[Federal Register Volume 83, Number 13 (Friday, January 19, 2018)]
[Notices]
[Pages 2828-2834]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-00851]
[[Page 2828]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-82494; File No. SR-NSCC-2017-020]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of a Proposed Rule Change To Enhance the
Calculation of the Volatility Component of the Clearing Fund Formula
That Utilizes a Parametric Value-at-Risk Model and Eliminate the Market
Maker Domination Charge
January 12, 2018.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934, as amended (``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is
hereby given that on December 28, 2017, National Securities Clearing
Corporation (``NSCC'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II and III below, which Items have been prepared by the
clearing agency.\3\ The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ On December 28, 2017, NSCC filed this proposed rule change
as an advance notice (SR-NSCC-2017-808) with the Commission 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''), 12 U.S.C. 5465(e)(1), and Rule 19b-4(n)(1)(i) of the Act, 17
CFR 240.19b-4(n)(1)(i). A copy of the advance notice is available at
http://www.dtcc.com/legal/sec-rule-filings.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
The proposed rule change of NSCC consists of modifications to
NSCC's Rules & Procedures (``Rules'') \4\ in order to enhance the
calculation of the volatility component of the Clearing Fund formula
that utilizes a parametric Value-at-Risk (``VaR'') model (``VaR
Charge'') by (1) adding an additional calculation utilizing the VaR
model that incorporates an evenly-weighted volatility estimation, which
would supplement the current calculation that utilizes the VaR model
but incorporates an exponentially-weighted moving average (``EWMA'')
volatility estimation,\5\ where the higher of the two calculations
would be the core parametric result (``Core Parametric Estimation'');
and (2) introducing two additional formulas to the calculation of the
VaR Charge--the Gap Risk Measure and the Portfolio Margin Floor, where
the results of these two calculations would be compared to the Core
Parametric Estimation and the highest of the three would be a Member's
final VaR Charge, as described in greater detail below.
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\4\ Capitalized terms not defined herein are defined in the
Rules, available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
\5\ As described in greater detail in the filing, an EWMA
volatility estimation is an estimation of volatility that gives more
weight to most recent market observations, where an evenly-weighted
volatility estimation is an estimation of volatility that gives even
weight to historic market observations.
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NSCC is also proposing to eliminate the existing Market Maker
Domination component (``MMD Charge'') from the Clearing Fund formula,
as described in greater detail below.
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, the clearing agency included
statements concerning the purpose of and basis for the proposed rule
change and discussed any comments it received on the proposed rule
change. The text of these statements may be examined at the places
specified in Item IV below. The clearing agency 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 Proposed Rule Change
1. Purpose
NSCC is proposing to enhance the calculation of the VaR Charge by
introducing an additional estimation of volatility that would be
incorporated into the VaR model, and introducing two additional
calculations, the Gap Risk Measure and the Portfolio Margin Floor, that
NSCC believes would collectively enhance its ability to mitigate market
price risk. NSCC currently calculates the VaR Charge by applying a
parametric VaR model that incorporates an EWMA volatility estimation.
NSCC is proposing to introduce an additional calculation that also
applies the parametric VaR model but replaces the EWMA volatility
estimation with an evenly-weighted volatility estimation.\6\ The result
of these two calculations using the parametric VaR model would be
compared and the higher of the two would be the Core Parametric
Estimation.
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\6\ See id.
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NSCC is also proposing to introduce two additional calculations to
arrive at a final VaR Charge, the Gap Risk Measure and the Portfolio
Margin Floor. NSCC would use the highest result between the Core
Parametric Estimation, the Gap Risk Measure, when applicable, and the
Portfolio Margin Floor calculations as a Member's final VaR Charge.\7\
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\7\ NSCC may calculate Members' VaR Charge on an intraday basis
for purposes of monitoring the risks presented by Members' activity.
These calculations would be also be performed using the proposed
enhanced methodology.
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Each of the separate calculations would provide NSCC with a measure
of the market price risk presented by the Net Unsettled Positions and
Net Balance Order Unsettled Positions (for purposes of this filing,
referred to collectively herein as ``Net Unsettled Positions'') \8\ in
a Member's portfolio. Collectively, the proposed enhancements to the
calculation of the VaR Charge would permit NSCC to more effectively
cover its credit exposures and produce margin levels commensurate with
the risks and particular attributes of each Member's portfolio, as
described in greater detail below.
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\8\ ``Net Unsettled Positions'' and ``Net Balance Order
Unsettled Positions'' refer to net positions that have not yet
passed their settlement date, or did not settle on their settlement
date. See Procedure XV (Clearing Fund Formula and Other Matters) of
the Rules, supra note 4.
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NSCC is also proposing to eliminate the existing MMD Charge from
the Clearing Fund formula. When the MMD Charge was first introduced, it
was developed to only address concentration risks presented by Net
Unsettled Positions in certain securities that are traded by firms that
are designated Market Makers, as described in greater detail below.
