Section 19(b)(3)(A) * Section 19(b)(3)(B) * Section 19(b)(2) * Rule. 19b-4(f)(1) 19b-4(f)(2) (Title *) Title * Vice President, Regulatory Filings

Transcription

1 OMB APPROVAL Required fields are shown with yellow backgrounds and asterisks. OMB Number: Estimated average burden hours per response...38 Page 1 of * 118 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C File No.* SR * 006 Form 19b-4 Amendment No. (req. for Amendments *) Filing by Options Clearing Corporation Pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 Initial * Amendment * Withdrawal Section 19(b)(2) * Section 19(b)(3)(A) * Section 19(b)(3)(B) * Rule Pilot Extension of Time Period for Commission Action * Date Expires * 19b-4(f)(1) 19b-4(f)(2) 19b-4(f)(4) 19b-4(f)(5) 19b-4(f)(3) 19b-4(f)(6) Notice of proposed change pursuant to the Payment, Clearing, and Settlement Act of 2010 Section 806(e)(1) * Section 806(e)(2) * Security-Based Swap Submission pursuant to the Securities Exchange Act of 1934 Section 3C(b)(2) * Exhibit 2 Sent As Paper Document Exhibit 3 Sent As Paper Document Description Provide a brief description of the action (limit 250 characters, required when Initial is checked *). Proposed rule change concerning changes to The Options Clearing Corporation's monthly and intra-month Clearing Fund sizing and monitoring processes. Contact Information Provide the name, telephone number, and address of the person on the staff of the self-regulatory organization prepared to respond to questions and comments on the action. First Name * Justin Last Name * Byrne Title * Vice President, Regulatory Filings * jbyrne@theocc.com Telephone * (202) Fax (312) Signature Pursuant to the requirements of the Securities Exchange Act of 1934, has duly caused this filing to be signed on its behalf by the undersigned thereunto duly authorized. (Title *) Date By 02/02/2018 Justin W. Byrne Vice President, Regulatory Filings (Name *) NOTE: Clicking the button at right will digitally sign and lock this form. A digital signature is as legally binding as a physical signature, and once signed, this form cannot be changed. Justin Byrne, jbyrne@theocc.com

2 Required fields are shown with yellow backgrounds and asterisks. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C For complete Form 19b-4 instructions please refer to the EFFS website. Form 19b-4 Information * Add Remove View The self-regulatory organization must provide all required information, presented in a clear and comprehensible manner, to enable the public to provide meaningful comment on the proposal and for the Commission to determine whether the proposal is consistent with the Act and applicable rules and regulations under the Act. Exhibit 1 - Notice of Proposed Rule Change * Add Exhibit 2 - Notices, Written Comments, Transcripts, Other Communications Add Remove Remove View Exhibit 1A- Notice of Proposed Rule Change, Security-Based Swap Submission, or Advance Notice by Clearing Agencies * Add Remove View View The Notice section of this Form 19b-4 must comply with the guidelines for publication in the Federal Register as well as any requirements for electronic filing as published by the Commission (if applicable). The Office of the Federal Register (OFR) offers guidance on Federal Register publication requirements in the Federal Register Document Drafting Handbook, October 1998 Revision. For example, all references to the federal securities laws must include the corresponding cite to the United States Code in a footnote. All references to SEC rules must include the corresponding cite to the Code of Federal Regulations in a footnote. All references to Securities Exchange Act Releases must include the release number, release date, Federal Register cite, Federal Register date, and corresponding file number (e.g., SR-[SRO] -xx-xx). A material failure to comply with these guidelines will result in the proposed rule change being deemed not properly filed. See also Rule 0-3 under the Act (17 CFR ) The Notice section of this Form 19b-4 must comply with the guidelines for publication in the Federal Register as well as any requirements for electronic filing as published by the Commission (if applicable). The Office of the Federal Register (OFR) offers guidance on Federal Register publication requirements in the Federal Register Document Drafting Handbook, October 1998 Revision. For example, all references to the federal securities laws must include the corresponding cite to the United States Code in a footnote. All references to SEC rules must include the corresponding cite to the Code of Federal Regulations in a footnote. All references to Securities Exchange Act Releases must include the release number, release date, Federal Register cite, Federal Register date, and corresponding file number (e.g., SR-[SRO] -xx-xx). A material failure to comply with these guidelines will result in the proposed rule change, security-based swap submission, or advance notice being deemed not properly filed. See also Rule 0-3 under the Act (17 CFR ) Copies of notices, written comments, transcripts, other communications. If such documents cannot be filed electronically in accordance with Instruction F, they shall be filed in accordance with Instruction G. Exhibit Sent As Paper Document Exhibit 3 - Form, Report, or Questionnaire Add Remove View Exhibit Sent As Paper Document Copies of any form, report, or questionnaire that the self-regulatory organization proposes to use to help implement or operate the proposed rule change, or that is referred to by the proposed rule change. Exhibit 4 - Marked Copies Add Remove View Exhibit 5 - Proposed Rule Text Add Remove View The full text shall be marked, in any convenient manner, to indicate additions to and deletions from the immediately preceding filing. The purpose of Exhibit 4 is to permit the staff to identify immediately the changes made from the text of the rule with which it has been working. The self-regulatory organization may choose to attach as Exhibit 5 proposed changes to rule text in place of providing it in Item I and which may otherwise be more easily readable if provided separately from Form 19b-4. Exhibit 5 shall be considered part of the proposed rule change. Partial Amendment Add Remove View If the self-regulatory organization is amending only part of the text of a lengthy proposed rule change, it may, with the Commission's permission, file only those portions of the text of the proposed rule change in which changes are being made if the filing (i.e. partial amendment) is clearly understandable on its face. Such partial amendment shall be clearly identified and marked to show deletions and additions.

3 Page 3 of 118 SECURITIES AND EXCHANGE COMMISSION Washington, D.C Form 19b-4 Proposed Rule Change by THE OPTIONS CLEARING CORPORATION Pursuant to Rule 19b-4 under the Securities Exchange Act of 1934

4 Page 4 of 118 Item 1. Text of the Proposed Rule Change This proposed rule change by The Options Clearing Corporation ( OCC ) would modify OCC s monthly and intra-month Clearing Fund sizing and monitoring processes to: (1) describe how OCC would use its existing authority under OCC Rule 601(c) to set amounts called as intraday margin under the current procedures as an additional margin requirement, which could be retained month-over-month for purposes of the monthly Clearing Fund sizing process and taken into consideration when determining final daily Clearing Fund draw calculations; (2) eliminate characterization of the current $500 million and 100% of net capital thresholds for intra-month Clearing Fund margin calls as caps on such margin calls; (3) adjust the minimum intra-month Clearing Fund resizing increment to $100 million (as opposed to the current minimum of either (i) $1 billion or (ii) 125% of the difference between the projected draw and the Clearing Fund in effect); and (4) codify existing OCC practices concerning the Clearing Fund (and in particular, practices currently detailed in OCC s Clearing Fund Intra-Month Re-sizing Procedure, Financial Resources Monitoring and Call Procedure ( FRMC Procedure ), and Monthly Clearing Fund Sizing Procedure) as well as the newly proposed enhancements through the formalizing and updating of OCC s Clearing Fund Methodology Policy ( CFM Policy ). OCC notes that, as part of the proposed changes, OCC would withdraw as rules of a clearing agency for purposes of the Securities Exchange Act of 1934 ( Exchange Act or Act ) 1 its existing Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure as the material aspects of OCC s Clearing Fund-related operations would be addressed 1 15 U.S.C. 78a et seq.

5 Page 5 of 118 in the Rules and proposed CFM Policy. The proposed amendments to OCC s Rules can be found in Exhibit 5A. Material proposed to be added to the Rules as currently in effect is marked by underlining, and material proposed to be deleted is marked in strikethrough text. The proposed CFM Policy is included in confidential Exhibit 5B of the filing and has been submitted generally without marking to facilitate review and readability of the document as it is being submitted in its entirety as new rule text. The Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure can be found in confidential Exhibits 5C, 5D and 5E, respectively, with the deletion (or withdrawing as rules ) of these procedures indicated by strikethrough text. All terms with initial capitalization not defined herein have the same meaning as set forth in OCC s By-Laws and Rules. 2 Item 2. Procedures of the Self-Regulatory Organization The proposed changes were approved for filing with the Commission by the Board of Directors of OCC ( Board ) at a meeting held on December 13, 2017, with additional clarifications approved by the Risk Committee of the Board pursuant to delegated authority on December 20, Questions should be addressed to Justin Byrne, Vice President, Regulatory Filings, at 2 OCC s By-Laws and Rules can be found on OCC s public website:

6 Page 6 of 118 (202) Item 3. Self-Regulatory Organization s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change A. Purpose Background 1. Overview of OCC s Clearing Fund Sizing and Monitoring Processes OCC Rule 1001(a) provides that the total size of OCC s Clearing Fund shall be established at an amount determined by OCC to be sufficient to protect it against loss under simulated default scenarios that include the default of the single Clearing Member Group whose default would be likely to result in the largest draw against the Clearing Fund as well as an event involving the near-simultaneous default of two randomly-selected Clearing Member Groups as modeled using Monte Carlo simulations similar to those referred to in Rule 601(c). Rule 1001(a) further provides that such calculations shall be made on a daily basis, and the size of the Clearing Fund shall be readjusted monthly to equal the peak five-day rolling average of such calculations observed over the preceding three calendar months plus a prudential margin of safety determined by OCC, but may be increased intra-month in accordance with OCC s procedures. OCC has established procedures regarding its processes for (i) the monthly resizing of its Clearing Fund (Monthly Clearing Fund Sizing Procedure), (ii) the addition of financial resources through intra-day margin calls and/or an intra-month increase of the Clearing Fund to ensure that it maintains adequate financial resources in the event of a default of a Clearing Member/Clearing Members Group presenting the largest exposure to OCC (FRMC Procedure), and the execution of any intra-month resizing of the Clearing Fund (Clearing Fund Intra-Month

7 Page 7 of 118 Re-sizing Procedure). 3 Pursuant to OCC s current Clearing Fund methodology, OCC sizes its Clearing Fund at an amount sufficient to protect OCC against losses under simulated default scenarios that include (i) an Idiosyncratic Default Scenario that includes the default of the single Clearing Member Group whose default would be likely to result in the largest draw against the Clearing Fund at a 99% confidence level and (ii) a Minor Systemic Event Default Scenario involving the nearsimultaneous default of two randomly-selected Clearing Member Groups with each pair of distinct Clearing Members being deemed equally likely calculated at a 99.9% confidence level. 4 Pursuant to the Monthly Clearing Fund Sizing Procedure, OCC uses the daily peak of such draw estimates to determine the monthly size of the Clearing Fund, which is established at the greater of (i) a Base Amount equal to the peak five-day rolling average of the Clearing Fund draws (i.e., the estimated stress loss exposures in excess of margin requirements) observed over the preceding three calendar months, plus a prudential margin of safety equal to $1.8 billion, or (ii) 110% of OCC s committed credit facilities. Supplemental to the monthly process, OCC s Financial Risk Management department ( FRM ) assesses on a daily basis the sufficiency of the Clearing Fund by monitoring Clearing Fund draw estimates in order to identify exposures that may require: (i) collection of additional margin from a Clearing Member Group pursuant to OCC s intra-day margin call authority under 3 See Securities Exchange Act Release No (May 15, 2015), 80 FR (May 21, 2015) (SR-OCC ). See also Securities Exchange Act Release No (May 15, 2015), 80 FR (May 21, 2015) (SR-OCC ). 4 See Securities Exchange Act Release No (September 23, 2011), 76 FR (September 29, 2011) (SR-OCC ).

8 Page 8 of 118 Rule or (ii) an intra-month resizing of the Clearing Fund in accordance with OCC s FRMC Procedure. In instances where an estimate of a particular Clearing Member Group s Clearing Fund draw under an Idiosyncratic Default Scenario (referred to herein as an Idiosyncratic Clearing Fund Draw ) exceeds 75% of the amount currently in the Clearing Fund (i.e., the current Clearing Fund requirement less any deficits) (such amount hereinafter referred to as the 75% threshold ), OCC has the authority to issue a margin call against the Clearing Member Group(s) generating such draw(s) for an amount equal to the difference between such estimated draw amount and the Base Amount of the Clearing Fund. 6 Under the FRMC Procedure, margin calls are subject to a per-clearing Member cap equal to the lesser of $500 million or 100% of such Clearing Member s net capital; however, OCC s management retains discretion under the FRMC Procedure to call for additional margin beyond those amounts. All margin calls issued under the FRMC Procedure remain in place until deficits associated with the next monthly Clearing Fund sizing are collected. 5 Rule 609 allows OCC to require the deposit of such additional margin ( intra-day margin ) by any Clearing Member in any account at any time during any business day, as an officer deems advisable to reflect changes in: (i) the market price during such day of any series of options held in a short position in such account or of any underlying interest underlying any cleared security (including an exercised option) in such account or of any Loaned Stock that is the subject of a stock loan or borrow position in such account, (ii) the size of such Clearing Member's positions in cleared securities or stock loan or borrow positions, (iii) the value of securities deposited by the Clearing Member as margin, or (iv) the financial position of the Clearing Member, or otherwise to protect OCC, other Clearing Members or the general public. 6 In the case where an estimated draw is associated with multiple Clearing Members within a single Clearing Member Group, the margin call is allocated among the individual Clearing Members in the Clearing Member Group based on each Clearing Member s proportionate share of the total risk for such Clearing Member Group, as that term is defined in OCC Rule 1001(b). Accordingly, the term total risk in this context means the margin requirement with respect to all accounts of the Clearing Member Group exclusive of the net asset value of the positions in such accounts aggregated across all such accounts.

