[Federal Register Volume 85, Number 54 (Thursday, March 19, 2020)]
[Notices]
[Pages 15830-15834]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-05697]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88382; File No. SR-FICC-2020-801]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Notice of No Objection To Advance Notice To Amend the Mortgage-Backed
Securities Division Stress Testing Methodology
March 13, 2020.
On January 21, 2020, Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission'') the
advance notice SR-FICC-2020-801 (``Advance Notice'') pursuant to
Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act entitled the Payment, Clearing, and
Settlement Supervision Act of 2010 (``Clearing Supervision Act'') \1\
and Rule 19b-4(n)(1)(i) under the Securities Exchange Act of 1934
(``Act'').\2\ The Advance Notice describes modifications to the
Mortgage-Backed Securities Division's (``MBSD'') stress testing
methodology, which is described in the Methodology Document--MBSD
Market and Credit Risk Stress Test Models (``Stress Testing Methodology
Document'').\3\ The Advance Notice was published for public comment in
the Federal Register on February 27, 2020,\4\ and the Commission has
received no comments regarding the changes proposed in the Advance
Notice. This publication serves as notice of no objection to the
Advance Notice.
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\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ As part of the Advance Notice, FICC filed Exhibit 3a--
Methodology Document--MBSD Market and Credit Risk Stress Models.
Pursuant to 17 CFR 240.24b-2, FICC requested confidential treatment
of Exhibit 3a.
\4\ Securities Exchange Act Release No. 34-88266 (February 24,
2020), 85 FR 11413 (February 27, 2020) (SR-FICC-2020-801) (``Notice
of Filing'').
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I. The Advance Notice
A. Background
MBSD provides trade comparison, netting, risk management,
settlement, and central counterparty services for U.S. mortgage-backed
securities market. FICC manages its credit exposures to its members by
collecting an appropriate amount of margin from each member.\5\ The
aggregate of all MBSD members' margin amounts (together with certain
other deposits required under the MBSD Rules) constitutes MBSD's
Clearing Fund, which FICC would access should a member default with
insufficient margin to satisfy any FICC losses caused by the
liquidation of the defaulting member's portfolio.\6\
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\5\ See Rule 4 (Clearing Fund and Loss Allocation) of the FICC
MBSD Clearing Rules (``MBSD Rules''), available at www.dtcc.com/legal/rules-and-procedures.aspx.
\6\ See id.
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FICC uses stress testing to test the sufficiency of its prefunded
financial resources.\7\ In contrast to FICC's margin methodologies,
which are designed to limit FICC's credit exposures under normal market
conditions,\8\ FICC's stress testing methodologies are designed to
quantify FICC's potential losses under extreme but plausible market
conditions.\9\ Therefore, stress testing is designed to help FICC
identify credit risks beyond those contemplated by FICC's margin
methodologies, including credit exposures that might result from the
realization of potential stress scenarios, such as extreme price
changes, multiple defaults, or changes in other valuation inputs and
assumptions.\10\ As a result, stress testing helps FICC identify the
amount of financial resources necessary to cover its credit exposure
under stress scenarios in extreme but plausible market conditions.\11\
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\7\ On December 19, 2017, the Commission approved FICC's
adoption of the Clearing Agency Stress Testing Framework (Market
Risk) (``Stress Testing Framework''), which among other things, sets
forth the purpose of FICC's stress testing and describes certain
methodologies FICC uses in its stress testing. Securities Exchange
Act Release No. 82368 (December 19, 2017), 82 FR 61082 (December 26,
2017) (SR-DTC-2017-005; SR-FICC-2017-009; SR-NSCC-2017-006)
(``Stress Testing Framework Order'').
\8\ See e.g., Securities Exchange Act Release No. 80253 (March
15, 2017), 82 FR 14581, 14582 (March 21, 2017) (SR-FICC-2017-004).
\9\ See Stress Testing Framework Order, supra note 7, 82 FR at
61083; Notice of Filing, supra note 4 at 11413.
\10\ See id.; 17 CFR 240.17Ad-22(a)(17).
