March 18, 2020

The Honorable Randal K. Quarles

Vice Chair for Supervision
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, D.C. 20551

Re: Emergency Interim Relief

Dear Vice Chair Quarles:

We are contacting the Board of Governors of the Federal Reserve System (the “Board”) to request
temporary emergency relief that is needed in the exchange-traded options market. As previously
highlighted, 1 the Current Exposure Method (“CEM”), which must be utilized by bank-affiliated options
clearing firms when calculating counterparty credit risk of clients, is adversely impacting liquidity provision
in the options market. By contrast, the eventual implementation of the Standardized Approach for
Counterparty Credit Risk (“SA-CCR”) will unlock market-maker liquidity and reduce the risk of market
dislocation that can be caused by CEM. However, SA-CCR implementation is not imminent, and CEM is
compromising needed liquidity provision in this volatile environment. Our exchange markets have held
up during this incredible period of market stress, but, as discussed below, it is critical to extend immediate
relief from the effects of CEM on the options markets. We believe the relief requested herein is
straightforward, modest and would significantly facilitate liquidity provision during these times of severe
market stress. We appreciate your attention and swift action.

Current Exposure Method

CEM is not sufficiently risk-sensitive as it does not account for the delta (i.e., market sensitivity) of an
options position or fully recognize the offsetting of positions with opposite economic exposures. More to
the point, CEM’s insensitivity to risk forces banking organizations that clear options market-makers’
positions to hold capital that is well in excess of what is necessary to fully cover the actual risk posed by
market-maker portfolios. This, in turn, limits options market-makers’ ability to freely deploy liquidity,
especially when it is most needed. In fact, limiting the size of the portfolios held by options market-makers
(i.e., implementing risk-weighted asset (“RWA”) limits) results in market-maker behavior that is
antithetical to making markets, notably, exiting positions (becoming takers of liquidity) in order to adhere
to artificial month/quarter-end limits. This has become a structural reality of the exchange-traded options

1
See Letter from Angelo Evangelou, Chief Policy Officer, Cboe Global Markets, to the Board, FDIC, and OCC in
response to the proposal to adopt the Standardized Approach to Counterparty Credit Risk (March 18, 2019),
available at, http://www.cboe.com/aboutcboe/government-relations/pdf/sa-ccr-comment.pdf.
March 18, 2020
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market despite the fact that options market-maker portfolios actually present a fraction of the risk
apportioned by the CEM methodology.

Market Conditions
Concerns related to the coronavirus (“COVID-19”) were a catalyst for recent market activity – increased
volatility, volumes, and market stress. In short order the Cboe Volatility Index (“VIX”) has risen from an
intraday low of 16.19 on February 21 to an intraday high of 49.48 on February 28 to a closing level of 82.69
on March 16 – the highest closing VIX level of all time and largest since the 2008 financial crisis. 2 In such
times, individuals and institutions seek to protect their portfolios, flocking to the exchange-traded options
market to do so. Importantly, the counterparties that investors trade against in order to manage risk are
overwhelmingly professional options market-makers. By way of example, this month, over 90% of volume
in S&P 500 Index options transacted with liquidity supplied by registered market-makers. This means that
when the entire market is seeking downside protection it is options market-makers that absorb inventory
and take the risk of further downside moves. 3 This is an invaluable service during normal markets, and a
critical service during times of market stress. While options market-makers have performed admirably,
the application of CEM structurally prevents them from fully deploying their liquidity capabilities. This of
course impacts pricing for investors and could potentially impact the ability of individuals and institutions
to properly manage risk. As important, however, is the fact that CEM causes options market-makers to
become takers of liquidity to a greater extent than they otherwise would be as they attempt to stay under
their RWA limits. This is exceptionally concerning when markets are stressed as it means the participants
most relied upon to provide liquidity (market-makers) are unable to do so effectively, which risks further
exacerbating market volatility.

Furthermore, recent market conditions have been such that market-makers are now at significant risk of
reaching their RWA limits. If these limits are reached, market-maker firms would be faced with the choice
to not trade at all (as that would cause them to exceed their limits) or exit much larger, likely market
impacting, positions. Either scenario would have serious negative implications with unknown magnitude.

SA-CCR
In the interest of adapting CEM’s structure to evolving market conditions, the Board approved CEM’s
replacement—SA-CCR.4 As mentioned previously, SA-CCR’s implementation will unlock market-maker
liquidity and reduce the risk of market dislocation that can be caused by CEM. That said, SA-CCR is an
expansive rulemaking that covers much more than a bank’s options clearing segment. Therefore, even
though banks may adopt SA-CCR as early as April 2020, the fact that they must do so in its entirety and
bank-wide means bank implementation is highly complex and unlikely to occur that quickly. Of greatest
concern, in no event in the ordinary course is SA-CCR available this month.

Recent market activity has made it clear that this targeted relief should not wait.

