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TRADERS Q&A: OCC’s Davidson Talks Options, Clearing Tech
Traders Magazine Online News, June 17, 2019
Options. Clearing. Technology. Three great tastes that go great together – or better learn to get along real quick.
The Options Clearing Corporation (OCC), founded in 1973, is the world's largest equity derivatives clearing organization and pays heed to the aforementioned. As it faces the new decade, the market utility remains dedicated to promoting stability and financial integrity in the marketplaces that it serves by focusing on sound risk management principles.
The 66-year-old entity is now under the command of Chief Executive Officer John Davidson, who is charged with shepherding the company into the future – one fraught with new technology and increased volume – and charting its future.
Davidson has over 35 years of experience in the global financial industry. Prior to joining OCC he served as Chief Compliance Officer at Citigroup. In that role, he led the global 2,400 person, 87 country compliance organization, responsible for proactively identifying, evaluating, mitigating and reporting on compliance, conduct, regulatory and reputation risks across the institution. Previously he served as Citi's Risk Division's Chief Administrative Officer, helping rebuild the risk function during the financial crisis, and subsequently as Head of Enterprise Risk Management, where he was responsible for managing Citi's operational risk across businesses and geographies.
Before his tenure at Citi, Davidson spent two years as Chief Business Development Officer at CME Group, a global exchange holding company. He spent 12 years at Morgan Stanley, serving as Managing Director for its Institutional Operations Division. He rebuilt the firm's global institutional processing system and opened new processing centers on four continents, away from major financial centers. Early in his career, Davidson worked for 10 years as head of the CME Clearing House, successfully guiding it through the 1987 stock market crash and leading the initiatives to substantially enhance its financial safeguards based on lessons from that period. Among other accomplishments, he was instrumental in developing and implementing the Standardized Portfolio Analysis of Risk (CME SPAN®) margining system as well as the Globex® Control Center.
Davidson took time out to speak with Traders Magazine editor John D’Antona Jr. on the firm and his goals.
Traders Magazine: First, please describe the transition from working at a trading firm (CITI) to a clearing house (OCC)
John Davidson: While the challenges at OCC are new and different, you have to remember that I have had previous experience in running a clearing operation. I was the head of CME’s clearing house from 1983 to 1993, which gave me a great opportunity to work with some talented individuals in developing SPAN, which became the industry standard for margin methodology. What also helped me in transitioning from Citi to OCC is the fact that for pretty much my entire career I have been involved with operational and risk management issues in the financial services industry, including serving as chief compliance officer for Citi’s risk division. At OCC I get the chance to work with some really smart people here in our Chicago, Dallas and Washington, D.C. offices who understand what we are trying to achieve from a strategic perspective as well as deliver on our day-to-day responsibilities as the world’s largest equity derivatives clearing organization. The level of collaboration and cooperation at OCC has made my transition very easy.
TM: Describe the state of options trading and OCC’s role
Davidson: I would describe the state of options trading as good. In 2018, OCC cleared a record 5.24 billion total contracts on behalf of our industry, which was up 21 percent from 2017 and the highest industry total since 2011. I think this reflects well on the stability and integrity of the services OCC provides to the users of our markets. Our ability to consistently support record volume numbers demonstrates that we are delivering on our key responsibilities to our participating exchanges, clearing firms and the investing public, and underscores OCC’s important role as the foundation for secure markets.
Our mission has been constant. We promote stability and market integrity through effective and efficient clearance, settlement and risk management services while providing thought leadership and education to market participants and the public about the prudent use of products we clear.
Under the direction of our Executive Chairman Craig Donohue, we have enhanced our compliance-related and financial resiliency, furthered our efforts to modernize our technology, strengthen our governance structure and continue in our role as an advocate for our industry. This progress builds on the solid foundation we have put in place since 2014 to shape and strengthen a culture of innovation and collaboration designed to ensure confidence in the financial markets and the broader economy.
TM: What are your prime objectives/goals to accomplish as CEO?
