82_FR_61601 82 FR 61354 - Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning Proposed Changes to The Options Clearing Corporation's Margin Methodology

82 FR 61354 - Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Advance Notice Concerning Proposed Changes to The Options Clearing Corporation's Margin Methodology

SECURITIES AND EXCHANGE COMMISSION

Federal Register Volume 82, Issue 247 (December 27, 2017)

Page Range61354-61360
FR Document2017-27832

Federal Register, Volume 82 Issue 247 (Wednesday, December 27, 2017)
[Federal Register Volume 82, Number 247 (Wednesday, December 27, 2017)]
[Notices]
[Pages 61354-61360]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2017-27832]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-82371; File No. SR-OCC-2017-811]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Advance Notice Concerning Proposed Changes to The 
Options Clearing Corporation's Margin Methodology

December 20, 2017.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, entitled Payment, Clearing 
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'') 
\1\ and Rule 19b-4(n)(1)(i) under the Securities Exchange Act of 1934 
(``Act''),\2\ notice is hereby given that on November 13, 2017, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') an advance notice as described in 
Items I and II below, which Items have been prepared by OCC. The 
Commission is publishing this notice to solicit comments on the advance 
notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This advance notice is filed in connection with proposed changes to 
OCC's margin methodology to move away from the existing monthly data 
source provided by its current vendor and towards obtaining and 
incorporating daily price and returns (adjusted for any corporate 
actions) data of securities to estimate accurate margins.\3\ This would 
be further supported by enhancing OCC's econometric model applied to 
different risk factors; \4\ improving the sensitivity and stability of 
correlation estimates between them; and enhancing OCC's methodology 
around the treatment of securities with limited historical data. OCC 
also proposes to make a few clarifying and clean-up changes to its 
margin methodology unrelated to the proposed changes described above.
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    \3\ OCC also has filed a proposed rule change with the 
Commission in connection with the proposed changes. See SR-OCC-2017-
022.
    \4\ The use of risk factors in OCC's margin methodology is 
discussed in more detail in the Description of the Proposed Change 
section below.
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    The proposed changes to OCC's Margins Methodology document are 
contained in confidential Exhibit 5 of the filing. The proposed changes 
are described in detail in Item III below. The proposed changes do not 
require any changes to the text of OCC's By-Laws or Rules. All terms 
with initial capitalization that are not otherwise defined herein have 
the same meaning as set forth in the OCC By-Laws and Rules.\5\
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    \5\ OCC's By-Laws and Rules can be found on OCC's public 
website: http://optionsclearing.com/about/publications/bylaws.jsp.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the advance notice and 
discussed any comments it received on the advance notice. The text of 
these statements may be examined at the places specified in Item IV 
below. OCC has prepared summaries, set forth in sections A and B below, 
of the most significant aspects of these statements.

[[Page 61355]]

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants or Others

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change and none have been received. OCC 
will notify the Commission of any written comments received by OCC.

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, 
Clearing, and Settlement Supervision Act

Description of the Proposed Change
Background
    OCC's margin methodology, the System for Theoretical Analysis and 
Numerical Simulations (``STANS''), is OCC's proprietary risk management 
system that calculates Clearing Member margin requirements.\6\ STANS 
utilizes large-scale Monte Carlo simulations to forecast price and 
volatility movements in determining a Clearing Member's margin 
requirement.\7\ The STANS margin requirement is calculated at the 
portfolio level of Clearing Member accounts with positions in 
marginable securities and consists of an estimate of a 99% expected 
shortfall \8\ over a two-day time horizon and an add-on margin charge 
for model risk (the concentration/dependence stress test charge).\9\ 
The STANS methodology is used to measure the exposure of portfolios of 
options and futures cleared by OCC and cash instruments in margin 
collateral.
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    \6\ See Securities Exchange Act Release No. 53322 (February 15, 
2006), 71 FR 9403 (February 23, 2006) (SR-OCC-2004-20).
    \7\ See OCC Rule 601.
    \8\ The expected shortfall component is established as the 
estimated average of potential losses higher than the 99% value at 
risk threshold. The term ``value at risk'' or ``VaR'' refers to a 
statistical technique that, generally speaking, is used in risk 
management to measure the potential risk of loss for a given set of 
assets over a particular time horizon.
    \9\ A detailed description of the STANS methodology is available 
at http://optionsclearing.com/risk-management/margins/.
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    A ``risk factor'' within OCC's margin system may be defined as a 
product or attribute whose historical data is used to estimate and 
simulate the risk for an associated product. The majority of risk 
factors utilized in the STANS methodology are total returns on 
individual equity securities. Other risk factors considered include: 
Returns on equity indexes; returns on implied volatility \10\ risk 
factors that are a set of nine chosen volatility pivots per product; 
\11\ changes in foreign exchange rates; and changes in model parameters 
that sufficiently capture the model dynamics from a larger set of data.
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    \10\ Generally speaking, the implied volatility of an option is 
a measure of the expected future volatility of the value of the 
option's annualized standard deviation of the price of the 
underlying security, index, or future at exercise, which is 
reflected in the current option premium in the market. Using the 
Black-Scholes options pricing model, the implied volatility is the 
standard deviation of the underlying asset price necessary to arrive 
at the market price of an option of a given strike, time to 
maturity, underlying asset price and given the current risk-free 
rate. In effect, the implied volatility is responsible for that 
portion of the premium that cannot be explained by the then-current 
intrinsic value (i.e., the difference between the price of the 
underlying and the exercise price of the option) of the option, 
discounted to reflect its time value.
    \11\ In December 2015, the Commission approved a proposed rule 
change and issued a Notice of No Objection to an advance notice 
filing by OCC to its modify margin methodology by more broadly 
incorporating variations in implied volatility within STANS. See 
Securities Exchange Act Release No. 34-76781 (December 28, 2015), 81 
FR 135 (January 4, 2016) (SR-OCC-2015-016) and Securities Exchange 
Act Release No. 34-76548 (December 3, 2015), 80 FR 76602 (December 
9, 2015) (SR-OCC-2015-804).
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    Under OCC's current margin methodology, OCC obtains monthly price 
data for most of its equity-based products \12\ from a widely used 
industry vendor. This data arrives around the second week of every 
month in arrears and requires a maximum of about four weeks for OCC to 
process the data after any clean up and reruns as may be required prior 
to installing into OCC's margin system. As a result, correlations and 
statistical parameters for risk factors at any point in time represent 
back-dated data and therefore may not be representative of the most 
recent market data. In the absence of daily updates, OCC employs an 
approach where one or many identified market proxies (or ``scale-
factors'') are used to incorporate day-to-day market volatility across 
all associated asset classes throughout.\13\ The scale factor approach, 
however, assumes a perfect correlation of the volatilities between the 
security and its scale factor, which gives little room to capture the 
idiosyncratic risk of a given security and which may be different from 
the broad market risk represented by the scale factor.
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    \12\ The securities underlying these products are also known as 
risk factors within OCC's margin system.
    \13\ Earlier this year, the Commission approved a proposed rule 
change, and issued a Notice of No Objection to an advance notice 
filing, by OCC which, among other things: (1) Expanded the number of 
scale factors used for equity-based products to more accurately 
measure the relationship between current and long-run market 
volatility with proxies that correlate more closely to certain 
products carried within the equity asset class, and (2) applied 
relevant scale factors to the greater of (i) the estimated variance 
of 1-day return scenarios or (ii) the historical variance of the 
daily return scenarios of a particular instrument, as a floor to 
mitigate procyclicality. See Securities Exchange Act Release No. 
80147 (March 3, 2017), 82 FR 13163 (March 9, 2017) (SR-OCC-2017-001) 
and Securities Exchange Act Release No. 80143 (March 2, 2017), 82 FR 
13036 (March 8, 2017) (SR-OCC-2017-801).
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    In risk management, it is a common practice to establish a floor 
for volatility at a certain level in order to protect against 
procyclicality \14\ in the model. OCC imposes a floor on volatility 
estimates for its equity-based products using a 500-day look back 
period. These monthly updates coupled with the dependency of margins on 
scale factors and the volatility floor can result in imprecise changes 
in margins charged to Clearing Members, specifically across periods of 
heavy volatility when the correlation between the risk factor and a 
scale factor fluctuate.
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    \14\ A quality that is positively correlated with the overall 
state of the market is deemed to be ``procyclical.'' For example, 
procyclicality may be evidenced by increasing margin or Clearing 
Fund requirements in times of stressed market conditions and low 
margin or Clearing Fund requirements when markets are calm. Hence, 
anti-procyclical features in a model are measures intended to 
prevent risk-based models from fluctuating too drastically in 
response to changing market conditions.
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    OCC's current methodology for estimating covariance and 
correlations between risk factors relies on the same monthly data 
described above, resulting in a similar lag time between updates. In 
addition, correlation estimates are based off historical returns 
series, with estimates between a pair of risk factors being highly 
sensitive to the volatility of either risk factor in the chosen pair. 
The current approach therefore results in potentially less stable 
correlation estimates that may not be representative of current market 
conditions.
    Finally, under OCC's existing margin methodology, theoretical price 
scenarios for ``defaulting securities'' \15\ are simulated using 
uncorrelated return scenarios with an average zero return and a pre-
specified volatility called ``default variance.'' The default variance 
is estimated as the average of the top 25 percent quantile of the 
conditional variances of all securities. As a result, these default 
estimates may be impacted by extremely illiquid securities with 
discontinuous data. In addition, the default variance (and the 
associated scale factors used to scale up volatility) is also subject 
to sudden jumps with the monthly simulation installations across 
successive months because it is derived from monthly data updates, as 
opposed to daily updates, which are prone to wider fluctuations and are 
subject to adjustments using scale factors.
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    \15\ Within the context of OCC's margin system, securities that 
do not have enough historical data for calibration are classified as 
``defaulting securities.''

