Explore
Close
Your acceptance of all cookies will permit robust site functionality. If you don't allow cookies, some features and functionality of OCC's site may not operate as expected. If you do not choose either cookie setting for our site, or if you close this window, this message will continue to display on each page you visit. Cookie settings can be controlled in your Internet browser to automatically reject some forms of cookies. For more details on cookies this site uses, see our OCC Site Cookies page. In addition to using cookies, we retain other information, including your Internet Protocol (IP) address, for the purposes listed in the Privacy Policy.

OCC Weighs In On Leverage Ratio and Impact on Listed Options Industry

John J. Fennell
August 11, 2016
By John J. Fennell, Executive Vice President and Chief Risk Officer

In its role as an advocate for the U.S. listed options industry, OCC constantly focuses on ensuring confidence in the financial markets and the broader economy by promoting stability and market integrity through effective and efficient clearance, settlement and risk management.

One place where OCC works to help the options industry is in the area of international regulatory standards. We recently signed on to a letter along with 30 other exchanges and trading firms regarding the leverage ratio framework as proposed by the Basel Committee on Banking Supervision (BCBS).

OCC and its co-signees continue to believe that unless the Standardized Approach for Counterparty Credit Risk (SA-CCR) method is adopted within the leverage ratio, market makers, who serve to provide deep liquidity to the listed options market, will be significantly diminished.

The issue with the leverage ratio, and specifically the Current Exposure Method (CEM), is that it neglects to recognize the risk limiting effects associated with being long and short options of different strikes on the same underlying instrument. Hedging option risk using other options is the most effective and relied upon way option market makers mitigate the risks assumed as they fulfill their vital role of providing committed liquidity to the cleared markets.

The leverage ratio creates the real potential to move liquidity away from the listed and centrally cleared markets and ultimately back to the opaque bilateral over-the-counter markets. This is counter to the global mandate by regulators to bring more over-the-counter (OTC) volume into centrally cleared solutions mitigating systemic risk.

Our letter noted that we are starting to see evidence of this evolution with a number of general clearing members (GCM) having already ceased their operations while others are re-assessing their business models. Data from the U.S. Commodity Futures Trading Commission shows a steady decrease in the numbers of futures commission merchants, while at the same time, the number of total cleared client assets has increased significantly driven by new clearing mandates since 2009. We fear that a further reduction of GCMs will result in greater concentration risks and a decrease of available balance sheet capacity for clearing of derivatives transactions, including those that are anticipated to become subject to mandatory clearing.

Our desire is that the regulators adopt SA-CCR as quickly as possible, which does not have the same shortcomings of CEM, or provide an exemption for options market makers, given the vital role they fill in providing committed liquidity to these markets.

We thank the BCBS for their efforts in reconsidering the application of the CEM methodology, and we are encouraged by their efforts to address the unintended consequences and shortcomings of the CEM methodology for CCP exposures. We continue to believe that SA-CCR provides better differentiation between margined and un-margined trades, and provides more meaningful recognition of netting benefits. Such efforts will allow OCC and our industry to work towards an appropriately calibrated and sustainable leverage ratio framework without creating serious economic disincentives for participants in the exchange-traded derivatives market. The proposed revisions and the introduction of a modified version of SA-CCR would dramatically reduce the unintended consequences we currently face on CEM. To learn more about OCC's thought leadership on industry issues, visit OCC's Blog.

This web site discusses exchange-traded options issued by The Options Clearing Corporation. No statement in this web site is to be construed as an endorsement, recommendation or solicitation to purchase or sell a security, or to provide investment advice. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the disclosure document, Characteristics and Risks of Standardized Options. Individuals should not enter into option transactions until they have read and understood this document. To obtain copies, contact your broker, any exchange on which options are traded, or The Options Clearing Corporation, 125 S. Franklin Street, Suite 1200, Chicago, IL 60606 (investorservices@theocc.com).