Options Clearing Corporation, The – S. 147
IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, CHAPTER S.5, AS AMENDED
(THE ACT)
AND
IN THE MATTER OF
THE OPTIONS CLEARING CORPORATION
ORDER
(Section 147 of the Act)
WHEREAS The Options Clearing Corporation (OCC) has filed an application dated August 17, 2012 (Application) with the Ontario Securities Commission (Commission) requesting an order pursuant to section 147 of the Act exempting OCC from the requirement to be recognized by the Commission as a clearing agency pursuant to section 21.2(0.1) of the Act.
AND WHEREAS OCC has represented to the Commission that:
1.1 OCC is a corporation organized under the laws of the state of Delaware and was founded in 1973.
1.2 OCC is registered as a clearing agency under Section 17A of the United States (U.S.) Securities Exchange Act of 1934 (Exchange Act) and as a derivatives clearing organization (DCO) under Section 7a-1 of the U.S. Commodity Exchange Act (CEA). It has been designated by the U.S. Financial Stability Oversight Council as a "systematically important" financial market utility under Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
1.3 In the U.S., OCC operates under the jurisdiction of both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Under the SEC's jurisdiction, OCC clears or is qualified to clear transactions in "standardized options," as defined in SEC regulations. These include options on common stocks and other equity issues, stock indices (including volatility, variance, and strategy-based indices), foreign currencies, interest rate composites, and credit default options. Under SEC jurisdiction, OCC also clears futures on single equity issues and narrow-based stock indices (security futures). As a registered DCO under CFTC jurisdiction, OCC offers clearing and settlement services for transactions in commodity futures (i.e., futures other than security futures) and options on commodity futures.
1.4 The Exchange Act establishes conditions that registered clearing agencies must satisfy relating to, among other things, the clearing agency's capacity to promptly and accurately clear and settle transactions, safeguarding of funds and securities, enforcement of the clearing agency's rules, equitable allocation of fees and charges among participants, and avoiding any unnecessary burden on competition. Similarly, the CEA establishes core principles with which registered DCOs must comply relating to, among other things, financial resources, appropriate admission and eligibility standards for participants, risk management, timely completion of settlements, ensuring the safety of funds and enforcement of the DCO's rules.
1.5 Because the overwhelming majority of OCC's business relates to clearing securities, the CFTC historically has deferred to the SEC as the lead regulator except in connection with matters specifically related to the clearing of transactions in commodity futures, options on such futures or other products subject to the CFTC's jurisdiction and compliance with the CEA and the CFTC's regulations thereunder.
1.6 In Quebec, OCC has received an exemption from certain requirements of the Derivatives Act (Quebec) in connection with its business and operations as a clearing house, subject to conditions.
1.7 OCC is owned equally by the following five participant securities exchanges that trade options, all of which are currently registered with the SEC:
(i) Chicago Board Options Exchange;
(ii) International Securities Exchange;
(iii) NYSE Amex (formerly the American Stock Exchange)
(iv) NYSE Arca (formerly the Pacific Stock Exchange); and
(v) NASDAQ OMX PHLX (formerly the Philadelphia Stock Exchange).
1.8 In addition to the five stockholder exchanges, OCC also performs clearing and settlement functions for other securities and futures exchanges.
1.9 OCC currently clears options traded on the U.S. securities exchanges named above, security futures traded on OneChicago, LLC, and commodity futures and in some cases options on commodity futures traded on four U.S. futures exchanges. OCC also clears stock loan transactions executed on a broker-to-broker basis and on AQS, an electronic trading platform regulated by the SEC and by the U.S. Financial Industry Regulatory Authority as an automated trading system. OCC intends to clear OTC derivatives beginning in late 2012 or the first quarter of 2013.
1.10 OCC operates as a not-for-profit industry utility and refunds excess revenues to its members (Clearing Members).
1.11 OCC currently clears the following products:
(i) Options on equity securities (including exchange-traded funds);
(ii) Options on stock indices (including volatility indices);
(iii) Foreign currency options;
(iv) Interest rate options (cash settled options on the yields of U.S. Treasury securities);
(v) Credit default options;
(vi) Interest rate futures;
(vii) Security futures, including single stock futures and narrow-based stock index futures;
(viii) Broad-based stock index, volatility and variance futures;
(ix) Options on commodity futures; and
(x) Stock loan transactions.
1.12 OCC does not have any office or maintain other physical installations in Ontario or any other Canadian province or territory.
1.13 OCC has approximately 120 Clearing Members, who are U.S. registered broker-dealers, futures commission merchants and non-U.S. securities firms.
