Notice2024-05834
Self-Regulatory Organizations; The Options Clearing Corporation; Order Granting Approval of Proposed Rule Change, as Modified by Partial Amendment No. 1 and Amendment No. 2, 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
March 20, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 55 (Wednesday, March 20, 2024)</title>
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[Federal Register Volume 89, Number 55 (Wednesday, March 20, 2024)]
[Notices]
[Pages 19907-19913]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-05834]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-99735; File Nos. SR-OCC-2023-007]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of Proposed Rule Change, as Modified by Partial
Amendment No. 1 and Amendment No. 2, Concerning Modifications to the
Amended and Restated Stock Options and Futures Settlement Agreement
Between The Options Clearing Corporation and the National Securities
Clearing Corporation
March 14, 2024.
I. Introduction
On August 10, 2023, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2023-007 (``Proposed Rule Change'')
pursuant to section 19(b) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder to change terms
related to the physical settlement of equities arising out of certain
futures and options contracts.\3\ On August 30, 2023, the Proposed Rule
Change was published for public comment in the Federal Register.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Notice of Filing infra note 4, at 88 FR 59976.
\4\ Securities Exchange Act Release No. 98215 (Aug. 24, 2023),
88 FR 59976 (Aug. 30, 2023) (File No. SR-OCC-2023-007) (``Notice of
Filing''). On Aug. 10, 2023, OCC also filed a related advance notice
(SR-OCC-2023-801) with the Commission pursuant to section 806(e)(1)
of Title VIII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, entitled the Payment, Clearing, and Settlement
Supervision Act of 2010 and Rule 19b-4(n)(1)(i) under the Exchange
Act (``Advance Notice''). 12 U.S.C. 5465(e)(1). 15 U.S.C. 78s(b)(1)
and 17 CFR 240.19b-4, respectively. The Advance Notice was published
in the Federal Register on Aug. 30, 2023. Securities Exchange Act
Release No. 98214 (Aug. 24, 2023), 88 FR 59988 (Aug. 30, 2023) (File
No. SR-OCC-2023-801).
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On September 25, 2023, pursuant to section 19(b)(2) of the Exchange
Act,\5\ the Commission designated a longer period within which to
approve, disapprove, or institute proceedings to determine whether to
approve or disapprove the Proposed Rule Change.\6\ On November 8, 2023,
OCC filed Partial Amendment No. 1 to the Proposed Rule Change.\7\ On
November 14, 2023, the Commission published notice of Partial Amendment
No. 1 and instituted proceedings, pursuant to section 19(b)(2)(B) of
the Exchange Act,\8\ to determine whether to approve or disapprove the
proposed rule change, as modified by the Partial Amendment No. 1.\9\ On
January 23, 2024, OCC filed Amendment No. 2 to the Proposed Rule
Change, which was published in the Federal Register for public comment
on January 30, 2024.\10\ The Commission has received public comment
regarding the Proposed Rule Change.\11\ On February 20, 2024, the
Commission designated a longer period for Commission action on the
proceedings to determine whether to approve or disapprove the Proposed
Rule Change.\12\ This order approves the Proposed Rule Change as
modified by Partial Amendment No. 1 and Amendment No.
[[Page 19908]]
2 (hereinafter defined as ``Proposed Rule Change'').
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\5\ 15 U.S.C. 78s(b)(2).
\6\ Securities Exchange Act Release No. 98508 (Sep. 25, 2023),
88 FR 67407 (Sep. 29, 2023) (File No. SR-OCC-2023-007).
\7\ Partial Amendment No. 1 delays implementation of the
proposed change. In Partial Amendment No. 1, OCC proposes to
implement the proposed rule change within 90 days of receiving all
necessary regulatory approvals and would announce the specific date
of implementation on its public website at least 14 days prior to
implementation. The delay is proposed in light of the technical
system changes that are required to implement the liquidity stress
testing enhancements and to be able to provide sufficient notice to
Clearing Members following receipt of approval.
\8\ 15 U.S.C. 78s(b)(2)(B).
\9\ See Securities Exchange Act Release No. 98932 (Nov. 14,
2023), 88 FR 80781 (Nov. 20, 2023) (File No. SR-OCC-2023-007).
\10\ See Securities Exchange Act Release No. 99426 (Jan. 24,
2024), 89 FR 5974 (Jan. 30, 2024) (File No. SR-OCC-2023-007)
(``Notice of Amendment''). Amendment No. 2 adds a second phase of
changes to the proposed rule change. The changes added in Phase 2
include improved information sharing between OCC and NSCC and are
designed to facilitate the shortening of the standard settlement
cycle for most broker-dealer transactions from T+2 to T+1. See
Securities Exchange Act Release No. 96930 (Feb. 15, 2023), 88 FR
13872 (Mar. 6, 2023) (File No. S7-05-22).]
