Feb. 13, 2024
Thank SEC for the opportunity to comment, noting the absence of opportunity for external input from the OCC. Express concerns about transparency, especially regarding the calculation of margin thresholds. Offer a brief overview of concerns, including but not limited to: o The lack of specific details on how parameters in the OCC's proprietary system are determined during high market volatility. o The potential risks associated with granting unchecked authority to the OCC's FRM Officer during periods of market stress. o The concern that the FRM Officer's role may lead to rubber-stamping margin reductions, impacting OCC resilience. Explain that these concerns will be addressed in detail below. Express the commitment to offer solutions addressing the flaws in both the proposal and the broader systemic issues that require attention and evaluation, urging the SEC to revalue the rule as a whole, not just the proposed changes. TRANSPARENCY CONCERNS. Lack of Public Visibility: ? Highlight the extensive redaction of supporting information making it impossible for the public to fully review and comment on the proposal. o Notably the redacted 205 pages detailing how margin thresholds will be calculated. ? Emphasise the importance of public review, especially considering the OCC's critical role as a Systemically Important Financial Market Utility (SIFMU). With note to the following: Transparency in Decision-Making: o Argue that clear & well-defined guidelines are essential for maintaining market confidence and preventing abuse. o Critique the statement in the section titled "Clearing Agency's Statement on Comments on the Proposed Rule Change Received from Members, Participants, or Others," where it explicitly asserts, "Written comments were not and are not intended to be solicited with respect to the proposed change." Question the decision's intent, suggesting the OCC neglects transparency and accountability by refusing to actively seek comments, leaving the public uninformed about crucial financial market operations. o Advocate for active engagement with stakeholders to understand potential impacts. o Emphasise that soliciting comments is essential for effective governance in a financial market utility. o Reinforce that transparency safeguards against potential abuse of control settings. o Argue for scrutiny and input from stakeholders to prevent unintended consequences. o Highlight that transparent processes and stakeholder engagement are crucial for regulatory decisions' legitimacy and effectiveness. RECOMMENDATIONS TO IMPROVE TRANSPARENCY AND ENGAGEMENT: Enhanced Public Visibility: ? Recommend the SEC to push for complete disclosure of supporting information, eliminating extensive redactions, notably the 205 pages detailing margin threshold calculation methods. ? Emphasise the importance of public review and comment, particularly in light of the OCC's substantial role as a Systemically Important Financial Market Utility (SIFMU). ? Encourage the SEC to take proactive steps to ensure transparency in the OCC's rule-making processes – such as enforcing requirements for the OCC to actively seek and consider input from its members and participants, enhancing transparency and stakeholder engagement. Transparency in Decision-Making: ? Advocate for the implementation of clear, comprehensive and well-defined guidelines to govern the use of idiosyncratic control settings, particularly including the calculation of margin thresholds during periods of high volatility. ? Stress the importance of transparency in safeguarding against the abuse of control settings and maintaining market integrity. ? Express concerns about potential misuse or abuse without well-defined guidelines, emphasising the need for market confidence and integrity. ? Recommend regulatory scrutiny to prevent frequent practices that may undermine effective risk management and contribute to a broader financial crisis. RISK MANAGEMENT AND PROCYCLICALITY: Credit & Procyclicality Risks Associated with Clearing Members' Potential Failure: ? Stress the need for effective risk management to mitigate credit risks and maintain the stability of the clearing system. ? Outline the liquidity challenges for non-defaulting Clearing Members if a defaulting member cannot meet its obligations. ? Clearing Members' default could lead to losses chargeable to the Clearing Fund, impacting other non-defaulting members. Observed Procyclicality in the STANS Model: ? Highlight the observed procyclicality in the STANS model, leading to excessive margin requirements during market downturns. With note to the following: Clearing Members need to be held accountable for meeting margin obligations even during challenging market conditions. Procyclicality should not be an excuse for Clearing Members to avoid fulfilling their financial responsibilities. Accountability ensures that Clearing Members proactively manage their portfolios to withstand market fluctuations. Stricter enforcement of obligations promotes a fair and transparent market, preventing shifts in responsibilities during tough times. Emphasisng accountability discourages risky behaviour by Clearing Members, contributing to overall market stability. The OCC's measures should reinforce accountability, ensuring that Clearing Members adhere to their margin obligations consistently. ? Helpful Tip: A Clearing Member default poses a