In a follow-up to my previous posts u/WhatCanIMakeToday has dug into it all and written a brilliant follow-up post with a template to comment to the SEC and given me permission to repost their post here.
The OCC is once again proposing rules to can kick MOASS and screw retail. The OCC is proposing a rule change to reduce margin requirements when there’s high volatility so that Clearing Members won’t default because it would basically start a domino effect that would tank multiple Clearing Members. [SR-OCC-2024-001 34-99393 (PDF, Federal Register)] Exhibit 5 (PDF) with the proposed changes is completely REDACTED, of course. Exhibit 3 (PDF) is similarly redacted, though we do get to see its Table Of Contents. 📝 A template to comment to the SEC is at the bottom of this DD.
If Margin Calls Are A Problem, Reduce Margin Requirements! 🤦♂️
Margin requirements have been calculated by the OCC using STANS (since 2006) to conservatively ensure margin requirements are satisfied:
Under the STANS methodology, which went into effect in August 2006, the daily margin calculation for each account is based on full portfolio Monte Carlo simulations and - as set out in more detail below - is constructed conservatively to ensure a very high level of assurance that the overall value of cleared products in the account, plus collateral posted to meet margin requirements, will not be appreciably negative at a two-day horizon.
As part of that calculation, margin requirements can go up when there’s a lot of volatility – which makes sense. But, as it turns out, this sensibility is “procyclical” because when the markets are stressed and margin requirements go up, a Clearing Member could fail to meet the margin requirements, default, and then create losses that are covered by a Clearing Fund. As the Clearing Fund is funded by other Clearing Members, a loss paid out by the Clearing Fund could screw over other Clearing Members and cause them to go under as well. Hello systemic risk!
In order to prevent this cascade of Clearing Member failures, the OCC proposes changing how margin requirements are calculated when there’s high volatility. When the market is under control, the OCC uses “regular” control settings for calculating margin requirements. But when things get frothy and turbulent, the OCC uses “high volatility” control settings “to prevent significant overestimation of Clearing Member margin requirements”. These “high volatility control settings may be applied to individual securities, which are among several “risk factors” under OCC’s margin methodology.”
The OCC uses the term “idiosyncratic” control settings when implementing high volatility control settings to an individual risk factor (e.g., single stock, like GameStop). An idiosyncratic control setting for an idiosyncratic risk stock. When the financial markets are really volatile, the OCC turns on “global” control settings to implement high volatility control settings across all or a class of risk factors.
Global control settings are very rarely implemented because it’s only for when big shits hits the fan. OCC notes only two instances of global control settings being implemented recently:
- March - April 2020 “associated with the onset of the COVID-19 pandemic”.
- January 27, 2021, the GameStop Sneeze, the so-called “meme stock” episode.
High volatility idiosyncratic controls on individual stocks happen far more often. Between Dec 2019 and Aug 2023, idiosyncratic control settings were implemented on over 200 stocks each lasting 10 days on average (ranging from 1 to 190 days).
In one instance on April 28, 2023, OCC’s idiosyncratic control settings reduced margin requirements by $2.6 billion for an unidentified stock (with no options listed) “that experienced multi-day jumps in stock price including from $6.72  on April 27, 2023  to$108.20 on April 28, 2023”. Which stock? I don’t know. Perhaps another ape can enlighten us.
As part of selling these proposed rule changes to the SEC, the OCC needs to backtest the proposed changes to see if the changes might have caused any problems for Clearing Members. Unsurprisingly, the OCC finds no problems because these idiosyncratic volatility control settings significantly reduce margin requirements for Clearing Members.
In general, OCC has not observed backtesting exceedances attributable to the implementation of global or idiosyncratic volatility control settings. Currently, OCC monitors margin sufficiency at the Clearing Member account level to identify backtesting exceedances. Account exceedances are investigated to determine the cause of the exceedance, including whether the exceedance can be attributed to the implementation of high volatility control settings. No account level exceedance has been attributed to the implementation of high volatility control settings. [SR-OCC-2024-001 34-99393 Federal Register]
Nobody would have been margin called because the OCC can reduce margin requirements with idiosyncratic volatility control settings anytime a Clearing Member needs help.