\11\ Comments on the Proposed Rule Change are available at
<a href="https://www.sec.gov/comments/sr-occ-2023-007/srocc2023007.htm">https://www.sec.gov/comments/sr-occ-2023-007/srocc2023007.htm</a>. The
Commission received comments on the proposed rule change that
express concerns unrelated to the substance of the filing. See,
e.g., comment from Gregory Englebert (Feb. 2, 2024) (raising
concerns about a conflict of interest in the role of Financial Risk
Management Officers as well as margin calls), comment from Curtis H.
(Feb. 3, 2024) (referencing short selling and margin), and comment
from CK Kashyap (Feb. 5, 2024) (referring to broker risk management
in response to margin). Since the proposal contained in the Proposed
Rule Change was also filed as an advance notice, all public comments
received on the proposal are considered regardless of whether the
comments are submitted on the Proposed Rule Change or the Advance
Notice. Comments on the Advance Notice are available at <a href="https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801.htm">https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801.htm</a>. The
Commission received one comment supporting the proposed changes. See
comment from John P. Davidson, Principal, Pirnie Advisory (Oct. 4,
2023), available at <a href="https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-268179-645042.htm">https://www.sec.gov/comments/sr-occ-2023-801/srocc2023801-268179-645042.htm</a>.
\12\ Securities Exchange Act Release No. 99568 (Feb. 20, 2024),
89 FR 14121 (Feb. 26, 2024) (File No. SR-OCC-2023-007).
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II. Background
The National Securities Clearing Corporation (``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).\13\ 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 and assignment of certain
options or maturation of certain futures cleared by OCC effectively
results in stock settlement obligations to be cleared by NSCC
(``Exercise and Assignment Activity'' or ``E&A Activity''). NSCC and
OCC maintain a legal agreement, generally referred to by the parties as
the ``Accord,'', that governs the processing of such E&A Activity for
firms that are members of both OCC and NSCC (``Common Members'').\14\
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\13\ The term ``physically-settled'' as used throughout the OCC
Rulebook 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 at the time of maturity in the case of
a future. Capitalized terms used but not defined herein have the
meanings specified in OCC's Rules and By-Laws, available at <a href="https://www.theocc.com/about/publications/bylaws.jsp">https://www.theocc.com/about/publications/bylaws.jsp</a>.
\14\ Pursuant to OCC Rule 302, outside of certain limited
exceptions, every Clearing Member that effects transactions in
physically-settled options or futures must also be a participant in
NSCC.
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Under certain circumstances, the Accord currently allows NSCC not
to guaranty the settlement of securities arising out of E&A Activity
for a Common Member for whom NSCC has ceased to act (e.g., due to a
default by that member). To the extent NSCC chooses not to guaranty
such transactions of a defaulting Clearing Member, OCC would have to
engage in an alternate method of settlement outside of NSCC to manage
the default. This presents two issues. First, based on historical data,
the cash required for such alternative settlement could be as much as
$300 billion.\15\ Second, because NSCC's netting process dramatically
decreases the volume of securities settlement obligations that must be
addressed, settlement of physically-settled options and futures outside
of NSCC introduces significant operational complexities. Specifically,
without NSCC's netting process, OCC would have to coordinate a
significantly increased number of transactions on a broker-to-broker
basis rather than through a single central counterparty, and the total
value of settlement obligations that would need to be processed would
be significantly higher.\16\
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\15\ See Notice of Filing, 88 FR at 59977.
\16\ For example, in 2022 it is estimated that netting through
NSCC's continuous net settlement (``CNS'') accounting system reduced
the value of CNS settlement obligations from $519 trillion to $9
trillion, an approximately 98 percent reduction. See id.
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OCC proposes to revise the Accord to address these liquidity and
operational issues. In particular, OCC and NSCC have agreed to modify
the Accord to require NSCC to accept E&A Activity from OCC (i.e.,
guaranty the positions of a defaulting Common Member), provided that
OCC makes a payment to NSCC called the ``Guaranty Substitution
Payment,'' or ``GSP.'' The GSP is designed to cover OCC's share of the
incremental risk to NSCC posed by the defaulting Common Member's
positions. The total risk posed to NSCC by a defaulting Common Member
would be the sum of (i) the defaulter's unpaid deposit to the NSCC
Clearing Fund (``Required Fund Deposit''),\17\ and (ii) the defaulter's
unpaid Supplemental Liquidity Deposit (``SLD'').\18\ If OCC pays the
GSP to NSCC, NSCC would be obligated under the amended Accord to accept
that member's E&A activity from OCC and conduct settlement through
NSCC's netting process and systems. NSCC would calculate how much of
the defaulting Common Member's Required Fund Deposit and SLD are
attributable to the E&A Activity that OCC sends to NSCC, and that
amount would be the GSP. Based on historical data, OCC's GSP could be
as much as $6 billion, which is significantly less than the potential
$300 billion that could be required for alternative settlement outside
of NSCC.\19\
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\17\ 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 Notice of Filing, 88 FR at 59979,
n.27.
