Mar. 4, 2024
Dear Securities and Exchange Commission, I commend the SEC's commitment to an open regulatory dialogue, but concerns arise regarding Rule SR-OCC-2024-001, particularly the lack of external input during its formulation. I have serious transparency concerns regarding Rule SR-OCC-2024-001. The extensive redaction of supporting information, notably the 205 pages detailing margin threshold calculations during high market volatility, impedes public scrutiny and hinders stakeholders from making informed decisions. Complete disclosure of supporting information is recommended to uphold the integrity of financial markets. Clear guidelines for idiosyncratic control settings, particularly in calculating margin thresholds during high volatility, should be implemented to prevent potential abuse and maintain market integrity. The statement in SR-OCC-2024-001 indicating that written comments were not solicited raises questions about the accountability and openness of the OCC in its rule-making procedures. Proactive measures, such as enforcing requirements for the OCC to actively seek and consider input from its members and participants, are needed to enhance transparency and stakeholder engagement. The recurring use of idiosyncratic control settings by the OCC sparks concerns about potential risks and their impact on market fairness. With over 200 decisions made in less than four years, questions arise about the nature and consequences of these choices for market coherence. The lack of transparency in the decision-making process raises concerns, allowing for selective application or insufficient justification, ultimately compromising market integrity. Public involvement and review are essential components. Emphasizing the importance of public consultations and hearings to gather diverse perspectives is crucial. Recommending clear guidelines and criteria for the application of these controls and introducing a periodic review mechanism by market participants will ensure ongoing adaptability to the dynamic nature of financial markets. This comprehensive approach aims to address inherent risks and strengthen the OCC's risk management for the benefit of all stakeholders. Mitigating potential systemic risks from undercapitalized Clearing Members is vital for overall financial system stability. A detailed analysis is needed to understand the complex interconnections and potential cascading effects resulting from a single Clearing Member's failure. Inadequate capitalization not only endangers the Clearing Member but can also trigger a ripple effect, impacting other market participants and potentially leading to a broader financial crisis. Expressing concerns about the fairness of discretionary margin requirement reductions is crucial for market integrity. The discretionary nature of these reductions raises questions about equitable treatment, potentially favoring certain Clearing Members. To ensure fairness and mitigate systemic risks, a comprehensive review and stringent measures are necessary to guarantee consistent and transparent application of margin requirements across all Clearing Members. If a Clearing Member faces financial distress and automatic loss allocation depletes the OCC's funds, it exposes the OCC to heightened financial risk. This may lead the OCC to make decisions, like adjusting margin thresholds or using idiosyncratic control settings, to protect its interests, raising concerns about its objectivity. In a Clearing Member default, suspending and liquidating their positions could impose losses on the mutualized Clearing Fund, potentially burdening non-defaulting Clearing Members disproportionately. This reliance on funds from non-defaulting firms in the Clearing Fund is unfair, impacting their liquidity and ability to meet obligations in stressed market conditions. Additionally, the proposal underscores the OCC's reluctance to sell Clearing Member collateral, emphasizing its concern over realizing losses. Clearing Members holding onto collateral assets may strategically manage losses, posing the risk of transferring losses to pension funds and insurance companies through the OCC's Non-Bank Liquidity Facility. This underscores the complex dynamics and potential ramifications associated with the Loss Allocation Waterfall and strategies employed by the OCC and Clearing Members to navigate financial challenges and mitigate losses. In exploring Rule SR-OCC-2024-001, attention is directed to the critical aspect of risk management. Risk management is vital for financial stability, especially concerning credit risks associated with potential Clearing Member failures, necessitating strict risk management measures. The cascading repercussions of a member default underscore the need for robust accountability measures to prevent compromising the financial stability of the clearing system, thus avoiding systemic risks undermining market integrity. However, it is crucial to stress that accountability should remain a cornerstone for Clearing Members even in challenging market conditions. Procyclicality should not serve as an excuse for Clearing Members to evade their financial responsibilities. Accountability ensures that Clearing Members proactively manage their portfolios, preventing disruptions that may arise from defaults