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115th Congress } { Report
HOUSE OF REPRESENTATIVES
2d Session } { 115-810
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OPTIONS MARKETS STABILITY ACT
_______
July 10, 2018.--Committed to the Committee of the Whole House on the
State of the Union and ordered to be printed
_______
Mr. Hensarling, from the Committee on Financial Services, submitted the
following
R E P O R T
[To accompany H.R. 5749]
The Committee on Financial Services, to whom was referred
the bill (H.R. 5749) to require the appropriate Federal banking
agencies to increase the risk-sensitivity of the capital
treatment of certain centrally cleared options, and for other
purposes, having considered the same, report favorably thereon
with an amendment and recommend that the bill as amended do
pass.
The amendment is as follows:
Strike all after the enacting clause and insert the
following:
SECTION 1. SHORT TITLE.
This Act may be cited as the ``Options Markets Stability Act''.
SECTION 2. RULEMAKING.
Within 180 days of the date of enactment of this Act, the Board of
Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, and the Comptroller of the Currency shall, jointly, issue
a proposed rule, and finalize such rule within 360 days of the date of
enactment of this Act, to adopt a methodology for calculating the
counterparty credit risk exposure, at default, of a depository
institution, depository institution holding company, or affiliate
thereof to a client arising from a guarantee provided by the depository
institution, depository institution holding company, or affiliate
thereof to a central counterparty in respect of the client's
performance under a derivative contract cleared through that central
counterparty pursuant to the risk-based and leverage-based capital
rules applicable to depository institutions and depository institution
holding companies under parts 3, 217, and 324 of title 12, Code of
Federal Regulations. In issuing such rule, the Board of Governors of
the Federal Reserve System, the Federal Deposit Insurance Corporation,
and the Comptroller of the Currency shall consider--
(1) the availability of liquidity provided by market makers
during times of high volatility in the capital markets;
(2) the spread between the bid and the quote offered by
market makers;
(3) the preference for clearing through central
counterparties;
(4) the safety and soundness of the financial system and
financial stability, including the benefits of central
clearing;
(5) the safety and soundness of individual institutions that
may centrally clear derivatives or options on behalf of a
client, including concentration of market share;
(6) the economic value of delta weighting a counterparty's
position and netting of a counterparty's position;
(7) the inherent risk of the positions;
(8) barriers to entry for depository institutions, depository
institution holding companies, affiliates thereof, and entities
not affiliated with a depository institution or depository
institution holding company to centrally clear derivatives or
options on behalf of market makers;
(9) the impact any changes may have on the broader capital
regime and aggregate capital in the system; and
(10) consideration of other potential factors that impact
market making in the options market, including changes in
market structure.
SEC. 3. REPORT TO CONGRESS.
At the end of the 5-year period beginning on the date the final rule
is issued under section 1, the Board of Governors of the Federal
Reserve System shall submit to the Committee on Financial Services of
the House of Representatives and the Committee on Banking, Housing, and
Urban Affairs of the Senate a report detailing the impact of the final
rule during such period on the factors described under paragraphs (1)
through (10) of section 2.
PURPOSE AND SUMMARY
On May 10, 2018, Representative Randy Hultgren introduced
H.R. 5749, the ``Options Markets Stability Act''. The bill, as
modified by an amendment in the nature of a substitute offered
by Representative Bill Foster, directs the Federal Reserve, the
Federal Deposit Insurance Company (FDIC), and the Comptroller
of the Currency (OCC) to issue a proposed rule, and to finalize
such rule within 360 days of enactment, to adopt a methodology
for calculating the counterparty credit risk exposure under
derivative contracts pursuant to risk-based and leverage-based
capital rules.
BACKGROUND AND NEED FOR LEGISLATION
In response to the 2008 financial crisis, the Basel
Committee on Banking Supervision (Basel Committee) agreed to
modify internationally negotiated bank regulatory standards
known as the Basel Accords to increase bank capital
requirements. On July 9, 2013, the federal banking regulators,
including the Federal Reserve, Federal Deposit Insurance
Corporation (FDIC), and the Office of the Comptroller of the
Currency (OCC), issued a final rule to implement most of the
Basel III recommendations.
In addition to raising the simple leverage ratio, Basel III
established a ``supplementary leverage ratio'' (SLR) that
requires certain larger banking organizations to include
leverage exposures that are both on and off the bank's balance
sheet, which includes exposures arising from futures, options,
and other derivative transactions. The SLR was intended to be
``a simple, transparent, non-risk based leverage ratio to act
as a credible supplementary measure to risk-based capital
requirements.'' All banks with at least $250 billion in total
assets and $10 billion in foreign assets must meet an SLR of 3
percent. Banks subject to these rules were required to meet the
SLR beginning in January 2018.
Under Title VII of Dodd-Frank, certain over-the-counter
(OTC) swaps were required to be centrally cleared in order to
take advantage of the risk mitigating benefits of clearing. As
a result, the role of clearing members and the amount of
transactions cleared by these institutions has expanded
significantly. However, businesses and end-users that use
futures and swaps to manage business risks can only trade
cleared derivatives through a clearing member, as they cannot
access clearinghouses directly.
