August 2015 Newsletter

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In This Issue

Luke Moranda on Enhancing Resiliency of the Marketplace through Reg. SCI

Luke MorandaOCC is intensely focused on implementing changes required by Reg. SCI. The rule published by the SEC in late 2014 requires OCC and other stock and options exchanges, clearinghouses and certain trading venues to implement procedures to safeguard computer trading systems. Luke Moranda, OCC’s Senior Vice President and Chief Information Officer, discusses his thoughts on the new regulatory framework, what OCC is doing to comply, and more.

Why is now such an important time for regulation like Reg. SCI?

Now, more than ever, the degree of interdependency and interconnectedness within financial markets makes it vital that all participants have resilient, well-controlled systems. An incident, whether it occurs at a central player like an exchange or clearinghouse, at a single member, or even at a supporting service like a data provider, can have far reaching impacts.

Markets can also be shut down by disasters and non-market events. These incidents can fundamentally weaken the trust that investors have in the markets. In just the last few years, we’ve seen events such as the Flash Crash in 2010 and Hurricane Sandy in 2012. These events and others have really shaped the development of the Reg. SCI rulemaking.

What is OCC doing today to ensure it is compliant with the new rules that must be in place by November 3, 2015?

We started with understanding the new Reg. SCI framework and an assessment of our risks. This includes designating our systems as SCI Systems, Critical SCI Systems, and Indirect SCI Systems. We then developed the overall program structure and are in the process of updating our policies to align with the new regulation. This includes addressing the new reporting requirements, updating our incident handling, and identifying our responsible SCI personnel.

Another key component of Reg. SCI is our controls, where we are doing a lot of work to ensure our IT and Security control procedures align with the Reg. SCI guidelines using Department of Commerce, National Institute of Standards and Technology (NIST). These efforts are critical to ensure each person knows what he or she needs to do, how to do it, and what evidence we are producing to show that it has been done correctly.

Organizationally, we have broken out risk and controls into a stand-alone team reporting directly to me so that I have full visibility and we have expanded senior management focus on Reg. SCI along with other risk and control projects. We’ve also established the standard project governance for such a critical effort, including management oversight, regular reporting and communication.

Firm-wide, OCC has been very focused for the last couple years on improving our resilience and meeting heightened regulatory standards like Dodd-Frank. The work being performed for Reg. SCI builds on this foundation, and we are able to tie this in with firm-wide work that is already underway.

Does the work for Reg. SCI end on November 3rd?

One major aspect of Reg. SCI is industry testing. This will include coordinated testing with designated clearing members to ensure that our business continuity and disaster recovery test plans will function as intended during an emergency. We are planning the test now, but the first test will not be executed until 2016. The scope of our testing will continue to evolve and expand in 2017 to include industry-wide testing among other market participants covered by Reg. SCI.

More importantly, as with any change, once our processes are updated to comply with Reg. SCI, we will continue to monitor the success of those changes and evolve and adapt them. For example, I would expect that we will find ways to streamline and automate so our ability to demonstrate compliance becomes easier and more consistent over time.

I also think it is important to continually challenge ourselves to do better. Whether mandated or not, we will continue to refine our processes, invest in our technology, and our people will learn from their experiences. Our goal should be to continually raise the bar on ourselves, rather than waiting for external events to force us to change.

Down the line how do you see the marketplace becoming stronger?

Reg. SCI is important to OCC and the marketplace because it will help build confidence in the markets’ ability to respond to different types of events, whether it is a systems problem, cyber-attack or even Mother Nature. We are always striving to be more resilient, and we can be more confident that other key participants are doing the same. It also forces all of us to work together to ensure the market is resilient against external events, and to refine our processes and technology for coordinating across entities when an issue does occur.