or financial troubles of participants in the clearing system. As we analyze the risks and implications of SR-OCC-2024-001, comprehensive risk management practices become increasingly evident. The introduction of regular and high volatility control settings by the OCC raises concerns about potential risks associated with procyclicality. These settings, designed to adjust margin requirements based on market conditions, carry the inherent risk of prioritizing Clearing Members' stability over broader market stability. The adaptability inherent in these control settings opens the door to potential exploitation by Clearing Members seeking self-benefit, posing a risk to the overall integrity of the market. To address these concerns, the following measures are suggested to navigate the risks and challenges associated with the OCC's proposed rule and current systems: Prioritize the establishment and regular review of stable and well-defined control parameters, emphasizing precision to align risk management practices with the dynamic nature of financial markets. External auditing serves as a testament to the OCC's transparency and commitment to robust risk management practices. External audits provide an additional layer of scrutiny, ensuring the proposed measures are effective and resilient to potential challenges. Hold Clearing Members accountable for meeting margin obligations, especially during challenging market conditions, imposing safeguards through routine assessments, regular reviews, sophisticated risk management tools, predictive analytics, clear guidelines, transparency, periodic audits, and an external oversight committee. Stricter enforcement of these obligations promotes a fair and transparent market, discourages risky behavior by Clearing Members, and contributes to overall market stability. The proposed measures represent a commitment to accountability, transparency, and risk management principles, fostering a financial environment where risks are managed responsibly and market integrity is upheld. The SR-OCC-2024-001 rule raises concerns about the considerable discretionary powers granted to the Financial Risk Management (FRM) Officer. Idiosyncratic Control Settings: The proposal allows the FRM Officer to adjust idiosyncratic control settings, risking subjective decision-making without proper justification. Potential conflicts of interest arise, as the FRM Officer's decisions could favor certain participants or securities, undermining market integrity. Reduction of Margin Requirements: Margin reductions from idiosyncratic control settings compromise the primary function of collateral, creating a risk of larger bailouts and threatening overall financial system stability. The discretionary power to adjust the duration of these settings introduces uncertainty, impacting market participants' decision-making and risk mitigation strategies. Conflict of Interest: The FRM Officer's role poses a conflict of interest, potentially leading to decisions that favor Clearing Members facing financial challenges, jeopardizing the integrity of margin collateral. Strategic Use of Master Repurchase Agreements (MRA): The OCC's strategic use of MRAs based on advanced knowledge of a Clearing Member default introduces a manipulation risk, emphasizing the need for accountability and transparency. To address these concerns: External Oversight: Establish an external oversight framework to evaluate and regulate the FRM Officer's discretionary decisions. Conduct external audits and create an independent oversight committee for diverse and unbiased evaluations. Transparency and Reporting: Mandate detailed documentation and justification for each decision, with regular reports to regulatory bodies. Publicly disclose criteria and considerations used by the FRM Officer in approving idiosyncratic control settings. Stakeholder Involvement: Form consultation panels with diverse stakeholders to provide input and prevent undue influence. Consider a collective board to perform the FRM role, minimizing concentration of power. Legislation and Training: Enact legislation defining clear criteria for approving idiosyncratic control settings. Implement regular training programs and certification requirements for the FRM Officer. Rotation and Scenario-based Stress Testing: Introduce a policy for periodic rotation of the FRM Officer position to mitigate long-term biases. Implement scenario-based stress testing to assess the impact of the FRM Officer's discretionary choices. Strengthen Margin Requirements: Align margin requirements with Clearing Member risks to discourage a "Too Big To Fail" strategy. Prevent privatisation of profits and socialisation of losses. Public Accessibility of Stress Testing Results: Advocate for public accessibility of stress testing results to showcase risk management effectiveness and build trust. In conclusion, the issues in proposed rule SR-OCC-2024-001 demand careful consideration for the integrity and stability of financial markets. I'm grateful to the SEC for the opportunity to comment, urging a thorough review for upholding transparency, accountability, and fairness in our financial regulatory framework. Thank you for your dedication to ensuring the soundness and resilience of our financial markets. Sincerely, Scott G