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[[Page 61356]]

Proposed Changes
    OCC proposes to modify its margin methodology by: (1) Obtaining 
daily price data for equity products (including daily corporate action-
adjusted returns of equities where price and thus returns of securities 
are adjusted for any dividends issued, stock splits, etc.) for use in 
the daily estimation of econometric model parameters; (2) enhancing its 
econometric model for updating statistical parameters (e.g., parameters 
concerning correlations or volatility) for all risk factors that 
reflect the most recent data obtained; (3) improving the sensitivity 
and stability of correlation estimates across risk factors by using de-
volatized \16\ returns (but using a 500 day look back period); and (4) 
improving OCC's methodology related to the treatment of defaulting 
securities that would result in stable and realistic risk estimates for 
such securities.\17\
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    \16\ De-volatization is a process of normalizing historical data 
with the associated volatility thus enabling any comparison between 
different sets of data.
    \17\ In addition to the proposed methodology changes described 
herein, OCC also would make some clarifying and clean-up changes, 
unrelated to the proposed changes described above, to update its 
margin methodology to reflect existing practices for the daily 
calibration of seasonal and non-seasonal energy models and the 
removal of methodology language for certain products that are no 
longer cleared by OCC.
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    The purpose of the proposed changes is to enhance OCC's margin 
methodology to mitigate the issues described above that arise from the 
current monthly update and scale factor approach. Specifically, by 
introducing daily (as opposed to monthly) updates for price data (and 
thereby allowing for daily updates of statistical parameters in the 
model) and making other proposed model enhancements described herein, 
the proposed changes are designed to result in more accurate and 
responsive margin requirements and a model that is more stable and 
proactive during times of market volatility, with margins that are 
based off of the most recent market data. In addition, the proposed 
changes are intended to improve OCC's approach to estimating covariance 
and correlations between risk factors in an effort to achieve more 
stable and sensitive correlation estimations and improve OCC's 
methodology related to the treatment of defaulting securities by 
reducing the impact that illiquid securities with discontinuous data 
have on default variance estimates.
    The proposed changes are described in further detail below.
1. Daily Updates of Price Data
    OCC proposes to introduce daily updates for price data for equity 
products, including daily corporate action-adjusted returns of 
equities, Exchange Traded Funds (``ETFs''), Exchange Traded Notes 
(``ETNs'') and certain indexes. The daily price data would be obtained 
from a widely used external vendor, as is the case with the current 
monthly updates. The purpose of the proposed change is to ensure that 
OCC's margin methodology is reliant on data that is more representative 
of current market conditions, thereby resulting in more accurate and 
responsive margin requirements.
    As described above, OCC currently obtains price data for all 
securities on a monthly basis from a third party vendor. After 
obtaining the monthly price data, additional time is required for OCC 
to process the data prior to installing into OCC's margin system. As a 
result, correlations and statistical parameters for risk factors at any 
point in time represent back-dated data and therefore may not be 
representative of the most recent market data. To mitigate pro-
cyclicality within its margin methodology in the absence of daily 
updates, OCC employs the use of scale-factors to incorporate day-to-day 
market volatility across all associated asset classes. While the scale 
factors help to reduce procyclicality in the model, the scale factors 
do not necessarily capture the idiosyncratic risks of a given security, 
which may be different from the broad market risk represented by the 
scale factor.
    OCC proposes to address these issues associated with its current 
margin methodology by eliminating its dependency on monthly price data, 
which arrives in arrears and requires additional time for OCC to 
process prior to installing into OCC's margin system, through the 
introduction of daily updates for price data for equity products. The 
introduction of daily price updates would enable OCC's margin 
methodology to better capture both market as well idiosyncratic risk by 
allowing for daily updates to the parameters associated with of the 
econometric model (discussed below) that capture the risk associated 
with a particular product, and therefore ensure that OCC's margin 
requirements are based on more current market conditions. As a result, 
OCC would also reduce its reliance on the use of scale factors to 
incorporate day-to-day market volatility, which, as noted above, give 
little room to capture the idiosyncratic risk of a given security and 
which may be different from the broad market risk represented by the 
scale factor. In addition, the processing time between receipt of the 
data and installation into the margin system would be reduced as the 
data review and processing for daily prices would be incorporated into 
OCC's daily price editing process.
2. Proposed Enhancements to the Econometric Model
    In addition to introducing daily updates for price and corporate 
action-adjusted returns data, OCC is proposing enhancements to its 
econometric model for calculating statistical parameters for all 
qualifying risk factors that reflect the most recent data obtained 
(e.g., OCC would be able to calculate parameters such as volatility and 
correlations on a daily basis using the new daily price data discussed 
above). Specifically, OCC proposes to enhance its econometric model by: 
(i) Introducing daily updates for statistical parameters; (ii) 
introducing features in its econometric model that are designed to take 
into account asymmetry in the model used to forecast volatility 
associated with a risk factor; (iii) modifying the statistical 
distribution used to model the returns of equity prices; (iv) 
introducing a second-day forecast for volatility into the model to 
estimate the two-day scenario distributions for risk factors; and (v) 
imposing a floor on volatility estimates using a 10-year look back 
period.
    These proposed model enhancements are described in detail below.
i. Daily Updates for Statistical Parameters
    Under the proposal, the statistical parameters for the model would 
be updated on a daily basis using the new daily price data obtained by 
OCC (as described in section 1 above).\18\ As a result, OCC would no 
longer need to rely on scale factors to approximate day-to-day market 
volatility for equity-based products. Statistical parameters would be 
calibrated on daily basis, allowing OCC to calculate more accurate 
margin requirements that are representative of the most recent market 
data.
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    \18\ OCC notes that this change would apply to most risk factors 
with the exception of certain equity indexes, Treasury securities, 
and energy futures products, which are already updated on a daily 
basis.
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ii. Proposed Enhancements To Capture Asymmetry in Conditional Variance
    In addition to the daily update of statistical parameters, OCC 
proposes to include new features in its econometric model that are 
designed to take into account asymmetry in the conditional variance 
process. The econometric model currently used in STANS for all

[[Page 61357]]

risk factors is a GARCH(1,1) with Student's t-distributed innovations 
of logarithmic returns \19\, which is a relatively straightforward and 
widely used model to forecast volatility.\20\ The current approach for 
forecasting the conditional variance for a given risk factor does not, 
however, consider the asymmetric volatility phenomenon observed in 
financial markets (also called the ``leverage effect'') where 
volatility is more sensitive and reactive to market downturns. As a 
result, OCC proposes to enhance its model by adding new features (i.e., 
incorporating asymmetry into its forecast volatility) designed to allow 
the conditional volatility forecast to be more sensitive to market 
downturns and thereby capture the most significant dynamics of the 
relationship between price and volatility observed in financial 
markets. OCC believes the proposed enhancement would result in more 
accurate and responsive margin requirements, particularly in market 
downturns.
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    \19\ The Student's t-distribution is a widely used statistical 
distribution to model the historical logarithmic price returns data 
of a security that allows for the presence of fat tails (aka 
kurtosis) or a non-zero conditional fourth moment.
    \20\ See generally Tim Bollerslev, ``Generalized Autoregressive 
Conditional Heteroskedasticity,'' Journal of Econometrics, 31(3), 
307-327 (1986). The acronym ``GARCH'' refers to an econometric model 
that can be used to estimate volatility based on historical data. 
The general distinction between the ``GARCH variance'' and the 
``sample variance'' for a given time series is that the GARCH 
variance uses the underlying time series data to forecast 
volatility.
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iii. Proposed Change in Statistical Distribution
    OCC further proposes to change the statistical distribution used to 
model the returns of equity prices. OCC's current methodology uses a 
fat tailed distribution \21\ (the Student's t-distribution) to model 
returns; however, price scenarios generated using very large log-return 
scenarios (positive) that follow this distribution can approach 
infinity and could potentially result in excessively large price jumps, 
a known limitation of this distribution. OCC proposes to move to a more 
defined distribution (Standardized Normal Reciprocal Inverse Gaussian 
or NRIG) for modeling returns, which OCC believes would more 
appropriately simulate future returns based on the historical price 
data for the products in question (i.e., it has a better ``goodness of 
fit'' \22\ to the historical data) and allows for more appropriate 
modeling of fat tails. As a result, OCC believes that the proposed 
change would lead to more consistent treatment of log returns both on 
the upside as well as downside of the distribution.
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    \21\ A data set with a ``fat tail'' is one in which extreme 
price returns have a higher probability of occurrence than would be 
the case in a normal distribution.
    \22\ The goodness of fit of a statistical model describes the 
extent to which observed data match the values generated by the 
model.
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iv. Second-Day Volatility Forecast
    OCC also proposes to introduce a second-day forecast for volatility 
into the model to estimate the two-day scenario distributions for risk 
factors.\23\ Under the current methodology, OCC typically uses a two-
day horizon to determine its risk exposure to a given portfolio. This 
is done by simulating 10,000 theoretical price scenarios for the two-
day horizon using a one-day forecast conditional variance, and the 
value at risk and expected shortfall components of the margin 
requirement are then determined from the simulated profit/loss 
distributions. These one-day and two-day returns scenarios are both 
simulated using the one-day forecast conditional variance estimate. 
This could lead to a risk factor's coverage differing substantially on 
volatile trading days. As a result, OCC proposes to introduce a second-
day forecast variance for all equity-based risk factors. The second-day 
conditional variance forecast would be estimated for each of the 10,000 
Monte Carlo returns scenarios, resulting in more accurately estimated 
two-day scenario distributions, and therefore more accurate and 
responsive margin requirements.
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    \23\ This proposed change would not apply to STANS implied 
volatility scenario risk factors. For those risk factors, OCC's 
existing methodology would continue to apply. See supra note 11.
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v. Anti-Procyclical Floor for Volatility Estimates
    Additionally, OCC proposes to modify its floor for volatility 
estimates. OCC currently imposes a floor on volatility estimates for 
its equity-based products using a 500-day look back period. OCC 
proposes to extend this look back period to 10-years (2520 days) in the 
enhanced model and to apply this floor to volatility estimates for 
other products (excluding implied volatility risk factor scenarios). 
The proposed model described herein is calibrated from historical data, 
and as a result, the level of the volatilities generated by the model 
will vary from time to time. OCC is therefore proposing to establish a 
volatility floor for the model using a 10-year look back period to 
reduce the risk of procyclicality in its margin model. OCC believes 
that using a longer 10-year look back period will ensure that OCC 
captures sufficient historical events/market shocks in the calculation 
of its anti-procyclical floor. The 10-year look back period also is in 
line with requirements of the European Market Infrastructure Regulation 
(including regulations thereunder) \24\ concerning the calibration of 
risk factors.
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    \24\ Regulation (EU) No 648/2012 of the European Parliament and 
of the Council of 4 July 2012 on OTC derivatives, central 
counterparties and trade repositories. Specifically, the proposed 
floor would be compliant with Article 28 of Commission Delegated 
Regulation (EU) No. 153/2013 of 19 December 2012 Supplementing 
Regulation (EU) No. 648/2012 of the European Parliament and of the 
Council with regard to Regulatory Technical Standards on 
Requirements for Central Counterparties (the ``Regulatory Technical 
Standards'').
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3. Proposed Enhancements to Correlation Estimates
    As described above, OCC's current methodology for estimating 
covariance and correlations between risk factors relies on the same 
monthly price data feeding the econometric model, resulting in a 
similar lag time between updates. In addition, correlation estimates 
are based off historical returns series, with estimates between a pair 
of risk factors being highly sensitive to the volatility of either risk 
factors in the chosen pair. The current approach therefore results in 
correlation estimates being sensitive to volatile historical data.
    In order to address these limitations, OCC proposes to enhance its 
methodology for calculating correlation estimates by moving to a daily 
process for updating correlations (with a minimum of one week's lag) to 
ensure Clearing Member account margins are more current and thus more 
accurate. Moreover, OCC proposes to enhance its approach to modeling 
correlation estimates by de-volatizing \25\ the returns series to 
estimate the correlations. Under the proposed approach, OCC would first 
consider the returns excess of the mean (i.e., the average estimated 
from historical data sample) and then further scale them by the 
corresponding estimated conditional variances. OCC believes that by 
using de-volatized returns, which is a widely suggested approach in 
relevant literature, it would lead to normalizing returns across a 
variety of asset classes and make the correlation estimator less 
sensitive to sudden market jumps and therefore more stable.
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    \25\ See supra note 16.
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4. Defaulting Securities Methodology
    Finally, OCC proposes to enhance its methodology for estimating the 
defaulting variance in its model. OCC's margin system is dependent on 
market

