April 2015 Newsletter

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In This Issue

Amy Lawson Discusses OCC Clearing of Nasdaq Energy Derivatives

Amy LawsonAs part of Nasdaq's effort to expand its offering in the fixed income, commodities and currency space, the exchange is launching a line of proprietary commodity futures products that will be cleared through OCC. The expansion into energy futures and options products will be based on oil, natural gas and U.S. power benchmarks. The products are set to trade on the Nasdaq Futures Exchange (NFX) by mid-year.

This new product suite will allow market participants to further diversify their portfolios while providing a valuable hedging tool. Amy Lawson, Vice President of Business and Product Development, shares her insight on what this expansion means for OCC and its clearing members.

What preparations is OCC making to clear energy derivatives?

OCC is working on a number of fronts to make accommodations to clear for NFX and its energy futures and options on futures. NFX futures and options fit nicely within OCC's current operational, systemic, risk management and legal and regulatory structure with some fine tuning to accommodate the re-launch and renaming of the exchange as well as the specific product set. Existing OCC members that are Future Commission Merchants will be automatically qualified to clear NFX energies through OCC. Clearing members and vendors are planning to test in a planned end-to-end test with the exchange and OCC.

The exchange is leading an industry-wide effort to ensure that its business partners, customers, traders, clearing members, ISV, data vendors and regulatory bodies will all be ready on a near simultaneous basis for launch day. To date the exchange has displayed detailed planning and flexible leadership in orchestrating this product launch.

Are there any key differences in clearing energy derivatives from other products that OCC clears?

From an operational standpoint, the proposed cash settled futures and physically delivered options on futures behave much like other futures and options currently cleared by OCC and in the past. However, OCC is making some relatively minor adjustments to its software to handle energy derivatives' uniqueness in expiration calendar. For example these products do not expire on the third Friday of the month. OCC will also draw from energy market experts for default management analysis and planning.

In what ways do customers benefit from OCC expanding the products it clears?

Members will benefit from a standard platform and business model used by OCC to clear derivative contracts in all markets it clears. Existing OCC Future Commission Merchants members will be able to maintain a single clearing fund and collateral pool across all OCC products within an account. OCC cleared products use its sole operational and systemic interface, ENCORE clearing system as well as OCC's STANS margining and risk management processes.

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Partnership with CalPERS Offers OCC Timely Access to Liquidity

OCC and eSecLending have collaborated with the California Public Employees' Retirement System (CalPERS) to establish an innovative pre-funded, $1 billion committed repurchase facility. The partnership is the first of its kind and helps diversify and increase OCC's overall liquidity resources from $2 to $3 billion while offering a risk-adjusted return for CalPERS, which serves 1.72 million members and over 3,000 employers, and pays over $12 billion in benefits.

"OCC explored the concept of accessing pension funds to identify alternate liquidity lenders that present right-way risk and can provide timely funding," John Fennell–Executive Vice President of Financial Risk Management.

Working with CalPERS secures OCC's liquidity in a way that is not pro-cyclical and preserves the liquidity of clearing members during a time of crisis. With the addition of CalPERS to the existing pool of banks and broker-dealers, OCC further ensures that sufficient capacity is maintained at all times, which promotes the uninterrupted flow of financial markets and reduces systemic risk.

As this model is validated and more lenders enter the marketplace, OCC plans to assess its needs and maintain a level of diversification in its committed liquidity through a mix of traditional and institutional-based funding.

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OCC Works to Ensure Compliance with Reg. SCI

OCC continues to place great focus on its implementation schedule for Reg. SCI. Toward the end of 2014, OCC identified 10 key policies and procedural areas of focus that will reduce potential systems risks and ensure compliance with standards set forth in the framework.

Since the final Reg. SCI rule was published in late 2014, OCC has organized several work streams to ensure compliance with the new rules that must be in place by November 3, 2015, including a work stream dedicated to classifying OCC systems that are covered by the regulation. Other work streams include those designed to review and update policies, procedures and internal controls related to software development, stress testing, and collection of market data, system monitoring, cybersecurity, business continuity and disaster recovery planning. Potential deficiencies will be promptly remedied.

Reg. SCI is one initiative undertaken by the SEC to address concerns about the reliability and resilience of U.S securities market infrastructure. SCI entities are required to have comprehensive policies and procedures in place for those systems that meet the criteria of "SCI systems," "Critical SCI Systems," or "Indirect SCI Systems" as defined by the rules. The rules further provide a framework for these entities to, among other things, take appropriate corrective action when systems issues occur; provide notifications and reports to the SEC regarding systems problems and systems changes; inform members and participants about systems issues; conduct business continuity testing; and conduct annual reviews of their automated systems.