Recently, in its October 6, 2017 Report on Capital Markets,
issued pursuant to President Trump's February 3, 2017 Executive
Order, the Department of Treasury identified the SLR as a risk-
insensitive capital rule that is discouraging central clearing
and increasing costs to customers. The Treasury's report noted
two particular problems with the SLR. The first--the treatment
of initial margin--is addressed by H.R. 4659. The second
problem--the current approach for calculating exposure for
cleared options--is addressed by H.R. 5749.
Under the Basel III rules, banks are required to calculate
charges for cleared options using the standardized approach
known as the Current Exposure Method (``CEM''). CEM is not
properly calibrated for options because it is not sufficiently
risk-sensitive, resulting in higher leverage ratio capital
requirements for certain derivatives products (including
exchange-traded derivatives) relative to risk-based measures.
The CEM model, for example, requires options contracts to be
sized on their notional face value rather than allowing for a
risk adjustment to notional to reflect the actual exposure
associated with these derivatives. Specifically, CEM does not
permit a delta adjustment for the notional value measurement of
options. Implementing a rule that would allow for a more risk-
adjusted approach to value centrally-cleared options as it
relates to capital rules will better and more accurately
reflect exposure and promote options market-marking activity.
As IOSCO (the International Organization of Securities
Commissions) noted the importance of market making in a May
1999 paper, ``The market maker in general adds to the
stability, liquidity and transparency (i.e. price discovery
mechanism) of financial markets.''
Moreover, the CEM measures exposures on a gross basis and
is, therefore, overly restrictive in permitting netting and the
offsetting of long and short positions. Typically, for example,
market makers and others who maintain hedged positions will
execute and clear offsetting trades. When done through the same
Central Counterparty (CCP), the risk of such hedged positions
is reduced, or even eliminated. The CEM, however, applies
separately--on a gross basis--to each of the offsetting
positions, compounding the capital that hedged traders' Futures
Commissions Merchants (FCMs) must set aside, even though the
hedged position has reduced exposure overall. By contrast, a
trader with an unhedged, directional position--by definition
more risky than a hedged position--will, from a CEM
perspective, have less exposure than a hedger with two
offsetting trades. Modernizing this calculation will
incentivize the use of hedged positions, reduce the amount of
capital required to place those positions, and reduce overall
risk exposure.
Options have sensitivity to the price of the underlying
stock, such that at any given point in time, the value of an
option will respond differently to changes in the price of the
option's underlying shares. This market sensitivity is referred
to as an option's delta. The CEM fails to account for the delta
of options and fails to fully recognize the offsetting of
positions with opposite economic exposure--i.e., long positions
and short positions. Thus, the CEM requires banking
organizations to hold capital that is disproportionate to the
actual risks posed by a bank-owned clearing firm's listed
options business. Accordingly, the CEM constrains the ability
of options market-makers to accumulate positions (even
offsetting positions), which hinders their ability to provide
liquidity. The knock-on effects are increased costs to
investors, heightened possibility of market dislocation during
volatile environments, and the discouragement of centrally-
cleared products that help limit systemic risk.
To remedy these problems, H.R. 5749, as amended, will
require the Federal Reserve Board, the OCC, and the FDIC to
issue a proposed rule to adopt a methodology for calculating
the counterparty credit risk exposure under exchange-listed
derivative contracts pursuant to risk-based and leverage-based
capital rules. In devising such methodology, the banking
regulators shall consider, among other things, the availability
of liquidity provided by market makers during a period of high
volatility, spreads between bids and quotes, the preference for
central clearing, the safety and stability of the financial
system and clearing institutions, the benefits of central
clearing, and the inherent risk of the positions.
The bill also requires the banking regulators to consider
the economic value of an offset using ``delta weighting'' and
``netting'' of correlated positions in the calculation. Delta
weighting takes into account the price sensitivity of a
derivative relative to changes in the price of the underlying
asset and is the number of points than an option's price is
expected to move for each one-point change in the underlying
asset. Delta provides an indication of how the option's value
will change with respect to price fluctuations in the
underlying instrument, assuming all other variables remain the
same. Netting acknowledges that counterparties may have
correlated positions where one party is long and another is
short on a specific position. Both of these policy changes can
be found in the Basel Committee on Banking Supervision's
``Standardized Approach for Counterparty Credit Risk
Exposures'' (SACCR), a more risk-sensitive method. The Basel
Committee agreed to replace CEM with SACCR by January 2017, but
the transition to SACCR is not imminent in the United States.
HEARINGS
The Subcommittee on Capital Markets, Securities, and
Investments held a hearing examining matters relating to H.R.
5749 on February 14, 2018.
COMMITTEE CONSIDERATION
The Committee on Financial Services met in open session on
June 14. 2018, and ordered H.R. 5749 to be reported favorably
to the House as amended by a recorded vote of 54 yeas to 0 nays
(recorded vote no. FC-188), a quorum being present. Before the
motion to report was offered, the Committee adopted an
amendment in the nature of a substitute offered by Mr. Foster
by voice vote.
