Notice2024-21035
Self-Regulatory Organizations; The Options Clearing Corporation; Order Granting Approval of Proposed Rule Change by The Options Clearing Corporation Concerning Its Backtesting Framework and To Establish a Resource Backtesting Margin Charge
Primary source
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Published
September 17, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 180 (Tuesday, September 17, 2024)</title>
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[Federal Register Volume 89, Number 180 (Tuesday, September 17, 2024)]
[Notices]
[Pages 76171-76176]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-21035]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-100998; File No. SR-OCC-2024-009]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of Proposed Rule Change by The Options Clearing
Corporation Concerning Its Backtesting Framework and To Establish a
Resource Backtesting Margin Charge
September 11, 2024.
I. Introduction
On July 11, 2024, the Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2024-009 (``Proposed Rule Change'')
pursuant to Section 19(b) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 \2\ thereunder. The Proposed Rule
Change would amend the OCC rules to more comprehensively describe its
approach to backtesting, including underlying assumptions; establish a
new category of backtesting regarding the maintenance of sufficient
margin resources; implement a new margin add-on charge based on
breaches of the new category of resource backtesting; and clarify
governance and escalation criteria related to the updated backtesting
framework. The Proposed Rule Change was published for public comment in
the Federal Register on July 30, 2024.\3\ The Commission has received
no comments regarding the Proposed Rule Change. This order approves the
Proposed Rule Change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 100584 (July 24, 2024),
89 FR 61211 (July 30, 2024) (File No. SR-OCC-2024-009) (``Notice of
Filing'').
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II. Description of the Proposed Rule Change
OCC is a central counterparty (``CCP''), which means that as part
of its function as a clearing agency it interposes itself as the buyer
to every seller and the seller to every buyer for certain financial
transactions. As the CCP for the listed options markets in the U.S.,\4\
as well as for certain futures and stock loans, OCC is exposed to
certain risks arising from providing settlement and clearing services
to its Clearing Members.\5\ Because OCC is obligated to perform on the
contracts it clears even where one of its Clearing Members defaults,
one such risk to which OCC is exposed is credit risk in the form of
exposure to its members' trading activities. OCC manages such credit
risk, in part, by collecting collateral from its members in the form of
margin. OCC evaluates the margin requirements it imposes on members by
periodically comparing such requirements to the potential risk of loss
arising out of a member default (i.e., backtesting).\6\ While
backtesting does not directly establish a member's margin requirements,
OCC maintains authority under its rules to collect additional margin if
OCC identifies--through backtesting results or otherwise--issues with
its margin coverage.\7\
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\4\ OCC describes itself as ``the sole clearing agency for
standardized equity options listed on a national securities exchange
registered with the Commission (`listed options').'' See Securities
Exchange Act Release No. 96533 (Dec. 19, 2022), 87 FR 79015 (Dec.
23, 2022) (File No. SR-OCC-2022-012).
\5\ Capitalized terms have the same meaning as provided in OCC's
By-Laws and Rules, which can be found on OCC's public website:
<a href="https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules">https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules</a>.
\6\ Under the rules applicable to OCC, backtesting means an ex-
post comparison of actual outcomes with expected outcomes derived
from the use of margin models. 17 CFR 240.17ad-22(a)
(``Backtesting'').
\7\ See Notice of Filing, 89 FR at 61212.
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OCC's current backtesting framework measures its Clearing Members'
losses in excess of calculated margin requirements to evaluate the
adequacy of OCC's model performance, improve margin methodology and
risk assessment processes, and identify trends in exceedances that may
indicate broader behavioral changes by market participants. However,
OCC's current backtesting framework does not provide detailed
descriptions of the backtesting process, nor does it require OCC to
measure whether it has collected sufficient margin resources in the
event of a Clearing Member default (a process often referred to as
``resource sufficiency'' evaluation), or detail the underlying
assumptions and governance process for the framework. To address these
issues, the Proposed Rule Change would update OCC's current backtesting
framework by:
<bullet> updating the current backtesting framework to more
comprehensively describe material aspects of model backtesting;
<bullet> providing for a new category of backtesting--``Resource
Backtesting''--that assesses the adequacy of OCC's margin resources to
cover its credit exposure at the Clearing Member level; and
<bullet> detailing the underlying assumptions and reporting
structure for the entire backtesting framework to provide for clearer
governance procedures, including escalation criteria.