1.14 OCC allows entities that have a head office or principal place of business in Ontario and dealers that are registered in Ontario that meet the criteria set out in its Rules (collectively, Ontario Clearing Members) to become Clearing Members.
1.15 OCC currently has five Clearing Members that are Ontario Clearing Members.
1.16 Additionally, OCC currently has one approved clearing bank with a head office or principal place of business in Ontario. As an OCC approved clearing bank, the bank provides settlement services for exchange transactions on behalf of the Ontario Clearing Members. Such services may include, but not be limited to, the payment and release of margin, payment and rebate of fees, and the payment and withdrawal of option premiums.
1.17 OCC initiates no direct contact with Canadian clients of Ontario Clearing Members.
1.18 OCC submits that it does not pose a significant risk to the Ontario capital markets and is subject to an appropriate regulatory and oversight regime in a foreign jurisdiction.
1.19 OCC maintains rigorous Clearing Member criteria that all applicants must satisfy before their applications are accepted, including fitness criteria, review of corporate constating documentation, financial standards, operational standards, appropriate registration qualifications with applicable statutory regulatory authorities, and OCC applies a due diligence process to ensure that all applicants meet the required criteria.
1.20 There are no material differences in terms of membership standards and financial requirements between Ontario Clearing Members and other Clearing Members.
1.21 OCC utilizes processes to minimize systemic risk, which processes include operational and financial criteria for all clearing members, margining and financial protections, the maintenance of a clearing/guarantee fund, sound information systems, comprehensive internal controls, ongoing monitoring of clearing members, and appropriate oversight by the Board of Directors.
1.22 As OCC has Ontario Clearing Members, it is considered by the Commission to be "carrying on business as a clearing agency" in Ontario. OCC cannot carry on business in Ontario as a clearing agency unless it is recognized by the OSC as a clearing agency under subsection 21.2(0.1) of the Act or exempted from such recognition under section 147 of the Act.
1.23 Based on the facts and representations set out in the Application, OCC satisfies the criteria set out in Schedule "A" to this order.
AND WHEREAS based on the Application and the representations of OCC to the Commission, the Commission has determined that OCC satisfies the criteria set out in Schedule "A" and that the granting of exemption from the requirement to be recognized as a clearing agency would not be prejudicial to the public interest;
AND WHEREAS the Commission will monitor developments in international and domestic capital markets and OCC's activities on an ongoing basis to determine whether it is appropriate that OCC continue to be exempted from the requirement to be recognized as a clearing agency and, if so, whether it is appropriate that it continue to be exempted subject to the terms and conditions in this order;
IT IS ORDERED by the Commission that pursuant to section 147 of the Act, OCC is exempt from the requirement to be recognized as a clearing agency under subsection 21.2(0.1) of the Act.
PROVIDED THAT OCC complies with the terms and conditions attached hereto as Schedule "B".
DATED October 30, 2012.
SCHEDULE "A"
Criteria for Exemption from Recognition by the OSC as a clearing agency pursuant to section 21.2(0.1) of the Act
PART 1 GOVERNANCE
1.1 The governance structure and governance arrangements of the clearing agency ensures:
(a) effective oversight of the clearing agency;
(b) the clearing agency's activities are in keeping with its public interest mandate;
(c) fair, meaningful and diverse representation on the governing body (Board) and any committees of the Board, including a reasonable proportion of independent directors;
(d) a proper balance among the interests of the owners and the different entities seeking access (participants) to the clearing, settlement and depository services and facilities (settlement services) of the clearing agency;
(e) the clearing agency has policies and procedures to appropriately identify and manage conflicts of interest;
(f) each director or officer of the clearing agency, and each person or company that owns or controls, directly or indirectly, more than 10 percent of the clearing agency is a fit and proper person; and
(g) there are appropriate qualifications, limitation of liability and indemnity provisions for directors and officers of the clearing agency.
PART 2 FEES
2.1 All fees imposed by the clearing agency are equitably allocated. The fees do not have the effect of creating unreasonable barriers to access.
2.2 The process for setting fees is fair and appropriate, and the fee model is transparent.
PART 3 ACCESS
3.1 The clearing agency has appropriate written standards for access to its services.
3.2 The access standards and the process for obtaining, limiting and denying access are fair and transparent. A clearing agency keeps records of
(a) each grant of access including, for each participant, the reasons for granting such access, and
(b) each denial or limitation of access, including the reasons for denying or limiting access to an applicant.
