[Federal Register Volume 85, Number 62 (Tuesday, March 31, 2020)]
[Notices]
[Pages 17929-17932]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-06598]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88469; File No. SR-NSCC-2020-801]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of No Objection To Advance Notice To Enhance the
Calculation of the Family-Issued Securities Charge
March 25, 2020.
On January 28, 2020, National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission'') advance notice SR-NSCC-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 Payment, Clearing
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'')
\1\ and Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of
1934 (``Exchange Act'') \3\ to amend the calculation of NSCC's existing
margin charge applied to long positions in Family-Issued Securities \4\
to address certain risk presented by these positions. The Advance
Notice was published for public comment in the
[[Page 17930]]
Federal Register on February 27, 2020,\5\ and the Commission has
received no comments regarding the changes proposed in the Advance
Notice.\6\ 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\ 15 U.S.C. 78a et seq.
\4\ Terms not defined herein are defined in NSCC's Rules and
Procedures (``Rules''), available at http://www.dtcc.com/~/media/
Files/Downloads/legal/rules/nscc_rules.pdf.
\5\ Securities Exchange Act Release No. 88267 (Feb. 24, 2020),
85 FR 11437 (Feb. 27, 2020) (SR-NSCC-2020-801) (``Notice of
Filing''). On January 28, 2020, NSCC also filed a related proposed
rule change (SR-NSCC-2020-002) with the Commission pursuant to
Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder
(``Proposed Rule Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-
4, respectively. In the Proposed Rule Change, which was published in
the Federal Register on February 18, 2020, NSCC seeks approval of
proposed changes to its rules necessary to implement the Advance
Notice. Securities Exchange Act Release No. 88163 (Feb. 11, 2020),
85 FR 8964 (Feb. 18, 2020). The comment period for the related
Proposed Rule Change filing closed on March 10, 2020.
\6\ Since the proposal contained in the Advance Notice was also
filed as a proposed rule change, all public comments received on the
proposal are considered regardless of whether the comments are
submitted on the Proposed Rule Change or the Advance Notice.
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I. The Advance Notice
A. Background
NSCC provides clearing, settlement, risk management, central
counterparty services, and a guarantee of completion for virtually all
broker-to-broker trades involving equity securities, corporate and
municipal debt securities, and certain other securities. NSCC manages
its credit exposure to its Members by determining an appropriate
Required Fund Deposit for each Member, which serves as each Member's
margin.\7\ The aggregate of all NSCC Members' Required Fund Deposits
(together with certain other deposits required under the Rules)
constitutes NSCC's Clearing Fund, which NSCC would access should a
Member default and that Member's Required Fund Deposit, upon
liquidation, is insufficient to satisfy NSCC's losses.
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\7\ Terms not defined herein are defined in NSCC's Rules and
Procedures (``Rules''), available at http://www.dtcc.com/~/media/
Files/Downloads/legal/rules/nscc_rules.pdf. See Rule 4 (Clearing
Fund) and Procedure XV (Clearing Fund Formula and Other Matters) of
the Rules.
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Each Member's Required Fund Deposit consists of a number of
applicable components, each of which is calculated to address specific
risks faced by NSCC.\8\ NSCC states that it regularly assesses the
market, liquidity, and other risks that its margining methodologies are
designed to mitigate to evaluate whether margin levels are commensurate
with the particular risk attributes of each relevant product,
portfolio, and market.\9\ Such risks include risks introduced by its
counterparties or Members. In particular, NSCC seeks to identify and
mitigate its exposures to specific wrong-way risk (``SWWR''), which is
the risk that an exposure to a counterparty is highly likely to
increase when the creditworthiness of that counterparty deteriorates.
Such risk would arise when NSCC acts as central counterparty to a
Member with unsettled long positions in securities that were issued by
a Member or an affiliate of that Member (``Family-Issued Securities'').
If that Member defaults, NSCC would seek to cover its losses by closing
out the unsettled Family-Issued Securities long positions. However,
because the Member default would also likely lead to a drop in the
creditworthiness of the Member and, therefore, the value of the Family-
Issued Securities, NSCC would likely not be able to completely cover
its losses in closing out those positions.
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\8\ Id.
\9\ See Notice of Filing supra note 5, at 85 FR 11437.
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In order to address this particular form of SWWR, NSCC imposes a
charge on all Members with unsettled long positions in their own
Family-Issued Securities, called the FIS Charge, which is calculated by
multiplying the value of the net unsettled long positions in Family-
Issued Securities by a certain percentage (``Haircut Rate'').
Currently, the Haircut Rate applied in the FIS Charge calculation is
based on a Member's rating category on NSCC's Credit Risk Rating Matrix
(``CRRM''), which ranges from 1 to 7. NSCC utilizes the CRRM to
evaluate its credit risk exposure to each Member; a higher CRRM rating
represents a higher credit risk (i.e., a greater risk of defaulting on
settlement obligations) and may cause a Member to be subject to
enhanced surveillance or additional margin requirements.\10\
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\10\ See Rule 1 and Section 4 of Rule 2B of the Rules, supra
note 8. See also Securities Exchange Act Release Nos. 80734 (May 19,
2017), 82 FR 24177 (May 25, 2017) (SR-DTC-2017-002, SR-FICC-2017-
006, SR-NSCC-2017-002); and 80731 (May 19, 2017), 82 FR 24174 (May
25, 2017) (SR-DTC-2017-801, SR-FICC-2017-804, SR-NSCC-2017-801).
