

[Federal Register: January 5, 2006 (Volume 71, Number 3)]
[Notices]               
[Page 629-632]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05ja06-57]                         

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53036; File No. SR-FICC-2005-18]

 
Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto To 
Enhance the Repo Collateral Substitution Process of FICC's Government 
Securities Division

December 29, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on September 30, 2005, the 
Fixed Income Clearing Corporation (``FICC'') filed with the Securities 
and Exchange Commission (``Commission'') and on December 20, 2005, 
amended the proposed rule change described in Items I, II, and III 
below, which items have been prepared primarily by FICC. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested parties.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The purpose of this proposed rule change is to enhance the repo 
collateral substitution process of FICC's Government Securities 
Division (``GSD'').

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FICC 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. FICC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.\2\
---------------------------------------------------------------------------

    \2\ The Commission has modified the text of the summaries 
prepared by FICC.
---------------------------------------------------------------------------

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Initial Substitution Notification Without Replacement Collateral 
Information
    The GSD's repo collateral substitution process provides a mechanism 
for a repo dealer to process its right to substitute the original 
collateral it

[[Page 630]]

provided as part of a repo transaction with replacement collateral. 
With respect to a brokered transaction,\3\ typically the repo dealer 
notifies the relevant broker that it wishes to substitute the repo 
collateral before it specifically identifies what the replacement 
collateral will be. The broker then contacts the reverse repo dealer 
and informs it that a repo collateral substitution process is being 
initiated, at which time the reverse repo dealer sends the original 
repo collateral to FICC. However, since under FICC's current system the 
repo dealer's substitution notification sent to FICC must contain 
information about the replacement collateral, often the substitution 
notification is not delivered to FICC at the time FICC receives the 
returned original repo collateral from the reverse repo dealer. When 
the repo dealer does determine what securities will constitute the 
replacement collateral, it often delivers the replacement collateral to 
FICC before sending the repo collateral substitution notification. Thus 
the parties have delivered the respective collateral to FICC, but until 
FICC receives the substitution notification, it is not able to deliver 
the collateral to the appropriate parties. This leaves FICC in an 
overdraft position at the clearing bank(s), which can cause expense and 
risk to FICC and to its members and settlement processing delays.
---------------------------------------------------------------------------

    \3\ With respect to a non-brokered repo transaction, the repo 
dealer would contact the reverse repo dealer directly about the repo 
collateral substitution.
---------------------------------------------------------------------------

    The proposed rule change will permit the repo dealer or repo 
broker, as appropriate, to submit a substitution notification to FICC 
without information about the replacement collateral. FICC will deliver 
the original collateral to the repo party's account at its clearing 
bank(s) upon receipt of the substitution notification so the original 
collateral will no longer linger in FICC's account. FICC believes this 
will encourage repo dealers to allocate replacement collateral more 
timely since they will be financing the original collateral 
intraday.\4\
---------------------------------------------------------------------------

    \4\ The changes necessary to reflect this part of the rule 
change are contained in GSD Rule 18, Sections 3(a), (b), (c), and 
(d) and in the Schedule of Required and Accepted Data Submission 
Items for a Right of Substitution. A new schedule, titled Schedule 
of Required and Accepted Data Submission Items for New Securities 
Collateral, is being proposed to be added to the rules to reflect 
that information on the replacement collateral will be contained in 
a separate submission to FICC.
---------------------------------------------------------------------------

2. Revised Repo Collateral Substitution Process Deadline and Fee 
Schedule
    The proposed change in repo processing requires a revision to GSD's 
schedule of timeframes. Also, in order to further encourage timely 
submission of collateral requests and the associated required 
information, FICC is proposing to add a new late fee to the repo 
substitution process. Currently, there is a two-tiered deadline and 
associated late fee for a repo party to submit a substitution 
notification.\5\ The proposed rule change would establish: (i) An 11:00 
a.m. Eastern Time deadline \6\ for a repo party to submit a 
substitution notification and (ii) a late fee of $100 for each 
substitution notification that is received after the deadline. The 
proposed rule change also would establish a two-tiered deadline and 
associated late fee schedule for a repo party to submit replacement 
collateral information. The proposed deadlines for submission of 
replacement collateral information are: (i) 12:00 p.m. Eastern Time and 
(ii) 12:30 p.m. Eastern Time. The proposed late fee assessments are: 
(i) $100 for each submission of replacement collateral information that 
is received after the first deadline but before the second deadline and 
(ii) $250 for each submission of replacement collateral information 
that is received after the second deadline.\7\
---------------------------------------------------------------------------

