Making the Case for Smarter Regulation of Centrally Cleared Markets
In light of the new administration in Washington, D.C., OCC Executive Chairman and CEO Craig Donohue shares his thoughts on highly prescriptive regulations.
In light of the new administration in Washington, D.C., OCC Executive Chairman and CEO Craig Donohue shares his thoughts on highly prescriptive regulations.
Amy Shelly joined OCC in December 2016 and brings over 20 years of financial services management experience to her role as Senior Vice President and Chief Financial Officer.
OCC announced that 2016 cleared volume was fifth highest ever, with cleared futures volume up 56 percent from 2015. Year-to-date stock loan activity was up 37 percent with over 1.9 million new loan transactions in 2016.
In 2016, OCC's evolution from a clearing and settlement utility to becoming a systemically important market influencer was highlighted by our company being recognized with two Clearinghouse of the Year Awards; from Global Investor/ISF and Futures and Options World. These awards underscore the hard work and dedication of OCC's entire team to ensuring confidence in the financial markets and the broader economy. They also recognize OCC as a preeminent clearing organization and they acknowledge our adaptions to increased expectations as a SIFMU.
In the past year, the OCC team took great strides to enhance our resiliency by reducing the regulatory remediation gap and putting in place proactive policies and procedures to identify and resolve new problems, all while strengthening our relationships with regulators and reaffirming OCC as a strong, visible advocate for the U.S. listed options industry.
OCC's resiliency was affirmed on several fronts in 2016. The development of our risk control principles served as the catalyst for significant and positive change in the resiliency of the listed options market, to the credit of the options exchanges and the benefit of the entire industry. The nearly 40 rule changes filed by the options exchanges consistent with the risk controls outlined in our March proposal are demonstrable steps that bolster the resiliency of our markets against the risk of erroneous trading activity.
On September 21st, Standard & Poor's reaffirmed OCC's AA+/Stable rating, saying "OCC has a credible plan to build the capital and liquidity resources to absorb the default of its two largest members." This decision was a positive recognition of our efforts to strengthen OCC's financial safeguards framework in order to better conform to international standards. It also reflects very favorably on the work performed by many of my OCC colleagues to strengthen the resiliency, risk management and capitalization of our company.
In February, the SEC affirmed its earlier approval of our capital plan, saying "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." We were gratified by the SEC's action, as 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.
OCC also is working hard to be a strong and visible advocate for the U.S. listed options industry. We were gratified in April when the U.S. Department of Labor's final fiduciary rule appropriately moved away from limiting the ability of investors to hold listed options in their retirement accounts. OCC worked closely with the U.S. Securities Markets Coalition to educate Members of Congress and regulators on the importance of providing individuals with the right risk management tools to help them save for their retirement, with a constant message that investor education is exactly what is needed to promote responsible and prudent use of listed options by investors.
Throughout the year OCC continued to advocate on behalf of the industry for recognition of U.S. central counterparties such as OCC to be deemed qualifying central counterparties by the European Commission. This recognition is important to OCC and market participants for several reasons, foremost among them that it would allow EU banks' and EU bank affiliates' exposure to those CCPs to be subject to a lower risk weight in calculating their regulatory capital. The SEC's approval of the clearing agency rules in September is a critical step toward an equivalency agreement between that agency and the EC. We are pleased that the EU extended the transitional period deadline, and we intend to continue working with the SEC, the EC, and the European Securities and Markets Authority as they strive toward a common approach for the regulation of cross-border CCPs.
With all of the change currently underway in Washington, D.C., it becomes more important than ever that OCC and the options industry continue our strong advocacy work on behalf of market participants. We must continue to promote with regulators and policymakers the importance of providing individual investors with unbiased educational content through The Options Industry Council so we can drive industry growth through prudent and responsible use of these valuable risk management tools.
