After 40 years as a relatively quiet clearing utility, the OCC has recently been shaken up. In just the past couple of years, the organization has seen dramatic changes in its leadership, staff, board and structure as it responds to new, more demanding regulatory requirements and a changing environment.
Perhaps the biggest change has been the OCC’s new designation in the wake of massive regulatory changes since the financial crisis. In July 2012 the Financial Stability Oversight Council, established under the Dodd-Frank Wall Street Reform and Consumer Protection Act, designated the OCC as a “systemically important financial market utility” (SIFMU). OCC was one of several clearinghouses and institutions to be marked as such, a major market structure reform that is designed to help prevent the “too big to fail” financial firms that led to the 2008 crisis.
That also means that the OCC is under increased regulatory scrutiny, overseen by three regulatory entities: Securities and Exchange Commission, Commodity Futures Trading Commission and Federal Reserve.
In October 2013, the SEC sent the OCC what Bloomberg called a “hair raising” letter chastising the organization for systemic weaknesses in its risk management and operations and saying it had not done a good enough job managing conflicts of interest on its board. The letter didn’t charge the clearinghouse with any wrongdoing but said its organizational structure had led to a lapse in oversight, according to the Wall Street Journal. Organizational changes have followed.
The OCC was already preparing for its first leadership change since its inception in 1973. Wayne Luthringshausen, who served as both executive chairman and CEO, retired at the end of 2013 after running the OCC for its entire 40 years.
The OCC board split the role of chairman and chief executive officer. Craig Donohue, the former CEO of CME Group, entered as executive chairman of OCC in January 2014, succeeding Luthringshausen. Mike Cahill was promoted to president and CEO. But Cahill surprised the industry and many at the OCC by announcing his plan to step down at the end of 2014 after only 14 months in the dual president and CEO post and 32 years at the organization.
Since taking the reins at OCC, Donohue has been focused on many of the SIFMU requirements. The changes pertaining to the SIFMU designation are “really all about enhancing our resiliency to systemic risks and shocks in the marketplace,” said Donohue, who spoke with JLN at the OCC’s Chicago offices. “The OCC, like most of the other major clearinghouses, has already been judged to have been truly effective in mitigating risks through central clearing party mechanisms.”
When the 2008 crisis occurred, various banking institutions stopped trading OTC derivatives and extending bilateral credit to other institutions. In short, the OTC markets were gridlocked, for fear that counterparties were weak or might collapse as Lehman Brothers had, and the transparency along the bilateral chain of OTC trades was nonexistent.
“But in the listed markets everything, in contrast, worked very well,” Donohue said.
That led to a regulatory shift to central counterparty clearing to mitigate bilateral credit risk.
“Along with that compliment came the recognition that clearing houses are systemically important and that as you transfer more market activity onto clearinghouses you further concentrate risk in those clearinghouses.” he said. “I agree with that.”
In a speech to the Risk USA Conference and SIFMA Listed Options Symposium earlier this year, Donohue said the expanded oversight of clearing meant “that regulatory standards for clearing houses are now similar to those in place for complex, systemically important banking institutions.”
And that means the OCC is now “very policy driven, very procedure driven — we have strong documenting of internal controls, elaborate stress testing, we do very comprehensive compliance testing, internal auditing, validation of all models that we use for margining.”
They also have more financial resources and cushioning requirements, he said. The organization just resized its clearing fund, which now holds about $7.8 billion, and increased its committed liquidity facility, which enables it to immediately borrow from banks and other institutions to meet its settlement obligations.
OCC also intends to expand its credit facilities from $2 to $3 billion. In addition to bolstering capital and enhancing risk control standards, the OCC will add about 100 employees to its staff in 2015, Donohue said.
The organization has seen significant turnover since Donohue has taken his post, with a number of high profile departures and several C-suite hires. In recent months, OCC has hired Kimberly McGarry as CFO and Laurie Flom as new head of enterprise risk management, along with Tracy Raben as head of human resources. Michael McClain, COO, is taking on the added role of president at the end of the year, and the organization is looking to fill Cahill’s CEO post. It is also looking to fill two more seats on its board of directors, increasing the number of public directors from three to five and adding to the diversity of the board.
“So that’s six key searches we have been executing on in the last six months, I think with great success,” Donohue said. “The hope is we’ll move quickly through the CEO search the same as with the other searches. We’re focused on building the bench strength of the management team.”
As for conflicts of interest on the board, Donohue countered that there has not been a conflict of interest that resulted in bad decision-making or harm to the organization, its stakeholders, or the public interest.
“There is certainly a focus on making sure that any conflicts of interest are handled properly and that where they exist there is a process of identifying them, disclosing them, and if needed recusing people from participation,” Donohue said. “We do have very effective processes and procedures we use for that.”
“These kinds of issues are always relevant in an industry utility or mutualized organization, because by definition you’ve created a structure and entity where industry representation is not only wanted but needed. So, there are times when the stakeholders here may want to launch a particular type of product that others have concerns about. Or we may want to expand our clearing services in ways our clearing firms would prefer we not. There are those potential conflicts, but they are endemic to the organization because it is a utility.”
With the increased regulatory demands and working capital mandates, the OCC was forced to increase costs for options market participants. The OCC raised its fees in April to cover the cost of the new requirements, which Donohue explained to a packed auditorium at the Options Industry Conference in Austin, Texas in May. Though many at the conference grumbled about higher fees, no one challenged Donohue publicly in announcing the increase, which is designed to bolster its working capital that will help with payouts in the event of a default.
When Donohue first joined the organization in January it had about $25 to $30 million for its net working capital, he said.
“In my remarks at the options industry conference in Austin in May, I said I thought it was self-evident that a central counterparty that holds $100 billion in other people’s money should be better capitalized than $30 million,” he said. “That was about a month and a half of our operating expenses at the time.”
The OCC also has told members that refunds would be much smaller than they had been in the past. (The OCC regularly returns refunds to its members when there is a surplus.)
There is also an SEC proposal to require clearing agencies like OCC to maintain significant minimum regulatory capital for the first time. The requirements are not yet final, but they will certainly be significantly in excess of the kind of capital the organization had at the beginning of this year, Donohue said.
“Nobody likes higher fees and I respect that,” Donohue said. “But I think there is a recognition that what OCC does is critical to the success of the industry. One reason we’ve been so successful for 40 years is that market participants have tremendous confidence in OCC, that their trades will be valid and their obligations will be performed.”