\18\ Under the NSCC Rules, in certain circumstances, NSCC
collects the Supplemental Liquidity Deposit, which is an additional
cash deposit from each of those Members who would generate the
largest settlement debits in stressed market conditions. See Rule 4A
of the NSCC Rules. See also Notice of Filing, 88 FR at 59979, n.28.
\19\ See Notice of Filing, 88 FR at 59977.
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As noted above, OCC amended the Proposed Rule Change after filing.
The primary purposes of the Amendment No. 2 were to provide for
improved information sharing between OCC and NSCC, and ensure that the
new process and timing for NSCC to calculate the GSP and OCC to pay the
GSP will be consistent with relevant process and timing requirements
necessitated by the industry transitions to a T+1 settlement cycle for
securities.\20\ OCC has labeled the proposed changes included in the
initial filing to allow OCC to pay the GSP to NSCC and enhance OCC's
liquidity stress testing as Phase 1 of the proposed changes, and the
additional changes in the amendment to enhance information sharing and
facilitate the transition to T+1 as Phase 2.\21\
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\20\ On February 15, 2023, the Commission adopted rules to
shorten the standard settlement cycle for most broker-dealer
transactions from T+2 to T+1. See Securities Exchange Act Release
No. 96930 (Feb. 15, 2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-
05-22).
\21\ OCC has proposed a two-step implementation based on the
categorization of changes as part of Phase 1 and Phase 2. See Notice
of Amendment, 89 FR at 5988.
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OCC also proposes to make conforming changes throughout its rules
to accommodate the changes summarized above, as well as a number of
changes to its rules to facilitate the proposed changes to the Accord
noted above. For example, OCC proposes to change its rules to permit
payment of the GSP to NSCC and revise other of its rules related to
liquidity risk management to account for the potential need to make
such a cash payment to NSCC.
A. Information Sharing and the Guaranty Substitution Payment
The proposed revisions to the Accord designed to introduce and
facilitate the new GSP include the following: changes designed to
facilitate improved information sharing between OCC and NSCC; changes
that would define the calculation of the GSP; changes that would define
the process and timing by which guaranty of the E&A Activity would
transfer from OCC to NSCC; \22\ and additional conforming changes to
the Accord to support these and the other changes described in more
detail below.
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\22\ Here, the ``transfer'' of the guaranty refers to the point
at which OCC's settlement guaranty with respect to E&A Activity ends
and NSCC's settlement guaranty begins.
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Improved Information Sharing. Currently, NSCC sends a file daily to
OCC defining which securities are eligible to settle through NSCC. OCC
then delivers to NSCC a file identifying securities to be physically
settled at NSCC as a result of E&A Activity. This process would
continue under the
[[Page 19909]]
proposal, however, as part of Phase 1 NSCC would also communicate the
GSP daily to OCC.\23\ In Phase 2, NSCC would continue to communicate
the GSP daily to OCC, but the calculation would differ, as described in
more detail below.
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\23\ NSCC would communicate both the total amount of collateral
required to cover the risk presented by each common clearing member
and what percentage of that risk is attributable to OCC (i.e., the
GSP) and therefore OCC would need to pay to require NSCC to guaranty
the positions of a Common Member for whom NSCC has ceased to act. As
described further below, OCC proposes to incorporate the total risk
presented by each common member into its management of liquidity
risk.
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Also in Phase 2, OCC and NSCC would share additional information
beyond the daily exchange of position files and communication of the
GSP. Specifically, NSCC would communicate to OCC daily the single
largest GSP observed in the prior 12 months (the ``Historical Peak
GSP''), which would in turn provide a data point for discussion between
OCC and NSCC to confirm that OCC will likely be in a position to commit
to paying the actual GSP in the event of the default of a Common
Member.\24\ NSCC would also communicate a set of margin and liquidity-
related data to OCC daily (the ``GSP Monitoring Data''). The GSP
Monitoring Data would be for informational purposes and would
facilitate OCC's daily assessment of its ability to commit to pay the
actual GSP in the event of the default of a Common Member.
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\24\ NSCC would provide the Historical Peak GSP to OCC daily,
and OCC would communicate to NSCC whether OCC has Clearing Fund cash
in excess of the Historical Peak GSP. If OCC does not have
sufficient cash in the Clearing Fund, this would allow OCC and NSCC
to escalate discussion of whether OCC will likely be in a position
to commit to paying the actual GSP (e.g., what other resources OCC
has, whether the actual GSP is likely to be as large as the
historical peak). The comparison of OCC's resources to the
Historical Peak GSP would not affect whether OCC is permitted to
send E&A Activity to NSCC.
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The Guaranty Substitution Payment. As described above, NSCC would
communicate to OCC the GSP amount each day. In the event of a Common
Member default, this is the amount OCC would need to pay to require
NSCC to guaranty the positions of the defaulting Common Member. Under
both Phases 1 and 2, the GSP for a given member would be the amount
necessary to cover the risk posed by the member's E&A Activity, and
would be calculated by determining the portion of the defaulting
Clearing Member's Required Fund Deposit and SLD that the member owes to
NSCC that is attributable to the member's E&A Activity at OCC. The
calculation of OCC's portion of the Required Fund Deposit obligation
would differ between Phases 1 and 2, with a precise calculation in
Phase 2 replacing a proxy from Phase 1.