That backtesting is true “in general”; except for one unidentified idiosyncratic risk factor (umm… perhaps the GameStop Sneeze?). Thankfully, the idiosyncratic control settings (combined with turning off the buy button) kept all the Clearing Members above water. Remember from above: if no Clearing Member goes bust then the cascade of Clearing Member failures never begin which is why the OCC believes that applying high volatility control settings won’t have any negative impact to OCC’s margin coverage. (To put this another way: the OCC’s margin coverage is only at risk if Clearing Members are margin called so the OCC proposal keeps the OCC afloat by lowering margin requirements which avoids margin calling anyone.)
Preventing A Cascade Of Clearing Member Failures
Here’s a prime example of how a Clearing Agency bureaucratically screams for help with a veiled threat of systemic risk to financial markets; annotated for apes.
🀺 Defaulting Clearing Member → OCC
According to the OCC's publicly disclosed Loss Allocation waterfall scheme in OCC’s Clearing Member Default Rules and Procedures (publicly linked to from OCC's web page on Default Rules and Procedures), the deposits of a defaulting (and suspended) Clearing Member are used first to cover losses (1. Margin Deposits followed by 2. Clearing Fund deposits) followed by OCC's own assets (3. OCC's own pre-funded financial resources).
Which means the OCC, a SIFMU backed by the US Government and thus taxpayers, falls before other Clearing Members (4. Clearing fund deposits of non-defaulting firms). So if one Clearing Member manages to screw up so badly that they default, the OCC takes the hits before other Clearing Members!
Insane, right? Why should the taxpayer backed Clearing Agency be the first to fall after a significant Clearing Member default? And why is the OCC trying to reduce the margin requirements of at risk firms which reduces the size of the first two buckets in the OCC's Loss Allocation Waterfall? It's almost as if the OCC is intentionally trying to embiggen the systemic risk with this proposal.
How Did We Get Such A Borked System? Regulatory Failure
Blame the [captured] regulators. Seriously! The OCC blames “U.S. regulators [who] chose not to adopt the types of prescriptive procyclicality controls codified by financial regulators in other jurisdictions”.
"The regulators didn't make us do anything to protect ourselves" is an interesting defense because the OCC is a Self-Regulatory Organization under the SEC which means the OCC basically regulates themselves; so blame goes directly back to the OCC!
OCC Doesn’t Want To Hear Comments From You
The OCC, a self-regulatory organization blaming regulatory failures, doesn't want to hear from you. Got it?
Comment To The SEC! 😈
If regulatory failure is the reason the OCC didn't protect themselves, then this is a perfect opportunity for apes to ask for more regulation and enforcement.
Here's a comment template. Feel free to use, modify, or write your own. And, send the email anonymously if you wish.
Subject: Comments on SR-OCC-2024-001 34-99393
Thank you for the opportunity to comment on SR-OCC-2024-001 34-99393 entitled “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” (PDF, Federal Register) as a retail investor. I have several concerns about the OCC rule proposal, do not support its approval, and appreciate the opportunity to comment.
I’m concerned about the lack of transparency in our financial system as evidenced by this rule proposal, amongst others. The details of this proposal in Exhibit 5 along with supporting information (see, e.g., Exhibit 3) are significantly redacted which prevents public review making it impossible for the public to meaningfully review and comment on this proposal. Without opportunity for a full public review, this proposal should be rejected on that basis alone.
