[Federal Register: June 13, 2007 (Volume 72, Number 113)]
[Notices]
[Page 32693-32695]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13jn07-122]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-55872; File No. SR-OCC-2007-01]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of a Proposed Rule Change Relating to Credit
Default Options
June 6, 2007.
I. Introduction
On February 13, 2007, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'')
proposed rule change File No. SR-OCC-2007-01 pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ On March
7, 2007, OCC filed an amendment to the proposed rule change.\2\ Notice
of the proposal was published in the Federal Register on March 5,
2007.\3\ No comment letters were received. This order approves the
proposed rule change as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ The March 7, 2007, amendment reflects OCC's determination to
seek approval for the credit default option product only and not for
binary options in general. Because Amendment No. 1 is technical in
nature, the Commission is not republishing the notice of filing for
public comment.
\3\ Securities Exchange Act Release No. 55362 (February 27,
2007), 72 FR 9826.
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II. Description
The purpose of the proposed rule change is to permit OCC to clear
and settle credit default options (``CDOs''), which are options related
to the creditworthiness of an issuer or guarantor (``reference
entity'') of one or more specified debt securities (``reference
obligation(s)''). CDOs are ``binary'' options that pay a fixed amount
to the holder of the option upon the occurrence of a ``credit event''
affecting the reference obligations.\4\ CDOs will be traded by the
Chicago Board Options Exchange (``CBOE'').\5\
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\4\ ``Binary'' options (also sometimes referred to as ``
digital'' options) are ``all-or-nothing'' options that pay a fixed
amount if automatically exercised and otherwise pay nothing.
\5\ Securities Exchange Act Release Nos. 55251 (February 7,
2007), 72 FR 7091 (February 14, 2007) (notice of filing of proposed
rule change); 55871 (June 6, 2007) (order approving proposed rule
change) [File No. SR-CBOE-2006-84].
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Description of Credit Default Options
CDOs are structured as binary options that are automatically
exercised and the exercise settlement amount payable if a ``credit
event'' occurs at any time prior to the last day of trading. A ``credit
event'' is generally defined as any failure to pay on any of the
reference
[[Page 32694]]
obligations or any other occurrence that would constitute an ``event of
default'' or ``restructuring'' under the terms of any of the reference
obligations and that the listing exchange has determined would be a
credit event for purposes of the CDO. The payout or settlement amount
for a single exercised option CBOE CDO will be $100,000.
By-Law and Rule Amendments Applicable to CDOs
In order to accommodate trading in CDOs, OCC is adding a new By-Law
Article and a new Chapter to its Rules to incorporate several new
defined terms and procedures for clearing and settling CDOs.
1. Terminology--Article I, Section 1 and Article XIV, Section 1 of the
By-Laws
The definition of ``expiration time'' in Article I of the By-Laws
is modified to be a default provision to permit the expiration time to
be defined differently for different classes of options. The definition
of ``option contract'' in Article I of the By-Laws is amended to
include a credit default option and to provide a more generic
definition of ``cash-settled option.''
``Adjustment event'' is defined in Article XIV by reference to the
rules of the listing exchange. Similarly, ``credit event'' is defined
by reference to exchange rules. The terms ``credit event confirmation''
and ``credit event confirmation deadline'' are used, respectively, to
refer to the notice that must be provided by the listing exchange or
other reporting authority to OCC that a credit event has occurred (and
that a CDO will therefore automatically be exercised) and to the
deadline for receipt of such notice if it is to be treated as having
been received on the business day on which it is submitted. Credit
event confirmations received after the deadline on the expiration date
but before the expiration time will be given effect but may result in
delayed exercise settlement.
OCC is also defining the term ``exercise settlement amount'' in
Article XIV for purposes of credit default options. The exercise
settlement amount of a credit default option is the amount specified by
the exchange on which the option is traded that will be paid in
settlement of an automatically exercised option. CBOE has specified the
exercise settlement amount for a single CDO as $100,000. OCC's proposed
definition would permit an exchange to specify a different exercise
settlement amount. The exercise settlement amount will be determined by
the exchange at the time of listing when the exchange fixes the other
variable terms for the options of a particular class or series.
OCC is replacing the definitions of ``variable terms,''
``premium,'' and ``multiplier'' in Article I with revised definitions
in Article XIV, Section 1 that are applicable to credit default
options. The term ``class'' is also redefined in Article XIV, Section
1. To be within the same class, CDOs must have the same reporting
authority, which OCC anticipates will ordinarily be the listing
exchange. This is necessary because of the degree of discretion that
the reporting authority will have in determining whether a credit event
has occurred.
