Self-Regulatory Organizations; the Options Clearing Corporation; Order Granting Approval of Proposed Rule Change by the Options Clearing Corporation Concerning the Amendment of Its Clearing Membership Standards

I. Introduction

On March 3, 2023, the Options Clearing Corporation (“OCC”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change SR–OCC–2023–002 pursuant to section 19(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 19b–4 thereunder. The proposed rule change concerns proposed changes to OCC's standards for its members. The proposed rule change was published for public comment in the Federal Register on March 21, 2023. The Commission has received no comments regarding the proposed rule change. For the reasons discussed below, the Commission is approving the proposed rule change.

II. Background

OCC acts as the central counterparty (“CCP”) for all listed options in the U.S., as well as for certain futures. It provides clearing services to its members, which are financial organizations that, in turn, facilitate the clearing and settlement of their customer transactions or proprietary transactions through OCC. OCC is proposing to change its rules that address standards for its membership by (i) expanding its membership types and updating its membership requirements and associated processes, including on-boarding and off-boarding procedures; (ii) amending members' financial responsibility standards; (iii) amending members' operational requirements; and (iv) changing rules governing disciplinary actions.

(i) Member Eligibility, On-Boarding, and Termination

OCC proposes rule changes to expand the types of entities that are eligible to become Clearing Members, while removing distinctions between certain membership categories to ensure consistent requirements across members. The proposed rule changes would also consolidate and streamline the procedures and requirements for admitting new members. Further, the proposed rule changes would allow a member to elect to voluntarily terminate its membership.

Currently, OCC's Articles and By-Laws permit three different types of institutions eligible for clearing membership: (i) broker-dealers, (ii) futures commission merchants, and (iii) non-U.S. securities firms. The proposed rule change would expand the list of eligible institutions to include certain banks. OCC proposes limiting bank membership to clearing proprietary activity only. The proposed rules would also require a bank member to provide assurances regarding its activities and ability to contribute collateral.

In addition to expanding its list of eligible institutions to include banks, OCC proposes additional revisions to member eligibility. For example, proposed Rule 201(b)(5) would clearly state the types of members who may clear stock loan transactions ( i.e., broker-dealers, non-U.S. securities firms, or banks). Similarly, proposed Rule 201(d) requires that each member meet standards related to risk management capability, in addition to the current requirements related to financial and operational capabilities.

The proposed rule change is designed to accommodate the admission of non-U.S. Clearing Members other than Canadian Clearing Members. Broadly, the changes would require that such members not conduct transactions or activities that would result in the imposition of taxes, withholding, or reporting obligations with respect to amounts paid or received by OCC (other than U.S. federal and state income taxes imposed on OCC's income).

The proposed rule change would consolidate the admission procedures and requirements and modify such admission procedures and requirements to help streamline the application review process. For example, proposed Rule 203(b) would include information about expedited approval through OCC's Risk Committee, if the approval of the applicant is appropriate for the protection of investors and the public interest. Moreover, proposed Rule 203(c) would allow for Clearing Members to clear additional types of transactions by requesting authorization from OCC through a business expansion request.

The proposed rule change would amend the conditions for admission as an OCC member. Such amendments would impose requirements on applicants ( e.g., an applicant must notify OCC in writing if it is or becomes subject to Statutory Disqualification) ¹⁰ as well as make less substantive updates ( e.g., removal of a duplicative choice of law provision addressed elsewhere in OCC's rules). The changes also describe, with minor clarifying changes, the terms of a new member's initial contribution and agreements; disapproval where an applicant engages in acts or practices inconsistent with “just and equitable principles of trade;” and other admission conditions.

The proposed rule change would adopt new Rule 212 to address circumstances in which a Clearing Member may elect to voluntarily terminate its membership. OCC's current Rules include information about voluntary membership termination, but only under certain specific circumstances, such as if the member's Clearing Fund contribution is increased as a result of an amendment of the Rules, or during a cooling-off period. Among other things, proposed Rule 212 would provide that a Clearing Member may elect to voluntarily terminate its membership by providing written notice to OCC that specifies a desired date for its withdrawal from membership. The terminating Clearing Member will be required to close out or transfer all open positions with OCC by the termination date.