Given this limited scope of application of this charge, and because
NSCC believes it more effectively addresses the risks this charge was
designed to address through other risk management measures, including
the proposed Gap Risk Measure calculation of the VaR Charge, NSCC is
proposing to eliminate the MMD Charge.
Each of these proposed changes is described in more detail below.
(i) Overview of the Required Deposit and NSCC's Clearing Fund
As part of its market risk management strategy, NSCC manages its
credit exposure to Members by determining the appropriate Required
Deposits to the Clearing Fund and monitoring its sufficiency, as
provided for in the Rules.\9\ The Required Deposit serves as
[[Page 2829]]
each Member's margin. The objective of a Member's Required Deposit is
to mitigate potential losses to NSCC associated with liquidation of
such Member's portfolio in the event that NSCC ceases to act for such
Member (hereinafter referred to as a ``default'').\10\ The aggregate of
all Members' Required Deposits constitutes the Clearing Fund of NSCC,
which it would access should a defaulting Member's own Required Deposit
be insufficient to satisfy losses to NSCC caused by the liquidation of
that Member's portfolio.
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\9\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund
Formula and Other Matters), supra note 4. NSCC's market risk
management strategy is designed to comply with Rule 17Ad-22(e)(4)
under the Act, where these risks are referred to as ``credit
risks.'' 17 CFR 240.17Ad-22(e)(4).
\10\ The Rules set out the circumstances under which NSCC may
cease to act for a Member and the types of actions it may take. For
example, NSCC may suspend a firm's membership with NSCC or prohibit
or limit a Member's access to NSCC's services in the event that
Member defaults on a financial or other obligation to NSCC. See Rule
46 (Restrictions on Access to Services) of the Rules, supra note 4.
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Pursuant to NSCC's Rules, each Member's Required Deposit amount
consists of a number of applicable components, each of which is
calculated to address specific risks faced by NSCC, as identified
within Procedure XV of the Rules.\11\ The volatility component of each
Member's Required Deposit is designed to measure market price
volatility and is calculated for Members' Net Unsettled Positions. The
volatility component is designed to capture the market price risk
associated with each Member's portfolio at a 99th percentile level of
confidence. The VaR Charge is the volatility component applicable to
most Net Unsettled Positions,\12\ and usually comprises the largest
portion of a Member's Required Deposit. Procedure XV of the Rules
currently provides that the VaR Charge shall be calculated in
accordance with a generally accepted portfolio volatility margin model
utilizing assumptions based on reasonable historical data and an
appropriate volatility range.\13\ As such, NSCC currently calculates a
Member's VaR Charge utilizing the VaR model, which incorporates an EWMA
volatility estimation.
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\11\ Supra note 4.
\12\ As described in Procedure XV, Section I(A)(1)(a)(ii) and
(iii) and Section I(A)(2)(a)(ii) and (iii) of the Rules, Net
Unsettled Positions in certain securities are excluded from the VaR
Charge and instead charged a volatility component that is calculated
by multiplying the absolute value of those Net Unsettled Positions
by a percentage. Supra note 4.
\13\ Procedure XV, Section I(A)(1)(a)(i) and Section
I(A)(2)(a)(i) of the Rules, supra note 4.
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Currently, Members' Required Deposits may also include an MMD
Charge, applicable only to Members that are Market Makers and Members
that clear for Market Makers.\14\ As described in greater detail below,
the MMD Charge is imposed when these Members hold a Net Unsettled
Position that is greater than 40 percent of the overall unsettled long
position (sum of each clearing broker's net long position) in that
security in the Continuous Net Settlement (``CNS'') system.\15\
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\14\ As used herein, ``Market Maker'' means a member firm of the
Financial Industry Regulatory Authority, Inc. (``FINRA'') that is
registered by FINRA as a Market Maker pursuant to FINRA's rules,
available at http://finra.complinet.com/en/display/display.html.
\15\ See Rule 11 (CNS System) and Procedure VII (CNS Accounting
Operation), supra note 4.
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NSCC employs daily backtesting to determine the adequacy of each
Member's Required Deposit. NSCC compares the Required Deposit \16\ for
each Member with the simulated liquidation gains/losses using the
actual positions in the Member's portfolio, and the historical security
returns. NSCC investigates the cause(s) of any backtesting
deficiencies. As part of this investigation, NSCC pays particular
attention to Members with backtesting deficiencies that bring the
results for that Member below the 99 percent confidence target (i.e.,
greater than two backtesting deficiency days in a rolling twelve-month
period) to determine if there is an identifiable cause of repeated
backtesting deficiencies.
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\16\ For backtesting comparisons, NSCC uses the Required Deposit
amount without regard to the actual collateral posted by the Member.
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Further, as a part of its model performance review, and consistent
with its regulatory requirements, NSCC regularly assesses its risks as
they relate to its model assumptions, parameters, and sensitivities,
including those of its parametric VaR model, to evaluate whether margin
levels are commensurate with the particular risk attributes of each
relevant product, portfolio, and market.\17\ As part of NSCC's model
performance monitoring, NSCC management analyzes and evaluates the
continued effectiveness of its parametric VaR model in order to
identify any weaknesses, and determine whether, and which, enhancements
may be necessary to its formulas, parameters or assumptions to improve
margin coverage.
