Feb. 6, 2024
Hello,
My name is Avery Moncure, and I am concerned about this new market rule
that's being proposed by the OCC. While I do not have sufficient time to
sit and comment on every proposed rule making, I am taking the time to
send a form-letter to you to assist in the regulation of our capital
markets. My day to day is filled with labor and toil, and I am appalled
that the SROs are attempting to litigate a singularly beneficial rule
for themselves and at the expense of hardworking Americans. It is my
hope that the public institution of the Securities and Exchange
Commission may perform their duties to the public of securing a free and
fair market for us all. Generations of Americans have poured their time
and energy into securing a better life for all and our posterity. While
I didn't have a significant amount of time to pore over the endless
pages of legalese (and I'm not even going to mention the decades of
prior rulings that are necessary to understand this ruling's full
impact), I am going to sign my name to the following form letter that a
concerned peer has written for his fellow concerned investors. I have
read over this letter, and I find myself agreeing with the content more
than I agree to the unamended SR-OCC-2024-01.
FORM LETTER:
Thank you for the opportunity to comment on SR-OCC-2024-001 34-99393
entitled “Proposed Rule Change by The Options Clearing Corporation
Concerning Its Process for Adjusting Certain Parameters in Its
Proprietary System for Calculating Margin Requirements During Periods
When the Products It Clears and the Markets It Serves Experience High
Volatility” (PDF, Federal Register) as a retail investor. I have
several concerns about the OCC rule proposal, do not support its
approval, and appreciate the opportunity to comment.
I’m concerned about the lack of transparency in our financial system as
evidenced by this rule proposal, amongst others. The details of this
proposal in Exhibit 5 along with supporting information (see, e.g.,
Exhibit 3) are significantly redacted which prevents public review
making it impossible for the public to meaningfully review and comment
on this proposal. Without opportunity for a full public review, this
proposal should be rejected on that basis alone.
Public review is of the particular importance as the OCC’s Proposed Rule
blames U.S. regulators for failing to require the OCC adopt prescriptive
procyclicality controls (“U.S. regulators chose not to adopt the typ??es
of prescriptive procyclicality controls codified by financial regulators
in other jurisdictions.” [1]). As “??procyclicality may be evidenced by
increasing margin in times of stressed market conditions” [2], an
“increase in margin requirements could stress a Clearing Member's
ability to obtain liquidity to meet its obligations to OCC” [Id.] which
“could expose OCC to financial risks if a Clearing Member fails to
fulfil its obligations” [3] that “could threaten the stability of its
members during periods of heightened volatility” [2]. With the OCC
designated as a SIFMU whose failure or disruption could threaten the
stability of the US financial system, everyone dependent on the US
financial system is entitled to transparency. As the OCC is classified
as a self-regulatory organization, the OCC blaming U.S. regulators for
not requiring the SRO adopt regulations to protect itself makes it
apparent that the public can not fully rely upon the SRO and/or the U.S.
regulators to safeguard our financial markets.
This particular OCC rule proposal appears designed to protect Clearing
Members from realizing the risk of potentially costly trades by rubber
stamping reductions in margin requirements as required by Clearing
Members; which would increase risks to the OCC. Per the OCC rule proposal:
The OCC collects margin collateral from Clearing Members to address
the market risk associated with a Clearing Member’s positions. [3]
OCC uses a proprietary system, STANS (“System for Theoretical
Analysis and Numerical Simulation”), to calculate each Clearing Member's
margin requirements with various models. One of the margin models may
produce “procyclical” results where margin requirements are correlated
with volatility which “could threaten the stability of its members
during periods of heightened volatility”. [2]
An increase in margin requirements could make it difficult for a
Clearing Member to obtain liquidity to meet its obligations to OCC. If
the Clearing Member defaults, liquidating the Clearing Member positions
could result in losses chargeable to the Clearing Fund which could
create liquidity issues for non-defaulting Clearing Members. [2]
Basically, a systemic risk exists because Clearing Members as a whole
are insufficiently capitalized and/or over-leveraged such that a single
Clearing Member failure (e.g., from insufficiently managing risks
arising from high volatility) could cause a cascade of Clearing Member
failures. In layman’s terms, a Clearing Member who made bad bets on
Wall St could trigger a systemic financial crisis because Clearing
Members as a whole are all risking more than they can afford to lose.
