Options Clearing Corporation (OCC) Alert! Completely [REDACTED] Model Risk Management Policy included with Notice of Filing of Proposed Rule Change by The Options Clearing Corporation to Amend and Enhance the Options Clearing Corporation's Model Risk

34-97484

Notice of Filing of Proposed Rule Change by The Options Clearing Corporation to Amend and Enhance the Options Clearing Corporation's Model Risk Management PolicyComments due: 21 days after publication in the Federal RegisterAdditional Materials: Exhibit 3, Exhibit 5 [REDACTED]

https://www.sec.gov/rules/sro/occ/2023/34-97484.pdf

The Model Risk Management Policy:

Purpose:

• This proposed rule change would make certain changes to OCC’s Model Risk Management Policy (“MRM Policy” or “Policy”) to enhance the manner in which OCC manages the risk models and methodologies used in connection with OCC’s business.
• OCC’s use of risk models exposes OCC to model risk.

Model risk is the potential for adverse consequences from decisions based on incorrect or misused model outputs.

• For example, a model that is not managed properly could potentially cause OCC to over collect or under-collect the appropriate amount of collateral to cover credit risk posed by Clearing Members.
• OCC notes that the MRM Policy is part of a broader framework regarding model risk management that is designed to further the appropriate design, validation, and operation of OCC’s Risk Models.
• The MRM Policy is designed to outline OCC’s framework for managing model risk and to define the roles and responsibilities throughout the risk model and methodology lifecycle.
• As detailed further below, the proposed changes to the MRM Policy primarily include amendments designed to:
• (1) more comprehensively address risk methodologies rather than just the underlying risk models;
• (2) revise the roles and responsibilities of various individuals, groups, and departments with respect to OCC’s managing of model risk;
• (3) reflect certain non-substantive changes, such as renaming certain policies and procedures; and
• (4) add a description of certain “Risk Applications” and “User Developed Applications” used by OCC.

Risk Methodologies

• OCC proposes to modify the MRM Policy to more directly contemplate “Risk Methodologies” rather than just “Risk Models.”
• As currently defined in the MRM Policy, a Risk Model refers to any quantitative method or approach that applies statistical, economic, financial, or mathematical theories, techniques, and/or assumptions to process inputs into quantitative estimates, forecasts, or projections and can also be a quantitative method with inputs that are qualitative or based on business judgment.
• As also currently defined in the MRM Policy, a Methodology refers to a collection of Risk Models that are used to estimate financial risk exposures.
• OCC proposes to specify in the MRM Policy that Risk Models are integrated into “Risk Methodologies” to broaden and align OCC’s internal model risk policies and procedures by the adoption of the more holistic and comprehensive Risk Methodologies framework consisting of a collection of components, related inputs and outputs, and potentially other tools and applications, as explained further below.
• Specifically, OCC proposes to replace the definition of Methodology with a definition of a “Risk Methodology,” providing that a Risk Methodology is a collection of Risk Models and related inputs and outputs, which are used to estimate or compute a distinct aspect of OCC’s credit (i.e., Clearing Fund and margin) and liquidity resources.
• The purpose of the expanding the definition in this way is to facilitate a more holistic view of the relevant processes and calculations, as described in more detail below.
• A Risk Methodology is therefore broader than a particular Risk Model because a Risk Methodology may include multiple constituent Risk Models, as well as any other inputs or outputs that may not be part of any one particular constituent Risk Model but that nonetheless contribute to the overarching Risk Methodology.
• Because Risk Models typically do not operate in isolation, but rather as part of a broader Risk Methodology, OCC believes that expanding the MRM Policy to more comprehensively focus on Risk Methodologies would promote a more sound risk management framework, consistent with Rule 17Ad-22(e)(3).
• The proposed definition of Risk Methodology is designed to capture each of the constituent Risk Models of which the Risk Methodology is comprised as well as any other inputs or outputs that might be part of how OCC manages OCC’s credit and liquidity resources.
• OCC believes that the proposed definition of Risk Methodology therefore takes a more holistic view toward the processes and calculations by which OCC manages risks arising in connection with the use of a Risk Model.
• Accordingly, OCC proposes to modify references to Risk Models in the MRM Policy to instead refer to Risk Methodologies in describing the manner in which OCC governs model risk and in describing the roles and responsibilities of various OCC groups and departments under the Policy.
• For example, rather than specifying that the design, theory, and logic of each Risk Model used by OCC shall take into consideration published literature and industry best practice, where it is available, the revised MRM Policy would provide that the design, theory, and logic of each Risk Methodology used by OCC will take into consideration published literature and industry best practice, where it is available.
• OCC notes that this proposed change to broaden the scope from Risk Models to Risk Methodologies would not modify OCC’s processes with respect to any individual Risk Model.
• That is, OCC would continue to perform the same review of each individual Risk Model as it does today, but would now include a more comprehensive consideration of each Risk Model as part of a Risk Methodology as well as any calculations or inputs that may contribute to a Risk Methodology but that may not necessarily be part of a particular Risk Model.