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\17\ See 17 CFR 240.17Ad-22(e)(6)(i), (vi).
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The proposed changes to the calculation of the VaR Charge,
described below, are a result of NSCC's regular review of the
effectiveness of its margining methodology.
(ii) Enhancements to the VaR Charge
Adding an Evenly-Weighted Volatility Estimation to the VaR Model.
To calculate the VaR Charge, NSCC uses a parametric VaR model that
currently only incorporates an EWMA volatility estimation. The EWMA
volatility estimation is considered front-weighted as it assigns more
weight to most recent market observations based on the assumption that
the most recent price history would have more relevance to, and
therefore is a better measure of, current market price volatility
levels. A calculation using this EWMA volatility estimation is
responsive to changing market volatility, and, because NSCC's Member-
level model backtesting results have generally remained above a 99th
percentile level of confidence over a 10-year performance window, NSCC
believes this calculation continues to be an effective measurement of
price volatility for the majority of Net Unsettled Positions that are
subject to the VaR Charge. More specifically, NSCC believes its
backtesting results show that this calculation has been proven to be
effective for calculating the price volatility of large diversified
portfolios, which represent the majority of Net Unsettled Positions
that are subject to the VaR Charge.
However, NSCC believes this calculation may not adequately cover a
rapid change in market price volatility levels, including, for example,
a drop in portfolio volatility in a stabilizing market. Additionally,
NSCC has observed poorer backtesting coverage for those Members with
less diversified portfolios in atypical market conditions.
In estimating volatility, the EWMA volatility estimation gives
greater weight to more recent market observations, and effectively
diminishes the value of older market observations. However, volatility
in equity markets often rapidly revert to pre-volatile levels, and then
are followed by a subsequent spike in volatility. So, while a
calculation that relies exclusively on the EWMA volatility estimation
can capture changes in volatility that emerge from a progressively calm
or non-volatile market, it may cause a reactive decrease in margin that
does not adequately capture the risks related to a rapid shift in
market price volatility levels. Alternatively, an evenly-weighted
volatility estimation would continue to give even weight to all
historical volatility observations in the look-back period (described
below), and would prevent margin from decreasing too quickly.
Therefore, in order to more adequately cover a rapid change in
market price volatility levels and the risks presented by less
diversified portfolios in its calculation of the VaR Charge, NSCC is
proposing to add another calculation of the VaR Charge utilizing its
parametric VaR model that would incorporate an evenly-weighted
volatility estimation. NSCC believes an
[[Page 2830]]
additional calculation using a volatility estimation that gives even
weight to market observations over a set look-back period would allow
it to more adequately address risks related to a rapid shift in general
market price volatility levels, which can occur as a result of either
idiosyncratic, issuer events (also referred to as ``gap risk
events''),\18\ or are due to specific characteristics of a Member's
portfolio based on their size, balance, direction, concentration, or
the degree of correlation with broad market returns.
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\18\ Gap risk events may include, for example, earning reports,
management changes, merger announcements, insolvency, or other
unexpected, issuer-specific events.
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The proposed calculation incorporating an evenly-weighted
volatility estimation would give equal weight to price observations
over a look-back period of at least 253 days. NSCC analyzed the impact
of using a look-back period of various lengths and determined that a
look-back period of at least 253 days would provide NSCC with an
adequate view of recent, past market observations in estimating
volatility to meet its backtesting performance targets, and wouldn't
result in unnecessarily high margin calculations. NSCC would weigh
these considerations periodically to determine an appropriate look-back
period that is at least 253 days.
NSCC would perform both calculations using the parametric VaR
model--one using the existing EWMA volatility estimation and an
additional calculation using the proposed evenly-weighted volatility
estimation--and would use the highest result of these calculations as
the Core Parametric Estimation in connection with calculating a
Member's VaR Charge. NSCC believes that, while the existing EWMA
calculation provides adequate responsiveness to increasing market
volatility, as described above, the proposed evenly-weighted
calculation would be better at covering the risk of a rapid change in
market volatility levels by retaining market observations from the
entire historical data set. Therefore, by using both calculations and
selecting the higher result, NSCC would be able to more effectively
cover its credit exposures and mitigate the risk presented by different
market conditions in arriving at a final Core Parametric Estimation.
In order to implement the proposed change, NSCC would amend
Procedure XV of the Rules by creating a new subjection (I) to Sections
I(A)(1)(a)(i) and I(A)(2)(a)(i) of the Rules, which would define the
Core Parametric Estimate as the higher result of two calculations--and
EWMA calculation and the proposed evenly-weighted calculation--both
utilizing the parametric VaR model.
Gap Risk Measure. NSCC is also proposing to introduce the Gap Risk
Measure as an additional calculation that, when applicable, would be
used to determine a Member's final VaR Charge.