\11\ See Stress Testing Framework Order, supra note 7, 82 FR at
61083; Notice of Filing, supra note 4 at 11413.
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FICC's stress testing methodologies have three key components.\12\
First, FICC analyzes the securities and risk exposures in its members'
portfolios to identify the principal market risk drivers and capture
the risk sensitivity of the portfolios under stressed market
conditions.\13\
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\12\ See id.
\13\ See id.
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Second, FICC develops a comprehensive set of scenarios designed
[[Page 15831]]
to test whether FICC's prefunded financial resources are sufficient to
cover losses sustained by member portfolios in such scenarios.\14\
Specifically, FICC assesses the impact on member portfolios under both
historical scenarios and hypothetical scenarios.\15\ Historical
scenarios are based on stressed market conditions as they have occurred
on specific dates in the past.\16\ In order to select historical stress
scenarios, MBSD's stress testing model selects dates from the past that
represent stressed market conditions based on the largest historical
changes of the selected risk factors. Hypothetical scenarios represent
theoretical market conditions that may not actually have occurred, but
could conceivably occur.\17\ In order to select hypothetical stress
scenarios, MBSD considers potential future events and their perceived
impact to portfolio market risk factors.
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\14\ See id.
\15\ See id.
\16\ See id.
\17\ See id.
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In developing historical scenarios for MBSD stress testing
purposes, FICC currently examines historical data to identify the
largest historical changes of two risk factors that influence the
pricing of mortgage-backed securities (``MBS''). Specifically, FICC
examines historical data to determine the sensitivity of MBS prices to
changes in interest rates and mortgage option adjusted spreads
(``OAS'').\18\ FICC currently uses its own internally-developed risk
factor historical data. FICC examines the historical data during a
rolling 10-year look-back period, with dates falling outside the 10-
year period eliminated quarterly.\19\
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\18\ OAS is the yield spread added to a yield curve necessary to
match the discounted present value of an MBS's cash flows to its
market price. The OAS reflects a credit premium and the option-like
characteristic of an MBS in that it incorporates prepayment. See
Notice of Filing, supra note 4 at 11413-14.
\19\ FICC retains and applies certain historical scenarios
beyond the 10-year data range because such events have had a
significant impact on the financial markets, including, for example,
May 29, 1994 (when the Federal Reserve significantly raised rates),
October 5, 1998 (when the Long-Term Capital Management crisis
occurred), and September 11, 2001. See Notice of Filing, supra note
4 at 11415.
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Third, to measure and aggregate the applicable risks, FICC applies
the historical and hypothetical scenarios described above to MBSD
member portfolios (1) to analyze the potential losses on each portfolio
in relation to margin amounts collected, and (2) to analyze the effects
that potential losses on member portfolios during stress scenarios
might have on FICC's prefunded financial resources. Specifically, FICC
calculates the stress profits-and-losses under each stress scenario and
determines the loss amount exceeding a member's margin for each
scenario (``Member Deficiency''). FICC further combines the Member
Deficiencies of the member and the member's affiliated family (that are
also MBSD members) (``Affiliated Family Deficiency''). FICC calculates
the ratio of an Affiliated Family Deficiency over the total value of
the MBSD Clearing Fund excluding the sum value of the applicable
affiliated family's margin.\20\
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\20\ 17 CFR 240.17Ad-22(e)(4) requires a covered clearing
agency, such as FICC, to establish, implement, maintain and enforce
written policies and procedures reasonably designed to monitor and
manage its credit exposures to participants and those arising from
its payment, clearing, and settlement processes, including by
maintaining sufficient prefunded financial resources at a minimum to
enable the clearing agency to cover the default of the member
(including relevant affiliates) that would potentially cause the
largest aggregate credit exposure for the clearing agency in extreme
but plausible conditions (``Cover 1 Requirement'').
