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SR-OCC-2024-001 = REJECTED.
Right folks, it seems our efforts in the regulatory space is paying off, and it's time for us to drive home the message to Wall Street that we mean business.
It's not about moving the goalposts when financial institutions have overextended themselves; rather, it's about fulfilling financial obligations when necessary. And we're here to work with the SEC to make this happen.
And given the spicy price action we've been seeing recently, perhaps Wall Street are starting to feel the heat 🌶️🔥
And who doesn't like to see some upward movement up in here:
With credit & appreciation to BadassTrader - and his Dorito of Doom
CREDIT: https://www.reddit.com/r/Superstonk/comments/1co6s3g/dorito_update_breakout_confirmed_hedgie/ (our very own, most excellent badasstrader).
So why are we here today?
It seems that when an idiosyncratic, volatile stock like GME poses a risk to the financial markets, regulatory bodies such as the OCC focus their efforts on implementing safeguards to protect themselves and their clearinghouse members in case of default.
Why?
Because if clearing members default in times of extreme market volatility - it will bring the rest of the financial house down with them.
And we're certainly starting to get an idea just how tentative things are getting out there in the banking and finance industry:
Uh oh.
Looks a little shaky out there.
So it makes perfect sense that the powers that be might be looking to bring in rules that are going to take the heat off.
Cue:
So let's recap:
Rule SR-OCC-2024-001 can give the OCC the authority to adjust margin thresholds in moments of high market volatility.
Like say - during a Black Swan event.
A black swan event in finance is an unexpected and highly impactful occurrence that disrupts the markets, often leading to major losses and chaos.
Like, MOASS.
Mother Of All Short Squeezes 🚀
What does this mean?
Wall Street firms (including banks, brokerage houses, and other financial institutions - like hedgefunds):
Banks like: JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup, and Bank of America Merrill Lynch etc
Or Hedge funds like: Citadel, Point72, Melvin Capital, Citron Research, and D1 Capital Partners etc
Utilise the Options Clearing Corporation (OCC) to handle the clearing and settlement of option trades.
Now, imagine some hedgefunds decided to short GME.
If options contracts are used in the shorting process, the OCC plays a role in handling the clearing and settlement of these trades.
The OCC acts as the central counterparty, ensuring the completion of options trades and managing the associated risks.
Being that these hedgefunds have taken a position betting that the price of GameStop's stock will go down (or you know, might engineer this happening by means of cellar boxing), and to do this they would have needed to borrow lots of shares of GameStop in order to sell them, all part of a plan to drive the price down. Then, they'd hope to buy those shares back later at a lower price and make a profit.
But when you borrow those shares, you usually have to put up some money, or other securities as collateral first, just in case things go a little pear shaped.
Issue is - this creates a problem for short sellers if the securities used as collateral for the borrowed stock fall in value due to market downturns, and the value of the stock you've been betting against keeps stock going up...
Like GME for example - which keeps going up:
Whereas the value of market securities are quickly diminishing. And my goodness, the market aren't looking too healthy right now:
https://reddit.com/link/1coo1ik/video/7p8j5rvexjzc1/player
So when the value of these securities (used as collateral against the bet) drops below a certain threshold set by the broker or lender, short sellers will be issued a margin call where they'd be asked to put up even more money or other assets as further collateral to cover their bet.
A margin call is essentially a demand for investors to deposit more funds or securities into their trading account to cover potential losses. Like a safety net for the lender to ensure they're protected if things go south.
And that might be hard if you're a hedge fund running out of cash.
- A loss in $38 billion for the previous 12 months reported in October can't be an easy pill to swallow. Ouch!
And failure to comply with margin calls can lead to forced liquidation of positions by the brokerage to cover the outstanding margin debt.
And this signals a big problem for short hedge funds everywhere.
🙋♀️ 🙋♂️❔What does this all mean?
Big picture time:
Have you ever played with dominoes?
The premise of the game mirrors real-life scenarios of firms defaulting, where the collapse of one firm triggers a chain reaction, similar to domino tiles toppling over and knocking down others in succession.
In the case of OCC Clearing Member defaults, this means that if, for instance, short sellers have borrowed heavy sums from the banks to fund their risky bets, those lenders (i.e the banks) are now also at risk of defaulting if they themselves can't cover the losses.
And in a scenario where MULTIPLE firms are, say, short on the same asset - like GME - hedge funds (and their lenders, aka the banks) might suddenly find themselves collectively in a very vulnerable position - especially should that very stock start moving quite rapidly upwards 🚀 which it might lead to a whole L**OAD **of defaults.