The proposed Gap Risk Measure would be calculated to address the
risks presented by a portfolio that is more susceptible to the effects
of gap risk events due to the idiosyncratic nature of the Net Unsettled
Positions in that portfolio. For example, the proposed calculation
would address the risk that a gap risk event affects the price of a
security in which a portfolio holds a Net Unsettled Position that
represents more than a certain percent of the entire portfolio's value,
such that the event could impact the entire portfolio's value. The
proposed Gap Risk Measure would supplement the calculation of the Core
Parametric Estimation because a parametric VaR model calculation is not
designed to fully capture this specific risk presented by a
concentrated position in a Member's portfolio.
The proposed Gap Risk Measure would only be applied for a Member if
the Net Unsettled Position with the largest absolute market value in
the portfolio represents more than a certain percent of the entire
portfolio's value (``concentration threshold''). NSCC is proposing a
concentration threshold to the application of the Gap Risk Measure
because its backtesting results have shown that portfolios with a Net
Unsettled Position that represents a proportional value of the entire
portfolio over 30 percent tend to have backtesting coverage below the
target 99 percent confidence level. These results also show that these
portfolios are more susceptible to the effects of gap risk events that
the proposed calculation is designed to measure. Therefore, NSCC would
only apply the Gap Risk Measure charge if the Net Unsettled Position
with the largest absolute market value in a Member's portfolio
represents more than 30 percent of that Member's entire portfolio
value. NSCC would set 30 percent as the ceiling for the concentration
threshold, and would evaluate the threshold periodically based on the
Member's backtesting results during a time period of not less than the
previous twelve months to determine if it may be appropriate to the
threshold at a lower percent.
Additionally, NSCC believes the risk of large, unexpected price
movements, particularly those caused by a gap risk event, may have a
greater impact on portfolios with large Net Unsettled Positions in
securities that are susceptible to those events. Generally, index-based
exchange-traded funds track closely to similar equity indices and are
less prone to the effects of gap risk events. As such, if the
concentration threshold is met, NSCC would calculate the Gap Risk
Measure for Net Unsettled Positions in the portfolio, other than
positions in index-based exchange traded funds (referred to herein for
ease of reference as ``non-index Net Unsettled Positions'').\19\
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\19\ NSCC would use a third-party market provider to identify
index-based exchange-traded funds. The third-party market provider
would identify index-based exchange-traded funds as those with
criteria that requires the portfolio returns to track to a broad
market index. Exchange-traded funds that do not meet this criteria
would not be considered index-based exchange-traded funds and would
be included the Gap Risk Measure calculation.
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When applicable, NSCC would calculate the Gap Risk Measure by
multiplying the gross market value of the largest non-index Net
Unsettled Position in the portfolio by a percent of not less than 10
percent.\20\ NSCC would determine such percent empirically as no less
than the larger of the 1st and 99th percentiles of three-day returns of
a set of CUSIPs that are subject to the VaR Charge pursuant to the
Rules,\21\ giving equal rank to each to determine which has the highest
movement over that three-day period. NSCC would use a look-back period
of not less than ten years that includes a one-year stress period.\22\
If the one-year stress period overlaps with the look-back period, only
the non-overlapping period would be combined with the look-back period.
The result would then be rounded up to the nearest whole percentage.
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\20\ NSCC believes it is prudent to set a floor for the Gap Risk
Measure charge, and has determined that a floor of 10 percent would
appropriately align this charge with the charge that is applied to
Net Unsettled Positions in certain securities that are excluded from
the VaR Charge and instead charged a similar haircut-based
volatility component. See supra note 12.
\21\ Supra note 12.
\22\ NSCC believes using a look-back period of not less than ten
years that includes a one-year stress period would provide it with a
stable risk measurement that incorporates a sufficient look-back
period that would be appropriate for purposes of determining the
appropriate percent to use in the calculation of the Gap Risk
Measure.
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By calculating this charge as a percent of the gross market value
of the largest non-index Net Unsettled Position that exceeds the set
threshold, NSCC believes the proposed Gap Risk Measure would allow it
to capture the risk that a gap risk event affects the price of a
security in which the Member holds a concentrated position and, due to
the disproportionate value of this position in the Member's portfolio,
the impact of
[[Page 2831]]
that event affects the entire portfolio. This calculation, as an
additional measure for the VaR Charge, would permit NSCC to assess an
adequate amount of margin to cover the gap risks not captured by the
parametric VaR model calculations. As such, the proposed calculation
would contribute to NSCC's goal of producing margin levels commensurate
with the risks and particular attributes of each Member's portfolio.
In order to implement this proposed change, NSCC would amend
Procedure XV of the Rules by creating a new subjection (II) to Sections
I(A)(1)(a)(i) and I(A)(2)(a)(i) of the Rules, which would describe the
calculation of the Gap Risk Measure.
Portfolio Margin Floor. NSCC is also proposing to introduce the
Portfolio Margin Floor as an additional calculation that, when
applicable, would be used to determine a Member's final VaR Charge.