In Phase 1, NSCC would approximate the percentage of the member's
Required Fund Deposit attributable to E&A Activity by referencing the
day-over-day change in gross market value of the Common Member's
positions at NSCC. OCC acknowledges that this gross market value proxy
methodology overestimates or underestimates the Required Fund Deposit
attributable to a Common Member's E&A Activity, but states that current
technology constraints prohibit NSCC from performing a precise
calculation of the GSP on a daily basis for every Common Member. The
Phase 2 changes to the Accord would introduce a more precise allocation
of the Required Fund Deposit portion of the GSP, which would help
eliminate the potential over- or under-estimation of OCC's portion of
the Required Fund Deposit.\25\ Specifically, in Phase 2, NSCC would
calculate OCC's portion of the Required Fund Deposit as a difference
between the Required Fund Deposit of the Common Member's entire
portfolio and the Required Fund Deposit of the Common Member's
portfolio prior to the submission of E&A Activity. This more precise
calculation would completely replace the Phase 1 gross market value
proxy. Under both Phases 1 and 2, the SLD portion of the GSP would be
the Common Member's unpaid SLD associated with any E&A Activity.
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\25\ See Notice of Amendment, 89 FR at 5986. OCC and NSCC agreed
that performing the necessary technology build during Phase 1 would
delay the implementation of the proposal. NSCC will incorporate
those technology updates in connection with Phase 2 of this
proposal. See Notice of Amendment, 89 FR at 5978, n.31.
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Guaranty Transfer. As described above, the purpose of the proposed
changes is to increase the circumstances under which NSCC must assume
the obligation to guaranty E&A Activity. Currently, the guaranty for
such transactions transfers from OCC to NSCC after NSCC has received
Required Fund Deposits from the Common Members. The guaranty would not
transfer if a member fails to satisfy its obligations to NSCC. Under
the proposed changes, the guaranty would transfer after NSCC has
received Required Fund Deposits from the Common Members or at such time
that OCC pays the GSP if a Common Member fails to satisfy its
obligations to NSCC.
B. Liquidity Risk Management
The changes to the Accord regarding the GSP and transfer of the
guaranty are designed to resolve a potential gap in OCC's liquidity
risk management. As noted above, the potential liquidity exposure to
OCC posed by E&A Activity would be dramatically reduced by the proposed
changes because it would go through NSCC's netting process. However,
that reduction would only occur if OCC has sufficient liquid resources
to pay the GSP. The potential payment of the GSP is, therefore, a
liquidity demand that OCC must manage.
OCC's Liquidity Risk Management Framework (``LRMF'') sets forth a
comprehensive overview of OCC's liquidity risk management practices and
governs OCC's policies and procedures as they relate to liquidity risk
management.\26\ OCC proposes changes to the LRMF as well as to OCC's
Comprehensive Stress Testing & Clearing Fund Methodology, and Liquidity
Risk Management Description \27\ to incorporate the GSP into OCC's
liquidity stress testing practices by treating the GSP as a potential
liquidity demand.\28\
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\26\ See Securities Exchange Act Release No. 89014 (June 4,
2020), 85 FR 35446 (June 10, 2020) (File No. SR-OCC-2020-003).
\27\ OCC provided a marked version of the Comprehensive Stress
Testing & Clearing Fund Methodology, and Liquidity Risk Management
Description to the Commission as exhibit 5E to File No. SR-OCC-2023-
007.
\28\ OCC would incorporate this potential liquidity demand at
the level of a group of affiliated members.
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To implement this change, OCC would add an amount representing the
potential GSP to each member account on each day on which options
expire. The amount would be based on historical data. Specifically, OCC
would add the peak GSP observed in the prior 12 months for the member
to the potential liquidity risk posed by the member.\29\ The reliance
on the peak GSP observed in a 12-month lookback, however, raises two
issues that OCC proposes to address in its management of liquidity
risk.
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\29\ OCC states that 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., Mar.,
June, Sep., and Dec.) and Jan. generally being more impactful than
non-quarterly expirations. See Notice of Filing, 88 FR at 59986. OCC
states further that the one-year lookback allows behavior changes of
a Clearing Member to be recognized within an annual cycle. See id.
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First, future liquidity exposures may exceed past exposures, so
holding enough liquidity to meet historical demands does not ensure
that OCC will hold enough to meet future exposures. To address this
issue, OCC proposes to incorporate a member's total Required Fund
Deposit and SLD obligations to
[[Page 19910]]
NSCC (not just the portion represented in the GSP), into its liquidity
risk management. As with most risk management, there is no guaranty
that a future GSP could not exceed OCC's stress test exposures, but the
proposed change increases the likelihood that OCC would have sufficient
cash to pay the GSP.\30\
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\30\ For example, assume the largest member obligation to NSCC
would have been $100, but the largest GSP (representing the amount
attributable to E&A Activity) would only have been $75. Rather than
hold $75 and hope that the future exposures do not exceed past
demands, OCC would hold $100 to cover a future GSP.
