May 11, 2024
Dear SEC, As a retail investor, I welcome the chance provided by SR-OCC-2024-001 Release No 34-100009 to offer feedback on SR-OCC-2024-001 34-99393, titled "Proposed Rule Change by The Options Clearing Corporation Concerning Its Process for Adjusting Certain Parameters in Its Proprietary System for Calculating Margin Requirements During Periods When the Products It Clears and the Markets It Serves Experience High Volatility." I endorse the SEC's considerations for potential disapproval, as I harbor various reservations about the OCC's proposal and do not endorse its approval. This opportunity to contribute to the rulemaking process is crucial in ensuring fairness, orderliness, and efficiency in the market, benefiting all investors. I am concerned by the opacity within our financial system, exemplified by this rule proposal and others. The extensive redaction of details and supporting information hinders public scrutiny, rendering it impossible for meaningful review and comment. Denying the public a comprehensive review opportunity warrants rejection of this proposal solely on this basis.Public review holds particular significance because the OCC's Proposed Rule places blame on U.S. regulators for not mandating the adoption of prescriptive procyclicality controls. This omission is concerning as it could lead to an increase in margin requirements during periods of market stress, potentially jeopardizing a Clearing Member's liquidity and exposing the OCC to financial risks. Given the OCC's designation as a SIFMU, which could impact the stability of the US financial system, transparency is essential for all stakeholders. The fact that the OCC, as a self-regulatory organization, faults U.S. regulators for not enforcing regulations to protect itself suggests a lack of reliability in the oversight of our financial markets. This specific OCC rule proposal seems crafted to shield Clearing Members from the potential risks of costly trades by swiftly approving reductions in margin requirements, as requested by Clearing Members. However, this approach poses increased risks to both the OCC and the stability of our financial system. According to the OCC rule proposal: The OCC acquires margin collateral from Clearing Members to manage the market risk associated with their positions. Utilizing its proprietary system, STANS (System for Theoretical Analysis and Numerical Simulation), the OCC calculates margin requirements for each Clearing Member using various models. One of these models may generate "procyclical" outcomes, linking margin requirements to volatility levels, thereby posing a threat to member stability during periods of heightened market volatility. An escalation in margin requirements could impede a Clearing Member's ability to secure liquidity to fulfill its obligations to the OCC. In the event of a Clearing Member default, liquidating their positions could lead to losses borne by the Clearing Fund, potentially causing liquidity challenges for non-defaulting Clearing Members. Essentially, there's a systemic risk because Clearing Members collectively lack adequate capitalization and may be overly leveraged. Consequently, if one Clearing Member fails due to inadequate risk management amid high volatility, it could potentially trigger a chain reaction of Clearing Member failures. Put simply, if a Clearing Member makes poor investment decisions on Wall Street, it could set off a broader financial crisis because Clearing Members are collectively risking more than they can sustain. The OCC's proposal aims to prevent a systemic financial crisis by reducing margin requirements through "idiosyncratic" and "global" control settings. This is exemplified by a specific instance where implementing idiosyncratic control settings for a particular risk factor led to a $2.6 billion decrease in aggregate margin requirements. The OCC has opted to avoid margin calls for one or more at-risk Clearing Members by employing these idiosyncratic control settings, a decision it has made over 200 times in less than 4 years, ranging from a few days to up to 190 days. This frequency of over 50 times annually suggests that these choices may not truly be idiosyncratic. Furthermore, besides addressing idiosyncratic risks, the OCC has also implemented "global" control settings during significant events such as the COVID-19 pandemic onset and the "meme-stock" episode on January 27, 2021.Essentially, these regulations establish an unjust environment for various market participants, including retail investors, who must endure the repercussions of long-tail risks while the OCC consistently exempts Clearing Members from margin calls through repeated reductions in their margin requirements. Consequently, this proposal should be dismissed, and Clearing Members should adhere to precisely defined margin requirements like other investors. Approval of this rule by the SEC would perpetuate a double standard in our financial system, contradicting the SEC's objective of upholding equitable markets.According to the OCC, this rule proposal and the special margin reduction procedures are necessary because a single Clearing Member default could trigger a chain reaction of defaults, posing financial risks to the OCC. Consequently, Clearing Members who neglect to adequately manage their portfolio risk regarding long-tail events effectively become Too Big To Fail. Therefore, this proposal should be opposed, and Clearing Members should bear the repercussions of inadequately managing their portfolio risk, including exposure to long-tail events. Clearing Member failure serves as an inherent deterrent against excessive leverage and inadequate capitalization, as others in the market will