to reflect that the Eligibility
Master Files referenced in that paragraph, which identify Eligible
Securities to OCC, are described in the SLA between OCC and NSCC.
Section 9(b) would be modified to include OCC's available liquidity
resources, including Clearing Fund cash balances in the information OCC
provides to NSCC, and to specify that information will be provided on
each Activity Date at an agreed upon time and in an agreed upon form by
the Clearing Agencies. Finally, Section 16(b) would be modified to
provide the correct current delivery address information for NSCC.
The Phase 2 changes would also include an Appendix A that would
describe in detail the calculation methodology for the Guaranty
Substitution Payment. This would provide the detailed technical
calculation to determine each of the Mutually Suspended Member's
Required Fund Deposit deficit and liquidity shortfall to NSCC. The full
text of Appendix A is filed confidentially with the Commission as
Exhibit 5 to this filing.
Phase 2 Guaranty Substitution Process Changes
As described above, the Phase 2 changes would modify the Guaranty
Substitution process to reflect the shortened time duration under which
the Guaranty Substitution will be processed in order to function in a
T+1 environment. Below is a description of how that process would
operate. The actual process would be implemented pursuant to a modified
SLA between the Clearing Agencies.\82\ All times provided below are in
Eastern Time and represent the latest time by which the specified
action must occur, unless otherwise agreed by the Clearing Agencies.
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\82\ OCC provided a draft of the SLA illustrating such changes
to the Commission as confidential Exhibit 3F to this filing.
---------------------------------------------------------------------------
Weekend Expirations: On Friday (the Activity Date), NSCC would
provide OCC with the Historical Peak GSP amount by 8:00 a.m. By 5:00
p.m. on Friday, OCC must acknowledge the Historical Peak GSP and
provide evidence of OCC's Clearing Fund cash resources sufficient to
cover that amount, following which NSCC would provide the Eligibility
Master File by 5:45 p.m. By 1:00 a.m. on Saturday, OCC would then
provide NSCC with the E&A/Delivery Transactions file and by 8:00 a.m.
NSCC would provide OCC with the Final GSP, which OCC must commit to pay
by 9:00 a.m. in the event of a mutual suspension of a Common
Member.\83\ By 8:00 a.m. Monday (the Settlement Date), if a cease to
act is declared over the weekend (or the later of 10:00 a.m. or one
hour after the cease to act is declared if declared on Monday), OCC
must pay the Final GSP if there has been a mutual suspension of a
Common Member. Finally, by 1:00 p.m. on Monday, OCC must provide
reversals for the defaulted member's E&A/Delivery Transactions if OCC
has not satisfied (or will not satisfy) the Final GSP.
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\83\ If OCC does not have sufficient cash resources to pay the
Final GSP and the Clearing Agencies are unable to reach an agreement
on additional terms for NSCC to accept E&A/Delivery Transactions,
OCC must submit a reversal file by 12:30 a.m. on Monday so that NSCC
can remove the E&A/Delivery Transactions from CNS prior to the start
of NSCC's overnight processing. See confidential Exhibit 3H to this
filing for additional details on action deadlines and processing
times.
---------------------------------------------------------------------------
Weekday Expirations: On the Activity Date, NSCC would provide OCC
with the Historical Peak GSP amount by 8:00 a.m. By 5:00 p.m. on the
Activity Date, OCC must acknowledge the Historical Peak GSP and provide
evidence of its cash resources in the OCC Clearing Fund sufficient to
cover that amount, following which NSCC would provide the Eligibility
Master File by 5:45 p.m. By 1:00 a.m. on the Settlement Date (the day
after the Activity Date in the T+1 environment), OCC would then provide
NSCC with the E&A/Delivery Transactions file, which also constitutes
OCC's commitment to pay the Final GSP. By 8:00 a.m. NSCC would provide
OCC with the Final GSP. By the later of 10:00 a.m. on the Settlement
Date or one hour after a cease to act is declared, OCC must pay the
Final GSP if there has been a mutual suspension of a Common Member.
Finally, by 1:00 p.m. on the Settlement Date, OCC must provide
reversals for the defaulted member's E&A/Delivery Transactions if OCC
has not satisfied (or will not satisfy) the Final GSP.
For both Weekend Expirations and Weekday Expirations, Guaranty
Substitution will take place only after the Common Members meet their
start of day margin funding requirements at NSCC, if any. In a Common
Member default event, the Guaranty Substitution will take place when
OCC pays the Final GSP to NSCC.