[[Page 61358]]

data to determine Clearing Member margin requirements. Securities that 
do not have enough historical data are classified as to be a 
``defaulting security'' within OCC systems (e.g., IPO securities). As 
noted above, within current STANs systems, the theoretical price 
scenarios for defaulting securities are simulated using uncorrelated 
return scenarios with a zero mean and a default variance, with the 
default variance being estimated as the average of the top 25 percent 
quantile of the conditional variances of all securities. As a result, 
these default estimates may be impacted by extremely illiquid 
securities with discontinuous data. In addition, the default variance 
(and the associated scale factors used to scale up volatility) is also 
subject to sudden jumps with the monthly simulation installations 
across volatile months. To mitigate these concerns, OCC proposes to: 
(i) Use only optionable equity securities to estimate the default 
variance; (ii) use a shorter time series to enable calibration of the 
model for all securities; and (iii) simulating default correlations 
with the driver Russell 2000 index (``RUT'').
i. Proposed Modifications to Securities and Quantile Used in Estimation
    OCC proposes that only optionable equity securities, which are 
typically more liquid, be considered while estimating the default 
variance. This limitation would eliminate from the estimation almost 
all illiquid securities with discontinuous data that could contribute 
to high conditional variance estimates and thus a high default 
variance. In addition, OCC proposes to estimate the default variance as 
the lowest estimate of the top 10% of the floored conditional variance 
across the risk factors. This change in methodology is designed to 
ensure that while the estimate is aggressive it is also robust to the 
presence of outliers caused by a few extremely volatile securities that 
influence the location parameter of a distribution. Moreover, as a 
consequence of the daily updates described above, the default variances 
would change daily and there would be no scale factor to amplify the 
effect of the variance on risk factor coverage.
ii. Proposed Change in Time Series
    In addition, OCC proposes to use a shorter time series to enable 
calibration of the model for all securities. Currently, OCC does not 
calibrate parameters for defaulting securities that have historical 
data of less than two years. OCC is proposing to shorten this time 
period to around 6 months (180 days) to enable calibration of the model 
for all securities within OCC systems. OCC believes that this shorter 
time series is sufficient to produce stable calibrated parameters.
iii. Proposed Default Correlation
    Finally, OCC proposes that returns scenarios for defaulting 
securities, securities with insufficient historical data, be simulated 
using a default correlation with the driver RUT.\26\ The RUT Index is a 
small cap index and is hence a natural choice to represent most new 
issues that are small cap and deemed to be a ``defaulting security.'' 
The default correlation is roughly equal to the median of all 
positively correlated securities with the index. Since 90% of the risk 
factors in OCC systems correlate positively to the RUT index, OCC would 
only consider those risk factors to determine the median. OCC believes 
that the median of the correlation distribution has been steady over a 
number of simulations and is therefore proposing that it replace the 
current methodology of simulating uncorrelated scenarios, which OCC 
believes is not a realistic approach.
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    \26\ OCC notes that, in certain limited circumstances where 
there are reasonable grounds backed by the existing return history 
to support an alternative approach in which the returns are strongly 
correlated with those of an existing risk factor (a ``proxy'') with 
a full price history, the Margins Methodology allows OCC's Financial 
Risk Management staff to construct a ``conditional'' simulation to 
override any default treatment that would have otherwise been 
applied to the defaulting security.
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Anticipated Effect on and Management of Risk
    OCC believes that the proposed changes would reduce the nature and 
level of risk presented by OCC because they would result in a margin 
methodology that is more accurate, responsive, stable, and robust, 
thereby reducing risks to OCC, its Clearing Members, and the markets it 
serves.
    As noted above, OCC's current margin methodology relies on monthly 
price data being obtained from a third party vendor. This data arrives 
monthly in arrears and requires additional time for OCC to process the 
data prior to installing into OCC's margin system. As a result, 
correlations and statistical parameters for risk factors at any point 
in time represent back-dated data and therefore may not be 
representative of the most recent market data. To mitigate 
procyclicality within its margin methodology in the absence of daily 
updates, OCC employs a scale factor approach to incorporate day-to-day 
market volatility across all associated asset classes throughout.\27\ 
For the reasons noted above, these monthly updates coupled with the 
dependency of margins on scale factors can result in imprecise changes 
in margins charged to Clearing Members, specifically across periods of 
heavy volatility.
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    \27\ See supra note 13 and accompanying text.
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    OCC proposes to enhance its margin methodology to introduce daily 
updates for equity price data, thereby allowing for daily updates of 
statistical parameters in its margin model for most risk factors. In 
addition, the proposed changes would introduce features to the model to 
better account for the asymmetric volatility phenomenon observed in 
financial markets and allow for conditional volatility forecast to be 
more sensitive to market downturns. The proposed changes would also 
introduce a new statistical distribution for modeling equity price 
returns that OCC believes would have a better goodness of fit and would 
more appropriately account for fat tails. Moreover, the proposed 
changes would introduce a second-day volatility forecast into the model 
to provide for more accurate and timely estimations of its two-day 
scenario distributions. OCC also proposes to enhance its econometric 
model by establishing a volatility floor using a 10-year look back 
period to reduce procyclicality in the margin model. OCC believes the 
proposed changes would result in more accurate and responsive margin 
requirements and a model that is more stable and proactive during times 
of market volatility, with risk charges that are based off of most 
recent market data.
    In addition, the proposed changes are intended to improve OCC's 
approach to estimating covariance and correlations between risk factors 
in an effort to achieve more stable and sensitive correlation 
estimations and improve OCC's methodology related to the treatment of 
defaulting securities by reducing the impact that illiquid securities 
with discontinuous data have on default variance estimates.
    The proposed methodology changes would be used by OCC to calculate 
margin requirements designed to limit its credit exposures to 
participants, and OCC uses the margin it collects from a defaulting 
Clearing Member to protect other Clearing Members from losses that may 
result from such a default. As a result, OCC believes the proposed 
changes would result in the reduction of risk for OCC, its Clearing 
Members, and the markets it serves.
Clearing Member Outreach
    OCC has discussed the proposed changes with its Financial Risk

[[Page 61359]]

Advisory Council \28\ at a meeting held on October 25, 2016. OCC also 
provided general updates to members at OCC Roundtable \29\ meetings on 
June 20, 2017, and November 9, 2017. Clearing Members expressed 
interest in seeing how reactive margin changes would be under the 
proposal; however, there were no objections or significant concerns 
expressed regarding the proposed changes. OCC will provide at least 30-
days of parallel reporting prior to implementation so that Clearing 
Members can see the impact of the proposed changes. In addition, OCC 
would publish an Information Memorandum to all Clearing Members 
describing the proposed change and will provide additional periodic 
Information Memoranda updates prior to the implementation date. 
Additionally, OCC would perform targeted and direct outreach with 
Clearing Members that would be most impacted by the proposed changes to 
the margin methodology and OCC would work closely with such Clearing 
Members to coordinate the implementation and associated funding for 
such Clearing Members resulting from the proposed change.\30\
---------------------------------------------------------------------------

    \28\ The Financial Risk Advisory Council is a working group 
consisting of representatives of Clearing Members and exchanges 
formed by OCC to review and comment on various risk management 
proposals.
    \29\ The OCC Roundtable was established to bring Clearing 
Members, exchanges and OCC together to discuss industry and 
operational issues. It is comprised of representatives of the senior 
OCC staff, participant exchanges and Clearing Members, representing 
the diversity of OCC's membership in industry segments, OCC-cleared 
volume, business type, operational structure and geography.
    \30\ Specifically, OCC will discuss with those Clearing Members 
how they plan to satisfy any increase in their margin requirements 
associated with the proposed change.
---------------------------------------------------------------------------

Consistency With the Payment, Clearing and Settlement Supervision Act
    The stated purpose of the Clearing Supervision Act is to mitigate 
systemic risk in the financial system and promote financial stability 
by, among other things, promoting uniform risk management standards for 
systemically important financial market utilities and strengthening the 
liquidity of systemically important financial market utilities.\31\ 
Section 805(a)(2) of the Clearing Supervision Act \32\ also authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like OCC, for which the Commission is the supervisory agency. Section 
805(b) of the Clearing Supervision Act \33\ states that the objectives 
and principles for risk management standards prescribed under Section 
805(a) shall be to:
---------------------------------------------------------------------------

    \31\ 12 U.S.C. 5461(b).
    \32\ 12 U.S.C. 5464(a)(2).
    \33\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and the Act, which include 
Commission Rules 17Ad-22(b)(1), (b)(2) and (e)(6).\34\
---------------------------------------------------------------------------

    \34\ 17 CFR 240. 17Ad-22. See Securities Exchange Act Release 
Nos. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-
08-11) (``Clearing Agency Standards''); 78961 (September 28, 2016, 
81 FR 70786 (October 13, 2016) (S7-03-14) (``Standards for Covered 
Clearing Agencies''). The Standards for Covered Clearing Agencies 
became effective on December 12, 2016. OCC is a ``covered clearing 
agency'' as defined in Rule 17Ad-22(a)(5) and therefore OCC must 
comply with new section (e) of Rule 17Ad-22.
---------------------------------------------------------------------------

    Rules 17Ad-22(b)(1) and (2) \35\ require that a registered clearing 
agency that performs central counterparty services establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to, in part: (1) Measure its credit exposures to 
its participants at least once a day and limit its exposures to 
potential losses from defaults by its participants under normal market 
conditions so that the operations of the clearing agency would not be 
disrupted and non-defaulting participants would not be exposed to 
losses that they cannot anticipate or control and (2) use margin 
requirements to limit its credit exposures to participants under normal 
market conditions and use risk-based models and parameters to set 
margin requirements.
---------------------------------------------------------------------------

    \35\ 17 CFR 240.17Ad-22(b)(1) and (2).
---------------------------------------------------------------------------

    As noted above, the proposed changes would introduce the use of 
daily price updates into OCC's margin methodology, which allows for 
daily updates to the statistical parameters in the model (e.g., 
parameters concerning volatility and correlation). These changes would 
be supported by a number of other risk-based enhancements to OCC's 
econometric model designed to: (i) More appropriately account for 
asymmetry in conditional variance; (ii) more appropriately model the 
statistical distribution of price returns; (iii) provide for an anti-
procyclical floor for volatility estimates based on a 10-year look back 
period; and (iv) more accurately model second-day volatility forecasts. 
Moreover, the proposed changes would improve OCC's approach to 
estimating covariance and correlations between risk factors in an 
effort to achieve more stable and sensitive correlation estimations and 
improve OCC's methodology related to the treatment of defaulting 
securities by reducing the impact that illiquid securities with 
discontinuous data have on default variance estimates.
    OCC would use the risk-based model enhancements described herein to 
measure its credit exposures to its participants on a daily basis and 
determine margin requirements based on such calculations. The proposed 
enhancements concerning daily price updates, daily updates of 
statistical parameters, and to more appropriately account for asymmetry 
in conditional variance would result in more accurate and responsive 
margin requirements and a model that is more stable and proactive 
during times of market volatility, with margin charges that are based 
off of the most recent market data. In addition, the proposed 
modifications to extend the look back period for determining volatility 
estimates for equity-based products from 500 days to 10 years will help 
to ensure that OCC captures sufficient historical events/market shocks 
in the calculation of its anti-procyclical floor. Additionally, the 
proposed changes would enhance OCC's margin methodology for calculating 
correlation estimates by moving to a daily process for updating 
correlations (with a minimum of one week's lag) so that Clearing Member 
account margins are more current and thus more accurate and using de-
volatized returns to normalize returns across a variety of asset 
classes and make the correlation estimator less sensitive to sudden 
market jumps and therefore more stable. Finally, the proposed changes 
to OCC's methodology for the treatment of defaulting securities is 
designed to result in stable and realistic risk estimates for such 
securities The proposed changes are therefore designed to ensure that 
OCC sets margin requirements, using risk-based models and parameters, 
that would serve to limit OCC's exposures to potential losses from 
defaults by its participants under normal market conditions so that the 
operations of OCC would not be disrupted and non-defaulting 
participants would not be exposed to losses that they cannot anticipate 
or control. Accordingly, OCC believes the proposed changes are 
consistent with Rules 17Ad-22(b)(1) and (2).\36\
---------------------------------------------------------------------------

    \36\ Id.