not bail them out. This rule proposal institutionalizes an inherent conflict of interest for the Financial Risk Management (FRM) Officer. While the FRM Officer's role is purportedly to safeguard the OCC's interests, the scenario described in the OCC proposal, where a Clearing Member's failure exposes the OCC to financial risk, obliges the FRM Officer to shield the Clearing Member from failure to safeguard the OCC. Consequently, the FRM Officer becomes merely an administrative rubber stamp for reducing margin requirements for Clearing Members facing the risk of failure. The OCC proposal corroborates this interpretation, as it explicitly mentions that "FRM applies the high volatility control set to a risk factor each time the Idiosyncratic Thresholds are breached," while still retaining the authority "to maintain regular control settings in the case of exceptional circumstances." Regrettably, rubber-stamping margin requirement reductions for at-risk Clearing Members undermines the protection from market risks associated with Clearing Members' positions, which would have been secured by the margin collateral collected by the OCC. Hence, this rule proposal should be dismissed, and the OCC ought to enforce adequate margin requirements to shield the OCC and mitigate the extent of any necessary bailouts. The OCC's Clearing Member Default Rules and Procedures Loss Allocation protocol prioritizes "3. OCC's own pre-funded financial resources" (referred to as OCC's "skin-in-the-game" in SR-OCC-2021-801 Release 34-91491) over "4. Clearing fund deposits of non-defaulting firms" when distributing losses. Consequently, any significant default by a Clearing Member that depletes both "1. The margin deposits of the suspended firm" and "2. Clearing fund deposits of the suspended firm" automatically poses a financial risk to the OCC. Given that this rule proposal focuses on potential liquidity challenges for non-defaulting Clearing Members due to Clearing Fund charges, it is evident that the OCC is wary of risks that erode its own pre-funded financial resources. With the primary line of defense for the OCC being "1. The margin deposits of the suspended firm," the logic behind this rule proposal to reduce margin requirements for at-risk Clearing Members via idiosyncratic control settings appears flawed and contradictory. According to the OCC's own acknowledgment of the potential magnitude of financial risk posed by a defaulting Clearing Member, the OCC should be increasing the amount of margin collateral required from these at-risk Clearing Members to enhance their protection against market risks associated with their positions and encourage prudent risk management. Interestingly, the OCC concedes that the purportedly "procyclical" STANS model predicts an increase in margin requirements, which it claims is an overestimation and seeks to alleviate. However, approving this rule proposal to mitigate the allegedly procyclical margin requirements directly undermines the primary line of defense for the OCC—margin collateral from at-risk Clearing Members. Therefore, this rule proposal should be declined and subjected to thorough public scrutiny. Interestingly, the OCC submitted a proposal for a rule change to establish their Minimum Corporate Contribution (referred to as OCC's "skin-in-the-game") to the SEC in SR-OCC-2021-003 on February 10, 2021, shortly after the "meme-stock" episode on January 27, 2021. This proposal outlined a scenario where, in the event of a default or series of defaults, the OCC would utilize its own capital contribution to cover remaining losses before resorting to contributions by non-defaulting members or assessments. Following this idiosyncratic market event, the OCC proposed this rule change to prioritize the allocation of losses upon one or more Clearing member defaults to the OCC's pre-funded financial resources, ahead of contributions by non-defaulting members or assessments. Now, the OCC seeks to justify approving this proposed rule change on adjusting margin requirement calculations by leveraging its exposure to financial risks, as outlined in the proposal itself. The proposal suggests that the OCC's clearing activities could expose it to financial risks if a Clearing Member fails to meet its obligations, which the OCC manages through financial safeguards, including the collection of margin collateral from Clearing Members. However, approving this rule proposal would essentially reduce these financial safeguards, contradicting the OCC's previous stance of seeking exposure to financial risks in the event of Clearing Member default(s). Particularly concerning is the OCC's indication of reluctance to liquidate Clearing Member positions, instead opting for readily available liquidity resources under stressed and volatile market conditions. Given this context, there appears to be no reasonable basis for approving this rule proposal, especially when it involves reducing financial safeguards previously deemed essential for managing financial risks associated with Clearing Member defaults. Furthermore, given its role as "the sole clearing agency for standardized equity options listed on national securities exchanges registered with the Commission," the OCC appears to be leveraging its status as a "single point of failure" within our financial system. This seems to be a deliberate tactic to pressure the SEC into approving the proposed rule, ostensibly aimed at mitigating systemic risk and bolstering financial stability by enhancing the liquidity of SIFMUs once again. Essentially, it appears that the OCC, as the exclusive clearing agency for standardized equity options, is using its pivotal position to extract additional liquidity, even at the