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OCC Chairman's Award Honors Top Performers

On March 2, 2015, OCC honored five employees with the Chairman's Award, which recognizes outstanding achievements that further corporate objectives, including enhancing resiliency as a Systemically Important Financial Market Utility. The Chairman's Award is one OCC program to honor top performers who have demonstrated a personal commitment to excellence.

Kiran Chilukuri (Application Services) was selected for building a program, initially as a side project, that is now called Automated Risk Dynamic File Import and Validation. The tool can be leveraged across the entire organization and provide functionality to run portfolios through Encore's Risk Dynamic Simulation application to show the potential collateral pools OCC would carry for the equity repo market.

Executive Chairman Craig S. Donohue with Kiran Chilukuri
Executive Chairman Craig S. Donohue with Kiran Chilukuri

Pat Dunn (Compliance) played a leading role in enhancing OCC's approach to regulatory remediation through managing the development and implementation of a formalized validation testing program that improved the overall quality and reliability of OCC's remediation efforts across the company. He also helped formulate many of the core aspects of the OCC's SIFMU Resiliency Program designed to strengthen the company.

Executive Chairman Craig S. Donohue with Pat Dunn
Executive Chairman Craig S. Donohue with Pat Dunn

"The Chairman's Award is a great way for OCC to honor these employees for their high achievements that contribute to OCC's overall success,"–Craig S. Donohue, Executive Chairman.

Bruce Kelber (Legal), Tracy Poole (Member Services) and Sheila Zak (Member Services) were rewarded for their work on the Continuous Improvements Project, which recommended a review of all Clearing Member membership documentation in order to conform to current business requirements, operational practices and regulatory requirements. Their efforts enhanced both the quality and efficiency of the process.

Executive Chairman Craig S. Donohue with Tracy Poole and Sheila Zak
Executive Chairman Craig S. Donohue with Tracy Poole and Sheila Zak
(Not pictured: Bruce Kelber)

We congratulate these five colleagues for their outstanding achievements on behalf of OCC and our market participants.

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OCC Files Motion with SEC to Lift Stay of Approval of Capital Plan

OCC filed a motion with the U.S. Securities and Exchange Commission (SEC) to lift the current stay of the approval order of its proposed capital plan. Under the SEC's rules, the stay was instituted automatically after petitions were filed and is part of the agency's approval process.

OCC believes no new issues were raised by the petitions and that the benefits of its capital plan are in the best interest of all market participants. The plan strengthens OCC's capital base and allows the company to meet the heightened capital requirements critical for SIFMUs like OCC in a timely manner.

On February 26 the SEC issued a "notice of no objection" to OCC's advance notice describing its capital plan, in which the SEC stated that the plan "contributes to reducing systemic risks and supporting the stability of the broader financial system." On March 6, the SEC approved OCC's proposed rule change in support of the plan, which was approved by the SEC through delegated authority to its staff. The SEC's rules of practice permit petitions requesting review of the approval order.

When the plan was approved, OCC announced a refund of $33.3 million from 2014 fees to its clearing members and the return to a lower fee schedule with reductions by approximately 19 percent. The implementation of the refunds and fee reductions was automatically stayed by the filing of the petitions until the SEC orders otherwise, and OCC intends to implement them as soon as the SEC allows.

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From Capitol Hill

March was a busy month in Washington, D.C. Congress was in session for six consecutive weeks, so there was a lot of pressure to get important legislative priorities approved. Big ticket items included the House and Senate approving separate versions of the Fiscal Year 2016 federal budget, replacing the Sustainable Growth Rate (SGR) formula for physicians under Medicare, and debating the pros and cons of a nuclear agreement with Iran.

In the area of financial services, the House Financial Services Committee (HFSC) and the Senate Banking Committee (SBC) were busy conducting hearings related to the SEC. On March 24, the HFSC held a hearing on the SEC's Fiscal Year 2016 budget request, with SEC Chair Mary Jo White as the only witness. Chairperson White testified and answered committee questions regarding the SEC fiduciary duty rule for broker-dealers, the pending SEC rules pursuant to the "crowdfunding" title of the Jumpstart Our Business Startups (JOBS) Act, the Volcker Rule, and the Financial Stability Oversight Council's (FSOC) recent determinations regarding several nonbank financial companies as systemically important financial institutions.