---------------------------------------------------------------------------

[[Page 61360]]

    Rule 17Ad-22(e)(6) \37\ further requires OCC to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to cover its credit exposures to its participants 
by establishing a risk-based margin system that, among other things: 
(i) Considers, and produces margin levels commensurate with, the risks 
and particular attributes of each relevant product, portfolio, and 
market; (ii) calculates margin sufficient to cover its potential future 
exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default; and (iii) uses reliable sources of timely price data and uses 
procedures and sound valuation models for addressing circumstances in 
which pricing data are not readily available or reliable.
---------------------------------------------------------------------------

    \37\ 17 CFR 240.17Ad-2(e)(6).
---------------------------------------------------------------------------

    As described in detail above, the proposed changes are designed to 
ensure that, among other things, OCC's margin methodology: (i) More 
appropriately accounts for asymmetry in conditional variance; (ii) more 
appropriately models the statistical distribution of price returns, 
(iii) more accurately models second-day volatility forecasts; (iv) 
improves OCC's approach to estimating covariance and correlations 
between risk factors to provide for stable and sensitive correlation 
estimations; and (v) improves OCC's methodology related to the 
treatment of defaulting securities by reducing the impact that illiquid 
securities with discontinuous data have on default variance estimates. 
These methodology enhancements would be used to calculate daily margin 
requirements for OCC's Clearing Members. In this way, the proposed 
changes are designed to consider, and produce margin levels 
commensurate with, the risks and particular attributes of each relevant 
product, portfolio, and market and to calculate margin sufficient to 
cover its potential future exposure to participants in the interval 
between the last margin collection and the close out of positions 
following a participant default.
    Moreover, the proposed changes would introduce daily updates for 
price data for equity products, including daily corporate action-
adjusted returns of equities, ETFs, ETNs, and certain indexes. This 
daily price data would be obtained from a widely used and reliable 
industry vendor. In this way, the proposed changes would ensure that 
OCC uses reliable sources of timely price data in its margin 
methodology, which better reflect current market conditions than the 
current monthly updates, thereby resulting in more accurate and 
responsive margin requirements.
    For these reasons, OCC believes that the proposed changes are 
consistent with Rule 17Ad 22(e)(6).\38\
---------------------------------------------------------------------------

    \38\ Id.
---------------------------------------------------------------------------

 III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of: (i) The 
date the proposed change was filed with the Commission or (ii) the date 
any additional information requested by the Commission is received. OCC 
shall not implement the proposed change if the Commission has any 
objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    OCC shall post notice on its website of proposed changes that are 
implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the advance 
notice is consistent with the Clearing Supervision Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-OCC-2017-811 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549.

All submissions should refer to File Number SR-OCC-2017-811. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the advance notice that are filed with the 
Commission, and all written communications relating to the advance 
notice between the Commission and any person, other than those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street, NE, Washington, DC 
20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of OCC and on OCC's website at 
hhttps://www.theocc.com/about/publications/bylaws.jsp.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-OCC-2017-811 and should be 
submitted on or before January 17, 2018.

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-27832 Filed 12-26-17; 8:45 am]
BILLING CODE 8011-01-P



                                               61354                    Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices

                                               and the LS Trust (the ‘‘Advisory                        safeguards, appropriate disclosure to                  (‘‘OCC’’) filed with the Securities and
                                               Agreement’’).2 The Adviser will provide                 Fund shareholders and notification                     Exchange Commission (‘‘Commission’’)
                                               the Funds with continuous and                           about sub-advisory changes and                         an advance notice as described in Items
                                               comprehensive investment management                     enhanced Board oversight to protect the                I and II below, which Items have been
                                               services subject to the supervision of,                 interests of the Funds’ shareholders.                  prepared by OCC. The Commission is
                                               and policies established by, each Fund’s                   4. Section 6(c) of the Act provides that            publishing this notice to solicit
                                               board of directors or trustees, as                      the Commission may exempt any                          comments on the advance notice from
                                               applicable (‘‘Board’’). The Advisory                    person, security, or transaction or any                interested persons.
                                               Agreement permits the Adviser, subject                  class or classes of persons, securities, or
                                               to the approval of the Board, to delegate               transactions from any provisions of the                I. Clearing Agency’s Statement of the
                                               to one or more sub-advisers (each, a                    Act, or any rule thereunder, if such                   Terms of Substance of the Advance
                                               ‘‘Sub-Adviser’’ and collectively, the                   relief is necessary or appropriate in the              Notice
                                               ‘‘Sub-Advisers’’) the responsibility to                 public interest and consistent with the                   This advance notice is filed in
                                               provide the day-to-day portfolio                        protection of investors and purposes                   connection with proposed changes to
                                               investment management of each Fund,                     fairly intended by the policy and                      OCC’s margin methodology to move
                                               subject to the supervision and direction                provisions of the Act. Applicants                      away from the existing monthly data
                                               of the Adviser. The primary                             believe that the requested relief meets                source provided by its current vendor
                                               responsibility for managing the Funds                   this standard because, as further                      and towards obtaining and
                                               will remain vested in the Adviser. The                  explained in the Application, the                      incorporating daily price and returns
                                               Adviser will hire, evaluate, allocate                   Advisory Agreements will remain                        (adjusted for any corporate actions) data
                                               assets to and oversee the Sub-Advisers,                 subject to shareholder approval, while                 of securities to estimate accurate
                                               including determining whether a Sub-                    the role of the Sub-Advisers is                        margins.3 This would be further
                                               Adviser should be terminated, at all                    substantially similar to that of                       supported by enhancing OCC’s
                                               times subject to the authority of the                   individual portfolio managers, so that                 econometric model applied to different
                                               Board.                                                  requiring shareholder approval of Sub-
                                                                                                                                                              risk factors; 4 improving the sensitivity
                                                  2. Applicants request an exemption to                Advisory Agreements would impose
                                                                                                                                                              and stability of correlation estimates
                                               permit the Adviser, subject to Board                    unnecessary delays and expenses on the
                                                                                                                                                              between them; and enhancing OCC’s
                                               approval, to hire certain Sub-Advisers                  Funds. Applicants believe that the
                                                                                                                                                              methodology around the treatment of
                                               pursuant to Sub-Advisory Agreements                     requested relief from the Disclosure
                                                                                                                                                              securities with limited historical data.
                                               and materially amend existing Sub-                      Requirements meets this standard
                                                                                                                                                              OCC also proposes to make a few
                                               Advisory Agreements without obtaining                   because it will improve the Adviser’s
                                                                                                                                                              clarifying and clean-up changes to its
                                               the shareholder approval required under                 ability to negotiate fees paid to the Sub-
                                                                                                                                                              margin methodology unrelated to the
                                               Section 15(a) of the Act and Rule 18f–                  Advisers that are more advantageous for
                                                                                                                                                              proposed changes described above.
                                               2 under the Act.3 Applicants also seek                  the Funds.
                                                                                                                                                                 The proposed changes to OCC’s
                                               an exemption from the Disclosure                          For the Commission, by the Division of
                                                                                                                                                              Margins Methodology document are
                                               Requirements to permit a Fund to                        Investment Management, under delegated
                                                                                                       authority.                                             contained in confidential Exhibit 5 of
                                               disclose (as both a dollar amount and a
                                                                                                       Eduardo A. Aleman,                                     the filing. The proposed changes are
                                               percentage of the Fund’s net assets): (a)
                                                                                                                                                              described in detail in Item III below.
                                               The aggregate fees paid to the Adviser                  Assistant Secretary.
                                                                                                                                                              The proposed changes do not require
                                               and any Wholly-Owned Sub-Advisers;                      [FR Doc. 2017–27807 Filed 12–26–17; 8:45 am]
                                                                                                                                                              any changes to the text of OCC’s By-
                                               and (b) the aggregate fees paid to Non-                 BILLING CODE 8011–01–P
                                                                                                                                                              Laws or Rules. All terms with initial
                                               Affiliated Sub-Advisers (collectively,
                                                                                                                                                              capitalization that are not otherwise
                                               ‘‘Aggregate Fee Disclosure’’). For any
                                                                                                       SECURITIES AND EXCHANGE                                defined herein have the same meaning
                                               Fund that employs an Affiliated Sub-
                                                                                                       COMMISSION                                             as set forth in the OCC By-Laws and
                                               Adviser, the Fund will provide separate
                                                                                                                                                              Rules.5
                                               disclosure of any fees paid to the                      [Release No. 34–82371; File No. SR–OCC–
                                               Affiliated Sub-Adviser.                                 2017–811]                                              II. Clearing Agency’s Statement of the
                                                  3. Applicants agree that any order                                                                          Purpose of, and Statutory Basis for, the
                                               granting the requested relief will be                   Self-Regulatory Organizations; The                     Advance Notice
                                               subject to the terms and conditions                     Options Clearing Corporation; Notice
                                               stated in the Application. Such terms                   of Filing of Advance Notice                              In its filing with the Commission,
                                               and conditions provide for, among other                 Concerning Proposed Changes to The                     OCC included statements concerning
                                                                                                       Options Clearing Corporation’s Margin                  the purpose of and basis for the advance
                                                 2 Applicants request relief with respect to the
                                                                                                       Methodology                                            notice and discussed any comments it
                                               named Applicants, any existing or future Series of                                                             received on the advance notice. The text
                                               the Companies, and any Sub-Advised Series. For          December 20, 2017.                                     of these statements may be examined at
                                               purposes of the requested order, ‘‘successor’’ is          Pursuant to Section 806(e)(1) of Title
                                               limited to an entity that results from reorganization
                                                                                                                                                              the places specified in Item IV below.
                                               into another jurisdiction or a change in the type of    VIII of the Dodd-Frank Wall Street                     OCC has prepared summaries, set forth
                                               business organization.                                  Reform and Consumer Protection Act,                    in sections A and B below, of the most
                                                 3 The requested relief will not extend to any Sub-    entitled Payment, Clearing and                         significant aspects of these statements.
                                               Adviser, other than a Wholly-Owned Sub-Adviser,         Settlement Supervision Act of 2010
                                               that is an affiliated person, as defined in Section
                                                                                                       (‘‘Clearing Supervision Act’’) 1 and Rule
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                                                                                                                                                                3 OCC also has filed a proposed rule change with
                                               2(a)(3) of the Act, of a Fund or an Adviser, other
                                               than by reason of serving as a sub-adviser to one       19b–4(n)(1)(i) under the Securities                    the Commission in connection with the proposed
                                               or more of the Funds (‘‘Affiliated Sub-Adviser’’).      Exchange Act of 1934 (‘‘Act’’),2 notice is             changes. See SR–OCC–2017–022.
                                                                                                                                                                4 The use of risk factors in OCC’s margin
                                               Each future Series shall obtain shareholder             hereby given that on November 13,
                                               approval (including formal approval of the initial                                                             methodology is discussed in more detail in the
                                               shareholder(s)) of the Manager of Managers
                                                                                                       2017, The Options Clearing Corporation                 Description of the Proposed Change section below.
                                               Structure (including with respect to Wholly-Owned                                                                5 OCC’s By-Laws and Rules can be found on
                                                                                                         1 12   U.S.C. 5465(e)(1).
                                               Subadvisers), prior to relying on the requested                                                                OCC’s public website: http://optionsclearing.com/
                                               relief.                                                   2 17   CFR 240.19b–4(n)(1)(i).                       about/publications/bylaws.jsp.