PART 4 RULES AND RULEMAKING
4.1 The clearing agency's rules are designed to govern all aspects of the settlement services offered by the clearing agency, and
(a) are not inconsistent with securities legislation,
(b) do not permit unreasonable discrimination among participants, and
(c) do not impose any burden on competition that is not necessary or appropriate.
4.2 The clearing agency's rules and the process for adopting new rules or amending existing rules should be transparent to participants and the general public.
4.3 The clearing agency monitors participant activities to ensure compliance with the rules.
4.4 The rules set out appropriate sanctions in the event of non-compliance by participants.
PART 5 DUE PROCESS
5.1 For any decision made by the clearing agency that affects an applicant or a participant, including a decision in relation to access, the clearing agency ensures that:
(a) an applicant or a participant is given an opportunity to be heard or make representations; and
(b) the clearing agency keeps a record of, gives reasons for, and provides for appeals or reviews of, its decisions.
PART 6 RISK MANAGEMENT
6.1 The clearing agency's settlement services are designed to minimize systemic risk.
6.2 The clearing agency has appropriate risk management policies and procedures and internal controls in place.
6.3 Without limiting the generality of the foregoing, the clearing agency's services or functions are designed to achieve the following objectives:
1. Where the clearing agency acts as a central counterparty, it rigorously controls the risks it assumes.
2. The clearing agency minimizes principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.
3. Final settlement occurs no later than the end of the settlement day. Intraday or real-time finality is provided where necessary to reduce risks.
4. Where the clearing agency extends intraday credit to participants, including a clearing agency that operates net settlement systems, it institutes risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle.
5. Assets used to settle the ultimate payment obligations arising from securities transactions carry little or no credit or liquidity risk. If central bank money is not used, steps are to be taken to protect participants in settlement services from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose.
6. If the clearing agency establishes links to settle cross-border trades, it designs and operates such links to reduce effectively the risks associated with cross-border settlements.
6.4 The clearing agency engaging in activities not related to settlement services carries on such activities in a manner that prevents the spillover of risk to the clearing agency that might affect its financial viability or negatively impact any of the participants in the settlement service.
PART 7 SYSTEMS AND TECHNOLOGY
7.1 For its settlement services systems, the clearing agency:
(a) develops and maintains,
(i) reasonable business continuity and disaster recovery plans,
(ii) an adequate system of internal control,
(iii) adequate information technology general controls, including controls relating to information systems operations, information security, change management, problem management, network support, and system software support;
(b) on a reasonably frequent basis, and in any event, at least annually, and in a manner that is consistent with prudent business practice,
(i) makes reasonable current and future capacity estimates,
(ii) conducts capacity stress tests to determine the ability of those systems to process transactions in an accurate, timely and efficient manner,
(iii) tests its business continuity and disaster recovery plans; and
(c) promptly notifies the regulator of any material systems failures.
7.2 The clearing agency annually engages a qualified party to conduct an independent systems review and prepare a report in accordance with established audit standards regarding its compliance with section 7.1(a).
PART 8 FINANCIAL VIABILITY AND REPORTING
8.1 The clearing agency has sufficient financial resources for the proper performance of its functions and to meet its responsibilities and allocates sufficient financial and staff resources to carry out its functions as a clearing agency in a manner that is consistent with any regulatory requirements.
PART 9 OPERATIONAL RELIABILITY
9.1 The clearing agency has procedures and processes to ensure the provision of accurate and reliable settlement services to participants.
PART 10 PROTECTION OF ASSETS
10.1 The clearing agency has established accounting practices, internal controls, and safekeeping and segregation procedures to protect the assets that are held by the clearing agency.
PART 11 OUTSOURCING
11.1 Where the clearing agency has outsourced any of its key functions, it has appropriate and formal arrangements and processes in place that permit it to meet its obligations and that are in accordance with industry best practices. The outsourcing arrangement provides regulatory authorities with access to all data, information, and systems maintained by the third party service provider required for the purposes of regulatory oversight of the agency.
PART 12 INFORMATION SHARING AND REGULATORY COOPERATION
12.1 For regulatory purposes, the clearing agency cooperates by sharing information or otherwise with the Commission and its staff, self-regulatory organizations, exchanges, quotation and trade reporting systems, alternative trading systems, other clearing agencies, investor protection funds, and other appropriate regulatory bodies.
SCHEDULE "B"
Terms and Conditions
REGULATION OF OCC
1. OCC will maintain its registration as a clearing agency with the SEC and as a DCO with the CFTC and will continue to be subject to the regulatory oversight of the SEC and CFTC.
2. OCC will continue to meet the Criteria for Exemption from Recognition as a Clearing Agency as set out in Schedule "A".
