[Federal Register: June 18, 2004 (Volume 69, Number 117)]
[Notices]
[Page 34207-34209]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18jn04-155]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-49841; File No. SR-OCC-2003-11]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving a Proposed Rule Change Relating to Clearing Member
Trade Assignment Processing
June 9, 2004.
On October 14, 2003, pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 \1\ (``Act''), The Options Clearing Corporation
(``OCC'') filed with the Securities and Exchange Commission
(``Commission'') a proposed rule change (File No. SR-OCC-2003-11) and
on February 18, 2004, amended the proposed rule change. Notice of the
proposal was published in the Federal Register on March 18, 2004.\2\
The Commission received one comment letter.\3\ For the reasons
discussed below, the Commission is approving the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 49378 (Mar. 9, 2004), 69
FR 12190 (Mar. 15, 2004).
\3\ Letter from John Berton and Georgia Bullitt, Ad Hoc CMTA
Committee of the Securities Industry Association, March, 22, 2004.
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I. Description
The proposed rule change will amend OCC's By-Laws and Rules to
expand its clearing member trade assignment (``CTMA'') processing
procedures, to increase OCC's initial and minimum net capital
requirements, and to increase OCC's minimum clearing fund requirement
for execution-only clearing members.
A. Background
CMTA processing permits one clearing member (``carrying clearing
member'') to authorize another clearing member (``executing clearing
member'') to direct that its exchange transactions be transferred to an
account of the carrying clearing member for clearance and
settlement.\4\ Generally, the executing clearing member executes the
transaction itself or guarantees the broker that executed the
transaction and directs the transaction to be cleared into an account
of the carrying clearing member through the options exchanges' systems
for reporting matching trade information to OCC. A carrying clearing
member does not have the ability to approve or reject such a direction
before the transaction is entered into the exchanges' systems for
reporting to OCC.
The matching trade information submitted by an exchange for a
transaction that has been executed pursuant to a CMTA arrangement will
identify both the carrying and executing clearing members by their
assigned clearing numbers. OCC permits an executing clearing member to
transfer transactions effected only on the exchange(s) designated by
the carrying clearing member in a CMTA authorization filed with OCC.
Accordingly, before a transaction is transferred to an account of the
carrying clearing member for clearance, OCC's system confirms that (i)
there is a valid CMTA arrangement between the carrying and executing
clearing members and (ii) the exchange transaction was effected on a
designated exchange. The carrying clearing member is then responsible
for settling the trade and maintaining the resulting position. If their
arrangement permits, a carrying clearing member may transfer the
position back to the executing clearing member through OCC's systems to
correct the execution member's good-faith error in identifying the
carrying clearing member in the submitted trade information.\5\
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\4\ The CMTA facility was developed to permit carrying clearing
members to clear and settle transactions effected on an exchange
where they are either not a member or do not maintain a presence for
trade execution.
\5\ This commonly occurs if the executing clearing member has
transposed digits of a carrying clearing member's clearing number
causing the transaction to clear in an account of a wrong clearing
member (assuming a valid CMTA arrangement exists between the
executing and misidentified carrying clearing member).
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OCC's CMTA facility supports two distinct types of business. First,
clearing members that execute transactions for correspondent brokers
use the process to transfer transactions to the correspondent brokers'
clearing firms. Second, firms that execute trades for institutional and
other customers with prime brokerage arrangements use the process to
transfer the trades to the prime broker clearing member.
B. CMTA Rule Changes
The new OCC Rule 403 will require clearing members that are parties
to a CMTA arrangement to register and provide certain details of their
arrangement with OCC. Such registration will be effective when the
clearing members provide matching information regarding their
arrangement. Rule 403 will also establish certain actions for OCC's
system to verify that a valid CMTA registration exists. Transactions
that fail these checks will be transferred to a designated account or,
if such designation has not been made, to the customers' account or
segregated futures account of the executing clearing member, as
applicable. A carrying clearing member is responsible for each
transaction transferred to its account pursuant to a CMTA arrangement
subject to its right to return the resulting position for certain
specified reasons (as explained below). Notwithstanding that right, the
carrying clearing member is responsible to effect premium or margin
settlement, as applicable, on the business day after the trade was
executed for any positions carried in its accounts after nightly
processing.\6\
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\6\ Certain exchanges submit matching trade information on a
real time or intermittent basis during a trading day. OCC
immediately processes such submissions and makes updated position
information available for clearing member review throughout the day.
For transactions effected on such exchanges, clearing members may be
able to effect a return before OCC closes its window for the
submission of returns, in which case the executing clearing member
would be responsible for any premium or margin settlement.
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A position transferred pursuant to a CMTA arrangement may be
returned to the executing clearing member upon notice for reasons to be
specified in a standard agreement.\7\ The reasons that are being
considered include: (i) The matching trade information did not conform
to the trade information supplied to the carrying clearing member by
the customer on whose behalf the trade was executed (e.g., transaction
was for a put option in a particular series rather than a call option);
(ii) the carrying clearing member's reasonable belief that the trade
involved a violation of applicable law, rule, or regulation (e.g.,
failure to deliver a prospectus); (iii) the carrying clearing member no
longer carries the account of the customer on whose behalf the trade
was executed or has restricted the customer's ability to use the CMTA
process; or (iv) the carrying clearing member was misidentified in the
matching trade information. Returns must be completed pursuant to
specified procedures by a prescribed cutoff time before trading
commences on the business day after trade date. OCC will transmit
certain information regarding the reasons given for a return, but will
not validate the stated reasons. A position that has been assigned,
exercised, or matured may not be transferred or returned under Rule 403
and will be dealt with in accordance with the provisions of the CMTA
agreement between the clearing members.