Additionally, OCC lacks a mechanism with which to collect
additional margin resources in instances where backtesting suggests
that OCC may otherwise not have sufficient resources to cover its
credit exposure during a Clearing Member's default. To that end, OCC
proposes to implement a new add-on charge called the ``Resource
Backtesting Margin Charge.'' Although this add-on would not be part of
the backtesting framework, OCC would use the proposed Resource
Backtesting category of backtesting to determine if additional margin
in the form of the Resource Backtesting Margin Charge is necessary and
in what amount. Specifically, OCC would apply the Resource Backtesting
Margin Charge to Clearing Members who experience Resource Backtesting
deficiencies that bring their margin coverage rates below a 99%
coverage target. OCC also proposes to include in the backtesting
framework governance procedures related to the Resource Backtesting
Margin Charge.\8\
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\8\ Under the Proposed Rule Change, OCC also would make
conforming changes to its rules and internal policies and procedures
to reflect these amendments and facilitate implementation, including
consolidating internal procedures for all backtesting into a
Backtesting Procedure and associated technical document, updating
references and descriptions, and inserting headings. See Notice of
Filing, 89 FR at 61219-20. OCC provided the new Backtesting
Procedure as confidential Exhibit 3B, and the updated technical
document as confidential Exhibit 3C to File No. SR-OCC-2024-009.
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A. OCC's Current Backtesting Framework
OCC conducts daily backtesting of collateral requirements generated
by its margin methodology using standard predetermined parameters and
assumptions. OCC uses such backtesting to update its credit risk
management and margin methodology \9\ or to adjust model parameters.
OCC relies on backtesting to evaluate the accuracy of its margin models
by comparing the calculated margin coverage for each margin account
against the realized profit and loss on the margined
[[Page 76172]]
portfolios. However, OCC's policies and procedures do not currently
identify the categories of relevant assumptions, provide for how they
are established or modified, or explain how assumptions may differ
across different types of backtesting depending on the purpose of those
backtesting variants.
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\9\ OCC's margin methodology, adopted in 2006, is titled the
System for Theoretical Analysis and Numerical Simulation
(``STANS''). See Notice of Filing, 89 FR at 61212-13.
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Currently, OCC conducts both backtesting of hypothetical portfolios
(which OCC currently refers to as ``Model Backtesting'') and actual
portfolios (which OCC currently refers to as ``Business
Backtesting'').\10\ OCC's internal backtesting procedures address data
acquisition, application of statistical tests, analyses initiated to
address root causes of exceedances, reporting of results, annual
methodology reviews, and issue escalation.
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\10\ See generally Securities Exchange Act Release Nos. 73749
(Dec. 5, 2014), 79 FR 73673 (Dec. 11, 2014) and 75290 (June 24,
2015), 80 FR 37323 (June 30, 2015) (File No. SR-OCC-2014-810).
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OCC's backtesting framework includes its Margin Policy.\11\ The
Margin Policy requires that OCC's Financial Risk Management Department
(``FRM'') continually evaluates the effectiveness of its margin models
through daily backtesting of each margin account.\12\ The Margin Policy
requires further that OCC's Quantitative Risk Management business unit
(``QRM'') design backtests to focus on satisfying OCC's regulatory
obligations, identifying potential opportunities to improve the margin
methodology, and identifying trends in exceedances that may be
indicative of behavioral changes by market participants. Acknowledging
that problems may arise from both technical \13\ and model-related
issues, the Margin Policy directs QRM to design backtests to find
potential opportunities to improve OCC's risk-assessment processes.
Under the current backtesting framework, FRM performs Business
Backtesting to measure whether the losses observed for a constant set
of positions over OCC's two-day margin period of risk were in excess of
the total risk charges (i.e., aggregate of expected shortfall, stress
test charges and add-on charges) required for the account. FRM is then
directed to classify any observation in which losses are in excess as
an exceedance.
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\11\ OCC provided the Margin Policy as confidential Exhibit 5B
to File No. SR-OCC-2024-009. OCC stated that, generally, ``the
Margin Policy establishes a process for ongoing monitoring, review,
testing and verification of OCC's risk-based margin system,
including by requiring OCC to conduct daily backtesting, conduct
analysis of exceedances, and report results at least monthly through
OCC's governance process. . .'' See Notice of Filing, 89 FR at
61212.
\12\ See Notice of Filing, 89 FR at 61213.
\13\ OCC indicated that such technical issues may arise from
corporate actions and special dividends. Id.
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With regard to governance, the current Margin Policy directs QRM to
report identified problems and overall performance to FRM and the Model
Risk Working Group (``MRWG''), which then determines whether the
results require escalation to OCC's Management Committee (``MC''). The
Margin Policy further requires routine reporting from QRM to the MRWG
that accumulate daily backtesting results and detailed descriptions of
the accounts that have incurred exceedances, trends, and causes of the
exceedances. As with the escalation of identified problems and overall
performance, the Margin Policy directs QRM to provide notable results
from these reviews to the Chief Financial Risk Officer, who is the head
of FRM, and the MRWG; and that the MRWG similarly determines whether
escalation is warranted to the MC, which may decide what remedial
actions may be taken. Under the current Margin Policy, QRM must also
perform a monthly review of parameters and assumptions for Business
Backtesting, and report such review to the MRWG to discuss and escalate
issues as necessary.