COMMITTEE VOTES
Clause 3(b) of rule XIII of the Rules of the House of
Representatives requires the Committee to list the record votes
on the motion to report legislation and amendments thereto. The
sole recorded vote was on a motion by Chairman Hensarling to
report the bill favorably to the House as amended by a recorded
vote of 54 yeas to 0 nays (recorded vote no. FC-188) a quorum
being present.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
COMMITTEE OVERSIGHT FINDINGS
Pursuant to clause 3(c)(1) of rule XIII of the Rules of the
House of Representatives, the findings and recommendations of
the Committee based on oversight activities under clause
2(b)(1) of rule X of the Rules of the House of Representatives,
are incorporated in the descriptive portions of this report.
PERFORMANCE GOALS AND OBJECTIVES
Pursuant to clause 3(c)(4) of rule XIII of the Rules of the
House of Representatives, the Committee states that H.R. 5749
will incentivize the use of hedged positions and reduce the
amount of capital required to place positions and reduce
overall exposure within option contracts.
NEW BUDGET AUTHORITY, ENTITLEMENT AUTHORITY, AND TAX EXPENDITURES
The Committee has not received an estimate of new budget
authority contained in the cost estimate prepared by the
Director of the Congressional Budget Office pursuant to Sec.
402 of the Congressional Budget Act of 1974. In compliance with
clause 3(c)(2) of rule XIII of the Rules of the House, the
Committee opines that H.R. 5749 will not establish any new
budget or entitlement authority or create any tax expenditures.
CONGRESSIONAL BUDGET OFFICE ESTIMATES
The cost estimate prepared by the Director of the
Congressional Budget Office pursuant to Sec. 402 of the
Congressional Budget Act of 1974 was not submitted timely to
the Committee.
FEDERAL MANDATES STATEMENT
This information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995.
The Committee has determined that the bill does not contain
Federal mandates on the private sector. The Committee has
determined that the bill does not impose a Federal
intergovernmental mandate on State, local, or tribal
governments.
ADVISORY COMMITTEE STATEMENT
No advisory committees within the meaning of section 5(b)
of the Federal Advisory Committee Act were created by this
legislation.
APPLICABILITY TO LEGISLATIVE BRANCH
The Committee finds that the legislation does not relate to
the terms and conditions of employment or access to public
services or accommodations within the meaning of the section
102(b)(3) of the Congressional Accountability Act.
EARMARK IDENTIFICATION
With respect to clause 9 of rule XXI of the Rules of the
House of Representatives, the Committee has carefully reviewed
the provisions of the bill and states that the provisions of
the bill do not contain any congressional earmarks, limited tax
benefits, or limited tariff benefits within the meaning of the
rule.
DUPLICATION OF FEDERAL PROGRAMS
In compliance with clause 3(c)(5) of rule XIII of the Rules
of the House of Representatives, the Committee states that no
provision of the bill establishes or reauthorizes: (1) a
program of the Federal Government known to be duplicative of
another Federal program; (2) a program included in any report
from the Government Accountability Office to Congress pursuant
to section 21 of Public Law 111-139; or (3) a program related
to a program identified in the most recent Catalog of Federal
Domestic Assistance, published pursuant to the Federal Program
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No.
98-169).
DISCLOSURE OF DIRECTED RULEMAKING
Pursuant to section 3(i) of H. Res. 5, (115th Congress),
the following statement is made concerning directed rule
makings: The Committee estimates that the bill requires a
directed rule making within the meaning of such section.
Specifically, the bill directs the Federal Reserve, the Federal
Deposit Insurance Company (FDIC), and the Comptroller of the
Currency (OCC) to issue a proposed rule, and to finalize such
rule within 360 days of enactment, to adopt a methodology for
calculating the counterparty credit risk exposure under
derivative contracts pursuant to risk-based and leverage-based
capital rules.
SECTION-BY-SECTION ANALYSIS OF THE LEGISLATION
Section 1. Short title
This Section cites H.R. 5749 as the ``Options Markets
Stability Act''.
Section 2. Rulemaking
This section requires the Federal Reserve Board, the OCC,
and the FDIC to issue a proposed rule, and to finalize such
rule within 360 days of enactment, to adopt a methodology for
calculating the counterparty risk exposure under exchange-
listed derivative contracts pursuant to risk-based and
leverage-based capital rules. It also sets forth issues that
should be considered in issuing such rule.
Section 3. Report to Congress
This section requires the Federal Reserve Board to issue a
report to Congress--at the end of the 5-year period beginning
on the date the final rule is issued--detailing the impact of
the final rule during that period on the factors described in
section 2.
CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED
H.R. 5749 does not repeal or amend any section of a
statute. Therefore, the Office of Legislative Counsel did not
prepare the report contemplated by clause 3(e)(1)(B) of rule
XIII of the House of Representatives.
[all]