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Second, the more E&A Activity that OCC sends to NSCC, the larger
the amount of Required Fund Deposit and SLD attributable to E&A
Activity. However, the level of E&A Activity varies predictably based
on the expiration cycle of options such that different expiration
cycles consistently present different volumes. Put simply, different
expiration cycles are likely to pose different levels of liquidity risk
to OCC in the form of the potential size of the GSP. Based on its
analysis, OCC proposes to separate expirations into five
categories.\31\ For each day, OCC proposes to apply the peak obligation
observed over the prior 12 months within the relevant expiration
category for that day.\32\ The five categories that OCC proposes to
employ are the following:
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\31\ OCC provided its analysis supporting the specific
categories to the Commission in confidential Exhibit 3E to File No.
SR-OCC-2023-007. The confidential Exhibit 3E sets forth data related
to OCC's liquidity stress testing for Sufficiency and Adequacy
scenarios with and without the inclusion of the GSP, including
Available Liquidity Resources, Minimum Cash Requirement thresholds,
and liquidity breaches.
\32\ For example, for a standard monthly expiration, which is
typically the third Friday of the month, OCC would look at the peak
obligation observed across all standard monthly expirations in the
preceding 12 months.
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<bullet> Standard Monthly Expiration: typically the third Friday of
each month;
<bullet> End of Week Expirations: the last business day of the
week, excluding the third Friday of each month;
<bullet> End of Month Expirations: the last trading day of the
month;
<bullet> Bank Holiday Expirations: days where banks are closed but
the markets are open; \33\
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\33\ 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. Because of this,
settlement at NSCC encompasses two days of equity trading and E&A
Activity. This creates the possibility of a significant outlying GSP
requirement due to the settlement of two days of activity
simultaneously. In OCC's view this necessitates the ability to
separately risk manage such occurrences through the creation of the
Bank Holiday category. Additional supporting data in support of the
creation of the Bank Holiday Expiration category is included as
Exhibit 3E to File No. SR-OCC-2023-007.
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<bullet> Daily Expirations: all other days with an expiration that
do not fall into any of the categories above (typically most Mondays
through Thursdays).
Notwithstanding this categorization and the underlying analysis,
OCC proposes to impose two floors to certain expirations. First, the
peak obligation applied in the End of Week, End of Month, and Bank
Holiday categories cannot be lower than the peak obligation observed in
the Daily Expirations category. Second, the obligation applied in the
Standard Monthly Expiration category cannot be lower than the peak
obligation observed in either the End of Week, End of Month, or Daily
Expiration category. As discussed below, the imposition of the floors
would help OCC control for the possibility of an unusually large
liquidity demand that is not related to the different expiration
cycles.
The liquidity risk management changes described above are part of
Phase 1. Additionally, OCC proposes changes to its Rules and By-Laws to
allow OCC to pay the GSP out of its liquid resources.\34\ Under Phase
2, OCC proposes to make further clarifying and definitional changes in
the LRMF, but the substance of the Phase 1 changes would persist in
Phase 2.
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\34\ For example, OCC proposes changes to its rules to allow OCC
to borrow funds from the Clearing Fund to pay the GSP, which is
consistent with OCC's use of the Clearing Fund to address other
liquidity needs such as to cover losses resulting from a member's
failure to satisfy an obligation on a confirmed trade accepted by
OCC. See OCC Rule 1006(a)(i).
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C. Transition to T+1
Phase 1 of the proposed changes are primarily designed to provide
OCC the right to require NSCC to accept and guaranty the E&A Activity
of a Common Member even if that member has not met its obligations to
NSCC. The mechanism by which OCC would exercise that right would be the
payment of the GSP to NSCC, and OCC would account for such payment as a
potential liquidity demand that it must manage. Phase 1 does not,
however, materially change the time at which OCC would cease (and NSCC
would start) to guaranty the E&A Activity.\35\
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\35\ The Commission described the current timing and process
under which OCC's guaranty ceases and NSCC's guaranty attaches in a
prior order. See Securities Exchange Act Release No. 81266 (July 31,
2017), 82 FR 36484, 36486-87 (Aug. 4, 2017) (File No. SR-OCC-2017-
013).
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Under the current Accord, NSCC's guaranty attaches (and OCC's
ceases) when NSCC has received all Required Fund Deposits taking into
account the E&A Activity.\36\ Currently, NSCC's guaranty would not
attach if a Common Member defaults on its obligations to NSCC. Under
Phase 1 of the proposed changes, however, OCC would have the
opportunity to pay the GSP to NSCC as an effective substitution for the
defaulted member's obligations with respect to the E&A Activity. Phase
1, therefore, allows for a change in who pays NSCC, but does not alter
the timing of payment.
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\36\ See id. at 36487.
