February 2015 Newsletter

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In This Issue

John Fennell Discusses Establishment of Innovative Committed Repurchase Facility with Pension Fund

John FennellOCC recently announced the establishment of an innovative pre-funded, committed repurchase facility with a leading pension fund. The new facility increases OCC's overall liquidity resources from $2 to $3 billion, while diversifying its committed lenders to include qualified pension funds in addition to its existing participant base of banks and broker-dealers. Executive Vice President of Financial Risk Management, John Fennell shares insight on the company's decision to expand its liquidity resources.


What prompted OCC to expand its liquidity resources?

Having access to committed liquidity is critical to central counterparties like OCC to ensure that we are able to meet our payment obligations at all times and in a timely manner. These resources safeguard OCC's guarantee to satisfy all obligations, even if its largest clearing member fails, which promotes the uninterrupted flow of settlements within our markets. Given the dynamic nature and growth of this industry, we continuously monitor our liquidity demands. Based on certain historical observations and forecasted derivatives volume, we determined it was prudent to raise our committed resources by $1 billion to ensure that we have sufficient liquidity.

That being said, we are also highly sensitive to both the demand and supply side of liquidity. We must have access to a sufficient supply of committed liquidity long term to support the anticipated growth in derivatives. Given the changes impacting the way banks account for committed liquidity on their balance sheet, which would effectively reduce the supply of liquidity available to central counterparties, it is important that OCC explore viable alternatives to securing access to liquidity in ways that enhance our diversification of counterparties where we already have exposure (i.e., banks, broker-dealers and FCMs).

How is this agreement an innovative move for the U.S. options industry?

Given our objective of identifying alternate liquidity lenders that present right-way risk and can provide timely funding, OCC explored the concept of accessing pension funds. Working with qualified pension funds fulfills our goal of securing liquidity in a way that is not pro-cyclical, preserving the liquidity of our clearing members during a time of crisis.

OCC is the first major U.S. derivatives clearinghouse to diversify its credit facilities through a nonbank facility. In doing so, we have enhanced our ability to meet settlement obligations in times of stress, thereby reducing systemic risk and promoting safety and soundness in the financial markets. Implementing this solution expands the range of qualified lenders that we rely on. It's the first of its kind, and because of this it required SEC approval, which we received in January.

Is OCC pursuing this type of agreement with other pension funds?

This was the initial step in diversifying our liquidity sources while promoting an alternative we hope will be viable long term. As we validate the model and as more lenders enter the marketplace, we anticipate that pension funds will become an increasingly attractive liquidity source to reduce concentration risk and overall pro-cyclicality, thus improving the resiliency of our markets. Depending on our needs we plan to maintain a level of diversification in our committed liquidity through a mix of traditional and pension-based funding.

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New Capital Plan Complies with Proposed Covered Clearing Agency Standards

OCC's Board of Directors approved a newly formed capital plan designed to comply with proposed standards for covered clearing agencies. Under the plan, OCC's existing stockholders, Chicago Board Options Exchange, Incorporated, International Securities Exchange, LLC, NASDAQ OMX PHLX, LLC, NYSE MKT LLC, and NYSE Arca, Inc. will contribute $150 million in equity capital, increasing OCC shareholders' equity to approximately $247 million by the first quarter of 2015. The stockholders will also provide specified replenishment capital if needed.

The $247 million of shareholders' equity consists of $117 million of baseline capital (equal to six months of forward-looking expenses) and a $130 million risk buffer (covering OCC's operational and business risks). The shareholders' equity would be further backed by a replenishment capital facility that would give OCC the ability to access additional committed equity capital from the owner exchanges in an amount up to the baseline capital in the event of unexpected losses. In total, the plan would provide OCC with ready access to approximately $364 million in equity capital resources.

The plan outlines an approach to modeling expense and risk profiles, capital requirements, fees and future refunds that restores predictability and transparency, and aims to maintain low costs and efficient operations for clearing members.

This creates an even stronger partnership between the stockholder exchanges and OCC's clearing members. As a systemically important institution OCC continually looks for ways to strengthen its risk management capabilities to meet today's elevated regulatory and marketplace expectations. The plan, which is subject to approval by the SEC and owner exchanges, will enable OCC to be compliant with the proposed new standards well in advance of the expected implementation.

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OCC Comments on Impact of Risk Weighted Capital Rules on Options Market

OCC leads legislative and regulatory advocacy efforts of the U.S. Securities Markets Coalition, which lobbies on behalf of the options exchanges and OCC on issues of common interest. OCC recently submitted a letter to staff of the Federal Reserve Board that addressed the impact on the listed options market of certain provisions of the capital rules for banks adopted by banking regulators.