FILING REQUIREMENTS
SEC/CFTC Filings
3. OCC will provide staff of the Commission, concurrently, the following information to the extent that it is required to file such information with the SEC or the CFTC or to the extent it routinely prepares and provides such information to the SEC or the CFTC:
(a) the annual audited financial statements of OCC;
(b) details of any material legal proceeding instituted against it;
(c) notification that OCC has failed to comply with an undisputed obligation to pay money or deliver property to a Clearing Member for a period of thirty days after receiving notice from the Clearing Member of OCC's past due obligation;
(d) notification that OCC has instituted a petition for a judgment of bankruptcy or insolvency or similar relief, or to wind up or liquidate OCC or has a proceeding for any such petition instituted against it;
(e) the appointment of a receiver or the making of any voluntary arrangement with creditors;
(f) changes and proposed changes to its bylaws, rules, operations manual, participant agreements and other similar instruments or documents which contain any contractual terms setting out the respective rights and obligations between OCC and Clearing Members or among Clearing Members;
(g) A summary of risk management test results related to the adequacy of required margin and the level of the guaranteed fund, including but not limited to stress testing and back testing results; and
(h) new services or clearing of new types of products to be offered to Ontario Clearing Members or services or products that will no longer be available to Ontario Clearing Members.
Prompt Notice
4. OCC will promptly notify staff of the Commission of any of the following:
(a) a material change to its business or operations or the information in the Application;
(b) a material problem with the clearance and settlement of transactions in contracts that could materially affect the safety and soundness of OCC;
(c) initiation of suspension proceedings by OCC against a Clearing Member; and
(d) a material change or proposed material change in OCC's status as a derivatives clearing agency or DCO or to the regulatory oversight by the SEC or the CFTC.
Quarterly Reporting
5. OCC will maintain the following updated information and submit such information to the Commission in a manner and form acceptable to the Commission on at least a quarterly basis, and at any time promptly upon the request of staff of the Commission:
(a) a current list of all Ontario Clearing Members;
(b) a list of all Ontario Clearing Members against whom disciplinary action has been taken in the previous quarter by OCC, or by the SEC or the CFTC with respect to activities on OCC;
(c) a list of all investigations by OCC relating to Ontario Clearing Members;
(d) a list of all Ontario applicants who have been denied Clearing Member status in OCC in the previous quarter;
(e) the average daily volume of trades cleared during the previous quarter for each Ontario Clearing Member by product type;
(f) the average daily value of assets loaned through OCC's stock loan facility during the previous quarter for each Ontario Clearing Member, provided that if OCC is unable to submit the average daily value of assets loaned through OCC's stock loan facility, OCC will alternatively submit the value of assets loaned through OCC's stock loan facility as of the last day of the month on a monthly basis;
(g) the portion of total volume of trades cleared during the previous quarter for all Clearing Members that represents the total volume of trades cleared during the previous quarter for each Ontario Clearing Member;
(h) the portion of total value of assets loaned during the previous quarter for all Clearing Members that represents the total value of assets loaned during the previous quarter for each Ontario Clearing Member;
(i) the aggregate total margin amount required by OCC ending on the last trading day during the pervious quarter for each Ontario Clearing Member;
(j) the portion of the total margin required by OCC ending on the last trading day of the previous quarter for all Clearing Members that represents the total margin required during the previous quarter for each Ontario Clearing Member;
(k) the Clearing Fund Status Report ending on the last trading day during the previous quarter for each Ontario Clearing Member; and
(l) any other information in relation to an OTC derivative cleared by OCC as may be required by the Commission from time to time in order to carry out the Commission's mandate.
INFORMATION SHARING
6. OCC will provide such information as may be requested from time to time by, and otherwise cooperate with, the Commission or its staff with respect to matters subject to the Commission's jurisdiction.
7. OCC will share information with and otherwise cooperate with other recognized and exempt clearing agencies as appropriate.
SUBMISSION TO JURISDICTION AND AGENT FOR SERVICE
8. With respect to a proceeding brought by the Commission arising out of, related to, concerning or in any other manner connected with the Commission's regulation and oversight of OCC's activities in Ontario, OCC will submit to the non-exclusive jurisdiction of (i) the courts and administrative tribunals of Ontario and (ii) an administrative proceeding in Ontario.
9. OCC will file with the Commission a valid and binding appointment of an agent for service in Ontario upon whom the Commission may serve a notice, pleading, subpoena, summons or other process in any action, investigation or administrative, criminal, quasi-criminal, penal or other proceeding arising out of or relating to or concerning the Commission's regulation and oversight of OCC's activities in Ontario.