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Phase 2 will alter the timing of payment, primarily to accommodate
the transition from a T+2 settlement cycle to a T+1 settlement
cycle.\37\ Under the current process, which takes place in a T+2
settlement cycle, there is sufficient time after expiration for NSCC
and OCC to determine whether a member has defaulted before NSCC begins
to process settlement of the E&A Activity. However, in a T+1 settlement
cycle, settlement processing could begin before NSCC or OCC become
aware of a member default. Thus, in a T+1 environment, the timing and
process by which OCC's guaranty would cease (and NSCC's would attach)
would need to shift.
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\37\ See Securities Exchange Act Release No. 96930 (Feb. 15,
2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
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Specifically, under Phase 2, OCC would commit to payment of the GSP
(regardless of whether a member has defaulted) prior to NSCC's
acceptance of E&A Activity. If OCC is unable to commit to pay the GSP,
NSCC would be permitted, but not required, to reject the E&A Activity.
The process would vary slightly between expirations occurring on a
Friday and expirations occurring Monday through Thursday. For a Friday
expiration, NSCC would communicate the GSP to OCC and OCC would
subsequently commit to pay the GSP on Saturday morning. For Monday
through Thursday expirations, OCC's transmission of the E&A Activity
itself to NSCC would constitute a commitment by OCC to pay the GSP
related to that E&A Activity.\38\ For all expirations, OCC would send
the E&A Activity to NSCC by 1 a.m. the morning after expiration (e.g.,
1 a.m. Saturday for a Friday expiration). This would help ensure that,
in a T+1 settlement environment, NSCC has OCC's commitment to pay the
GSP before NSCC must begin processing any E&A Activity from OCC.
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\38\ The requirement to commit prior to calculation of the final
GSP for E&A Activity arising Monday through Thursday highlights the
importance of the improved information sharing described above.
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[[Page 19911]]
III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Exchange Act directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to such organization.\39\ After carefully
considering the Proposed Rule Change, the Commission finds that the
Proposed Rule Change is consistent with the requirements of the
Exchange Act and the rules and regulations thereunder applicable to
OCC. More specifically, the Commission finds that the Proposed Rule
Change is consistent with section 17A(b)(3)(F) of the Exchange Act,\40\
and Rules 17Ad-22(e)(1), (e)(7), and (e)(20) \41\ thereunder, as
described in detail below.
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\39\ 15 U.S.C. 78s(b)(2)(C).
\40\ 15 U.S.C. 78q-1(b)(3)(A).
\41\ 17 CFR 240.17Ad-22(e)(1); 17 CFR 240.17Ad-22(e)(7); and 17
CFR 240.17Ad-22(e)(20).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act
Section 17A(b)(3)(F) of the Exchange Act requires, among other
things, that the rules of a clearing agency be designed to promote the
prompt and accurate clearance and settlement of securities
transactions, to foster cooperation and coordination with persons
engaged in the clearance and settlement of securities transactions,
and, in general, to protect investors and the public interest.\42\
Based on its review of the record, and for the reasons described below,
allowing OCC to make the changes described above is consistent with
promoting prompt and accurate clearance and settlement of securities
transactions, fostering cooperation and coordination between with
persons engaged in the clearance and settlement of securities
transactions, and, in general, the protection of investors and the
public interest.
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\42\ 15 U.S.C. 78q-1(b)(3)(F).
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OCC proposes changes to its rule related to the management of
liquidity risk management, such as the introduction of the GSP, which
would allow OCC to require NSCC to accept E&A Activity in the event of
a Common Member default, so long as OCC pays the GSP to NSCC.
Processing E&A Activity through NSCC's netting system would
significantly reduce the risk posed by such E&A Activity by reducing
the volume and value of settlement obligations.\43\ It would also
reduce OCC's potential liquidity demands as a result of the E&A
Activity from an amount that could exceed its available liquid
resources to an amount that would fall well within its current liquid
resources. Further, the information sharing contemplated under the
proposed changes would allow OCC to better understand and monitor its
exposures and provide for more dialogue between NSCC and OCC, which
could, in turn, allow them to better manage the risks posed by the E&A
Activity.
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\43\ As noted above, it is estimated that, in 2022, netting
through NSCC's CNS accounting system reduced the value of CNS
settlement obligations by approximately 98% or $510 trillion from
$519 trillion to $9 trillion. See Notice of Filing, 88 FR at 59977.
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OCC is the only clearing agency for standardized U.S. securities
options listed on Commission-registered national securities exchanges
(``listed options'').\44\ Strengthening OCC's overall approach to
liquidity risk management, strengthens OCC's ability to manage Clearing
Member defaults, which, in turn, facilitates the clearance and
settlement of listed options. The Proposed Rule Change would promote
the prompt and accurate clearance and settlement of securities
transactions and is, therefore, consistent with the requirements of
section 17A(b)(3)(F) of the Exchange Act.\45\
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\44\ See Securities Exchange Act Release No. 85121 (Feb. 13,
2019), 84 FR 5157 (Feb. 20, 2019) (File No. SR-OCC-2015-02).