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Scot Warren Shares Insight on OCC’s Stock Loan Program

Scot WarrenOCC is the only CCP that currently clears stock loan transactions. As a pioneer in the clearance of stock loan, OCC’s program has evolved over the last 20 years to meet the needs of market participants in the ever-changing listed options landscape. With firms increasingly encouraged by regulators to clear through CCPs, OCC is poised to be the industry leader in stock loan clearing. OCC is working on expanding its securities lending capabilities and Scot Warren, Executive Vice President of Business Development and The Options Industry Council, discusses where we’ve been and where we’re headed on the stock loan frontier.

How did OCC’s stock loan program begin and how has it evolved?

OCC’s stock loan program started in 1993 with 10 clearing members, allowing market-making firms to offset their options positions with stock loan positions, thereby reducing their OCC margin requirement as they were facing double margins in the OTC market on their stock loans and at OCC. Transactions numbered under a few hundred a day. Membership now has grown to 70 OCC clearing members conducting an average of 5,000 transactions a day with open interest measuring roughly $190 billion. That is significant growth, and it represents equally significant opportunities for OCC.

The OCC program has evolved over time to more of a credit enhancement vehicle for firms that participate in securities lending markets. With OCC guaranteeing every trade, clearing members can increase credit limits with current counterparties as well as add new counterparties to transact loans. With capital requirements changing, clearing members and banks will see benefits by transacting loans with OCC as the central counterparty. As a qualified CCP under Basel III, OCC carries a very low risk-weighted average amount, allowing clearing members to significantly reduce their capital charges. The OCC program currently supports the dealer-to-dealer market, but as part of our strategy to drive industry growth, we are looking to expand to include banks and agent lenders. We want our services to be as robust as our markets want them to be. The market ultimately will decide how big we become in this space.

What does the market for securities lending look like and how does OCC fit into it?

OCC estimates show securities lending outstanding volumes in the U.S. to be in the $1.5 to $2 trillion range, and the overall U.S. equity securities lending market in a range of $600 to $700 billion. As of July 31, securities lending CCP volume increased 12 percent from a year ago, with notional value growth up 36 percent over the same time period. Using our estimates, OCC is currently clearing approximately 15 percent of the overall U.S equity securities lending market (agent lending plus dealer to dealer). While transaction volumes grew steadily over the past 12 months, notional values have sharply increased over the same time period, suggesting that larger trades (including financing trades) are being transacted. (See chart below).

Why is OCC expanding its stock loan capabilities?

This is a growth area that we believe we can be very good at in delivering service and capabilities for market participants, as we think it is critical to the formation of liquidity in our markets. In turn, this supports our desire to drive more growth for the listed options industry, and create more opportunities for our firm. OCC’s existing base of business provides an excellent opportunity to build from to expand the synergies for our market participants. While new entrants are anticipated, they will need to gain regulatory approvals to conduct their business as well as create the functionality that market participants need to expand participation in cleared solutions. As a result, OCC’s experience and existing eco-system of market participants provide an advantage in reducing our time to market versus potential new entrants.

OCC Stock Loan Volume

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OCC Submits Comment Letter on Department of Labor Fiduciary Proposal

OCC recently submitted a comment letter addressing the impact of the Fiduciary Proposal by the Department of Labor on the use of listed options by IRA accounts. The proposal could significantly impact the U.S. options market by taking away the ability for individual investors to use listed options in their IRA accounts. It also could cause a reduction in liquidity in the options markets.

Almost 25 percent of volume, and perhaps even more, on U.S. options exchanges is attributable to individual investors and IRA account owners are increasingly using listed options in their accounts. The comment letter notes the definition of fiduciary would be significantly expanded under the proposal causing many brokers and other service providers to IRAs and ERISA plans who are not fiduciaries under current law to be considered fiduciaries. Many transactions relating to the trading of listed options by individual investors in their IRAs may become prohibited transactions for which the proposed new Best Interest Contract Exemption would be the only reasonably available exemption. Although that exemption defines the types of “Assets” that can be traded in IRA and plan accounts in reliance on the exemption, listed options are currently excluded.