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Currently, the applicable Haircut Rate for the FIS Charge depends
on a Member's rating on the CRRM. Specifically, for Members that are
rated 6 or 7 on the CRRM, the applicable Haircut Rate for net unsettled
long positions in Family-Issued Securities shall be (1) at least 80
percent for fixed income securities, and (2) 100 percent for equity
securities. For Members that are rated 1 through 5 on the CRRM, the
applicable Haircut Rate shall be (1) at least 40 percent for fixed
income securities, and (2) at least 50 percent for equity
securities.\11\
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\11\ See Procedure XV (Clearing Fund Formula and Other Matters)
of the Rules, supra note 7.
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B. Proposed Changes to FIS Charge
In the Advance Notice, NSCC is proposing to revise the calculation
of the FIS Charge to use the same Haircut Rate for all Members
regardless of their CRRM rating category. Under the proposal, net
unsettled long positions in (1) fixed income securities that are
Family-Issued Securities are charged a Haircut Rate of no less than 80
percent, and (2) equity securities that are Family-Issued Securities
are charged a Haircut Rate of 100 percent.
NSCC states that it may still be exposed to SWWR despite applying
different Haircut Rates based on a Member's rating on the CRRM, and it
can better mitigate its exposure to this risk by calculating the FIS
Charge without considering Members' CRRM rating categories.\12\
According to NSCC, while the current methodology appropriately assumes
that Members with a higher rating category on the CRRM present a
heightened credit risk to NSCC or have demonstrated higher risk related
to their ability to meet settlement, this methodology does not account
for the risk that a Member may default due to unanticipated causes
(referred to as a ``jump-to-default'' scenario) not captured by the
CRRM.\13\ This is because the CRRM relies on historical data as a
predictor of future risks,\14\ whereas jump-to-default scenarios are
triggered by unanticipated causes that could not be predicted based on
historical trends or data (e.g., instances of fraud or other bad
actions by a Member's management). Therefore, NSCC represents that the
proposed change is designed to cover SWWR arising from potential jump-
to-default scenarios by applying the higher applicable Haircut Rate in
calculating the FIS Charge for all Members.\15\
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\12\ See Notice of Filing supra note 5, at 85 FR 11438.
\13\ See id.
\14\ See id.
\15\ See id.
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The practical outcome of this proposed change is that for all
Family Issued Securities, NSCC would apply a haircut equivalent to the
current Haircut Rate for Members that are rated 6 or 7 on the CRRM
regardless of whether a Member is rated at a 6 or 7. To implement this
proposal, NSCC would amend Sections I.(A)(1)(a)(iv) and I.(A)(2)(a)(iv)
of Procedure XV of the Rules.
[[Page 17931]]
II. Discussion and Commission Findings
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.\16\
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\16\ 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.\17\ 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):\18\
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\17\ 12 U.S.C. 5464(a)(2).
\18\ 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.\19\
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\19\ 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'').\20\ 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.\21\ 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,\22\ and in Rules 17Ad-
22(e)(4)(i) \23\ and (e)(6)(i) and (v) \24\ of the Clearing Agency
Rules.
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\20\ 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''). NSCC is a ``covered clearing agency'' as
defined in Rule 17Ad-22(a)(5).
\21\ Id.
\22\ 12 U.S.C. 5464(b).
\23\ 17 CFR 240.17Ad-22(e)(4)(i).
\24\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
For the reasons discussed immediately 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.\25\ Specifically, as discussed below, the Commission believes that
the changes proposed in the Advance Notice are consistent with
promoting robust risk management, promoting safety and soundness,
reducing systemic risks, and supporting the broader financial
system.\26\
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\25\ 12 U.S.C. 5464(a)(2) and (b).
\26\ 12 U.S.C. 5464(b).
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First, the Commission believes that the proposal is consistent with
promoting robust risk management. NSCC faces SWWR when it acts as
central counterparty to a Member with long positions in FIS. Although
NSCC's current margin methodology addresses SWWR through imposition of
the FIS Charge, it does not address SWWR associated with a jump-to-
default scenario. As described above, the proposal would address SWWR
associated with a jump-to-default scenario by using the higher
applicable Haircut Rate for all Members concerning their net unsettled
long positions in Family-Issued Securities, regardless of the Members'
CRRM rating category. As such, the proposal would address a risk not
captured currently under NSCC's margin methodology and provide for more
comprehensive risk management of NSCC's risks, consistent with the
promotion of robust risk management.
Second, the Commission believes that the proposal is consistent
with the promotion of safety and soundness at NSCC. The collection of
additional margin, by applying the higher applicable Haircut Rate in
calculating the FIS Charge for all Members, would better enable NSCC to
manage the potential losses arising out of a Member default. Holding
additional resources to address such losses would promote NSCC's safety
and soundness.