The proposed Portfolio Margin Floor would be calculated to address
risks that may not be adequately accounted for in the other
calculations of the VaR Charge by operating as a floor to, or minimum
amount of, the final VaR Charge. A parametric VaR model may result in a
low VaR Charge for balanced portfolios. For example, in circumstances
where the gross market value of a Member's Net Unsettled Positions is
high and the cost of liquidation in the event that Member defaults
could also be high, the parametric VaR model may not adequately measure
the potential costs of liquidation. The proposed charge would be based
on the balance and direction of Net Unsettled Positions in the Members'
portfolio and is designed to be proportional to the market value of the
portfolio. In this way, the Portfolio Margin Floor would allow NSCC to
more effectively cover its credit exposures.
The Portfolio Margin Floor would be the sum of two separate
calculations, both of which would measure the market value of the
portfolio based on the direction of Net Unsettled Positions in that
portfolio. In this way, the calculation would effectively set a floor
on the VaR Charge based on the composition of the portfolio and would
mitigate the risk that low price volatility in portfolios with either
large gross market values or large net directional market values could
hinder NSCC's ability to effectively liquidate or hedge the Member's
portfolio in three business days.
First, NSCC would calculate the net directional market value of the
portfolio by calculating the absolute difference between the market
value of the long Net Unsettled Positions and the market value of the
short Net Unsettled Positions in the portfolio,\23\ and then
multiplying that amount by a percentage. Such percentage would be
determined by examining the annual historical volatility levels of
benchmark equity indices over a historical look-back period, as a
standard and generally accepted reference that incorporates sufficient
data history. Second, NSCC would calculate the balanced market value of
the portfolio by taking the lowest market value of either (i) the long
Net Unsettled Positions, or (ii) the short Net Unsettled Positions in
the portfolio,\24\ and then multiplying that value by a percentage.
Such percentage would generally be a fraction of the percentage used in
the calculation of the net directional market value of the portfolio
and would be an amount that covers the transaction costs and other
basis risks present for the Net Unsettled Positions in that
portfolio.\25\
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\23\ For example, if the market value of the long Net Unsettled
Positions is $100,000, and the market value of the short Net
Unsettled Positions is $200,000, the net directional market value of
the portfolio is $100,000.
\24\ For example, if the market value of the long Net Unsettled
Positions is $100,000, and the market value of the short Net
Unsettled Positions is $110,000, the balanced market value of the
portfolio is $100,000.
\25\ NSCC would use a third-party market provider to identify
these transaction costs and other basis risks.
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NSCC would add the results of these two calculations to arrive at
the final Portfolio Margin Floor amount. The sum of these two
calculations would provide a minimum VaR Charge by effectively
establishing a margin floor for certain portfolios that may not be
effectively assessed in the other calculations of the VaR Charge. NSCC
would compare the Portfolio Margin Floor result with the Gap Risk
Measure, when applicable, and the Core Parametric Estimation and would
use the highest of the three calculations as the final VaR Charge for
each Member, as applicable.
In order to implement this proposed change, NSCC would amend
Procedure XV of the Rules by creating a new subjection (III) to
Sections I(A)(1)(a)(i) and I(A)(2)(a)(i) of the Rules, which would
describe the calculation of the Portfolio Margin Floor.
(iii) Eliminating the MMD Charge
Finally, NSCC is proposing to eliminate the MMD Charge from its
Clearing Fund calculation. The MMD Charge is an existing component of
the Clearing Fund formula and is calculated for Members that are Market
Makers and Members that clear for Market Makers.\26\ The charge was
introduced during a period of rapid growth in the adaptation of the
internet, and was developed to address the risks presented by
concentrated positions held specifically by Market Makers. The MMD
Charge is described in Procedure XV of the Rules, which provides that,
if the Market Maker (either the Member or the correspondent of the
Member) holds a Net Unsettled Position that is greater than 40 percent
of the overall unsettled long position (sum of each clearing broker's
net long position) in that security in the CNS system, NSCC may impose
the MMD Charge. NSCC calculates the MMD charge as the sum of each of
the absolute values of the Net Unsettled Positions in these securities,
less the reported amount of excess net capital for that Member.\27\ The
MMD charge is designed to address dominated securities that are
susceptible to marketability and liquidation impairment because of the
relative size of the Net Unsettled Positions that NSCC would have to
liquidate or hedge in the case of Member default.
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\26\ See Procedure XV, Section I(A)(1)(d) of the Rules, supra
note 4.
\27\ NSCC does not apply the excess net capital offset for
Members rated 7 on the Credit Risk Rating Matrix. See Procedure XV,
Sections I(A)(1)(d) and I(A)(2)(c) of the Rules, supra note 4.
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Since the MMD Charge was implemented, the U.S. equities market has
evolved with improved price transparency, access across exchange
venues, and participation by market liquidity providers to reduce the
risks that the charge was designed to address. Further, NSCC believes
the MMD Charge may not effectively address concentration risk because
(1) it only applies to Net Unsettled Positions in certain dominated
securities, as described above and currently in Procedure XV of the
Rules; (2) it does not address concentration risk presented by Net
Unsettled Positions in securities that are not listed on NASDAQ or in
securities traded by firms that are not Market Makers; and (3) it does
not account for concentration in market capitalization categories.