The Clearing Agencies note that the Phase 2 changes described above
are designed to change the process by which the GSP is implemented such
that the use of the GSP as a mechanism to facilitate the acceptance of
settlement obligations by NSCC can continue to operate within the
condensed timing for clearance and settlement in a T+1 environment.
However, the ultimate use of the GSP, its purpose, and its substantive
import would remain consistent with the Phase 1 changes.
Proposed Liquidity Risk Management Framework Changes
OCC proposes changes to the Liquidity Risk Management Framework to
incorporate the Phase 2 changes into its liquidity risk management
practices. In the Contingency Funding Plan section, OCC would specify
that it endeavors to maintain sufficient cash resources to cover its
projected settlement demands. Projected settlement demands may include
settlements associated with option exercise & assignment activity that
create obligations for OCC under the Accord (e.g., Final GSP,
Historical Peak GSP). Final and Historical Peak GSP would be defined in
the Definitions section. OCC proposes a footnote referencing the
proposed Phase 1 changes to the Comprehensive Stress Testing & Clearing
Fund Methodology, and Liquidity Risk Management Description with
respect to the Final GSP. Namely, to account for the liquidity demand
associated with the potential payment of a Final GSP, OCC would include
the peak amount of the entire actual NSCC Required Fund Deposit
deficits and SLD start-of-day obligations, without regard to allocation
between NSCC and OCC, specific to each CMO Group for the relevant type
of expiration on a rolling twelve-month lookback. Moreover, OCC may
require the deposit of cash by a Clearing Member pursuant to its
current Rules if projected settlement demands exceed OCC liquidity
resources available to make settlement in the event of a Clearing
Member default.
OCC also proposes related and clarifying changes in the document.
For example, OCC would include a minor clarifying change to the
Liquidity Risk Identification section to define GSP as a firm-specific
liquidity demand. OCC would also amend the Stress Testing
[[Page 5968]]
and Liquidity Resource Sizing section to incorporate information
pertaining to GSP obligations into the annual analysis presented to the
Board on projected liquidity demands that OCC may face under a variety
of scenarios.
Proposed By-Law Changes
OCC proposes to update its By-Laws to conform with the revised
Accord. OCC proposes to remove a reference to Balance Order Accounting
Operation to align with the exclusion of transactions settled through
NSCC's Balance Order System under the amended definition of Eligible
Securities in the Phase 2 Accord.
Implementation Framework
The proposed Phase 1 and Phase 2 changes will be implemented as
follows:
<bullet> Phase 1: Within 120 days after the date OCC and NSCC
receive all necessary regulatory approvals for these proposed changes
to the Accord, OCC will implement all Phase 1 changes. OCC would
announce the implementation date by an Information Memorandum posted to
its public website at least seven days prior to implementation.
<bullet> Phase 2: On the compliance date with respect to the final
T+1 amendments to Exchange Act Rule 15c6-1(a) established by the SEC,
OCC will implement all Phase 2 changes, keep in place any applicable
Phase 1 changes that carry over to Phase 2, and decommission all Phase
1 changes that do not apply to Phase 2.\84\
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\84\ If, due to the timing of regulatory approval, the
implementation dates for Phase 1 and Phase 2 overlap, OCC would
implement only the Phase 2 changes and Phase 1 changes that carry
over to Phase 2.
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Anticipated Effect on and Management of Risk
OCC believes that the proposed changes would reduce the nature and
level of risk presented by OCC because the purpose of the proposed
changes to enhance its stress testing processes and create the Guaranty
Substitution Payment mechanism is to provide OCC and NSCC with
additional default management tools to help manage liquidity and
settlement risks that OCC believes would be presented to each covered
clearing agency in connection with a Mutually Suspended Member. As
described above in the Phase 1 changes, OCC believes that having the
ability to make a Guaranty Substitution Payment to NSCC in regard to
any unmet Required Fund Deposit or Supplemental Liquidity Deposit
obligations of a Mutually Suspended Member would promote prompt and
accurate clearance and settlement in the national system for the
settlement of securities transactions by causing NSCC to guarantee
certain securities settlement obligations that result from exercised
options and matured futures contracts that are cleared and settled by
OCC. OCC further believes that enhancing its stress testing processes
will help to ensure that it maintains the resources to make such a
payment. The Phase 2 changes would also promote prompt and accurate
clearance and settlement in the national system for the settlement of
securities transactions because, as described above, they would
facilitate implementation of the new settlement cycle and support the
Commission's stated goal of implementing necessary risk reducing
changes in connection with the move to T+1 settlement, currently set
for May 28, 2024. The Phase 2 changes would further enable OCC to
provide certain assurances that would permit NSCC to begin processing
E&A/Delivery Transactions prior to guaranty substitution occurring--
thereby promoting the continued effectiveness of the guaranty
substitution process in an environment with a shorter settlement cycle.