Finally, the Commission believes that the proposal is consistent
with reducing systemic risk and supporting the broader financial
system. As discussed above, NSCC proposes to collect additional margin
to collateralize exposures to SWWR associated with a jump-to-default
scenario, which could reduce the probability that NSCC would mutualize
a loss stemming from the close-out of a defaulted Member with net
unsettled long positions in Family-Issued Securities. While unavoidable
under certain circumstances, reducing the probability of loss
mutualization during periods of market stress could lessen the
transmission of financial risks arising from a Member default to non-
defaulting Members, their customers, and the broader market. Further,
NSCC maintaining additional margin could further reduce the potential
that NSCC would need to call for additional resources from Members in
times of market stress. The Commission believes, therefore, that the
proposal would be consistent with reducing systemic risk and supporting
the stability of the broader financial system. Accordingly, and for the
reasons stated above, the Commission believes the changes proposed in
the Advance Notice are consistent with Section 805(b) of the Clearing
Supervision Act.
B. Consistency With Rule 17Ad-22(e)(4)(i)
Rule 17Ad-22(e)(4)(i) under the Act requires that each covered
clearing agency 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,
including by maintaining sufficient financial resources to cover its
credit exposure to each participant fully with a high degree of
confidence.\27\
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\27\ 17 CFR 240.17Ad-22(e)(4)(i).
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As described above, NSCC is exposed to SWWR where it acts as
central counterparty for its Members' transactions in Family-Issued
Securities. Applying the same higher Haircut Rate to all Members with
net long unsettled positions in Family-Issued Securities, regardless of
their rating on the CRRM, would help further mitigate NSCC's SWWR
exposures, especially in a jump-to-default scenario. Therefore,
applying the same Haircut Rate in the FIS charge calculation is
designed to help NSCC collect sufficient financial resources to help
cover its credit exposures, with a high degree of confidence, to those
Members seeking to clear and settle transactions in Family-Issued
Securities. Therefore, the Commission believes the
[[Page 17932]]
proposed change is consistent with Rule 17Ad-22(e)(4)(i).\28\
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\28\ Id.
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C. Consistency With Rule 17Ad-22(e)(6)(i) and (v)
Rule 17Ad-22(e)(6)(i) under the Act requires that each covered
clearing agency that provides central counterparty services establish,
implement, maintain and enforce written policies and procedures
reasonably designed to cover its credit exposures to its participants
by establishing a risk-based margin system that, at a minimum,
considers, and produces margin levels commensurate with, the risks and
particular attributes of each relevant product, portfolio, and
market.\29\ Rule 17Ad-22(e)(6)(v) under the Act requires that each
covered clearing agency that provides central counterparty services
establish, implement, maintain and enforce written policies and
procedures reasonably designed to cover its credit exposures to its
participants by establishing a risk-based margin system that, at a
minimum, uses an appropriate method for measuring credit exposure that
accounts for relevant product risk factors and portfolio effects across
products.\30\
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\29\ 17 CFR 240.17Ad-22(e)(6)(i).
\30\ 17 CFR 240.17Ad-22(e)(6)(v).
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As described above, NSCC faces SWWR in jump-to-default scenarios
where it acts as central counterparty to Member transactions in Family-
Issued Securities. This risk is present regardless of a Member's rating
on the CRRM. However, the current methodology assumes that Members with
a higher rating on the CRRM present a heightened credit risk to NSCC
and applies a higher Haircut Rate to such Members. This distinction
does not take into account the SWWR that would manifest in a jump-to-
default scenario. As such, NSCC proposes to apply the same higher
Haircut Rate to all Members. This proposal would improve NSCC's ability
to mitigate its exposure to SWWR in a jump-to-default scenario, thereby
helping NSCC to maintain a risk-based margin system that considers, and
produces margin levels commensurate with, the risks and particular
attributes of net unsettled long positions in Family-Issued Securities.
Therefore, the Commission believes that the proposal would be
consistent with Rule 17Ad-22(e)(6)(i).\31\
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\31\ 17 CFR 240.17Ad-22(e)(6)(i).
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Additionally, because the enhanced FIS Charge would be a component
of the margin that NSCC collects from its Members to help cover NSCC
credit exposure to the Members, and because the charge would be based
on different product risk factors with respect to equity and fixed-
income securities, it would be part of an appropriate method for
measuring credit exposure that accounts for relevant product risk
factors and portfolio effects across products, as described above.
Therefore, the Commission believes the proposed change is consistent
with Rule 17Ad-22(e)(6)(v).\32\
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\32\ 17 CFR 240.17Ad-22(e)(6)(v).
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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
Advance Notice (SR-NSCC-2020-801) and that NSCC is authorized to
implement the proposal as of the date of this notice or the date of an
order by the Commission approving proposed rule change SR-NSCC-2020-
002, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-06598 Filed 3-30-20; 8:45 am]
BILLING CODE 8011-01-P