significant credit risk to the Options Clearing Corporation (OCC). PROPOSED MEASURES TO MITIGATE PROCYCLICALITY: ** Procyclicality refers to a phenomenon where financial activities and risks are positively correlated with the overall economic cycle. In simpler terms, it means that certain factors, such as margin requirements or risk-taking behavior, tend to increase during economic upswings and decrease during downturn. Overview of OCC's Proposed Measures: ? Provide an overview of the OCC's proposed measures, specifically regular and high volatility control settings, aimed at addressing procyclicality. ? Stress the importance of establishing and regularly reviewing control parameters for effective risk management. ? Advocate for external auditing to ensure the robustness of risk management practices. Credit & Procyclicality Risks: ? Emphasise the critical role of effective risk management in mitigating credit risks and maintaining clearing system stability. Highlighting the crucial role of effective risk management means emphasising the importance of implementing strategies to identify and control the potential financial risks associated with clearing members. This is essential to ensure stability and prevent disruptions caused by defaults or financial troubles of participants in the clearing system. ? Outline the liquidity challenges that non-defaulting Clearing Members may face if a defaulting member fails to meet obligations. ? Highlight the potential impact on other non-defaulting members due to losses chargeable to the Clearing Fund in case of a default. Accountability of Clearing Members: ? Stress the need for holding Clearing Members accountable for meeting margin obligations, especially during challenging market conditions. ? Assert that procyclicality should not serve as an excuse for Clearing Members to evade financial responsibilities. ? Advocate for accountability to ensure proactive portfolio management by Clearing Members to withstand market fluctuations. ? Call for stricter enforcement of obligations to maintain a fair and transparent market, preventing shifts in responsibilities during tough times. ? Emphasise that accountability discourages risky behavior by Clearing Members, contributing to overall market stability. ? Argue that the OCC's measures should reinforce accountability, ensuring consistent adherence to margin obligations by Clearing Members. IDIOSYNCRATIC CONTROL SETTINGS: ** Idiosyncratic Control Settings refer to specific adjustments made by financial institutions to manage risk in their trading activities. These settings can include changes to margin requirements, risk parameters, or other factors tailored to individual circumstances. Frequency of Idiosyncratic Choices: ? Express concern about the OCC's recurrent use of idiosyncratic control settings and the potential impact on market fairness. o Raise questions about the idiosyncratic nature of over 200 decisions made in less than four years (from December 2019 to August 2023). o Emphasise the need for transparency and clarity in the decision-making process for idiosyncratic control settings. o Highlight the risk of selective application or lack of justification for idiosyncratic control settings, potentially impacting fairness and market integrity. Potential Market Impact: ? Warn of the market instability resulting from frequent reductions in margin requirements for individual securities. o Highlight the specific instance mentioned in the OCC's rule proposal where aggregate margin requirements decreased by $2.6 billion after implementing idiosyncratic control settings for one risk factor ? On April 28, 2023, OCC's idiosyncratic control settings were applied to a stock (without listed options) that underwent significant multi-day price jumps, going from $6.72 on April 27, 2023, to $108.20). ? Emphasise the need for fair and transparent practices to maintain market integrity. ? Discuss concerns about waiving margin calls for Clearing Members over 50 times a year, challenging the notion of idiosyncrasy. KEY DISCUSSION POINTS: ? The OCC used "idiosyncratic" control settings to avoid margin calls for one or more at-risk Clearing Members, resulting in a $2.6 billion decrease in aggregate margin requirements. ? The OCC's rule proposal employs "idiosyncratic" and "global" control settings to prevent a systemic financial crisis. ? The frequency of these idiosyncratic choices has surpassed 200 times in less than four years, with durations ranging up to 190 days (median duration of 10 days). ? The characterisation of these choices as purely idiosyncratic is challenged, given their high occurrence rate. ? A comprehensive review and justification process for both idiosyncratic and global control settings to ensure fairness and stability in the market is required. ADVANCING TRANSPARENCY IN IDIOSYNCRATIC CONTROLS: Enhanced Review and Transparency: ? Establish the need for a detailed, transparent, and well-documented review and justification process for applying idiosyncratic and global control settings. ? Advocate for the disclosure of specific criteria, considerations, and reasoning behind each instance to enhance public understanding and trust. ? Urge the OCC to provide accessible information detailing the criteria and considerations guiding idiosyncratic control setting decisions. External Oversight for Rigorous Evaluation ? Recommend regular