[Federal Register Volume 63, Number 117 (Thursday, June 18, 1998)]
[Notices]
[Pages 33424-33426]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-16262]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40083; File No. SR-OCC-98-03]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Accelerated Approval of a Proposed Rule Change Relating
to the Stock Loan/Hedge Program
June 11, 1998.
On April 13, 1998, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') a proposed
rule change (File No. SR-OCC-98-03) pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'').\1\ Notice of the proposal
was published in the Federal Register on June 4, 1998.\2\ No comment
letters were received. For the reasons discussed below, the Commission
is granting accelerated approval of the proposed rule change.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 40042 (May 28, 1998), 63
FR 30544 (June 4, 1998).
---------------------------------------------------------------------------
I. Description
OCC's stock loan/hedge program (``hedge program'') is a clearing
system for stock loans between OCC clearing members.\3\ The rule change
amends OCC's By-Laws and Rules governing the hedge program.\4\
---------------------------------------------------------------------------
\3\ For a complete description of the hedge program, refer to
Securities Exchange Act Release No. 32638 (July 15, 1993), 58 FR
39264 (July 22, 1993) [File No. SR-OCC-92-34] (order approving
proposed rule change).
\4\ For a detailed section-by-section discussion of the specific
changes to OCC's By-Laws and Rules refer to Securities Exchange Act
Release No. 40042, supra note 2. The rule change adds a new Rule
2201 to OCC's rules. As a result, Rules 2201-2210 have been
renumbered 2202-2211 and they are referred to in this order by their
revised numbers.
---------------------------------------------------------------------------
A. Stock Loan Initiation and Mark-to-Market Payments
Currently under the hedge program, a stock loan is initiated when
two hedge clearing members agree on the terms of the loan.\5\ Next, the
lending clearing member transfers the stock to OCC's account at a
``correspondent depository''
[[Page 33425]]
(i.e., a clearing agency which is registered with the Commission, which
acts as a securities depository and at which OCC has an account). OCC
then directs the correspondent depository to redeliver the stock to the
borrowing clearing member against payment of the required collateral
amount. OCC then pays the required collateral amount to the lending
clearing members.
---------------------------------------------------------------------------
\5\ Clearing members that are approved to participate in the
hedge program are referred to as ``hedge clearing members.'' A
clearing member that lends stock through the hedge program is
referred to as a ``lending clearing member,'' and a clearing member
that borrows stock through the hedge program is referred to as a
``borrowing clearing member.''
---------------------------------------------------------------------------
Under the rule change, OCC will not participate in a stock loan
transaction until after the hedge clearing members that are parties to
the stock loan have transferred the securities and required collateral
between themselves through the facilities of The Depository Trust
Company (``DTC''). Upon receiving notice of the stock loan from DTC,
OCC will verify the accuracy of the clearing members' account numbers
and the information supplied to OCC with respect to the transaction. If
this information is verified, OCC will accept the loan into the hedge
program. Upon OCC's acceptance of the loan, the stock loan contract
will be replaced by two parallel contracts with congruent terms: one
between the lending clearing member and OCC as stock borrower and one
between the borrowing clearing member and OCC as stock lender. If OCC
rejects a stock loan transaction, the transaction will remain in effect
between the lending clearing member and the borrowing clearing member
but will be outside the hedge program.
B. Eligible Stock
Currently, the only stocks that are eligible for the hedge program
are stocks that are the underlying stocks for stock option contracts.
Under the rule change, all equity securities that are eligible for
deposit at DTC will be eligible for the hedge program (other than any
stock as to which OCC has made a determination pursuant to Article XXI,
Section 2(c) of its By-Laws to terminate all outstanding stock loans
relating to that stock).
C. Collection of Margin on Stock Loan and Borrow Positions
Currently a hedge clearing member is required to deposit margin
with OCC to cover OCC's risk that the market will move against the
member's stock loan and borrow positions during a day and that the
member will fail before making the required mark-to-market payment on
the next business day. All stock loan and stock borrow positions are
taken into account in calculating each clearing member's obligation to
deposit ``additional margin'' with OCC and may generate either an
increased additional margin requirement (if the stock loan or borrow
positions do not hedge other positions of the clearing member) or a
reduced additional margin requirement (if the stock loan or borrow
positions do hedge other positions of the clearing member).