NSCC also believes that the proposed enhancements to the VaR
Charge, specifically the introduction of an evenly-weighted volatility
measure and the calculation of the Gap Risk Measure, would provide it
with more effective measures of risks related to concentrated positions
in its Members' portfolios. Subject to applicable thresholds, these
proposed risk measures would be applicable to all Members as part of
the calculation VaR Charge, and would not, like the MMD
[[Page 2832]]
Charge, be limited to positions held by Market Makers. Further, as a
threshold-based calculation, the Gap Risk Measure would provide NSCC
with a more appropriate measure of the potential risk presented by a
large Net Unsettled Position in a portfolio. Therefore, NSCC believes
that these proposed enhancements to the VaR Charge and other existing
risk management measures (described below) would provide it with more
effective measures of the risks presented by concentrated positions,
and, as such, it is appropriate to eliminate the MMD Charge.
In order to implement this proposed change, NSCC would amend
Procedure XV of the Rules by removing subsection (d) of Section I(A)(1)
and subsection (c) of Section I(A)(2) of the Rules, and renumbering the
subsequent subsections accordingly.
(iv) Mitigating Risks of Concentrated Positions
For the reasons described above, NSCC believes that the proposed
enhancements to its VaR Charge would allow it to better measure and
mitigate the risks presented by certain Net Unsettled Positions,
including the risk presented to NSCC when those positions are
concentrated in a particular security. One of the risks presented by a
Net Unsettled Position concentrated in an asset class is that NSCC may
not be able to liquidate or hedge the Net Unsettled Positions of a
defaulted Member in the assumed timeframe at the market price in the
event of a Member default. Because NSCC relies on external market data
in connection with monitoring exposures to its Members, the market data
may not reflect the market impact transaction costs associated with the
potential liquidation as the concentration risk of a Net Unsettled
Position increases. However, NSCC believes that, through the proposed
changes and through existing risk management measures,\28\ it would be
able to effectively measure and mitigate risks presented when a
Member's Net Unsettled Positions are concentrated in a particular
security.
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\28\ For example, pursuant to existing authority under Procedure
XV, Sections I(A)(1)(e) and I(A)(2)(d) of the Rules (to be re-
numbered pursuant this proposed rule change to Sections I(A)(1)(d)
and I(A)(2)(c) of Procedure XV of the Rules), NSCC may require an
additional payment as part of a Member's Required Deposit in the
event it observes price fluctuations in or volatility or lack of
liquidity of any security that are not otherwise addressed by its
VaR Charge or the other components of the Clearing Fund. An example
of where this additional payment may be required is in circumstances
where NSCC identifies an exposure that is not adequately addressed
by its margining methodology. Supra note 4.
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NSCC will continue to evaluate its exposures to these risks. Any
future, proposed changes to the margining methodology to address such
risks would be subject to a separate proposed rule change pursuant to
Section 19(b)(1) of the Act,\29\ and the rules thereunder, and advance
notice pursuant to Section 806(e)(1) of the Clearing Supervision
Act,\30\ and the rules thereunder.
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\29\ 15 U.S.C. 78s(b)(1).
\30\ 12 U.S.C. 5465(e)(1).
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2. Statutory Basis
NSCC believes that the proposed changes described above are
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a registered clearing agency. In
particular, NSCC believes that the proposed changes are consistent with
Section 17A(b)(3)(F) of the Act,\31\ and Rules 17Ad-22(e)(4)(i) and
(e)(6)(i) and (v), each promulgated under the Act,\32\ for the reasons
described below.
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\31\ 15 U.S.C. 78q-1(b)(3)(F).
\32\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i) and (v).
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Section 17A(b)(3)(F) of the Act \33\ requires that the rules of
NSCC be designed to, among other things, assure the safeguarding of
securities and funds which are in the custody or control of the
clearing agency or for which it is responsible. As discussed above,
NSCC is proposing a number of changes to the way it calculates the VaR
Charge, one of the components of its Members' Required Deposits--a key
tool that NSCC uses to mitigate potential losses to NSCC associated
with liquidating a Member's portfolio in the event of Member default.
NSCC believes the proposed changes are designed to assure the
safeguarding of securities and funds which are in its custody or
control or for which it is responsible because they are designed to
enable NSCC to better limit its exposure to Members in the event of a
Member default.
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\33\ 15 U.S.C. 78q-1(b)(3)(F).
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First, NSCC's proposal to introduce an additional calculation using
its parametric VaR model that uses an evenly-weighted volatility
estimation would better enable NSCC to limit its exposures to Members
by enhancing the calculation of the VaR Charge to better cover the risk
of a rapid change in market price volatility levels, including, for
example, a drop in portfolio volatility in a stabilizing market.