OCC also experienced an evolution in the leadership of our organization. We were fortunate to attract three new members to our Board of Directors who bring valuable market knowledge and expertise to support the work of our leadership team. These new members: Susan Lester; who has nearly 30 years of banking experience, Tom Wittman; Executive Vice President and Global Head of Equities for Nasdaq, and Bill Yates; Managing Director of Finance for TD Ameritrade, strengthen OCC's mission to provide exceptional risk management and innovative solutions to reduce systemic risk.
From a management perspective, we enhanced our leadership structure with the creation of an Office of the Executive Chairman, which includes Mike McClain as Chief Operating Officer and Scot Warren as Chief Administrative Officer. Mike's experience with technology and operations, and Scot's focus on driving enterprise alignment and enhanced execution of our corporate objectives, allows us to combine their breadth and depth of knowledge more effectively to support our organization as we move forward.
The addition of Amy Shelly as CFO, and the promotion of John Fennell to Chief Risk Officer, along with several other additions to our leadership team, were a clear demonstration of our ability to attract the best talent to OCC, and of our deep bench strength within in the company.
Throughout the year, and despite the strong economic and regulatory headwinds, OCC's mission remained the same. And that mission will continue into 2017. We remain committed to providing confidence in the markets we serve through a robust and transparent risk management framework. As the foundation for secure markets, OCC will sustain its resiliency, foster innovation, and lead advocacy and educational efforts with global policy makers to ensure that we continue to drive industry growth and contribute to the reduction of systemic risk in the financial system.
In light of the new administration in Washington, D.C., OCC Executive Chairman and CEO Craig Donohue shares his thoughts on how highly prescriptive regulations in the derivatives markets could have unintended consequences.
Following the 2008 financial crisis, global policymakers borrowed several key market principles in mandating regulatory reform of the over-the-counter derivatives markets. Today, though, neither the G-20 reforms nor the new capital requirements for important financial market participants – particularly, the Basel III regime that covers banks and their affiliated entities – have been fully implemented. Yet, international policymakers have already started efforts to re-write the rules that underpin the regulatory framework for central counterparties such as OCC in "further guidance" issued by the International Organization of Securities Commissions earlier this summer.
In other words, while we are just learning to walk under this new, emerging regulatory regime, we are being asked to run. Instead of that, we should hit the pause button to allow us to get our proper footing with the current efforts to reregulate centrally cleared, exchange-traded markets. Then we need to do a holistic assessment with a robust cost benefit analysis to ensure efforts to prevent the next financial crisis are not actually fueling it. Let's take appropriate corrective action to address identified problems. Let's act incrementally and intelligently, based on how the evolving rules are impacting the markets. Before we have more regulations, let's have smarter regulations.
Make no mistake, OCC supported the enhanced regulatory requirements imposed on central counterparties in conjunction with OTC regulatory reform. This includes requirements that expanded our compliance obligations, increased the amount of day-to-day oversight and scrutiny by policymakers, and raised the cost of doing business in our markets. We are seriously concerned, however, that repeated cycles of new and overly prescriptive regulation of centrally cleared markets will undermine the core objective of OTC regulatory reform: mandating the use of central counterparties for standardized OTC derivatives products and financially incentivizing the use of central counterparties in markets where there is no mandate to centrally clear such OTC derivatives.
The incredibly prescriptive nature of the new IOSCO 'guidance' poses model and contagion risk for cleared markets globally by, for example, attempting to create uniform stress testing and risk management requirements for all central counterparties.
IOSCO's new approach would eliminate virtually any discretion that a CCP currently possesses to tailor its risk management framework to the business and the services it provides. This interferes with a central counterparty's ability to continue to successfully manage its unique credit, liquidity, operational and business risks.
Moreover, the cost of capital to support cleared and regulated derivatives markets stands to cut off access to central counterparties, increase concentration risk among intermediaries and markets, eliminate incentives to use cleared markets and drive banks to riskier markets that provide a better return-on-equity.