Under the rule change, a clearing member will be able to designate
one or more of its accounts with OCC as ``margin-ineligible.'' If an
account is designated as margin-ineligible, OCC will not include any
stock loan and stock borrow positions carried in that account in the
calculation of the clearing member's additional margin obligations.
However, margin-ineligible accounts will be subject of the other
elements of OCC's protection and back-up systems (such as OCC's
clearing fund and its concentration monitoring surveillance system) to
mitigate OCC's risk with respect to the positions carried in those
accounts.
Rule 601 currently provides that additional margin calculations are
based in part on the ``gross'' stock loan and borrow positions of a
hedge clearing member (i.e., without regard to whether a position on
the other side of the market is carried in the account). The rule
change amends Rule 601(c) to state that additional margin on margin-
eligible stock loan and borrow positions will be based only on the
``net'' stock loan or borrow position in an account in a manner
analogous to the method that OCC uses for options.
D. Stock Loan and Borrow Baskets
Under the rule change, a clearing member will be able to instruct
OCC to treat specified stock loan positions in an account as
constituting a ``stock loan basket'' and may instruct OCC to treat
specified stock borrow positions in an account as constituting a
``stock borrow basket.'' All stock loan baskets and all stock borrow
baskets will be subject to margin under OCC's Rule 602.\6\ Currently,
the hedge program has no provisions for stock loan and borrow baskets.
---------------------------------------------------------------------------
\6\ OCC rule 602 describes the calculation of margin
requirements for securities which are neither equity securities nor
based on equity securities. This margin system is sometimes referred
to as OCC's ``NEO'' or ``non-equity option'' margin system.
---------------------------------------------------------------------------
The rule change amends the definition of ``class group'' in Rule
602(b)(2) to state that OCC will treat any stock loan basket or stock
borrow basket defined by a clearing member as within the class group
identified by the clearing member even if the stock loan or borrow
positions the basket do not replicate the composition or weighting of
the index group for the class group and even if the stocks underlying
the identified stock loan or borrow positions are not even included in
the index group. However, a stock loan or borrow basket that does not
meaningfully replicate the composition and weighting of the index group
for a class group will be subject to a large haircut when OCC takes the
basket into account in determining the additional margin requirement
for the class group.\7\ In addition, the rule change amends Rule
602(c)(1)(ii)(A) to state that if a clearing member defines two or more
stock loan baskets or two or more stock borrow baskets in an account as
within the same class group, OCC will take each basket into account
separately and calculate a ``haircut'' for each separately in
determining additional margin for the class group.
---------------------------------------------------------------------------
\7\ OCC's authority to determine haircuts is set forth in OCC
Rule 602(c)(1)(ii)(C)(1).
---------------------------------------------------------------------------
The rule change also adds Rule 602(f)(8) which sets forth OCC's
procedures if a hedge clearing member modifies a stock loan or borrow
position that is completely or partly included in a stock loan basket
or stock borrow basket. Rule 602(f)(8) states that if a hedge clearing
member reduces or terminates one or more of the stock loan or borrow
positions that are included in a stock loan or borrow basket OCC will
regard any stock loan or borrow positions remaining in the basket as a
new basket in the same class group as the previous basket unless the
hedge clearing member instructs OCC otherwise. In addition, Rule
602(f)(8) states that if a hedge clearing member reduces a stock loan
or borrow position that is partially included in a stock loan or borrow
basket OCC will regard the entire remaining stock loan or borrow
position as having been withdrawn from the basket unless the hedge
clearing member instructs OCC otherwise through standing instructions
or timely instructions after the reduction of the position.
E. Stock Loan Termination and Hedge Member Suspension
Under the current hedge program, the termination of a stock loan
begins when the borrowing clearing member transfers the stock to OCC's
account at the corresponding depository. Next, OCC directs the
correspondent depository to redeliver the stock to the lending clearing
member against payment of the collateral amount to OCC. OCC then pays
the collateral amount to the borrowing clearing member. Under the rule
change, a stock loan will be terminated when the borrowing clearing
member transfers the stock to the lending clearing member's account at
DTC against payment by the lending
[[Page 33426]]
clearing member of the collateral amount.