Additionally, OCC proposes to relocate existing rules, remove distinctions between certain membership categories to ensure consistent requirements across members, and remove rules regarding implementation dates that have already passed.

(ii) Financial Responsibility Standards

OCC proposes to eliminate the current distinction between initial and ongoing capital requirements for its members. OCC also proposes to increase the minimum financial requirements for members and set out requirements for banks as a new member category. The current broker-dealer and FCM minimum requirement of $2.5 million in initial capital and adjusted net capital would be increased to $10 million in net capital and adjusted net capital. Similarly, OCC proposes to set capital requirements for Canadian Investment Dealers and Non-U.S. Securities Firms at $10 million generally. The proposed rule change also introduces capital requirements for banks as a new type of Clearing Member. Specifically, U.S. banks would be required to maintain Tier 1 Capital of at least $500 million, a Tier 1 Capital Ratio greater than 6%, and be either “well-capitalized” or “adequately-capitalized” as measured by prompt corrective action (“PCA”) capital category ratios applicable to such U.S. Banks. OCC represents that, upon Commission approval of the proposed rule change, OCC would provide a six-month grace period for existing Clearing Members to meet the proposed increase in capital requirements.

(iii) Operational Requirements

OCC proposes changes to rules governing certain operation requirements and processes for its members. As described below, such changes include, but are not limited to, the acceptance of e-signatures, record retention requirements, and the consolidation of existing rules.

OCC proposes changes to its rules designed to reflect changes in technology. OCC proposes to expand its rules to permit the reliance on electronic signatures, in addition to reliance on an original signature. Additionally, OCC proposes to remove references to authorization stamps as a security measure because OCC no longer uses such stamps. Additionally, OCC proposes removing its current Rule 204 that requires members to designate physical locations as clearing offices of the Clearing Member, because the rule is no longer relevant to OCC's operations or to its Clearing Members given the migration of trading, clearance and settlement activities to electronic means.

OCC proposes changes to its rules regarding various submissions and reports between OCC and its members. OCC proposes to align its rules regarding the submission to and retrieval from OCC of documents by Clearing Members. The proposed rules also permit OCC to disregard untimely submissions from a Clearing Member, except in unusual or unforeseen circumstances. Additionally, OCC proposes to require that it post proposed rule changes on its website after (rather than before) filing such changes to provide notice to members.

OCC also proposes to reorganize and update various rules pertaining to member processes and operational requirements. With regard to member processes, OCC proposes to streamline its rule regarding record retention requirements for Clearing Members to state that such requirements apply to all confirmed trade data required pursuant to the By-Laws and Rules, including confirmed trade information reported to OCC under Rule 401. With regard to operational requirements, OCC proposes to consolidate existing provisions regarding Clearing Members' operational capability in proposed Rule 302. In addition to consolidation, OCC proposes the following changes to such requirements:

• Adopt a new general statement requiring members to meet OCC's operational capability, experience and competence standards;
• Require that an authorized representative of each Clearing Member be available during regular and overnight business hours;
• Simplify and standardize the record keeping requirements applicable to each Clearing Member;
• Clarify that each Clearing Member must be able to participate in applicable operational and default management activities; and
• Make additional minor clarifying changes.

Proposed Rule 302 would also set forth the requirement that Clearing Members must maintain operationally sufficient facilities, systems, and procedures to discharge their clearing functions in a timely and efficient manner. The proposed rule also provides additional operational requirements for Clearing Members that effect transactions in physically-settled equity options and stock futures, or participate in OCC's stock loan programs.

