Message to the Membership
It was 43 years ago when I was hired by Joe Sullivan to join a small staff working with a group of Chicago Board of Trade members to create the first listed market for options contracts. At the time, options were only traded over-the-counter. Sullivan and his team were developing Ed O'Connor's idea to trade options contracts much like listed futures. CBOT was not then subject to securities regulation, so the plan was that the new exchange and its clearinghouse would be created as SEC-regulated entities with a separate membership from CBOT.
When we opened for business in April 1973, it was as the Chicago Board Options Exchange and its wholly-owned subsidiary CBOE Clearing Corp. That historic event was the result of many creative and hardworking individuals. I remember the fortitude of CBOT members like Paul McGuire and Phil Rashman. They kept the project alive and funded through some reasonably dark days. It wouldn't have happened without them.
Those who were involved
in the creation of this
marketplace had a strong
sense of what could be.
Others, particularly those who saw their future in making markets in listed options, saw a great opportunity. The large customer firms had to be sold on the idea for the most part, and Sullivan did so by showing them the benefits of providing new investing ideas for their clients. The strategy worked.
From the clearing side, access for liquidity providers was critical to getting CBOE underway. For many years market makers and specialists generated half the daily options volume. People like Irwin "Corky" Eisen, Dave and Bobby Goldberg and other important CBOT players opened clearing firms at the outset that proved to be a key element in building the market.
In 1975, first the American Stock Exchange and then the Philadelphia Stock Exchange received approval from the SEC to list options. The SEC gave CBOE and Amex a choice–maintain separate clearinghouses that would be required to interface with each other or have one entity clear for both exchanges. It was at that moment The Options Clearing Corporation was created. Joe Sullivan, Robert Birmbaum of Amex and I were instrumental in the decision of the two exchanges to join forces in clearing. Around this time, the SEC was considering the addition of puts to the current market of only call options. Puts were approved in 1977.
In the early years I recall the great OCC debate over margins. Until then margins consisted of cash or U.S. Treasury Securities. A bold idea had surfaced to allow similar options to be treated as margin spreads. It took many Board discussions to finally approve the concept. It was the right thing to do and ultimately led to the overall growth of the industry.
The 1980s were a time of system developments to meet the growing needs of our members, and the market. In 1982 industry-wide options volume exceeded 500,000 contracts per day. By 1986 it had more than doubled to 1.1 million contracts. The Options Disclosure Document was created for investors, reducing the need for a prospectus and saving our industry $2 million annually in repetitive costs. The Escrow Receipt Depository system enabled customers to permit clearing members to pledge customers' collateral held by third-party banks. This decade also witnessed major product innovations with the introduction of cash-settled index options and options on foreign currencies, which required OCC to create a Delivery Versus Payment system with the banks and participating members to settle the underlying currencies. Townsend Walker, at the time a Vice President with Bank of America, convinced his bank to work with OCC to support DVP settlements. In 1986, out of the vision of John Hiatt and Tim Hinkes, OCC introduced the Theoretical Intermarket Margin System (TIMS), a risk-based portfolio margining methodology– the first of its kind.
None of us who dealt with
the events of 1987 will ever
forget the test of people and
systems that occurred.
It was a difficult week that became a liquidity crisis as opposed to a debit crisis. OCC's President and COO at the time, Fred Casey, knew the business very well and his thoughtfulness and hard work solved many of those liquidity challenges. The events pointed to issues with the way the markets were being used and the way OCC's margin systems operated. We formed an industry-wide committee to study the events and recommend changes. Critically important was that Bill Brodsky, then CEO of the Chicago Mercantile Exchange, and I reacted quickly and introduced cross-margining for index options cleared at OCC with futures cleared at CME. The result created a liquidity-safe environment for the index market while reducing margin requirements. The program continues to thrive. In 2013, OCC/CME cross-margin participants realized an average daily reduction in margin requirements of $1.6 billion, or an average of
78 percent savings per participant.
The 1987 market correction and probably more importantly 1989's setback had a dampening effect on our markets. The chairman of each options exchange and I gathered to discuss what could be done to repair the situation. The key challenge we faced was changing customers' negative view of options. We formed The Options Industry Council in 1992 to reach out to the press and to establish an education program for professionals and customers alike. OIC was, and still is, about the intelligent and responsible use of options. Having OCC's Paul Stevens run OIC was a great decision. Paul immediately embraced the concept and made progress very quickly. In 1997, just five years later, options volume set a new annual record with more than 350 million contracts traded, surpassing the previous record set in 1987. Since 1997, only three years have not set annual volume records. OIC has evolved both in its scope and its reach, which includes wealth advisors, institutional investors and international audiences.