Recent data supports that we are on the verge of this pendulum swing. A working paper by the Office of Financial Research titled "Does OTC Derivatives Reform Incentivize Central Clearing?" shows that the cost comparison of cleared versus bilateral derivatives "does not necessarily favor central clearing and, when it does, the incentive may be driven by questionable differences in central counterparties' default waterfall resources." Beyond that, it's worth noting that the OFR paper did not consider the relative costs once the leverage ratio requirements are implemented.
This is also supported by anecdotal evidence that banks are reducing the capital they allocate to market-making and agency services in the U.S.-listed equity options markets. Many in my professional network are sharing with me that the business case to deploy capital to support client clearing and market-making activity in U.S.-listed equity options markets is becoming more challenging. Unless policymakers clarify soon that banks and bank affiliates can hedge their notional exposures and offset certain risk exposures within a portfolio for equity options market-marking activity, some entities may be forced to exit the client-clearing business altogether.
At the end of the day, the unintended, adverse consequences of overly prescriptive regulations on central counterparties and exorbitant capital requirements for banks will be increased systemic risk and disruption to the use and continued growth of these important financial markets. Though actions and regulations are always going to be needed, it's important to walk before we run – and not add new regulations on top of those just now being put into practice until we see the near-term impacts and dynamics created by those recent changes to the markets.
Craig's blog post also can be read here.
Amy Shelly joined OCC in December 2016 and brings over 20 years of financial services management experience to her role as Senior Vice President and Chief Financial Officer. Ms. Shelly shares her experience and what she does in her current role at OCC.
As CFO, I oversee all Corporate Finance functions, including accounting operations, financial planning and analysis, capital management, liquidity planning, and strategic sourcing in addition to OCC's facilities management and vendor management programs.
The industry role was CFO of Optiver US LLC, a global market maker on many of the U.S. derivatives exchanges. I managed all of the financial risks for the business, including financial regulatory compliance, investments, tax compliance and other treasury functions. Before I joined OCC, I was the interim CFO for a private equity portfolio company, and before that, from 2015 to 2016, I was a project manager for CF Industries, where I worked with the company's corporate controller to manage the integration of a large international acquisition.
I received my Bachelor of Business Administration with concentrations in Accounting and Finance from St. Mary's College. I am also a licensed Certified Public Accountant and belong to the American Institute of Certified Public Accountants and the Illinois CPA Society. Previously, I have held Series Licenses 27, 24 and 7.
The financial services industry as a whole has been continually changing as a result of new rules and regulations. The challenges for most CFOs is staying abreast of those changes and understanding how each change impacts the business and its financials. CFOs in highly regulated industries like financial services are particularly focused on finding business efficiencies while maintaining a strong control environment. All regulators, such as the SEC, Fed and CFTC, require a firm to have strong and meaningful internal controls.
Firms must go through an analysis to determine risks to the firm, identifying key controls and mitigating controls. CFOs at a minimum will manage and influence the controls in Accounting, Finance, Treasury and Tax depending on the size and set-up of a firm. In addition, some CFOs will have Facilities, IT, HR and/or Operations reporting into them. This means CFOs must possess a broad view of the entire organization and stay actively engaged across the enterprise to serve as a strategic partner as the business and industry evolves.
As a SIFMU, OCC understands the value and importance of maintaining and operating an effective and reliable internal control infrastructure that assures risk management and processing outcomes expected by our stakeholders. Our responsibility to assure integrity, timeliness and completeness in the services we provide to market participants span beyond the enterprise. That is why OCC continues to invest in evolving and maturing our internal control infrastructure in response to ever-changing business and regulatory needs.
I enjoy training for and racing in triathlons, especially the Ironman distance. An Ironman consists of a 2.4 mile swim, a 112 mile bike, and a 26.2 mile run, or a marathon. Training for this distance can be like taking on a part time job whereby I am working out 6 days a week usually twice a day. It requires me to be efficient with my time. My workouts give me an opportunity to unwind from the stresses of the job and think more clearly. I train with Precision Multisport in Evanston, IL. The friendships I have made have been supportive, encouraging, and fun.