    \5\ The current deadlines are 12:00 p.m. Eastern Time and 12:30 
p.m. Eastern Time. The deadlines are extended by one hour on days 
that: (i) FICC determines are high-volume days or (ii) The Bond 
Market Association announces in advance will be high-volume days. 
FICC assesses a late fee of: (i) $100 for each substitution 
notification that is received after the first deadline but before 
the second deadline and (ii) $250 for each substitution notification 
that is received after the second deadline.
    \6\ The proposed 11:00 a.m. Eastern Time deadline will not be 
extended on high-volume days.
    \7\ The proposed allocation of collateral deadlines will be 
extended by one hour on days that: (i) FICC determines are high-
volume days or (ii) The Bond Market Association announces in advance 
will be high-volume days. The rule changes necessary to affect this 
part of the proposed rule are contained in the Schedule of 
Timeframes and in the Fee Structure under ``Late Fees.''
---------------------------------------------------------------------------

3. Risk Management Measures and Technical Changes
    As part of the proposed rule change, FICC believes it is necessary 
to address the risk presented to FICC in the repo collateral 
substitution process by the failure of a party to timely submit 
information regarding the replacement collateral to FICC. The risk that 
arises in such a situation is that by the time FICC receives the 
information about the replacement collateral, the replacement 
collateral may have a different market value than the original 
collateral on which FICC's margin calculations were based. To address 
this, FICC is proposing certain risk management measures. Specifically, 
FICC will: (i) increase the clearing fund calculation of the repo 
dealer and allow margining with respect to replacement collateral based 
on applicable generic CUSIP numbers only; \8\ and (ii) impose mark-to-
market consequences on both the repo dealer and the reverse dealer with 
respect to unknown replacement collateral.
---------------------------------------------------------------------------

    \8\ Generic CUSIP numbers represent the range of permissible 
securities that can constitute the replacement collateral. For 
example, there is a generic CUSIP number which represents Treasury 
securities with remaining maturity of fewer than thirty years.
---------------------------------------------------------------------------

    A. Clearing Fund Calculation and Permissible Margin Offsets. With 
respect to the calculation of the repo dealer's clearing fund 
requirement, FICC will assign a value to a repo transaction where FICC 
has not received information regarding the replacement collateral, 
which value will be 150 percent of the contract value of the original 
securities collateral.\9\ FICC will also apply the highest applicable 
margin factor in its rules in connection with the repo transaction. In 
GSD's rules, the highest margin factor is the factor for securities 
with a remaining maturity of fewer than 30 years. Therefore, if the 
generic CUSIP number that is assigned to the unknown replacement 
collateral is the generic CUSIP number for Treasury securities with a 
remaining maturity of under 30 years, FICC will use the existing margin 
factor of 1.450 (applicable to category 1 members with positions in 
non-zeros).\10\
---------------------------------------------------------------------------

    \9\ New subsection 3(f) has been proposed to be added to Rule 18 
in order to effect this change. It should be noted that the 
application of the 150 percent for clearing fund purposes applies to 
both the receive/deliver and repo volatility components of the 
clearing fund calculation.
    \10\ The GSD's margin factor schedules apply different margin 
factors to category 1 and category 2 dealers. In this example, if 
the member were a category 2 member electing not to receive credit 
forward mark adjustment payments, the applicable margin factor under 
the proposed rule change would be 1.5.
---------------------------------------------------------------------------

    The proposed risk management measures applicable to non-timely 
allocation of replacement collateral will further affect the clearing 
fund calculation of the repo dealer by limiting permissible offsets. A 
regular part of the GSD's margining system is to permit offsets between 
resulting margin amounts of long and short net settlement positions. 
The GSD's rules contain disallowance factor tables that set forth 
specific limits on these permissible offsets. For example, where a 
short net settlement position in Treasury Offset Class A is to be 
offset

[[Page 631]]

against a long net settlement position in Treasury Offset Class B, the 
applicable disallowance factor table rules provides that 20 percent of 
this offset will be disallowed. For offset purposes under the proposed 
rule change, FICC will define two new offset classes to capture the 
generic CUSIP numbers that can be assigned to unknown replacement 
collateral. These new offset classes will be identified as ``H'' for 
Treasury securities and ``h'' for non-mortgage-backed Agency 
securities. Under the proposed rule change, as a further risk 
management measure, FICC will not permit offsets: (i) Between Offset 
Classes H and h or (ii) between Offset Classes H or h on the one hand 
and other existing GSD Offset Classes on the other.
    B. Modified Mark-to-Market Calculation. FICC also believes that a 
prudent risk management measure in the case where a generic CUSIP 
number is used for underlying collateral will be to calculate a 
modified mark-to-market obligation with respect to the replacement 
collateral and to impose this on both the repo dealer and the reverse 
repo dealer. In a typical scenario where the replacement collateral is 
identified, FICC reverses any previous mark-to-market calculation for 
the old collateral and recalculates, collects, and passes through a 
mark-to-market associated with the actual replacement collateral. This 
computation is defined as the Forward Mark Adjustment Payment.\11\ In 
the scenario where the replacement collateral has not been identified, 
FICC will calculate a modified Forward Mark Adjustment Payment to 
protect FICC against market risk. Specifically, the definition of 
Forward Mark Adjustment Payment will be amended by noting that, with 
respect to a repo transaction for which a substitution request has been 
made but for which replacement collateral information has not been 
provided to FICC, a new Forward Unallocated Sub Mark will be applied. 
This new mark will take into account repo interest that has accrued 
with respect to the repo transaction to date, as well as changes in the 
repo rate (to reflect the difference between the contract rate and the 
market rate for the remaining term of the repo transaction).\12\
---------------------------------------------------------------------------

