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

By John Fennell, OCC Executive Vice President of Financial Risk Management
August 11, 2016

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.


Categories: Comment Letters, Risk Management