In the following ways, OCC believes that this proposal would be
beneficial to and protective of OCC, NSCC, their participants, and the
markets they serve.
First, OCC's ability to make the Guaranty Substitution Payment
would ensure that the relevant securities settlement obligations would
be accepted by NSCC for clearance and settlement and therefore the size
of the related settlement obligations could be decreased from netting
through NSCC's CNS Accounting Operation and/or NSCC's Balance Order
Accounting Operation. Second, this outcome would avoid a scenario in
which OCC's Guaranty would continue to apply and the settlement
obligations would be settled on a broker-to-broker basis between OCC
Clearing Members pursuant to the applicable provisions in Chapter IX of
OCC's Rules. As noted above, OCC believes that such a broker-to-broker
settlement scenario could result in substantial collateral and
liquidity requirements for OCC Clearing Members. OCC believes that
these potential collateral and liquidity consequences would be due to
the lost benefit of netting of the settlement obligations through
NSCC's facilities and also due to the short time between a rejection by
NSCC of the settlement obligations for clearing and the associated
settlement date on which settlement would be otherwise required to be
made bilaterally by OCC Clearing Members. This scenario also raises the
potential for procyclical liquidity demands on OCC Clearing Members and
participants during stressed market conditions. Third, OCC will plan to
size its liquidity resource requirements to reasonable expectations
with a high probability of making a Guaranty Substitution Payment in
order to facilitate the settlement of a Mutually Suspended Member's
obligations through NSCC. Accounting for net liquidity demands from a
Mutually Suspended Member's settlement obligations at the central
counterparty-level enhances liquidity in the financial system and
promotes the efficient use of capital by reducing the demand for
liquidity associated with gross settlement of obligations and enabling
the application of resources at both clearing agencies to satisfy the
Member's obligation. Fourth, OCC believes that the potential for the
size of the settlement obligations to be comparatively larger than the
Guaranty Substitution Payment coupled with the short time remaining to
settlement could also increase the risk of default by the affected OCC
Clearing Members at a time when a Common Member has already been
suspended. Therefore, OCC believes that the proposed changes to
implement the ability for OCC to make a Guaranty Substitution Payment
to NSCC would allow OCC to avoid these risks by causing NSCC to accept
the relevant obligations arising from exercised options and matured
futures cleared and settled by OCC, as it ordinarily would, and
guarantee their settlement, upon OCC making a Guaranty Substitution
Payment to NSCC in accordance with the revised Accord.
Consistency With the Payment, Clearing and Settlement Supervision Act
The stated purpose of the Clearing Supervision Act is to mitigate
systemic risk in the financial system and promote financial stability
by, among other things, promoting uniform risk management standards for
systemically important financial market utilities and strengthening the
liquidity of systemically important financial market utilities.\85\
Section 805(a)(2) of the Clearing Supervision Act \86\ also authorizes
the Commission to prescribe risk management standards for the payment,
clearing and settlement activities of designated clearing entities,
like OCC, for which the Commission is the supervisory agency. Section
805(b) of the Clearing Supervision Act \87\ states
[[Page 5969]]
that the objectives and principles for risk management standards
prescribed under Section 805(a) shall be to:
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\85\ 12 U.S.C. 5461(b).
\86\ 12 U.S.C. 5464(a)(2).
\87\ 12 U.S.C. 5464(b).
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<bullet> promote robust risk management;
<bullet> promote safety and soundness;
<bullet> reduce systemic risks; and
<bullet> support the stability of the broader financial system.
