[Federal Register Volume 78, Number 12 (Thursday, January 17, 2013)]
[Notices]
[Pages 3960-3964]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-00772]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-68621; File No. SR-NSCC-2012-810]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Advance Notice To Eliminate the Offset
of Its Obligations With Institutional Delivery Transactions That Settle
at The Depository Trust Company for the Purpose of Calculating Its
Clearing Fund Under Procedure XV of Its Rules & Procedures
January 10, 2013.
Pursuant to Section 806(e)(1) of the Payment, Clearing, and
Settlement Supervision Act of 2010 (``Clearing Supervision Act'') \1\
and Rule 19b-4(n)(1)(i) \2\ thereunder, notice is hereby given that on
December 18, 2012, the National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission'')
[[Page 3961]]
the advance notice described in Items I, II and III below, which Items
have been prepared primarily by NSCC. The Commission is publishing this
notice to solicit comments on the advance notice from interested
persons.
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\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(i).
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I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
NSCC proposes to modify its Rules & Procedures (``Rules'') to
eliminate the offset of NSCC obligations with institutional delivery
(``ID'') transactions that settle at the Depository Trust Company
(``DTC'') for the purpose of calculating the NSCC clearing fund
(``Clearing Fund'') under Procedure XV of the Rules.
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
In its filing with the Commission, NSCC included statements
concerning the purpose of and basis for the advance notice and
discussed any comments it received on the advance notice. The text of
these statements may be examined at the places specified in Item IV
below. NSCC has prepared summaries, set forth in sections (A) and (B)
below, of the most significant aspects of these statements.\3\
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\3\ The Commission has modified the text of the summaries
prepared by NSCC.
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(A) Advance Notices Filed Pursuant to Section 806(e) of the Payment,
Clearing and Settlement Supervision Act
Description of Change
Background
A primary objective of NSCC's Clearing Fund is to have on deposit
from each applicable clearing member (``Member'') assets sufficient to
satisfy losses that may otherwise be incurred by NSCC as the result of
the default of the Member and the resultant close out of that Member's
unsettled positions under NSCC's trade guaranty. Each Member's Clearing
Fund required deposit is calculated daily pursuant to a formula set
forth in Procedure XV of the Rules designed to provide sufficient funds
to cover this risk of loss. The Clearing Fund formula accounts for a
variety of risk factors through the application of a number of
components, each described in Procedure XV.\4\
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\4\ In addition to those described in this filing, Clearing Fund
components also include (i) A mark-to-market component which, with
certain exclusions, takes into account any difference between the
contract price and market price for net positions of each security
in a Member's portfolio through settlement; (ii) a ``special
charge'' in view of price fluctuations in or volatility or lack of
liquidity of any security; (iii) an additional charge relating to a
Member's outstanding fail positions; (iv) a ``specified activity
charge'' for transactions scheduled to settle on a shortened
settlement cycle (i.e., less than T+3 or T+3 for ``as-of''
transactions); (v) an additional charge that NSCC may require of
Members on surveillance status; and (vi) an ``Excess Capital
Premium'' that takes into account the degree to which a Member's
collateral requirement compares to the Member's excess net capital
by applying a charge if a Member's Required Deposit, minus any
amount applied from the charges described in (ii) and (iii) above,
is above its required capital.
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The Value-at-Risk component, or ``VaR,'' is a core component of
this formula and is designed to calculate the amount of money that may
be lost on a portfolio over a given period of time assumed necessary to
liquidate the portfolio, within a given level of confidence.\5\ The
Market Maker Domination component, or ``MMDOM,'' is charged to Market
Makers,\6\ or firms that clear for them. In calculating the MMDOM, if
the sum of the absolute values of net unsettled positions in a security
for which the firm in question makes a market is greater than that
firm's excess net capital, NSCC may then charge the firm an amount
equal to such excess or the sum of each of the absolute values of the
affected net unsettled positions, or a combination of both. MMDOM
operates to identify concentration within a given CUSIP.
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\5\ NSCC's equity VaR model assumes a 99% confidence interval,
uses a 150-day historical look-back period, and assumes a three-day
liquidation period. In effect, NSCC assumes the market conditions
observed over the past 150 days are predictive of the market
conditions expected over the course of the next three business days.
Pursuant to Procedure XV, NSCC may exclude from the VaR charge ``Net
Unsettled Positions in classes of securities whose volatility is (x)
less amendable to statistical analysis, such as OTC Bulletin Board
or Pink Sheet issues or issues trading below a designated dollar
threshold, or (y) amendable to generally accepted statistical
analysis in a complex manner, such as municipal or corporate
bonds.'' The charge for such positions is determined by multiplying
the absolute value of the positions by a pre-determined percentage.
\6\ As used in Procedure XV, the term Market Maker means a firm
that is registered by FINRA as a Market Maker.
