John Davidson has big shoes to fill. On February 20, he was approved by US regulator the Securities and Exchange Commission (SEC) as the new chief executive of US equity derivatives clearing house the OCC, replacing Craig Donohue, the CEO and executive chairman since 2016 who has returned the position of OCC chair.
Donohue, also the chief executive of CME Group from 2004 to 2012, started in his OCC tenure a programme of modernisation and increasing commercialisation at the world’s largest equity derivatives clearing house.
Donohue also repositioned in his time as chief the OCC as an advocate for the US equity options market, a nascent role that has seen in recent years the OCC represent the industry it serves in opposition to various reforms proposed by US authorities.
In his role as chief, Davidson is charged with continuing these efforts. His immediate priority however is an ambitious initiative to modernise the clearing firm’s aging technology.
The OCC’s Renaissance Initiative was mooted at the end of Donohue’s reign as chief executive in late 2018 and was officially launched in mid-January this year, just weeks before Davidson was approved as CEO.
Speaking to Global Investor Group, Davidson said his appointment as chief executive had been well-planned by Donohue, himself, OCC chief operating officer Scot Warren and the firm’s board of directors.
The launch of the Renaissance Initiative was a priority when making this transition and will remain a key challenge for Davidson for his first years in charge.
The new OCC chief executive officer told Global Investor Group: “We launched in January our Renaissance Initiative to modernise our technology infrastructure, which is a three year, multi-million dollar project. We received approval from our board to start the initiative and we have already laid the groundwork for the risk systems.”
Davidson said the plan is to replace the OCC’s 20-year old clearing system called Encore which he described as “resilient and insensitive to volume spikes but relatively inflexible”.
Renaissance aims to “redevelop and modernise the company’s risk management, clearing and data systems”. Donohue called it in January “perhaps the most important project undertaken by OCC in the past 20 years”.
Davidson said the initiative comprises three streams: “First, we are using technology to build a whole new data infrastructure which will be hosted in the public cloud. The technology lead on this is reporting directly to the Chief Information Officer.
“Second, there is a transaction processing system which handles the matched trades coming from the exchanges. To help us build the system, we are working with Stockholm-based tech firm Cinnober, which has been acquired by Nasdaq.”
Nasdaq, one of the US exchange groups that uses the OCC to clear its equity derivatives, completed in January its acquisition of Cinnober, a Stockholm, Sweden-based supplier of trading and clearing technology.
Davidson continued: “The third element is the risk management piece which uses a real-time set of models to identify risks which are then reflected in the risk margin calculations. The risk management piece, which we are developing internally, has had a head-start on the data and transaction processing functions.”
The OCC chief executive said the data, transaction and risk management development stream will run in parallel with different technology teams but Davidson placed a particular emphasis on ensuring that “we have in place the right control environment”.
“We clear some 970,000 different instruments, while single stock options are fungible on 16 exchanges each of which have different risk management environments,” said Davidson.
Miami International Holdings, the parent of the Miami International Securities Exchange, launched on February 22 its third options market called MIAX Emerald, taking to 16 the number of exchanges that use the OCC to clear their trades.
Davidson said “the Renaissance Initiative is our main internal focus, but we have of course other areas of focus”.
Under Donohue, the OCC became more vocal in its representation of the US options market and often found itself at odds with US authorities over proposed reforms that could have hurt the US options industry.
Most recently, the OCC suffered a setback in mid-February when the SEC rejected its plan to boost its cash reserves despite the US regulator having earlier backed the plan on three separate occasions.
Davidson said: “Our capital plan was disapproved in February by the SEC. When we started down this road in 2015, OCC had $25 million of operating capital, whereas thanks to Craig Donohue’s leadership now we have well over $250 million, which is above our capital target base, so we are well-capitalised and way above the capital levels set by international regulators.”
He continued: “The capital plan was a divisive issue and we are conscious that we need to work harder on some pieces of the plan. We are working with our board to develop a new capital management process.”
The new OCC chief stressed the operating capital plan was “not part of the default waterfall” rather it was “designed to protect us against operational problems” and pointed to other areas where the OCC has worked with its regulator to benefit its clearing members, such as the OCC adopting a new SEC-approved methodology to size its clearing fund
He said: “Driving greater efficiencies is something that OCC needs to continue to work on and this was the rationale for the resizing of our clearing fund, which resulted in our returning over $3 billion in capital to our clearing firms.”
Davidson said the OCC has also worked with its regulator to better protect the US options market from the prospect of clearing firm defaults.
“OCC’s clearing fund had previously been designed to handle the default of only its largest clearing member (known as Cover One) from a risk perspective but we wanted to be more robust and able to handle the possible default of our largest two clearing members (known as Cover Two).
“We made the changes to the clearing fund and our default process and worked with the SEC -- we were the first clearing house whose primary supervisory agency is the SEC to have its recovery tools and recovery wind down plan approved by them. Alongside that, we have introduced various additional enhancements to our clearing process so we are well along that path,” Davidson added.
The OCC, with its subsidiary the Options Industry Council, is also active in helping to educate policy-makers and investors on the pros and cons of trading options. Davidson believes the unique structure of the US options market – many markets clearing through a single clearing house – makes it resilient.
He said: “Diversification is an important contributor to financial security and there is more diversification in the US equity options business than people might think. For example, the fastest growing sector among exchange-traded products is exchange-traded funds which might not have stocks or indices as their underlying.”
Recently, the OCC has been raising awareness over the lack of clearing equivalence between the US and European authorities, an issue has been resolved for futures firms but not those trading options.
“This is reflected in the work we do in Washington, D.C. where we are helping the industry recognise the effects of the US regulatory regime on European firms that own OCC clearing members.”
Davidson added: “We have also been involved in the equivalence negotiation and have found the Bank of England to be very responsive in that process. They have placed OCC and a number of other central counterparties on a recognised basis for three years while we put in our applications.
He continued: “We need however the European Union to recognise the equivalence of the SEC so we can then refresh our application to be recognised in Europe, which is important for the European-based parents of various OCC clearing members.”
The OCC is a very different firm to the one that Craig Donohue joined in 2014. The challenge for Davidson is maintaining that pace of reform starting with the Renaissance Initiative.