Roles and Responsibilities of OCC Departments

• OCC proposes to modify the allocation of responsibility to instead provide that OCC’s FRM department is responsible for the tasks currently performed by QRM, such as, among other things, monitoring the use and performance of Risk Methodologies according to relevant procedures and maintaining risk tolerances and associated key risk indicators to measure and monitor risk associated with Risk Methodologies.
• While QRM has, and will continue to have, primary responsibility for individual Risk Models, OCC proposes to change the references from QRM to FRM to encompass the responsibilities of other departments within FRM that may have responsibility for an input or output that is not necessarily part of a particular Risk Model, but which is part of a Risk Methodology.
• The particular responsibilities of each department within FRM depend on the particular Risk Methodology and the constituent Risk Models and any additional inputs or outputs, but all groups within FRM would be subject to the Policy.

In addition, OCC proposes to set forth the responsibilities of Model Risk Management (“MRM”) under the Policy with respect to Risk Methodologies.

• For example, MRM is currently responsible under the MRM Policy for, among other things, validating all Risk Models prior to implementation and evaluating the performance of each Risk Model by performing independent model validations, in each case in accordance with relevant procedures.
• As proposed, the MRM Policy would instead provide that MRM is responsible for, among other things, validating all Risk Models and Methodologies (including any changes to Risk Methodologies) prior to implementation and also for evaluating the performance of each Risk Model by performing independent model validations in each case in accordance with relevant procedures.
• As proposed, the MRM Policy would provide that the head of MRM develops and maintains the, now renamed, Annual Validation Plan (“Annual Plan”) and schedule for all in-use Risk Methodologies, including Risk Models.
• In certain other places within the MRM Policy, OCC proposes to modify references to certain specific procedures. Specifically, the MRM Policy currently specifies that QRM monitors the use and performance of Risk Models according to OCC’s Model Backtesting Procedures, the Business Backtesting Procedure, and the Margin Model Parameter Review and Sensitivity Analysis Procedure. OCC proposes to add to this list that this also includes other “related policies and procedures,” and note that these additional related policies and procedures relate to OCC’s Clearing Fund Methodology Policy, Liquidity Risk Management Framework and Margin Policy. OCC proposes to add “and related policies and procedures” because there are a number of additional policies or procedures (over 20) not specifically enumerated in the MRM Policy that OCC believes should be generally referenced in the MRM Policy given their relevance to Risk Methodology monitoring functions.

Solicitation of Comments:

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, security-based swap submission or advance notice is consistent with the Act. Comments may be submitted by any of the following methods:

Electronic Comments:

• Use the Commission’s Internet comment form (http://www.sec.gov/rules/sro.shtml) or
• Send an e-mail to [email protected]. Please include File Number SR-OCC2023-004 on the subject line.

Paper Comments:

• Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.
• All submissions should refer to File Number SR-OCC-2023-004.
• Do not include personal identifiable information in submissions; you should submit only information that you wish to make available publicly.
• They may redact in part or withhold entirely from publication submitted material that is obscene or subject to copyright protection.
• All submissions should refer to File Number SR-OCC-2023-004 and should be submitted on or before June 1st.

TLDRS:

• [REDACTED] Exhibit included with Notice of Filing of Proposed Rule Change by The Options Clearing Corporation to Amend and Enhance the Options Clearing Corporation's Model Risk Management Policy.
• This proposed rule change would make certain changes to OCC’s Model Risk Management Policy (“MRM Policy” or “Policy”) to enhance the manner in which OCC manages the risk models and methodologies used in connection with OCC’s business.

The proposed changes to the MRM Policy primarily include amendments designed to:

• (1) more comprehensively address risk methodologies rather than just the underlying risk models;
• (2) revise the roles and responsibilities of various individuals, groups, and departments with respect to OCC’s managing of model risk;
• (3) reflect certain non-substantive changes, such as renaming certain policies and procedures; and
• (4) add a description of certain “Risk Applications” and “User Developed Applications” used by OCC.
• Specifically, OCC proposes to replace the definition of Methodology with a definition of a “Risk Methodology,” providing that a Risk Methodology is a collection of Risk Models and related inputs and outputs, which are used to estimate or compute a distinct aspect of OCC’s credit (i.e., Clearing Fund and margin) and liquidity resources.

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