B. Proposed Updates to the Backtesting Framework
OCC's current backtesting framework does not specify certain
materials aspects of OCC's backtesting processes, namely, a
comprehensive description of the different types of backtesting OCC
performs and their respective purposes, and how OCC establishes and
modifies its assumptions for backtesting. Importantly, the current
framework does not require OCC to conduct backtesting to measure margin
resource sufficiency, but rather, is designed to identify technical and
model-based issues as described above. OCC's current backtesting
framework also lacks detailed guidance around governance, specifically
the reporting process and escalation criteria and thresholds, which
could lead to inconsistencies in the escalation of similar backtesting
exceedances or deficiencies, and reviews of backtesting assumptions.
To help mitigate these issues, OCC proposes to:
<bullet> more comprehensively describe material aspects of its
model backtesting framework, including the purpose and scope of the
backtesting OCC performs;
<bullet> introduce a new category of backtesting, Resource
Backtesting, to measure whether OCC's margin resources adequately cover
its credit exposure at the Clearing Member level;
<bullet> list the assumptions underlying OCC's backtesting and the
process for reviewing and modifying those assumptions; and
<bullet> outline in more detail the backtesting reporting process,
including which decision-makers are involved and escalation criteria
for exceedances or deficiencies and reviews.
1. Model Backtesting
Under the Proposed Rule Change, OCC would consolidate discussion of
its two current ``Model'' and ``Business'' backtesting programs under
the heading of Model Backtesting, without changing its current process
for conducting daily backtesting of hypothetical and actual portfolios
to evaluate the performance of its margin methodology. OCC proposes to
add descriptions in the Margin Policy to explain that FRM conducts
Model Backtesting of hypothetical portfolios to target specific aspects
of the models that may be masked by the backtesting of actual
portfolios, because margin accounts may have thousands of positions in
many diverse products. Under the Proposed Rule Change, the Margin
Policy would include additional details consistent with OCC's current
backtesting practices. Such details would include that OCC would
conduct Model Backtesting (i) over a set liquidation horizon; (ii) at
the marginable account level; \14\ and (iii) at a 99 percent confidence
level. The Margin Policy would add a definition of ``exceedance'' to
mean a daily outcome in which the loss in portfolio value over the
applicable time horizon is larger in magnitude than what the daily
STANS model predicted at the start of that time horizon.
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\14\ See Notice of Filing, 89 FR at 61214 (``OCC conducts Model
Backtesting at this level because Model Backtesting exceedances
potentially indicate issues that could be actively impacting OCC's
margin requirements for the margin accounts. In addition,
backtesting at this level is consistent with OCC's obligations in
its capacity as a derivatives clearing organization (`DCO')
registered with the Commodity Futures Trading Commission.'')
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OCC would continue to limit the purpose of Model Backtesting to
assessing the performance of OCC's margin models in calculating margin
requirements, as opposed to assessing the performance of other aspects
of OCC's credit risk management. Consistent with this intent, the
Margin Policy would state that OCC would continue to exclude collateral
from Model Backtesting that is not modeled by STANS, such as collateral
that is valued using the more traditional method of fixed collateral
haircuts outside of the STANS margin methodology, or collateral that
does not capture changes in market risk factors, such as add-ons that
are unrelated to
[[Page 76173]]
changes in market risk factors (e.g., when a Clearing Member's
operational or financial condition presents elevated risks). The
collateral that is not modelled by STANS instead would be accounted for
under the new backtesting category of Resource Backtesting, as
described in Section II.B.2. below.\15\
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\15\ Notwithstanding the inclusion of such collateral in
Resource Backtesting rather than in Model Backtesting, OCC also
would have the authority under the proposed Margin Policy to
maintain variations of Model Backtesting for diagnostic or
informational purposes that include such add-ons. See Notice of
Filing, 89 FR at 61214.
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2. Resource Backtesting
In addition to formalizing the process of performing daily Model
Backtesting in the Margin Policy, OCC would add a new category of
backtesting, called Resource Backtesting, to evaluate whether OCC's
financial resources are sufficient to cover its credit exposures during
a Clearing Member default. Pursuant to the proposed Margin Policy, FRM
would be required to conduct Resource Backtesting using actual
portfolios at the Clearing Member level to evaluate whether OCC
maintains sufficient financial resources to cover its credit exposure
to the liquidation portfolio of each Clearing Member from the last
deposit of margin assets until the end of the liquidation horizon
following the Clearing Member's default. Since Resource Backtesting
would be designed to determine whether the liquidating value of a
Clearing Member's portfolios would be positive or negative at the end
of OCC's liquidation horizon, it would take into account observed
intraday position changes from the time of the last good margin
collection until the assumed point of default.