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Currently, in determining the potential losses to a member's
portfolio under a stress scenario, FICC applies a profit-and-loss
calculation that multiplies a set of risk factor stress movements by
the sensitivity (i.e., the percentage value change in response to the
stress movements) of the securities in the portfolio. FICC estimates
MBS risk sensitivities based on two interest rate risk factors and an
OAS risk factor by using a regression model with a two-month look-back
period.\21\
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\21\ Regression is a statistical approach that FICC uses to
determine the coefficient range used in the stress profit-and-loss
calculation. See Notice of Filing, supra note 4 at 11415.
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B. Proposed Changes to MBSD's Stress Testing Methodology
1. Changes to the Scenario Selection Process
As proposed in the Advance Notice, FICC would continue to examine
historical risk factor data on interest rates and OAS. However, FICC
proposes to add two new risk factors--interest rate volatility \22\ and
mortgage basis \23\--and to obtain all of the historical risk factor
data from a vendor.\24\ FICC states that the vendor-sourced data would
be more comprehensive than FICC's currently internally-sourced
data.\25\ As such, FICC states that the proposed change would enable
FICC to better understand market price changes of MBS cleared by FICC
and would enhance FICC's ability to identify risk exposures under
broader and more varied market conditions.\26\ FICC also states that
using the vendor-sourced data could prove beneficial for its
members.\27\ Specifically, FICC states that its use of the vendor-
sourced data would enable its members to align their stress testing
analyses with FICC's analyses, because its members use similar data and
analysis for their own internal stress testing methodologies.\28\
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\22\ Interest rate volatility reflects the market view of
fluctuations in interest rates. A high degree of interest rate
volatility will affect the price sensitivity of a security.
Identifying historical dates with high degrees of interest rate
volatility provides additional historical stress shocks.
\23\ Mortgage basis captures the difference between the
prevailing mortgage rate and a blended U.S. Treasury rate, which
impacts borrowers' refinance incentives and the model prepayment
assumptions. The smaller the mortgage basis, the greater the
incentive for mortgage borrowers to refinance their loans and prepay
their existing mortgage, thus increasing prepayment speeds. Changes
in prepayment speeds affect the value of MBS securities. Identifying
historical dates of changes in the mortgage basis provides
additional historical stress shocks.
\24\ FICC currently receives the historical risk-factor data
from the vendor for use in MBSD's value-at-risk (``VaR'') model,
which calculates the VaR Charge component of each member's margin.
See MBSD Rule 1, Definitions--VaR Charge, supra note 5. See also
Securities Exchange Act Release No. 79843 (January 19, 2017), 82 FR
8555, 8556 (January 26, 2017) (SR-FICC-2016-801); Securities
Exchange Act Release No. 79868 (January 24, 2017), 82 FR 8780, 8781
(January 30, 2017) (SR-FICC-2016-007). As proposed in the Advance
Notice, FICC would use the same data set for MBSD stress testing
purposes.
\25\ For example, FICC's current methodology uses four tenors
for the interest rate factor and two individual factors for the OAS
factor. The vendor-supplied data would include 11 tenors for the
interest rate factor and approximately 32 individual factors for the
OAS factor, which would enable FICC's analysis to differentiate
between various agency mortgage programs, underlying collateral
maturities, and other MBS features. See Notice of Filing, supra note
4 at 11414-16.
\26\ See Notice of Filing, supra note 4 at 11416.
\27\ See Notice of Filing, supra note 4 at 11414-15.
\28\ See id.
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In addition, as proposed in the Advance Notice, FICC would change
the look-back period for identifying historical stress scenarios by
anchoring the starting date of the look-back period to May 29, 2002
\29\ and not eliminating any time period after that date.\30\ FICC
states that expanding the look-back period beyond the 10-year rolling
window would enable FICC to include a broader range of extreme but
plausible market conditions in the stress testing methodology.
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\29\ FICC states that it chose May 29, 2002 as the fixed
starting point of the look-back period based on FICC's assessment of
the accuracy and consistency of the vendor's historical data. See
Notice of Filing, supra note 4 at 11415.
\30\ FICC would continue to include events prior to the May 29,
2002 date range that FICC identifies as important periods of
historical stress. See id.
