December 2013 Newsletter

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Industry Insight: John Fennell

John FennelJohn Fennell is Senior Vice President, Risk Management & Treasury Operations at OCC. He has been with OCC since 1993 and has spent the majority of his career in the Risk Department. Read about the changes he has witnessed in this area over the last 20 years, the impact of OCC’s Systemically Important Financial Market Utility designation, goals for the future and more.

What is the role of OCC's risk management?

The label “risk management” has really evolved over the past few years. Early on, risk management represented managing the financial risk that external counterparties, primarily clearing members, brought to OCC. Now it represents managing all risks related to the company, at an enterprise level. Risks include not only the obvious risks like market risk and credit risk, but additional risks like operational, model, reputational, legal and regulatory risks.

OCC is making a significant investment to expand its capabilities in this area. When OCC received regulatory approval to separate the roles of Chairman and CEO, this created separation between the control functions (Internal Audit, Compliance, Model Validation and Enterprise Risk Management) and the business functions. This was done to ensure independence of the control functions when assessing OCC’s business level controls. In addition, financial risk management, business line functions such as Credit Risk, Market Risk, Default Management, etc., was separated from the Chief Risk Officer and now reports to the CEO, again emphasizing the independence of the control functions. Going into 2014, OCC will be expanding these risk roles on both the control side and the business side by adding resources in financial risk management, enterprise risk, compliance and audit.

You’ve been involved with OCC’s risk area for more than 20 years. How have things changed?

Risk management at OCC has advanced in scope, sophistication and discipline. We used to have a saying that risk management was ‘more art than science’ but in the last 10 years the science part of it has played a more sophisticated role with the addition of STANS and Monte Carlo simulations. The art has become more disciplined through the development of robust policies that provide a clear definition of OCC’s risk tolerances and the governance associated with establishing those risk tolerances.

How does STANS benefit clearing members?

The STANS margin methodology uses sophisticated modeling techniques to identify where exposures within a clearing member’s positions exist so the exposures can be collateralized by margin. It does this by modeling the co-movements of more than 7,000 different underlying instruments that can be carried by a clearing member in an account and not only highlights where exposures are being aggregated (e.g., concentration risk), but also where different positions hedge and reduce exposure. This helps OCC incent clearing members to maintain positions that carry less risk with OCC, which can result in a lower margin requirement.

How does cross-margining provide financial flexibility to program participants?

The cross-margin program maximizes capital efficiency by recognizing a clearing member’s hedged positions split between two different clearinghouses, such as OCC and CME. Without cross-margining each clearinghouse would charge the member margin on its respective un-hedged positions, requiring a significant amount of collateral be posted and increasing pressure on the member’s liquidity resources. Combining both sets of positions into a single account allows for the hedges to be recognized, which becomes even more critical during periods of intense market volatility.

How has OCC’s designation as a Systemically Important Financial Market Utility, or SIFMU, reshaped the landscape for your work?

Being designated as a SIFMU was a significant event in OCC’s history. As one of only a handful of organizations identified as being critical to the U.S. financial markets infrastructure, it is important that OCC operate in a robust and disciplined manner. While we have maintained a high level of performance over the past 40 years, the SIFMU designation has caused us to reevaluate areas where we might improve and also to ensure that all critical activities are repeatable, especially during periods of extreme market conditions. This assessment has resulted in an effort to build out company-wide policies and procedures by year-end that clearly define roles, responsibilities, risk tolerances and governance in a transparent manner. In addition, several action plans designed to enhance OCC’s processes will be implemented by end of first quarter 2014.

What are some of the goals and growth opportunities for the risk area in 2014?

One of the areas we will focus on in 2014 is liquidity risk – first, to better identify and forecast scenarios that cause liquidity risk and second, to expand OCC’s access and flexibility to sources of liquidity. OCC plays a significant role in setting and administering customer margin requirements. We will work in tandem with industry participants and exchanges to evaluate and consider potential enhancements to the processes for customer margins. There will be continued growth of risk management enterprise-wide. I would expect to see a significant evolution in the way that OCC manages risk associated with implied volatility as well as the approaches OCC takes to risk manage volatility products.

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From the Hill

Beginning several years ago, Ways and Means Chairman Dave Camp (R-Michigan) undertook a process to enact comprehensive tax reform, and has worked with Finance Chairman Max Baucus (D-Montana) over the past year to generate support for this endeavor. Chairman Camp even released draft legislation over the past couple of years that would significantly modify several different parts of the tax code. Hearings were held this spring and both the Committees and their staffs worked diligently on comprehensive tax reform.

