Feb. 7, 2024
Thank you for the opportunity to comment on SR-OCC-2024-001 34-99393 entitled "Proposed
Rule Change by The Options Clearing Corporation Concerning lts 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 types 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" [ld.] 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 1 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
1. 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.
2. External auditing and supervision as a "fourth line of defense" similar to that described in The
"four lines of defence model" for financial institutions [1 2] with enhanced public reporting to
ensure that risks are identified and managed before they become systemically significant.
3. 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://www.theocc.com/getmedia/e8792e3c-8802-4f5d-bef2-ada408ed1d96/default-rules
-and-procedures.pdf, which is publicly available and linked to from the OCC's web page on Default
Rules & Procedures at https://www.theocc.com/risk-management/default-rules-and-procedures
[10] https://www.federalregister.gov/documents/2021/04/12/2021-07454/self-regulatory
-organizations-the-options-clearing-corporation-notice-of-no-obiection-to-advance
[11] https://www.federalregister.gov/d/2024-01386/p-16
[12] https://www.bis.org/fsi/fsipapers11.pdf
Sincerely,
A Concerned Retail Investor