The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and the Exchange Act in
furtherance of these objectives and principles.\88\ Rule 17Ad-22
requires registered clearing agencies, like OCC, to establish,
implement, maintain, and enforce written policies and procedures that
are reasonably designed to meet certain minimum requirements for their
operations and risk management practices on an ongoing basis.\89\
Therefore, the Commission has stated \90\ that it believes it is
appropriate to review changes proposed in advance notices against Rule
17Ad-22 and the objectives and principles of these risk management
standards as described in Section 805(b) of the Clearing Supervision
Act.\91\
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\88\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016),
81 FR 70786 (October 13, 2016) (S7 17 CFR 240.17Ad-22. See
Securities Exchange Act Release Nos. 68080 (October 22, 2012), 77 FR
66220 (November 2, 2012) (S7-08-11) (``Clearing Agency Standards'');
78961 (September 28, 2016), 81 FR 70786 (October 13, 2016).
\89\ 17 CFR 240.17Ad-22.
\90\ See, e.g., Exchange Act Release No. 89039, 85 FR at 36446.
\91\ 12 U.S.C. 5464(b).
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OCC believes the proposed changes are consistent with Section
805(b)(1) of the Clearing Supervision Act \92\ because they would
promote the reduction of risks to OCC, its Clearing Members and the
markets OCC serves. As described above in the Phase 1 changes, OCC
believes that the proposed enhancements to its stress testing processes
and having the ability to make a Guaranty Substitution Payment to NSCC
with respect to any unmet obligations of a Mutually Suspended Member
would promote the reduction of risk because it would ensure that OCC
maintains sufficient liquidity resources and that the relevant
securities settlement obligations would be accepted by NSCC for
clearance and settlement and therefore the size of the related
settlement obligations for both the Mutually Suspended Member and its
assigned delivery counterparties could be decreased from netting
through NSCC's CNS Accounting Operation and/or NSCC's Balance Order
Accounting Operation. This would also avoid a scenario in which OCC's
Guaranty would continue to apply and the settlement obligations would
be settled on a broker-to-broker basis between OCC Clearing Members,
which OCC believes could result in substantial collateral and liquidity
requirements for OCC Clearing Members and that, in turn, could also
increase a risk of default by the affected OCC Clearing Members at a
time when a Common Member has already been suspended. Additionally, the
Phase 2 changes would facilitate implementation of the new settlement
cycle and support the Commission's stated goal of implementing
necessary risk reducing changes in connection with the move to T+1
settlement. The Phase 2 changes would further enable OCC to provide
certain assurances that would permit NSCC to begin processing E&A/
Delivery Transactions prior to guaranty substitution occurring--thereby
promoting the continued effectiveness of the guaranty substitution
process in an environment with a shorter settlement cycle. For these
reasons, OCC believes that the proposed changes: (i) are designed to
promote robust risk management; (ii) are consistent with promoting
safety and soundness; and (iii) are consistent with reducing systemic
risks and promoting the stability of the broader financial system.
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\92\ 12 U.S.C. 5464(b)(1).
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OCC believes that the proposed changes are also consistent with the
SEC rules that apply to OCC as a covered clearing agency.\93\ In
particular, SEC Rule 17Ad-22(e)(20) requires OCC to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify, monitor and manage risks related to
any link that OCC establishes with one or more other clearing agencies,
financial market utilities, or trading markets.\94\ As described in
OCC's publicly available disclosure framework for financial market
infrastructures,\95\ the Existing Accord between OCC and NSCC is one
such link. As described above, OCC believes (i) the proposed
modifications to OCC's stress testing procedures that are designed to
enhance its ability to call for additional liquidity resources, and
(ii) the implementation of the ability for OCC to make a Guaranty
Substitution Payment to NSCC in the relevant circumstances involving a
Mutually Suspended Member would help manage the risks presented to OCC
and its Clearing Members by the settlement link with NSCC because the
Guaranty Substitution Payment would ensure that the relevant securities
settlement obligations would be accepted by NSCC for clearance and
settlement and therefore the size of the related settlement obligations
could be decreased from netting through NSCC's CNS Accounting Operation
and/or NSCC's Balance Order Accounting Operation.
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\93\ 17 CFR 240.17Ad-22(a)(5).
\94\ 17 CFR 240.17Ad-22(e)(20).
\95\ See The Options Clearing Corporation Disclosure Framework
for Financial Market Infrastructures, pg. 105, (2023), available at
<a href="https://www.theocc.com/risk-management/pfmi-disclosures">https://www.theocc.com/risk-management/pfmi-disclosures</a>.