and detailed reporting on the application of both idiosyncratic and global controls, including frequency, duration, and specific circumstances for each instance. ? Propose the involvement of an external oversight committee, comprising industry experts and academics, for a rigorous evaluation of idiosyncratic and global control decisions. ? Suggest external audits to ensure adherence to established guidelines and fairness in decision-making. ? Advocate for active engagement with Clearing Members during the application of idiosyncratic and global controls. Public & Expert Review W/ Adaptive Adjustments: Framework Risk Assessment: ? Propose the development of a comprehensive framework defining the circumstances, duration, and impact assessment of these controls. ? Recommend the inclusion of a thorough risk impact assessment in the decision-making process for idiosyncratic and global controls. ? Encourage consideration of broader market implications and potential systemic risks associated with the frequent use of these controls. Public Involvement and Guidelines: ? Emphasise the importance of public consultations and hearings to gather diverse perspectives on the potential market impact of these controls. ? Stress the need for clear guidelines and criteria governing the application of idiosyncratic and global control settings. ? Suggest a periodic review mechanism to assess the effectiveness and necessity of idiosyncratic and global controls. ? Emphasise the importance of adaptive risk management measures that align with the dynamic nature of financial markets. SYSTEMIC RISK AND FAIRNESS: ? Analyse the potential systemic risks arising from insufficiently capitalised Clearing Members and the cascade effect of a single failure. ? Express concerns about the fairness of discretionary reduction of margin requirements and its impact on market integrity. LOSS ALLOCATION WATERFALL: ** Loss Allocation Waterfall is a step-by-step process that determines how financial losses are distributed and absorbed in a financial system, typically in the event of a default or crisis. It outlines the order in which different parties or funds bear the losses, ensuring a structured and fair approach to managing financial risks. Automatic Financial Risk to OCC: Emphasise that the OCC's Clearing Member Default Rules the clearing fund deposits of non-defaulting firms allocate losses to its own pre-funded financial resources (skin-in-the-game) before o Highlight the financial risk automatically posed to the OCC in the event of a sufficiently large Clearing Member default. o Emphasise the importance of OCC's skin-in-the-game as the first line of protection. Impact on Financial Protections: Emphasise the rule proposal's potential impact on OCC's primary protection line - the margin deposits of the at-risk Clearing Member(s). o Argue that reducing margin requirements directly undermines the first line of defense against market risks associated with Clearing Member positions. o Highlight the need for increased margin collateral to protect against market risks and promote responsible risk management. Highlighting OCC's Specific Concerns: Emphasise the OCC's explicit fear of charging losses to the Clearing Fund, potentially causing liquidity issues for non-defaulting Clearing Members. o Discuss the domino effect, stressing that insufficient liquidity might trigger defaults among non-defaulting members. Recap the OCC's acknowledgment of concerns about the STANS model predicting increasing margin in stressed market conditions. Illogical Nature of Margin Reduction: Express concerns about the illogical nature of reducing margin requirements for at-risk Clearing Members through idiosyncratic control settings as a solution to minimising OCC’s exposure to Clearing Member defaults. o Argue that, based on OCC's own admissions, increasing margin requirements would be logical for better protection against potential financial risks. o Challenge the proposal's contradiction to the OCC's acknowledgment of predicted procyclical increases in margin requirements. SUPPORTING INFORMATION: ? The OCC acknowledges that an upsurge in margin requirements may strain a Clearing Member's ability to secure liquidity. ? The correlation between concerns regarding liquidity, potential defaults, and the OCC's proactive measures is evident through proposed rule changes. ? A comprehensive understanding of the OCC's Loss Allocation Waterfall reveals the systematic distribution of losses and its potential ramifications on various financial segments. ? The projection of potential costs to the OCC in case of a default is based on the average deposits per Clearing Member, prompting inquiries about the adequacy of financial resources. ? The OCC's strategic approach involves retaining Clearing Member collateral and postponing close-out transactions, underscoring potential repercussions for market stability. STRENGTHENING LOSS ALLOCATION: PROPOSED MEASURES Advocate for increased transparency in the Loss Allocation Waterfall process to ensure a clear understanding of how losses are distributed. Call for improved communication channels to keep stakeholders informed about changes and potential impacts on financial protections. Reinforce the concept of skin-in-the-game as a critical first line of protection for the OCC. Propose measures to enhance the sufficiency and effectiveness of OCC's pre-funded