Further, OCC proposes to apply its existing rules regarding an applicant's financial, operations, and risk management personnel to OCC Clearing Members. Under OCC's current rules, different personnel requirements exist for applicants and Clearing Members. OCC's proposal would make such requirements the same for both. In addition to applying the personnel requirements for applicants to Clearing Members, OCC proposes to change such standards as follows. Proposed Rule 303(a) would provide that every applicant and Clearing Member must employ personnel or maintain contractual arrangements with third-party service providers acceptable to OCC with substantial experience in clearing the kind(s) of cleared contracts applicable to the applicant or Clearing Member. Proposed paragraph (b) would require Clearing Members to employ personnel or retain third-party service providers responsible for Clearing Members' compliance with applicable net capital, recordkeeping and other financial, operational, and risk management rules. Proposed paragraph (c) would require Clearing Members to ensure that they employ an appropriate number of clearing operations personnel or retain third-party service providers with requisite capability, experience, and competency, among other requirements. The proposed Rule also sets forth additional requirements for contractual arrangements with third-party personnel, as well as requirements for replacing relevant personnel or third-party providers who are being separated or terminated from OCC. The proposed modifications to the existing financial, operations, and risk management personnel requirements include eliminating the requirements for Managed Clearing Members and Managing Clearing Members, and removing references to facilities management agreements, Managing Clearing Members and Managed Clearing Members. These requirements, in current Rule 309, would be replaced by proposed Rule 303's more general rules for outsourcing third-party service providers. According to OCC, the modifications are intended to reduce administrative burdens and provide OCC and its Clearing Members with greater flexibility.

OCC proposes to add two new rule provisions designed to expand its rules related to operational and default management testing. The first would state that OCC will periodically designate Clearing Members required to participate in business continuity and disaster recovery testing. The second would state that OCC may require Clearing Members to participate in other operational and connectivity testing and related reporting requirements that OCC deems necessary to ensure the continuing operational capability of the Clearing Members and the continuing ability of OCC to perform its clearing, settlement, and risk management activities.

OCC proposes three sets of changes to its rules regarding notification and reporting requirements for Clearing Members. First, OCC proposes to add a rule stating that each Clearing Member must provide to OCC such notices, reports, documentation, or other information required in the Rules and any other requirements promulgated by OCC. In contrast, OCC's current rules prescribe a series of narrow notice requirements under specific circumstances such as currently requiring “prompt” written notice (rather than 30-day prior written notice).

Second, OCC proposes to change the requirements for event-based reporting by Clearing Members. Specifically, proposed Rule 306A(a) would require Clearing Members to provide early-warning notices to OCC of any financial or operational difficulty, or any instances where a Clearing Member fails to meet certain financial or operational thresholds, depending on the nature of the Clearing Member's business. For example, if the Clearing Member is a fully-registered broker-dealer and fails to meet specific thresholds for net capital, it would need to provide an early-warning notice to OCC. The proposed rule also provides the specific circumstances where early-warning notices would be required from other Clearing Member types, such as fully-registered FCMs, non-U.S. securities firms, and banks. Proposed Rule 306A(b) sets forth the requirements for Clearing Members to report material changes to their organizational structure, finances, or operations; their intentions to enter into, terminate, or alter outsourcing activities; and provide other types of event-based reporting or responses to information requests from OCC. Proposed Rule 306A(c) provides the statutory disqualification notification requirements for Clearing Members.

Third, OCC proposes to change the requirements for periodic reporting by Clearing Members. The proposed rule would cover periodic reporting of financial reports and annual audited financial statements, as well as the timing and frequency of such reporting, including providing OCC discretion to allow for extensions.

