There have been significant transformation efforts undertaken at OCC by our colleagues during the last several years. OCC’s transformation is a broad, multi-year undertaking covering every aspect of our organization: our financial resiliency, our people, our processes, and our technology. While our colleagues have overcome many challenges and accomplished a great deal, we still have more to do. We would like to share their progress with you.
Transforming Our Financial Resiliency
OCC has significantly increased its liquidity resources by expanding and diversifying its committed credit facilities from $2 billion to $3 billion while also ensuring a minimum of $3 billion of cash in the clearing fund. This reduces the risk of a liquidity crisis during periods of extreme market stress and bolsters our resources to meet our daily settlement obligations to our clearing members even in the most challenging market environments.
Last year, OCC became the first SIFMU whose primary supervisory agency is the SEC to receive SEC approval for an expanded set of recovery tools, as well as our Recovery and Orderly Wind-Down Plan (RWD Plan). These new recovery tools include clarified assessment powers and the ability to extinguish residual losses in order to re-establish a matched book following the failure of one or more clearing firms. Our RWD Plan and our improved capitalization significantly improve OCC’s ability to successfully manage extreme market disruptions.
In 2014, OCC had only $25 million of capital on the balance sheet. Today, OCC maintains equity capital (separate from our clearing fund capital) above its target level of $247 million. Our Board of Directors, which represents a broad cross-section of industry participants and public directors, determined that this level of capitalization is appropriate given our SIFMU status and the critical role OCC plays in ensuring stability in our financial markets and the broader economy.
On August 9, 2019, OCC formally filed with the SEC its Capital Management Policy (“Policy”), which addresses four core elements, discussed below:
- Provides OCC’s approach to determining clearing fees, inclusive of an operating margin based on the variance in average daily volume;
- Identifies the considerations made in determining OCC’s level of target capital on an annual basis;
- Describes how OCC will periodically monitor its capital levels to identify whether OCC’s equity has fallen or is in danger of falling below defined thresholds triggering further action; and
- Establishes a Replenishment Plan for accessing additional capital should OCC’s equity fall below those defined thresholds.
OCC is now well capitalized and better prepared to meet our obligations to market participants. This is reflected by the fact that OCC is one of only 191 companies out of 9,535 that have a rating of AA+/Stable or better from Standard & Poor’s. While we are still on Negative Credit Watch by S&P, filing our Capital Management Policy with the SEC addresses their concern that OCC have in place a viable Replenishment Plan. We believe we are on track to achieve that and maintain our current rating.
Transforming Our People
We greatly strengthened OCC’s Board of Directors to meet the heightened regulatory expectation as a SIFMU. We recruited industry veterans with expertise in trading and markets, quantitative risk management, operations, technology and regulatory compliance from a wide cross section of clearing firms and market makers. We enhanced our Board oversight capabilities by establishing a Board-level Technology Committee and Regulatory Oversight Working Group, in addition to our Risk, Audit, Governance and Compensation Committees.
We also enhanced our senior leadership team with knowledgeable and experienced subject matter experts from the listed U.S. equity options and futures markets. We hired a new Chief Executive Officer, Chief Operating Officer, Head of Financial Risk Management, Chief Information Officer, Chief Security Officer, General Counsel, Chief Financial Officer and Chief Compliance Officer. Since 2014 we have increased our senior officer leadership team across every function of our company, from 56 in 2014 to 104 today, with 68 percent being new to our organization. At the same time, we have increased our employee headcount by 75 percent, including in areas such as Compliance, Financial Risk Management, Information Security, and Internal Audit. These changes give OCC the technical expertise to meet our SIFMU responsibilities and reposition the company for future innovation and growth opportunities as a market leader.
Transforming Our Processes
Since 2014, OCC has focused significant attention and effort on enhancing our compliance posture. We created a cross-functional process to match policies, procedures, controls and rules to regulatory requirements. This is instrumental in assessing OCC’s current compliance and provides a comprehensive inventory of regulatory requirements. It also enhances our ability to demonstrate compliance to our regulators and transforms the way we discuss our compliance efforts.
While OCC has met its settlement financial obligations to our clearing members every business day for the past 46 years, we continue to make material enhancements to our margin methodology and associated margin models. We implemented margin model enhancements that increase margin coverage by moving from monthly to daily calibration of price moves, instituting a 10-year anti-procyclicality look-back period which requires that we adopt the most conservative time-based measure of price volatility for any given instrument, and adding an asymmetric distribution to better reflect the greater likelihood of realizing significant downside versus upside price risks during periods of market volatility. We also received regulatory approval for margin model enhancements that more conservatively account for the expected execution cost (bid/ask slippage) of liquidating an option portfolio in stressed market conditions in the event of a clearing firm default.
In 2018 we gained regulatory approval to implement the first phase of our new Financial Safeguards Framework (FSF), with an improved methodology for determining the size of our clearing fund, driven by enhanced stress-testing capabilities that include historical market events and defined “extreme but plausible” scenarios. This resulted in OCC returning more than $3 billion to our clearing firms. The FSF includes a “Cover Two” approach that allows OCC to cover the concurrent default of its two largest clearing firms. This exceeds U.S. regulatory standards and better aligns OCC with other systemically important derivative clearing houses. We also implemented a new risk-based allocation for clearing fund contribution requirements that improves transparency and incentivizes clearing members to manage margin risk. These changes have had a strong, positive impact on our clearing members, including with respect to their regulatory capital requirements.
Transforming Our Technology
In January 2019, we launched our Renaissance Initiative, an ambitious, multi-year investment to modernize OCC’s risk management, clearing and data systems to better serve market participants. This will enhance OCC’s resiliency, improve our compliance posture, and help us operate in a more effective and efficient manner so we can best serve market participants and the investing public.
The risk management elements of the Renaissance Initiative will expand our current capabilities, providing an environment for intra-day risk management, intra-day computations, pricing and revaluation. It will enhance the efficiency and speed of margin, stress-testing and back-testing capabilities.
Our core clearing system will deliver many advantages, including enhanced functionality to procure and submit data to and from the system for external and internal users, stronger ad hoc reporting capabilities, enhanced control and information security mechanisms throughout the systems, improved industry-standard futures processing, and greater flexibility in processing clearing member trade agreements.
The development of our data platform, which will be independent from our clearing and risk systems, enhances OCC’s ability to process and manage data. We will have self-service capability for data discovery, search and historical analysis as well as a scalable and secure centralized enterprise repository that can serve data to concurrent processing needs, including report generation, back-testing and stress-testing.
Moving Forward
Our OCC colleagues have accomplished a great deal during the last several years. We fully accept responsibility for what needed, and still needs, to be done. We will continue to work tirelessly as a team to earn the trust and confidence of our clearing members and participant exchanges, our business partners and our regulators. We also will continue to strive for excellence as we complete our transformation and fulfill our mission to serve as the foundation for secure markets.