9 Page 9 of 118 In more extreme observations, where OCC observes an Idiosyncratic Clearing Fund Draw estimate (after factoring in margin calls issued) exceeding 90% of the Clearing Fund ( 90% threshold ), OCC has the authority under Rule 1001(a), FRMC Procedure, and Clearing Fund Intra-Month Re-sizing Procedure to increase the size of the Clearing Fund by a minimum amount equal to the greater of (i) $1 billion or (ii) 125% of the difference between the projected draw (reduced by margin calls issued) and the Clearing Fund in effect. Any deficits associated with the increase to the Clearing Fund must be satisfied within two business days of the resizing. Under OCC s Clearing Fund methodology, OCC includes any margin deposited as a result of both calculated margin requirements under Rule 601 and intra-day margin calls for the month in question under Rule 609 (including calls made pursuant to the FRMC Procedure) when calculating Clearing Fund draw exposure estimates for purposes of intra-day margin calls and intra-month resizing. 7 Intra-day margin is excluded, however, from the calculation of daily Clearing Fund draw estimates used in the monthly sizing process, and this additional exposure is therefore incorporated into the new monthly Clearing Fund size with the associated risk being mutualized through all Clearing Members Clearing Fund contribution requirements. 8 In addition to the Clearing Fund sizing and intra-day margin call authority described 7 That is, both daily margin requirements and intra-day margin on deposit are included when determining the amount of stress test losses from the Clearing Fund draw in excess of margin on the day of the calculation. 8 The current Clearing Fund methodology and Monthly Clearing Fund Sizing Procedure do not contemplate the inclusion of intra-day margin collected under the FRMC Procedure in the estimated daily Clearing Fund draws used to size the Clearing Fund because this intra-month margin is returned to affected Clearing Member Groups upon the collection of all deficits associated with the next monthly resizing

10 Page 10 of 118 above, OCC notes that existing Rule 601(c) provides OCC with the authority to fix the margin requirement for any account or any class of cleared contracts at such amount as it deems necessary or appropriate under the circumstances to protect the respective interests of Clearing Members, OCC, and the public. This authority exists separate from OCC s authority to call for intra-day margin under Rule 609, and any additional fixed margin amount would be considered part of the regular daily margin requirement under Rule 601 for the Clearing Member/account in question. To-date, OCC has not exercised its authority under Rule 601(c) in connection with the monthly and intra-month Clearing Fund sizing and monitoring processes. 2. Recent Events Impacting OCC s Clearing Fund For the month of October 2017, OCC s Clearing Fund was sized to approximately $9.2 billion. By mid-month, however, OCC observed stress test exposures for a very small subset of Clearing Member Groups breaching the 75% threshold of the Clearing Fund, which triggered a series of intra-day margin calls for those Clearing Member Groups under the FRMC Procedure. Near the end of October, increased exposures by these Clearing Member Groups persisted, ultimately resulting in an observed breach exceeding 90% of the Clearing Fund (after accounting for intra-day margin calls), prompting OCC to execute an intra-month resizing of the Clearing Fund under the FRMC Procedure and Clearing Fund Intra-Month Re-sizing Procedure. On October 26, 2017, OCC mutualized a portion of these increased exposures through an intramonth increase in the size of the Clearing Fund by the minimum increment of $1 billion (to a total of approximately $10.2 billion). On November 1, 2017, the Clearing Fund was further increased to approximately $11.6

11 Page 11 of 118 billion through the normal monthly sizing process to account for those peak exposures observed during the month of October, which had been collateralized in the form of intra-day margin from the Clearing Member Groups in question under the FRMC Procedure. Based on peak exposures realized during the month of November 2017, the limited number of Clearing Member Groups in question were subject to significant additional margin calls under the FRMC Procedure, which required OCC management to waive margin call caps under the FRMC Procedure on a number of occasions. At the end of November, OCC initiated its normal course monthly sizing process under OCC s Clearing Fund methodology and the Monthly Clearing Fund Sizing Procedure. As described in detail above, OCC s Clearing Fund methodology and Monthly Clearing Fund Sizing Procedure currently provide that intra-day margin collected under the FRMC Procedure for the prior month is excluded from the calculation of daily Clearing Fund draw estimates for that month for purposes of the next monthly Clearing Fund sizing. As a result, these increased exposures observed in November, which again were being driven only by a small subset of OCC Clearing Members, were mutualized into the overall Clearing Fund at month s end, and on December 1, 2017, the Clearing Fund was increased an additional $3.1 billion for a total Clearing Fund size of approximately $14.7 billion (an increase of approximately 60% over a two month period). OCC notes that these increases in Clearing Fund size were being driven by a very small subset of Clearing Members presenting significantly higher stress test exposures under OCC s Clearing Fund methodology. As a result, Clearing Members whose own activities were not

12 Page 12 of 118 driving the size of the Clearing Fund higher and who had limited ability to take action to reduce their requirements were nevertheless subjected to the risk and cost of these increased exposures through mutualized Clearing Fund requirements. Moreover, OCC notes that the current fixed intra-month resizing increment of $1 billion constrains OCC s flexibility to appropriately adjust the size of the Clearing Fund given the particular facts and circumstances at the time of the resizing (e.g., OCC may be forced to resize the fund at a level that limits its ability to meet its mandate to be effective and efficient in meeting the requirements of its participants and the markets it serves). As a result of these recent events, OCC s Risk Committee and Board have approved, and OCC proposes to make, certain modifications and clarifications to OCC s monthly and intramonth Clearing Fund processes to more appropriately allocate the risk presented in these unique circumstances between mutualized resources (i.e., Clearing Fund) and defaulter pay resources (i.e., margin) so that those that bring risk to OCC will bear that risk. Proposed Changes to OCC s Monthly and Intra-Month Clearing Fund Processes OCC is proposing a number of enhancements to its monthly and intra-month Clearing Fund sizing and monitoring processes to provide additional flexibility for OCC to appropriately manage its risks and to address the recent Clearing Fund-related issues described above. Specifically, OCC proposes to: (1) describe how OCC would use its existing authority under OCC Rule 601(c) to set amounts called as intra-day margin under the current procedures as an additional Rule 601 margin requirement, which could be retained month-over-month for purposes of the monthly Clearing Fund sizing process and taken into consideration when

13 Page 13 of 118 determining final daily Clearing Fund draw calculations; (2) eliminate the current $500 million and 100% of net capital caps on intra-month Clearing Fund margin calls; (3) adjust the minimum increment of OCC s intra-month resizing authority to $100 million so that it is not limited to a minimum increment of (i) $1 billion or (ii) 125% of the difference between the projected draw (reduced by margin calls issued) and the Clearing Fund in effect; and (4) effect these changes through the amendment of OCC s Rules and through the formalizing and updating of its CFM Policy, as described in further detail below. 1. Incorporation of Rule 601(c) Margin Authority into Clearing Fund Processes OCC calculates and collects margin from its Clearing Members on a daily basis. Rule 601 describes OCC s authority to determine daily margin requirements, the deposit of margin assets by Clearing Members, and the holding of margin assets by OCC. In addition, Rule 609 allows OCC to require the deposit of intra-day margin under certain circumstances, including those arising under the FRMC Procedure. 9 Notwithstanding the provisions above, Rule 601(c) provides OCC with the authority to fix the margin requirement for any account or any class of cleared contracts at such amount as it deems necessary or appropriate under the circumstances to protect the respective interests of Clearing Members, OCC, and the public. This authority exists separate from OCC s authority to call for intra-day margin under Rule 609, and any additional fixed margin amount would be considered part of the regular daily margin requirement under Rule 601 for the Clearing Member/account in question. As described above, OCC Rule 1001(a) requires that the total size of the Clearing Fund 9 See supra note 5 and associated text.

14 Page 14 of 118 be established each month at an amount determined by OCC to be sufficient to protect it against losses under simulated default scenarios that include the default of the single Clearing Member Group whose default would be likely to result in the largest draw against the Clearing Fund as well as an event involving the near-simultaneous default of two randomly-selected Clearing Member Groups as modeled using Monte Carlo simulations similar to those referred to in Rule 601(c). The rule further provides that such calculations be made on a daily basis and that the size of the Clearing Fund shall be readjusted monthly to equal the peak five-day rolling average of such calculations observed over the preceding three calendar months (plus the prudential margin of safety). Under OCC s Clearing Fund methodology and the Monthly Clearing Fund Sizing Procedure, Clearing Member margin requirements under Rule 601 are taken into consideration when calculating these daily Clearing Fund draw exposure estimates. Intra-day margin held under Rule 609 is excluded, however, from the calculation of Clearing Fund draw estimates, and this additional exposure is therefore incorporated into the new monthly Clearing Fund size with the associated risk being mutualized through all Clearing Members Clearing Fund contribution requirements. OCC proposes to describe how it would use its authority under OCC Rule 601(c) to set amounts called as intra-day margin under the current Clearing Fund procedures as an additional margin requirement at such an amount or amounts determined to be necessary or appropriate under the circumstances to protect the respective interests of Clearing Member Groups, OCC, and the public. Specifically, the proposed CFM Policy would clearly provide that in the event two or fewer Clearing Member Group(s) are presenting exposure in the form of elevated

15 Page 15 of 118 projected draws to a much greater magnitude than other Clearing Member Groups (i.e., where the projected stress test exposure of the third largest Clearing Member Group(s) is less than or equal to 50% of the projected Clearing Fund size, including the prudential margin of safety), any two of the Executive Chairman and Chief Executive Officer ( Executive Chairman ), President and Chief Operating Officer ( COO ), or Chief Administrative Officer ( CAO ) (collectively referred to as the Office of the Executive Chairman ) shall have the authority to impose an additional margin amount for the Clearing Member Group(s) in question pursuant to Rule 601(c), taking into consideration trends in stress test exposure and the amount of margin calls made during the month and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. 10 In this situation, FRM s Stress Testing and Liquidity Risk Management group ( STLRM ) would present an analysis containing a recommendation for the amount of the additional margin requirement, and the impact to the proposed Clearing Fund Size that would be effective upon approval of the additional margin requirement (based on a reduction of the Clearing Fund draws of the Clearing Member Group(s) in question by the amount of the additional margin requirement, as discussed in further detail below). This additional margin amount would constitute part of the Clearing Member Group(s) daily margin requirement under Rule 601 and would remain in place until the next regular monthly Clearing Fund sizing. In the event that a special margin call is proposed, or had been 10 In event two members of the Office of the Executive Chairman are not available, the Chief Risk Officer ( CRO ) or the Executive Vice President of FRM ( EVP-FRM ) would be able to serve in the approval process.

16 Page 16 of 118 imposed during the most recent three-month period, the affected Clearing Member s draws over the preceding month would be adjusted by the amount of the subsequent month s special margin requirement when calculating the Clearing Fund size. The amount of this special margin requirement would be proposed by FRM based on an analysis of trends in stress test exposure, the amount of any margin calls made under the intra-month monitoring policy and procedures, and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. Pursuant to the proposed CFM Policy, the Rule 601(c) margin requirement would be reviewed on a monthly basis by STLRM and the amount of the additional fixed margin requirement may be adjusted upon the approval of at least two of three members of the Office of the Executive Chairman: (i) upwards in subsequent months if risk exposures continue increasing, or (ii) downward to the extent that risk exposures have declined or future increases in the Clearing Fund offset the need for the increased requirement. Under the proposed CFM Policy, any two members of the Office of the Executive Chairman shall have the authority to reduce the amount of the special margin call if the Clearing Member Group s current exposure drops below the 75% threshold for protective measures, and any such reduction would be effected after the collection of deficits associated with the monthly sizing process. If a special margin call is adjusted, the affected Clearing Member s draws over the preceding month would be adjusted by the new special margin call amount when calculating the Clearing Fund size. Clearing Fund draws within the most recent three-month period, which had previously been adjusted for a special margin call, would remain adjusted by that special margin call amount for the purposes of

17 Page 17 of 118 calculating the Clearing Fund size. Any use of authority to retain special margin charges, including upward or downward adjustments, would require same business day notification to the Risk Committee and OCC s regulators. Under the proposed CFM Policy, in certain situations when a Clearing Member Group presents significantly higher stress test exposures relative to other Clearing Member Groups, it may be determined that the factors that led to margin calls under the financial resources monitoring and call process in the current month have changed significantly such that it is no longer appropriate to impose either a special margin requirement or to mutualize them through an increase to the Clearing Fund. In such a scenario, STLRM would present an analysis to the Office of the Executive Chairman containing a recommendation for the amount of the proposed Clearing Fund size. If the Clearing Member Group(s) Clearing Fund draw driving margin calls made under the financial resources monitoring and call process in the most current month have declined under the threshold used to enact enhanced monitoring (i.e., 65% of the Clearing Fund size, referred to as the enhanced monitoring threshold ), the imposition of additional margin requirements may be waived, while Clearing Fund draws within the most recent month would be adjusted based on the margin calls made under the financial resources monitoring and call process for purposes of calculating the Clearing Fund size. Any such waiver and adjustment of the Clearing Fund size shall require approval by any two of the three members of the Office of the Executive Chairman In event two members of the Office of the Executive Chairman are not available, the CRO or EVP-FRM would be able to serve in the approval process.