(iv) Protective Measures and Disciplinary Actions

OCC proposes to change its rules related to (i) the imposition of protective measures on Clearing Members who may pose a risk to OCC and (ii) disciplinary actions OCC may take in response to violations of its rules. With regard to the imposition of protective measures, OCC proposes to adopt new Rule 307, which would grant OCC the authority to impose broader protective measures on a member or applicant that (i) is approaching or does not meet OCC's minimum membership standards or fails to provide information such that OCC is unable to determine whether it meets the minimum membership standards, (ii) presents increased credit or liquidity risk to OCC, (iii) is subject to enhanced monitoring and surveillance under OCC's watch level reporting process, or (iv) whose financial condition, operational capability, or risk management capability otherwise makes it necessary or advisable, for the protection of OCC, other Clearing Members, or the general public. Although proposed Rule 307 would not provide OCC with entirely new authority to impose protective measures, it would clarify that OCC has the authority to impose such measures under a broader set of circumstances, not just on Clearing Members, but on applicants for membership as well. Additionally, OCC proposes to modify two of its current rules regarding the imposition of protective measures on its members. OCC proposes to clarify that restrictions on distributions apply to all qualified regulatory capital (as opposed to funds from specific accounts), and to provide that OCC may prohibit a Clearing Member from withdrawing qualified regulatory capital if it is subject to enhanced monitoring and surveillance under OCC's watch level reporting process or the distribution could increase OCC's credit or liquidity risk. Further, the proposal would permit OCC to impose activity restrictions as additional protective measures. The proposed changes would link certain restrictions on activities to the potential risks posed by that Clearing Member ( e.g., limiting transactions that increase credit or liquidity risk). OCC also proposes to adopt a new Rule 307C that would authorize it to impose protective measures in the form of additional operational, personnel, financial resource, or risk management requirements.

With regard to disciplinary actions, OCC proposes to increase the potential fines for minor rule violations ( e.g., increasing the fine for a first occasion from $300 to $1500). Additionally, the proposed rules would reduce the number of minor rule violations within a twenty-four month period that would result in a disciplinary proceeding from four to three violations. OCC also proposes to modify its current Rule 209 to require that any fine levied by OCC for a minor rule violation that has not been timely contested will be due and payable immediately upon notice as opposed to within five business days following the end of each calendar month.

III. Discussion and Commission Findings

Section 19(b)(2)(C) of the Exchange Act directs the Commission to approve a proposed rule change of a self-regulatory organization if it finds that such proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to such organization. After carefully considering the proposed rule change, the Commission finds that the proposal is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to OCC. More specifically, the Commission finds that the proposal is consistent with Exchange Act sections 17A(b)(3)(B), (F), and (G) as well as Rules 17Ad–22(e)(2)(i) and 17Ad–22(e)(18), as described in detail below.

A. Consistency With Section 17A(b)(3)(B) of the Exchange Act

Section 17A(b)(3)(B) of the Exchange Act requires that the rules of a clearing agency provide, among other things, that any registered broker or dealer, bank may become a participant in such clearing agency. OCC's rules currently allow for registered broker-dealers to become members if they meet the applicable membership requirements. As described above, OCC proposes to expand the list of entities eligible for membership to include banks. Such expansion includes the description of specific standards for banks to become Clearing Members. These standards, including bank-specific financial thresholds, operational requirements, and risk requirements, are consistent with the types of standards for other entities already eligible for clearing membership with OCC, such as broker-dealers and futures commission merchants. The Commission believes, therefore, that the proposal is consistent with the requirements of section 17A(b)(3)(B) of the Exchange Act.

B. Consistency With Section 17A(b)(3)(F) of the Exchange Act

Section 17A(b)(3)(F) of the Exchange Act requires, among other things, that a clearing agency's rules are designed to promote the prompt and accurate clearance and settlement of securities transactions and are not designed to permit the unfair discrimination in the admission of participants or among participants in the use of the clearing agency.

As described above, OCC proposes to align and strengthen its financial responsibility standards for members. OCC also proposes to modify its operational requirements for members to (i) reflect changes in technology ( e.g., allowing for reliance on electronic signatures); (ii) remove provisions no longer applicable to current practice ( e.g., the use of authorization stamps or designation of a physical location as a clearing office); and (iii) expand requirements with regard to members' operational capability, personnel, and reporting, as well as testing ( e.g., participation in business continuity testing). The Commission believes that such enhancements to OCC's financial and operational standards for Clearing Members should help to ensure that OCC's Clearing Members are capable of meeting their obligations to OCC, which in turn will help ensure that OCC continues to promote the prompt and accurate clearance and settlement of securities transactions.