The OCC’s rule proposal attempts to avoid triggering a systemic
financial crisis by reducing margin requirements using “idiosyncratic”
and “global” control settings; highlighting one instance for one
individual risk factor that “[a]fter implementing idiosyncratic control
settings for that risk factor, aggregate margin requirements decreased
$2.6 billion.” [4] The OCC chose to avoid margin calling one or more
Clearing Members at risk of default by implementing “idiosyncratic”
control settings for a risk factor. According to footnote 35 [5], the
OCC has made this “idiosyncratic” choice over 200 times in less than 4
years (from December 2019 to August 2023) of varying durations up to 190
days (with a median duration of 10 days). The OCC is choosing to waive
away margin calls for Clearing Members over 50 times a year; which seems
too often to be idiosyncratic. In addition to waiving away margin calls
for 50 idiosyncratic risks a year, the OCC has also chosen to implement
“global” control settings in connection with long tail [6] events
including the onset of the COVID-19 pandemic and the so-called
“meme-stock” episode on January 27, 2021. [7]
Fundamentally, these rules create an unfair marketplace for other market
participants, including retail investors, who are forced to face the
consequences of long-tail risks while the OCC repeatedly waives margin
calls for Clearing Members by repeatedly reducing their margin
requirements. For this reason, this rule proposal should be rejected
and Clearing Members should be subject to strictly defined margin
requirements as other investors are.
Per the OCC, this rule proposal and these special margin reduction
procedures exist because a single Clearing Member defaulting could
result in a cascade of Clearing Member defaults potentially exposing the
OCC to financial risk. [8] Thus, Clearing Members who fail to properly
manage their portfolio risk against long tail events become de facto Too
Big To Fail. For this reason, this rule proposal should be rejected and
Clearing Members should face the consequences of failing to properly
manage their portfolio risk, including against long tail events.
Clearing Member failure is a natural disincentive against excessive
leverage and insufficient capitalization as others in the market will
not cover their loss.
This rule proposal codifies an inherent conflict of interest for the
Financial Risk Management (FRM) Officer. While the FRM Officer’s
position is allegedly to protect OCC’s interests, the situation outlined
by the OCC proposal where a Clearing Member failure exposes the OCC to
financial risk necessarily requires the FRM Officer to protect the
Clearing Member from failure to protect the OCC. Thus, the FRM Officer
is no more than an administrative rubber stamp to reduce margin
requirements for Clearing Members at risk of failure. Unfortunately,
rubber stamping margin requirement reductions for Clearing Members at
risk of failure vitiates the protection from market risks associated
with Clearing Member’s positions provided by the margin collateral that
would have been collected by the OCC. For this reason, this rule
proposal should be rejected and the OCC should enforce sufficient margin
requirements to protect the OCC and minimize the size of any bailouts
that may already be required.
As the OCC’s Clearing Member Default Rules and Procedures [9] Loss
Allocation waterfall allocates losses to “?3. OCC’s own pre-funded
financial resources” (OCC ‘s “skin-in-the-game” per SR-OCC-2021-801
34-91491 [10]) before “4. Clearing fund deposits of non-defaulting
firms”, any sufficiently large Clearing Member default which exhausts
both “1. The margin deposits of the suspended firm” and “2. Clearing
fund deposits of the suspended firm” automatically poses a financial
risk to the OCC. As this rule proposal is concerned with potential
liquidity issues for non-defaulting Clearing Members as a result of
charges to the Clearing Fund, it is clear that the OCC is concerned
about risk which exhausts OCC’s own pre-funded financial resources.