2
Today the VIX level exceeded 85.
3
Options market-makers are proprietary trading firms trading their own capital. They do not have clients and are
first and foremost professional liquidity providers with regulatory obligations to publicly disseminate prices at which
they are willing to buy and sell. Ultimately, these firms are experts in managing risk. While they accumulate large
portfolios of options as market participants proactively trade against the passive liquidity provided by the market-
makers’ public quotes, the positions are hedged and risk mitigated.
4
Standardized Approach for Calculating the Exposure Amount of Derivative Contracts – Finale Rule, 85 FR 4362
(January 24, 2020).
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Request for Relief

We implore the Board to exercise its considerable authority to grant relief in order to expand clearing
capacity during a time of extraordinary market stress. Specifically, we request the Board take any
combination of the following, immediate and near-term, steps:

1) allow banking organizations to immediately discount exchange-traded options positions cleared

on behalf of options market-makers thereby reducing RWA associated with professional liquidity
provision;
2) provide assurances that the requirement to use CEM for purposes of calculating exposures arising
from a clearing guarantee related to exchange-traded options will not be enforced for the
remainder of 2020 or some other period;
3) allow banking organizations to adopt SA-CCR before the end of March 2020 solely for purposes of
calculating exposures arising from a clearing guarantee related to exchange-traded options,
regardless of whether the banking organization adopts SA-CCR early bank-wide; and/or
4) allow banking organizations to immediately adjust risk weights within CEM 5 for purposes of
calculating exposures arising from a clearing guarantee related to exchange-traded options until
such time as SA-CCR is adopted.

Relief is necessary to ensure options market-makers continue to have sufficient clearing capacity, which
is paramount for them to be able to provide liquidity. Given the current historic levels of market volatility,
uncertainty related to COVID-19, and the temporary closing of trading floors (an important source of
liquidity) and other steps taken to ensure the health and safety of people across the industry, anything
that can be done to alleviate liquidity constraints is worth considering.

The Board has broad authority to adjust risk weights to more accurately reflect the risks of particular
exposures. 6 Regulation Q provides that “[i]f the Board determines that the risk-weighted asset amount
calculated under [Regulation Q] by the Board-regulated institution for one or more exposures is not
commensurate with the risks associated with those exposures, the Board may require the Board-
regulated institution to assign a different risk-weighted asset amount to the exposure(s) or to deduct the
amount of the exposure(s) from its regulatory capital.” 7

We believe the CEM methodology fits squarely within the purpose of Regulation Q as the CEM
methodology results in calculated risk-weighted assets that are not commensurate with the risk
associated with those exposures. The Board’s move from CEM to SA-CCR and focus on risk-sensitivity of
SA-CCR implies the Board agrees. In adopting SA-CCR, the Board stated that “SA-CCR provides important
improvements to risk sensitivity and calibration relative to CEM and is responsive to concerns that CEM

5
Pursuant to 12 C.F.R. § 3.34; § 217.34; and § 324.34, the PFE for a single option is currently calculated by multiplying
the notional principal amount (𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 ∙ 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎) of the derivative by the appropriate conversion factor (“CF”)
found in Table 1 of § 3.34; § 217.34; and § 324.34. We are seeking the inclusion of a measure of market sensitivity
in the PFE calculation, such as delta (“𝛿𝛿”), which represents the ratio of the change in the value of options to the
corresponding change in the price of the underlying security or index. For example: 𝑃𝑃𝑃𝑃𝑃𝑃 = 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 ∙ 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 ∙
|𝛿𝛿| ∙ 𝐶𝐶𝐶𝐶
6
See e.g., Letter from Board to Gregory J. Lyons, dated Aug. 15, 2006; Letter from Board to Fred Gonfiantini (Morgan
Stanley & Co, Inc.), dated April 10, 2009; Letter from Board to Alton E. Yother (Regions Financial Corporation), dated
Dec. 18, 2007; Letter from Board to Jeffrey D. Landau (The Bank of New York Mellon), dated Dec. 17, 2007; Letter
from Board to John C. Gerspach (Citigroup Inc.), dated June 15, 2007.
7
12 C.F.R. 217.1(d)(3).
March 18, 2020
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has not kept pace with market practices used by large banking organizations that are active in the
derivatives market.” 8

This request does not require the Board to assess or consider new policy. The Board has made the policy
determination to move from CEM to SA-CCR, embracing the move away from a risk-insensitive
methodology. Thus, this relief request simply allows risk-sensitivity to be embedded into banks’ risk-
weighted asset calculations for purposes of clearing exchange-traded options earlier than would
otherwise be adopted.

In addition to Regulation Q, the Board has authority to implement interim final rules 9 and adopt policy
statements 10 and undoubtedly has additional powers to bear. Ultimately, we are agnostic as to the
method of Board assistance, but Board action is necessary to establish appropriate clearing capacity and
ensure liquidity is sustained during this period of market stress. We urge the Board to swiftly provide
relief from the detrimental impact of CEM. The relief is needed before quarter-end and month-end limits
are compromised. Any such relief would help free up much needed liquidity in the exchange-traded
options market and would help bridge the gap from a stated regulatory preference for SA-CCR to actual
implementation of SA-CCR. We stand ready to work with the bank regulatory agencies on this important
matter.

Sincerely,

Edward T. Tilly Stacey Cunningham Tal Cohen

Chairman, President & CEO President EVP, Head of North
Cboe Global Markets NYSE Group American Market Services
Nasdaq

CC: The Honorable Jerome H. Powell, Chairman, Board of Governors of the Federal Reserve System
The Honorable Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation
The Honorable Joseph M. Otting, Comptroller, Office of the Comptroller of the Currency
The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission
The Honorable Heath P. Tarbert, Chairman, U.S. Commodity Futures Trading Commission

8
See note 3 at 4369.
9
See e.g., Regulatory Capital Rule: Eligible Retained Income – Interim Final Rule, (March 17, 2020), available at,
https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20200317a2.pdf (adopting interim final rule
due“[i]n light of recent disruptions in economic conditions caused by the coronavirus disease 2019 (COVID-19) and
current strains in U.S. financial markets”).
10
See e.g., Interagency statement regarding the impact of the Economic Growth, Regulatory Relief, and Consumer
Protection Act (July 6, 2018), available at,
https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20180706a1.pdf (identifying rules the
Board will not enforce).