                                          VerDate Sep<11>2014   21:43 Dec 26, 2017   Jkt 244001   PO 00000   Frm 00104    Fmt 4703   Sfmt 4703   E:\FR\FM\27DEN1.SGM   27DEN1


                                                                         Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices                                                            61355

                                               (A) Clearing Agency’s Statement on                        nine chosen volatility pivots per                           from the broad market risk represented
                                               Comments on the Advance Notice                            product; 11 changes in foreign exchange                     by the scale factor.
                                               Received From Members, Participants or                    rates; and changes in model parameters                         In risk management, it is a common
                                               Others                                                    that sufficiently capture the model                         practice to establish a floor for volatility
                                                 Written comments were not and are                       dynamics from a larger set of data.                         at a certain level in order to protect
                                               not intended to be solicited with respect                    Under OCC’s current margin
                                                                                                                                                                     against procyclicality 14 in the model.
                                               to the proposed rule change and none                      methodology, OCC obtains monthly
                                                                                                         price data for most of its equity-based                     OCC imposes a floor on volatility
                                               have been received. OCC will notify the                                                                               estimates for its equity-based products
                                               Commission of any written comments                        products 12 from a widely used industry
                                                                                                         vendor. This data arrives around the                        using a 500-day look back period. These
                                               received by OCC.                                                                                                      monthly updates coupled with the
                                                                                                         second week of every month in arrears
                                               (B) Advance Notices Filed Pursuant to                     and requires a maximum of about four                        dependency of margins on scale factors
                                               Section 806(e) of the Payment, Clearing,                  weeks for OCC to process the data after                     and the volatility floor can result in
                                               and Settlement Supervision Act                            any clean up and reruns as may be                           imprecise changes in margins charged to
                                                                                                         required prior to installing into OCC’s                     Clearing Members, specifically across
                                               Description of the Proposed Change                                                                                    periods of heavy volatility when the
                                                                                                         margin system. As a result, correlations
                                               Background                                                and statistical parameters for risk factors                 correlation between the risk factor and
                                                  OCC’s margin methodology, the                          at any point in time represent back-                        a scale factor fluctuate.
                                               System for Theoretical Analysis and                       dated data and therefore may not be                            OCC’s current methodology for
                                               Numerical Simulations (‘‘STANS’’), is                     representative of the most recent market                    estimating covariance and correlations
                                               OCC’s proprietary risk management                         data. In the absence of daily updates,                      between risk factors relies on the same
                                               system that calculates Clearing Member                    OCC employs an approach where one or                        monthly data described above, resulting
                                               margin requirements.6 STANS utilizes                      many identified market proxies (or                          in a similar lag time between updates.
                                               large-scale Monte Carlo simulations to                    ‘‘scale-factors’’) are used to incorporate                  In addition, correlation estimates are
                                               forecast price and volatility movements                   day-to-day market volatility across all                     based off historical returns series, with
                                               in determining a Clearing Member’s                        associated asset classes throughout.13                      estimates between a pair of risk factors
                                               margin requirement.7 The STANS                            The scale factor approach, however,                         being highly sensitive to the volatility of
                                               margin requirement is calculated at the                   assumes a perfect correlation of the
                                                                                                                                                                     either risk factor in the chosen pair. The
                                               portfolio level of Clearing Member                        volatilities between the security and its
                                                                                                                                                                     current approach therefore results in
                                               accounts with positions in marginable                     scale factor, which gives little room to
                                                                                                                                                                     potentially less stable correlation
                                               securities and consists of an estimate of                 capture the idiosyncratic risk of a given
                                                                                                         security and which may be different                         estimates that may not be representative
                                               a 99% expected shortfall 8 over a two-                                                                                of current market conditions.
                                               day time horizon and an add-on margin
                                               charge for model risk (the                                Black-Scholes options pricing model, the implied               Finally, under OCC’s existing margin
                                                                                                         volatility is the standard deviation of the                 methodology, theoretical price scenarios
                                               concentration/dependence stress test                      underlying asset price necessary to arrive at the
                                               charge).9 The STANS methodology is                        market price of an option of a given strike, time to
                                                                                                                                                                     for ‘‘defaulting securities’’ 15 are
                                               used to measure the exposure of                           maturity, underlying asset price and given the              simulated using uncorrelated return
                                               portfolios of options and futures cleared                 current risk-free rate. In effect, the implied volatility   scenarios with an average zero return
                                                                                                         is responsible for that portion of the premium that         and a pre-specified volatility called
                                               by OCC and cash instruments in margin                     cannot be explained by the then-current intrinsic
                                               collateral.                                               value (i.e., the difference between the price of the        ‘‘default variance.’’ The default variance
                                                  A ‘‘risk factor’’ within OCC’s margin                  underlying and the exercise price of the option) of         is estimated as the average of the top 25
                                               system may be defined as a product or                     the option, discounted to reflect its time value.           percent quantile of the conditional
                                                                                                            11 In December 2015, the Commission approved a
                                               attribute whose historical data is used to                                                                            variances of all securities. As a result,
                                                                                                         proposed rule change and issued a Notice of No
                                               estimate and simulate the risk for an                     Objection to an advance notice filing by OCC to its         these default estimates may be impacted
                                               associated product. The majority of risk                  modify margin methodology by more broadly                   by extremely illiquid securities with
                                               factors utilized in the STANS                             incorporating variations in implied volatility within       discontinuous data. In addition, the
                                               methodology are total returns on                          STANS. See Securities Exchange Act Release No.              default variance (and the associated
                                                                                                         34–76781 (December 28, 2015), 81 FR 135 (January
                                               individual equity securities. Other risk                  4, 2016) (SR–OCC–2015–016) and Securities                   scale factors used to scale up volatility)
                                               factors considered include: Returns on                    Exchange Act Release No. 34–76548 (December 3,              is also subject to sudden jumps with the
                                               equity indexes; returns on implied                        2015), 80 FR 76602 (December 9, 2015) (SR–OCC–              monthly simulation installations across
                                               volatility 10 risk factors that are a set of              2015–804).
                                                                                                            12 The securities underlying these products are
                                                                                                                                                                     successive months because it is derived
                                                                                                         also known as risk factors within OCC’s margin              from monthly data updates, as opposed
                                                  6 See Securities Exchange Act Release No. 53322
                                                                                                         system.                                                     to daily updates, which are prone to
                                               (February 15, 2006), 71 FR 9403 (February 23, 2006)
                                               (SR–OCC–2004–20).
                                                                                                            13 Earlier this year, the Commission approved a          wider fluctuations and are subject to
                                                  7 See OCC Rule 601.
                                                                                                         proposed rule change, and issued a Notice of No             adjustments using scale factors.
                                                                                                         Objection to an advance notice filing, by OCC
                                                  8 The expected shortfall component is established
                                                                                                         which, among other things: (1) Expanded the
                                               as the estimated average of potential losses higher       number of scale factors used for equity-based                  14 A quality that is positively correlated with the
                                               than the 99% value at risk threshold. The term            products to more accurately measure the                     overall state of the market is deemed to be
                                               ‘‘value at risk’’ or ‘‘VaR’’ refers to a statistical      relationship between current and long-run market            ‘‘procyclical.’’ For example, procyclicality may be
                                               technique that, generally speaking, is used in risk       volatility with proxies that correlate more closely to      evidenced by increasing margin or Clearing Fund
                                               management to measure the potential risk of loss for      certain products carried within the equity asset            requirements in times of stressed market conditions
                                               a given set of assets over a particular time horizon.     class, and (2) applied relevant scale factors to the        and low margin or Clearing Fund requirements
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                                                  9 A detailed description of the STANS                                                                              when markets are calm. Hence, anti-procyclical
                                                                                                         greater of (i) the estimated variance of 1-day return
                                               methodology is available at http://                       scenarios or (ii) the historical variance of the daily      features in a model are measures intended to
                                               optionsclearing.com/risk-management/margins/.             return scenarios of a particular instrument, as a           prevent risk-based models from fluctuating too
                                                  10 Generally speaking, the implied volatility of an    floor to mitigate procyclicality. See Securities            drastically in response to changing market
                                               option is a measure of the expected future volatility     Exchange Act Release No. 80147 (March 3, 2017),             conditions.
                                               of the value of the option’s annualized standard          82 FR 13163 (March 9, 2017) (SR–OCC–2017–001)                  15 Within the context of OCC’s margin system,

                                               deviation of the price of the underlying security,        and Securities Exchange Act Release No. 80143               securities that do not have enough historical data
                                               index, or future at exercise, which is reflected in the   (March 2, 2017), 82 FR 13036 (March 8, 2017) (SR–           for calibration are classified as ‘‘defaulting
                                               current option premium in the market. Using the           OCC–2017–801).                                              securities.’’



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                                               61356                    Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices

