[Federal Register Volume 79, Number 76 (Monday, April 21, 2014)]
[Notices]
[Pages 22174-22177]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-08972]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-71945; File No. SR-NSCC-2014-802]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Advance Notice To Enhance NSCC's
Existing Parametric Value-at-Risk Margining Model
April 15, 2014.
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
March 28, 2014, National Securities Clearing Corporation (``NSCC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-NSCC-2014-802 (``Advance Notice'') as described in
Item I, II and III below, which Items have been prepared primarily by
NSCC. The
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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
The Advance Notice is filed by NSCC in connection with a proposed
adjustment to NSCC's existing parametric Value-at-Risk (``VaR'')
margining model, as more fully described below.
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), (B), and
(C) below, of the most significant aspects of such statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
1. Purpose
In connection with its on-going assessment of the performance of
its margining models, NSCC is proposing to enhance its existing
parametric VaR model by supplementing the assumption of normal
distribution underlying the current model with a family of Student's t-
distributions. Currently, NSCC's parametric VaR methodology is based on
the assumption that the underlying securities portfolio return
distribution is normal. In an effort to enhance its parametric VaR
model, NSCC has reviewed prevalent academic research and data analyses
which show that the empirical distributions of securities portfolio
returns in the equities markets have ``fatter tails'' than what the
normal distribution implies, and VaR margin computed based only on the
normality assumption may underestimate the tail risk that is observed
during market volatility (``fat-tail'' risk).
NSCC has evaluated a number of possible approaches to enhance its
parametric VaR model in order to better accommodate fat-tail risks, and
is proposing to apply an approach that is most appropriate for NSCC and
its circumstances. As such, the proposed enhancement would utilize
NSCC's existing parametric VaR model, and would supplement the normal
distribution underlying the model with a factor that utilizes the
degrees of freedom (``DOF'') derived from a family of Student's t-
distributions. The factor will help adjust the normal-based VaR model
to better reflect the distribution of actual observed historical
returns. Further, the existing normal distribution in the parametric
VaR model will operate as a floor to the proposed adjustments.
2. Statutory Basis
The proposed change is being filed pursuant to Section 806(e)(1) of
the Clearing Supervision Act, and is consistent with Rule 17Ad-
22(b)(2), promulgated thereunder, which requires a registered clearing
agency to ``use margin requirements to limit its credit exposures to
participants under normal market conditions and use risk-based models
and parameters to set margin requirements.'' \3\ Specifically, the
adjustment is expected to allow NSCC's parametric VaR model to remain
above its 99% coverage target during market volatility, and to more
appropriately calculate and collect margin, which better enables NSCC
to respond in the event that a Member defaults and minimizes potential
losses to NSCC and its non-defaulting Members. As such, NSCC believes
that the proposal promotes robust risk management and the safety and
soundness of NSCC's operations, which reduce systemic risk and support
the stability of the broader financial system, consistent with the
requirements of Rule 17Ad-22(b)(2), cited above.
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\3\ 17 CFR 240.17Ad-22(b)(2).
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(B) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants, or Others
In November 2013, NSCC distributed a White Paper to its Members
that described the proposed enhancement to the parametric VaR model and
the results of an impact study showing the potential impact of this
proposal on Members' Clearing Fund required deposits. NSCC did not
receive any written comments relating to the enhancement to the
parametric VaR model in response to this White Paper. NSCC will notify
the Commission of any written comments received by NSCC.
(C) Advance Notice Filed Pursuant to Section 806(e) of the Payment,
Clearing and Settlement Supervision Act
1. Description of Change
(i) Overview
A primary objective of NSCC's Clearing Fund is to have on deposit
from each applicable 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 NSCC's Rules and Procedures (``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. The VaR
component 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.
Parametric VaR models utilized in the equities markets have
historically computed risk on the assumption that the underlying
securities portfolio return distribution is normal. The increased
frequency of market volatility in recent years has stressed the
performance of parametric VaR models throughout the financial services
industry. Analyses of these events and VaR models have shown that
``fat-tail'' risk may not be properly addressed by parametric VaR
models that are based only on the normal distribution assumption. As
such, it has become market practice to move away from the use of normal
distribution assumptions in parametric VaR models and to instead use
distributions, such as Student's t-distributions, that better
accommodate these fat-tail risk events.
NSCC conducts back tests to measure the performance of Members'
portfolios against the calculated VaR margin requirements for those
portfolios. Over the past few years, these back tests have shown that,
while NSCC's VaR margin component has remained mostly above its 99%
coverage target when tested over a longer time horizon (a 12-month
rolling window), coverage fell below the 99% target in a few instances
in which back tests were conducted over shorter time frames (1-month
windows). Therefore, and in connection with its on-going assessment of
the performance of its margining models, NSCC has evaluated various
possible approaches to enhance its parametric VaR model, and is
proposing to apply an approach that incorporates Student's t-
distributions into that model in a way that is appropriate for NSCC and
its circumstances.