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Pursuant to Procedure XV of the Rules, NSCC may calculate the VaR
and MMDOM components of a Member's Clearing Fund requirement after
taking into account any offsetting pending (i.e., non-fail) ID
transactions that have been confirmed and/or affirmed through an
institutional delivery system acceptable to NSCC (typically Omgeo LLC
(``Omgeo''), a joint venture of the Depository Trust and Clearing
Corporation and Thomson Reuters) (``ID Offset'').\7\ NSCC is proposing
to eliminate the ID Offset from its Clearing Fund calculations in order
to eliminate the market risk that, in the event NSCC ceases to act for
a Member with pending ID transactions, it may be unable to complete
those pending ID transactions in the time frame contemplated by its
current Clearing Fund calculations and, as a result, may have
insufficient margin in its Clearing Fund.
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\7\ The changes proposed by this advance notice will not impact
NSCC's ID Net Service.
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ID Transactions
The parties involved in an institutional trade include the
institutional investor (such as mutual funds, insurance companies,
hedge funds, bank trust departments, and pension funds), the investment
manager (who enters trade orders on behalf of institutional investors),
the buying broker and the selling broker, and custodian banks.\8\
Trades between the buying broker and the selling broker are typically
settled through NSCC's Continuous Net Settlement system (``CNS'').\9\
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\8\ Prime broker ID transactions settling at NSCC are not
included in the ID Offset, as they are included in the Member's NSCC
activity once such transactions are affirmed, and, therefore, are
not addressed in this filing. The ID transactions included in the ID
Offset and described in this advance notice are activity that is
held in custody at a bank.
\9\ CNS is NSCC's core netting and allotting system, where all
eligible compared and recorded transactions for a particular
settlement date are netted by issue into one net long (buy) or net
short (sell) position, and NSCC becomes the contra-party for
settlement purposes, assuming the obligation of its Members that are
receiving securities to receive and pay for those securities, and
the obligation of Members that are delivering securities to make the
delivery.
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Before ID trades are sent to DTC, where they settle delivery versus
payment, the trade allocation details are matched between the executing
broker and the institutional investor. After an executing broker has
provided a final notice of execution associated with the client's
order, most institutional clients will provide trade allocation details
to the executing broker using a service provided by Omgeo. When the
executing broker accepts and processes the trade allocations, an
electronic confirmation is provided through Omgeo's TradeSuite service
to the institutional investor or its agent (typically the institutional
client's custodian bank) for affirmation. Omgeo links with the various
parties to institutional trades to provide real-time central matching
capabilities, electronically comparing trade details and notifying
parties of any exceptions. After the trade allocation details are
affirmed, the trade is considered matched and institutional delivery
details are sent to DTC for settlement.
Completion of the money and securities settlement of institutional
trades occurs at DTC. Because
[[Page 3962]]
investment managers are not participants of and do not have direct
accounts at DTC, their securities are held in custodial accounts with
banks who are participants at DTC. Therefore, when the institutional
delivery details for confirmed and affirmed ID trades are sent to DTC
from Omgeo, the delivering investment manager's custodian bank or
broker, as the case may be, must authorize the delivery, generating a
deliver order that will settle in accordance with DTC's rules.
NSCC Risk Management receives a daily feed from Omgeo, including
both ID trades that have only been confirmed as well as those that have
also been affirmed. For purposes of the ID Offset, NSCC includes ID
trades that are confirmed and/or affirmed on trade date (T) and those
ID trades which have been affirmed on T+1 and remain affirmed through
settlement date (SD).
ID Offset
Procedure XV currently allows for a Member's net unsettled NSCC
position in a particular CUSIP to be compared to any pending ID
transactions settling at DTC for potential offset for purposes of
calculating the VaR and the MMDOM components of a Member's Clearing
Fund requirement, defined as the ID Offset. The ID Offset is based on
the assumption that, in the event of a Member insolvency, NSCC will be
able to close out any trades for which there is a corresponding ID
transaction settling at DTC by completing that ID transaction.
Therefore, the VaR and the MMDOM components are calculated after taking
into account any offsetting pending (i.e., non-fail) ID transactions
that have been confirmed and/or affirmed, reducing the Clearing Fund
requirement for those Members with ID transactions. ID transactions are
included in the ID Offset only if they are on the opposite side of the
market from the Member's net NSCC position (i.e., only if they reduce
that net position).