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\7\ OCC clearing members have formed an ad hoc committee under
the auspices of the Securities Industry Association to collaborate
on a standard form agreement. That agreement is currently in draft
form.
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A carrying clearing member may not effect a return after the
prescribed cutoff time. Initiating a return after the applicable cutoff
time might subject the carrying clearing member to disciplinary action.
In the case of a position returned to an executing clearing member due
to a misidentification of the carrying clearing member, the executing
clearing member may retransfer the position to the correct carrying
clearing member in order to correct the error.\8\
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\8\ There is no approval process associated with position
transfers between clearing members to correct clearing errors. OCC
determined not to include an approval process for such transfers
based on discussions with clearing members during the development of
ENCORE Release 3.0. Clearing members claimed that an approval
process would be inefficient from an operational and administrative
perspective, would increase system overhead, and would adversely
affect their ability to review position changes on a timely basis.
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A registered CMTA arrangement may only be terminated as specified
in Rule 403, which permits clearing members to either mutually or
unilaterally terminate the arrangement.\9\ Terminations by mutual
agreement will be effective when OCC receives notice of termination
from both clearing members. Unilateral terminations will be effective
the next business day after notice of the termination has been given to
OCC and the other clearing member. Transactions effected after the
effective time of a termination will be treated as failed CMTAs and
will be the responsibility of the executing clearing member.
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\9\ OCC has retained the right to terminate all CMTA
arrangements of a suspended clearing member.
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Other rule changes relating to CMTAs include additional definitions
of terms used in CMTA processing (e.g., ``carrying clearing member''
and ``executing clearing member'') and other conforming changes.
C. Increases in Net Capital and Minimum Clearing Fund Requirements
OCC has also reassessed the risks associated with CMTA
transactions. Wth the increase in the number of permissible reasons for
returning a position, OCC believes that there is an increased
possibility that executing clearing members, including execution-only
firms, will be required to make premium or margin settlement for a
position before it can be closed out or otherwise managed. To address
this possibility, OCC will increase its initial and minimum net capital
requirements for all clearing members and will increase the minimum
clearing fund deposit for execution-only firms. Initial required net
capital will be increased from $1 million to $2.5 million, and minimum
net capital would be increased from $750,000 to $2 million.\10\ The
minimum clearing fund deposit for execution-only firms will be
increased from $150,000 to $150,000 plus $15 times the firm's average
daily executed volume for the preceding calendar month. The increases
are being applied to all clearing members because over 80% of OCC's
clearing members are eligible to use the CMTA facility.
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\10\ These new capital standards are consistent with the capital
requirements of other clearing organizations. For example, the
Chicago Mercantile Exchange's initial net capital requirement is $2
million, while the Board of Trade Clearing Corporation is $2.5
million.
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The special net capital requirements for firms providing facilities
management services and stock settlement services are being increased
proportionately.\11\ A firm providing such services will be required to
have a minimum net capital of $4 million plus $200,000 times the number
of firms over four that it services. Clearing members will be given a
one-year grace period from October 1, 2003, to achieve compliance with
the new requirements. However, the OCC's membership/margin committee
shall have the discretion to extend that deadline to a date no later
than October 1, 2006, for clearing members admitted to membership after
the date of this approval order, provided that such clearing members
undertake not to engage in a CMTA execution business during the period
of such extention.
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\11\ Securities Exchange Act Release No. 49478 (Mar. 25, 2004),
69 FR 17258 (Apr. 1, 2004) [File No. SR-OCC-2003-09] (proposing new
OCC Rule 309A).
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Execution-only clearing members pose a special risk because they do
not ordinarily carry positions overnight and therefore do not
ordinarily deposit margin with OCC. This means that if a position is
returned to an execution-only member and if the execution-only member
fails to make settlement, the only asset of the member that OCC can
draw upon to liquidate the position is the member's clearing fund
deposit. Accordingly, OCC will increase the minimum clearing fund
requirement for execution-only members to $150,000 plus $15 times
average daily executed volume for the preceding month. Execution-only
firms will also be given the one-year grace period described above to
comply with this new minimum.
OCC also will make conforming changes to the definitional
provisions of its by-laws, qualification standards for admission,
various financial responsibility rules, and the rule defining monthly
contributions to the clearing fund.
II. Comment Letter
John Berton and Georgia Bullitt, on behalf of the Ad Hoc CMTA
Committee of the Securities Industry Association, expressed their
support for the proposed rule. Among other things, they contended that
it will provide ``definitional clarity regarding the CTMA process and
appropriate procedures to protect against systemic risk in connection
with options clearing.''
III. Discussion
Section 17A(b)(3)(F) of the Act \12\ requires that the rules of a
clearing agency be designed to promote the prompt and accurate
clearance and
[[Page 34209]]
settlement of securities transactions and to assure the safeguarding of
securities and funds that are in the custody or control of the clearing
agency or for which it is responsible. The Commission finds that the
proposed rule change is consistent with OCC's obligations under Section
17A(b)(3)(F) because it substantially clarifies the rights and
responsibilities of OCC members that participate in the CMTA facility,
which should help OCC promote the prompt and accurate clearance and
settlement of securities transactions and also provide greater
certainty and transparency over how CMTA transactions will be
processed. In addition, increasing members' net capital and minimum
clearing fund requirements should appropriately protect itself against
the greater risk it faces as a result of its expansion of its CMTA
services.
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\12\ 15 U.S.C. 78q-1(b)(3)(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 with the requirements of Section 17A of the Act \13\ and
the rules and regulations thereunder.
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\13\ 15 U.S.C. 78q-1.
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It is therefore ordered, pursuant to section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-2003-11) be, and hereby
is, approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\14\
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\14\ 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13744 Filed 6-17-04; 8:45 am]
BILLING CODE 8010-01-P