OCC announced 2016 total cleared contract volume reached 4,167,747,777 contracts, a one percent decrease from the 2015 volume of 4,210,542,258 contracts. The year ended with 337,076,118 cleared contracts in December, a three percent decrease from December 2015. OCC also reported record-breaking volume for cleared futures, with 104,523,581 cleared contracts in 2016; a 56 percent increase from 2015.
"In 2016, OCC took great strides as the foundation for secure markets to enhance its resiliency by reducing the regulatory remediation gap and putting in place proactive policies and procedures to identify and resolve new problems," said Craig Donohue, OCC Executive Chairman and CEO. "We also made great progress in strengthening our relationships with regulators and policy makers and in reaffirming OCC's position as a strong, visible advocate for the U.S. listed options industry and market participants."
On December 6, OCC hosted an online summit, "The Election is Over, Now What?", for investors to help them navigate the political and economic landscape and learn from experts on how the outcome of the November presidential election might impact investment portfolios and more specifically, investing with exchange-listed options. Over 1,300 investors registered for the event, managed by OIC, with nearly 600 tuning in for the four hour-long sessions.
The first session, "Post-Election: What Now for the Markets and Volatility?", featured CBOE's Russell Rhoads, Director of Education for the CBOE Options Institute. During his presentation, Russell looked at how the equity market reacted to the election and how the markets have behaved in the past during the transition of power and the first 100 days of new administrations.
The second session covered three options strategies for unconventional times. Joe Burgoyne, OIC's Director of Institutional and Retail Marketing, moderated the discussion with Allan Ellman from Blue Collar Investor Corp., Dan Gramza from Capital Management Inc. and Skip Raschke from Real Money/TheStreet.com. The panelists shared ideas on how investors can protect their portfolios and potentially generate income in an ultra-low-interest-rate environment using exchange-listed options.
Eric Cott, OIC's Director of Financial Advisor Education, moderated the third session, "Beyond the Election: Investment Strategies for 2017." Panelists Ralph Drybrough from Fort Point Capital Partners, Randy Swan with Swan Global Investments and Tripp Zimmerman from Wisdom Tree discussed the challenges of constructing a portfolio using traditional asset classes and theories given the realities of current economic circumstances.
The last session was presented by Lynn Vavreck, a professor of political science and communication studies at UCLA, who analyzed the election. She provided insight into what really mattered in the campaign and what the results mean going forward.
As the leading source for education in the listed-options industry, OIC continues on its mission to increase the awareness, knowledge and responsible use of exchange-listed equity options among a global audience of investors—including individuals, financial advisors and institutional managers—by providing independent, unbiased education and practical knowledge. OIC will be announcing its 2017 seminars and webinars soon, and that information will be available here.
With a new administration in the White House and Republican control on Capitol Hill, there are several issue areas that may see increased legislative activity in 2017, including comprehensive tax reform and proposals to reform the Dodd-Frank Act.
President-elect Donald Trump and Members of Congress continue to indicate that comprehensive tax reform is a top priority for 2017. House Ways and Means Committee Chairman Kevin Brady (R-TX) is working with the Republican committee members to address comprehensive tax reform. We understand that Chairman Brady intends to have a completed draft of a tax reform package ready for consideration in time for President-elect Trump's inauguration on January 20th. To prepare for this draft, House Ways and Means Republicans convened a policy retreat in Washington on December 15-16 to review Republican priorities and principles on tax reform.
Over the past few weeks, OCC and the U.S. Securities Markets Coalition have met with Chairman Brady's staff and other Republican members of the Ways and Means Committee to reiterate our deep concerns on behalf of the listed options industry about the previous mark-to-market proposals drafted by former Committee Chairman Dave Camp (R-MI) and Senate Finance Committee Ranking Member Ron Wyden (D-OR). These meetings have put key Republican committee members on alert that any proposal to mark-to-market listed options continues to be a major concern for the options industry, and we believe those members have been in constructive conversations with the Chairman.
