May 14, 2024
As a retail investor, I am grateful for the chance to comment on SR-OCC-2024-001 Release No. 34-100009 regarding "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." I strongly support the SEC's grounds for disapproval, as I have numerous concerns about the OCC rule proposal and do not support its approval. It is vital to ensure all investors are protected in a fair, orderly, and efficient market.
The lack of transparency in our financial system, as evidenced by this rule proposal, is concerning. The proposal's details in Exhibit 5 and supporting information (e.g., Exhibit 3) are heavily redacted, preventing meaningful public review and commentary. Without full public scrutiny, this proposal should be rejected on this basis alone.
Public review is particularly important since the OCC’s proposed rule blames U.S. regulators for not requiring prescriptive procyclicality controls, unlike financial regulators in other jurisdictions. Procyclicality, evidenced by increasing margin in stressed market conditions, could stress a Clearing Member's ability to meet its obligations, exposing the OCC to financial risks and threatening stability during periods of heightened volatility. Given the OCC's designation as a SIFMU, whose failure could threaten the US financial system's stability, transparency is essential. The public cannot fully rely on the SRO and U.S. regulators to safeguard our markets.
This OCC rule proposal appears designed to protect Clearing Members from costly trades by reducing margin requirements, increasing risks to the OCC and the financial system's stability. According to the proposal, the OCC uses a proprietary system, STANS, to calculate margin requirements. However, this system may produce "procyclical" results where margin requirements correlate with volatility, potentially threatening stability during volatile periods. An increase in margin requirements could make it difficult for a Clearing Member to obtain liquidity, leading to potential defaults and liquidity issues for non-defaulting Clearing Members.
Essentially, a systemic risk exists because Clearing Members are insufficiently capitalized or over-leveraged, meaning a single failure could trigger a cascade of failures. In layman's terms, a Clearing Member's bad bets could cause a systemic financial crisis. The OCC’s rule proposal aims to avoid this by reducing margin requirements using "idiosyncratic" and "global" control settings. The OCC has repeatedly chosen to waive margin calls, which seems too frequent to be truly idiosyncratic. This undermines a fair marketplace for other participants, including retail investors, who must face long-tail risks.
The rule proposal codifies a conflict of interest for the Financial Risk Management (FRM) Officer, who is supposed to protect the OCC's interests but must also protect Clearing Members from failure, reducing margin requirements. This effectively makes the FRM Officer a rubber stamp for margin reductions, undermining the protections provided by margin collateral.
The OCC's own admissions regarding the potential scale of financial risk posed by a defaulting Clearing Member highlight the need to increase, not reduce, margin requirements. The proposed rule is illogical and nonsensical, reducing the first line of protection for the OCC. The OCC should enforce sufficient margin requirements to protect itself and minimize potential bailouts.
The OCC’s Loss Allocation waterfall allocates losses to the OCC’s pre-funded financial resources before Clearing fund deposits of non-defaulting firms. This rule proposal to reduce margin requirements for at-risk Clearing Members is illogical, given the potential financial risk posed by a defaulting Clearing Member. Increasing margin requirements is necessary to ensure protection from market risks and promote proper risk management.
The OCC's proposal to establish their Minimum Corporate Contribution ("skin-in-the-game") shortly after the "meme-stock" episode shows a pattern of leveraging their position as a "single point of failure" to gain liquidity. The SEC must not approve this rule proposal, which would reduce financial safeguards and increase systemic risk.
The combination of SR-OCC-2022-802, SR-OCC-2022-803, and this proposal would allow the OCC to manipulate market conditions to their advantage, potentially impacting pensions and insurance companies. This is inappropriate and indicative of systemic risk exacerbated by insufficient regulatory enforcement.
Therefore, the SEC is correct in identifying reasonable grounds for disapproval of this Proposed Rule Change as it is inconsistent with Section 17A(b)(3)(F), Rule 17Ad-22(e)(2), and Rule 17Ad-22(e)(6) of the Exchange Act. The proposed rule fails to safeguard securities and funds, protect investors and the public interest, provide clear governance arrangements, prioritize the clearing agency's safety, or produce margin levels commensurate with risks. The SEC should consider additional grounds for disapproval, given the proposal's failure to properly manage liquidity risk and increase systemic risk.
In light of these issues, I urge the following actions:
1. Increase and enforce margin requirements commensurate with the risks associated with Clearing Member positions.
2. Implement external auditing and supervision with enhanced public reporting to ensure risks are managed before they become significant.
3. Swap the order of loss allocation to encourage Clearing Members to police each other.
4. Immediately suspend and liquidate Clearing Members projected to exceed their margin deposits to reserve resources for extraordinary circumstances.
5. Reduce "single points of failure" in our financial system by increasing redundancy and resiliency.
Thank you for considering my comments to protect all investors and ensure a fair, transparent, and resilient market.
Regards,
A concerned retail investor