The proposed Margin Policy would set the coverage target for
Resource Backtesting at 99 percent, meaning that any Resource
Backtesting deficiencies should be no more than one percent in the
rolling 12-month lookback period for each Clearing Member. The proposed
changes to the Margin Policy would define a ``deficiency'' as a daily
result where the prefunded financial resources collected from the
Clearing Member would have been insufficient to cover the potential
loss in case of its default (i.e., a negative liquidating value of the
Clearing Member's portfolios).
While OCC conducts Model Backtesting at the account level, OCC
would consider resources and exposures across a given member's account
for Resource Backtesting. Because OCC's By-Laws and Rules provide for
different types of liens over different types of accounts, OCC would
consider the liens on a particular account when netting deficits and
surpluses across account types to ensure that surpluses in an account
over which OCC maintains a restricted lien do not offset losses in
another account for purposes of Resource Backtesting.
In contrast with Model Backtesting, OCC would include collateral
that is not modelled by STANS in Resource Backtesting. The margin
resources that would be considered by Resource Backtesting would be
limited to a member's margin requirements; accordingly, any excess
margin collateral would be excluded. OCC would continue to exclude
Clearing Fund deposits from all margin backtesting.
3. Backtesting Assumptions and Reporting
The proposed Margin Policy would explicitly list certain
assumptions that inform OCC's backtesting practices: the timing of
default, liquidation horizon, available resources, confidence level,
lookback period, and the backtesting portfolio.\16\ The proposed
changes to the Margin Policy would define OCC's process for evaluating
and changing such assumptions. Specifically, changes to backtesting
assumptions would require escalation by MRWG and the MC, with ultimate
approval by the Risk Committee (``RC''). Under the proposed changes to
the Margin Policy, changes to backtesting assumptions that would result
in or arise from changes to OCC's margin methodology, in such a way as
to require a rule change proposal to be filed with the Commission,
would continue to require the approval of OCC's Board of Directors.
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\16\ Although the type of assumptions would be listed in the
Margin Policy, OCC would maintain the specific assumptions in its
underlying documentation.
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As proposed, the Margin Policy would provide that, at least
monthly,\17\ FRM will review the results of backtesting to identify any
Model Backtesting exceedances or Resource Backtesting deficiencies and
present a detailed analysis of such information, as well as a review of
backtesting assumptions, to the MRWG to determine whether OCC's
backtesting practices are appropriate for measuring the adequacy of
margin requirements. The proposed changes to the Margin Policy state
that escalation criteria for backtesting results would include (i)
thresholds related to the size and number of exceedances for Model
Backtesting of actual portfolios; (ii) thresholds related to
statistical tests for Model Backtesting of hypothetical portfolios; and
(iii) thresholds related to the size of an individual Clearing Member's
Resource Backtesting deficiency and the coverage rate across all
Clearing Members in the aggregate. Further, escalation criteria for
backtesting assumptions would include (i) market conditions, (ii)
changes to OCC's risk methodologies, and (iii) unusual exceedances.\18\
Under the proposed Margin Policy, FRM would prepare and present to MRWG
a review of the backtesting assumptions more frequently than monthly in
the event of triggers related to high market volatility, low market
liquidity, and significant increases or decreases in position size or
concentration risk.
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\17\ The monthly reviews are part of the current backtesting
framework, as described in Section II.A. above. The Proposed Rule
Change does not seek to change this monthly cadence.
\18\ OCC's internal procedures would include further detail
regarding escalation criteria for backtesting results and
assumptions.
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The amended Margin Policy would provide that, annually, QRM will
present to MRWG a backtesting framework evaluation, including QRM's
recommendations regarding whether OCC should change any of its
assumptions or exceedance escalation criteria. The Margin Policy would
require that changes to the escalation criteria must be approved by the
governing body to which the escalation must be made. That is, the MRWG
would be authorized to approve changes to the criteria for escalation
to the MRWG, and the MC would be authorized to approve changes to the
escalation criteria to the MC. The MRWG also would be responsible for
determining whether to escalate any changes to backtesting assumptions
or the escalation criteria to the MC or RC for consideration. On an
annual basis, the MC would report to the RC the results of the annual
Backtesting Framework evaluation, including any changes it believes
should be made to OCC's backtesting assumptions or the escalation
criteria to the RC. The RC would be authorized to approve such
assumption changes and escalation criteria to the RC for
implementation, as proposed in the Margin Policy.
C. Establishing the Resource Backtesting Margin Charge
In addition to the Model Backtesting and Resource Backtesting
amendments described above, OCC proposes to implement a margin add-on
charge to help ensure it has sufficient financial resources as a method
of managing its credit risk exposure. OCC determined that the proposed
Resource Backtesting would identify deficiencies showing whether its
Clearing Members fall below
[[Page 76174]]
the 99 percent coverage threshold described above.\19\ To address such
deficiencies, OCC proposes to adopt a new margin charge to increase the
likelihood that OCC's margin resources would be sufficient to cover
fully its potential future exposure to each participant.\20\
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\19\ See Notice of Filing, 89 FR at 61217. (``[. . .B]ased on
2023 historical data, approximately 25% of Clearing Members would
have fallen below the Resource Backtesting coverage target.)