18 Page 18 of 118 The proposed course of action would allow OCC to effectively convert, where appropriate, intra-day margin calls that are currently made pursuant to Rule 609 and the FRMC Procedure (and which are not factored in during the monthly Clearing Fund sizing process) into a daily margin requirement under Rule 601, resulting in a defaulter pays approach to collateralizing the associated risks as the special Rule 601(c) margin requirement would then be taken into consideration when calculating Clearing Fund draw exposure estimates during the monthly Clearing Fund sizing process as opposed to mutualizing that risk through all Clearing Member Groups Clearing Fund contribution requirements. 2. Elimination of Caps on Intra-Month Clearing Fund Margin Calls Currently, under the FRMC Procedure, intra-day margin calls resulting from a breach of the 75% threshold are capped at the lesser of $500 million per Clearing Member or 100% of a given Clearing Member s net capital; however, OCC s management retains discretion to call for additional margin beyond those amounts. OCC proposes to modify this process such that the Office of the Executive Chairman would continue to be notified of any margin call in excess of the $500 million threshold but to eliminate the concept of the $500 million threshold serving as a cap on margin calls. In addition, OCC proposes to modify the process so that the 100% of Clearing Member net capital amount would serve as a trigger for escalation to the Office of the Executive Chairman, and each of the Executive Chairman, COO, or CAO would have the authority to determine whether to continue calling for additional margin in excess of this amount (as opposed to this amount serving as a cap on margin calls) or to cease margin calls for the member in question. Under the proposed CFM Policy, the Office of the Executive Chairman

19 Page 19 of 118 may determine to impose a cap on margin calls above these thresholds if necessary or appropriate. Any determination to impose a cap on margin calls shall be based on consideration of factors including, but not limited to, the amount of the call above the threshold, FRM s assessment of the Clearing Members ability to meet the call based on its financial condition, and the amount of collateral it has available to pledge. OCC believes the proposed changes would clarify OCC management s current discretionary authority to call for additional margin beyond the $500 million and 100% of net capital amounts and more appropriately reflect the Risk Committee and Board s determination that those that bring the risk to OCC should bear this risk intra-month. 3. Adjustment to Minimum Intra-Month Resizing Amount OCC also proposes to adjust the minimum quantum of its intra-month Clearing Fund resizing authority. Currently, under the FRMC Procedure, any intra-month resizing of the Clearing Fund is subject to a minimum amount equal to the greater of (i) $1 billion or (ii) 125% of the difference between the projected draw (reduced by margin calls issued) and the Clearing Fund in effect. This fixed amount eliminates OCC s flexibility to appropriately adjust the size of the Clearing Fund given the particular facts and circumstances at the time of the resizing. As a result, OCC may be forced to resize the fund at a level that limits its ability to meet its mandate to be effective and efficient. 12 OCC therefore proposes to reduce the minimum intra-month 12 See, e.g., Rule 17Ad-22(e)(21), which requires, in part, that OCC establish, implement, maintain and enforce written policies and procedures reasonably designed to be efficient and effective in meeting the requirements of its participants and the markets it serves, and have OCC s management regularly review the efficiency and effectiveness of its risk management policies and procedures.

20 Page 20 of 118 resizing increment to $100 million. Under the proposed CFM Policy, the ultimate intra-month resizing increment would be determined based on factors including, but not limited to, the amount of exceedance above the threshold, the time of the month, information related to the Clearing Member or Clearing Member Group s exposures (both current and projected), the number of Clearing Member Groups breaching the 75% threshold, and the market environment for the products which OCC clears (including, among other things, changes in volume or volatility). Consistent with OCC s current practices, any intra-month increase in the Clearing Fund would require approval from the Executive Chairman, COO, or CAO. 4. Proposed Changes to Rules, Policies, and Procedures Finally, OCC proposes to effectuate the proposed changes described above by formalizing and updating OCC s CFM Policy and making related amendments to Rule In connection with these changes, OCC proposes to replace as rules of OCC its Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure with the CFM Policy as the material aspects of OCC s Clearing Fund-related operations would now be addressed in the Rules and proposed CFM Policy. 13 i. Amendments to OCC Rules OCC proposes to amend Rule 1001 to include new Interpretation and Policy.05 to provide that, notwithstanding the last sentence of Rule 1001(a), daily Clearing Fund calculations 13 OCC notes that it would continue to maintain the Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure as internal OCC procedures; however, these procedures would no longer be filed as rules of OCC under the Exchange Act. The procedures would also be revised to conform to the proposed changes described herein.

21 Page 21 of 118 used to set the monthly Clearing Fund size may be adjusted to reflect the imposition of any special margin charges pursuant to OCC s authority under Rule 601(c) and in accordance with OCC s policies and procedures. OCC also proposes non-substantive clean-up and conforming changes to Rule 1001(a). ii. Formalizing and Updating of the Clearing Fund Methodology Policy OCC also proposes to formalize its CFM Policy to describe OCC s current practices regarding its Clearing Fund and update the policy to implement the proposed changes described above. The proposed policy changes are described in detail below. Clearing Fund Size Computation and Estimation The proposed CFM Policy would describe OCC s current model-based approach to estimating the monthly Clearing Fund size, 14 including the overall Clearing Fund model framework and assumptions. The CFM Policy would provide that OCC uses the STANS framework and incorporates various further assumptions specific to the Clearing Fund sizing methodology. These assumptions include, for example: (i) the use of the same two-day liquidation risk horizon as OCC s margin methodology; (ii) the use of the Idiosyncratic Default Scenario or the Minor Systemic Event Default Scenario in calculating the Clearing Fund size; (iii) the distribution assumptions used in simulations; (iv) the assumption of a tripling of market volatility for the Clearing Fund stress scenarios; (v) the exclusion of Clearing Fund replenishment rights or for any recoveries the Clearing Fund might make from assets of defaulted clearing firm(s) not held at OCC; and (vi) the use of a prudential margin of safety to 14 See supra note 4 and associated text.

22 Page 22 of 118 provide an additional buffer to absorb potential future exposures not previously observed during the look-back period. The CFM Policy would also discuss the generation of Monte Carlo scenarios for the liquidation values of cleared products and of equity and certain U.S. Treasury securities deposited as margin in Clearing Members accounts at OCC as well as the treatment of other securities that are subject to traditional haircuts and valued for Clearing Fund estimation purposes at post-haircut valuation. In addition, the CFM policy would describe the daily computation of OCC s projected maximum financial resources under extreme but plausible market conditions. On the first business day of each month, STLRM would determine the peak five-day rolling average of the Clearing Fund draws observed over the preceding three calendar months to establish the size of the Clearing Fund for the current calendar month and recommend the monthly Clearing Fund size for approval to an officer (Vice President or higher) of FRM in accordance with the Monthly Clearing Fund Sizing Procedure. The CFM Policy would further provide that the daily Clearing Fund draws used to determine the monthly Clearing Fund size would take into consideration, if applicable, any special margin requirements imposed under Rule 601(c) as proposed above. Financial Resources Monitoring and Call Process Under the proposed CFM Policy, OCC would maintain certain processes to ensure that on a continuous basis it maintains sufficient financial resources to protect it from the default of one or more of its Clearing Member Groups. In support of this objective, FRM would be responsible for maintaining procedures designed to monitor and analyze on a daily basis OCC s peak exposure in order to identify circumstances where it should consider collection of

23 Page 23 of 118 additional margin from a Clearing Member Group responsible for the peak exposure or an intramonth resizing of the Clearing Fund. Consistent with current practice and the FRMC Procedure, FRM would monitor the daily future hypothetical exposures computed under OCC s Clearing Fund methodology and compare those exposures to the current Clearing Fund size. In any instance where a projected Idiosyncratic Clearing Fund Draw(s) exceeds 65% of the Clearing Fund in effect or, when a Clearing Member or Clearing Member Group previously received a margin call as a result of the financial resources monitoring and call process, STLRM staff would begin enhanced monitoring of such Clearing Members/Groups to track instances where projected draws are approaching thresholds for protective action in accordance with the FRMC Procedure. STLRM would be required to notify FRM in writing whenever the enhanced monitoring threshold is exceeded. Under the proposed CFM Policy and consistent with the current FRMC Procedure, in the event that FRM observes a scenario where the Idiosyncratic Clearing Fund Draw exceeds 75% of the Clearing Fund, FRM shall issue an intra-day margin call pursuant to Rule 609 against the Clearing Member or Clearing Member Group that caused such a draw with the amount of the margin call being the difference between the projected draw and the Base Amount ( Exceedance Above Base Amount ). All such margin calls shall be reviewed and if appropriate approved by an officer of FRM. The proposed CFM Policy would be updated, however, to reflect the newly proposed process described in the Elimination of Caps on Intra-Month Clearing Fund Margin Calls section above whereby the $500 million dollar and 100% of net capital thresholds would serve as notification and escalation triggers, respectively, for the Office of the Executive

24 Page 24 of 118 Chairman and would no longer be characterized as caps on margin calls under the policy and associated procedures to more accurately reflect OCC managements existing discretionary authority to exceed these amounts. The proposed CFM Policy also would address OCC s existing authority to increase the size of the fund intra-month in more extreme scenarios if a projected draw exceeds 90% of the Clearing Fund (after applying any funds then on deposit with OCC from the applicable Clearing Member or Clearing Member Group pursuant to a margin call made under the CFM Policy). The CFM Policy would be updated, however, to reflect the proposed changes to OCC s minimum intra-month resizing increment (to $100 million) as discussed in the Adjustment to Minimum Intra-Month Resizing Amount section above. The proposed CFM Policy would also clarify that, consistent with current practice under the Clearing Fund Intra-Month Re-sizing Procedure, if, during external notification to Clearing Members, OCC staff discovers a Clearing Member may have a concern with satisfying the projected pay, staff will immediately notify the Vice President of STLRM ( VP-STLRM ) or another officer of FRM. In this case, enhanced monitoring and reporting of settlement processing on the second business day may be recommended, and the VP-STLRM or another officer of FRM would escalate the issue to the Office of the Executive Chairman based on the situation. In addition, under the proposed CFM Policy, and in accordance with existing practice, the Risk Committee would retain the authority to determine whether the Clearing Fund increase was sufficient or to further increase the size of the Clearing Fund or any margin calls made pursuant to the policy. In addition, Clearing Members would continue to be required to meet the call for additional Clearing Fund assets by

25 9:00 AM CT on the second business day following the intra-month increase. File No. SR-OCC Page 25 of 118 The proposed CFM Policy also would be updated to reflect the proposed incorporation of special margin charges under Rule 601(c) into the monthly and intra-month Clearing Fund sizing and monitoring processes as described in the Incorporation of Rule 601(c) Margin Authority into Clearing Fund Processes section above. Clearing Fund Deposits The proposed CFM Policy would describe OCC s existing rules and practices with respect to Clearing Fund deposits. Specifically, the policy would provide that Clearing Fund deposits be limited to the most liquid forms of collateral to ensure that OCC maintains adequate sources of liquidity in the event of a Clearing Member default (e.g., those assets acceptable for pledging under OCC s committed liquidity facilities). Forms of acceptable assets currently include: (1) cash (U.S. dollar only); (2) U.S. government securities; and (3) Canadian government securities. In addition, the policy would provide that OCC s first line business operations shall ensure each time a liquidity facility is renewed that the securities eligible for pledge as Clearing Fund deposits align with those securities permitted for pledge under the committed liquidity facility. Additionally, the proposed policy would contain a discussion of OCC s minimum cash Clearing Fund requirement, which was recently approved by the Commission and is expected to be implemented on March 1, See Order Approving Proposed Rule Change, as Modified by Amendment No. 1, Concerning The Options Clearing Corporation's Adoption of a New Minimum Cash Requirement for the Clearing Fund, Securities Exchange Act Release No (January 12, 2018), 83 FR 2825 (January 19,

26 Page 26 of 118 Clearing Fund Assessments The CFM Policy also would describe OCC s existing authority to call for replenishment of the Clearing Fund in accordance with Article VIII, Sections 5 and 6 of OCC s By-Laws, upon approval of any of the Executive Chairman, COO, or CAO. Clearing Fund Methodology Monitoring and Review Activities Finally, the CFM Policy would formalize and update the Clearing Fund monitoring, review, and reporting responsibilities of various OCC personnel. Under the proposed policy, on a daily basis, STLRM would be responsible for monitoring the results of all Clearing Fund draws, in accordance with the FRMC Procedure. STLRM would be required to prepare summary reports describing the results of the Clearing Fund draw estimates on a daily and monthly basis and reviewing the adequacy of OCC s financial resources in accordance with OCC s Stress Test Reporting Procedure. The monthly analysis shall be reported to OCC s Management Committee and Risk Committee, and other reports may be provided to the Management Committee, Risk Committee, and other stakeholders pursuant to procedures established for those purposes. The CFM Policy would provide that, on a monthly basis, OCC s Stress Test Working Group ( STWG ), a cross-departmental group including members from FRM, Quantitative Risk Management, and Enterprise Risk Management, shall review a summary of the month s stress- 2018) (SR-OCC ) and Notice of No Objection to Advance Notice, as Modified by Amendment No. 1, Concerning the Adoption of a New Minimum Cash Requirement for the Clearing Fund, Securities Exchange Act Release No (January 12, 2018), 83 FR 2843 (January 19, 2018) (SR-OCC ).

27 testing results in accordance with the Stress Test Working Group Procedure. File No. SR-OCC Page 27 of 118 In addition, the CFM Policy would require that, on an annual basis, the Model Validation Group shall perform a model validation of OCC s Clearing Fund model and propose any changes in accordance with the Model Risk Management Policy and related procedures. Additionally, the Risk Committee would be required to review the model validation report. Moreover, on an annual basis, the Risk Committee would be required to review and approve the CFM Policy. iii. Clearing Fund Procedures OCC previously filed with the Commission, and received approval for, a proposed rule change concerning its Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure, which detail OCC s procedures regarding the monthly resizing of its Clearing Fund and the addition of financial resources through intra-day margin calls and/or an intra-month increase of the Clearing Fund to ensure that it maintains adequate financial resources in the event of a default of a Clearing Member or group of affiliated Clearing Members presenting the largest exposure to OCC. 16 As part of this proposed rule change, OCC proposes to withdraw as rules of a clearing agency for purposes of the Exchange Act its existing Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure and replace them with the proposed CFM Policy. 17 OCC 16 See supra note Section 19(b)(1) of the Exchange Act requires a self-regulatory organization ( SRO ) such as OCC to file with the Commission any proposed rule or any proposed change in, addition to, or deletion from the rules of such SRO. See 15 U.S.C. 78s(b)(1). Section 3(a)(27) of the Exchange Act defines rules of a clearing agency to mean its (1) constitution, (2) articles of incorporation, (3) bylaws, (4) rules, (5) instruments corresponding to the foregoing and (6) such stated policies, practices and interpretations ( SPPI ) as the Commission may determine by rule. See 15 U.S.C.