                                               Proposed Changes                                        1. Daily Updates of Price Data                        represented by the scale factor. In
                                                                                                          OCC proposes to introduce daily                    addition, the processing time between
                                                  OCC proposes to modify its margin                                                                          receipt of the data and installation into
                                               methodology by: (1) Obtaining daily                     updates for price data for equity
                                                                                                       products, including daily corporate                   the margin system would be reduced as
                                               price data for equity products (including                                                                     the data review and processing for daily
                                                                                                       action-adjusted returns of equities,
                                               daily corporate action-adjusted returns                                                                       prices would be incorporated into
                                                                                                       Exchange Traded Funds (‘‘ETFs’’),
                                               of equities where price and thus returns                                                                      OCC’s daily price editing process.
                                                                                                       Exchange Traded Notes (‘‘ETNs’’) and
                                               of securities are adjusted for any
                                                                                                       certain indexes. The daily price data                 2. Proposed Enhancements to the
                                               dividends issued, stock splits, etc.) for               would be obtained from a widely used                  Econometric Model
                                               use in the daily estimation of                          external vendor, as is the case with the
                                               econometric model parameters; (2)                                                                                In addition to introducing daily
                                                                                                       current monthly updates. The purpose                  updates for price and corporate action-
                                               enhancing its econometric model for                     of the proposed change is to ensure that
                                               updating statistical parameters (e.g.,                                                                        adjusted returns data, OCC is proposing
                                                                                                       OCC’s margin methodology is reliant on                enhancements to its econometric model
                                               parameters concerning correlations or                   data that is more representative of
                                               volatility) for all risk factors that reflect                                                                 for calculating statistical parameters for
                                                                                                       current market conditions, thereby                    all qualifying risk factors that reflect the
                                               the most recent data obtained; (3)                      resulting in more accurate and
                                               improving the sensitivity and stability                                                                       most recent data obtained (e.g., OCC
                                                                                                       responsive margin requirements.                       would be able to calculate parameters
                                               of correlation estimates across risk                       As described above, OCC currently
                                               factors by using de-volatized 16 returns                                                                      such as volatility and correlations on a
                                                                                                       obtains price data for all securities on a            daily basis using the new daily price
                                               (but using a 500 day look back period);                 monthly basis from a third party vendor.              data discussed above). Specifically, OCC
                                               and (4) improving OCC’s methodology                     After obtaining the monthly price data,               proposes to enhance its econometric
                                               related to the treatment of defaulting                  additional time is required for OCC to                model by: (i) Introducing daily updates
                                               securities that would result in stable                  process the data prior to installing into             for statistical parameters; (ii)
                                               and realistic risk estimates for such                   OCC’s margin system. As a result,                     introducing features in its econometric
                                               securities.17                                           correlations and statistical parameters               model that are designed to take into
                                                  The purpose of the proposed changes                  for risk factors at any point in time                 account asymmetry in the model used to
                                               is to enhance OCC’s margin                              represent back-dated data and therefore               forecast volatility associated with a risk
                                               methodology to mitigate the issues                      may not be representative of the most                 factor; (iii) modifying the statistical
                                               described above that arise from the                     recent market data. To mitigate pro-                  distribution used to model the returns of
                                               current monthly update and scale factor                 cyclicality within its margin                         equity prices; (iv) introducing a second-
                                               approach. Specifically, by introducing                  methodology in the absence of daily                   day forecast for volatility into the model
                                               daily (as opposed to monthly) updates                   updates, OCC employs the use of scale-                to estimate the two-day scenario
                                               for price data (and thereby allowing for                factors to incorporate day-to-day market              distributions for risk factors; and (v)
                                               daily updates of statistical parameters in              volatility across all associated asset                imposing a floor on volatility estimates
                                               the model) and making other proposed                    classes. While the scale factors help to              using a 10-year look back period.
                                                                                                       reduce procyclicality in the model, the                  These proposed model enhancements
                                               model enhancements described herein,
                                                                                                       scale factors do not necessarily capture              are described in detail below.
                                               the proposed changes are designed to
                                                                                                       the idiosyncratic risks of a given
                                               result in more accurate and responsive                                                                        i. Daily Updates for Statistical
                                                                                                       security, which may be different from
                                               margin requirements and a model that is                                                                       Parameters
                                                                                                       the broad market risk represented by the
                                               more stable and proactive during times                                                                           Under the proposal, the statistical
                                                                                                       scale factor.
                                               of market volatility, with margins that                    OCC proposes to address these issues               parameters for the model would be
                                               are based off of the most recent market                 associated with its current margin                    updated on a daily basis using the new
                                               data. In addition, the proposed changes                 methodology by eliminating its                        daily price data obtained by OCC (as
                                               are intended to improve OCC’s                           dependency on monthly price data,                     described in section 1 above).18 As a
                                               approach to estimating covariance and                   which arrives in arrears and requires                 result, OCC would no longer need to
                                               correlations between risk factors in an                 additional time for OCC to process prior              rely on scale factors to approximate day-
                                               effort to achieve more stable and                       to installing into OCC’s margin system,               to-day market volatility for equity-based
                                               sensitive correlation estimations and                   through the introduction of daily                     products. Statistical parameters would
                                               improve OCC’s methodology related to                    updates for price data for equity                     be calibrated on daily basis, allowing
                                               the treatment of defaulting securities by               products. The introduction of daily                   OCC to calculate more accurate margin
                                               reducing the impact that illiquid                       price updates would enable OCC’s                      requirements that are representative of
                                               securities with discontinuous data have                 margin methodology to better capture                  the most recent market data.
                                               on default variance estimates.                          both market as well idiosyncratic risk by
                                                                                                                                                             ii. Proposed Enhancements To Capture
                                                  The proposed changes are described                   allowing for daily updates to the
                                                                                                                                                             Asymmetry in Conditional Variance
                                               in further detail below.                                parameters associated with of the
                                                                                                       econometric model (discussed below)                      In addition to the daily update of
                                                 16 De-volatization is a process of normalizing        that capture the risk associated with a               statistical parameters, OCC proposes to
                                               historical data with the associated volatility thus     particular product, and therefore ensure              include new features in its econometric
                                               enabling any comparison between different sets of       that OCC’s margin requirements are                    model that are designed to take into
                                               data.                                                   based on more current market                          account asymmetry in the conditional
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                                                 17 In addition to the proposed methodology
                                                                                                       conditions. As a result, OCC would also               variance process. The econometric
                                               changes described herein, OCC also would make
                                               some clarifying and clean-up changes, unrelated to      reduce its reliance on the use of scale               model currently used in STANS for all
                                               the proposed changes described above, to update its     factors to incorporate day-to-day market
                                               margin methodology to reflect existing practices for    volatility, which, as noted above, give                 18 OCC notes that this change would apply to

                                               the daily calibration of seasonal and non-seasonal                                                            most risk factors with the exception of certain
                                               energy models and the removal of methodology
                                                                                                       little room to capture the idiosyncratic              equity indexes, Treasury securities, and energy
                                               language for certain products that are no longer        risk of a given security and which may                futures products, which are already updated on a
                                               cleared by OCC.                                         be different from the broad market risk               daily basis.



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                                                                         Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices                                                    61357

                                               risk factors is a GARCH(1,1) with                         allows for more appropriate modeling of               market shocks in the calculation of its
                                               Student’s t-distributed innovations of                    fat tails. As a result, OCC believes that             anti-procyclical floor. The 10-year look
                                               logarithmic returns 19, which is a                        the proposed change would lead to                     back period also is in line with
                                               relatively straightforward and widely                     more consistent treatment of log returns              requirements of the European Market
                                               used model to forecast volatility.20 The                  both on the upside as well as downside                Infrastructure Regulation (including
                                               current approach for forecasting the                      of the distribution.                                  regulations thereunder) 24 concerning
                                               conditional variance for a given risk                                                                           the calibration of risk factors.
                                               factor does not, however, consider the                    iv. Second-Day Volatility Forecast
                                               asymmetric volatility phenomenon                             OCC also proposes to introduce a                   3. Proposed Enhancements to
                                               observed in financial markets (also                       second-day forecast for volatility into               Correlation Estimates
                                               called the ‘‘leverage effect’’) where                     the model to estimate the two-day                        As described above, OCC’s current
                                               volatility is more sensitive and reactive                 scenario distributions for risk factors.23            methodology for estimating covariance
                                               to market downturns. As a result, OCC                     Under the current methodology, OCC                    and correlations between risk factors
                                               proposes to enhance its model by                          typically uses a two-day horizon to                   relies on the same monthly price data
                                               adding new features (i.e., incorporating                  determine its risk exposure to a given                feeding the econometric model,
                                               asymmetry into its forecast volatility)                   portfolio. This is done by simulating                 resulting in a similar lag time between
                                               designed to allow the conditional                         10,000 theoretical price scenarios for the            updates. In addition, correlation
                                               volatility forecast to be more sensitive to               two-day horizon using a one-day                       estimates are based off historical returns
                                               market downturns and thereby capture                      forecast conditional variance, and the                series, with estimates between a pair of
                                               the most significant dynamics of the                      value at risk and expected shortfall                  risk factors being highly sensitive to the
                                               relationship between price and                            components of the margin requirement                  volatility of either risk factors in the
                                               volatility observed in financial markets.                 are then determined from the simulated                chosen pair. The current approach
                                               OCC believes the proposed                                 profit/loss distributions. These one-day              therefore results in correlation estimates
                                               enhancement would result in more                          and two-day returns scenarios are both                being sensitive to volatile historical
                                               accurate and responsive margin                            simulated using the one-day forecast                  data.
                                               requirements, particularly in market                      conditional variance estimate. This                      In order to address these limitations,
                                               downturns.                                                could lead to a risk factor’s coverage                OCC proposes to enhance its
                                                                                                         differing substantially on volatile                   methodology for calculating correlation
                                               iii. Proposed Change in Statistical
                                                                                                         trading days. As a result, OCC proposes               estimates by moving to a daily process
                                               Distribution
                                                                                                         to introduce a second-day forecast                    for updating correlations (with a
                                                  OCC further proposes to change the                     variance for all equity-based risk factors.           minimum of one week’s lag) to ensure
                                               statistical distribution used to model the                The second-day conditional variance                   Clearing Member account margins are
                                               returns of equity prices. OCC’s current                   forecast would be estimated for each of               more current and thus more accurate.
                                               methodology uses a fat tailed                             the 10,000 Monte Carlo returns                        Moreover, OCC proposes to enhance its
                                               distribution 21 (the Student’s t-                         scenarios, resulting in more accurately               approach to modeling correlation
                                               distribution) to model returns; however,                  estimated two-day scenario                            estimates by de-volatizing 25 the returns
                                               price scenarios generated using very                      distributions, and therefore more                     series to estimate the correlations.
                                               large log-return scenarios (positive) that                accurate and responsive margin                        Under the proposed approach, OCC
                                               follow this distribution can approach                     requirements.                                         would first consider the returns excess
                                               infinity and could potentially result in                                                                        of the mean (i.e., the average estimated
                                               excessively large price jumps, a known                    v. Anti-Procyclical Floor for Volatility              from historical data sample) and then
                                               limitation of this distribution. OCC                      Estimates                                             further scale them by the corresponding
                                               proposes to move to a more defined                           Additionally, OCC proposes to modify               estimated conditional variances. OCC
                                               distribution (Standardized Normal                         its floor for volatility estimates. OCC               believes that by using de-volatized
                                               Reciprocal Inverse Gaussian or NRIG)                      currently imposes a floor on volatility               returns, which is a widely suggested
                                               for modeling returns, which OCC                           estimates for its equity-based products               approach in relevant literature, it would
                                               believes would more appropriately                         using a 500-day look back period. OCC                 lead to normalizing returns across a
                                               simulate future returns based on the                      proposes to extend this look back period              variety of asset classes and make the
                                               historical price data for the products in                 to 10-years (2520 days) in the enhanced               correlation estimator less sensitive to
                                               question (i.e., it has a better ‘‘goodness                                                                      sudden market jumps and therefore
                                                                                                         model and to apply this floor to
                                               of fit’’ 22 to the historical data) and                                                                         more stable.
                                                                                                         volatility estimates for other products
                                                  19 The Student’s t-distribution is a widely used
                                                                                                         (excluding implied volatility risk factor             4. Defaulting Securities Methodology
                                               statistical distribution to model the historical          scenarios). The proposed model
                                               logarithmic price returns data of a security that         described herein is calibrated from                      Finally, OCC proposes to enhance its
                                               allows for the presence of fat tails (aka kurtosis) or    historical data, and as a result, the level           methodology for estimating the
                                               a non-zero conditional fourth moment.                                                                           defaulting variance in its model. OCC’s
                                                  20 See generally Tim Bollerslev, ‘‘Generalized
                                                                                                         of the volatilities generated by the
                                                                                                         model will vary from time to time. OCC                margin system is dependent on market
                                               Autoregressive Conditional Heteroskedasticity,’’
                                               Journal of Econometrics, 31(3), 307–327 (1986). The       is therefore proposing to establish a
                                                                                                                                                                 24 Regulation (EU) No 648/2012 of the European
                                               acronym ‘‘GARCH’’ refers to an econometric model          volatility floor for the model using a 10-
                                               that can be used to estimate volatility based on                                                                Parliament and of the Council of 4 July 2012 on
                                               historical data. The general distinction between the
                                                                                                         year look back period to reduce the risk              OTC derivatives, central counterparties and trade
                                               ‘‘GARCH variance’’ and the ‘‘sample variance’’ for        of procyclicality in its margin model.                repositories. Specifically, the proposed floor would
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                                               a given time series is that the GARCH variance uses       OCC believes that using a longer 10-year              be compliant with Article 28 of Commission
                                               the underlying time series data to forecast volatility.   look back period will ensure that OCC                 Delegated Regulation (EU) No. 153/2013 of 19
                                                  21 A data set with a ‘‘fat tail’’ is one in which                                                            December 2012 Supplementing Regulation (EU) No.
                                               extreme price returns have a higher probability of
                                                                                                         captures sufficient historical events/                648/2012 of the European Parliament and of the
                                               occurrence than would be the case in a normal                                                                   Council with regard to Regulatory Technical
                                               distribution.                                               23 This proposed change would not apply to          Standards on Requirements for Central
                                                  22 The goodness of fit of a statistical model          STANS implied volatility scenario risk factors. For   Counterparties (the ‘‘Regulatory Technical
                                               describes the extent to which observed data match         those risk factors, OCC’s existing methodology        Standards’’).
                                               the values generated by the model.                        would continue to apply. See supra note 11.             25 See supra note 16.