\45\ 15 U.S.C. 78q-1(b)(3)(F).
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Phase 2 contemplates further enhancement of information sharing
between two clearing agencies as well as updating the Accord to support
the shortening of the standard settlement cycle for most broker-dealer
transactions from T+2 to T+1. Enhanced information sharing would
support closer coordination and cooperation between OCC and NSCC
through frequent dialogue. For example, the communication of the
Historical Peak GSP would allow OCC to assess its liquidity resources
and facilitate discussion of whether OCC will likely be in a position
to commit to paying the actual GSP. The changes to support the
shortening of the standard settlement cycle would allow OCC and NSCC to
coordinate as they seek to comply with the relevant rulemaking adopted
by the Commission under the Exchange Act consistent with the
requirements of section 17A(b)(3)(F) of the Exchange Act.\46\
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\46\ 15 U.S.C. 78q-1(b)(3)(F).
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Further, OCC has been designated as a systemically important
financial market utility, in part, because its failure or disruption
could increase the risk of significant liquidity or credit problems
spreading among financial institutions or markets.\47\ The proposed
changes would support OCC's ability to continue providing services to
the options markets by addressing losses and shortfalls arising out of
the default of a Common Member. OCC's continued operations would, in
turn, reduce systemic risk by reducing the risk of significant
liquidity or credit problems spreading among market participants that
rely on OCC's central role in the options market. The Proposed Rule
Change would, therefore, generally support the protection of investors
and the public interest, consistent with the requirements of section
17A(b)(3)(F) of the Exchange Act,\48\ because it would reduce systemic
risk.
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\47\ See Financial Stability Oversight Council (``FSOC'') 2012
Annual Report, Appendix A, <a href="https://home.treasury.gov/system/files/261/here.pdf">https://home.treasury.gov/system/files/261/here.pdf</a> (last visited Feb. 17, 2022).
\48\ 15 U.S.C. 78q-1(b)(3)(F).
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Accordingly, and for the reasons stated above, the Proposed Rule
Change is consistent with the requirements of section 17A(b)(3)(F) of
the Exchange Act.\49\
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\49\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(1) Under the Exchange Act
Rule 17Ad-22(e)(1) under the Exchange Act requires, in part, that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to provide for a
well-founded, clear, transparent, and enforceable legal basis for each
aspect of its activities in all relevant jurisdictions.\50\ In adopting
Rule 17Ad-22(e)(1), the Commission provided guidance that a covered
clearing agency generally should consider in establishing and
maintaining policies and procedures that address legal risk.\51\ The
Commission stated that a covered clearing agency should consider, inter
alia, whether its contracts are consistent with relevant laws and
regulations.\52\
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\50\ 17 CFR 240.17Ad-22(e)(1).
\51\ See Securities Exchange Act Release No. 78961 (Sept. 28,
2016), 81 FR 70786, 70802 (Oct. 13, 2016) (S7-03-14) (``Covered
Clearing Agency Standards'').
\52\ See id.
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On February 15, 2023, the Commission adopted a final rule to
shorten the standard settlement cycle for most broker-dealer
transactions from two business days after the trade date to one
business day after the trade date.\53\
[[Page 19912]]
Currently, and under Phase 1, the terms of the Accord are designed for
consistency with a T+2 settlement cycle. As described above, the terms
of the Accord under Phase 2, which OCC intends to implement on the T+1
compliance date established by the Commission,\54\ would be designed
for consistency with a T+1 settlement cycle.
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\53\ See Securities Exchange Act Release No. 96930 (Feb. 15,
2023), 88 FR 13872 (Mar. 6, 2023) (File No. S7-05-22).
\54\ See Notice of Amendment, 89 FR at 5968.
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Accordingly, the proposal to amend the Accord to conform to a T+1
settlement cycle is consistent with Rule 17Ad-22(e)(1) under the
Exchange Act.\55\
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\55\ 17 CFR 240.17Ad-22(e)(1).
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C. Consistency With Rule 17Ad-22(e)(7) Under the Exchange Act
Rule 17Ad-22(e)(7) under the Exchange Act requires that a covered
clearing agency 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
the covered clearing agency, including measuring, monitoring, and
managing its settlement and funding flows on an ongoing and timely
basis, and its use of intraday liquidity.\56\ In adopting Rule 17Ad-
22(e)(7), the Commission provided guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address liquidity risk.\57\ The Commission
stated that a covered clearing agency should consider, inter alia,
whether it maintains sufficient liquid resources in all relevant
currencies to settle securities-related payments and meet other payment
obligations on time with a high degree of confidence under a wide range
of stress scenarios.\58\
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\56\ 17 CFR 240.17Ad-22(e)(7).
\57\ See Covered Clearing Agency Standards, 81 FR at 70823.
\58\ See id.