Potential Inability To Complete ID Transactions
Generally, when NSCC ceases to act for a Member, it is obligated,
for those transactions to which the trade guaranty has attached, to pay
for deliveries made by non-defaulting Members that are due, through
CNS, to the failed Member on the day of insolvency and the days
following. As described above, the current calculation of the VaR and
MMDOM components of NSCC's Clearing Fund are based on the assumption
that, in the event of a Member default, NSCC will be able to complete
the pending ID transactions that were used to offset that Member's
unsettled NSCC position. If NSCC is unable to complete the ID
transactions as contemplated by this calculation, then NSCC may need to
liquidate a portfolio that could be substantially different than the
portfolio that NSCC collected Clearing Fund for, leaving NSCC
potentially under collateralized and exposed to market risk, because
when it calculated the Clearing Fund requirement, NSCC assumed, under
its current rules, a portfolio that included Member positions to be
offset by ID transactions.
There are a number of reasons why NSCC may not be able to complete
an insolvent Member's open ID transactions. First, NSCC does not
guarantee ID transactions and completion of these transactions by the
counterparty of the ID transaction, which is not a Member of NSCC, is
voluntary. Further, the institutional customer is not a Member of NSCC,
is not bound by NSCC's Rules, and is not party to any legally binding
contract with NSCC that requires the institutional customer or its
custodian to complete the transaction. Finally, based on news that a
Member may be in distress or insolvent, the institutional customer or
its investment advisor may feel compelled to take immediate market
action with respect to the institutional buy or sell transaction, in
order to reduce its market risk; this effectively eliminates the option
for NSCC to complete these transactions, either entirely or on the
timetable assumed by the Clearing Fund calculation.
While NSCC's Risk Management systems net ID transactions by CUSIP
across all settlement days for the purposes of the ID Offset, ID
transactions settle trade by trade between the executing broker and the
custodian. As a result, the netted ID position used to offset the NSCC
position could potentially be comprised of thousands of individual
trades with hundreds of different counterparties. It would be time
consuming for NSCC to contact each counterparty individually to get
their agreement to complete ID transactions, which would delay the
determination of the portfolio requiring liquidation in the event of a
cease to act, and thus hold up the prompt close out of the defaulter's
open positions, exposing NSCC to additional market risk not covered by
the margin collected.
Implementation Time Frame
Following Commission approval, in order to mitigate the impact of
this advance notice, NSCC proposes to implement the changes set forth
in this filing on over an 18-month period. On a date no earlier than 10
days following notice to Members by Important Notice (``Initial
Implementation Date''), NSCC proposes to eliminate the ID Offset from
ID transactions that have only been confirmed, but have not yet been
affirmed. At this time, NSCC will continue to apply the ID Offset to ID
transactions that have been affirmed. During the 12-month period
following the Initial Implementation Date, NSCC will discuss with
Members, whose business will be affected by the elimination of the ID
Offset, mechanisms to mitigate this impact.
Beginning on a date approximately 12 months from the Initial
Implementation Date, and no earlier than 10 days following notice to
Members by Important Notice, NSCC will eliminate from the ID Offset all
affirmed ID transactions that have reached settlement date at the time
the Clearing Fund calculations are run. Three months later, or
approximately 15 months following the Initial Implementation Date, and
on a date no earlier than 10 days following notice to Members by
Important Notice, NSCC will eliminate from the ID Offset all affirmed
ID transactions that have reached either settlement date or the day
prior to settlement date. Finally, on a date approximately 18 months
following the Initial Implementation Date, and no earlier than 10 days
following notice to Members by Important Notice, NSCC will eliminate
the ID Offset entirely for all ID transactions. Members will be advised
of each proposed implementation date through issuance of NSCC Important
Notices, which are publically available at www.dtcc.com.
The table below illustrates this proposed implementation schedule:
[[Page 3963]]
Proposed Implementation Schedule for Elimination of ID Offsets
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Action Scheduled implementation
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Eliminate from ID Offset those ID Following approval of rule
transactions that have only been filing, and on a date no
confirmed, but have not yet been earlier than 10 days following
affirmed. notice to Members by Important
Notice (``Initial
Implementation Date'').
Eliminate from ID Offset all affirmed 12 months following the Initial
ID transactions that have reached Implementation Date, and on a
Settlement Date (``SD''). date no earlier than 10 days
following notice to Members by
Important Notice.
Eliminate from ID Offset all affirmed 15 months following the Initial
ID transactions that have reached SD Implementation Date, and on a
and the day prior to SD (SD-1). date no earlier than 10 days
following notice to Members by
Important Notice.
Eliminate from ID Offset all ID 18 months following the Initial
transactions. Implementation Date, and on a
date no earlier than 10 days
following notice to Members by
Important Notice.
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Proposed Rule Changes
NSCC proposes to amend Procedure XV to eliminate the ID Offset from
calculation of the VaR and MMDOM components of a Member's Clearing Fund
requirement as currently provided for in, with respect to CNS
transactions, Section I(A)(1)(a)(i) and Section I(A)(1)(d), and, with
respect to Balance Order transactions, Section I(A)(2)(a)(i) and
Section I(A)(2)(c).
