The privately held financial-market utility that settles and clears transactions for all 15 U.S. option exchanges and 3 futures exchanges has a problem: Its technology is woefully outdated.
That’s not quite the disaster it may seem. Options Clearing Corp.’s existing, 20-year-old system is “incredibly stable and still manages our processes on a daily basis, well within the [service-level agreements] we’ve set with our clearing members,” says Amy Shelly, OCC’s finance chief.
The problem, though, is that the current system was built in a fully integrated fashion, whereas most of today’s best-of-breed software tools are more modular in nature. That scenario hinders OCC from improving its technological capabilities and operating with optimal efficiency.
Shelly is a point person for a recently begun project to completely replace OCC’s technology within three to four years. It’s the biggest strategic priority for the clearinghouse, a for-profit organization that’s regulated by both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).
The duties Shelly performs are somewhat different from those of a typical CFO, although they resemble those of finance chiefs at public power utilities, for example.
About 90% to 95% of OCC’s revenue is derived from fees for its clearing and settlement services, according to Shelly. Under its SEC-approved capital plan, half of its pre-tax profit is distributed to its approximately 115 clearing members (U.S. broker-dealers, U.S. Futures Commission merchants, and non-U.S. securities firms representing both professional traders and public customers). The other half of the earnings is tax-effected and distributed as dividends to the five securities exchanges that own the company.
(A group of the exchange members has pursued a legal action challenging the capital plan, which has been in effect since September 2015. Before that, exchange members received 100% of OCC’s pre-tax profits. In August of this year, a federal appeals court ruled that the SEC approved the capital plan without sufficiently reviewing it and “effectively abdicated that responsibility to [OCC].” The court ordered the SEC to conduct a more thorough review of the capital plan.)
OCC, which was designated as a “systemically important financial market utility” (SIFMU) under the Dodd-Frank Act, doesn’t take any actions that influence the volume of transactions it handles. Shelly and her finance team do have input on recommendations OCC makes to the regulators on the clearing fees that it’s allowed to charge.
The organization also manages the risk it takes on, as guarantor that the obligations under the contracts it clears are fulfilled, by setting the clearing members’ “margins” — the funds they’re required to post that serve as insurance against OCC’s risk.
With its technology transformation, OCC may opt to build proprietary functionality to handle its risk management activities, as there’s likely nothing adequate that’s commercially available, Shelly says. That problem probably won’t apply to new systems for clearing and settling transactions, for which there are commercial applications used by other clearinghouses. The roster of vendors OCC is looking at for that portion of its technology needs has been winnowed to three or four.
But financing the new technology could prove tricky. OCC is required to maintain liquid net assets equal to or greater than its shareholders’ equity, which currently weighs in at $247 million.
“We have to be very mindful of how much cash we use,” Shelly says. “We may have to create some sort of financing package deal.” Such a deal could resemble a sale-leaseback agreement with a bank that OCC used to finance the recent construction of a new facility in Dallas. The deal granted OCC the right to buy the assets back at the end of the deal’s term. However, no final decisions have been made regarding financing for the technology transformation.
Aside from operational efficiency, another goal of the technology upgrade is to “free up our development time so that we are in a better position to bring to market the new products we are being asked for,” says Shelly. Already, in addition to its options and futures clearing and settlement services, OCC operates a business that clears stock loans. That business grew 37% in 2016, exceeding 1.9 million cleared loans.
The core businesses are also growing. OCC cleared 4.17 billion option contracts in 2016, the fifth-most in its 25-year history. The organization’s volume of futures contracts cleared hit 104 million last year, the most ever.
Partly because of the massive transaction volume, OCC has struggled with the question of whether to shut off the old technology system simultaneously with switching on its new ones, or implement the latter piecemeal. “I think where we’ve landed is that we’ll try to set up our new risk management platform first, and then run the old clearing and settlement system in parallel with [the new technology] for a period of time,” Shelly says.
The implementation process will be complicated by the need to work with the clearing members, who will have to make corresponding changes to their own systems. “We don’t want to be a disruptor to the marketplace,” the CFO says.