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                                               61358                    Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices

                                               data to determine Clearing Member                       within OCC systems. OCC believes that                 updates coupled with the dependency
                                               margin requirements. Securities that do                 this shorter time series is sufficient to             of margins on scale factors can result in
                                               not have enough historical data are                     produce stable calibrated parameters.                 imprecise changes in margins charged to
                                               classified as to be a ‘‘defaulting                                                                            Clearing Members, specifically across
                                                                                                       iii. Proposed Default Correlation
                                               security’’ within OCC systems (e.g., IPO                                                                      periods of heavy volatility.
                                               securities). As noted above, within                        Finally, OCC proposes that returns
                                                                                                       scenarios for defaulting securities,                     OCC proposes to enhance its margin
                                               current STANs systems, the theoretical
                                                                                                       securities with insufficient historical               methodology to introduce daily updates
                                               price scenarios for defaulting securities
                                                                                                       data, be simulated using a default                    for equity price data, thereby allowing
                                               are simulated using uncorrelated return
                                                                                                       correlation with the driver RUT.26 The                for daily updates of statistical
                                               scenarios with a zero mean and a
                                               default variance, with the default                      RUT Index is a small cap index and is                 parameters in its margin model for most
                                               variance being estimated as the average                 hence a natural choice to represent most              risk factors. In addition, the proposed
                                               of the top 25 percent quantile of the                   new issues that are small cap and                     changes would introduce features to the
                                               conditional variances of all securities.                deemed to be a ‘‘defaulting security.’’               model to better account for the
                                               As a result, these default estimates may                The default correlation is roughly equal              asymmetric volatility phenomenon
                                               be impacted by extremely illiquid                       to the median of all positively correlated            observed in financial markets and allow
                                               securities with discontinuous data. In                  securities with the index. Since 90% of               for conditional volatility forecast to be
                                               addition, the default variance (and the                 the risk factors in OCC systems correlate             more sensitive to market downturns.
                                               associated scale factors used to scale up               positively to the RUT index, OCC would                The proposed changes would also
                                               volatility) is also subject to sudden                   only consider those risk factors to                   introduce a new statistical distribution
                                               jumps with the monthly simulation                       determine the median. OCC believes                    for modeling equity price returns that
                                               installations across volatile months. To                that the median of the correlation                    OCC believes would have a better
                                               mitigate these concerns, OCC proposes                   distribution has been steady over a                   goodness of fit and would more
                                               to: (i) Use only optionable equity                      number of simulations and is therefore                appropriately account for fat tails.
                                               securities to estimate the default                      proposing that it replace the current                 Moreover, the proposed changes would
                                               variance; (ii) use a shorter time series to             methodology of simulating uncorrelated                introduce a second-day volatility
                                               enable calibration of the model for all                 scenarios, which OCC believes is not a                forecast into the model to provide for
                                               securities; and (iii) simulating default                realistic approach.                                   more accurate and timely estimations of
                                               correlations with the driver Russell                    Anticipated Effect on and Management                  its two-day scenario distributions. OCC
                                               2000 index (‘‘RUT’’).                                   of Risk                                               also proposes to enhance its
                                               i. Proposed Modifications to Securities                                                                       econometric model by establishing a
                                                                                                          OCC believes that the proposed                     volatility floor using a 10-year look back
                                               and Quantile Used in Estimation                         changes would reduce the nature and                   period to reduce procyclicality in the
                                                  OCC proposes that only optionable                    level of risk presented by OCC because                margin model. OCC believes the
                                               equity securities, which are typically                  they would result in a margin                         proposed changes would result in more
                                               more liquid, be considered while                        methodology that is more accurate,                    accurate and responsive margin
                                               estimating the default variance. This                   responsive, stable, and robust, thereby               requirements and a model that is more
                                               limitation would eliminate from the                     reducing risks to OCC, its Clearing                   stable and proactive during times of
                                               estimation almost all illiquid securities               Members, and the markets it serves.                   market volatility, with risk charges that
                                               with discontinuous data that could                         As noted above, OCC’s current margin
                                                                                                                                                             are based off of most recent market data.
                                               contribute to high conditional variance                 methodology relies on monthly price
                                               estimates and thus a high default                       data being obtained from a third party                   In addition, the proposed changes are
                                               variance. In addition, OCC proposes to                  vendor. This data arrives monthly in                  intended to improve OCC’s approach to
                                               estimate the default variance as the                    arrears and requires additional time for              estimating covariance and correlations
                                               lowest estimate of the top 10% of the                   OCC to process the data prior to                      between risk factors in an effort to
                                               floored conditional variance across the                 installing into OCC’s margin system. As               achieve more stable and sensitive
                                               risk factors. This change in methodology                a result, correlations and statistical                correlation estimations and improve
                                               is designed to ensure that while the                    parameters for risk factors at any point              OCC’s methodology related to the
                                               estimate is aggressive it is also robust to             in time represent back-dated data and                 treatment of defaulting securities by
                                               the presence of outliers caused by a few                therefore may not be representative of                reducing the impact that illiquid
                                               extremely volatile securities that                      the most recent market data. To mitigate              securities with discontinuous data have
                                               influence the location parameter of a                   procyclicality within its margin                      on default variance estimates.
                                               distribution. Moreover, as a                            methodology in the absence of daily                      The proposed methodology changes
                                               consequence of the daily updates                        updates, OCC employs a scale factor                   would be used by OCC to calculate
                                               described above, the default variances                  approach to incorporate day-to-day                    margin requirements designed to limit
                                               would change daily and there would be                   market volatility across all associated               its credit exposures to participants, and
                                               no scale factor to amplify the effect of                asset classes throughout.27 For the                   OCC uses the margin it collects from a
                                               the variance on risk factor coverage.                   reasons noted above, these monthly                    defaulting Clearing Member to protect
                                               ii. Proposed Change in Time Series                                                                            other Clearing Members from losses that
                                                                                                          26 OCC notes that, in certain limited
                                                                                                                                                             may result from such a default. As a
                                                  In addition, OCC proposes to use a                   circumstances where there are reasonable grounds
                                                                                                                                                             result, OCC believes the proposed
                                               shorter time series to enable calibration               backed by the existing return history to support an
                                                                                                                                                             changes would result in the reduction of
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                                                                                                       alternative approach in which the returns are
                                               of the model for all securities. Currently,             strongly correlated with those of an existing risk    risk for OCC, its Clearing Members, and
                                               OCC does not calibrate parameters for                   factor (a ‘‘proxy’’) with a full price history, the
                                                                                                                                                             the markets it serves.
                                               defaulting securities that have historical              Margins Methodology allows OCC’s Financial Risk
                                               data of less than two years. OCC is                     Management staff to construct a ‘‘conditional’’
                                                                                                       simulation to override any default treatment that
                                                                                                                                                             Clearing Member Outreach
                                               proposing to shorten this time period to                would have otherwise been applied to the
                                               around 6 months (180 days) to enable                    defaulting security.                                    OCC has discussed the proposed
                                               calibration of the model for all securities                27 See supra note 13 and accompanying text.        changes with its Financial Risk


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                                                                        Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices                                          61359

                                               Advisory Council 28 at a meeting held                   of the Clearing Supervision Act 33 states             to estimating covariance and
                                               on October 25, 2016. OCC also provided                  that the objectives and principles for                correlations between risk factors in an
                                               general updates to members at OCC                       risk management standards prescribed                  effort to achieve more stable and
                                               Roundtable 29 meetings on June 20,                      under Section 805(a) shall be to:                     sensitive correlation estimations and
                                               2017, and November 9, 2017. Clearing                       • Promote robust risk management;                  improve OCC’s methodology related to
                                               Members expressed interest in seeing                       • promote safety and soundness;                    the treatment of defaulting securities by
                                               how reactive margin changes would be                       • reduce systemic risks; and                       reducing the impact that illiquid
                                               under the proposal; however, there were                    • support the stability of the broader
                                                                                                                                                             securities with discontinuous data have
                                               no objections or significant concerns                   financial system.
                                                                                                          The Commission has adopted risk                    on default variance estimates.
                                               expressed regarding the proposed
                                               changes. OCC will provide at least 30-                  management standards under Section                       OCC would use the risk-based model
                                               days of parallel reporting prior to                     805(a)(2) of the Clearing Supervision                 enhancements described herein to
                                               implementation so that Clearing                         Act and the Act, which include                        measure its credit exposures to its
                                               Members can see the impact of the                       Commission Rules 17Ad–22(b)(1), (b)(2)                participants on a daily basis and
                                               proposed changes. In addition, OCC                      and (e)(6).34                                         determine margin requirements based
                                                                                                          Rules 17Ad–22(b)(1) and (2) 35 require             on such calculations. The proposed
                                               would publish an Information
                                                                                                       that a registered clearing agency that                enhancements concerning daily price
                                               Memorandum to all Clearing Members
                                                                                                       performs central counterparty services                updates, daily updates of statistical
                                               describing the proposed change and will
                                                                                                       establish, implement, maintain and                    parameters, and to more appropriately
                                               provide additional periodic Information
                                                                                                       enforce written policies and procedures               account for asymmetry in conditional
                                               Memoranda updates prior to the
                                                                                                       reasonably designed to, in part: (1)                  variance would result in more accurate
                                               implementation date. Additionally, OCC
                                                                                                       Measure its credit exposures to its                   and responsive margin requirements
                                               would perform targeted and direct
                                                                                                       participants at least once a day and limit            and a model that is more stable and
                                               outreach with Clearing Members that
                                                                                                       its exposures to potential losses from                proactive during times of market
                                               would be most impacted by the
                                                                                                       defaults by its participants under                    volatility, with margin charges that are
                                               proposed changes to the margin
                                                                                                       normal market conditions so that the
                                               methodology and OCC would work                                                                                based off of the most recent market data.
                                                                                                       operations of the clearing agency would
                                               closely with such Clearing Members to                                                                         In addition, the proposed modifications
                                                                                                       not be disrupted and non-defaulting
                                               coordinate the implementation and                                                                             to extend the look back period for
                                                                                                       participants would not be exposed to
                                               associated funding for such Clearing                                                                          determining volatility estimates for
                                                                                                       losses that they cannot anticipate or
                                               Members resulting from the proposed                                                                           equity-based products from 500 days to
                                                                                                       control and (2) use margin requirements
                                               change.30                                                                                                     10 years will help to ensure that OCC
                                                                                                       to limit its credit exposures to
                                               Consistency With the Payment, Clearing                  participants under normal market                      captures sufficient historical events/
                                               and Settlement Supervision Act                          conditions and use risk-based models                  market shocks in the calculation of its
                                                                                                       and parameters to set margin                          anti-procyclical floor. Additionally, the
                                                  The stated purpose of the Clearing                   requirements.                                         proposed changes would enhance OCC’s
                                               Supervision Act is to mitigate systemic                    As noted above, the proposed changes               margin methodology for calculating
                                               risk in the financial system and promote                would introduce the use of daily price                correlation estimates by moving to a
                                               financial stability by, among other                     updates into OCC’s margin                             daily process for updating correlations
                                               things, promoting uniform risk                          methodology, which allows for daily                   (with a minimum of one week’s lag) so
                                               management standards for systemically                   updates to the statistical parameters in              that Clearing Member account margins
                                               important financial market utilities and                the model (e.g., parameters concerning                are more current and thus more accurate
                                               strengthening the liquidity of                          volatility and correlation). These                    and using de-volatized returns to
                                               systemically important financial market                 changes would be supported by a                       normalize returns across a variety of
                                               utilities.31 Section 805(a)(2) of the                   number of other risk-based                            asset classes and make the correlation
                                               Clearing Supervision Act 32 also                        enhancements to OCC’s econometric                     estimator less sensitive to sudden
                                               authorizes the Commission to prescribe                  model designed to: (i) More                           market jumps and therefore more stable.
                                               risk management standards for the                       appropriately account for asymmetry in                Finally, the proposed changes to OCC’s
                                               payment, clearing and settlement                        conditional variance; (ii) more                       methodology for the treatment of
                                               activities of designated clearing entities,             appropriately model the statistical                   defaulting securities is designed to
                                               like OCC, for which the Commission is                   distribution of price returns; (iii)                  result in stable and realistic risk
                                               the supervisory agency. Section 805(b)                  provide for an anti-procyclical floor for             estimates for such securities The
                                                                                                       volatility estimates based on a 10-year               proposed changes are therefore designed
                                                 28 The Financial Risk Advisory Council is a
                                                                                                       look back period; and (iv) more                       to ensure that OCC sets margin
                                               working group consisting of representatives of          accurately model second-day volatility
                                               Clearing Members and exchanges formed by OCC to                                                               requirements, using risk-based models
                                               review and comment on various risk management           forecasts. Moreover, the proposed                     and parameters, that would serve to
                                               proposals.                                              changes would improve OCC’s approach                  limit OCC’s exposures to potential
                                                 29 The OCC Roundtable was established to bring