The proposal would enhance NSCC's existing parametric VaR model,
which is
[[Page 22176]]
used as part of the calculation of the VaR component, by supplementing
the assumption of normal distribution underlying the current model with
a factor that utilizes the DOF derived from a family of Student's t-
distributions. The proposal is expected to improve NSCC's back-testing
performance over shorter time horizons, particularly during more
volatile market environments, and should enable the model to better
account for the higher degree of fat-tail risk observed in equities
markets.
(ii) Adjustment to Existing Parametric VaR Model
The proposed enhancement would utilize NSCC's current parametric
VaR model, and would supplement the current normal distribution
underlying the parametric VaR model with a factor that utilizes the DOF
derived from a family of Student's t-distributions, which are more
representative of the historically observed distributions in the
equities markets. The Student's t-distributions would introduce an
additional statistical parameter, the DOF factor, to the model.
Following this enhancement, NSCC would estimate the DOF factor of the
empirical t-distribution in the model periodically by using daily
return data from the S&P 500 over a historical window no shorter than
12-months. NSCC would then compute a multiplication factor that
represents the magnitude of increase of t-distribution-based parametric
VaR from the normal-based parametric VaR. This multiplication factor
would be applied to Members' VaR margin requirement.
NSCC has considered various alternatives to enhance its parametric
VaR model, and its internal studies have shown that this proposed
enhancement is an appropriate approach to addressing tail risks at
NSCC, and may be a more effective enhancement to the model than other
possible adjustments, including the augmented volatility model (AVM),
which NSCC has also considered. In 2012, NSCC designed AVM to protect
NSCC from elevated levels of volatility that were not captured in
historical data by incorporating the CBOE VIX, a forward-looking
measure of volatility, into the model. While both this proposal and AVM
would improve NSCC's ability to meet its back-testing coverage target,
the proposed enhancement to NSCC's parametric VaR model described in
this filing is expected to be a more stable adjustment to Members' VaR
margin components than AVM, while still improving the model's back-test
performances.
2. Anticipated Effect on and Management of Risks
NSCC believes that the proposed enhancement to its current
parametric VaR model would improve NSCC's risk management by enabling
the model to remain above its 99% coverage target during market
volatility, and to more appropriately calculate and collect margin,
which better enables NSCC to respond in the event that a Member
defaults. Further, incorporation of the DOF factor into NSCC's existing
parametric VaR model should more accurately capture the fat-tail
characteristics of stock market return distributions.
Additionally, NSCC has conducted extended outreach with its Members
regarding the proposed enhancement, describing the proposed change, the
reasoning for the change, and the potential impact of the change--both
the expected impact on Members' Clearing Fund required deposits as well
as the improvement to NSCC's risk management. This outreach included
the publication of a White Paper to impacted Members in November 2013
as well as individual outreach to Members to discuss the results of
impact studies. The proposed enhancement is expected to have a
relatively low impact on Members' VaR margin components and thus a
minimal impact on Members' overall Clearing Fund required deposits.
NSCC did not receive any objections to the proposed change from Members
in response to this outreach.
NSCC believes that the proposed change should allow it to collect
margin that covers to a greater degree of certainty the risk that it
may face during market volatility or even extreme market environments.
While this change would impact NSCC's Members' Clearing Fund
requirements, as stated above, NSCC's Members are aware of the proposed
change and the potential impact on their Clearing Fund required
deposits. Further, prior to implementation of the proposed changes,
NSCC will run a parallel period during which Members would be able to
further review the possible impact.
III. Date of Effectiveness of the Advance Notice, and Timing for
Commission Action
The proposed change may be implemented if the Commission does not
object to the proposed change within 60 days of the later of (i) the
date that the proposed change was filed with the Commission or (ii) the
date that any additional information requested by the Commission is
received. NSCC shall not implement the proposed change if the
Commission has any objection to the proposed change.
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 or the Board of Governors of the Federal Reserve System
providing NSCC with prompt written notice of the extension. A proposed
change may be implemented in less than 60 days from the date the
advance notice is filed, or the date further information requested by
the Commission is received, if the Commission notifies NSCC in writing
that it does not object to the proposed change and authorizes NSCC to
implement the proposed change on an earlier date, subject to any
conditions imposed by the Commission.
NSCC shall post notice on its Web site of proposed changes that are
implemented.
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:
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 No. SR-NSCC-2014-802 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File No. SR-NSCC-2014-802. 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
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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 the filing also will be available
for inspection and copying at the principal office of NSCC and on
NSCC's Web site (http://dtcc.com/legal/sec-rule-filings.aspx). 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 No. SR-NSCC-2014-802 and should be
submitted on or before May 12, 2014.
By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-08972 Filed 4-18-14; 8:45 am]
BILLING CODE 8011-01-P