28 Page 28 of 118 believes that the proposed CFM Policy more appropriately describes the material aspects of OCC s Clearing Fund-related operations and is therefore properly filed as a rule of OCC under the Exchange Act. Accordingly, OCC believes that, with the formalizing of its CFM Policy, the Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure would no longer be appropriately filed as rules of OCC under the Exchange Act because they would contain only the procedural and administrative aspects of OCC s Clearing Fund-related processes that would be reasonably and fairly implied by the CFM Policy or would otherwise not be deemed to be material aspects of OCC s Clearing Fund-related operations. OCC therefore believes it would be appropriate to withdraw these procedures as rules and replace them with the CFM Policy. B. Statutory Basis Section 17A(b)(3)(F) of the Act 18 requires, among other things, that the rules of a clearing agency be designed to assure the safeguarding of securities and funds in the custody or control of the clearing agency or for which it is responsible, and, in general, to protect investors and the public interest. OCC believes that the proposed changes would provide OCC with greater flexibility to address the risks presented by its Clearing Members on both a monthly and intra-month basis by allowing OCC to more appropriately allocate risk charges between margin 78c(a)(27). Exchange Act Rule 19b-4(a)(6) defines the term SPPI to mean, in addition to certain publicly facing statements, any material aspect of the operation of the facilities of the [SRO]. See 17 CFR b-4(a)(6). Rule 19b-4(c) provides, however, that an SPPI may not be deemed to be a proposed rule change if it is: (i) reasonably and fairly implied by an existing rule of the SRO or (ii) concerned solely with the administration of the SRO and is not an SPPI with respect to the meaning, administration, or enforcement of an existing rule the SRO U.S.C. 78q-1(b)(3)(F).

29 Page 29 of 118 requirements and Clearing Fund contributions so that those contributions are commensurate to the risks posed by Clearing Members. Specifically, the proposed changes to incorporate OCC s Rule 601(c) margin authority into the monthly and intra-month Clearing Fund sizing and monitoring processes would allow OCC to more appropriately allocate risk charges (e.g., margin or Clearing Fund) to those Clearing Members driving the risks under the limited and unique circumstances where two or fewer Clearing Member Group(s) are presenting exposure in the form of elevated projected draws to a much greater magnitude than other Clearing Member Groups (i.e., where the projected stress test exposure of the third largest Clearing Member Group(s) is less than or equal to 50% of the projected Clearing Fund size, including the prudential margin of safety). The application of this authority would take into consideration trends in stress test exposure, the amount of margin calls made during the month, and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. The proposed changes also would provide more clarity and transparency around OCC s intra-day Clearing Fund margin call process by more explicitly describing OCC s authority to continue calling for additional margin above certain pre-established thresholds where OCC management believes it is more appropriate that those Clearing Members bringing risk to OCC should bear that risk on an intra-month basis. The proposed changes would provide OCC with the clear, transparent, and ex ante authority to employ a defaulter pays approach in these circumstances. The additional clarity and transparency around the monthly and intra-month Clearing Fund processes should allow OCC Clearing Members to better understand and anticipate their potential obligations to OCC so

30 Page 30 of 118 that they can manage these risks. Moreover, a clearly articulated defaulter pays approach in these circumstances would help incentivize those members generating significantly higher stress test exposures to reduce those exposures, and thereby mitigate risks presented to OCC and its Clearing Members generally. In addition, the proposed reduction in the minimum increment for resizing the Clearing Fund on an intra-month basis would allow OCC the flexibility to more appropriately resize the Clearing Fund intra-month based on factors including, but not limited to, the amount of exceedance above the threshold, the time of the month, information related to the Clearing Member or Clearing Member Groups exposures (both current and projected), the number of Clearing Member Groups breaching the 75% threshold, and the market environment for the products which OCC clears (including, among other things, changes in volume or volatility). OCC notes that, under the proposed change, it would not be precluded from resizing the Clearing Fund at either of the current (i) $1 billion or (ii) 125% of the difference between the projected draw and Clearing Fund in effect amounts. The proposed change is intended to provide increased flexibility to resize the Clearing Fund at different minimum increments if such amounts would (i) enable OCC to continue to cover its credit exposure to each participant fully with a high degree of confidence and to cover the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions and (ii) more appropriately enable OCC to be efficient and effective in meeting the requirements of its participants and the markets it serves. For the foregoing reasons, OCC believes the proposed rule change is designed to assure

31 Page 31 of 118 the safeguarding of securities and funds in the custody or control of the clearing agency or for which it is responsible, and, in general, to protect investors and the public interest in accordance with the requirements Section 17A(b)(3)(F) of the Act. 19 OCC also believes the proposed rule change is consistent with the rules promulgated under the Act for the reasons set forth below. Incorporation of Rule 601(c) Margin Authority into OCC s Clearing Fund Processes and Elimination of Margin Call Caps Rules 17Ad-22(e)(4)(i) and (iii) 20 generally require that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by maintaining sufficient financial resources to (i) cover its credit exposure to each participant fully with a high degree of confidence and (ii) cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions. With respect to the use of clearing funds and the requirements of Rule 17Ad- 22(e)(4), 21 the Commission has noted that, [t]o the extent that a clearing agency uses guaranty or clearing fund contributions to mutualize risk across participants, the clearing agency generally should value margin and guaranty fund contributions so that the contributions are commensurate 19 Id CFR Ad-22(e)(4)(i) and (iii) CFR Ad-22(e)(4).

32 Page 32 of 118 to the risks posed by the participants activity and that [t]he clearing agency also generally should consider the appropriate balance of individualized and pooled elements within its default waterfall, with a careful consideration of whether the balance of those elements mitigates risk and to what extent an imbalance among those elements might encourage moral hazard, in that one participant may take more risks because the other participants bear the costs of those risks. 22 OCC believes that the proposed changes to its monthly and intra-month Clearing Fund sizing, monitoring and margin call processes as described in the proposed CFM Policy (including the conforming changes to Rule 1001(a)) are reasonably designed to allow OCC to continue to measure, monitor, and manage its credit exposures to participants and maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence. The proposed incorporation of OCC s special margin charge authority under Rule 601(c) into the monthly and intra-month Clearing Fund sizing and monitoring processes, and the related authority to adjust daily Clearing Fund draw calculations accordingly, would allow OCC to effectively convert, where appropriate, intra-day margin calls that are currently made pursuant to Rule 609 and the FRMC Procedure (and which are not factored in during the monthly Clearing Fund sizing process) into a daily margin requirement under Rule 601, resulting in a defaulter pays approach to collateralizing the associated risks. The special Rule 601(c) margin requirement would then be taken into consideration when calculating Clearing Fund draw 22 See Securities Exchange Act Release Nos (September 28, 2016), 81 FR 70786, (October 13, 2016) (S ).

33 Page 33 of 118 exposure estimates during the monthly Clearing Fund sizing process as opposed to mutualizing that risk through all Clearing Member Groups Clearing Fund contribution requirements. OCC notes that the proposed use of its Rule 601(c) margin authority in this context would be subject to the requirements of the CFM Policy and only be applicable in limited and unique circumstances where two or fewer Clearing Member Group(s) are presenting exposure in the form of elevated projected draws to a much greater magnitude than other Clearing Member Groups (i.e., where the projected stress test exposure of the third largest Clearing Member Group(s) is less than or equal to 50% of the projected Clearing Fund size, including the prudential margin of safety), and the application of this authority would take into consideration trends in stress test exposure, the amount of margin calls made during the month, and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. In addition, OCC proposes to provide additional clarity and transparency around the intended use of OCC management s discretion to call for intra-day margin beyond the $500 million and 100% of net capital thresholds by updating the proposed CFM Policy to provide that the $500 million and 100% of net capital thresholds would serve as notification and escalation triggers, respectively, for the Office of the Executive Chairman and would no longer be characterized as caps on margin calls under the policy and associated procedures. Under the proposed CFM Policy, any determination to impose a cap on margin calls would be based on a consideration of factors including, but not limited to, the amount of the call above the threshold, FRM s assessment of the Clearing Members ability to meet the call based on its financial

34 Page 34 of 118 condition, and the amount of collateral it has available to pledge. OCC believes the proposed changes would clarify OCC management s current discretionary authority to call for additional margin beyond the $500 million and 100% of net capital amounts to more appropriately reflect the determination of OCC s Risk Committee and Board that those that bring the risk to OCC should bear this risk intra-month. OCC believes that the proposed changes would allow OCC to more appropriately value margin and Clearing Fund contributions so that those contributions are commensurate to the risks posed by individual Clearing Members in these circumstances and provide for a more appropriate balance of individualized and pooled elements within OCC s default waterfall. The proposed changes would provide OCC with the clear and transparent authority to employ a defaulter pays approach in circumstances where (i) two or fewer Clearing Members are presenting significantly higher stress test exposures that are driving Clearing Fund requirements for all members in the monthly Clearing Fund sizing process, or (ii) OCC s management determines it is more appropriate that those Clearing Members bringing risk to OCC should bear that risk on an intra-month basis by requiring the deposit of additional intra-day margin beyond certain established thresholds. The proposed changes would allow OCC to give careful consideration to the appropriate balance of individual and mutualized resources, and, where appropriate, require those Clearing Members that bring elevated risk exposures to OCC to bear the costs of those risks. Such a defaulter pays approach would help incentivize those members to reduce their exposures to OCC, and thereby mitigate risks to OCC and its Clearing Members and discourage moral hazard. OCC notes that the proposed changes described herein

35 Page 35 of 118 would not impact OCC s current Clearing Fund methodology or the underlying parameters and assumptions of the methodology. As a result, OCC believes the proposed changes would continue to provide OCC with the authority to maintain sufficient financial resources in the form of both margin and Clearing Fund requirements to cover its credit exposure to each participant fully with a high degree of confidence and to cover the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions. Accordingly, OCC believes that the proposed changes are reasonably designed to promote compliance with the requirements of Rules 17Ad-22(e)(4)(i) and (iii). 23 Adjustment to Minimum Intra-Month Resizing Amount As noted above, Rules 17Ad-22(e)(4)(i) and (iii) 24 generally require that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by maintaining sufficient financial resources to (i) cover its credit exposure to each participant fully with a high degree of confidence and (ii) cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions. Rule 17Ad-22(e)(21) 25 further requires, in part, that OCC establish, CFR Ad-22(e)(4)(i) and (iii). 24 Id CFR Ad-22(e)(21).

36 Page 36 of 118 implement, maintain and enforce written policies and procedures reasonably designed to be efficient and effective in meeting the requirements of its participants and the markets it serves, and have OCC s management regularly review the efficiency and effectiveness of its risk management policies and procedures. OCC proposes to change its minimum intra-month Clearing Fund resizing authority to $100 million (as opposed to the current minimum amount, which is equal to the greater of (i) $1 billion or (ii) 125% of the difference between the projected draw reduced by margin calls issued and the Clearing Fund in effect). OCC believes that the current fixed amounts constrain OCC s flexibility to appropriately adjust the size the Clearing Fund given the particular facts and circumstances at the time of the resizing. Under the proposed CFM Policy, the minimum increment for resizing the Clearing Fund on an intra-month basis would be $100 million; however, the ultimate intra-month resizing increment would be determined based on factors including, but not limited to, the amount of exceedance above the threshold, the time of the month, information related to the Clearing Member or Clearing Member Group s exposures (both current and projected), the number of Clearing Member Groups breaching the 75% threshold, and the market environment for the products which OCC clears (including, among other things, changes in volume or volatility. OCC notes that, under the proposed change, it would not be precluded from resizing the Clearing Fund at either of the current (i) $1 billion or (ii) 125% of the difference between the projected draw and Clearing Fund in effect amounts; however, OCC would have increased flexibility to resize the Clearing Fund at different minimum increments if such amounts would (i) enable OCC to continue to cover its credit exposure to each

37 Page 37 of 118 participant fully with a high degree of confidence and to cover the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions and (ii) more appropriately enable OCC to be efficient and effective in meeting the requirements of its participants and the markets it serves. OCC therefore believes the proposed change is reasonably designed to comply with the requirements of Rules 17Ad- 22(e)(4)(i) and (iii) 26 and Rule 17Ad-22(e)(21). 27 Proposed Changes to Policies and Procedures Rule 17Ad-22(e)(3) 28 requires, generally, that at covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain a sound risk management framework for comprehensively managing legal, credit, liquidity, operational, general business, investment, custody, and other risks that arise in or are borne by the covered clearing agency. Moreover, Rule 17Ad-22(e)(4) 29 generally requires that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes. The proposed changes would consolidate into OCC s CFM Policy a number of its existing Clearing Fund and Clearing Fund methodology related practices, which have already been filed in some form with the Commission. For example, the CFM Policy would outline CFR Ad-22(e)(4)(i) and (iii) CFR Ad-22(e)(21) CFR Ad-22(e)(3) CFR Ad-22(e)(4).

38 Page 38 of 118 OCC s current methodology for sizing its Clearing Fund. 30 The CFM Policy also would outline OCC s existing financial resources monitoring and call process, subject to the proposed changes described herein. 31 In addition, the CFM Policy would outline OCC s current authority with respect to the use of Clearing Fund and Clearing Fund replenishment requirements 32 as well as the acceptable forms of Clearing Fund deposits. 33 The proposed CFM Policy would serve as key component of OCC s overall risk management framework 34 by describing OCC s existing policies (subject to the proposed changes described herein) for identifying, measuring, monitoring, and managing the credit exposures intended to be covered by OCC s Clearing Fund. As a result, OCC believes the formalizing and updating of its CFM Policy is reasonably designed to meet the requirements of Rules 17Ad-22(e)(3) and (4), generally. 35 Rules 17Ad-22(e)(2)(i), (ii) and (iv) 36 require that at covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to provide 30 See supra note See supra note See OCC By-Laws, Article VIII, Sections 5 and See OCC By-Laws, Article VIII, Section The Commission recently approved a proposed rule change by OCC to adopt a Risk Management Framework Policy ( RMF ). The RMF describes OCC's framework for comprehensive risk management, including OCC's framework to identify, measure, monitor, and manage all risks faced by OCC in the provision of clearing, settlement, and risk management services. With respect to credit risk, the RMF requires that OCC's credit risk management framework encompass policies and procedures for, among other things, maintaining sufficient prefunded resources in the form of margin and Clearing Fund deposits and a process for replenishing resources. See Securities Exchange Act Release No (December 7, 2017), 82 FR (December 13, 2017) (SR-OCC ). The CFM Policy would serve as a critical component of OCC s credit risk management framework under the RMF CFR Ad-22(e)(3) and (4) CFR Ad-22(2)(i), (ii) and (iv).