As we previously reported, House Financial Services Committee (HFSC) Chairman Jeb Hensarling (R-TX) has been working to reform the Dodd-Frank Act to reduce regulatory burdens on the financial services industry. His bill, H.R. 5983, the Financial CHOICE Act of 2016, was passed by the HFSC in 2016, and at the time was considered as more of a messaging exercise with little thought of the bill actually becoming law, given strong speculation that Hillary Clinton would win the November election. Donald Trump's victory and Republican control of Washington in 2017 has changed that view. Chairman Hensarling and members of the HFSC will have to re-write the CHOICE Act to garner enough support for the bill to facilitate passage in the House of Representatives and potentially the U.S. Senate.
The Coalition has been working with Chairman Hensarling's staff regarding our concerns about Title VI of the CHOICE Act. As currently drafted, Title VI imposes a time-consuming cost-benefit analysis requirement on Self-Regulatory Organizations (SROs), including exchanges and clearing agencies, that will make it exceedingly difficult to adopt rules. We believe the intention of the cost-benefit language is aimed at rulemakings by the Financial Industry Regulatory Authority (FINRA), the Municipal Securities Rulemaking Board (MSRB) and Public Company Accounting Oversight Board (PCAOB), SROs that already provide a cost-benefit analysis. The Coalition argues that the rulemaking process for exchanges and clearing agencies, as administered by the SEC, affords affected parties ample opportunity to affect the outcome of a rule change, particularly given that all rule changes are published for notice and comment by the Securities and Exchange Commission (SEC). Therefore, the cost-benefit analysis requirement should not be required for exchanges and clearing agencies. The Coalition is currently engaged in a dialog with HFSC staff to hopefully agree to change the current version of the CHOICE Act to exclude exchange and clearing agency rulemaking from the economic analysis requirements in Title VI. We will keep you updated on our progress with this issue.
As we reported in November, SEC Chair Mary Jo White announced her departure from the agency on January 20th. There also been resignation announcements by several of her colleagues, including Stephen Luparello, Director of the Division of Trading and Markets and Andrew J. Ceresney, the Director of Enforcement. Republican SEC Commissioner Michael Piwowar will likely take over the role of SEC Chair in an acting capacity until a nominee by President-elect Trump is confirmed by the Senate.
In a November 30th letter to Chair White after the announcement of her resignation, the leaders of the HFSC and the Senate Banking Committee stated their concerns that the SEC may try to rush through several "Midnight Regulations" that could impose controversial regulations in the final days of the Obama Administration. Both HFSC Chairman Jeb Hensarling (R-TX), former Senate Banking Committee Chairman Richard Shelby (R-AL) and incoming Senate Banking Chairman Mike Crapo (R-ID) have requested that Chair White and the SEC delay implementation of any proposed rules currently being promulgated by the agency. Chair White responded that while she is "not insensitive" to requests from Republicans to delay finalizing any proposed rule until the incoming administration and Congress get settled in, she did suggest that the SEC enacted rules during the transition period after the 2008 and 2000 elections and that the Commission should not deviate from its historical practice of independently carrying out its duties.
On Friday, December 9th, the House and Senate passed a short-term spending bill, known as a Continuing Resolution (CR), which would fund the government at continuing fiscal year 2016 levels through April 28, 2017. With passage of this CR, Congress left Washington and returned home for the remainder of 2016. This adjournment concluded the 114th Congress.
Any questions on the issues and activities impacting the U.S. equity options industry in Washington, D.C. can be directed to Julie Bauer, OCC's Senior Vice President, Government Relations, at email@example.com, or James Hall, OCC's Director of Government Relations, at firstname.lastname@example.org.