financial resources, ensuring they can adequately absorb losses in the event of a default. Advocate for scenario-based stress testing of the Loss Allocation Waterfall to assess its resilience under various market conditions. Propose periodic reviews and adjustments based on the outcomes of stress tests to enhance the robustness of the entire process. Suggest educational programs for Clearing Members to understand the rationale behind margin adjustments and loss allocation procedures. Encourage the OCC to provide clear guidelines and explanations to mitigate concerns and foster proactive risk management by Clearing Members. FINANCIAL RISK MANAGEMENT OFFICER'S ROLE: Discretionary Power and Uncertainty: ? Express concerns over the extensive monopolising authority granted to the FRM Officer, especially in approving idiosyncratic control settings and adjusting their duration. ? Address the inherent conflict of interest in the FRM Officer's role, balancing OCC's and Clearing Members' interests. ? Highlight the paradoxical situation where the FRM Officer becomes an administrative rubber stamp, reducing margin requirements for Clearing Members at risk compromising margin collateral's integrity. ? Highlight the increased uncertainty resulting from this discretionary power and its potential adverse effects on market participants and stakeholders. ? Stress the importance of transparency and clear guidelines in decision-making for maintaining market confidence. ? Emphasise challenges arising from the lack of a clear, predefined schedule for idiosyncratic control settings. Impact on Market Risks: ? Underscore the serious implications of margin requirement reductions for at-risk Clearing Members. ? State that such actions directly undermine margin collateral's role in safeguarding against market risks, potentially leading to larger bailouts. PROPOSED ENHANCEMENTS FOR FRM OFFICER OVERSIGHT: ? Propose the establishment of an external oversight framework to evaluate and regulate the FRM Officer's discretionary decisions. o Stress the need for increased transparency regarding the FRM Officer's discretionary powers and actions, fostering trust among stakeholders. ? Advocate for transparent and well-defined guidelines, outlining specific criteria for the FRM Officer's decision-making process. o Stress the importance of establishing a clear and predefined schedule for the FRM Officer's discretionary decisions to reduce uncertainty. ? Recommend external audits of the FRM Officer's discretionary actions to ensure adherence to established guidelines. ? Call for improved communication channels to keep stakeholders informed about the FRM Officer's decisions and the rationale behind them. o Suggest involving relevant stakeholders in the process through consultations, ensuring their perspectives are considered in decision-making. ? Propose incorporating scenario-based stress testing specifically tailored to evaluate the impact of the FRM Officer's discretionary choices. RECOMMENDATIONS: Recap of the solutions: ? Strengthen and enforce margin requirements to align with Clearing Member risks, discouraging a "Too Big To Fail" strategy that could pressure the OCC, privatize profits, and socialise losses. ? Introduce external auditing and supervision as a "fourth line of defense" for enhanced transparency and proactive risk management with public reporting. ? Incorporate public input through consultations and hearings in the rule-making process for inclusive and representative regulatory actions. ? Advocate for public accessibility of stress testing results to showcase risk management effectiveness and build trust among market participants. ? Consider establishing an external oversight committee of industry experts, academics, and investor advocacy representatives for impartial evaluation of risk management practices. ? Reorder the Loss Allocation waterfall, prioritizing Clearing fund deposits of non-defaulting firms over OCC's pre-funded financial resources and the EDCP Unvested Balance to foster self-regulation among Clearing Members. ? Enhance transparency requirements, ensuring clear and accessible disclosure in reporting and decision-making processes related to risk management measures. ? Strengthen oversight mechanisms, involving regulatory bodies more actively to maintain accountability and address emerging risks during periods of heightened market volatility. ? Provide clear guidelines for the application of idiosyncratic controls, preventing misuse, and proposing a structured evaluation framework for consistency and full disclosure for public review. ? Consider establishing an external oversight committee comprised of industry experts, academics, and investor advocacy representatives for impartial evaluation and scrutiny of risk management practices. CLOSER & CALL TO ACTION: ? Conclude by expressing the need for careful consideration and revisions to the proposed rule. ? Recommend enforcing sufficient and strictly defined margin requirements for Clearing Members to prevent systemic risks and ensure market stability. ? Stress the importance of transparency, external auditing, and a fair playing field for all market participants. ? Closing: ? Thank the SEC for the opportunity to comment and express hope for a thorough review of the concerns raised. Concern investor, Terrance Wilson Sent from my iPhone Virginia's Community Colleges Alumni