39 Page 39 of 118 for governance arrangements that are clear and transparent, clearly prioritize the safety and efficiency of the covered clearing agency, and specify clear and direct lines of responsibility. The proposed CFM Policy would consolidate and update the Clearing Fund monitoring, review, and reporting requirements for various OCC personnel, including the regular review and monitoring activities performed by FRM staff and OCC s STWG as well as the reporting and escalation of Clearing Fund related matters to OCC s Management Committee and Risk Committee. OCC believes that, in this way, the CFM Policy is reasonably designed to provide for governance arrangements are clear and transparent, clearly prioritize the safety and efficiency of OCC, and specify clear and direct lines of responsibility with respect to OCC s Clearing Fund in accordance with the requirements of Rules 17Ad-22(e)(2)(i), (ii) and (iv). 37 For the reasons set forth above, OCC believes the proposed rule change is designed to assure the safeguarding of securities and funds at OCC and, in general, protect investors and the public interest consistent with Section 17A(b)(3)(F) of the Act 38 and the rules promulgated thereunder. Item 4. Self-Regulatory Organization s Statement on Burden on Competition Section 17A(b)(3)(I) of the Act 39 requires that the rules of a clearing agency not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act. OCC does not believe that the proposed rule change would impact or impose any burden on 37 Id. 38 Id U.S.C. 78q-1(b)(3)(I).

40 Page 40 of 118 competition. The proposed changes to OCC s monthly and intra-month Clearing Fund processes would apply equally to all Clearing Members. The proposed changes would not affect Clearing Members access to OCC s services, nor would any of these proposed changes disadvantage or favor any particular user in relationship to another user. As such, OCC believes that the proposed changes would not have any impact or impose any burden on competition. Item 5. Self-Regulatory Organization s Statement on Comments on the Proposed Rule Change 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. Item 6. Extension of Time Period for Commission Action Not applicable. Item 7. Basis for Summary Effectiveness Pursuant to Section 19(b)(3) or for Accelerated Effectiveness Pursuant to Section 19(b)(2) or Section 19(b)(7)(D) Not applicable. Item 8. Proposed Rule Change Based on Rule of Another Self-Regulatory Organization or of the Commission Not applicable. Item 9. Security-Based Swap Submissions Filed Pursuant to Section 3C of the Act Not applicable. Item 10. Advance Notices Filed Pursuant to Section 806(e) of the Payment, Clearing and Settlement Supervision Act Not applicable.

41 Page 41 of 118 Item 11. Exhibits Exhibit 1A. Completed Notice of Advance Notice for publication in the Federal Register. Exhibit 5A. Exhibit 5B. Exhibit 5C. Exhibit 5D. Exhibit 5E. OCC Rules. Clearing Fund Methodology Policy. Clearing Fund Intra-Month Re-sizing Procedure. Financial Resources Monitoring and Call Procedure. Monthly Clearing Fund Sizing Procedure. Confidential Treatment is Requested for Exhibits 5B-5E Pursuant to SEC Rule 24b-2

42 Page 42 of 118 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, The Options Clearing Corporation has caused this filing to be signed on its behalf by the undersigned hereunto duly authorized. THE OPTIONS CLEARING CORPORATION By: Justin W. Byrne Vice President, Regulatory Filings

43 Page 43 of 118 EXHIBIT 1A SECURITIES AND EXCHANGE COMMISSION (Release No. 34-[ ]; File No. SR-OCC ) February, 2018 Self-Regulatory Organizations; The Options Clearing Corporation; Notice of Filing of Proposed Rule Change Related to The Options Clearing Corporation s Monthly and Intra-Month Clearing Fund Sizing and Monitoring Processes Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 ( Act ), 1 and Rule 19b-4 thereunder, 2 notice is hereby given that on February 2, 2018, The Options Clearing Corporation ( OCC ) filed with the Securities and Exchange Commission ( Commission ) the proposed rule change as described in Items I, II, and III below, which Items have been prepared primarily by OCC. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Clearing Agency s Statement of the Terms of Substance of the Proposed Rule Change The proposed rule change by OCC would modify OCC s monthly and intramonth Clearing Fund sizing and monitoring processes to: (1) describe how OCC would use its existing authority under OCC Rule 601(c) to set amounts called as intra-day margin under the current procedures as an additional margin requirement, which could be retained month-over-month for purposes of the monthly Clearing Fund sizing process and taken into consideration when determining final daily Clearing Fund draw calculations; (2) eliminate characterization of the current $500 million and 100% of net capital 1 15 U.S.C. 78s(b)(1) CFR b-4.

44 Page 44 of 118 thresholds for intra-month Clearing Fund margin calls as caps on such margin calls; (3) adjust the minimum intra-month Clearing Fund resizing increment to $100 million (as opposed to the current minimum of either (i) $1 billion or (ii) 125% of the difference between the projected draw and the Clearing Fund in effect); and (4) codify existing OCC practices concerning the Clearing Fund (and in particular, practices currently detailed in OCC s Clearing Fund Intra-Month Re-sizing Procedure, Financial Resources Monitoring and Call Procedure ( FRMC Procedure ), and Monthly Clearing Fund Sizing Procedure) as well as the newly proposed enhancements through the formalizing and updating of OCC s Clearing Fund Methodology Policy ( CFM Policy ). OCC notes that, as part of the proposed changes, OCC would withdraw as rules of a clearing agency for purposes of the Exchange Act 3 its existing Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure as the material aspects of OCC s Clearing Fund-related operations would be addressed in the Rules and proposed CFM Policy. The proposed amendments to OCC s Rules can be found in Exhibit 5A. Material proposed to be added to the Rules as currently in effect is marked by underlining, and material proposed to be deleted is marked in strikethrough text. The proposed CFM Policy is included in confidential Exhibit 5B of the filing and has been submitted generally without marking to facilitate review and readability of the document as it is being submitted in its entirety as new rule text. The Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure can be found in Exhibits 5C, 5D and 5E, 3 15 U.S.C. 78a et seq.

45 Page 45 of 118 respectively, with the deletion (or withdrawing as rules ) of these procedures indicated by strikethrough text. All terms with initial capitalization not defined herein have the same meaning as set forth in OCC s By-Laws and Rules. 4 II. Clearing Agency s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, OCC included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. 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), (B), and (C) below, of the most significant aspects of these statements. (A) Clearing Agency s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change (1) Purpose Background 1. Overview of OCC s Clearing Fund Sizing and Monitoring Processes OCC Rule 1001(a) provides that the total size of OCC s Clearing Fund shall be established at an amount determined by OCC to be sufficient to protect it against loss under simulated default scenarios that include the default of the single Clearing Member Group whose default would be likely to result in the largest draw against the Clearing Fund as well as an event involving the near-simultaneous default of two randomlyselected Clearing Member Groups as modeled using Monte Carlo simulations similar to those referred to in Rule 601(c). Rule 1001(a) further provides that such calculations 4 OCC s By-Laws and Rules can be found on OCC s public website:

46 Page 46 of 118 shall be made on a daily basis, and the size of the Clearing Fund shall be readjusted monthly to equal the peak five-day rolling average of such calculations observed over the preceding three calendar months plus a prudential margin of safety determined by OCC, but may be increased intra-month in accordance with OCC s procedures. OCC has established procedures regarding its processes for (i) the monthly resizing of its Clearing Fund (Monthly Clearing Fund Sizing Procedure), (ii) the addition of financial resources through intra-day margin calls and/or an intra-month increase of the Clearing Fund to ensure that it maintains adequate financial resources in the event of a default of a Clearing Member/Clearing Members Group presenting the largest exposure to OCC (FRMC Procedure), and the execution of any intra-month resizing of the Clearing Fund (Clearing Fund Intra-Month Re-sizing Procedure). 5 Pursuant to OCC s current Clearing Fund methodology, OCC sizes its Clearing Fund at an amount sufficient to protect OCC against losses under simulated default scenarios that include (i) an Idiosyncratic Default Scenario that includes the default of the single Clearing Member Group whose default would be likely to result in the largest draw against the Clearing Fund at a 99% confidence level and (ii) a Minor Systemic Event Default Scenario involving the near-simultaneous default of two randomlyselected Clearing Member Groups with each pair of distinct Clearing Members being deemed equally likely calculated at a 99.9% confidence level. 6 Pursuant to the Monthly Clearing Fund Sizing Procedure, OCC uses the daily peak of such draw estimates to 5 See Securities Exchange Act Release No (May 15, 2015), 80 FR (May 21, 2015) (SR-OCC ). See also Securities Exchange Act Release No (May 15, 2015), 80 FR (May 21, 2015) (SR-OCC ). 6 See Securities Exchange Act Release No (September 23, 2011), 76 FR (September 29, 2011) (SR-OCC ).

47 Page 47 of 118 determine the monthly size of the Clearing Fund, which is established at the greater of (i) a Base Amount equal to the peak five-day rolling average of the Clearing Fund draws (i.e., the estimated stress loss exposures in excess of margin requirements) observed over the preceding three calendar months, plus a prudential margin of safety equal to $1.8 billion, or (ii) 110% of OCC s committed credit facilities. Supplemental to the monthly process, OCC s Financial Risk Management department ( FRM ) assesses on a daily basis the sufficiency of the Clearing Fund by monitoring Clearing Fund draw estimates in order to identify exposures that may require: (i) collection of additional margin from a Clearing Member Group pursuant to OCC s intra-day margin call authority under Rule or (ii) an intra-month resizing of the Clearing Fund in accordance with OCC s FRMC Procedure. In instances where an estimate of a particular Clearing Member Group s Clearing Fund draw under an Idiosyncratic Default Scenario (referred to herein as an Idiosyncratic Clearing Fund Draw ) exceeds 75% of the amount currently in the Clearing Fund (i.e., the current Clearing Fund requirement less any deficits) (such amount hereinafter referred to as the 75% threshold ), OCC has the authority to issue a margin call against the Clearing Member Group(s) generating such draw(s) for an amount equal to the difference between 7 Rule 609 allows OCC to require the deposit of such additional margin ( intra-day margin ) by any Clearing Member in any account at any time during any business day, as an officer deems advisable to reflect changes in: (i) the market price during such day of any series of options held in a short position in such account or of any underlying interest underlying any cleared security (including an exercised option) in such account or of any Loaned Stock that is the subject of a stock loan or borrow position in such account, (ii) the size of such Clearing Member's positions in cleared securities or stock loan or borrow positions, (iii) the value of securities deposited by the Clearing Member as margin, or (iv) the financial position of the Clearing Member, or otherwise to protect OCC, other Clearing Members or the general public.

48 Page 48 of 118 such estimated draw amount and the Base Amount of the Clearing Fund. 8 Under the FRMC Procedure, margin calls are subject to a per-clearing Member cap equal to the lesser of $500 million or 100% of such Clearing Member s net capital; however, OCC s management retains discretion under the FRMC Procedure to call for additional margin beyond those amounts. All margin calls issued under the FRMC Procedure remain in place until deficits associated with the next monthly Clearing Fund sizing are collected. In more extreme observations, where OCC observes an Idiosyncratic Clearing Fund Draw estimate (after factoring in margin calls issued) exceeding 90% of the Clearing Fund ( 90% threshold ), OCC has the authority under Rule 1001(a), FRMC Procedure, and Clearing Fund Intra-Month Re-sizing Procedure to increase the size of the Clearing Fund by a minimum amount equal to the greater of (i) $1 billion or (ii) 125% of the difference between the projected draw (reduced by margin calls issued) and the Clearing Fund in effect. Any deficits associated with the increase to the Clearing Fund must be satisfied within two business days of the resizing. Under OCC s Clearing Fund methodology, OCC includes any margin deposited as a result of both calculated margin requirements under Rule 601 and intra-day margin calls for the month in question under Rule 609 (including calls made pursuant to the FRMC Procedure) when calculating Clearing Fund draw exposure estimates for purposes 8 In the case where an estimated draw is associated with multiple Clearing Members within a single Clearing Member Group, the margin call is allocated among the individual Clearing Members in the Clearing Member Group based on each Clearing Member s proportionate share of the total risk for such Clearing Member Group, as that term is defined in OCC Rule 1001(b). Accordingly, the term total risk in this context means the margin requirement with respect to all accounts of the Clearing Member Group exclusive of the net asset value of the positions in such accounts aggregated across all such accounts.

49 Page 49 of 118 of intra-day margin calls and intra-month resizing. 9 Intra-day margin is excluded, however, from the calculation of daily Clearing Fund draw estimates used in the monthly sizing process, and this additional exposure is therefore incorporated into the new monthly Clearing Fund size with the associated risk being mutualized through all Clearing Members Clearing Fund contribution requirements. 10 In addition to the Clearing Fund sizing and intra-day margin call authority described above, OCC notes that existing Rule 601(c) provides OCC with the authority to fix the margin requirement for any account or any class of cleared contracts at such amount as it deems necessary or appropriate under the circumstances to protect the respective interests of Clearing Members, OCC, and the public. This authority exists separate from OCC s authority to call for intra-day margin under Rule 609, and any additional fixed margin amount would be considered part of the regular daily margin requirement under Rule 601 for the Clearing Member/account in question. To-date, OCC has not exercised its authority under Rule 601(c) in connection with the monthly and intra-month Clearing Fund sizing and monitoring processes. 2. Recent Events Impacting OCC s Clearing Fund For the month of October 2017, OCC s Clearing Fund was sized to approximately $9.2 billion. By mid-month, however, OCC observed stress test exposures for a very 9 That is, both daily margin requirements and intra-day margin on deposit are included when determining the amount of stress test losses from the Clearing Fund draw in excess of margin on the day of the calculation. 10 The current Clearing Fund methodology and Monthly Clearing Fund Sizing Procedure do not contemplate the inclusion of intra-day margin collected under the FRMC Procedure in the estimated daily Clearing Fund draws used to size the Clearing Fund because this intra-month margin is returned to affected Clearing Member Groups upon the collection of all deficits associated with the next monthly resizing

