We Like Big Brother! Why Options Exchanges Want OCC’s Eyes

May 6, 2014

Is this the holy grail of risk management? Maybe.

The OCC is the sole clearing house for the US options industry, what many would call a shining example of centralized clearing in today’s marketplace – with low clearing fees (even with the recent fee change), a straightforward focus on clearing – and with a new directive to take on a greater risk management role.

An interesting discussion percolated during the Options Industry Conference last week in Austin, Texas, where several exchange leaders promoted the concept of having OCC as THE central risk manager across the 13 US options markets.

Since it clears every US options trade, it is in the unique position of having a view of risk across the 13 different equity exchanges – every trade, every participant. That also means it could theoretically stop a rogue trader or algorithm before it sinks a firm or multiple firms.

Exchanges have been pushed by regulators over the past year to develop and roll out new risk mitigation technology and tools to pull erroneous trades or participants out of the market. And they have. The limitation to such efforts, however, is that each exchange is only able to pull out the bad trades or bad actors on its own exchange, which could leave other markets vulnerable. So why not parlay the OCC’s vantage point into a more comprehensive risk manager for the US options markets?

“OCC is the only one that’s got the ability to see broad risk across all the markets,” said Ed Boyle, senior vice president of business development and strategy at BOX. “Analyzing risk is really about the entire trade process as it goes through. This is much more of an industry effort than a single point.”

And this appears to be more than idle talk. Gary Katz, CEO of the International Securities Exchange, said that exchanges, which are the shareholders of the OCC, are actively looking at just how it could be done.

“Right now, it [the concept] is in a fact finding period,” Katz said. “With that we can develop a framework on how to move ahead. And we’re hearing support for it from firms as well. The question is how far should it drill down – to the clearing member firm, to the individual customer at the retail level?”

There are some concerns that such a system may slow down the trading process, and in the case of a major trading problem, may not move quickly enough. But Katz counters that those worries should not prevent the effort from getting off the ground.

“I’m a little concerned, when I hear almost everyone say, it’s not fast enough if we do it through OCC,” Katz said on the panel. “We can’t try to achieve perfection on day one;  otherwise, we will not be able to accomplish the ultimate goal which is to improve continuously over time.”

The initiative is filled with complexities and there are moves to harmonize the myriad of error rules on exchanges which may help the effort. Yet, for market participants, it is a step toward safer markets.


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