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For this same reason, OCC also believes that the proposed changes
are consistent with the requirements of SEC Rules 17Ad-22(e)(3) and
(7).\96\ SEC Rule 17Ad-22(e)(3) requires OCC to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain a sound risk management framework for
comprehensively managing, among other things, liquidity, credit and
other risks that arise in or are borne by OCC.\97\ SEC Rule 17Ad-
22(e)(7) requires OCC, in relevant part, to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to effectively measure, monitor and manage the liquidity risk
that arises in or is borne by OCC and to, among other things, address
foreseeable liquidity shortfalls that would not be covered by OCC's
liquid resources.\98\ As noted, OCC believes the proposed stress
testing enhancements and the ability to make a Guaranty Substitution
Payment to NSCC would allow OCC to better manage liquidity and credit
risks related to the settlement link with NSCC by ensuring that the
relevant securities settlement obligations would be accepted by NSCC
for clearance and settlement. It would avoid a scenario in which OCC's
Guaranty would continue to apply and the settlement obligations would
be settled on a broker-to-broker basis between OCC Clearing Members,
which OCC believes could result in substantial collateral and liquidity
requirements for OCC Clearing Members that, in turn, could also
increase a risk of default by the affected OCC Clearing Members,
particularly in circumstances where the prior suspension of a Mutually
Suspended Member relates to broader stress in the financial system.
Moreover, the incorporation of the Guaranty Substitution Payment into
OCC's liquidity risk management practices would enhance OCC's ability
to maintain additional liquidity resources to effect the settlement of
exercise and assignment activity in the event of a
[[Page 5970]]
Common Member default, and therefore, potentially increase the
promotion of market stability. Regarding the Phase 2 changes, OCC
believes that the continued ability in a T+1 environment to make a
Guaranty Substitution Payment to NSCC would allow OCC to better manage
liquidity and credit risks related to the settlement link with NSCC by
ensuring that the relevant securities settlement obligations would be
accepted by NSCC for clearance and settlement.
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\96\ 17 CFR 240.17Ad-22(e)(3), (7).
\97\ 17 CFR 240.17Ad-22(e)(3).
\98\ 17 CFR 240.17Ad-22(e)(7).
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III. Date of Effectiveness of the Advance Notice and Timing for
Commission Action
The proposed change may be implemented if the Commission does not
object to the proposed change within 60 days of the later of (i) the
date that the proposed change was filed with the Commission or (ii) the
date that any additional information requested by the Commission is
received. The clearing agency shall not implement the proposed change
if the Commission has any objection to the proposed change.
The Commission may extend the period for review by an additional 60
days if the proposed change raises novel or complex issues, subject to
the Commission or the Board of Governors of the Federal Reserve System
providing the clearing agency with prompt written notice of the
extension. A proposed change may be implemented in less than 60 days
from the date the advance notice is filed, or the date further
information requested by the Commission is received, if the Commission
notifies the clearing agency in writing that it does not object to the
proposed change and authorizes the clearing agency to implement the
proposed change on an earlier date, subject to any conditions imposed
by the Commission. The clearing agency shall post notice on its website
of proposed changes that are implemented.
The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the advance
notice is consistent with the Clearing Supervision Act. Comments may be
submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#592b2c353c743a3634343c372d2a192a3c3a773e362f"><span class="__cf_email__" data-cfemail="b4c6c1d8d199d7dbd9d9d1dac0c7f4c7d1d79ad3dbc2">[email protected]</span></a>. Please include
file number SR-OCC-2023-801 on the subject line.
Paper Comments
<bullet> Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to file number SR-OCC-2023-801. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>).
Copies of the submission, all subsequent amendments, all written
statements with respect to the advance notice that are filed with the
Commission, and all written communications relating to the advance
notice between the Commission and any person, other than those that may
be withheld from the public in accordance with the provisions of 5
U.S.C. 552, will be available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10 a.m. and 3 p.m.
Copies of the filing also will be available for inspection and copying
at the principal office of the self-regulatory organization.
Do not include personal identifiable information in submissions;
you should submit only information that you wish to make available
publicly. We may redact in part or withhold entirely from publication
submitted material that is obscene or subject to copyright protection.
All submissions should refer to file number SR-OCC-2023-801 and should
be submitted on or before February 14, 2024.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\99\
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\99\ 17 CFR 200.30-3(a)(91).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-01748 Filed 1-29-24; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on January 30, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.