And in light of this, it seems the clearinghouse (OCC) has chosen to step in.
Why has the OCC brought in proposed rule: SR-OCC-2024-001?
The SR-OCC-2024-001 proposal aims to grant the OCC the authority to modify margin threshold parameters using undisclosed criteria to mitigate the risk of such defaults occurring.
As below:
SOURCE: https://www.sec.gov/files/rules/sro/occ/2024/34-99393.pdf
Looks like the OCC is starting to get a little nervous about their clearing members' ability to meet their financial obligations.
OCC:
🤷♀️ 🤷♂️❔ Wait a minute, Kibble. If a clearing member defaults on their financial obligations, the OCC, as the central counterparty, has an obligation to the counterparties on the other side of those short sell transactions - right?
That's right.
🤷♀️ 🤷♂️❔ So if the OCC has a fiduciary duty to ensure that counterparties of short selling, such as the shareholders of GME, are protected in the event of defaults by clearing members involved in short selling transactions - an essential responsibility for upholding the integrity and stability of the options market - why would they be creating a rule to bail out Wall Street, essentially prolonging the inevitable if they lack the financial capacity to cover their bets?
Well, you see - if multiple clearing members default, the OCC will also incur losses from having to cover those defaults. Therefore, it's indeed in the OCC's interest to prevent clearing members from defaulting - because they'll lose money too.
Trading's a tough game, ain't it Wall Street?
_____________🔥______________
There's a lot to breakdown in the proposal itself: https://www.sec.gov/files/rules/sro/occ/2024/34-99393.pdf?ref=dismal-jellyfish.com
But the headlines are:
🚩 OCC seek to change the "idiosyncratic volatility control settings" anytime a Clearing Member needs help.
🚩We don't know HOW these margin thresholds are calculated, and everything in the proposal's supporting evidence as related to this is REDACTED.
🚩The OCC want to give significant authority to role of the Financial Risk Management (FRM) for approving idiosyncratic control settings.
🚩BUT this introduces significant risk and it poses a conflict as they are required to safeguard both OCC's interests and at-risk Clearing Members.
Kinda important.
And being that this proposed rule favours Clearing Members at the expense of market fairness and investor protection, this was flagged to the SEC.
By none other than the mighty household investors.
In March, 2024 - over 2.5k investors worldwide came together to address the risks posed within the OCC's rule proposal.
Household investors submitted their comments to the SEC - flagging issues with an over reliance on idiosyncratic control settings to handle adjustments in OCC's operations when the markets face high volatility, as decided by a FRM Officer, who is also responsible for protecting the OCC's interests, creating a conflict of interest in the role.
And it was incredible.
Posts like this littered the internet as communities came together to spread the word and questions were addressed:
_____________🔥______________
Questions included:
🤷♀️ 🤷♂️ Why should the OCC adjust margin thresholds with "idiosyncratic volatility control settings" during high volatility when Clearing Members need help?
🤷♀️ 🤷♂️ If the SR-OCC-2024-001 rule is to ascertain parameters in the OCC's proprietary system for calculating margin requirements during high volatility - why are we not provided with the specific details on how these parameters will be calculated?
🤷♀️ 🤷♂️ Why entrust the OCC's FRM Officer with unchecked authority to make unilateral decisions regarding during periods of high market stress? Particularly when their role is to safeguard the OCC's interests?
FRM:
Also FRM:
And many more. You can check out some of the discussion points in this post here: https://dismal-jellyfish.com/the-exposed-threat-of-margin-erosion-and-risk-escalation/
But it worked.
The SEC took notice.
And in recognition of the flaws - coupled with calls for increased margin requirements, external auditing, and changes to loss allocation procedures to mitigate systemic risks and the promotion of market resilience as put forward, the proposal was swiftly served up on a hot steamy plate of rejection.
Which takes us quite smoothly to part two of the post.
Submitting our comments to the SEC to support the rejection of this rule.....
TL;DR
- OCC appear fearful of clearing member default toppling the market.
- Not wanting to use their own funds to bail out bad bets, they are proposing a rule to adjust margin thresholds during volatile market periods.
- SEC has rejected this proposal, and now household investors have the opportunity to support this decision to get it removed completely.
_____________🔥______________
FOR A COMPLETE VERSION OF THIS POST - CHECK OUT: https://dismal-jellyfish.com/regulatory-killshot-wall-streets-attempts-to-shift-goalposts-have-been-shut-down/
Pigeon out ✌️🐦
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