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OCC's LRMF sets forth a comprehensive overview of OCC's liquidity
risk management practices and governs OCC's policies and procedures as
they relate to liquidity risk management. As described above, the
potential cash necessary to manage a member default without utilizing
NSCC's settlement process could exceed OCC's available liquid
resources. The proposed changes to the Accord would allow OCC to send
E&A Activity to NSCC even in the event of a Common Member default,
which, based on an analysis of historical data, would reduce OCC's
potential liquidity to an amount that is within the scope of its
current resources.
To take advantage of the proposed changes to the Accord, OCC must
be prepared to make a cash payment to NSCC (i.e., the GSP). OCC
proposes to recognize that potential payment obligation as an input to
OCC's liquidity risk processes. In particular, OCC proposes to consider
the full amount of a Common Member's past obligations to NSCC rather
than consider only the portion of such obligation attributable to E&A
Activity. OCC's reliance on historical data would allow it to
approximate, but not predict potential future exposures. Reliance
solely on past GSP requirements would not position OCC to cover a
future peak GSP. The incorporation of the full amount of a Common
Member's past obligations, however, would provide a buffer to increase
the likelihood that OCC would be in a position to pay a future GSP that
exceeds historical GSP requirements. OCC also proposes to align its
measurement of the potential obligation to pay NSCC with the cyclical
nature of the products that OCC clears,\59\ and to increase its
information sharing with NSCC, which would allow OCC to better monitor
the potential liquidity need posed by the GSP.
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\59\ Alignment with the cyclical nature of the products would be
achieved, as described above, through the use of expiration
categories when incorporating collateral requirements into OCC's
stress testing. To balance this process, however, OCC would also
impose floors across expiration categories that would help control
for the possibility for an unusually large liquidity demand that is
not related to the different expiration cycles.
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Accordingly, the proposed changes to the Accord regarding the GSP
and to OCC's internal liquidity risk management rules are consistent
with Rule 17Ad-22(e)(7) under the Exchange Act.\60\
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\60\ 17 CFR 240.17Ad-22(e)(7).
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D. Consistency With Rule 17Ad-22(e)(20) Under the Exchange Act
Rule 17Ad-22(e)(20) under the Exchange Act requires that a covered
clearing agency establish, implement, maintain, and enforce written
policies and procedures reasonably designed to identify, monitor, and
manage risks related to any link the covered clearing agency
establishes with one or more other clearing agencies, financial market
utilities, or trading markets.\61\ For the purposes of Rule 17Ad-
22(e)(20), ``link'' means, among other things, a set of contractual and
operational arrangements between two or more clearing agencies,
financial market utilities, or trading markets that connect them
directly or indirectly for the purpose of participating in
settlement.\62\
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\61\ 17 CFR 240.17Ad-22(e)(20).
\62\ 17 CFR 240.17Ad-22(a)(8).
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In adopting Rule 17Ad-22(e)(20), the Commission provided guidance
that a covered clearing agency generally should consider in
establishing and maintaining policies and procedures that address
links.\63\ Notably, the Commission stated that a covered clearing
agency should consider whether a link has a well-founded legal basis,
in all relevant jurisdictions, that supports its design and provides
adequate protection to the covered clearing agencies involved in the
link.\64\
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\63\ See Covered Clearing Agency Standards, 81 FR at 70841.
\64\ Id.
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As described above, the Accord is a contractual arrangement between
NSCC and OCC that governs the processing of E&A Activity, which
consists of settlement obligations arising out of certain products
cleared by OCC. The Accord, therefore, is a link for the purposes of
Rule 17Ad-22(e)(20). The specific legal basis for the Accord to conform
to a T+1 settlement cycle was discussed above in section III.B.
Likewise, Section III.C. discussed the ways the Accord provides
adequate protection to both OCC and NSCC by introducing the GSP,
enhancing information sharing between OCC and NSCC, and ensuring that
OCC and NSCC have the tools and information they need to monitor the
potential liquidity need posed by the GSP.
For the reasons discussed in those sections, the Accord between OCC
and NSCC has a well-founded legal basis that supports its design and
provides adequate protection to the covered clearing agencies involved
in the Accord. Accordingly, the proposed changes to the Accord are
consistent with Rule 17Ad-22(e)(20) under the Exchange Act.\65\
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\65\ 17 CFR 240.17Ad-22(e)(20).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
Proposed Rule Change, as modified by Partial Amendment No. 1 and
Amendment No. 2, is consistent with the requirements of the Exchange
Act, and in particular, the requirements of section 17A of the Exchange
Act \66\ and the rules and regulations thereunder.
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\66\ In approving the Proposed Rule Change, the Commission has
considered the proposed rules' impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to section 19(b)(2) of the
Exchange Act,\67\ that the Proposed Rule Change, as modified by Partial
Amendment No. 1
[[Page 19913]]
and Amendment No. 2, (SR-OCC-2023-007) be, and hereby is, approved.
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\67\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\68\
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\68\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-05834 Filed 3-19-24; 8:45 am]
BILLING CODE 8011-01-P
</pre></body>
</html>Indexed from Federal Register on March 20, 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.