Public review is of the particular importance as the OCC’s Proposed Rule blames U.S. regulators for failing to require the OCC adopt prescriptive procyclicality controls (“U.S. regulators chose not to adopt the types of prescriptive procyclicality controls codified by financial regulators in other jurisdictions.” ). As “procyclicality may be evidenced by increasing margin in times of stressed market conditions” , an “increase in margin requirements could stress a Clearing Member's ability to obtain liquidity to meet its obligations to OCC” [Id.] which “could expose OCC to financial risks if a Clearing Member fails to fulfil its obligations”  that “could threaten the stability of its members during periods of heightened volatility” . With the OCC designated as a SIFMU whose failure or disruption could threaten the stability of the US financial system, everyone dependent on the US financial system is entitled to transparency. As the OCC is classified as a self-regulatory organization, the OCC blaming U.S. regulators for not requiring the SRO adopt regulations to protect itself makes it apparent that the public can not fully rely upon the SRO and/or the U.S. regulators to safeguard our financial markets.
This particular OCC rule proposal appears designed to protect Clearing Members from realizing the risk of potentially costly trades by rubber stamping reductions in margin requirements as required by Clearing Members; which would increase risks to the OCC. Per the OCC rule proposal:
- The OCC collects margin collateral from Clearing Members to address the market risk associated with a Clearing Member’s positions. 
- OCC uses a proprietary system, STANS (“System for Theoretical Analysis and Numerical Simulation”), to calculate each Clearing Member's margin requirements with various models. One of the margin models may produce “procyclical” results where margin requirements are correlated with volatility which “could threaten the stability of its members during periods of heightened volatility”. 
- An increase in margin requirements could make it difficult for a Clearing Member to obtain liquidity to meet its obligations to OCC. If the Clearing Member defaults, liquidating the Clearing Member positions could result in losses chargeable to the Clearing Fund which could create liquidity issues for non-defaulting Clearing Members. 
Basically, a systemic risk exists because Clearing Members as a whole are insufficiently capitalized and/or over-leveraged such that a single Clearing Member failure (e.g., from insufficiently managing risks arising from high volatility) could cause a cascade of Clearing Member failures. In layman’s terms, a Clearing Member who made bad bets on Wall St could trigger a systemic financial crisis because Clearing Members as a whole are all risking more than they can afford to lose.
The OCC’s rule proposal attempts to avoid triggering a systemic financial crisis by reducing margin requirements using “idiosyncratic” and “global” control settings; highlighting one instance for one individual risk factor that “[a]fter implementing idiosyncratic control settings for that risk factor, aggregate margin requirements decreased $2.6 billion.”  The OCC chose to avoid margin calling one or more Clearing Members at risk of default by implementing “idiosyncratic” control settings for a risk factor. According to footnote 35 , the OCC has made this “idiosyncratic” choice over 200 times in less than 4 years (from December 2019 to August 2023) of varying durations up to 190 days (with a median duration of 10 days). The OCC is choosing to waive away margin calls for Clearing Members over 50 times a year; which seems too often to be idiosyncratic. In addition to waiving away margin calls for 50 idiosyncratic risks a year, the OCC has also chosen to implement “global” control settings in connection with long tail  events including the onset of the COVID-19 pandemic and the so-called “meme-stock” episode on January 27, 2021. 
Fundamentally, these rules create an unfair marketplace for other market participants, including retail investors, who are forced to face the consequences of long-tail risks while the OCC repeatedly waives margin calls for Clearing Members by repeatedly reducing their margin requirements. For this reason, this rule proposal should be rejected and Clearing Members should be subject to strictly defined margin requirements as other investors are.
Per the OCC, this rule proposal and these special margin reduction procedures exist because a single Clearing Member defaulting could result in a cascade of Clearing Member defaults potentially exposing the OCC to financial risk.  Thus, Clearing Members who fail to properly manage their portfolio risk against long tail events become de facto Too Big To Fail. For this reason, this rule proposal should be rejected and Clearing Members should face the consequences of failing to properly manage their portfolio risk, including against long tail events. Clearing Member failure is a natural disincentive against excessive leverage and insufficient capitalization as others in the market will not cover their loss.