Second, the proposal to introduce the Gap Risk Measure calculation as
an additional measure of volatility in connection with the calculation
of the VaR Charge would better enable NSCC to limit its exposures to
Members by more effectively capturing the risk that gap risk events
impact the entire portfolio's value due to the idiosyncratic nature of
the Net Unsettled Positions in that portfolio. Third, the proposal to
introduce the Portfolio Margin Floor in its calculation of a Member's
VaR Charge would enable NSCC to better limit its exposures to Members
by better capturing the risks that may not be adequately accounted for
in the other calculations of the VaR Charge. Finally, NSCC's proposal
to eliminate the MMD Charge would enable NSCC to remove a component of
the Required Deposit that provides NSCC with only a limited measure of
risks presented by Net Unsettled Positions that are concentrated in
certain securities, which NSCC believes it can more adequately measure
through other proposed and existing risk management measures, as
described above.
By enabling NSCC to better limit its exposure to Members, the
proposed changes are designed to ensure that, in the event of Member
default, NSCC's operations would not be disrupted and non-defaulting
Members would not be exposed to losses they cannot anticipate or
control. In this way, the proposed rules are designed to assure the
safeguarding of securities and funds which are in the custody or
control of NSCC or for which it is responsible and therefore consistent
with Section 17A(b)(3)(F) of the Act.\34\
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\34\ Id.
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Rule 17Ad-22(e)(4)(i) under the Act \35\ requires, in part, that
NSCC 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.
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\35\ 17 CFR 240.17Ad-22(e)(4)(i).
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As described above, the proposed changes would enable NSCC to
better identify, measure, monitor, and, through the collection of
Members' Required Deposits, manage its credit exposures to Members by
maintaining sufficient resources to cover those credit exposures fully
with a high degree of confidence. Each of the additional calculations
that NSCC is proposing to introduce to enhance its methodology for
calculating a Member's VaR Charge would provide NSCC with a more
effective measure of the risks these calculations were designed to
assess, as described above. As such, the proposed
[[Page 2833]]
enhancements to the calculation of the VaR Charge would permit NSCC to
more effectively identify, measure, monitor and manage its exposures to
market price risk, and would enable it to better limit its exposure to
potential losses from Member default. The proposal to use the highest
result of each of the calculations as among the Core Parametric
Estimation, the Gap Risk Measure and the Portfolio Margin Floor, would
enable NSCC to manage its credit exposures by allowing it to collect
and maintain sufficient resources to cover those exposures fully and
with a high degree of confidence.
Furthermore, removing the MMD Charge would enable NSCC to remove
from the Clearing Fund calculations a component that is limited in
scope and would allow it to address the risks presented by Net
Unsettled Positions that are concentrated in certain securities more
effectively by other Clearing Fund components and risk management
measures.
Therefore, the proposal would enhance NSCC's ability to effectively
identify, measure and monitor its credit exposures and would enhance
its ability to maintain sufficient financial resources to cover its
credit exposure to each participant fully with a high degree of
confidence. As such, NSCC believes the proposed changes are consistent
with Rule 17Ad-22(e)(4)(i) under the Act.\36\
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\36\ Id.
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Rule 17Ad-22(e)(6)(i) under the Act \37\ requires, in part, that
NSCC 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. Rule 17Ad-22(e)(6)(v) under the Act \38\ requires, in part,
that NSCC 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.
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\37\ 17 CFR 240.17Ad-22(e)(6)(i).
\38\ 17 CFR 240.17Ad-22(e)(6)(v).
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The Required Deposits are made up of risk-based components (as
margin) that, that are calculated and assessed daily to limit NSCC's
credit exposures to Members. NSCC's proposal to enhance the calculation
of its VaR Charge in order to more effectively address market price
volatility would permit it to produce margin levels that are
commensurate with the particular risk attributes, including risks
related to rapid changes in market price volatility levels due to gap
risk events, or risks related to a unique composition of securities
within a portfolio, as described above. For example, the use of an
evenly-weighted volatility estimation utilizing the VaR model, as an
additional calculation of the VaR Charge, which gives equal weight to a
long historical data set, rather than more weight to recent
observations, would permit NSCC to more effectively measure the risk of
a rapid change in market price volatility. The addition of the Gap Risk
Measure and the Portfolio Margin Floor would also provide NSCC with
additional measurements of the market price volatility of a Member's
Net Unsettled Position, enabling NSCC to assess a VaR Charge that
accounts for the risks those charges are designed to address, as
described above.
Finally, NSCC is proposing to eliminate the MMD Charge because this
component of the Clearing Fund has only a limited application and, as
such, does not provide as effective a measurement of the risk presented
by Net Unsettled Positions that are concentrated in certain securities
as other proposed and existing risk management measures. Therefore, the
proposal to eliminate this charge would enable NSCC to remove an
unnecessary component from the Clearing Fund calculation, and would
help NSCC to rely on an appropriate method of measuring its exposures
to this risk.