\20\ OCC represented that the Resource Backtesting Margin Charge
is modeled on the implementation of similar add-ons by other
clearing agencies to collect additional financial resources when a
Clearing Member's margin coverage falls below the agency's coverage
target. See Notice of Filing, 89 FR at 61217, citing Securities
Exchange Act Release No. 79167 (Oct. 26, 2016), 81 FR 75883, 75884
(Nov. 1, 2016) (SR-FICC-2016-006; SR-NSCC-2016-004).
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To implement the Resource Backtesting Margin Charge, OCC proposes
to add subsection (h) to its Rule 601 and amend its Margin Policy.\21\
Under the Proposed Rule Change, Rule 601(h)(1) would provide that OCC
may require a Clearing Member to deposit additional margin assets to
mitigate OCC's exposures that may not otherwise be covered by
calculated margin requirements in accordance with Rule 601 and OCC's
policies and procedures. Additionally, Rule 601(h)(1) would state that
OCC may assess this charge as part of a Clearing Member's daily margin
requirement, as needed, to enable OCC to achieve its Resource
Backtesting coverage rate. As proposed, Rule 601(h)(1) would state that
this add-on may apply to Clearing Members that have a 12-month trailing
Resource Backtesting coverage rate below OCC's 99 percent backtesting
coverage target.
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\21\ Implementation of the proposed charge would also require
revisions to OCC's internal documentation, including the Backtesting
Procedure and associated technical document, which OCC provided as
confidential Exhibits 3B and 3C, respectively, to File No. SR-OCC-
2024-009.
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Rule 601(h)(2) would provide that, generally, the Resource
Backtesting Margin Charge will be equal to the third-largest Resource
Backtesting deficiency during the previous 12 months, rounded up to the
nearest $1,000. Rule 601(h)(2) also would grant OCC the discretion to
adjust the Resource Backtesting Margin Charge if it determines that
circumstances particular to a Clearing Member's clearance and
settlement activity and/or market volatility warrant a different
approach to determining or applying such charge in a manner consistent
with achieving OCC's Resource Backtesting coverage target.
Under proposed Rule 601(h)(3), in calculating a Clearing Member's
Resource Backtesting coverage for purposes of the Resource Backtesting
Margin Charge and in calculating the third-largest Resource Backtesting
deficiency, OCC will not include amounts already collected as a
Resource Backtesting Margin Charge from that Clearing Member.
Lastly, under the proposal, Rule 601(h)(4) would provide that for
the purposes of this rule, ``Resource Backtesting'' means backtesting
pursuant to OCC's policies and procedures that is designed to evaluate,
with a high degree of confidence, whether OCC maintains sufficient
financial resources to cover its credit exposure to the liquidation
portfolio of each Clearing Member from the last margin collection until
the end of the liquidation horizon following the Clearing Member's
default.
In addition to new Rule 601(h), OCC proposes amendments to its
Margin Policy governing how the Resource Backtesting Margin Charge
would be applied, calculated and, in certain circumstances, adjusted.
OCC states that the Resource Backtesting Margin Charge would apply to
any Clearing Member whose 12-month trailing Resource Backtesting falls
below the 99 percent coverage target, using three or more confirmed
Resource Backtesting deficiencies over the previous 12 months.\22\ At
least once per month, and more often in circumstances described below,
OCC would review and determine which Clearing Member may be subject to
the Resource Backtesting Margin Charge, or which Clearing Member's
existing Resource Backtesting Margin Charge is subject to change, based
on the trailing 12-month Resource Backtesting coverage rate. The
Resource Backtesting Margin Charge would be applied daily to the
accounts of Clearing Members that contributed to the deficiencies. If
in the subsequent month an affected Clearing Member's trailing 12-month
coverage rises above 99 percent, the Resource Backtesting Margin Charge
would be removed.
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\22\ See Notice of Filing, 89 FR at 61217-18.
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The Resource Backtesting Margin Charge would be calculated as the
equivalent of a member's third largest Resource Backtesting deficiency
in the rolling 12-month lookback period rounded up to the nearest
$1,000, subject to adjustment described below. The Resource Backtesting
Margin Charge generally would be allocated proportionally to the
Clearing Member's accounts contributing to the third-largest Resource
Backtesting deficiency, with the goal of restoring the Clearing
Member's margin coverage to the 99 percent target. If applying and
allocating the Margin Resource Backtesting Margin Charge would not
bring the Clearing Member above this coverage target based on the third
largest deficiency,\23\ the proposed rules would allow OCC to increase
the add-on for a particular account in an amount necessary to meet the
coverage target. For purposes of application, calculation, or
adjustment, OCC would not take into account any Resource Backtesting
Margin Charge(s) already in effect, but would take into account the
number and size of deficiencies subsequent to the Resource Backtesting
Margin Charge(s) already applied.\24\
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\23\ This may occur when the account driving the third largest
deficiency, such as a customer account, is experiencing losses that
cannot be offset by funds is a different type of account, such as a
firm account. See Notice of Filing, 89 FR at 61218, n. 55 and
accompanying text.
