We promote stability and market integrity through
effective and efficient clearance, settlement and
risk management services while providing thought
leadership and education to market participants and
the public about the prudent use of products we clear.
Craig S. Donohue (left), and Michael W. McClain
Chairman’s Message / Craig S. Donohue
On behalf of the Board of Directors and employees of OCC, I am pleased to share with you our 2015 Annual Report. Strong volume in the U.S. listed equities options industry continued in 2015, with cleared contract volume of more than 4.1 billion; the third- highest year in our 43-year history. OCC also cleared nearly 1.4 million new stock loan transactions, up 16 percent from 2014. These achievements underscore the critical role that OCC plays in serving industry participants and the greater public interest.
In this report you will not only learn of our progress in continuing OCC’s mission as a foundation for secure markets, you also will gain useful insights from three OCC stakeholders and partners, ABN AMRO Clearing Chicago LLC, CalPERS, the largest U.S. pension fund, and the Securities Industry and Financial Markets Association (SIFMA), on how OCC is sustaining resiliency, fostering innovation, and solidifying our leadership position with policy makers on legislative, regulatory, and tax issues impacting the industry.
Regulated central counterparties (CCPs) such as OCC have an excellent track record of performing extremely well during times of market stress. This demonstrated resiliency led global policy makers to mandate that more financial transactions be centrally cleared through CCPs following the 2008 financial crisis. OCC, and other Systemically Important Financial Market Utilities (SIFMUs), are even stronger today as a result of the improvements that regulators have made to the regulatory framework for CCPs. These enhancements bolster OCC’s leadership role in fostering confidence and reducing systemic risk, while maintaining our position as an independent risk manager. The changes that OCC has made to meet heightened regulatory expectations have instilled even greater confidence in OCC to support market participants in both the ordinary course and during times of crises.
THESE ACHIEVEMENTS UNDERSCORE THE CRITICAL ROLE OCC PLAYS IN SERVING INDUSTRY PARTICIPANTS AND THE GREATER PUBLIC INTEREST.
Within this new regulatory landscape, OCC has engaged in a comprehensive review of every aspect of our business, including technology, operations, risk management and compliance. This ongoing review has prompted us to implement significant enhancements to further strengthen our core processes and achieve an elevated level of resiliency. Notable accomplishments in 2015 include ensuring regulatory compliance on a number of critical fronts, and maintaining our AA+/ Stable credit rating from Standard & Poor’s.
In February 2016, the U.S. Securities and Exchange Commission (SEC) affirmed its earlier approval of OCC’s capital plan. In doing so, the SEC said “given OCC’s critical clearing functions and its systemic importance, the Commission agrees that having OCC increase its capitalization is appropriate and in the public interest.” Following the SEC’s approval order, Petitioners requested the U.S. Court of Appeals for the D.C. Circuit to review the SEC’s order and restrict OCC from taking further action to implement the capital plan until such review is complete. On February 23, 2016, the court denied a motion to restrict OCC from continuing to implement the capital plan. While the Petitioners’ appeal of the SEC approval order remains pending, these determinations by the SEC and the Court of Appeals permitted OCC to distribute the refunds and dividends that our clearing members and stockholder exchanges are entitled to under the plan. In February 2016, we paid a 2014 refund of $33.3 million and a regular 2015 refund of $40.0 million to our clearing members, as well as a dividend of $19.7 million to our stockholder exchanges. We also confirmed that we will pay a special refund of $69.4 million to our clearing members as soon as practicable in 2016 upon further determination that such refund will not cause OCC’s capital to fall below its total equity capital resource requirements of $247.0 million. Finally, we announced a new fee schedule, effective March 1, 2016, that will result in a reduction in the average clearing fee of approximately 19 percent. Cumulative refunds and discounts to our clearing member firms since 1974 exceed $2.1 billion.
Under the plan OCC’s shareholders, Chicago Board of Options Exchange, Incorporated; International Securities Exchange, LLC; NASDAQ OMX PHLX, LLC; NYSE MKT LLC and NYSE Arca, Inc. have contributed $150 million in equity capital, increasing OCC shareholders’ equity to $247 million. The shareholders also committed to contribute up to $200 million in replenishment capital if OCC’s capital falls below certain thresholds.