While the exchanges were increasing the number of options listings throughout the 1990s, OCC was looking to enhance and expand our clearing systems. Harvey Silverman, Member Vice Chairman, was part of the leadership that prompted OCC to make some important strategic decisions. The multi-year effort resulted in ENCORE, our state-of-the-art clearing system. In 1993 we received our first 'AAA' credit rating from Standard and Poor's Corporation, thus carrying out our part in reassuring all levels of industry participants that we were properly managing risk. Also significant was the introduction of the Hedge System that for the first time allowed market participants to use stock borrowed on a short sale to hedge puts, thereby reducing risks and liquidity issues. In 2013, the combined activity of OCC's Hedge program and Quadriserv's AQS platform led to a record year for stock loan clearing with 1,233,708 new loan transactions.
David Krell and Gary Katz changed the execution side of the listed options market when they launched the International Securities Exchange in 2000. They also helped to usher in our current era of highly competitive options markets. Volumes skyrocketed in that first decade of the century, topping 1 billion contracts traded in 2004 and more than 3.5 billion in 2008.
The attacks of September 11 were devastating to our industry and our nation. In the days and weeks that followed, I remember how diligently staff worked to help restore a sense of normalcy and security for our clearing members and exchanges. Like the rest of the world, our immediate focus was on business continuity. Management Vice Chairman George "Gig" Hender was instrumental in the public/private partnership that established the Financial Services Sector Coordinating Council for Critical Infrastructure and Homeland Security (FSSCC). Gig became the third chairman of FSSCC and during his two-year term, he addressed issues relating to physical and cyber security risks to our nation's financial infrastructure. Today, we remain committed to the strength of our infrastructure and a geographically-dispersed workforce to ensure preparedness in the event of a crisis.
Much of the focus in 2008 was on the state of the economy. OCC felt the impact of the financial crisis but we succeeded in effectively managing liquidity risk, contributing to a new record in options volume that year. The downgrade of our 'AAA' credit rating in 2011 was not the result of a specific OCC event but rather part of the ripple effect after S&P's unprecedented move to downgrade its assessment of the creditworthiness of the United States. Most of the collateral that OCC holds to secure us from losses relative to the risk we undertake for our members is in U.S. Treasuries. The downgrade did not impact our operations. In fact, the market turbulence that was caused by S&P's actions reaffirmed the safety and soundness of OCC. A record 4.6 billion contracts were traded in 2011, the ninth consecutive year of record volume and the first time cleared contract volume surpassed 4 billion. At 4.1 billion contracts, 2013 is the second best year in options history, and the third consecutive year above 4 billion contracts.
The shaken marketplace of 2008 led to the Dodd-Frank Act and altered the way that the government views and oversees the operations of financial institutions.
Our world has changed. We are
seeing a greater connectivity
of risks that are not in our direct
line of business.
Ultimately these regulatory reforms brought about OCC's designation as a Systemically Important Financial Market Utility.OCC and the U.S. Securities Markets Coalition closely monitored Congressional efforts on tax reform in 2013. Advocating on behalf of the Coalition and the options industry, OCC actively works to ensure that members of Congress and the Administration understand that the current tax rules governing options are simple, clear and straightforward, and that the proposal would introduce significant complexity and unfairness in the tax treatment of options and negatively affect investors. We will continue to champion this and other industry-wide causes such as proposed IRS rulemakings that would impact listed options.
I must recognize the efforts of current Member Vice Chairman Gerry McGraw in helping to shape OCC's future. Charged with the hefty task of recruiting new leadership at OCC, Gerry did an outstanding job, resulting in the selection of Craig Donohue as Executive Chairman and Mike Cahill as President and Chief Executive Officer. A 31-year veteran of OCC, Mike has the ability to effectively lead and manage others. OCC would not be what it is today without Mike Cahill. I thank him and congratulate him. I wish Craig much success.
I am proud to have led such an outstanding organization in this thriving industry for the past 40 years. I know that our unwavering commitment to high-quality clearing and settlement services and risk management will continue for many years to come. A very heart felt 'thank you' to each and every one of the dedicated individuals who are our OCC employees. This huge success OCC has experienced over the last 40 years would not have been possible without them.
Wayne P. Luthringshausen
Chairman of the Board and
Chief Executive Officer