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[[Page 15832]]
2. Changes to the Risk Measurement and Aggregation Process
As proposed in the Advance Notice, FICC would replace the
regression-based profit-and-loss calculation with a financial profit-
and-loss calculation using vendor-sourced data. The vendor-sourced data
would expand the set of risk factors available to FICC for calculating
the potential losses generated by the liquidation of a member's
portfolio during stress scenarios. FICC believes that the vendor-
sourced data would improve the accuracy of FICC's stress testing
methodology by generating profit-and-loss calculations that are closer
to the actual MBS price changes during the large market moves that are
typical in stress testing scenarios.\31\
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\31\ See Notice of Filing, supra note 4 at 11416-17.
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3. Back-Up Calculation
Finally, FICC proposes to implement a back-up calculation that it
would use in the event the vendor fails to provide FICC with the
vendor-sourced data described above. Specifically, if the vendor fails
to provide any data or a significant portion of the data in accordance
with the timeframes to which FICC and the vendor agreed, FICC would use
the most recently available data on the first day that such disruption
occurs. If FICC and the vendor expect that the vendor would resume
providing data within five business days, FICC would determine whether
to calculate the daily stress testing calculation using the most
recently available data or a back-up calculation, described below. If
FICC and the vendor expect that the data disruption would extend beyond
five days, FICC would utilize the back-up calculation.
The proposed back-up calculation would be as follows: FICC would
(1) calculate each member's portfolio net exposures in four
securitization programs,\32\ (2) calculate the stress return for each
securitization program as the three-day price return for each
securitization program for each scenario date, and (3) calculate each
member's stress profit-and-loss as the sum of the products of the net
exposure of each category and the stress return value for each
category. The proposed back-up calculation would use publicly available
indices as the data source for the stress return calculations.
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\32\ The securitization programs are as follows: (1) FNMA and
Freddie Mac (``FHLMC'') conventional 30-year mortgage-backed
securities, (2) GNMA 30-year mortgage-backed securities, (3) FNMA
and FHLMC conventional 15-year mortgage-backed securities, and (4)
GNMA 15-year mortgage-backed securities.
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II. Discussion
Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, the stated purpose of the Clearing
Supervision Act is instructive: to mitigate systemic risk in the
financial system and promote financial stability by, among other
things, promoting uniform risk management standards for SIFMUs and
strengthening the liquidity of SIFMUs.\33\
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\33\ See 12 U.S.C. 5461(b).
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Section 805(a)(2) of the Clearing Supervision Act authorizes the
Commission to prescribe regulations containing risk management
standards for the payment, clearing, and settlement activities of
designated clearing entities engaged in designated activities for which
the Commission is the supervisory agency.\34\ Section 805(b) of the
Clearing Supervision Act provides the following objectives and
principles for the Commission's risk-management standards prescribed
under Section 805(a): \35\
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\34\ 12 U.S.C. 5464(a)(2).
\35\ 12 U.S.C. 5464(b).
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To promote robust risk management;
to promote safety and soundness;
to reduce systemic risks; and
to support the stability of the broader financial system.
Section 805(c) provides, in addition, that the Commission's risk
management standards may address such areas as risk management and
default policies and procedures, among others areas.\36\
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\36\ 12 U.S.C. 5464(c).
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The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and Section 17A of the
Exchange Act (the ``Clearing Agency Rules'').\37\ The Clearing Agency
Rules require, among other things, each covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to meet certain minimum
requirements for its operations and risk management practices on an
ongoing basis.\38\ As such, it is appropriate for the Commission to
review advance notices against the Clearing Agency Rules and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Clearing Supervision Act. As
discussed below, the Commission believes the proposal in the Advance
Notice is consistent with the objectives and principles described in
Section 805(b) of the Clearing Supervision Act,\39\ and in the Clearing
Agency Rules, in particular Rules 17Ad-22(e)(4).\40\
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\37\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No.
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
See also Securities Exchange Act Release No. 78961 (September 28,
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing
Agency Standards''). FICC is a ``covered clearing agency'' as
defined in Rule 17Ad-22(a)(5).
