Feb. 14, 2023
Thank you for taking a longer period of consideration on proposed rule change SR-OCC-2022-012 and please consider the enclosed comments. (1) This proposal includes additional material heavily redacted. Significant redactions prevent public review and comment so this proposal should be rejected on that basis alone. (2) This proposal eliminates using Monte Carlo simulations as part of its STANS margin methodology in favor of applying fixed collateral haircuts that OCC would set and adjust on, essentially, an as needed basis potentially more frequent than daily. From the OCC’s own website (https://protect2.fireeye.com/v1/url?k=31323334-50bba2bf-3132d782-4544474f5631-bd7bc7b0ffe50ded&q=1&e=65df9219-0982-407e-8ce6-0a733a0e01ab&u=https%3A%2F%2Fwww.theocc.com%2Frisk-management%2Fmargin-methodology), the STANS margin methodology has been in use through the 2008 Global Financial Crisis and the Monte Carlo simulations would calculate margin reflecting the scope of price movements for collateral: - "Under the STANS methodology, which went into effect in August 2006, the daily margin calculation for each account is based on full portfolio Monte Carlo simulations and - as set out in more detail below - is constructed conservatively to ensure a very high level of assurance that the overall value of cleared products in the account, plus collateral posted to meet margin requirements, will not be appreciably negative at a two-day horizon.” - "Until February 2010, securities posted as collateral were not included in the Monte Carlo simulations, but were subjected to traditional "haircuts." Since then, the "collateral in margins" scheme has taken effect, whereby some collateral securities - specifically equity securities and, more recently, U.S. Treasury securities (excluding TIPS) - have instead been included in the Monte Carlo simulations. Thus, the margin calculations now reflect the scope for price movements in these forms of collateral to exacerbate or mitigate losses on the cleared products on the account. To replace the Monte Carlo simulations reverting back to traditional haircuts represents an intentional step backwards against the advancement of risk management methodologies. Notably, the justification provided for this proposal reveals the OCC's intention by focusing on how: - The OCC “expects the fixed haircut schedule under the [proposed] procedure-based approach would _initially_ be the same as those currently defined in OCC’s rules”, - “_In general_, the fixed haircut approach would be less pro cyclical.” - “OCC’s preliminary analysis shows the _average_ impact as a percentage of the value of Government securities and GSE debt securities is _typically_ under 1 percent and that the impact to the Clearing Fund is negligible.” Risk management focusing on the average, typical, general, and initial cases intentionally excludes consideration of long tail risks [https://en.wikipedia.org/wiki/Tail_risk], including for example, the 2008 Global Financial Crisis, which is explicitly excluded by the Historical Value-at-Risk (“H-VaR”) approach proposed by the OCC with multiple look-back period including 2, 5 and 10 years. By defining such limited look-back periods for the H-VaR model, the OCC is intentionally cherry-picking model data excluding the 2008 Global Financial Crisis when defining periods of market stress for consideration. Bluntly stated, “[w]hile [the proposal] may be more conservative in periods of low market volatility, it would prevent spikes in margin requirements during periods of heightened volatility that may take place under the existing CiM approach.” This proposal is more conservative in periods of low market volatility and, thus, riskier during periods of hightened volatility. Heightened volatility and periods of market stress are exactly the conditions where heightened risk management is required. Preventing spikes in margin requirements, a key indicator of significant risk, simply obscures risk from view without ensuring the underlying risks are manageable. Could you imagine if we built door openings with a height set for the average person? Tall people would have to duck every time they go through a doorway! Consideration for extremes is a requirement, especially in risk management. Do we not have fire sprinklers installed in case of a fire? As the current STANS margin methodology (CiM), in use since 2006 and improved after the 2008 Global Financial Crisis, already predicts heightened risk and increased margin requirements, this proposal to obfuscate risk by eliminating the current methodology in favor of allowing the OCC to set their own valuations flies in the face of precedent and reason. (3) The heightened risk to the OCC is clear with the proposed 5x increase in Tier 1 capital requirements from $100M to $500M USD. This flat increase to current Tier 1 Capital requirements clearly impacts smaller members more than larger members without consideration of their underlying risk profile. A more balanced approach would propose varying Tier 1 Capital requirements based on the size and risk of each Clearing Bank with larger and/or riskier institutions having higher capital requirements. (4) Further ignoring risk, this proposal lowers the sovereign rating standard for “low credit risk” from AAA to A-/A3 to “allow for issuers from France with which the OCC previously had relationships before France’s sovereign credit rating fell below AAA” simply because the OCC *believes* the current requirement is too conservative. Similarly, this proposal would “delete the external credit rating standards for a non-U.S. institutions commercial paper, other short-term obligations or long-term obligations” because the “OCC has had to terminate several [] relationships pursuant to these external credit rating standards even though the institutions otherwise met OCC’s requirements and were not reporting elevated internal credit risk metrics”. In the vernicular, the OCC is relying upon “trust me bro” to accommodate external credit ratings falling below requirements. Eliminating and/or lowering third party credit rating requirements increases risk to the OCC and the stability of our financial system so this proposal should be rejected. (5) As noted in this paper on the BIS website, "The "four lines of defence model" for financial institutions” [https://www.bis.org/fsi/fsipapers11.htm], proposes a fourth line of defense relying upon external audit and regulation because the traditional three lines of defense are insufficient for prevention banking scandals, failures of internal control systems, substantial financial losses, and near-bankruptcies. Simply put, that paper finds financial institutions can not be trusted to regulate and govern themselves — external auditors and regulatory supervisor(s) are required. The proposed changes to reduce external audit, regulation, supervision, and credit ratings introduces weaknesses into Risk Management models allowing more banking scandals, failures, and bankruptcies to occur. To conclude, the proposed rule change as drafted is objected to as it intentionally obscures risk, ignores long tail risks, and fails to properly manage risk for periods of heightened volatility and market stress. Thank you for your consideration on these comments on proposed rule change SR-OCC-2022-012.