CDOs will be a category of options where exercise is triggered by a
discrete event such as a ``credit event'' affecting the ``reference
obligations'' issued by a ``reference entity,'' which terms are defined
to have the meanings given to them in the rules of the listing
exchange. The term ``underlying interest'' is defined to be the
reference obligation(s) with respect to which the credit event will or
will not occur.
2. Terms of Cleared Contracts--Article VI, Section 10(e)
A new paragraph (e) is added to Article VI, Section 10 so that an
exchange is required to designate the exercise settlement amount,
expiration date, and exercise price for a series of credit default
options at the time the series is opened for trading. Section 10(e)
also reminds the reader that credit default options are subject to
adjustment under Article XIV.
3. Rights and Obligations--Article XIV, Section 2
Article XIV, Section 2 defines the general rights and obligations
of holders and writers of credit default options. As noted above, the
holder of a credit default option that is automatically exercised has
the right to receive the fixed exercise settlement amount from OCC, and
the assigned writer has the obligation to pay that amount to OCC.
4. Adjustments of Credit Default Options--Article XIV, Section 3;
Determination of Occurrence of Credit Event--Article XIV, Section 4
Article XIV, Section 3 provides for adjustment of CDOs in
accordance with the rules of the listing exchange. CBOE's rules provide
for adjustment of CDOs in the case of certain corporate events
affecting the reference obligations, and OCC proposes simply to defer
to the rules and to the determinations of the listing exchange pursuant
to its rules. Accordingly, OCC will have no responsibility for
adjustment determinations with respect to CDOs.
Similarly, Section 4 provides that the listing exchange for a class
of CDOs will have responsibility for determining the occurrence of a
credit event that will result in automatic exercise of the options of
that class. The listing exchange has the obligation to provide a credit
event confirmation to OCC in order to trigger the automatic exercise.
5. Exercise and Settlement--Chapter XV of the Rules and Rule 801
Credit default options will not be subject to the exercise-by-
exception procedures applicable to most other options under OCC's Rules
but would instead be automatically exercised at expiration if the
specified criterion for exercise is met. The procedures for the
automatic exercise of credit default options, as well as their
assignment and settlement (including during periods when a clearing
member is suspended), are set forth in Rules 1501 through 1505 of new
Chapter XV and in revised Rule 801(b).
6. Special Margin Requirements--Rule 601; Deposits in Lieu of Margin--
Rule 1506
OCC will not initially margin CDOs through its usual ``STANS''
system. Because of CDOs' fixed payout feature, further systems
development is needed to accommodate these options in STANS. Until such
development is completed, OCC has initially determined to require that
writers of such options post margin in a fixed amount that will be set
at 100% of the fixed exercise settlement amount applicable to each
series of CDOs. OCC would have discretion to reduce the requirement to
something less than 100% if research, analysis, and experience suggest
that a lower percentage is sufficient. Initially, long positions in
CDOs will be valued at zero and will provide no offset against margin
requirements on shorts. Again, based on research, analysis, and
experience, OCC may determine to give some value to the longs.
Ultimately, CDOs will be incorporated into the STANS system and will be
valued and margined on a risk basis.
OCC does not propose to accept escrow deposits in lieu of clearing
margin for credit default options. Therefore, Rule 1506 states that
Rule 610, which otherwise would permit such deposits, does not apply to
credit default options.
[[Page 32695]]
7. Acceleration of Expiration Date--Rule 1507
This provision permits OCC to accelerate the expiration date of a
credit default option when the option is deemed to have been exercised
on any day prior to the expiration date.
III. Discussion
Section 17A(b)(3)(F) of the Act requires that the rules of a
clearing agency be designed to promote the prompt and accurate
clearance and settlement of securities transactions.\6\ The Commission
finds the proposed rule change to be consistent with Section
17A(b)(3)(F) of the Act because it is designed to promote the prompt
and accurate clearance and settlement of transactions in, including
exercises of, credit default options and to remove impediments to and
perfect the mechanism of a national system for the prompt and accurate
clearance and settlement of such transactions.\7\ These purposes are
accomplished by having the clearance and settlement of CDOs take place
at OCC and by OCC applying substantially the same rules and procedures
to CDOs as it applies to similar transactions in other cash-settled
options.
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\6\ 15 U.S.C. 78q-1(b)(3)(F).
\7\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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IV. 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 Section 17A of the Act and the rules and regulations
thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-2007-01) as modified by
Amendment No. 1 be and hereby is approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\8\
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\8\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-11370 Filed 6-12-07; 8:45 am]
BILLING CODE 8010-01-P