\24\ See Notice of Filing, 89 FR at 61217. Additionally, OCC
would test the sufficiency of the Resource Backtesting Margin Charge
against a Resource Backtesting variant that includes that charge as
a financial resource for purposes of: (i) confirming that the
charge, as allocated proportionally to the accounts contributing to
the third-largest Resource Backtesting deficiency, would be
sufficient to achieve the 99 percent coverage target, and (ii)
increasing the Resource Backtesting Margin Charge for a particular
account that may be contributing a proportionally greater amount to
other Resource Backtesting deficiencies if the coverage target is
not met. Id., at 61218-19.
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OCC proposes to amend the Margin Policy further to outline the
governance around the calculation of and adjustment to the Resource
Backtesting Margin Charge, as defined in proposed Rule 601(h)(2). As
proposed, the Margin Policy would require FRM to review the Resource
Backtesting results at least monthly \25\ to determine whether a
Clearing Member should be assessed a Resource Backtesting Margin Charge
and, if so, the amount of the add-on. Imposing a Resource Backtesting
Margin Charge on a Clearing Member would require an FRM Officer's
approval, which the FRM Officer would grant unless an adjustment to the
charge is necessary. Any adjustment to increase the charge would
require approval by an FRM Officer, while any adjustment to reduce the
charge would require escalation to and approval by the MRWG.\26\ Under
the Proposed Rule Change, the MRWG may authorize such adjustment under
certain circumstances, including, but not limited to, differences in
magnitude of the deficiencies observed over the last 12-month period,
variability in the Clearing Member's
[[Page 76175]]
activity since the observed deficiencies, cyclicality of observed
deficiencies, and/or market volatility. Under the Proposed Rule Change,
if OCC implements changes to its margin methodology that affect
Clearing Members' margin requirements, FRM would reevaluate Resource
Backtesting coverage within the 12-month lookback period based on the
margin resources OCC would have collected under the revised methodology
to determine whether a Resource Backtesting Margin Charge for a
particular Clearing Member is required and, if so, in what amount.\27\
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\25\ This review and determination would be conducted at least
monthly but could be done on an intramonth basis based on the daily
backtesting results reviewed by FRM.
\26\ Such adjustments are distinct from the routine process of
setting the charge on a monthly basis.
\27\ OCC stated that such a reevaluation is designed to avoid
double-margining Clearing Members if and/or when OCC would begin to
collect additional margin resources after a margin methodology
change. See Notice of Filing, 89 FR at 61219.
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III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Exchange Act directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to such organization.\28\ Under the Commission's
Rules of Practice, the ``burden to demonstrate that a proposed rule
change is consistent with the Exchange Act and the rules and
regulations issued thereunder . . . is on the self-regulatory
organization [`SRO'] that proposed the rule change.'' \29\
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\28\ 15 U.S.C. 78s(b)(2)(C).
\29\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
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The description of a proposed rule change, its purpose and
operation, its effect, and a legal analysis of its consistency with
applicable requirements must all be sufficiently detailed and specific
to support an affirmative Commission finding,\30\ and any failure of an
SRO to provide this information may result in the Commission not having
a sufficient basis to make an affirmative finding that a proposed rule
change is consistent with the Exchange Act and the applicable rules and
regulations.\31\ Moreover, ``unquestioning reliance'' on an SRO's
representations in a proposed rule change is not sufficient to justify
Commission approval of a proposed rule change.\32\
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\30\ Id.
\31\ Id.
\32\ Susquehanna Int'l Group, LLP v. Securities and Exchange
Commission, 866 F.3d 442, 447 (D.C. Cir. 2017) (``Susquehanna'').
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After carefully considering the Proposed Rule Change, the
Commission finds that the proposal is consistent with the requirements
of the Exchange Act and the rules and regulations thereunder applicable
to OCC. More specifically, the Commission finds that the proposal is
consistent with Section 17A(b)(3)(F) of the Exchange Act,\33\ and Rules
17Ad-22(e)(6),\34\ 17Ad-22(e)(4),\35\ and 17Ad-22(e)(2) \36\
thereunder, as described below.
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\33\ 15 U.S.C. 78q-1(b)(3)(F).
\34\ 17 CFR 240.17Ad-22(e)(6).
\35\ 17 CFR 240.17Ad-22(e)(4).