The benefits of the capital plan extend beyond the enhanced resiliency of the markets we serve, and demonstrate our commitment to operating as a not-for-profit industry utility. Under the plan, after retaining equity capital sufficient to ensure that OCC remains above its target capital requirements, OCC pays a refund equal to 50 percent of distributable earnings before tax. Moreover, the plan stipulates that OCC targets a 25 percent buffer margin on revenue, a reduction of six percent of average operating margins during the last decade.
OUR COLLECTIVE DEDICATION TO THESE EFFORTS IS CRITICAL TO PROMOTING CONTINUED GROWTH IN OUR INDUSTRY.
Last year, OCC continued to strengthen its business processes, internal controls and infrastructure resiliency across the company and continued to make progress towards implementing critical risk management objectives. For example, we accelerated the closure of more than 90 percent of legacy regulatory examination findings, and we are on track to close the remaining items in early 2016. We also implemented changes needed to comply with new requirements under SEC Regulation SCI and certain provisions of its proposed Covered Clearing Agency Rules.
The dedication and hard work of our management team and employees, as well as the commitment of our shareholders and clearing members, was recognized in May 2015 with the reaffirmation of OCC’s AA+/Stable credit rating by Standard & Poor’s. OCC first received this rating in June 2013, and the 2015 rating acknowledges our vigilance to strengthen and sustain our resiliency and continued focus on our role as the foundation for secure markets. In reaffirming our rating, Standard & Poor’s observed: “The stable rating outlook incorporates our expectation that Options Clearing Corp. [OCC] will maintain its cautious risk appetite and preserve the sound quality of its financial safeguards.”
OCC is proud of the changes we have made since our designation as a SIFMU in 2012 and we are honored to continue contributing to reduced systemic risk in our financial markets. As an expert in managing the risks of others, we deeply understand the need to appropriately incentivize users to help safeguard our markets and contribute to maintaining equilibrium in a mutualized system. Without that balance,we run the risk of becoming less secure or diverting activity away from CCPs—in contravention of the goals established by domestic and international policy makers in dealing with the 2008 financial crisis.
Innovation is the lifeblood of financial markets. To this end, OCC is proactively engaged with our exchanges and clearing members to identify and develop new products and solutions which serve the ever-evolving needs of market participants. As our industry continues to face strong economic and regulatory headwinds, our collective dedication to these efforts is critical to promoting continued growth in our industry.
In March 2015, OCC, CalPERS, and eSecLending, announced an innovative initiative to help OCC diversify and increase its committed liquidity resources while offering a compelling risk-adjusted return for CalPERS. The fully collateralized liquidity facility offers OCC a source of timely access to liquidity while maintaining CalPERS’ conservative risk profile. OCC’s President and Chief Operating Officer, Mike McClain, and Dan Kiefer, Investment Manager at CalPERS, discuss this first-of-a-kind collaborative solution in this report.
In 2015, OCC supported NASDAQ OMX PHLX in launching energy-related derivatives products at NASDAQ Futures (NFX). OCC worked with the team at NFX to develop a clearing solution that serves the needs of its customers and OCC’s clearing members. This collaboration increases competition in the energy futures markets and expands the scope of savings available at OCC through portfolio offsets. Since inception, open interest in NFX products has grown to 421,854 contracts as of February 2016, with January 2016 average daily volume of 61,441.
In April 2015, our Board of Directors created a Technology Committee to enhance its oversight of technology and cyber- information security risks, which continues to be a top board-level issue across the globe. I am pleased that OCC is leading on this issue: today, only eight percent of S&P 500 companies have dedicated technology committees. As technology oversight evolves as a critical governance practice, the foresight of our Board in creating this committee will position us to continue to be an industry leader in this space.
The legislative, regulatory and policy initiatives impacting OCC, our clearing members and their customers reflect the global and interconnected nature of the listed U.S. equities options markets. These external factors can sometimes disrupt the balance that we as independent risk managers strive to maintain. For this reason, we take seriously our role in educating policy makers about our markets and to advocate for legislation and regulation that maintains the efficiency and competitiveness of our markets.