Even with a plan in place and staff hard at work this year, a number of unanticipated obstacles have been placed in the path comprehensive tax reform legislation. In mid-May, the IRS scandal related to its apparent targeting of the tax-exempt conservative groups pulled the attention of the Ways and Means Committee away from tax reform. In October, the government was shut down for the first half of the month and many Congressional staffers were laid-off during that time, hurting progress on tax reform. Now it’s November and the Ways and Means Committee, along with the rest of the House Republican caucus, is knee-deep in dealing with the Affordable Care Act rollout.

"While some progress was made in 2013, efforts in both the House and Senate to comprehensively reform the tax code appear to be on hold until next year."

On the Senate side, the Senate Finance Committee starting in March published “option papers” outlining “a whole host of ideas to change various aspects of the tax code.” The papers have yet to materialize into legislation, and several roadblocks have emerged in Chairman Baucus’s drive for tax reform. The biggest roadblock came in the form of Senate Majority Leader Harry Reid (D-Nevada) publicly insisting earlier this year that any tax reform legislation considered by the full Senate include significant revenues.

Raising revenue through tax reform is obviously a non-starter in the House, so Chairman Baucus has yet to decide what will be included in his Committee’s legislation. He recently decided to release draft legislation in a piecemeal fashion, beginning with addressing how multinational corporations are taxed on their foreign profits. While some progress was made in 2013, efforts in both the House and Senate to comprehensively reform the tax code appear to be on hold until next year.

In regulatory news, CFTC Commissioner Bart Chilton earlier this month surprisingly announced his resignation from the CFTC at the end of the year. His resignation, combined with the upcoming departure of CFTC Chairman Gary Gensler and the still-vacant seat formerly held by Commissioner Jill Sommers will leave the CFTC with just two Commissioners in January. President Obama has nominated Treasury Department official Tim Massad to replace Chairman Gensler as head of the CFTC. The Senate Agriculture Committee has said that it will not consider Mr. Massad’s nomination, nor the nomination of J. Christopher Giancarlo to replace Commissioner Jill Sommers, who left in August, before 2014.

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OCC Converts Risk-Based Haircut / Customer Portfolio Margin Output Files to FIXML

Risk-Based Haircut / Customer Portfolio Margin (RBH/CPM) theoretical profit and loss values files are now available in FIXML format. RBH/CPM theoretical files support regulatory capital and margin calculations; OCC began daily publishing of the files in July 2013.The FIXML transmission will ultimately replace the existing flat file, though OCC will continue to support the current format into Q1 of 2015.

FIXML allows greater flexibility for adding new fields without requiring program changes to be made by all file users. The new files contain theoretical profit and loss values for all products currently included on the existing flat file format. Whereas the existing flat files are delineated by account type, including Customer Portfolio Margin (CPM), Broker-Dealer and Market Maker, the FIXML formatted files are delineated by product type and translational purpose:

  • RBH/CPM Parameters
  • RBH/CPM Theoreticals
  • Foreign Marginable Securities Theoreticals
  • FMS Translation
  • OTC Theoreticals (available only to firms holding clearing OTC contracts through OCC)

Current subscribers to the RBH/CPM output files may request access to the FIXML version at no additional cost by contacting their Clearing Member Representative or the OCC help desk (1-800-621-6072). Please address questions and comments to RiskSystems@theocc.com.

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OIC Expands Outreach Efforts, Partnerships in China

OIC delegates made their fourth trip to China this past October to help educate China’s investor base about options. Visits to Shanghai, Shenzhen and Taipei further established relationships with exchanges, regulators, industry associations and firms to position OIC as a trusted source for education as China prepares to launch exchange-listed options.

At the invitation of the Shanghai Municipal Bureau of Foreign Experts Affairs, OIC presented advanced options education to more than 200 industry professionals in Shanghai and met with senior officers at Guo Tai Jun An Futures, China Financial Futures Exchange and Shanghai Stock Exchange. In Shenzhen, delegates presented options education and participated in discussions with the Shenzhen Stock Exchange and China Capital Markets Institute, an industry cooperative under the direction of China Securities Regulatory Commission. OIC launched its Train the Trainers program in Taipei. The program is a cooperative initiative with the Taipei Foundation of Finance (TFF) to train industry professionals to teach Chinese investors about options.

Earlier this year, OIC and TFF signed a Memorandum of Understanding (MOU) and entered into a content sharing agreement. Partnerships such as this will help OIC leverage its reach in China and provide additional opportunities for investors, professionals, regulators and industry organizations to learn about exchange-listed options.

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Register by January 31 to take advantage of the early bird discount for the 2014 Options Industry Conference. The event takes place April 30-May 2 in Austin, Texas. Sponsorship and Exhibitor opportunities are still available!

 
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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.