risk of endangering itself. Does the designation of SIFMU (Systemically Important Financial Market Utility) imply that a segment of our financial system is deemed Too Big To Fail, prompting regulatory agencies and the government to provide liquidity at any cost, even if it's a consequence of self-imposed risks? It appears so, especially given recent instances like SR-OCC-2022-802 and SR-OCC-2022-803. These proposals expand the OCC's Non-Bank Liquidity Facility, now including pension funds and insurance companies, granting the OCC unrestricted access to liquidity from these sources. Despite numerous objections raised in comments, the SEC did not interject. If the SEC either permits or refrains from objecting to this proposal, it essentially signals a readiness to ensure liquidity through any available means. The combination of the current OCC proposal with SR-OCC-2022-802 and SR-OCC-2022-803 facilitates a significant, uncapped transfer of liquidity from the OCC's Non-Bank Liquidity Facility to the OCC itself, all under the OCC's authority. Although the FRM Officer serves as an administrative rubber stamp for margin reductions, the OCC's FRM Officer still holds the power "to maintain regular control settings in the case of exceptional circumstances." Essentially, in undisclosed or redacted exceptional situations, the OCC's FRM Officer can refrain from rubber-stamping a margin reduction, potentially triggering a margin call for a Clearing Member. This, in turn, could lead to a possible default or suspension of the Clearing Member unable to fulfill their obligations to the OCC. With the authority to withhold a rubber stamp margin reduction for a Clearing Member, the OCC can proactively activate Master Repurchase Agreements (further empowered by SR-OCC-2022-802) to compel Non-Bank Liquidity Facility Participants (such as pension funds and insurance companies) to purchase Clearing Member collateral from the OCC under these agreements before a significant Clearing Member default occurs. This preemptive measure serves as an alternative to selling Clearing Member collateral under potentially stressed and volatile market conditions, which could emerge in the event of a substantial Clearing Member default posing financial risks to the OCC and other Clearing Members. Under the OCC's Master Repurchase Agreements, the OCC also retains the option to repurchase collateral on demand, enabling it to buy back collateral during the turbulent market conditions triggered by the Clearing Member default, likely at a discounted rate. In essence, the combination of SR-OCC-2022-802, SR-OCC-2022-803, and the current proposal empowers the OCC to strategically sell collateral to non-banks (including pension funds and insurance companies) at opportune moments, followed by repurchasing it at lower rates after a Clearing Member default. Despite the voluntary participation of non-banks in this facility, the potential ramifications for other parties cannot be ignored. For instance, pension funds and retirements could be impacted even if they voluntarily engage, while insurance companies might face insolvency, potentially necessitating another bailout reminiscent of the 2008 financial crisis. Given the OCC's concerns regarding the repercussions of a Clearing Member's failure, which could expose the OCC to financial jeopardy and create liquidity challenges for non-defaulting Clearing Members, the previously relied-upon justification for mitigating systemic risk seems inadequate. The systemic risk has already been substantial, exacerbated by a lack of regulatory enforcement and insufficient risk management, exemplified by the recurrent reduction of margin requirements for at-risk Clearing Members. Rather than accruing larger debts that cannot be repaid, it is imperative that those who incurred the debts bear the responsibility for repayment, rather than passing the burden onto pensions, insurance companies, or the public, especially before the debts reach systemic proportions. Therefore, the SEC is correct to have identified reasonable grounds for disapproval as this Proposed Rule Change is NOT consistent with at least Section 17A(b)(3)(F), Rule 17Ad-22(e)(2), and Rule 17Ad-22(e)(6) of the Exchange Act (15 U.S.C. 78s(b)(2)). The SEC has appropriately identified valid grounds for disapproving the Proposed Rule Change under Section 17A(b)(3)(F) for the following reasons: The Proposed Rule neglects to ensure the protection of securities and funds under the custody or oversight of the clearing agency, as it improperly diminishes margin requirements for Clearing Members at risk of default. This action heightens financial risk for the OCC and other market participants, as outlined previously. The Proposed Rule fails to uphold the interests of investors and the broader public by transferring the financial burdens resulting from Clearing Member default(s) to the non-bank liquidity facility, which includes pension funds and insurance companies. Moreover, it engenders a moral hazard by broadening the concept of "Too Big To Fail" to encompass any Clearing Member experiencing losses beyond their margin and clearing fund deposits, as discussed earlier. The SEC has appropriately identified valid grounds for disapproving this Proposed Rule Change concerning Rule 17Ad-22(e)(2) for several reasons: The Proposed Rule lacks a governance structure that is transparent and clear. The role of the FRM Officer, which prioritizes the safety of Clearing Members over that of the clearing agency, is not transparent. Additionally, the repeated application of "idiosyncratic" and "global" control settings for reducing margin requirements lacks transparency. The Proposed Rule fails to prioritize the safety