50 Page 50 of 118 small subset of Clearing Member Groups breaching the 75% threshold of the Clearing Fund, which triggered a series of intra-day margin calls for those Clearing Member Groups under the FRMC Procedure. Near the end of October, increased exposures by these Clearing Member Groups persisted, ultimately resulting in an observed breach exceeding 90% of the Clearing Fund (after accounting for intra-day margin calls), prompting OCC to execute an intra-month resizing of the Clearing Fund under the FRMC Procedure and Clearing Fund Intra-Month Re-sizing Procedure. On October 26, 2017, OCC mutualized a portion of these increased exposures through an intra-month increase in the size of the Clearing Fund by the minimum increment of $1 billion (to a total of approximately $10.2 billion). On November 1, 2017, the Clearing Fund was further increased to approximately $11.6 billion through the normal monthly sizing process to account for those peak exposures observed during the month of October, which had been collateralized in the form of intra-day margin from the Clearing Member Groups in question under the FRMC Procedure. Based on peak exposures realized during the month of November 2017, the limited number of Clearing Member Groups in question were subject to significant additional margin calls under the FRMC Procedure, which required OCC management to waive margin call caps under the FRMC Procedure on a number of occasions. At the end of November, OCC initiated its normal course monthly sizing process under OCC s Clearing Fund methodology and the Monthly Clearing Fund Sizing Procedure. As described in detail above, OCC s Clearing Fund methodology and Monthly Clearing Fund Sizing Procedure currently provide that intra-day margin collected under the FRMC Procedure for the prior month is excluded from the calculation

51 Page 51 of 118 of daily Clearing Fund draw estimates for that month for purposes of the next monthly Clearing Fund sizing. As a result, these increased exposures observed in November, which again were being driven only by a small subset of OCC Clearing Members, were mutualized into the overall Clearing Fund at month s end, and on December 1, 2017, the Clearing Fund was increased an additional $3.1 billion for a total Clearing Fund size of approximately $14.7 billion (an increase of approximately 60% over a two month period). OCC notes that these increases in Clearing Fund size were being driven by a very small subset of Clearing Members presenting significantly higher stress test exposures under OCC s Clearing Fund methodology. As a result, Clearing Members whose own activities were not driving the size of the Clearing Fund higher and who had limited ability to take action to reduce their requirements were nevertheless subjected to the risk and cost of these increased exposures through mutualized Clearing Fund requirements. Moreover, OCC notes that the current fixed intra-month resizing increment of $1 billion constrains OCC s flexibility to appropriately adjust the size of the Clearing Fund given the particular facts and circumstances at the time of the resizing (e.g., OCC may be forced to resize the fund at a level that limits its ability to meet its mandate to be effective and efficient in meeting the requirements of its participants and the markets it serves). As a result of these recent events, OCC s Risk Committee and Board have approved, and OCC proposes to make, certain modifications and clarifications to OCC s monthly and intra-month Clearing Fund processes to more appropriately allocate the risk presented in these unique circumstances between mutualized resources (i.e., Clearing

52 Page 52 of 118 Fund) and defaulter pay resources (i.e., margin) so that those that bring risk to OCC will bear that risk. Proposed Changes to OCC s Monthly and Intra-Month Clearing Fund Processes OCC is proposing a number of enhancements to its monthly and intra-month Clearing Fund sizing and monitoring processes to provide additional flexibility for OCC to appropriately manage its risks and to address the recent Clearing Fund-related issues described above. Specifically, OCC proposes to: (1) describe how OCC would use its existing authority under OCC Rule 601(c) to set amounts called as intra-day margin under the current procedures as an additional Rule 601 margin requirement, which could be retained month-over-month for purposes of the monthly Clearing Fund sizing process and taken into consideration when determining final daily Clearing Fund draw calculations; (2) eliminate the current $500 million and 100% of net capital caps on intra-month Clearing Fund margin calls; (3) adjust the minimum increment of OCC s intra-month resizing authority to $100 million so that it is not limited to a minimum increment of (i) $1 billion or (ii) 125% of the difference between the projected draw (reduced by margin calls issued) and the Clearing Fund in effect; and (4) effect these changes through the amendment of OCC s Rules and through the formalizing and updating of its CFM Policy, as described in further detail below. 1. Incorporation of Rule 601(c) Margin Authority into Clearing Fund Processes OCC calculates and collects margin from its Clearing Members on a daily basis. Rule 601 describes OCC s authority to determine daily margin requirements, the deposit of margin assets by Clearing Members, and the holding of margin assets by OCC. In addition, Rule 609 allows OCC to require the deposit of intra-day margin under certain

53 Page 53 of 118 circumstances, including those arising under the FRMC Procedure. 11 Notwithstanding the provisions above, Rule 601(c) provides OCC with the authority to fix the margin requirement for any account or any class of cleared contracts at such amount as it deems necessary or appropriate under the circumstances to protect the respective interests of Clearing Members, OCC, and the public. This authority exists separate from OCC s authority to call for intra-day margin under Rule 609, and any additional fixed margin amount would be considered part of the regular daily margin requirement under Rule 601 for the Clearing Member/account in question. As described above, OCC Rule 1001(a) requires that the total size of the Clearing Fund be established each month at an amount determined by OCC to be sufficient to protect it against losses under simulated default scenarios that include the default of the single Clearing Member Group whose default would be likely to result in the largest draw against the Clearing Fund as well as an event involving the near-simultaneous default of two randomly-selected Clearing Member Groups as modeled using Monte Carlo simulations similar to those referred to in Rule 601(c). The rule further provides that such calculations be made on a daily basis and that the size of the Clearing Fund shall be readjusted monthly to equal the peak five-day rolling average of such calculations observed over the preceding three calendar months (plus the prudential margin of safety). Under OCC s Clearing Fund methodology and the Monthly Clearing Fund Sizing Procedure, Clearing Member margin requirements under Rule 601 are taken into consideration when calculating these daily Clearing Fund draw exposure estimates. Intra-day margin held under Rule 609 is excluded, however, from the calculation of 11 See supra note 7 and associated text.

54 Page 54 of 118 Clearing Fund draw estimates, and this additional exposure is therefore incorporated into the new monthly Clearing Fund size with the associated risk being mutualized through all Clearing Members Clearing Fund contribution requirements. OCC proposes to describe how it would use its authority under OCC Rule 601(c) to set amounts called as intra-day margin under the current Clearing Fund procedures as an additional margin requirement at such an amount or amounts determined to be necessary or appropriate under the circumstances to protect the respective interests of Clearing Member Groups, OCC, and the public. Specifically, the proposed CFM Policy would clearly provide that in the event two or fewer Clearing Member Group(s) are presenting exposure in the form of elevated projected draws to a much greater magnitude than other Clearing Member Groups (i.e., where the projected stress test exposure of the third largest Clearing Member Group(s) is less than or equal to 50% of the projected Clearing Fund size, including the prudential margin of safety), any two of the Executive Chairman and Chief Executive Officer ( Executive Chairman ), President and Chief Operating Officer ( COO ), or Chief Administrative Officer ( CAO ) (collectively referred to as the Office of the Executive Chairman ) shall have the authority to impose an additional margin amount for the Clearing Member Group(s) in question pursuant to Rule 601(c), taking into consideration trends in stress test exposure and the amount of margin calls made during the month and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. 12 In this situation, FRM s Stress Testing and Liquidity Risk Management group ( STLRM ) 12 In event two members of the Office of the Executive Chairman are not available, the Chief Risk Officer ( CRO ) or the Executive Vice President of FRM ( EVP- FRM ) would be able to serve in the approval process.

55 Page 55 of 118 would present an analysis containing a recommendation for the amount of the additional margin requirement, and the impact to the proposed Clearing Fund Size that would be effective upon approval of the additional margin requirement (based on a reduction of the Clearing Fund draws of the Clearing Member Group(s) in question by the amount of the additional margin requirement, as discussed in further detail below). This additional margin amount would constitute part of the Clearing Member Group(s) daily margin requirement under Rule 601 and would remain in place until the next regular monthly Clearing Fund sizing. In the event that a special margin call is proposed, or had been imposed during the most recent three-month period, the affected Clearing Member s draws over the preceding month would be adjusted by the amount of the subsequent month s special margin requirement when calculating the Clearing Fund size. The amount of this special margin requirement would be proposed by FRM based on an analysis of trends in stress test exposure, the amount of any margin calls made under the intra-month monitoring policy and procedures, and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. Pursuant to the proposed CFM Policy, the Rule 601(c) margin requirement would be reviewed on a monthly basis by STLRM and the amount of the additional fixed margin requirement may be adjusted upon the approval of at least two of three members of the Office of the Executive Chairman: (i) upwards in subsequent months if risk exposures continue increasing, or (ii) downward to the extent that risk exposures have declined or future increases in the Clearing Fund offset the need for the increased requirement. Under the proposed CFM Policy, any two members of the Office of the

56 Page 56 of 118 Executive Chairman shall have the authority to reduce the amount of the special margin call if the Clearing Member Group s current exposure drops below the 75% threshold for protective measures, and any such reduction would be effected after the collection of deficits associated with the monthly sizing process. If a special margin call is adjusted, the affected Clearing Member s draws over the preceding month would be adjusted by the new special margin call amount when calculating the Clearing Fund size. Clearing Fund draws within the most recent three-month period, which had previously been adjusted for a special margin call, would remain adjusted by that special margin call amount for the purposes of calculating the Clearing Fund size. Any use of authority to retain special margin charges, including upward or downward adjustments, would require same business day notification to the Risk Committee and OCC s regulators. Under the proposed CFM Policy, in certain situations when a Clearing Member Group presents significantly higher stress test exposures relative to other Clearing Member Groups, it may be determined that the factors that led to margin calls under the financial resources monitoring and call process in the current month have changed significantly such that it is no longer appropriate to impose either a special margin requirement or to mutualize them through an increase to the Clearing Fund. In such a scenario, STLRM would present an analysis to the Office of the Executive Chairman containing a recommendation for the amount of the proposed Clearing Fund size. If the Clearing Member Group(s) Clearing Fund draw driving margin calls made under the financial resources monitoring and call process in the most current month have declined under the threshold used to enact enhanced monitoring (i.e., 65% of the Clearing Fund size, referred to as the enhanced monitoring threshold ), the imposition of additional

57 Page 57 of 118 margin requirements may be waived, while Clearing Fund draws within the most recent month would be adjusted based on the margin calls made under the financial resources monitoring and call process for purposes of calculating the Clearing Fund size. Any such waiver and adjustment of the Clearing Fund size shall require approval by any two of the three members of the Office of the Executive Chairman. 13 The proposed course of action would allow OCC to effectively convert, where appropriate, intra-day margin calls that are currently made pursuant to Rule 609 and the FRMC Procedure (and which are not factored in during the monthly Clearing Fund sizing process) into a daily margin requirement under Rule 601, resulting in a defaulter pays approach to collateralizing the associated risks as the special Rule 601(c) margin requirement would then be taken into consideration when calculating Clearing Fund draw exposure estimates during the monthly Clearing Fund sizing process as opposed to mutualizing that risk through all Clearing Member Groups Clearing Fund contribution requirements. 2. Elimination of Caps on Intra-Month Clearing Fund Margin Calls Currently, under the FRMC Procedure, intra-day margin calls resulting from a breach of the 75% threshold are capped at the lesser of $500 million per Clearing Member or 100% of a given Clearing Member s net capital; however, OCC s management retains discretion to call for additional margin beyond those amounts. OCC proposes to modify this process such that the Office of the Executive Chairman would continue to be notified of any margin call in excess of the $500 million threshold but to eliminate the concept of the $500 million threshold serving as a cap on margin calls. In 13 In event two members of the Office of the Executive Chairman are not available, the CRO or EVP-FRM would be able to serve in the approval process.

58 Page 58 of 118 addition, OCC proposes to modify the process so that the 100% of Clearing Member net capital amount would serve as a trigger for escalation to the Office of the Executive Chairman, and each of the Executive Chairman, COO, or CAO would have the authority to determine whether to continue calling for additional margin in excess of this amount (as opposed to this amount serving as a cap on margin calls) or to cease margin calls for the member in question. Under the proposed CFM Policy, the Office of the Executive Chairman may determine to impose a cap on margin calls above these thresholds if necessary or appropriate. Any determination to impose a cap on margin calls shall be based on consideration of factors including, but not limited to, the amount of the call above the threshold, FRM s assessment of the Clearing Members ability to meet the call based on its financial condition, and the amount of collateral it has available to pledge. OCC believes the proposed changes would clarify OCC management s current discretionary authority to call for additional margin beyond the $500 million and 100% of net capital amounts and more appropriately reflect the Risk Committee and Board s determination that those that bring the risk to OCC should bear this risk intra-month. 3. Adjustment to Minimum Intra-Month Resizing Amount OCC also proposes to adjust the minimum quantum of its intra-month Clearing Fund resizing authority. Currently, under the FRMC Procedure, any intra-month resizing of the Clearing Fund is subject to a minimum amount equal to the greater of (i) $1 billion or (ii) 125% of the difference between the projected draw (reduced by margin calls issued) and the Clearing Fund in effect. This fixed amount eliminates OCC s flexibility to appropriately adjust the size of the Clearing Fund given the particular facts and circumstances at the time of the resizing. As a result, OCC may be forced to resize the

59 Page 59 of 118 fund at a level that limits its ability to meet its mandate to be effective and efficient. 14 OCC therefore proposes to reduce the minimum intra-month resizing increment to $100 million. Under the proposed CFM Policy, the ultimate intra-month resizing increment would be determined based on factors including, but not limited to, the amount of exceedance above the threshold, the time of the month, information related to the Clearing Member or Clearing Member Group s exposures (both current and projected), the number of Clearing Member Groups breaching the 75% threshold, and the market environment for the products which OCC clears (including, among other things, changes in volume or volatility). Consistent with OCC s current practices, any intra-month increase in the Clearing Fund would require approval from the Executive Chairman, COO, or CAO. 4. Proposed Changes to Rules, Policies, and Procedures Finally, OCC proposes to effectuate the proposed changes described above by formalizing and updating OCC s CFM Policy and making related amendments to Rule In connection with these changes, OCC proposes to replace as rules of OCC its Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure with the CFM Policy as the material aspects of OCC s 14 See, e.g., Rule 17Ad-22(e)(21), which requires, in part, that OCC establish, implement, maintain and enforce written policies and procedures reasonably designed to be efficient and effective in meeting the requirements of its participants and the markets it serves, and have OCC s management regularly review the efficiency and effectiveness of its risk management policies and procedures.