\38\ 17 CFR 240.17Ad-22.
\39\ 12 U.S.C. 5464(b).
\40\ 17 CFR 240.17Ad-22(e)(4).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
For the reasons discussed below, the Commission believes that the
Advance Notice is consistent with the stated objectives and principles
of Section 805(b) of the Clearing Supervision Act.\41\
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\41\ 12 U.S.C. 5464(b).
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1. Changes to the Scenario Selection Process
As described above in Section I.A., in developing historical
scenarios for MBSD stress testing purposes, FICC currently (1) examines
historical data to identify the largest historical changes of two risk
factors that influence MBS pricing (i.e., interest rates and OAS), (2)
relies on its own internally-developed risk factor historical data, and
(3) considers the historical data during a rolling 10-year look-back
period, with dates falling outside the 10-year period eliminated
quarterly. As proposed in the Advance Notice, FICC would replace the
internally-generated historical data with more comprehensive vendor-
sourced data designed to enhance FICC's ability to identify risk
exposures under broader and more varied market conditions.
Additionally, FICC proposes to expand the look-back period for
identifying historical stress scenarios from a rolling 10-year period
to one that starts on May 29, 2002 and continues forward without
eliminating time periods. Expanding the look-back period beyond the 10-
year rolling window would include a broader range of extreme but
plausible market conditions in FICC's stress testing methodology.
Taken together, these changes should allow FICC to identify and
analyze risk exposures under a broader and more varied range of
stressed market conditions covering a longer time period, which should,
in turn, help FICC identify the amount of financial resources necessary
to cover its credit exposure under stress scenarios in extreme but
plausible market conditions. The Commission, therefore, believes that
the proposed methodology would be consistent with the promotion
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of robust risk management as well as safety and soundness at FICC.
Further, the proposed methodology would provide FICC with more
information to address potential deficiencies in its prefunded
financial resources than the current methodology because more
comprehensive data and the expanded look-back period would allow FICC
to identify and analyze additional risk exposures under a broader range
of stressed market conditions than under the current methodology.
Addressing potential deficiencies should help FICC ensure that it is
collecting adequate prefunded financial resources to cover its
potential losses resulting from the default of a clearing member and
its affiliated family under multiple extreme but plausible market
conditions, thereby improving FICC's ability to meet its Cover 1
Requirement and to limit its exposures in the event of such a default.
Accordingly, the Commission believes the proposed methodology would be
consistent with reducing systemic risks and supporting the stability of
the broader financial system.
2. Changes in Risk Measurement and Aggregation Process
As described above in Section I.A., FICC's stress testing
methodology uses a regression model with a two-month look-back period
to determine the potential losses to a member's portfolio under a
stress scenario, estimating each members' MBS sensitivity to two
interest rate risk factors and an OAS risk factor. As proposed in the
Advance Notice, FICC would replace the regression-based calculation
with a financial profit-and-loss calculation using more comprehensive
vendor-sourced data. The vendor-sourced data would expand the set of
risk factors available to FICC for calculating the potential losses
generated by the liquidation of a member's portfolio during stress
scenarios.
The proposed methodology's profit-and-loss calculation using more
comprehensive vendor-sourced data should enable FICC to perform a more
robust assessment of Member Deficiencies and Affiliated Member
Deficiencies and to identify potential additional risk exposures that
it may not have captured before. Accordingly, the Commission believes
that the proposed methodology would be consistent with promoting robust
risk management and safety and soundness. Moreover, because using the
profit-and-loss calculation based on more comprehensive vendor-sourced
data should better enable FICC to identify and address potential risks
with respect to specific members and their affiliates, it should help
FICC ensure that it is collecting adequate prefunded financial
resources to cover its potential losses resulting from the default of
clearing members and their affiliates under multiple extreme but
plausible market conditions, thereby improving FICC's ability to meet
its Cover 1 Requirement and to limit its exposures in the event of such
a default. Accordingly, the Commission believes the proposed
methodology would be consistent with reducing systemic risks and
supporting the stability of the broader financial system.