Anticipated Effect on and Management of Risk
As a central counterparty, NSCC occupies an important role in the
securities settlement system by interposing itself between
counterparties to financial transactions and thereby reducing the risk
faced by participants and contributing to global financial stability.
In this role, however, NSCC is necessarily subject to certain risks in
the event of the default or failure of a Member.
NSCC reviews its risk management processes against federal
securities laws and rulemaking promulgated by the Commission, and
applicable regulatory and industry guidelines, including but not
limited to the Principles for Financial Market Infrastructures
(``PFMI'') of the Committee on Payment and Settlement Systems and the
Technical Committee of the International Organization of Securities
Commissions (``CPSS-IOSCO'').\10\ In accordance with Commission
rules,\11\ specifically Rule 17Ad-22(b)(1) addressing measurement and
management of credit exposures, Rule 17Ad-22(b)(2) addressing margin
requirements, and Rule 17Ad-22(d)(11) addressing default procedures,
and also in accordance with the PFMIs, this advance notice should
enhance NSCC's ability to more effectively manage its credit exposures
to participants, help ensure that it is able to cover its credit
exposures to its participants for all products through an effective,
risk-based margin system, limit NSCC's exposures and losses, and
enhance protections against market risk that may arise when NSCC ceases
to act for a Member with open ID transaction activity.
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\10\ CPSS-IOSCO PFMI (April 2012), available at http://www.bis.org/publ/cpss101a.pdf.
\11\ Securities and Exchange Commission Release No. 34-68080
(October 22, 2012), 77 FR 66219 (November 2, 1012; File No. S7-08-11
(available at http://www.sec.gov/rules/final/2012/34-68080.pdf),
effective on January 2, 2013.
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(B) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants, or Others
While written comments relating to the advance notice have not yet
been solicited, NSCC has received a letter on behalf of certain Members
seeking further review of the impact of the proposed changes contained
in the advance notice and consideration of alternatives. NSCC notified
the Commission of the contents of the letter and promptly delivered a
response to those Members addressing their concerns. A Member working
group has been established to discuss mechanisms for impacted Members
to mitigate the potential impact of the rule changes described in this
filing.
III. Date of Effectiveness of the Advance Notice and Timing for
Commission Action
The clearing agency may implement the proposed change pursuant to
Section 806(e)(1)(G) of the Clearing Supervision Act \12\ if it has not
received an objection to the proposed change within 60 days of the
later of (i) the date that the Commission received the advance notice
or (ii) the date the Commission receives any further information it
requested for consideration of the notice. The clearing agency shall
not implement the proposed change if the Commission has any objection
to the proposed change.
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\12\ 12 U.S.C. 5465(e)(1)(G).
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The Commission may extend the period for review by an additional 60
days if the proposed change raises novel or complex issues, subject to
the Commission providing the clearing agency with prompt written notice
of the extension. A proposed change may be implemented in less than 60
days from the date of receipt of the advance notice, or the date the
Commission receives any further information it requested, if the
Commission notifies the clearing agency in writing that it does not
object to the proposed change and authorizes the clearing agency to
implement the proposed change on an earlier date, subject to any
conditions imposed by the Commission. The clearing agency shall post
notice on its Web site of proposed changes that are implemented.
The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.\13\
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\13\ NSCC also filed the proposals contained in this advance
notice as a proposed rule change under Section 19(b)(1) of the Act
and Rule 19b-4 thereunder. 15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4.
Pursuant to Section 19(b)(2) of the Act, within 45 days of the date
of publication of the proposed rule change in the Federal Register
or within such longer period up to 90 days if the Commission
designates or the self-regulatory organization consents the
Commission will either: (i) By order approve or disapprove the
proposed rule change or (ii) institute proceedings to determine
whether the proposed rule change should be disapproved. 17 U.S.C.
78s(b)(2)(A). See Release No. 34-68549 (December 28, 2012), 78 FR
792 (January 4, 2013).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the advance
notice is consistent with the Clearing Supervision Act. Comments may be
submitted by any of the following methods:
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Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-NSCC-2012-810 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-NSCC-2012-810. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the advance notice that are filed
with the Commission, and all written communications relating to the
advance notice between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street NE., Washington,
DC 20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filings also will be available for inspection
and copying at the principal office of NSCC and on NSCC's Web site at
http://dtcc.com/downloads/legal/rule_filings/2012/nscc/SR-NSCC-2012-10.pdf. All comments received will be posted without change; the
Commission does not edit personal identifying information from
submissions. You should submit only information that you wish to make
available publicly. All submissions should refer to File Number SR-
NSCC-2012-810 and should be submitted on or before February 7, 2013.
By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-00772 Filed 1-16-13; 8:45 am]
BILLING CODE 8011-01-P