Regulators Probe Options Market’s Major Clearinghouse

Discussion in 'Options' started by ajacobson, Aug 5, 2018.

  1. ajacobson

    ajacobson

    The Commodity Futures Trading Commission and the Securities and Exchange Commission are looking into how Options Clearing Corp. handled a period of market turbulence earlier this year. PHOTO: STEPHEN VOSS FOR THE WALL STREET JOURNAL
    By
    Dave Michaels and
    Gunjan Banerji
    Aug. 2, 2018 5:30 a.m. ET

    The company tasked with curbing risk in the U.S. options market is under investigation by federal regulators for how it handled a recent period of market turbulence, according to people familiar with the matter.

    The probes from the Securities and Exchange Commission and Commodity Futures Trading Commission include concerns that Options Clearing Corp. failed to accurately forecast how much cash would be needed to cover trading losses triggered by a spike in volatility last February, some of the people said.

    The turbulence wiped out exchange-traded funds that offered a way for investors to bet on volatility and left many traders with losses. The role of Options Clearing as a clearinghouse is to keep enough collateral on hand to protect trader defaults from rippling through markets and causing widespread losses.

    The SEC and CFTC investigations place new scrutiny on an institution that U.S. regulators labeled “systemically important” in 2012, subjecting it to stricter standards. Clearinghouses are supposed to help reduce systemwide risk by guaranteeing trades between buyers and sellers. Their operations and financial health are considered critical to smooth market functioning.

    A spokesman for Options Clearing declined to comment on the investigations.

    The Chicago-based clearinghouse reported that the average size of traders’ margin breaches in the first quarter was $61.4 million, up from $26,355 at the end of 2017, and a multiyear high.

    Options Clearing conducts backtesting to gauge the quality of its models. A margin breach occurs when the actual amount posted as margin is less than what the volatility in markets indicates was needed. Options Clearing recently won approval to change its margin model and plans to make the shift in October.


    Amy McCormick, first vice president of financial risk management at Options Clearing, said through a spokeswoman that the clearinghouse functioned properly and that the firm expects some breaches “when there are extraordinary events.” She said there were no disruptions to clearing.

    This isn’t the first time the entity has attracted regulators’ attention. The SEC in 2013 cited Options Clearing for a dozen deficiencies related to inadequate risk-management systems, corporate governance and compliance during regulatory exams conducted from 2011 to 2013.

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    The new enforcement probes by the SEC and CFTC began after the jump in market volatility during the first quarter of 2018, the people said. SEC and CFTC examiners became frustrated about the clearinghouse’s models and referred their findings to their respective enforcement divisions, said people familiar with the matter.

    The regulators are now looking into the clearinghouse’s risk-management models and databases in an effort to determine if there are any violations of rules governing how Options Clearing calculates margin levels, stress tests its members’ trading positions, and maintains its own critical computer systems, the people said.


    Options Clearing protects against market meltdowns through a combination of margin accounts and a $13 billion guarantee fund, which includes contributions from other traders and brokers. When the level of collateral, known as margin, is too low, sudden price moves or upticks in volatility can result in losses for traders that exceed the balance of their margin accounts.

    Brokerage firms have said the clearinghouse’s models haven't accurately estimated the size of the guarantee fund. If set too high, the amount of money firms need to post at the clearing crimps the ability to trade, which hurts market liquidity and can even spur more volatility.

    Regulators have in recent months given the green light for Options Clearing to make some changes to how it operates. In May, the SEC said the clearinghouse could use daily price data instead of monthly figures to calculate the cash cushion that traders post.

    In June, Options Clearing asked the SEC to approve a change to how it calculates the size of its guarantee fund, or the money it has in case the other collateral posted is insufficient to cover a failure.

    It said in that proposal there are “a number of limitations” to its models, which cause the size of the guarantee fund to fluctuate wildly even when volatility is fleeting. The SEC approved the change on July 27.