                                               Clearing Members, exchanges and OCC together to           33 12
                                                                                                                                                             losses from defaults by its participants
                                                                                                                U.S.C. 5464(b).
                                               discuss industry and operational issues. It is            34 17  CFR 240. 17Ad–22. See Securities Exchange
                                                                                                                                                             under normal market conditions so that
                                               comprised of representatives of the senior OCC          Act Release Nos. 68080 (October 22, 2012), 77 FR      the operations of OCC would not be
                                               staff, participant exchanges and Clearing Members,      66220 (November 2, 2012) (S7–08–11) (‘‘Clearing       disrupted and non-defaulting
                                               representing the diversity of OCC’s membership in
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                                                                                                       Agency Standards’’); 78961 (September 28, 2016, 81    participants would not be exposed to
                                               industry segments, OCC-cleared volume, business         FR 70786 (October 13, 2016) (S7–03–14)
                                               type, operational structure and geography.              (‘‘Standards for Covered Clearing Agencies’’). The    losses that they cannot anticipate or
                                                 30 Specifically, OCC will discuss with those
                                                                                                       Standards for Covered Clearing Agencies became        control. Accordingly, OCC believes the
                                               Clearing Members how they plan to satisfy any           effective on December 12, 2016. OCC is a ‘‘covered    proposed changes are consistent with
                                               increase in their margin requirements associated        clearing agency’’ as defined in Rule 17Ad–22(a)(5)
                                               with the proposed change.                               and therefore OCC must comply with new section
                                                                                                                                                             Rules 17Ad–22(b)(1) and (2).36
                                                 31 12 U.S.C. 5461(b).                                 (e) of Rule 17Ad–22.
                                                 32 12 U.S.C. 5464(a)(2).                                 35 17 CFR 240.17Ad–22(b)(1) and (2).                 36 Id.




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                                               61360                      Federal Register / Vol. 82, No. 247 / Wednesday, December 27, 2017 / Notices

                                                  Rule 17Ad–22(e)(6) 37 further requires                 updates, thereby resulting in more                    Commission, 100 F Street NE,
                                               OCC to establish, implement, maintain                     accurate and responsive margin                        Washington, DC 20549.
                                               and enforce written policies and                          requirements.                                         All submissions should refer to File
                                               procedures reasonably designed to cover                     For these reasons, OCC believes that                Number SR–OCC–2017–811. This file
                                               its credit exposures to its participants by               the proposed changes are consistent                   number should be included on the
                                               establishing a risk-based margin system                   with Rule 17Ad 22(e)(6).38                            subject line if email is used. To help the
                                               that, among other things: (i) Considers,                  III. Date of Effectiveness of the Advance             Commission process and review your
                                               and produces margin levels                                Notice and Timing for Commission                      comments more efficiently, please use
                                               commensurate with, the risks and                          Action                                                only one method. The Commission will
                                               particular attributes of each relevant                                                                          post all comments on the Commission’s
                                               product, portfolio, and market; (ii)                         The proposed change may be                         internet website (http://www.sec.gov/
                                               calculates margin sufficient to cover its                 implemented if the Commission does                    rules/sro.shtml). Copies of the
                                               potential future exposure to participants                 not object to the proposed change                     submission, all subsequent
                                               in the interval between the last margin                   within 60 days of the later of: (i) The               amendments, all written statements
                                               collection and the close out of positions                 date the proposed change was filed with               with respect to the advance notice that
                                               following a participant default; and (iii)                the Commission or (ii) the date any                   are filed with the Commission, and all
                                               uses reliable sources of timely price data                additional information requested by the               written communications relating to the
                                               and uses procedures and sound                             Commission is received. OCC shall not                 advance notice between the
                                               valuation models for addressing                           implement the proposed change if the                  Commission and any person, other than
                                               circumstances in which pricing data are                   Commission has any objection to the                   those that may be withheld from the
                                               not readily available or reliable.                        proposed change.                                      public in accordance with the
                                                  As described in detail above, the                         The Commission may extend the
                                                                                                                                                               provisions of 5 U.S.C. 552, will be
                                               proposed changes are designed to                          period for review by an additional 60
                                                                                                                                                               available for website viewing and
                                               ensure that, among other things, OCC’s                    days if the proposed change raises novel
                                                                                                                                                               printing in the Commission’s Public
                                               margin methodology: (i) More                              or complex issues, subject to the
                                                                                                                                                               Reference Room, 100 F Street, NE,
                                               appropriately accounts for asymmetry in                   Commission providing the clearing
                                                                                                                                                               Washington, DC 20549 on official
                                               conditional variance; (ii) more                           agency with prompt written notice of
                                                                                                         the extension. A proposed change may                  business days between the hours of
                                               appropriately models the statistical                                                                            10:00 a.m. and 3:00 p.m. Copies of the
                                               distribution of price returns, (iii) more                 be implemented in less than 60 days
                                                                                                         from the date the advance notice is                   filing also will be available for
                                               accurately models second-day volatility                                                                         inspection and copying at the principal
                                               forecasts; (iv) improves OCC’s approach                   filed, or the date further information
                                                                                                         requested by the Commission is                        office of OCC and on OCC’s website at
                                               to estimating covariance and                                                                                    hhttps://www.theocc.com/about/
                                               correlations between risk factors to                      received, if the Commission notifies the
                                                                                                         clearing agency in writing that it does               publications/bylaws.jsp.
                                               provide for stable and sensitive                                                                                   All comments received will be posted
                                               correlation estimations; and (v)                          not object to the proposed change and
                                                                                                         authorizes the clearing agency to                     without change. Persons submitting
                                               improves OCC’s methodology related to                                                                           comments are cautioned that we do not
                                               the treatment of defaulting securities by                 implement the proposed change on an
                                                                                                         earlier date, subject to any conditions               redact or edit personal identifying
                                               reducing the impact that illiquid                                                                               information from comment submissions.
                                               securities with discontinuous data have                   imposed by the Commission.
                                                                                                            OCC shall post notice on its website               You should submit only information
                                               on default variance estimates. These                                                                            that you wish to make available
                                               methodology enhancements would be                         of proposed changes that are
                                                                                                         implemented.                                          publicly. All submissions should refer
                                               used to calculate daily margin                                                                                  to File Number SR–OCC–2017–811 and
                                               requirements for OCC’s Clearing                              The proposal shall not take effect
                                                                                                         until all regulatory actions required                 should be submitted on or before
                                               Members. In this way, the proposed                                                                              January 17, 2018.
                                               changes are designed to consider, and                     with respect to the proposal are
                                               produce margin levels commensurate                        completed.                                              By the Commission.
                                               with, the risks and particular attributes                 IV. Solicitation of Comments                          Eduardo A. Aleman,
                                               of each relevant product, portfolio, and                                                                        Assistant Secretary.
                                                                                                           Interested persons are invited to
                                               market and to calculate margin                            submit written data, views and                        [FR Doc. 2017–27832 Filed 12–26–17; 8:45 am]
                                               sufficient to cover its potential future                  arguments concerning the foregoing,                   BILLING CODE 8011–01–P
                                               exposure to participants in the interval                  including whether the advance notice is
                                               between the last margin collection and                    consistent with the Clearing
                                               the close out of positions following a                    Supervision Act. Comments may be                      SOCIAL SECURITY ADMINISTRATION
                                               participant default.                                      submitted by any of the following
                                                  Moreover, the proposed changes                                                                               [Docket No. SSA 2017–0002]
                                                                                                         methods:
                                               would introduce daily updates for price
                                                                                                                                                               Privacy Act of 1974; Matching Program
                                               data for equity products, including daily                 Electronic Comments
                                               corporate action-adjusted returns of                        • Use the Commission’s internet                     AGENCY:    Social Security Administration
                                               equities, ETFs, ETNs, and certain                         comment form (http://www.sec.gov/                     (SSA).
                                               indexes. This daily price data would be                   rules/sro.shtml); or                                  ACTION:Notice of a New Matching
                                               obtained from a widely used and                             • Send an email to rule-comments@                   Program.
                                               reliable industry vendor. In this way,                    sec.gov. Please include File Number SR–
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                                               the proposed changes would ensure that                    OCC–2017–811 on the subject line.                     SUMMARY:  In accordance with the
                                               OCC uses reliable sources of timely                                                                             provisions of the Privacy Act, as
                                               price data in its margin methodology,                     Paper Comments                                        amended, this notice announces a new
                                               which better reflect current market                         • Send paper comments in triplicate                 matching program with the Railroad
                                               conditions than the current monthly                       to Secretary, Securities and Exchange                 Retirement Board (RRB).
                                                                                                                                                               DATES: The deadline to submit
                                                 37 17   CFR 240.17Ad–2(e)(6).                             38 Id.                                              comments on the proposed matching


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Document Created: 2017-12-27 02:24:01
Document Modified: 2017-12-27 02:24:01
CategoryRegulatory Information
CollectionFederal Register
sudoc ClassAE 2.7:
GS 4.107:
AE 2.106:
PublisherOffice of the Federal Register, National Archives and Records Administration
SectionNotices
FR Citation82 FR 61354 

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