May 7, 2024
SEC, As a retail investor, I am grateful for the opportunity to share my thoughts on the proposed changes by The Options Clearing Corporation (OCC) concerning how they handle margin requirements during volatile market periods, detailed in SR-OCC-2024-001 Release No 34-100009 and 34-99393. I want to express that I do not support the approval of this proposal and I'm thankful for the chance to help ensure that all investors are protected in a fair and efficient market. One of my primary concerns is the secrecy within the financial system, as shown by significant redactions in the documents related to this proposal. These omissions prevent the public from fully understanding and evaluating the proposed changes, and for this reason alone, I believe the proposal should not be approved. The OCC has criticized U.S. regulators for not enforcing stricter rules that would limit how financial swings impact margin requirements. The OCC uses a system called STANS to determine the necessary margin, or security deposit, that covers potential losses. This system can raise margin requirements during unstable times, which might financially strain clearing members, leading to failures that could destabilize the financial system. The OCC often lowers these requirements, claiming it prevents broader financial disruptions. However, I argue this approach unfairly protects clearing members from the consequences of their risky behaviors, while increasing risk to the OCC and the broader market. Additionally, the OCC has made adjustments to its rules to lower margin requirements in response to specific market events like the COVID-19 pandemic and the meme-stock surge. The regularity of these adjustments suggests they are not as infrequent or unique as the OCC claims. This practice not only protects clearing members at the expense of the broader market but also undermines the integrity of financial regulations. The proposal suggests that during financial troubles, losses should first be covered by the failing firm's own reserves, then by funds from firms that are not failing. This method, which places the burden on firms that are not failing, could lead to wider financial instability. I believe the OCC should enforce stricter and higher margin requirements to better protect itself and the market instead of lowering them to accommodate high-risk clearing members. Given these issues, I believe the SEC has valid reasons to disapprove this rule change, especially because it risks the safety of the clearing agency, fails to protect investors, and does not adequately manage liquidity risks. I recommend that the SEC demand stricter margin requirements that reflect true risks and insist on more audits and clearer rules to ensure that clearing members manage their portfolios against potential long-term risks. The SEC has rightfully identified valid reasons to disapprove this proposed rule change because it does not comply with specific sections and rules of the Exchange Act, specifically Section 17A(b)(3)(F), Rule 17Ad-22(e)(2), and Rule 17Ad-22(e)(6). Here are the key reasons why the SEC is right in its assessment: Section 17A(b)(3)(F) Concerns: The proposed rule does not adequately protect the securities and funds under the control of the clearing agency. By lowering margin requirements for clearing members who are at risk of failing, it increases financial risks for the OCC and other market players. It also endangers investors and the public by transferring the costs of a clearing member's failure to a non-bank liquidity facility, which includes pension funds and insurance companies. This expansion essentially makes any failing clearing member "too big to fail," as it allows them to incur losses that surpass their own financial safeguards. Rule 17Ad-22(e)(2) Concerns: The rule lacks a clear and transparent governance structure. For example, the Financial Risk Management (FRM) Officer’s role is more focused on protecting clearing members rather than the clearing agency itself. It prioritizes the safety of clearing members over the clearing agency by frequently reducing margin requirements without sufficient transparency or justification. The rule shifts financial burdens of clearing member failures onto a non-bank liquidity facility, affecting pension funds and insurance companies, contrary to the public interest and investor protection. It fails to establish clear lines of responsibility, notably seen in the FRM Officer acting merely as a rubber stamp to lower margin requirements for at-risk clearing members. By reducing margin requirements for these members, the rule increases systemic risk and creates a double standard within our financial system, fostering a "rules for thee, but not for me" scenario. The proposed rule change is not suitable for approval, as it compromises both the safety of the clearing agency and the broader financial market. Additionally, the SEC might also consider Rule 17Ad-22(e)(3), 17Ad-22(e)(4), and 17Ad-22(e)(6) as further reasons for disapproval. The proposed rule change does not adequately manage liquidity risks and increases systemic risk. There may be other reasons for rejecting this rule, but due to extensive redactions in the document, the public cannot fully evaluate the proposal. Given these concerns, I recommend the following actions: Increase Margin Requirements: Margins should reflect the actual risks associated with clearing member positions. Rather than lowering these requirements, clearing members should be prepared for stressed market conditions and long-tail risks. The current rule encourages a situation where clearing members can become too big to fail, pressuring the OCC into frequently using idiosyncratic controls to privatize profits and spread losses across the public. Implement External Auditing and Supervision: Introduce a "fourth line of defense," as per the model used in financial institutions, with enhanced public reporting. This will help identify and manage risks before they become systemically significant. Rearrange Loss Allocation Order: Change the order of loss allocation in the OCC's Loss Allocation waterfall. By placing the clearing fund deposits of non-defaulting firms before the OCC’s own pre-funded financial resources in the waterfall, this will motivate clearing members to monitor each other's risk management practices. This rearrangement would also provide greater protection to the OCC by ensuring that losses are covered by clearing member deposits first, reducing the risk of needing public bailouts for the OCC. Immediate Suspension and Liquidation of Failing Members: As soon as a clearing member's losses are projected to exceed their margin deposits, they should be suspended and their positions liquidated immediately. This prompt action contrasts with past practices of delaying intervention, which allowed risks to escalate and threatened financial stability. Reduce Systemic Vulnerabilities: Introduce more redundancy into the system, such as having multiple clearing agencies, to decrease the risk posed by a single point of failure. The principle that 'Too Big To Fail' must be eliminated; failure should always be a viable outcome to maintain systemic stability. These measures will help ensure a more robust, transparent, and fair financial market system. Thank you for considering my views and for this chance to contribute to a process that aims to create a transparent, fair, and stable market. Very respectfully, Justin Hosford Concerned Investor