Our efforts to ensure that OCC is recognized as a qualifying central counterparty (QCCP) under the European Market Infrastructure Regulation will continue into 2016. Like other CCPs located in the U.S., this recognition will have significant positive impacts on the capital treatment of exposures to OCC held by European bank-affiliated clearing members and other market participants subject to Basel III capital regulation in Europe. Our unique regulatory oversight regime requires OCC to actively work with the SEC, the U.S. Commodity Futures Trading Commission (CFTC), the European Commission and the European Securities Market Association (ESMA) to achieve this goal.
As a SIFMU and service provider to exchanges and clearing members with a global customer base, OCC’s efforts on the international regulatory and policy front have extended beyond seeking QCCP status. We have participated in international industry discussions and consultations emanating from the Committee on Payment and Settlement Systems (CPSS) and International Organization of Securities Commissions (IOSCO) related to the Principles for Financial Market Infrastructure (PFMIs) that OCC must follow as a SIFMU. The issues presented by the PFMIs range from cybersecurity to governance to recovery and resolution. We expect these international standards-setting bodies to remain active in 2016.
In partnership with the U.S. Securities Markets Coalition, OCC strives to advance its leadership role in Washington D.C. For example, in partnership with the Coalition we educated Members of Congress and the U.S. Department of Labor about the potential adverse consequences that a proposed fiduciary rule would have on individual investors who use exchange-listed options to manage financial risk in their retirement accounts. We also continued our advocacy efforts with the Coalition and others in the industry on various tax initiatives and bank capital rules that, if implemented, would adversely impact U.S. equities options markets. In 2016, we will also continue our educational and advocacy efforts in response to the SEC’s proposed rulemaking that would limit the use of certain derivatives by regulated investment companies.
As the financial industry continues to face strong economic and regulatory headwinds, OCC’s mission remains the same. We are committed to providing confidence in the markets we serve through a robust and transparent risk management framework, delivered in an efficient and cost-effective manner. As the foundation for secure markets, we will sustain our resiliency, foster innovation and lead advocacy and educational efforts with global policy makers to ensure that OCC continues to drive industry growth and contributes to the reduction of systemic risk in the financial system.
Craig S. Donohue
President’s Message / MICHAEL W. MCCLAIN
Thanks to the dedication and hard work of our employees, OCC again demonstrated its leadership position in clearing and settlement services for exchange-listed options, futures and stock loan transactions. In 2015, OCC processed more than 4.1 billion cleared contracts. Average daily volume for the year totaled 16.4 million cleared contracts. Open interest peaked on November 19 with 366.1 million contracts. In August, OCC experienced its third-highest monthly volume on record with 426 million options contracts cleared. For the year, securities-lending activity posted strong numbers with nearly 1.4 million new transactions. This exceeded 2014 volume by 16 percent, with an average daily loan value of more than $155 billion.
As the foundation for secure markets, OCC must cultivate confidence in our resiliency while continuing
to meet the needs of the markets through cost-effective solutions. Last year, OCC accomplished these
objectives through a keen focus on three key areas: (i) maturing our risk management framework;
(ii) strengthening our cyber defenses and overall system resiliency; and (iii) laying the
foundation for overhauling our technology infrastructure. We also launched new products and
at growing and sustaining vibrant exchange-listed options markets. Across each of these initiatives, the dedication and hard work of our employees proved critical to our success.
OCC introduced several measures designed to mature our risk management framework in 2015. First, we improved the accuracy of our STANS margining system by integrating implied volatility modeling. This enhancement significantly improves the precision with which we calculate position risk. Second, we expanded our capabilities to measure the adequacy of our financial resources by implementing rigorous new stress testing modules. Third, we developed the ability to collect clearing fund contributions intra-month, ensuring that the size of our clearing fund is calibrated to risk presented by our cleared contracts on a timely basis. In 2016, OCC will implement a new clearing fund sizing approach, further enhancing the precision of our sizing methodology and ensuring the robustness of our clearing fund at all times. Continuous refinement of our risk management tools ensures that OCC can manage extreme market events and reduce systemic risk.