\36\ 17 CFR 240.17Ad-22(e)(2).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act
Section 17A(b)(3)(F) of the Exchange Act requires, among other
things, that a clearing agency's rules are designed to assure the
safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible.\37\
Based on its review of the record, and for the reasons described below,
the changes described above are consistent with assuring the
safeguarding of securities and funds which are in OCC's custody or
control or for which it is responsible.
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\37\ 15 U.S.C. 78q-1(b)(3)(F).
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As discussed above, OCC's backtesting framework is used, in part,
to monitor whether STANS-calculated margin requirements are adequate,
as well as to evaluate the adequacy of credit risk assessment
procedures. As described above, OCC proposes to improve its current
backtesting by, among other things, clearly defining terms and
parameters. However, the current backtesting focuses on the
identification of technical or model-related issues, rather than on the
sufficiency of OCC's resources to cover its credit exposure during a
Clearing Member's default.
To address the gap in its current backtesting, OCC proposes to
implement a new category of backtesting, Resource Backtesting, that
would measure whether OCC maintains sufficient financial resources to
cover its credit exposure to the liquidation portfolio of each Clearing
Member from the last deposit of margin assets until the end of the
liquidation horizon following the Clearing Member's default. Based on
the information OCC provided to the Commission,\38\ the proposed
Resource Backtesting would reveal that OCC does not always meet its
coverage target at the member level.
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\38\ OCC provided impact data as confidential Exhibit 3A to File
No. SR-OCC-2024-009.
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To address the gap in coverage, which suggests OCC may not be
holding sufficient margin collateral, OCC also proposes to implement a
new margin add-on, the Resource Backtesting Margin Charge, that is
designed to increase the likelihood that OCC collects margin sufficient
to cover its potential future exposure to each participant in the
interval between the last margin collection and the close-out of
positions following a participant default. Working in tandem, the
proposed backtesting category and add-on would support OCC's efforts to
collect sufficient margin resources to maintain a 99 percent coverage.
Improving OCC's current backtesting processes as well as adoption
of the proposed Resource Backtesting and Resource Backtesting Margin
Charge add-on would increase the likelihood that OCC collects
sufficient margin collateral to mitigate OCC's credit exposure to a
Clearing Member default. Increasing the likelihood that OCC collects
sufficient margin collateral to address a member default would, in
turn, assure the safeguarding of non-defaulting Clearing Members'
collateral by reducing the likelihood that OCC would be forced to
charge losses to the Clearing Fund.
Accordingly, the changes proposed to the backtesting framework are
consistent with the requirements of Section 17A(b)(3)(F) of the
Exchange Act.\39\
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\39\ Id.
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B. Consistency With Rule 17Ad-22(e)(6)(vi)(A) Under the Exchange Act
Rule 17Ad-22(e)(6)(vi)(A) under the Exchange Act requires that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to cover, if the
covered clearing agency provides central counterparty services, its
credit exposures to its participants by establishing a risk-based
margin system that, at a minimum is monitored by management on an
ongoing basis and regularly reviewed, tested, and verified by
conducting backtests of its margin model at least once each day using
standard predetermined parameters and assumptions.\40\ In adopting Rule
17Ad-22(e)(6), the Commission provided guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures for margin, including whether the covered
clearing agency analyzes and monitors its model performance and overall
margin coverage by conducting rigorous daily backtesting and at least
monthly, and more frequent when appropriate, sensitivity analysis; as
well as whether, in conducting sensitivity analysis of the model's
coverage, the covered clearing agency has taken into account a wide
[[Page 76176]]
range of parameters and assumptions that reflect possible market
conditions.\41\
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\40\ 17 CFR 240.17Ad-22(e)(6)(vi)(A).
\41\ Securities Exchange Act Release No. 78961 (Sept. 28, 2016),
81 FR 70786, 70819 (Oct. 13, 2016) (File No. S7-03-14) (``Standards
for Covered Clearing Agencies'').
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As described above, OCC's Proposed Rule Change is designed to
improve the level of detail about the material aspects of OCC's
backtesting framework included in the overall framework, including how
OCC establishes and modifies its assumptions for backtesting. OCC's
proposal also is designed to establish a process for assessing the
adequacy of OCC's margin resources to cover its credit exposure at the
Clearing Member level, and would detail the assumptions underlying
OCC's margin backtesting framework and the process for reviewing and
modifying those assumptions.