This rule proposal codifies an inherent conflict of interest for the Financial Risk Management (FRM) Officer. While the FRM Officer’s position is allegedly to protect OCC’s interests, the situation outlined by the OCC proposal where a Clearing Member failure exposes the OCC to financial risk necessarily requires the FRM Officer to protect the Clearing Member from failure to protect the OCC. Thus, the FRM Officer is no more than an administrative rubber stamp to reduce margin requirements for Clearing Members at risk of failure. Unfortunately, rubber stamping margin requirement reductions for Clearing Members at risk of failure vitiates the protection from market risks associated with Clearing Member’s positions provided by the margin collateral that would have been collected by the OCC. For this reason, this rule proposal should be rejected and the OCC should enforce sufficient margin requirements to protect the OCC and minimize the size of any bailouts that may already be required.
As the OCC’s Clearing Member Default Rules and Procedures  Loss Allocation waterfall allocates losses to “3. OCC’s own pre-funded financial resources” (OCC ‘s “skin-in-the-game” per SR-OCC-2021-801 34-91491 ) before “4. Clearing fund deposits of non-defaulting firms”, any sufficiently large Clearing Member default which exhausts 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. As this rule proposal is concerned with potential liquidity issues for non-defaulting Clearing Members as a result of charges to the Clearing Fund, it is clear that the OCC is concerned about risk which exhausts OCC’s own pre-funded financial resources. With the first and foremost line of protection for the OCC being “1. The margin deposits of the suspended firm”, this rule proposal to reduce margin requirements for at risk Clearing Members via idiosyncratic control settings is blatantly illogical and nonsensical. By the OCC’s own admissions regarding the potential scale of financial risk posed by a defaulting Clearing Member, the OCC should be increasing the amount of margin collateral required from the at risk Clearing Member(s) to increase their protection from market risks associated with Clearing Member’s positions and promote appropriate risk management of Clearing Member positions. Curiously, increasing margin requirements is exactly what the OCC admits is predicted by the allegedly “procyclical” STANS model  that the OCC alleges is an overestimation and seeks to mitigate . If this rule proposal is approved, mitigating the procyclical margin requirements directly reduces the first line of protection for the OCC, margin collateral from at risk Clearing Member(s), so this rule proposal should be rejected, made fully available for public review, and approved only with significant amendments to address the issues raised herein.
In light of the issues outlined above, please consider the following modifications:
- Increase and enforce margin requirements commensurate with risks associated with Clearing Member positions instead of reducing margin requirements. Clearing Members should be encouraged to position their portfolios to account for stressed market conditions and long-tail risks. This rule proposal currently encourages Clearing Members to become Too Big To Fail in order to pressure the OCC with excessive risk and leverage into implementing idiosyncratic controls more often to privatize profits and socialize losses.
- External auditing and supervision as a “fourth line of defense” similar to that described in The “four lines of defence model” for financial institutions  with enhanced public reporting to ensure that risks are identified and managed before they become systemically significant.
- Swap “3. OCC’s own pre-funded financial resources” and “4. Clearing fund deposits of non-defaulting firms” for the OCC’s Loss Allocation waterfall so that Clearing fund deposits of non-defaulting firms are allocated losses before OCC’s own pre-funded financial resources and the EDCP Unvested Balance. Changing the order of loss allocation would encourage Clearing Members to police each other with each Clearing Member ensuring other Clearing Members take appropriate risk management measures as their Clearing Fund deposits are at risk after the deposits of a suspended firm are exhausted. This would also increase protection to the OCC, a SIFMU, by allocating losses to the clearing corporation after Clearing Member deposits are exhausted. By extension, the public would benefit from lessening the risk of needing to bail out a systemically important clearing agency.
Thank you for the opportunity to comment as all investors benefit from a fair, transparent, and resilient market.
 https://www.theocc.com/getmedia/e8792e3c-8802-4f5d-bef2-ada408ed1d96/default-rules-and-procedures.pdf, which is publicly available and linked to from the OCC’s web page on Default Rules & Procedures at https://www.theocc.com/risk-management/default-rules-and-procedures
A Concerned Retail Investor
Credit to Jellyfish for raising awareness and providing analysis on this one; and also kibble pigeon for help on the comment letter. ❤️