Cybersecurity and system safeguards continue to be top priorities for the industry and OCC. At OCC, 2015 brought on further investment in cyber preparedness and system resiliency as part of our efforts to implement the U.S. Securities and Exchange Commission’s (SEC) Regulation SCI. In particular, we completed a concerted effort to perform a survey of our systems, identify which systems are covered by these new regulatory standards, and then further identify critical systems within our infrastructure. Collecting this information allowed us to make further systems enhancements, as well as update and align policies and controls to the new regulation. In 2016, we will continue to make significant investments in system- and cyber-related projects that will further improve our alignment with SEC Regulation SCI. Further focus will also be directed to engaging designated clearing members in the extensive testing of our business continuity and disaster-recovery plans. All of these efforts demonstrate OCC’s ongoing commitment to providing a foundation for secure markets.
In addition to the system work for SEC Regulation SCI, OCC conducted a thorough evaluation of our technology infrastructure to assess our ability to support the evolving needs of our clearing members, while also meeting the heightened expectations of global regulators. We used the assessment to develop a comprehensive strategy for rebuilding and modernizing our technology infrastructure. As part of this new roadmap, we will refine our risk systems and data analytics, boost our clearing and settlement systems, and upgrade corporate support. This multi-year effort will ensure that OCC has the technology necessary to deliver best-in-class clearing solutions for yearsto come.
IN 2016 WE WILL CONTINUE TO SAFELY GUIDE OUR CUSTOMERS THROUGH AN INCREASINGLY DYNAMIC MARKETPLACE.
As the only central counterparty in the U.S. that clears stock loan transactions today, OCC continues to see this as an area of strong growth. Since its introduction in 1993, our stock loan program has evolved to become a significant capital efficiency tool for firms that participate in securities lending markets. Transaction volumes have grown steadily and notional values have increased sharply over the last two years. We also are seeing an increase in requests from agent lenders on behalf of their beneficial owners for information on the benefits of central clearing of stock loan transactions by OCC. Market participants are looking at how a central counterparty solution can enhance the efficiency of securities lending activity for lenders as well as the broker-dealer borrowing community. This advancement in the market’s view provides OCC with further opportunities to deliver top-of-the-line services and capabilities to market participants and enhance liquidity in our markets.
In 2015, OCC expanded our liquidity resources to include non-bank facilities; in collaboration with CalPERS and eSecLending, OCC announced a first-of-its-kind product to diversify and increase its committed liquidity resources. This unique collateralized facility addresses OCC’s desire to combat wrong-way risk in our funding sources. In January 2016, we renewed our pre-funded committed repurchase facility with CalPERS for a total of $1 billion, with a staggered maturity schedule in which $500 million would be available for renewal in June 2016 and the remaining $500 million would be available for renewal in January 2017. With the renewal of this facility, OCC maintains $3 billion total in liquidity resources to backstop our daily settlement processes.
Our efforts to ensure that the exchange-listed options markets remain vibrant include developing useful educational programs and creating compelling content for investors. In this regard, OCC continues to lead The Options Industry Council (OIC), an industry collective whose mission is to educate investors about the responsible use of exchange-listed equity options. In October, OIC released the results of a new study conducted by Harris Poll demonstrating that industry efforts to educate investors about the use of listed options are generating positive results. To increase awareness and understanding by investors of the value of exchange-listed options, OIC continues work on a number of digital initiatives, such as a dynamic webinar program that reached nearly 5,000 investors during 15 sessions. In December, OIC hosted its first all-day Options & ETFs Summit that brought together nearly 1,300 attendees over four sessions. Further, our online radio show, “The Wide World of Options,” attracted more than 34,000 listeners throughout 2015 and episodes were downloaded nearly 100,000 times. We believe our strong education program increases investors’ knowledge and enhances the industry’s regulatory and policy initiatives.
We are excited about the progress and momentum we achieved in 2015, and we look forward to the opportunities we have in 2016 and beyond. We intend to continue to listen to and work with our partner exchanges, clearing members, and market participants in the development of new products and solutions to make our markets more secure and attractive to those who rely on us. As we move into 2016, we look to continue our legacy of safely guiding our customers through an increasingly dynamic marketplace.
Michael W. McClain
President and Chief Operating Officer