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The Role of Central Clearing and How it Could be Applied to Securities Lending

June 29, 2016

OCC, in its role as a Systemically Important Financial Market Utility, serves 14 options exchanges, four futures exchanges, two securities lending programs and approximately 115 clearing member firms. OCC operates under the jurisdiction of the U. S. Securities and Exchange Commission (SEC) and the U.S. Commodity Futures Trading Commission (CFTC), and clears transactions for put and call options on common stock and other equity issues, stock indexes, foreign currencies, interest rate composites, stock loan, and single stock futures. As a registered derivatives clearing organization under CFTC jurisdiction, OCC offers clearing and settlement services for transactions in futures and options-on-futures contracts.

As the foundation for secure markets, OCC now is working to expand its securities finance capabilities. OCC is the only U.S. central counterparty (CCP) for equity stock loan transactions where it guarantees return of stock or cash to stock loan participants.

This service was created based on demand from market participants. OCC's stock loan program began in 1993 with 10 clearing member firms, and it allowed market-making firms to offset their option positions with stock loan positions, reducing their OCC margin requirement as there were margin requirements on both their bilateral stock loan positions and the related transactions cleared at OCC.

At the start, transactions numbered under a few hundred a day. Today, there are now 70 OCC clearing members conducting an average of 5,000 transactions daily with open interest measuring approximately $190 billion. Clearing volume at OCC increased 16 percent in 2015 with notional value growth up over 1,100 percent since 2011. In May 2016, OCC's securities lending CCP activity was up 52 percent with over 167,000 transactions, and year-to-date activity is up 46 percent from 2015 with over 787,000 new loan transactions so far in 2016.

We estimate that OCC presently clears about 10-15 percent of the $2 trillion U.S. equities stock loan market. This growth reflects a continued shift toward CCP clearing.

Regulatory change is creating a tailwind for cleared solutions, resulting in demand for CCPs to expand the solutions they provide to the market. As new regulations create a more resilient financial services industry, they have also introduced higher capital requirements that impact costs for bank-owned broker dealers. As a result, our program has evolved over time from providing margin efficiencies to delivering capital and credit efficiencies.

Migration to a CCP solution becomes more efficient for banks and agent lenders from a capital usage perspective. The cost differential created by the capital efficiencies between cleared and un-cleared solutions will likely result in bifurcated pricing for the asset owners, i.e., to preserve or enhance revenue streams they will need to participate in cleared solutions.

The opportunities for credit, capital and collateral efficiencies make OCC a compelling value proposition for market participants. We are working with an industry coalition to refine the collateral model to allow for expanded participation in our clearing solution. We know participants want to keep aspects of bilateral trading intact, namely the relationship with their counterparties.

We are designing the processing and operational framework that the market needs to function so we can build the technological, risk management and regulatory framework to support it. We intend to continue working in a very collaborative fashion to determine the future direction of cleared stock loan.

Scot Warren is Executive Vice President, Business Development, for OCC, the world's largest equity derivatives clearing house and the foundation for secure markets.