On March 19, the House Subcommittee on Capital Markets and Government Sponsored Enterprises of the HFSC held an oversight hearing on the SEC's Division of Enforcement. Andrew J. Ceresney, Director of the Division of Enforcement mentioned in his written testimony that the SEC brought the highest number of enforcement actions to date, currently 755, and obtained fines totaling over $4.16 billion. He also emphasized that the SEC will continue to take advantage of its improved information processing and analytic capabilities in its efforts to identify, punish, and deter misconduct.

The Senate Banking Committee's Subcommittee on Securities, Insurance and Investment held an oversight hearing on venture exchanges and small-cap companies. Previously, the SEC's Advisory Committee on Small and Emerging Companies recommended to the SEC the creation of a separate U.S. equity market that would facilitate trading in the securities of small and emerging companies. Witnesses who testified at the hearing were divided about whether venture exchanges could facilitate this goal or whether further amendments to the JOBS Act would increase the trading of smaller company stocks. It is unclear whether this hearing will result in legislation.

March also saw activity in the House Agriculture Committee, where Commodity Exchanges, Energy and Credit Subcommittee Chairman Austin Scott (R-GA) held a hearing related to the reauthorization of the CFTC. In his opening statement, Chairman Scott mentioned that derivatives markets have changed in the five years since the passage of Dodd-Frank, both because of and in response to the new rules written by the Commission. Chairman Scott also stated that, "My goal throughout this process is to ensure that we have a healthy balance between market integrity and market access. Derivative markets exist for those who have risks to hedge. Hedgers need markets that are safe, but they also need markets with affordable execution, available counterparties, and consistent liquidity. This subcommittee will continue to look for that healthy balance." A draft legislative proposal to reauthorize the CFTC is expected soon.

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Two New Directors Appointed to OCC Board

Thomas Cardello, owner of Venice Group, LLC, and Robert Litterman, Chairman of the Risk Committee at Kepos Capital, were appointed to the OCC Board of Directors as public directors. The board is now comprised of five public directors to broaden the mix of viewpoints and best support the public interest when making decisions. Their skills and expertise in risk management will benefit OCC as the company furthers its efforts to enhance resiliency and meet the heightened expectations of regulators and market participants.

Thomas Cardello   Robert Litterman
Thomas Cardello   Robert Litterman

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2014 Annual Report Is Now Online

2014 OCC Annual ReportThe 2014 report's theme, "The Only Constant is Change", features the many ways OCC enhanced its resiliency to meet the heighted expectations as a systemic institution.

OCC in the News

OCC, CalPERS Talk about Liquidity with Pension & Investments Magazine

Following up on the earlier announcement of a repurchase facility with access to cash from the California Public Employees' Retirement System (CalPERS), OCC, CalPERS and other market participants talked about this important initiative with Pension & Investments Magazine, a multi-media platform that reaches executives that work for organizations with an average of $4.15 billion in retirement assets.

OCC's Scot Warren told P&I that CalPERS is filling a gap in default protection left by brokers with less capital to spend due to regulations limiting their risk. He said OCC saw asset owners as a unique source of liquidity that "wouldn't be part of the problem, who was an arm's length removed from brokerages. That's how CalPERS came in."

Daniel E. Kiefer, head of securities lending at CalPERS, said "OCC introduced the concept of the collaterized liquidity facility between a public pension fund and (central counterparty clearinghouse) to their regulators (the Commodity Futures Trading Commission). We're taking the cash collateral from our securities lending program." Kiefer went on to say that the real benefit of the Options Clearing e-SecLending agreement is that it will reduce systemic risk by adding stability to derivatives trading.

Craig Donohue Talks to Financial Times

During the Futures Industry Association meeting in Florida in March, OCC Executive Chairman Craig Donohue sat down with Philip Stafford of the Financial Times to discuss some of the changes underway at OCC.

Acknowledging Luke Moranda's appointment as OCC's new chief information officer, Craig told the FT, "This is an opportune time to think about our technology. We will take the opportunity to take a step back." He added, "Clearing is changing and new regulatory requirements drive changes in capabilities in technology."

Craig also talked to the FT about OCC's agreement to clear NASDAQ's new energy futures trading business, our efforts to strengthen OCC's internal processes, and the new capital plan which is designed to bolster OCC's capital structure.

Volume Update

Volume Update
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The information contained in this newsletter is for general information purposes only. Although every attempt is made to ensure the accuracy of the information, OCC assumes no responsibility for any errors or omissions. All materials pertaining to rules and specifications are made subject to and are superseded by the By-Laws and Rules of OCC.