The proposed changes are designed to assist NSCC in maintaining a
risk-based margin system that considers, and produces margin levels
commensurate with, the risks and particular attributes of portfolios
that exhibit idiosyncratic risk attributes, are more susceptible to
price volatility caused by to gap risk events, and contain concentrated
Net Unsettled Positions. Therefore, NSCC believes the proposed change
is consistent with Rule 17Ad-22(e)(6)(i) and (v) under the Act.\39\
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\39\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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(B) Clearing Agency's Statement on Burden on Competition
NSCC believes that the proposed changes that would enhance the
calculation of its VaR Charge could have an impact on competition.
Specifically, NSCC believes that the proposed changes could burden
competition because they would result in larger Required Deposit
amounts for Members when the enhancements result in a VaR Charge that
is greater than the amount calculated pursuant to the current
methodology. When the proposal results in a larger VaR Charge, and,
thus, a larger Required Deposit, for Members that have lower operating
margins or higher costs of capital compared to other Members, the
proposed changes could burden competition. However, the increase in
Required Deposit would be in direct relation to the market price risk
presented by each Members' Net Unsettled Positions, and each Member's
Required Deposit would continue to be calculated with the same
parameters and at the same confidence level for each Member. Therefore,
Members that present similar Net Unsettled Positions would have similar
impacts on their Required Deposit amounts. As such NSCC believe that
any burden on competition imposed by the proposed changes would not be
significant and, further, would be both necessary and appropriate in
furtherance of NSCC's efforts to mitigate risks and meet the
requirements of the Act, as described in this filing and further below.
NSCC believes that the above described burden on competition that
may be created by the proposed changes associated with the enhancements
to the VaR Charge would be necessary in furtherance of the Act,
specifically Section 17A(b)(3)(F) of the Act,\40\ because, as described
above, the Rules must be designed to assure the safeguarding of
securities and funds that are in NSCC's custody or control or which it
is responsible. NSCC believes the proposed changes to enhance the VaR
Charge would also support NSCC's compliance with Rules 17Ad-22(e)(4)(i)
and Rule 17Ad-22(e)(6)(i) and (v) under the Act,\41\ which require NSCC
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to (x) 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;
(y) 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; and (z) cover its credit
[[Page 2834]]
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. As described above, NSCC believes
implementing the proposed enhancements to the VaR Charge would improve
the risk-based methodology that NSCC employs to measure market price
risk and would better limit NSCC's credit exposures to Members,
consistent with these requirements.
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\40\ 15 U.S.C. 78q-1(b)(3)(F).
\41\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i) and (v).
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NSCC believes that the above described burden on competition that
could be created by the proposed changes would be appropriate in
furtherance of the Act because such changes have been appropriately
designed to assure the safeguarding of securities and funds which are
in the custody or control of NSCC or for which it is responsible, as
described in detail above. By introducing additional calculations for
arriving at a Member's final VaR Charge, each of which are designed to
address the unique risks presented by Members' Net Unsettled Positions,
as described above, the proposal would allow NSCC to produce margin
levels commensurate with the risks and particular attributes of each
Member's portfolio. Therefore, because the proposed changes were
designed to provide NSCC with an appropriate measure of the risks
presented by Members' Net Unsettled Positions, NSCC believes the
proposals are appropriately designed to meet its risk management goals
and its regulatory obligations.
NSCC believes that it has designed the proposed changes in a
reasonable and appropriate way in order to meet compliance with its
obligations under the Act. Specifically, implementing the proposed
enhancements to the calculation of its VaR Charge would improve the
risk-based margining methodology that NSCC employs to set margin
requirements and better limit NSCC's credit exposures to its Members.
Therefore, NSCC believes the proposed changes are necessary and
appropriate in furtherance of NSCC's obligations under the Act,
specifically Section 17A(b)(3)(F) of the Act \42\ and Rules 17Ad-
22(e)(4)(i) and Rule 17Ad-22(e)(6)(i) and (v) under the Act.\43\
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\42\ 15 U.S.C. 78q-1(b)(3)(F).
\43\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i) and (v).
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Because the proposal to eliminate the MMD Charge would remove this
charge from the margining methodology as applied to all Members, when
applicable, NSCC does not believe the proposed change to eliminate the
MMD Charge would have any impact on competition.
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants, or Others
While NSCC has not solicited or received any written comments
relating to this proposal, NSCC has conducted outreach to Members in
order to provide them with notice of the proposal. NSCC will notify the
Commission of any written comments received by NSCC.
III. Date of Effectiveness of the Proposed Rule Change, and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the clearing agency consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the 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 Number SR-NSCC-2017-020 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-NSCC-2017-020. 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 website (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change 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 website 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 the filing also will be available for inspection
and copying at the principal office of NSCC and on DTCC's website
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received
will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly.
All submissions should refer to File Number SR-NSCC-2017-020 and
should be submitted on or before February 9, 2018.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\44\
Eduardo A. Aleman,
Assistant Secretary.
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\44\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 2018-00851 Filed 1-18-18; 8:45 am]
BILLING CODE 8011-01-P