The rule change adds an interpretation to section 2 of Article XXI
of the By-Laws to address situations in which the termination of a
stock loan is reported to OCC at a settlement price (i.e., the amount
of collateral that the lending clearing member must return to the
borrowing clearing member) that is not consistent with OCC's records. A
similar interpretation is added to Rule 2209 to address situations in
which OCC receives a report of the termination either of a purported
stock loan that does not exist on OCC's records or of a stock loan on
OCC's records in a quantity that does not match the quantity in the
termination report. In each case, the interpretation states that OCC's
records will be dispositive in both of these situations and that OCC
will not accept any responsibility for reconciling the discrepancy
between its record and those of the affected clearing members.
The rule change also provides for an alternative termination
process if OCC has suspended a hedge clearing member. Under the rule
change, Rules 2202(c) and 2208(c) are amended to give OCC the express
authority to instruct each hedge clearing member on the other side of a
suspended clearing member's stock loans to terminate the stock loan in
a manner other than the standard terminated described above. The rule
change amends Rules 2210(b) and 2211 to allow OCC to direct the hedge
clearing member that has not been suspended to use the collateral to
buy in the loaned stock (if the suspended clearing member is the
borrowing clearing member) or to sell out the loaned stock and apply
the proceeds to the repayment of the collateral (if the suspended
clearing member is the lending clearing member).
The rule changes amends Rule 2210(a) to state that if DTC suspends
one of the parties to a stock loan prior to the time at which OCC would
have otherwise accepted the stock loan into the hedge program, OCC will
not accept the stock loan. Rule 2210(a) is also amended to state that
OCC will accept any stock loan that complies with the completeness and
accuracy requirements of Rule 2202(b) even if OCC suspends one of the
hedge clearing members which is a party to the stock loan prior to the
time at which OCC accepts the stock loan.\8\
---------------------------------------------------------------------------
\8\ In such cases, OCC will instruct the hedge clearing member
that has not been suspended to terminate the stock loan contract
through the process set forth in revised Rules 2210(b) and 2211, as
described above.
---------------------------------------------------------------------------
II. Discussion
Section 17A(b)(3)(F) of the Act \9\ requires that the rules of a
clearing agency by designed to remove impediments to and perfect the
mechanism of the national system for the prompt and accurate clearance
and settlement of securities transactions. The Commission believes that
the rule change is consistent with OCC's obligation under Section
17A(b)(3)(F) because it should increase the use of OCC's hedge program
which should in turn help to improve the efficiency and safety of stock
lending transactions. Specifically, the Commission believes that
increased use of the hedge program should reduce exposure to
counterparty default, increase payment netting, reduce collateral
requirements, and apply advanced clearing and risk management practices
to the stock loan market. Accordingly, the Commission believes that the
rule change should enable OCC to remove impediments to and help perfect
the mechanism of the national system for the prompt and accurate
clearance and settlement of securities transactions.
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
OCC requested that the Commission approve the proposed rule change
prior to the thirtieth day after the publication of notice of the
filing. The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after publication of notice because
such approval should allow OCC to provide needed assurances to clearing
members that the hedge program will be implemented, should OCC to
institute changes to the hedge program to make it more attractive to
clearing members and should allow OCC to train hedge clearing members
on the new system interfaces. These changes should result in increased
efficiency in the clearance and settlement process for OCC's clearing
members that use the hedge program. The Commission also notes that the
use of the hedge program is not mandated by OCC.
III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular with Section 17A of the Act \10\ and the rules and
regulations thereunder.
---------------------------------------------------------------------------
\10\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-98-03) be and hereby is
approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\11\
---------------------------------------------------------------------------
\11\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Jonathan G. Katz,
Secretary.
[FR Doc. 98-16262 Filed 6-17-98; 8:45 am]
BILLING CODE 8010-01-M