60 Page 60 of 118 Clearing Fund-related operations would now be addressed in the Rules and proposed CFM Policy. 15 i. Amendments to OCC Rules OCC proposes to amend Rule 1001 to include new Interpretation and Policy.05 to provide that, notwithstanding the last sentence of Rule 1001(a), daily Clearing Fund calculations used to set the monthly Clearing Fund size may be adjusted to reflect the imposition of any special margin charges pursuant to OCC s authority under Rule 601(c) and in accordance with OCC s policies and procedures. OCC also proposes nonsubstantive clean-up and conforming changes to Rule 1001(a). ii. Formalizing and Updating of the Clearing Fund Methodology Policy OCC also proposes to formalize its CFM Policy to describe OCC s current practices regarding its Clearing Fund and update the policy to implement the proposed changes described above. The proposed policy changes are described in detail below. Clearing Fund Size Computation and Estimation The proposed CFM Policy would describe OCC s current model-based approach to estimating the monthly Clearing Fund size, 16 including the overall Clearing Fund model framework and assumptions. The CFM Policy would provide that OCC uses the STANS framework and incorporates various further assumptions specific to the Clearing Fund sizing methodology. These assumptions include, for example: (i) the use of the 15 OCC notes that it would continue to maintain the Clearing Fund Intra-Month Resizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure as internal OCC procedures; however, these procedures would no longer be filed as rules of OCC under the Exchange Act. The procedures would also be revised to conform to the proposed changes described herein. 16 See supra note 6 and associated text.

61 Page 61 of 118 same two-day liquidation risk horizon as OCC s margin methodology; (ii) the use of the Idiosyncratic Default Scenario or the Minor Systemic Event Default Scenario in calculating the Clearing Fund size; (iii) the distribution assumptions used in simulations; (iv) the assumption of a tripling of market volatility for the Clearing Fund stress scenarios; (v) the exclusion of Clearing Fund replenishment rights or for any recoveries the Clearing Fund might make from assets of defaulted clearing firm(s) not held at OCC; and (vi) the use of a prudential margin of safety to provide an additional buffer to absorb potential future exposures not previously observed during the look-back period. The CFM Policy would also discuss the generation of Monte Carlo scenarios for the liquidation values of cleared products and of equity and certain U.S. Treasury securities deposited as margin in Clearing Members accounts at OCC as well as the treatment of other securities that are subject to traditional haircuts and valued for Clearing Fund estimation purposes at post-haircut valuation. In addition, the CFM policy would describe the daily computation of OCC s projected maximum financial resources under extreme but plausible market conditions. On the first business day of each month, STLRM would determine the peak five-day rolling average of the Clearing Fund draws observed over the preceding three calendar months to establish the size of the Clearing Fund for the current calendar month and recommend the monthly Clearing Fund size for approval to an officer (Vice President or higher) of FRM in accordance with the Monthly Clearing Fund Sizing Procedure. The CFM Policy would further provide that the daily Clearing Fund draws used to determine the monthly Clearing Fund size would take into consideration, if applicable, any special margin requirements imposed under Rule 601(c) as proposed above.

62 Page 62 of 118 Financial Resources Monitoring and Call Process Under the proposed CFM Policy, OCC would maintain certain processes to ensure that on a continuous basis it maintains sufficient financial resources to protect it from the default of one or more of its Clearing Member Groups. In support of this objective, FRM would be responsible for maintaining procedures designed to monitor and analyze on a daily basis OCC s peak exposure in order to identify circumstances where it should consider collection of additional margin from a Clearing Member Group responsible for the peak exposure or an intra-month resizing of the Clearing Fund. Consistent with current practice and the FRMC Procedure, FRM would monitor the daily future hypothetical exposures computed under OCC s Clearing Fund methodology and compare those exposures to the current Clearing Fund size. In any instance where a projected Idiosyncratic Clearing Fund Draw(s) exceeds 65% of the Clearing Fund in effect or, when a Clearing Member or Clearing Member Group previously received a margin call as a result of the financial resources monitoring and call process, STLRM staff would begin enhanced monitoring of such Clearing Members/Groups to track instances where projected draws are approaching thresholds for protective action in accordance with the FRMC Procedure. STLRM would be required to notify FRM in writing whenever the enhanced monitoring threshold is exceeded. Under the proposed CFM Policy and consistent with the current FRMC Procedure, in the event that FRM observes a scenario where the Idiosyncratic Clearing Fund Draw exceeds 75% of the Clearing Fund, FRM shall issue an intra-day margin call pursuant to Rule 609 against the Clearing Member or Clearing Member Group that caused such a draw with the amount of the margin call being the difference between the

63 Page 63 of 118 projected draw and the Base Amount ( Exceedance Above Base Amount ). All such margin calls shall be reviewed and, if appropriate, approved by an officer of FRM. The proposed CFM Policy would be updated, however, to reflect the newly proposed process described in the Elimination of Caps on Intra-Month Clearing Fund Margin Calls section above whereby the $500 million dollar and 100% of net capital thresholds would serve as notification and escalation triggers, respectively, for the Office of the Executive Chairman and would no longer be characterized as caps on margin calls under the policy and associated procedures to more accurately reflect OCC managements existing discretionary authority to exceed these amounts. The proposed CFM Policy also would address OCC s existing authority to increase the size of the fund intra-month in more extreme scenarios if a projected draw exceeds 90% of the Clearing Fund (after applying any funds then on deposit with OCC from the applicable Clearing Member or Clearing Member Group pursuant to a margin call made under the policy). The CFM Policy would be updated, however, to reflect the proposed changes to OCC s minimum intra-month resizing increment (to $100 million) as discussed in the Adjustment to Minimum Intra-Month Resizing Amount section above. The proposed CFM Policy would also clarify that, consistent with current practice under the Clearing Fund Intra-Month Re-sizing Procedure, if, during external notification to Clearing Members, OCC staff discovers a Clearing Member may have a concern with satisfying the projected pay, staff will immediately notify the Vice President of STLRM ( VP-STLRM ) or another officer of FRM. In this case, enhanced monitoring and reporting of settlement processing on the second business day may be recommended, and the VP-STLRM or another officer of FRM would escalate the issue to the Office of the

64 Page 64 of 118 Executive Chairman based on the situation. In addition, under the proposed CFM Policy, and in accordance with existing practice, the Risk Committee would retain the authority to determine whether the Clearing Fund increase was sufficient or to further increase the size of the Clearing Fund or any margin calls made pursuant to the policy. In addition, Clearing Members would continue to be required to meet the call for additional Clearing Fund assets by 9:00 AM CT on the second business day following the intra-month increase. The proposed CFM Policy also would be updated to reflect the proposed incorporation of special margin charges under Rule 601(c) into the monthly and intramonth Clearing Fund sizing and monitoring processes as described in the Incorporation of Rule 601(c) Margin Authority into Clearing Fund Processes section above. Clearing Fund Deposits The proposed CFM Policy would describe OCC s existing rules and practices with respect to Clearing Fund deposits. Specifically, the policy would provide that Clearing Fund deposits be limited to the most liquid forms of collateral to ensure that OCC maintains adequate sources of liquidity in the event of a Clearing Member default (e.g., those assets acceptable for pledging under OCC s committed liquidity facilities). Forms of acceptable assets currently include: (1) cash (U.S. dollar only); (2) U.S. government securities; and (3) Canadian government securities. In addition, the policy would provide that OCC s first line business operations shall ensure each time a liquidity facility is renewed that the securities eligible for pledge as Clearing Fund deposits align with those securities permitted for pledge under the committed liquidity facility.

65 Page 65 of 118 Additionally, the proposed policy would contain a discussion of OCC s minimum cash Clearing Fund requirement, which was recently approved by the Commission and is expected to be implemented on March 1, Clearing Fund Assessments The CFM Policy also would describe OCC s existing authority to call for replenishment of the Clearing Fund in accordance with Article VIII, Sections 5 and 6 of OCC s By-Laws, upon approval of any of the Executive Chairman, COO, or CAO. Clearing Fund Methodology Monitoring and Review Activities Finally, the CFM Policy would formalize and update the Clearing Fund monitoring, review, and reporting responsibilities of various OCC personnel. Under the proposed policy, on a daily basis, STLRM would be responsible for monitoring the results of all Clearing Fund draws, in accordance with the FRMC Procedure. STLRM would be required to prepare summary reports describing the results of the Clearing Fund draw estimates on a daily and monthly basis and reviewing the adequacy of OCC s financial resources in accordance with OCC s Stress Test Reporting Procedure. The monthly analysis shall be reported to OCC s Management Committee and Risk Committee, and other reports may be provided to the Management Committee, Risk Committee, and other stakeholders pursuant to procedures established for those purposes. 17 See Order Approving Proposed Rule Change, as Modified by Amendment No. 1, Concerning The Options Clearing Corporation's Adoption of a New Minimum Cash Requirement for the Clearing Fund, Securities Exchange Act Release No (January 12, 2018), 83 FR 2825 (January 19, 2018) (SR-OCC ) and Notice of No Objection to Advance Notice, as Modified by Amendment No. 1, Concerning the Adoption of a New Minimum Cash Requirement for the Clearing Fund, Securities Exchange Act Release No (January 12, 2018), 83 FR 2843 (January 19, 2018) (SR-OCC ).

66 Page 66 of 118 The CFM Policy would provide that, on a monthly basis, OCC s Stress Test Working Group ( STWG ), a cross-departmental group including members from FRM, Quantitative Risk Management, and Enterprise Risk Management, shall review a summary of the month s stress-testing results in accordance with the Stress Test Working Group Procedure. In addition, the CFM Policy would require that, on an annual basis, the Model Validation Group shall perform a model validation of OCC s Clearing Fund model and propose any changes in accordance with the Model Risk Management Policy and related procedures. Additionally, the Risk Committee would be required to review the model validation report. Moreover, on an annual basis, the Risk Committee would be required to review and approve the CFM Policy. iii. Clearing Fund Procedures OCC previously filed with the Commission, and received approval for, a proposed rule change concerning its Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure, which detail OCC s procedures regarding the monthly resizing of its Clearing Fund and the addition of financial resources through intra-day margin calls and/or an intra-month increase of the Clearing Fund to ensure that it maintains adequate financial resources in the event of a default of a Clearing Member or group of affiliated Clearing Members presenting the largest exposure to OCC. 18 As part of this proposed rule change, OCC proposes to withdraw as rules of a clearing agency for purposes of the Exchange Act its existing Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly 18 See supra note 5.

67 Page 67 of 118 Clearing Fund Sizing Procedure and replace them with the proposed CFM Policy. 19 OCC believes that the proposed CFM Policy more appropriately describes the material aspects of OCC s Clearing Fund-related operations and is therefore properly filed as a rule of OCC under the Exchange Act. Accordingly, OCC believes that, with the formalizing of its CFM Policy, the Clearing Fund Intra-Month Re-sizing Procedure, FRMC Procedure, and Monthly Clearing Fund Sizing Procedure would no longer be appropriately filed as rules of OCC under the Exchange Act because they would contain only the procedural and administrative aspects of OCC s Clearing Fund-related processes that would be reasonably and fairly implied by the CFM Policy or would otherwise not be deemed to be material aspects of OCC s Clearing Fund-related operations. OCC therefore believes it would be appropriate to withdraw these procedures as rules and replace them with the CFM Policy. (2) Statutory Basis 19 Section 19(b)(1) of the Exchange Act requires a self-regulatory organization ( SRO ) such as OCC to file with the Commission any proposed rule or any proposed change in, addition to, or deletion from the rules of such SRO. See 15 U.S.C. 78s(b)(1). Section 3(a)(27) of the Exchange Act defines rules of a clearing agency to mean its (1) constitution, (2) articles of incorporation, (3) bylaws, (4) rules, (5) instruments corresponding to the foregoing and (6) such stated policies, practices and interpretations ( SPPI ) as the Commission may determine by rule. See 15 U.S.C. 78c(a)(27). Exchange Act Rule 19b-4(a)(6) defines the term SPPI to mean, in addition to certain publicly facing statements, any material aspect of the operation of the facilities of the [SRO]. See 17 CFR b-4(a)(6). Rule 19b-4(c) provides, however, that an SPPI may not be deemed to be a proposed rule change if it is: (i) reasonably and fairly implied by an existing rule of the SRO or (ii) concerned solely with the administration of the SRO and is not an SPPI with respect to the meaning, administration, or enforcement of an existing rule the SRO.

68 Page 68 of 118 Section 17A(b)(3)(F) of the Act 20 requires, among other things, that the rules of a clearing agency be designed to assure the safeguarding of securities and funds in the custody or control of the clearing agency or for which it is responsible, and, in general, to protect investors and the public interest. OCC believes that the proposed changes would provide OCC with greater flexibility to address the risks presented by its Clearing Members on both a monthly and intra-month basis by allowing OCC to more appropriately allocate risk charges between margin requirements and Clearing Fund contributions so that those contributions are commensurate to the risks posed by Clearing Members. Specifically, the proposed changes to incorporate OCC s Rule 601(c) margin authority into the monthly and intra-month Clearing Fund sizing and monitoring processes would allow OCC to more appropriately allocate risk charges (e.g., margin or Clearing Fund) to those Clearing Members driving the risks under the limited and unique circumstances where two or fewer Clearing Member Group(s) are presenting exposure in the form of elevated projected draws to a much greater magnitude than other Clearing Member Groups (i.e., where the projected stress test exposure of the third largest Clearing Member Group(s) is less than or equal to 50% of the projected Clearing Fund size, including the prudential margin of safety). The application of this authority would take into consideration trends in stress test exposure, the amount of margin calls made during the month, and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. The proposed changes also would provide more clarity and transparency around OCC s intra-day Clearing Fund margin call process by more explicitly describing OCC s authority to continue calling for U.S.C. 78q-1(b)(3)(F).