On August 13, Gary Katz, President and Chief Executive Officer of the International Securities Exchange, testified before a U.S. Department of Labor hearing on behalf of the U.S. Securities Markets Coalition and OCC on the effects of the proposal, noting the Coalition and OCC are "deeply concerned about preserving the ability of these investors to trade options in their IRAs should they choose to do so."

The proposal taken as a whole would deprive many individual investors of their current ability to invest in listed options using their IRA accounts. OCC strongly believes that exchange-traded options should be added to the list of permissible products under the Best Interest Contract Exemption.

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OCC Supports Successful Launch of NFX Energy Derivatives

NASDAQ launched its U.S.-based NASDAQ OMX Futures Exchange, Inc. (NFX) on July 24, 2015. NFX is part of NASDAQ’s effort to expand its offering in the fixed income, commodities and currency space. The new platform lists key energy benchmarks including oil, natural gas and U.S. power with a competitive fee structure and no exchange execution or OCC clearing fees for the first nine months. All products are cleared through OCC.

NFX is a designated contract market that features a transparent central limit order book, real-time trade reporting functionality, robust pre-trade risk management capabilities and allows for open, neutral access through proprietary order management systems, broker platforms and software vendors. NFX brings a competitive mix of new products, fees, innovative technology, and clearing services to traders. Banks are able to trade NFX products to achieve market exposure they cannot find on the spot markets because NFX consists of cash settled products.

OCC Clearing Members eligible to clear commodity futures and options are automatically eligible to clear NFX energy futures and options on futures. These products will be treated similar to other cash-settled futures cleared by OCC. Members will benefit from a standard platform and business model used by OCC to clear derivative contracts in all markets it clears.

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From Capitol Hill

As the August congressional recess approached, there was hope that the Senate could come to an agreement regarding consideration of the Cybersecurity Information Sharing Act (CISA), a bill intended to encourage the sharing of data on hackers between the public and private sectors. That hope was dashed, however, when the Senate decided to indefinitely put off further consideration of CISA.

It was reported that there was uncertainty over the bill’s prospects, and without an agreement to limit the number of amendments considered, the Senate faced the prospect of CISA consideration dragging on, a scenario the chamber sought to avoid, in light of the upcoming six-week Senate recess. Therefore, the consideration of CISA will be postponed to the fall, if at all.

On the issue of taxes, consideration of tax reform is moving slowly. Senate Finance Committee Chairman Orrin Hatch (R-UT) had a long to-do list after returning from the Fourth of July recess: funding the Highway Trust Fund, working on international trade agreements and tax reform. However, Chairman Hatch hinted to various news outlets that he’s not confident about tax reform happening this year.

Chairman Hatch’s statement came days before the Senate Finance Committee released the reports from its five bipartisan working groups on tax reform. The U.S. Securities Markets Coalition’s tax counsel has reviewed the report from the Savings and Investment Working Group, which was given responsibility for financial products taxation, and, as expected, the report only addresses retirement savings issues and does not address the Camp proposal or changes to the taxation of listed options. The reports issued by the other four working groups, including the report by the Business Income Working Group, also do not make any mention of the Camp proposal or changes to the taxation of listed options.

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OCC in the News

Craig Donohue Featured on the CEO Show

OCC Executive Chairman Craig Donohue sat down with the Robert Reiss, host of the CEO Show, to talk about the role OCC plays in the financial markets. Donohue discusses his previous history at the CME and how he ultimately ended up at OCC. He also touches on his views on Dodd-Frank, leadership philosophy and advice to CEOs. Click here to listen.

Talking Dividend Trades with OCC

Michael McClain, OCC's President and Chief Operating Officer, discusses new initiatives such as OCC's capital plan, market volatility and trading volume, dividend trades and more with Mark Longo of The Options Insider Radio. Click here to listen.

OCC Fact Sheet

Click here to view the Fact Sheet

OCC Fact Sheet

Volume Update

Interested in reading about what is happening with options volume? Click here for OCC's monthly volume press release.

OCC News Archive

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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.