3. Back-Up Calculation
As described above in Section I.B., FICC proposes to implement a
back-up calculation that it would utilize in the event of an
interruption in the vendor-sourced data feed. The back-up calculation
should provide FICC with a reasonable alternative method for
calculating stress profits-and-losses in the event of an interruption
in the vendor-sourced data feed. Accordingly, the Commission believes
the proposed back-up calculation would be consistent with promoting
robust risk management because it would help ensure that FICC has the
ability to execute its stress tests with a reasonable alternative in
the event of a vendor data disruption.
Further, by providing FICC with a reasonable alternative method for
conducting stress testing, the proposed back-up calculation would help
FICC avoid gaps in assessing the sufficiency of its prefunded financial
resources with respect to meeting FICC's Cover 1 Requirement during a
vendor data disruption. Accordingly, the Commission believes the
proposed back-up calculation would be consistent with promoting safety
and soundness at FICC, which in turn is consistent with reducing
systemic risks and supporting the stability of the broader financial
system.
B. Consistency With Rule 17Ad-22(e)(4)(iii) and (vi)
Rule 17Ad-22(e)(4)(iii) requires, in part, each covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
arising from its payment, clearing, and settlement processes, by
maintaining additional financial resources at the minimum to enable it
to cover a wide range of foreseeable stress scenarios that include, but
are not limited to, the default of the participant family that would
potentially cause the largest aggregate credit exposure for the covered
clearing agency in extreme but plausible market conditions.\42\ Rule
17Ad-22(e)(4)(vi) requires, in part, each covered clearing agency to
effectively identify, measure, monitor, and manage its credit exposures
to participants and those arising from its payment, clearing, and
settlement processes, by testing the sufficiency of its total financial
resources available by conducting stress testing of its total financial
resources once each day using standard predetermined parameters and
assumptions.\43\
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\42\ 17 CFR 240.17Ad-22(e)(4)(iii).
\43\ 17 CFR 240.17Ad-22(e)(4)(vi).
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As described above in Section I.B., FICC proposes to change its
stress testing methodology to: (1) Enhance the scenario selection
process by replacing its internally-generated historical data with more
comprehensive vendor-sourced data and expanding the look-back period
for identifying historical stress scenarios from a rolling 10-year
period to one that starts on May 29, 2002 and continues forward without
eliminating time periods; (2) replace the regression-based calculation
with a financial profit-and-loss calculation using more comprehensive
vendor-sourced data; and (3) implement a back-up calculation that it
would utilize in the event of an interruption in the vendor-sourced
data feed. Taken together, these changes should allow FICC to identify
and analyze risk exposures under a broader range of stressed market
conditions covering a longer time period, which should, in turn, help
FICC identify the amount of financial resources necessary to cover its
credit exposure under stress scenarios in extreme but plausible market
conditions.
Accordingly, the Commission believes that FICC's proposed stress
testing methodology is consistent with Rule 17Ad-22(e)(4)(iii) because
it should better enable FICC to assess its ability to maintain
sufficient financial resources to cover a wide range of foreseeable
stress scenarios that include the default of the member (including
relevant affiliates) that would potentially cause FICC's largest
aggregate credit exposure in extreme but plausible conditions.\44\
Additionally, the Commission believes FICC's proposed stress testing
methodology is consistent with Rule 17Ad-22(e)(4)(vi) because it should
enable FICC to test the sufficiency of its minimum financial resources
by conducting stress testing using standard
[[Page 15834]]
predetermined parameters and assumptions.\45\
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\44\ See 17 CFR 240.17Ad-22(e)(4)(iii).
\45\ See 17 CFR 240.17Ad-22(e)(4)(vi).
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III. Conclusion
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Clearing Supervision Act, that the Commission does not object to this
advance notice proposal (SR-FICC-2020-801) and that FICC is authorized
to implement the proposal as of the date of this notice.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-05697 Filed 3-18-20; 8:45 am]
BILLING CODE 8011-01-P