January 2018

Advocating for a Stronger U.S. Options Market

John Davidson says the U.S. exchange-listed options industry will continue to be impacted by various regulations and risks in the year ahead.

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Advocating for a Stronger U.S. Options Market

John Davidson, OCC Chief Operating Officer, recently spoke at SIFMA's Annual Listed Options Symposium and shared his insight on how the exchange-listed options industry could be impacted by various regulations and risks in 2018.

As we begin 2018 at OCC, one thing is abundantly clear: the U.S. exchange-listed options industry will continue to be impacted by various regulations and risks in the year ahead. At SIFMA's annual Listed Options Symposium in November, I discussed some of the key issues that will be critical for the industry and regulators to address over the next 12 months.

Navigating the options regulatory agenda – the ORF and market makers

OCC hopes that the SEC, under the leadership of Chair Jay Clayton, will be able to streamline its rulemaking review process so that a number of straightforward issues impacting options, SIFMUs like OCC, and exchanges can move forward at a faster pace to better serve market participants.

For one, the process around assessing the Options Regulatory Fee (ORF) remains complex and is still determined by individual exchanges, as opposed to being standardized across the industry. While exchanges have legitimate regulatory costs that we all benefit from, there is an acute need to rationalize those costs. I believe that in 2018 we must work toward a more transparent, consistent, and simpler means of ORF assessments. OCC, as the ORF collection intermediary among exchanges, can help facilitate progress toward a resolution.

Additionally, options industry market makers are being put in a tough spot today by regulators exploring potential changes to market structure, such as introducing speed bumps. While some view these as protective measures that give some market makers a price advantage over high frequency traders, the measures are also unintentionally driving some market makers out of the transaction life cycle entirely and ultimately cramping liquidity for market participants executing options orders. I see the exclusive focus on price in speed bumps as a fundamental flaw to any market structure adjustments, especially considering the rise of index and passive investing. Price may be important to market participants, but so are execution certainty and size visibility.

While the SEC chairman has been quite sympathetic to this challenge, this mission remains: whatever changes regulators look to roll out in 2018, it will be important for them to consider the real-world impact those changes could have on the volume of options market makers, who are the lifeblood of this industry.

Bitcoin's debut on exchange platforms - OCC first to clear bitcoin futures

Another key story is that 2018 is presenting itself as the year of institutionalized trading of cryptocurrency derivatives. The industry has the infrastructure in place, and OCC was the first clearinghouse to successfully clear the record number of new product contracts experienced with Cboe bitcoin futures debuting on December 10. OCC also stands ready to process bitcoin futures for Nasdaq’s launch.

However, it will be critical for the industry to remain alert to the volatility that comes with bitcoin and related currencies. OCC has a great deal of confidence in our STANS margining system, which has a two-day liquidation horizon, to handle products with this kind of volatility – although the volatility levels of bitcoin-like currencies are less relevant for a central counterparty that clears related futures trades due to our not-less-than-daily mark-to-market settlements among clearing members.

Even so, a well-regulated derivative market should dampen the volatility in the underlying instrument based on other products that have demonstrated similar stabilization over the years. Only time will tell how bitcoin performs in a regulated setting, so it will be equally important for OCC and regulatory bodies like FINRA, the SEC, and the CFTC to monitor how the product stands up against concerns around its volatility.

Increasing urgency to solve risks associated with CMTA and exchange give-ups

One of the other big issues that the industry should address in 2018 is the very significant operational risk associated with the Clearing Member Transfer Agreement (CMTA) and exchange give-ups. The current system puts the carrying clearing member at a tremendous risk that it doesn’t have any way to mitigate.

It is important to tackle these concerns in a decisive way. As a result, both the SIFMA Options Committee and the OCC Roundtable will work to address these concerns in 2018. As we work toward this, there are three key CMTA issues that will need to be addressed:

  1. Industry standard CMTA agreement: Currently, only one clearing firm has a right-of-return agreement between the carrying clearing firms and executing clearing firms in transactions. Throughout the next several months, OCC will work with the industry to develop an industry standard CMTA agreement between clearing members of OCC that will provide specific, agreed-upon terms for why a trade can be returned and a set time frame in which that can happen. The end result will be to provide executing firms with assurance of when they are off the hook for a returned trade and provide carrying firms with the confidence to mitigate transfer risks.
  2. Customer group identifiers for CMTAs: Today, clearing firms are burdened by the fact that they have no way of determining the customer source of CMTA trades. In the year ahead, I see it as critical that we work to develop some sort of a high-level customer group identifier – separate from a beneficial owner account identifier – on every single non-market maker trade (e.g. X was a Fidelity trade, Y was a Schwab retail trade, etc.). This will save carrying clearing firms the costs involved with origination guesswork, providing them with the means to determine where any trade belongs on their books and records.
  3. Mitigating the immitigable risks of exchange give-ups: With very few exceptions, virtually all options exchanges allow any member to give up a trade to any OCC clearing firm. The challenge with this is when an improperly executed trade is given up: the rules are unclear as to that clearing firm’s ability to return the trade to the member that originally executed it. This all boils down to a recipe for immitigable risk for clearing firms. In 2018, we must also explore a solution to this issue, which could be as simple as giving clearing members veto rights over give-ups.

I am optimistic about the ability of our industry to meet these challenges in 2018, and my OCC colleagues and I are ready to work with our partner exchanges, clearing firms, and market participants to create positive change that benefits the U.S. financial marketplace.

John Davidson's Signature

OCC's AA+/Stable Rating Reaffirmed By S&P

OCC, the world's largest equity derivatives clearing organization, commented on the reaffirmation of its AA+/Stable rating by Standard & Poor's (S&). S&P published their rating on December 28, 2017.

"We are pleased that S&P has again reaffirmed OCC's AA+/Stable rating," said Craig Donohue, OCC Executive Chairman and Chief Executive Officer. "S&P's decision is a powerful recognition of our efforts to strengthen OCC's financial safeguards framework and to promote stability and market integrity through effective and efficient clearance, settlement and risk management services.

"This decision also reflects favorably on the outstanding work being performed every day by our entire team to strengthen the resiliency, risk management, and capitalization of OCC. We will continue to deliver on these initiatives in order to serve our exchanges, clearing firms, and market participants, and to ensure confidence in the financial markets and the broader economy."

In its report, S&P said OCC's outlook is stable because it expects OCC "to implement the new financial safeguards in 2018, provided it receives regulatory approval." S&P also noted that OCC "enjoys large economies of scale and has ample capacity to absorb up to 2.5 times the largest historical trading volumes per day with the current OCC systems. As a processor of over 17.5 million contracts daily, we consider OCC's operational risk to be high. The company must meet the demands of its members and the trading community at large, which requires exceptional technology and back-office operations. In our opinion, operational risk receives an appropriate level of attention and resources, and is well managed (including technology and recovery centers)."

John Davidson, OCC President and Chief Operating Officer and who oversees the company's technology and operations functions, said, "OCC appreciates S&P's recognition of our exceptional technology and operations, as well as our keen focus on managing operational risk. This is a product of our continuing investment in human and technology resources, plus a durable working relationship with our clearing firms and exchange partners."

OCC received an AA+/Stable rating from S&P in June 2013, which was reaffirmed in 2015 and 2016.

OIC Continues to Promote Responsible Use of Exchange-listed Options

The Options Industry Council (OIC), which is celebrating its 25th anniversary as the leading resource for unbiased education on the responsible use of exchange-listed options as a risk management tool, continues its mission to educate individual investors, financial advisors and institutions.

To kick off a year-long anniversary celebration, OCC, the world's largest equity derivatives clearing organization and a key supporter of OIC, asked industry influencers to participate in the #OIC25Years video series. Among the participants were John Lothian, Executive Chairman of John J. Lothian & Company, Inc., Mark Longo, Founder & CEO of Options Insider Media Group, and JJ Kinahan, Chief Market Strategist at TD Ameritrade. See what they have to say about OIC and the importance of providing education to investors worldwide.

OIC will produce monthly webinars on a variety of options topics in 2018. On January 18, OIC will host Putting Your Best (Financial) Foot Forward with Options Fundamentals, where attendees will learn about the fundamentals of options trading. Learn more about OIC’s educational resources for investors by visiting www.optionseducation.org.

OCC Supports Charitable Organizations Who Help Families and Communities at Risk

To support the communities where its colleagues live and work, OCC is pleased to provide financial support to its two employee-designated 2017 charitable organizations: Metrocrest Services in Dallas and Marillac St. Vincent Family Services in Chicago.

