OCC, the world's largest equity derivatives clearing organization, today announced that the U.S. Securities and Exchange Commission approved the company's proposed Financial Safeguards Framework, which impacts how OCC sizes its Clearing Fund and allocates contributions to the Clearing Fund from OCC's clearing members. OCC plans to implement the FSF starting on September 4.
"Our current clearing fund methodology, which has been in place since 2012, needed significant modifications in order to meet new and evolving regulatory requirements and industry best practices. Our new Financial Safeguards Framework will provide a significantly improved methodology and enhanced resources to our clearing firms and liquidity providers," said Craig Donohue, OCC Executive Chairman and Chief Executive Officer. "Enhancing our resiliency as a SIFMU is critical to our ability to reduce systemic risk, increase market transparency, and provide capital and collateral efficiencies for the users of the U.S. exchange-listed options and futures markets."
Market participants will see several key benefits from OCC's new clearing fund methodology:
Improved Methodology: The size of OCC's clearing fund will now be based on stress testing results that include historical and other "extreme but plausible scenarios" rather than trebling margin variances.
- The new FSF will reduce pro-cyclicality by decoupling the simultaneous increase in margin and clearing fund contributions that can place undue liquidity demands on OCC's clearing members.
- The new FSF will also make the manner in which OCC handles stress shocks on index options products and single-name equity options consistent.
- The new FSF will eliminate the $1.8 billion "prudential margin of safety" given the improved methodology enhancements.
Enhanced Resources: OCC's new clearing fund will now be sized to cover the simultaneous default of its two largest clearing members ("Cover Two") versus a default by its single largest clearing member ("Cover One").
- While the new Cover Two approach exceeds U.S. regulatory requirements, this higher standard better aligns OCC with other systemically important derivative clearing houses, including CME and ICE.
- Moving to Cover Two also allows OCC to meet international standards, which will be important for OCC in ultimately achieving recognition as a "Qualified Central Counterparty" in Europe.
- Meeting Cover Two requirements will also better enable OCC to maintain its exceptional AA+/Stable credit rating by Standard & Poor's. Of the 9,328 global entities and sovereigns rated by S&P, only one percent have a AA+/Stable rating like OCC, reflecting our efforts to strengthen our FSF and promote stability and market integrity through effective and efficient clearance, settlement and risk management services.
Risk-Based Allocation: The new FSF more appropriately risk-weights OCC's allocation of clearing fund contribution requirements to each of its clearing members. OCC's clearing fund now will be allocated to clearing members based on 70 percent margin risk, 15 percent open interest, and 15 percent cleared volume, rather than 35 percent margin risk, 50 percent open interest, and 15 percent cleared volume under the current methodology. Margin risk provides a transparent and easily understood metric for clearing firms and aligns incentives with clearing members by increasing the allocation to members with more margin risk.