of the clearing agency and instead emphasizes the safety of Clearing Members by routinely approving margin requirement reductions. The Proposed Rule does not align with the public interest requirements, particularly in terms of investor protection. By transferring the costs of Clearing Member defaults to the non-bank liquidity facility, including pension funds and insurance companies, investor protection is compromised. The Proposed Rule lacks clarity regarding lines of responsibility. For instance, the role of the FRM Officer as an administrative rubber stamp for reducing margin requirements for at-risk Clearing Members is unclear. The Proposed Rule overlooks the interests of customers and securities holders. Reducing margin requirements for Clearing Members at risk of default amplifies systemic risk, impacting all market participants. Furthermore, it perpetuates an environment of unequal treatment in the financial system. The SEC has appropriately identified reasonable grounds for disapproving this Proposed Rule Change concerning Rule 17Ad-22(e)(6) for several reasons: The Proposed Rule overlooks the necessity of considering and establishing margin levels that align with associated risks. Reducing margin for Clearing Members at risk of default defies logic and rationality, as detailed above. The Proposed Rule neglects to calculate margin at levels adequate to cover potential future exposure. Given that margin requirements are already deemed insufficient, the proposal to further reduce these requirements is concerning, particularly as Clearing Member defaults could lead to losses impacting the Clearing Fund and causing liquidity issues for non-defaulting Clearing Members, as outlined above. The Proposed Rule lacks a valid model for the margin system. It attempts to reduce margin requirements despite existing models indicating the necessity of increased margin requirements. Furthermore, it acknowledges the potential magnitude of financial risk posed by a defaulting Clearing Member, surpassing current margin requirements and resulting in losses allocated beyond suspended firms to the OCC and non-defaulting members, as elucidated above. Furthermore, the SEC might also take into account Rule 17Ad-22(e)(3), 17Ad-22(e)(4), and 17Ad-22(e)(6) as supplementary bases for disapproval, given that the Proposed Rule Change inadequately addresses liquidity risk management and exacerbates systemic risk, as outlined earlier. While there may be other valid reasons for disapproval, the extensive redactions hinder the public's ability to thoroughly assess and evaluate the Proposed Rule. Given the issues highlighted earlier, please take into consideration the following recommendations: Increase and rigorously enforce margin requirements in line with the risks associated with Clearing Member positions instead of reducing them. Clearing Members should be incentivized to structure their portfolios to accommodate stressed market conditions and long-tail risks. The current rule proposal incentivizes Clearing Members to grow excessively large in order to pressure the OCC with heightened risk and leverage, leading to more frequent implementation of idiosyncratic controls to privatize gains and socialize losses. Implement external auditing and supervision as a "fourth line of defense," akin to the model described in the "four lines of defense model" for financial institutions. This should be coupled with enhanced public reporting to ensure that risks are identified and managed proactively before they escalate to a systemic level. Swap the positions of "3. OCC’s own pre-funded financial resources" and "4. Clearing fund deposits of non-defaulting firms" in the OCC's Loss Allocation waterfall so that Clearing fund deposits of non-defaulting firms are prioritized for loss allocation before OCC’s own pre-funded financial resources and the EDCP Unvested Balance. This reordering of loss allocation would foster a system where Clearing Members are incentivized to monitor each other, ensuring that appropriate risk management measures are taken by all Clearing Members, as their Clearing Fund deposits would be at risk following the depletion of deposits from a suspended firm. Additionally, this adjustment would enhance protection for the OCC, a SIFMU, by assigning losses to the clearing corporation only after Clearing Member deposits have been exhausted. Consequently, the public would benefit from a reduced risk of having to provide a bailout to a systemically important clearing agency, as non-defaulting Clearing Members would be safeguarded by the suspension and liquidation of a defaulting Clearing Member before any potential loss allocation to their contributions. Immediately suspend and initiate the liquidation process for a Clearing Member as soon as their projected losses surpass "1. The margin deposits of the suspended firm." This approach allows for the conservation of additional resources in the loss allocation waterfall for unforeseen exigencies. In contrast to previous methods of margin requirement reduction, which delay the suspension and liquidation of Clearing Members, early interventions curtail systemic risk by halting issues before they escalate and jeopardize the stability of the financial system. Enhance the resilience of our financial markets and diminish "single points of failure" by bolstering redundancy, such as fostering competition among multiple Clearing Agencies. The concept of Too Big To Fail (TBTF) should be eradicated, and the prospect of failure should always be viable. I appreciate the chance to provide input to ensure the safeguarding of all investors, as a fair, transparent, and robust market benefits everyone involved. Sincerely Brenton Carling