With the first and foremost line of protection for the OCC being “1. The
margin deposits of the suspended firm”, this rule proposal to reduce
margin requirements for at risk Clearing Members via idiosyncratic
control settings is blatantly illogical and nonsensical. By the OCC’s
own admissions regarding the potential scale of financial risk posed by
a defaulting Clearing Member, the OCC should be increasing the amount of
margin collateral required from the at risk Clearing Member(s) to
increase their protection from market risks associated with Clearing
Member’s positions and promote appropriate risk management of Clearing
Member positions. Curiously, increasing margin requirements is exactly
what the OCC admits is predicted by the allegedly “procyclical” STANS
model [2] that the OCC alleges is an overestimation and seeks to
mitigate [11]. If this rule proposal is approved, mitigating the
procyclical margin requirements directly reduces the first line of
protection for the OCC, margin collateral from at risk Clearing
Member(s), so this rule proposal should be rejected, made fully
available for public review, and approved only with significant
amendments to address the issues raised herein.
In light of the issues outlined above, please consider the following
modifications:
Increase and enforce margin requirements commensurate with risks
associated with Clearing Member positions instead of reducing margin
requirements. Clearing Members should be encouraged to position their
portfolios to account for stressed market conditions and long-tail
risks. This rule proposal currently encourages Clearing Members to
become Too Big To Fail in order to pressure the OCC with excessive risk
and leverage into implementing idiosyncratic controls more often to
privatize profits and socialize losses.
External auditing and supervision as a “fourth line of defense”
similar to that described in The “four lines of defence model” for
financial institutions [12] with enhanced public reporting to ensure
that risks are identified and managed before they become systemically
significant.
Swap “?3. OCC’s own pre-funded financial resources” and “4.
Clearing fund deposits of non-defaulting firms” for the OCC’s Loss
Allocation waterfall so that Clearing fund deposits of non-defaulting
firms are allocated losses before OCC’s own pre-funded financial
resources and the EDCP Unvested Balance. Changing the order of loss
allocation would encourage Clearing Members to police each other with
each Clearing Member ensuring other Clearing Members take appropriate
risk management measures as their Clearing Fund deposits are at risk
after the deposits of a suspended firm are exhausted. This would also
increase protection to the OCC, a SIFMU, by allocating losses to the
clearing corporation after Clearing Member deposits are exhausted. By
extension, the public would benefit from lessening the risk of needing
to bail out a systemically important clearing agency.
Thank you for the opportunity to comment as all investors benefit from a
fair, transparent, and resilient market.
[1] https://www.federalregister.gov/d/2024-01386/p-11
[2] https://www.federalregister.gov/d/2024-01386/p-8
[3] https://www.federalregister.gov/d/2024-01386/p-7
[4] https://www.federalregister.gov/d/2024-01386/p-50
[5] https://www.federalregister.gov/d/2024-01386/p-51
[6] https://en.wikipedia.org/wiki/Long_tail
[7] https://www.federalregister.gov/d/2024-01386/p-45
[8] https://www.federalregister.gov/d/2024-01386/p-79
[9]
https://protect2.fireeye.com/v1/url?k=31323334-50bba2bf-3132d782-4544474f5631-8eaacaa8d5ebe586&q=1&e=9fa01310-e42e-4923-ba48-7d6d61563439&u=https%3A%2F%2Fwww.theocc.com%2Fgetmedia%2Fe8792e3c-8802-4f5d-bef2-ada408ed1d96%2Fdefault-rules-and-procedures.pdf,
which is publicly available and linked to from the OCC’s web page on
Default Rules & Procedures at
https://protect2.fireeye.com/v1/url?k=31323334-50bba2bf-3132d782-4544474f5631-e96eacc2542ab5f5&q=1&e=9fa01310-e42e-4923-ba48-7d6d61563439&u=https%3A%2F%2Fwww.theocc.com%2Frisk-management%2Fdefault-rules-and-procedures
[10]
https://www.federalregister.gov/documents/2021/04/12/2021-07454/self-regulatory-organizations-the-options-clearing-corporation-notice-of-no-objection-to-advance
[11] https://www.federalregister.gov/d/2024-01386/p-16
[12] https://www.bis.org/fsi/fsipapers11.pdf
Sincerely,
Louis Avery Moncure