Options Clearing Corporation (OCC) alert! Approval of proposed rule to amend & enhance the OCC's Model Risk Management Policy.
Looks to address OCC model risk that if not managed properly could potentially cause OCC to under-collect the collateral used to cover credit risk posed by a Clearing Member
https://www.sec.gov/rules/sro/occ/2023/34-97763.pdf
Background:
- Options Clearing Corporation ("OCC") is a central counterparty (“CCP”), which means it interposes itself as the buyer to every seller and seller to every buyer for financial transactions.
- As the CCP for the listed options markets in the U.S., as well as for certain futures, OCC is exposed to certain risks arising from its relationships with its members.
- To manage such risks, OCC uses quantitative methods to make estimates, forecasts, and projections in the context of its credit risk models, margin system and related models, and liquidity risk models (each a “Risk Model”).
OCC’s use of models inherently exposes OCC to model risk, such as the risk of losses arising out of decisions based on incorrect or misused model outputs.
- For example, a model that is not managed properly could potentially cause OCC to under-collect the collateral used to cover credit risk posed by a Clearing Member.
- OCC’s MRM Policy outlines OCC’s framework for managing model risk and defines the roles and responsibilities throughout the risk model and methodology lifecycle.
- Currently, the Policy applies to the Risk Models that OCC uses to determine, quantify, or measure actual or potential risk exposures or risk mitigating actions.
- The Policy also describes and outlines the roles and responsibilities of various groups at OCC with regard to model risk management.
- Further, changes to the Policy are subject to annual review and approval by the Risk Committee of OCC’s Board of Directors.
- OCC proposes to expand the application of the Policy to contemplate methodologies comprising Risk Models and their related inputs and outputs, rather than only individual Risk Models.
- To accommodate the expansion of the Policy’s scope beyond individual Risk Models, OCC proposes to revise the roles and responsibilities described in the MRM Policy.
- To further broaden the Policy, OCC proposes adding a new section regarding the use of tools with quantitative or mathematical techniques not focused on credit risk models, margin system and related models, and liquidity risk models (such tools and techniques referred to as “Risk Applications”).
Expanding from Risk Models to Risk Methodologies:
- As noted above, OCC proposes to expand the scope of its MRM Policy to encompass not only individual Risk Models, but also the methodologies such models comprise.
- Such “Risk Methodologies” include the related inputs and outputs of OCC’s Risk Models, which OCC uses to estimate or compute the distinct aspects of OCC’s credit (i.e., Clearing Fund and margin) and liquidity resources.
- To effectuate this expansion, OCC proposes to replace references to Risk Models with references to Risk Methodologies, and to revise the roles and responsibilities of OCC staff as described below.
OCC Internal Roles and Responsibilities:
- OCC proposes changes to the roles and responsibilities defined in its MRM Policy to accommodate the shift in focus from Risk Models to Risk Methodologies.
- Such changes include the expansion of the Model Risk Management (“MRM”) department’s responsibilities.
- MRM would become responsible for validating both Risk Models and Risk Methodologies no less than annually.
- Further, the proposed Policy would require MRM, in validating OCC’s Risk Methodologies, to review the performance of each methodology and verify the related software implementation.
- Additionally, certain references to a specific department would be replaced with references to such department’s parent to encompass a broader set of staff and responsibilities.
- For example, discussion of OCC’s Quantitative Risk Management (“QRM”) department’s role in monitoring the use and performance of individual Risk Models would be replaced with discussion of OCC’s Financial Risk Management (“FRM”) department, of which QRM is a part.
- Similarly, OCC proposes to expand the responsibilities of the Model Risk Working Group (“MRWG”) in accordance with the expansion of the MRM Policy.
- Currently, the MRWG reviews risk model changes and determines which should be sent to OCC’s Management Committee for further consideration. OCC proposes to expand the MRWG’s purview to include review of Risk Methodologies (not just individual Risk Models).
New Section on Risk Applications:
- Lastly, OCC proposes to add a new section regarding the use of Risk Applications. The current MRM Policy focuses on OCC’s financial risk management (i.e., credit risk models, margin system and related models, and liquidity risk models).
- The Risk Applications are tools with quantitative or mathematical techniques specifically not focused on financial risk management. Although the Risk Applications do not affect OCC’s Risk Methodologies (or the underlying Risk Models), the processes for managing the potential risks are similar, so OCC proposes to encompass both Risk Methodologies and Risk Applications in its Model Risk Management Policy going forward.
TLDRS:
The Options Clearing Corporation (OCC) is proposing to expand its Model Risk Management (MRM) Policy, which currently applies to the risk models it uses to manage potential risk exposures.
- The policy expansion includes Risk Methodologies, which comprise the inputs and outputs related to the OCC's risk models, as well as Risk Applications, which use quantitative or mathematical techniques not focused on financial risk models.
This expansion requires changes to the roles and responsibilities defined in the MRM Policy.
- For instance, the MRM department's responsibilities will be broadened to include the validation of both risk models and methodologies.
- The Model Risk Working Group (MRWG) will also have a wider scope, reviewing risk methodologies in addition to individual risk models.
- Overall, the changes aim to better manage model risk, such as losses arising from decisions based on incorrect model outputs, by incorporating broader risk assessment methodologies and applications.
- For example, currently, a model that is not managed properly could potentially cause OCC to under-collect the collateral used to cover credit risk posed by a Clearing Member.