Davidson: OCC must always be focused on flawless execution and in delivering operational and capital efficiencies to our participating exchanges and clearing firms in our role as a Systemically Important Financial Market Utility. To achieve that objective, we are focused on three strategic imperatives. First, we are reinforcing our foundation, which means we are maturing OCC’s foundational capabilities to enhance our compliance posture and deliver cost-effective and efficient services. Thanks to Craig’s leadership, we are making good progress in that regard; considering that OCC had to transform to meet the increased demands of a new regulatory environment. We needed to solidify our financial and capital resources, and we had to focus on developing and retaining a strong leadership team.
Second, we need to grow our base. We must make sure we have the right policies, processes and procedures in place to enable growth in our core business and provide capital efficiencies to the users of our markets. Finally, we need to be more nimble, agile and innovative so we can fulfill OCC’s mandate as an industry steward and influential thought leader.
TM: Do you see clearing technology improving or seeing significant updates in the future?
Davidson: The U.S. has the world’s deepest and most liquid capital markets in part because it has the best and most innovative technology from a plethora of highly competitive users and providers. Within the market infrastructure industry, I see technology as an enabler of efficient and effective capital markets
Technology is central to OCC’s role as a CCP. Our reliability and clearing efficiency allow the users of the U.S. equity options and futures markets to trade with confidence in the underlying system. That is why OCC’s key strategic priority over the next several years is our Renaissance Initiative. It is a multi-year investment to modernize our critical risk management, core clearing, and data systems. Our goal is to deliver numerous improvements to our capabilities, including improved extended hours risk management, industry-standard futures processing, and easier and more timely access to clearing data, with the final aspects in parallel production by the end of 2021.
The Renaissance Initiative will be a substantial technology upgrade that when completed will benefit OCC and the users of our markets. When completed, it will provide OCC with the ability to operate risk, clearing and data applications based on a modular architecture, improve real-time and extended hours risk management capabilities, drive operational efficiency through process reengineering and automation, and improve information transparency and services to our clearing firms while also increasing product development agility and reduce time-to-market.
TM: Are there any new educational initiatives OCC looks to bring in the coming months or year?
Davidson: We intend to continue to do more of the same educational work we have conducted in years past with policymakers and investors on behalf of our participating exchanges and clearing firms. OCC and the U.S. Securities Markets Coalition engages in regular outreach to congressional and regulatory officials and staff to educate them on options market trends and developments, as well as to discuss the potential impacts of various regulatory and tax proposals on investors who use the markets we clear.
Last year our efforts were successful when H.R. 5749, the Options Markets Stability Act, was passed unanimously by the U.S. House of Representatives. The legislation required the appropriate U.S. federal banking agencies to increase the risk sensitivity of the capital treatment of centrally-cleared options. While the measure was not considered by the U.S. Senate and therefore did not become law in 2018, federal banking agencies published proposed rules in December that would, among other things, address this concern.
We also do great educational work with investors through our Options Industry Council. The development of unbiased content has made a significant contribution to the continued education of the users of the U.S. exchange-listed options markets. More than 84,000 individual options investors participated in our robust digital and live instructional programming in 2018, and we are seeing growing interest in our webinars, podcasts and videos.
In May at the annual options industry conference, OCC released the results of new study that showed that listed index and ETF option overlays may improve the performance of small, mid-sized and very large endowments. We intend to build upon our educational offerings through even greater cooperation with our participating exchanges, clearing firms, and broker-dealers to attract more investors to the U.S. equity options and futures markets.
TM: OCC is a uniquely U.S. clearing agent – do you plan to reach out globally into other areas?
Davidson: While all of the markets for which OCC provides clearing services are in the United States, we have many global connections. A significant number of our clearing members have Asian, Canadian, or European parents. As a result, OCC must pay careful attention to global standards, both those that pertain to the operation of a central counterparty, as well as those that pertain to our clearing members, such as capital requirements in various regulatory jurisdictions. Our $2 billion committed bank credit facility is provided by a consortium of international banks.
Several of our exchanges have a global focus and, in the future may wish to launch products which are denominated in currencies other than the U.S. Dollar. I would be very surprised if an exchange outside the United States came to OCC for clearing services, but as our clearing members, exchanges and market participants seek to leverage the advantages of the deep and liquid capital markets in the U.S. and our role as the foundation for secure markets, our product offerings may well have a number of more global features.
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