Further, OCC proposes to consolidate its admission procedures and requirements and modify such admission procedures and requirements to help streamline the application review process. The Commission believes that such streamlining should promote consistent application across membership types, which, in turn may reduce the likelihood of unfair discrimination in the admission of OCC's Clearing Members. OCC also proposes to amend its conditions for member admission ( e.g., an applicant must notify OCC in writing if it is or becomes subject to Statutory Disqualification), and directly address voluntary membership termination.

The Commission believes, therefore, that the proposal is consistent with the requirements of section 17A(b)(3)(F) of the Exchange Act.

C. Consistency With Section 17A(b)(3)(G) of the Exchange Act

Section 17A(b)(3)(G) of the Exchange Act requires, among other things, that the rules of a clearing agency provide that its participants shall be appropriately disciplined for violation of any provision of the rules of that clearing agency by expulsion, suspension, limitation of activities, functions, and operations, fine, censure, or any other fitting sanction.

As described above, OCC proposes to broaden its authority to impose protective measures on Clearing Members who may pose a risk to OCC. Such measures include the imposition of financial obligations, such as additional margin requirements, as well as activity restrictions. OCC also proposes to raise fines, reduce the threshold for instituting a disciplinary proceeding, define when fines for uncontested violations become due, and make other strengthening changes to the way it enforces and addresses minor rule violations. The Commission believes that strengthening OCC's ability to respond to risks and violations in this way is consistent with the requirements of section 17A(b)(3)(G) of the Exchange Act.

D. Consistency With Rule 17Ad–22(e)(2)(i) of the Exchange Act

Rule 17Ad–22(e)(2)(i) requires that a covered clearing agency establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for governance arrangements that are clear and transparent.

OCC's existing membership eligibility requirements, admissions criteria, and ongoing standards are scattered across OCC's By-Laws and Rules. As described above, OCC proposes to reorganize, relocate, or consolidate such rule text into chapters 2 and 3 of OCC's Rules (along with supporting definitional changes to chapter 1 of OCC's rules). Further, OCC proposes other non-substantive wording changes throughout its rules ( e.g., changing “will” to “shall”). Because such changes would improve the readability of OCC's publically available rules, which, in turn, would make such rules clearer and more transparent to members and the public, the Commission believes that such changes are consistent with Rule 17Ad–22(e)(2)(i).

E. Consistency With Rule 17Ad–22(e)(18) of the Exchange Act

Rule 17Ad–22(e)(18) requires a covered clearing agency to establish, implement, maintain, and enforce policies and procedures reasonably designed to, among other things, establish objective, risk-based, and publically disclosed criteria for participation, which permit fair and open access by direct participants, require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency, and to monitor compliance with such participation requirements on an ongoing basis.

As stated above, OCC proposes to align and strengthen its financial responsibility standards for members. OCC also proposes to modify its operational requirements for members to (i) reflect changes in technology ( e.g., allowing for reliance on electronic signatures); (ii) remove provisions no longer applicable to current practice ( e.g., the use of authorization stamps or designation of a physical location as a clearing office); and (iii) expand requirements with regard to members' operational capability, personnel, and reporting, as well as testing ( e.g., participation in business continuity testing). The Commission believes that such enhancements to OCC's financial and operational standards should help to ensure that OCC's membership has sufficient financial resources and robust operational capacity to meet obligations for participation in OCC. Further, OCC proposes to modify and consolidate its admission procedures and requirements to help streamline the application review process. The Commission believes that such streamlining should promote consistent application across membership types, which, in turn, would permit fair and open access by direct participants.

Therefore, the Commission believes, therefore, that the proposal is consistent with the requirements of Rule 17Ad–22(e)(18) of the Exchange Act.

VI. Conclusion

On the basis of the foregoing, the Commission finds that the proposed rule change is consistent with the requirements of the Exchange Act, and in particular the requirements of section 17A of the Exchange Act and the rules and regulations thereunder.

It is therefore ordered, pursuant to section 19(b)(2) of the Exchange Act, that the proposed rule change (SR–OCC–2023–002) be, and hereby is, approved.