As described above, OCC proposes to codify in the framework its
current backtesting procedures, including incorporating definitions,
detailing coverage level measurements of actual and hypothetical
portfolios, and establishing which types of collateral would be
reviewed. Further, OCC's proposal would consolidate its current
backtests under one heading (Model Backtesting) that would be governed
by a single set of rules and internal procedures. The proposed
revisions would improve clarity and consistency across OCC's current
backtesting framework. Likewise, OCC proposes adding to the framework a
new category of backtesting, Resource Backtesting, as well as related
definitions and descriptions of material aspects of how this new
resource sufficiency measurement would apply at a Clearing Member
level. The proposed rules would also address how OCC would consider
different types of accounts and liens when netting, and would provide
OCC with more accurate insights into the collected margin levels of its
Clearing Members, that could, in turn, affect OCC's credit exposures.
OCC's proposal to specifically list the assumptions on which Model
Backtesting and Resource Backtesting would rest, and how these
assumptions would be reviewed and, if necessary, escalated according to
set criteria, would standardize these assumptions and parameters,
incorporates the Commission's guidance provided in the adopting
release,\42\ and provide OCC's management with clear guidelines to
continue its monitoring on an ongoing basis.
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\42\ Id.
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Accordingly, the proposed changes to OCC's backtesting framework
are consistent with the requirements of Rule 17Ad-22(e)(6)(vi)(A) under
the Exchange Act.\43\
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\43\ 17 CFR 240.17Ad-22(e)(6)(vi)(A).
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C. Consistency With Rule 17Ad-22(e)(4)(i) Under the Exchange Act
Rule 17Ad-22(e)(4)(i) under the Exchange Act requires that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to effectively
identify, measure, monitor, and manage its credit exposures to
participants and those arising from its payment, clearing, and
settlement processes, including by maintaining sufficient financial
resources to cover its credit exposure to each participant fully with a
high degree of confidence.\44\ In adopting Rule 17Ad-22(e)(4), the
Commission provided guidance that a covered clearing agency generally
should consider in establishing and maintaining policies and procedures
that address credit risk, including whether, if providing central
counterparty services, the covered clearing agency has covered its
current and potential future exposures to each participant fully with a
high degree of confidence using margin and other prefunded financial
resources.\45\
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\44\ 17 CFR 240.17Ad-22(e)(4)(i).
\45\ See Standards for Covered Clearing Agencies, 81 FR at
70814-15.
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As described above, OCC proposes to adopt the Resource Backtesting
Margin Charge to address coverage gaps identified by the proposed
Resource Backtesting. The proposed Resource Backtesting Margin Charge
would be applied daily based on an at-least monthly assessment of a
Clearing Member's 12-month trailing deficiencies to the extent they
fall below OCC's 99 percent coverage rate. Collecting additional margin
based on such deficiencies would reduce the likelihood of future margin
deficiencies for each member. This, in turn, would increase the
likelihood that OCC would maintain sufficient financial resources to
cover its credit exposure to each participant fully with a high degree
of confidence.
Accordingly, the proposed adoption of the Resource Backtesting
Margin Charge is consistent with the requirements of Rule 17Ad-
22(e)(4)(i) under the Exchange Act.\46\
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\46\ Id.
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D. Consistency With Rule 17Ad-22(e)(2)(v) Under the Exchange Act
Rule 17Ad-22(e)(2)(v) under the Exchange Act requires that a
covered clearing agency establish, implement, maintain, and enforce
written policies and procedures reasonably designed to provide for
governance arrangements that specify clear and direct lines of
responsibility.\47\
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\47\ 17 CFR 240.17Ad-22(e)(2)(v).
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OCC's backtesting framework documentation lacks explicit guidance
around the reporting process as well as escalation criteria and
thresholds, which could lead to inconsistencies in the escalation of
similar backtesting exceedances or deficiencies, and inconsistencies in
reviews of backtesting assumptions. The Proposed Rule Change would list
the escalation criteria considered during reviews of backtesting
results and assumptions and would clearly specify which business units,
working groups, and committees would be involved in such reviews, as
well as each group's respective authorities and obligations. The
Proposed Rule Change also would describe OCC's reporting process and
timelines for review of backtesting results, assumptions, and
parameters. Adding such detail to OCC's rules would more clearly
specify the lines of responsibly governing OCC's backtesting framework.
Accordingly, the proposed changes to further detail OCC's processes
for governing its backtesting framework are consistent with the
requirements of Rule 17Ad-22(e)(2)(v) under the Exchange Act.\48\
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\48\ Id.
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
Proposed Rule Change is consistent with the requirements of the
Exchange Act, and in particular, the requirements of Section 17A of the
Exchange Act \49\ and the rules and regulations thereunder.
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\49\ In approving this Proposed Rule Change, the Commission has
considered the proposed rules' impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\50\ that the proposed rule change (SR-OCC-2024-009),
hereby is, approved.
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\50\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\51\
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\51\ 17 CFR 200.30-3(a)(12).
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Vanessa A. Countryman,
Secretary.
[FR Doc. 2024-21035 Filed 9-16-24; 8:45 am]
BILLING CODE 8011-01-P
</pre></body>
</html>Indexed from Federal Register on September 17, 2024.
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