69 Page 69 of 118 additional margin above certain pre-established thresholds where OCC management believes it is more appropriate that those Clearing Members bringing risk to OCC should bear that risk on an intra-month basis. The proposed changes would provide OCC with the clear, transparent, and ex ante authority to employ a defaulter pays approach in these circumstances. The additional clarity and transparency around the monthly and intra-month Clearing Fund processes should allow OCC Clearing Members to better understand and anticipate their potential obligations to OCC so that they can manage these risks. Moreover, a clearly articulated defaulter pays approach in these circumstances would help incentivize those members generating significantly higher stress test exposures to reduce those exposures, and thereby mitigate risks presented to OCC and its Clearing Members generally. In addition, the proposed reduction in the minimum increment for resizing the Clearing Fund on an intra-month basis would allow OCC the flexibility to more appropriately resize the Clearing Fund intra-month based on factors including, but not limited to, the amount of exceedance above the threshold, the time of the month, information related to the Clearing Member or Clearing Member Groups exposures (both current and projected), the number of Clearing Member Groups breaching the 75% threshold, and the market environment for the products which OCC clears (including, among other things, changes in volume or volatility). OCC notes that, under the proposed change, it would not be precluded from resizing the Clearing Fund at either of the current (i) $1 billion or (ii) 125% of the difference between the projected draw and Clearing Fund in effect amounts. The proposed change is intended to provide increased flexibility to resize the Clearing Fund at different minimum increments if such amounts

70 Page 70 of 118 would (i) enable OCC to continue to cover its credit exposure to each participant fully with a high degree of confidence and to cover the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions and (ii) more appropriately enable OCC to be efficient and effective in meeting the requirements of its participants and the markets it serves. For the foregoing reasons, OCC believes the proposed rule change is designed to assure the safeguarding of securities and funds in the custody or control of the clearing agency or for which it is responsible, and, in general, to protect investors and the public interest in accordance with the requirements Section 17A(b)(3)(F) of the Act. 21 OCC also believes the proposed rule change is consistent with the rules promulgated under the Act for the reasons set forth below. Incorporation of Rule 601(c) Margin Authority into OCC s Clearing Fund Processes and Elimination of Margin Call Caps Rules 17Ad-22(e)(4)(i) and (iii) 22 generally require that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by maintaining sufficient financial resources to (i) cover its credit exposure to each participant fully with a high degree of confidence and (ii) cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions. With respect to 21 Id CFR Ad-22(e)(4)(i) and (iii).

71 Page 71 of 118 the use of clearing funds and the requirements of Rule 17Ad-22(e)(4), 23 the Commission has noted that, [t]o the extent that a clearing agency uses guaranty or clearing fund contributions to mutualize risk across participants, the clearing agency generally should value margin and guaranty fund contributions so that the contributions are commensurate to the risks posed by the participants activity and that [t]he clearing agency also generally should consider the appropriate balance of individualized and pooled elements within its default waterfall, with a careful consideration of whether the balance of those elements mitigates risk and to what extent an imbalance among those elements might encourage moral hazard, in that one participant may take more risks because the other participants bear the costs of those risks. 24 OCC believes that the proposed changes to its monthly and intra-month Clearing Fund sizing, monitoring and margin call processes as described in the proposed CFM Policy (including the conforming changes to Rule 1001(a)) are reasonably designed to allow OCC to continue to measure, monitor, and manage its credit exposures to participants and maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence. The proposed incorporation of OCC s special margin charge authority under Rule 601(c) into the monthly and intramonth Clearing Fund sizing and monitoring processes, and the related authority to adjust daily Clearing Fund draw calculations accordingly, would allow OCC to effectively convert, where appropriate, intra-day margin calls that are currently made pursuant to Rule 609 and the FRMC Procedure (and which are not factored in during the monthly CFR Ad-22(e)(4). 24 See See Securities Exchange Act Release Nos (September 28, 2016), 81 FR 70786, (October 13, 2016) (S ).

72 Page 72 of 118 Clearing Fund sizing process) into a daily margin requirement under Rule 601, resulting in a defaulter pays approach to collateralizing the associated risks. The special Rule 601(c) margin requirement would then be taken into consideration when calculating Clearing Fund draw exposure estimates during the monthly Clearing Fund sizing process as opposed to mutualizing that risk through all Clearing Member Groups Clearing Fund contribution requirements. OCC notes that the proposed use of its Rule 601(c) margin authority in this context would be subject to the requirements of the CFM Policy and only be applicable in limited and unique circumstances where two or fewer Clearing Member Group(s) are presenting exposure in the form of elevated projected draws to a much greater magnitude than other Clearing Member Groups (i.e., where the projected stress test exposure of the third largest Clearing Member Group(s) is less than or equal to 50% of the projected Clearing Fund size, including the prudential margin of safety), and the application of this authority would take into consideration trends in stress test exposure, the amount of margin calls made during the month, and any impact that a particular Clearing Member Group s exposure may have on the next overall monthly Clearing Fund size. In addition, OCC proposes to provide additional clarity and transparency around the intended use of OCC management s discretion to call for intra-day margin beyond the $500 million and 100% of net capital thresholds by updating the proposed CFM Policy to provide that the $500 million and 100% of net capital thresholds would serve as notification and escalation triggers, respectively, for the Office of the Executive Chairman and would no longer be characterized as caps on margin calls under the policy and associated procedures. Under the proposed CFM Policy, any determination to

73 Page 73 of 118 impose a cap on margin calls would be based on a consideration of factors including, but not limited to, the amount of the call above the threshold, FRM s assessment of the Clearing Members ability to meet the call based on its financial condition, and the amount of collateral it has available to pledge. OCC believes the proposed changes would clarify OCC management s current discretionary authority to call for additional margin beyond the $500 million and 100% of net capital amounts to more appropriately reflect the determination of OCC s Risk Committee and Board that those that bring the risk to OCC should bear this risk intra-month. OCC believes that the proposed changes would allow OCC to more appropriately value margin and Clearing Fund contributions so that those contributions are commensurate to the risks posed by individual Clearing Members in these circumstances and provide for a more appropriate balance of individualized and pooled elements within OCC s default waterfall. The proposed changes would provide OCC with the clear and transparent authority to employ a defaulter pays approach in circumstances where (i) two or fewer Clearing Members are presenting significantly higher stress test exposures that are driving Clearing Fund requirements for all members in the monthly Clearing Fund sizing process, or (ii) OCC s management determines it is more appropriate that those Clearing Members bringing risk to OCC should bear that risk on an intra-month basis by requiring the deposit of additional intra-day margin beyond certain established thresholds. The proposed changes would allow OCC to give careful consideration to the appropriate balance of individual and mutualized resources, and, where appropriate, require those Clearing Members that bring elevated risk exposures to OCC to bear the costs of those risks. Such a defaulter pays approach would help incentivize those

74 Page 74 of 118 members to reduce their exposures to OCC, and thereby mitigate risks to OCC and its Clearing Members and discourage moral hazard. OCC notes that the proposed changes described herein would not impact OCC s current Clearing Fund methodology or the underlying parameters and assumptions of the methodology. As a result, OCC believes the proposed changes would continue to provide OCC with the authority to maintain sufficient financial resources in the form of both margin and Clearing Fund requirements to cover its credit exposure to each participant fully with a high degree of confidence and to cover the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions. Accordingly, OCC believes that the proposed changes are reasonably designed to promote compliance with the requirements of Rules 17Ad-22(e)(4)(i) and (iii). 25 Adjustment to Minimum Intra-Month Resizing Amount As noted above, Rules 17Ad-22(e)(4)(i) and (iii) 26 generally require that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by maintaining sufficient financial resources to (i) cover its credit exposure to each participant fully with a high degree of confidence and (ii) cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions CFR Ad-22(e)(4)(i) and (iii). 26 Id.

75 Page 75 of 118 Rule 17Ad-22(e)(21) 27 further requires, in part, that OCC establish, implement, maintain and enforce written policies and procedures reasonably designed to be efficient and effective in meeting the requirements of its participants and the markets it serves, and have OCC s management regularly review the efficiency and effectiveness of its risk management policies and procedures. OCC proposes to change its minimum intra-month Clearing Fund resizing authority to $100 million (as opposed to the current minimum amount, which is equal to the greater of (i) $1 billion or (ii) 125% of the difference between the projected draw reduced by margin calls issued and the Clearing Fund in effect). OCC believes that the current fixed amounts constrain OCC s flexibility to appropriately adjust the size the Clearing Fund given the particular facts and circumstances at the time of the resizing. Under the proposed CFM Policy, the minimum increment for resizing the Clearing Fund on an intra-month basis would be $100 million; however, the ultimate intra-month resizing increment would be determined based on factors including, but not limited to, the amount of exceedance above the threshold, the time of the month, information related to the Clearing Member or Clearing Member Group s exposures (both current and projected), the number of Clearing Member Groups breaching the 75% threshold, and the market environment for the products which OCC clears (including, among other things, changes in volume or volatility. OCC notes that, under the proposed change, it would not be precluded from resizing the Clearing Fund at either of the current (i) $1 billion or (ii) 125% of the difference between the projected draw and Clearing Fund in effect amounts; however, OCC would have increased flexibility to resize the Clearing Fund at CFR Ad-22(e)(21).

76 Page 76 of 118 different minimum increments if such amounts would (i) enable OCC to continue to cover its credit exposure to each participant fully with a high degree of confidence and to cover the default of the participant family that would potentially cause the largest aggregate credit exposure for OCC in extreme but plausible market conditions and (ii) more appropriately enable OCC to be efficient and effective in meeting the requirements of its participants and the markets it serves. OCC therefore believes the proposed change is reasonably designed to comply with the requirements of Rules 17Ad-22(e)(4)(i) and (iii) 28 and Rule 17Ad-22(e)(21). 29 Proposed Changes to Policies and Procedures Rule 17Ad-22(e)(3) 30 requires, generally, that at covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain a sound risk management framework for comprehensively managing legal, credit, liquidity, operational, general business, investment, custody, and other risks that arise in or are borne by the covered clearing agency. Moreover, Rule 17Ad-22(e)(4) 31 generally requires that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes. The proposed changes would consolidate into OCC s CFM Policy a number of its existing Clearing Fund and Clearing Fund methodology related practices, which have CFR Ad-22(e)(4)(i) and (iii) CFR Ad-22(e)(21) CFR Ad-22(e)(3) CFR Ad-22(e)(4).

77 Page 77 of 118 already been filed in some form with the Commission. For example, the CFM Policy would outline OCC s current methodology for sizing its Clearing Fund. 32 The CFM Policy also would outline OCC s existing financial resources monitoring and call process, subject to the proposed changes described herein. 33 In addition, the CFM Policy would outline OCC s current authority with respect to the use of Clearing Fund and Clearing Fund replenishment requirements 34 as well as the acceptable forms of Clearing Fund deposits. 35 The proposed CFM Policy would serve as key component of OCC s overall risk management framework 36 by describing OCC s existing policies (subject to the proposed changes described herein) for identifying, measuring, monitoring, and managing the credit exposures intended to be covered by OCC s Clearing Fund. As a result, OCC believes the formalizing and updating of its CFM Policy is reasonably designed to meet the requirements of Rules 17Ad-22(e)(3) and (4), generally See supra note See supra note See OCC By-Laws, Article VIII, Sections 5 and See OCC By-Laws, Article VIII, Section The Commission recently approved a proposed rule change by OCC to adopt a Risk Management Framework Policy ( RMF ). The RMF describes OCC's framework for comprehensive risk management, including OCC's framework to identify, measure, monitor, and manage all risks faced by OCC in the provision of clearing, settlement, and risk management services. With respect to credit risk, the RMF requires that OCC's credit risk management framework encompass policies and procedures for, among other things, maintaining sufficient prefunded resources in the form of margin and Clearing Fund deposits and a process for replenishing resources. See Securities Exchange Act Release No (December 7, 2017), 82 FR (December 13, 2017) (SR-OCC ). The CFM Policy would serve as a critical component of OCC s credit risk management framework under the RMF CFR Ad-22(e)(3) and (4).

78 Page 78 of 118 Rules 17Ad-22(e)(2)(i), (ii) and (iv) 38 require that at covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for governance arrangements that are clear and transparent, clearly prioritize the safety and efficiency of the covered clearing agency, and specify clear and direct lines of responsibility. The proposed CFM Policy would consolidate and update the Clearing Fund monitoring, review, and reporting requirements for various OCC personnel, including the regular review and monitoring activities performed by FRM staff and OCC s STWG as well as the reporting and escalation of Clearing Fund related matters to OCC s Management Committee and Risk Committee. OCC believes that, in this way, the CFM Policy is reasonably designed to provide for governance arrangements are clear and transparent, clearly prioritize the safety and efficiency of OCC, and specify clear and direct lines of responsibility with respect to OCC s Clearing Fund in accordance with the requirements of Rules 17Ad-22(e)(2)(i), (ii) and (iv). 39 For the reasons set forth above, OCC believes the proposed rule change is designed to assure the safeguarding of securities and funds at OCC and, in general, protect investors and the public interest consistent with Section 17A(b)(3)(F) of the Act 40 and the rules promulgated thereunder. (B) Clearing Agency s Statement on Burden on Competition CFR Ad-22(2)(i), (ii) and (iv). 39 Id. 40 Id.

79 Page 79 of 118 Section 17A(b)(3)(I) of the Act 41 requires that the rules of a clearing agency not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act. OCC does not believe that the proposed rule change would impact or impose any burden on competition. The proposed changes to OCC s monthly and intra-month Clearing Fund processes would apply equally to all Clearing Members. The proposed changes would not affect Clearing Members access to OCC s services, nor would any of these proposed changes disadvantage or favor any particular user in relationship to another user. As such, OCC believes that the proposed changes would not have any impact or impose any burden on competition. (C) Clearing Agency s Statement on Comments on the Proposed Rule Change Received from Members, Participants or Others Written comments on the proposed rule change were not and are not intended to be solicited with respect to the proposed rule change and none have been received. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or within such longer period up to 90 days (i) as the Commission may designate if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self- regulatory organization consents, the Commission will: (A) by order approve or disapprove the proposed rule change, or (B) institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments U.S.C. 78q-1(b)(3)(I).

80 Page 80 of 118 Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments: Use the Commission s Internet comment form ( or Send an to rule-comments@sec.gov. Please include File Number SR- OCC on the subject line. Paper Comments: Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC All submissions should refer to File Number SR-OCC This file number should be included on the subject line if 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 ( Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change 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 such filing also will be available for inspection and copying at the

81 Page 81 of 118 principal office of OCC and on OCC s website at 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 and should be submitted on or before [insert date 21 days from publication in the Federal Register]. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority. 42 Secretary CFR (a)(12).

82 Page 82 of 118 EXHIBIT 5A OCC Rules Underlined text indicates new text Strikethrough text indicates deleted text