At the December Dallas Town Hall meeting, OCC presented a year-end donation of $5,000 to Metrocrest Services, whose mission is to provide programs for individuals, families and senior citizens that lead to self-sufficiency and foster independence. Jayme Wright, OCC Manager, Risk Examinations, led this effort on behalf of the Dallas office. OCC’s total 2017 contribution to Metrocrest Services was $15,000.

OCC also presented a $10,000 donation at its Chicago Town Hall meeting to Marillac St. Vincent Family Services, which is committed to embracing and caring for the most vulnerable population of infants, children, teens, adults and seniors living in Chicago. Sam Angileri, OCC Clearing Member Representative, led this effort on behalf of the Chicago office. OCC’s total 2017 contribution to Marillac St. Vincent Family Services was $20,000.

"OCC has a responsibility to play an important role in the communities where our colleagues live and work," said Craig Donohue, OCC Executive Chairman and CEO. "We have an obligation as an organization to be good corporate citizens, and our values of stewardship and integrity should carry over from the financial markets to our colleagues' neighborhoods."

"I am very proud of the work by the members of our employee charitable contributions committee to select and support two very deserving organizations," added John Davidson, OCC President and Chief Operating Officer. "One of our goals in 2018 will be to combine our growing financial support of targeted charitable organizations with increased colleague engagement with those groups to better serve our communities."

OCC Supports Charitable Organizations for Families and Communities at Risk

OCC Continues to Advocate for U.S. Exchange-Listed Options Industry

In its role as an industry advocate and influencer, OCC continues to maintain a visible presence at relevant conferences and events to provide thought leadership on key issues in support of the exchange-listed options industry.

On November 30th, John Davidson, OCC President and Chief Operating Officer, spoke at the SIFMA Listed Options Symposium in New York. Chip Dempsey, OCC Senior Vice President and Chief Commercial Officer, participated in a panel discussion with DTCC on December 13th at the SIFMA Operations and Technology Society meeting in New York.

In 2018, OCC Executive Chairman and CEO Craig Donohue, along with Tracy Raben, OCC Senior Vice President and Chief Human Resources Officer, and Mary Savoie, First Vice President of Industry Services, will be speaking at the 2018 Quinnipiac G.A.M.E. conference in New York on March 22nd. John Davidson will be the keynote speaker at Marketforce's 9th Annual Conference – The Future of Post-Trade, in London on March 7th, and he will be participating on the clearing leaders panel at FIA International Conference in Boca Raton on March 15th. On January 10th, John Fennell, OCC Executive Vice President and Chief Risk Officer, moderate panel on market structure at the 2018 STAC Mid-Winter Conference in Chicago, and he will be a keynoter and panel participant at the GARP Annual Risk Conference in New York on March 6th. Matt Wolfe, OCC Vice President of Product Development, will be participating on a CCP panel at IMN's 24th Annual Beneficial Owners' Conference on February 1st in Florida. In March, Dave Hoag, OCC Senior Vice President and Chief Information Officer, will be attending The Wall Street Journal CIO Network Annual Meeting in San Francisco. Jason Stradley, OCC Vice President of Security Operations, will be speaking at the CISO Chicago Summit on March 8th in Chicago.

To stay up-to-date on OCC Thought Leadership, visit OCC Views.

Update from Capitol Hill


Comprehensive Tax Reform Legislation Enacted into Law
Mark-to-Market Proposals for Derivatives NOT Included

On December 20th, the U.S. House of Representatives passed the Tax Cuts and Jobs Act by a vote of 224-201. The House passage of this comprehensive tax reform package follows the bill's passage in the U.S. Senate by a margin of 51-48. The Tax Cuts and Jobs Act overhauls America’s tax code by lowering individual tax rates for Americans and lowering the corporate tax rate from 35 percent to 21 percent. The bill was subsequently signed into law by President Trump on December 22nd.

With tax reform enacted into law, we are pleased to report that our review of the final package confirms there is no mark-to-market provision for derivatives included in the bill. OCC and the U.S. Securities Markets Coalition have been engaged with members of Congress and their staffs since 2013 to educate them about the harmful consequences of previous financial products tax proposals.

As the various proposals have been released, OCC, Cboe, and our coalition partners have had numerous meetings and submitted written comments to congressional and Administration officials to communicate the industry's view that current tax treatment for options works well and that efforts to subject options to mark-to-market tax treatment would be devastating. We are pleased Congress chose to exclude any mark-to-market proposals from its final tax package.

Editorial Team