These rules may be interpreted to require a U.S. bank, when calculating its trade exposures to customers, to disregard risk-reducing properties of certain spread positions in listed options and impose capital requirements that are unrelated to economic risks entailed. This could result in a dramatic increase in the capital required to support customer positions for many market making firms, despite the limited risk. To read the full letter and its discussion regarding the potential for interpretive relief, click here.

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OCC Hires New Chief Risk Officer

John Grace

John Grace joined OCC as Executive Vice President and Chief Risk Officer in January. He will be responsible for driving and implementing OCC's risk management strategy. This includes advising senior management and the Board of Directors on risk issues, overseeing OCC's Model Validation and Enterprise Risk Management departments, and working with regulators from the Securities and Exchange Commission, the Board of Governors of the Federal Reserve System, and the Commodity Futures Trading Commission. His experience in banking, risk management and interfacing with financial regulators will further enhance OCC's risk management capabilities and significantly strengthen its resiliency as a Systemically Important Financial Market Utility.

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From the Hill

In January both the House and Senate convened to organize the 114th Congress. With both chambers now in Republican control, the House and Senate quickly moved to pass certain bills, including the Terrorism Risk Insurance Reauthorization Act and the Keystone XL Pipeline Act. While the relatively noncontroversial Terrorism Risk Insurance Reauthorization Act rapidly became the first official law of the 114th Congress, the political football that is the Keystone XL Pipeline Act is expected to be deflated by President Obama's veto pen as soon as it reaches his desk.

"Under the plan the capital gains tax would be increased and a new tax on the nation's 100-largest banks would be imposed."

During his State of the Union address on January 20, 2015, President Obama provided some details on his new tax plan. This plan has been characterized by a number of folks as a “Robin Hood” tax that would finance middle class tax benefits by increasing taxes on the wealthy. For instance, under the plan the capital gains tax would be increased and a new tax on the nation's 100-largest banks would be imposed. Interestingly, the Obama administration has noted that the proposed bank tax is similar to a proposal by former Republican House Ways and Means Committee Chairman Dave Camp (R-MI) as part of his comprehensive tax reform bill (H.R. 1) from 2014. Even though the President's plan as a whole has no chance of passing Congress, it along with Chairman Camp's comprehensive tax reform bill is expected to be part of a broader debate on tax reform in the coming months.

Given the continued interest in tax reform, the U.S. Securities Markets Coalition is planning to meet with new members of the House Ways and Means Committee Representatives Kristi Noem (R-SD), Patrick Meehan (R-PA), Jason Smith (R-MO) and George Holding (R-NC) to express our deep concerns about Chairman Camp's mark-to-market proposal. In addition, the Coalition is planning to meet with staff of Senators who are members of the Senate Finance Committee. Senator Hatch, the new Chairman of the Committee, has announced the creation of five separate bipartisan “Finance Committee Tax Working Groups” with the goal of spurring congressional comprehensive tax reform efforts in the current Congress.

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2014 OCC Charity Efforts Culminate in Success

Each year, OCC employees raise money for two worthwhile charities. 2014 was no exception.

Chicago—OCC's Chicago office selected Jake's Heroes, which is dedicated to providing assistance for children stricken with cancer who undergo stem cell treatments. Employees raised funds through events such as the Ice Bucket Challenge, Crosstown Classic outing, Mother's Day fudge sale, bag tournament, a Taste of OCC cooking event, and more. Fundraising events yielded a contribution of more than $33,000. The money raised will provide packages for the children to aid in the process of receiving stem cell treatments and include items such as communication devices (tablet or laptop), game systems, board games, clothes, blankets and stuffed animals to keep kids' minds occupied and allow them to stay in touch with their families.

Keller—Employees supported Vogel Alcove, an organization that offers a free, comprehensive early childhood education program in Dallas. Vogel Alcove provides childcare and case management for children and their families residing at local emergency shelters, domestic violence shelters and housing programs. Employees raised funds through silent auctions, bake sales, jeans days, a book fair, and a chili cook-off that, together, yielded a contribution of more than $19,000. This money will fund needed equipment and updates to Vogel Alcove's building to create a more comfortable place to work, educate and deliver care.

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Enhanced OIC Mobile App Now Live

OIC Mobile App for iOS Screenshot

The Options Industry Council (OIC) released an updated mobile app (v1.1) for iOS devices. Users will find design enhancements and the addition of the following courses:

  • An Introduction to Capital Markets
  • Symbols and Quotes
  • Covered Calls

The app features content from OIC's website and puts it in a more user-friendly format for people on the go. The app offers educational materials and resources including mobile courses, options strategies, and registration for OIC's seminars and special events. Download it today for free.

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Register for the 2015 Options Industry Conference, the premier event for top-level management and trading professionals. The conference takes place at the Fontainebleau Hotel in Miami Beach, Florida, May 6-8. 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.