    \11\ The Forward Mark Adjustment Payment is the sum of two 
components: the Collateral Mark and the Financing Mark. The 
Collateral Mark is the absolute value of the difference between the 
trade's contract value and market value. The Financing Mark reflects 
the financing cost that would be incurred by FICC if it replaced the 
reverse side of the repo by buying securities and putting them out 
on repo.
    \12\ The following new definitions have been proposed to effect 
this change: Accrued Repo Interest-to-Date, Repo Interest Rate 
Differential, and Forward Unallocated Sub Mark.
---------------------------------------------------------------------------

    C. Technical Changes. Additionally, FICC proposes changes to its 
GSD rules relating to repo collateral substitutions and repo 
transactions generally to make certain technical changes and/or to 
align the applicable provisions with standard internal or industry 
practice. These are:
    1. Section 3(a) of Rule 18: Delete the requirement that details 
regarding the rights of substitution match between counterparties. 
Details regarding rights of substitution are not a required trade 
reporting item and thus will not be a required match item in GSD's 
system. References in this respect will be deleted to reflect actual 
operating practice;
    2. Sections 3(e) and 3(f) of Rule 18: Delete the requirement that 
upon receipt of either the original or the replacement collateral, FICC 
will promptly redeliver the securities to the appropriate party. As 
stated in the narrative above, FICC may receive securities that are the 
subject of a repo collateral substitution request but may not yet have 
the requisite information for delivery of those securities. These 
provisions should be deleted to reflect actual operating practice and 
also to make the rule consistent with the proposed changes;
    3. Section 3(h) of Rule 18: Delete the provision regarding 
implications of repo collateral substitutions on margin and mark-to-
market requirements. This provision is redundant because the effects of 
repo substitutions on such requirements are covered in the rules 
governing these items and the rules to be modified by the proposed rule 
change;
    4. Section 4 of Rule 18: Make optional a requirement that for 
general collateral, forward-starting repos, the specific CUSIP and par 
value be submitted prior to the repo start date. FICC typically does 
not receive such allocations from its members prior to the repo start 
date and thus the proposed change will align the rule with industry 
practice. The proposed change further reflects operating practice as 
well as industry expectations that a general collateral, forward-
starting repo will be removed from the GSD's books if FICC does not 
receive the specific CUSIP by the time noted in the rule. Members 
typically submit new transactions with the specific CUSIPs and expect 
that the general collateral transaction will be removed from the GSD's 
books.
    5. Section 5 of Rule 18: Amend the provision that addresses repo 
transactions with maturing collateral. The proposed rule change 
provides that the repo party in such a repo transaction must make the 
required substitution of collateral by the time noted in the rule or 
FICC will remove the transaction from its books. This is because the 
underlying contract terminates if the collateral is not replaced in 
time, and therefore, the proposed rule change reflects industry 
practice. The proposed rule change further reflects industry practice 
by deleting the requirement that the replacement collateral meet 
certain specific criteria and replacing that requirement with a 
requirement that the replacement collateral be ``in accordance with the 
terms of the transaction.'' This change also reflects industry 
practice.
    FICC believes the proposed rule change is consistent with the 
requirements of Section 17A of the Act \13\ and the rules and 
regulations thereunder applicable to FICC because it promotes timely 
processing of participant transactions. As such, FICC believes the 
proposed rule facilitates the prompt settlement of transactions and 
assures the safeguarding of securities and funds that are in the 
custody and control of FICC or for which it is responsible.
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------

(B) Self-Regulatory Organization's Statement on Burden on Competition

    FICC does not believe that the proposed rule change will have any 
impact or impose any burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments relating to the proposed rule change have not been 
solicited or received. FICC will notify the Commission of any written 
comments received by FICC.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within thirty-five days of the date of publication of this notice 
in the Federal Register or within such longer period: (i) as the 
Commission may designate up to ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding; or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (A) By order approve such proposed rule change or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

[[Page 632]]

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 e-mail to rule-comments@sec.gov. Please include 

File Number SR-FICC-2005-18 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-FICC-2005-18. This 
file number should be included on the subject line if e-mail 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 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 inspection 
and copying in the Commission's Public Reference Section, 100 F Street, 
NE., Washington, DC 20549. Copies of such filings also will be 
available for inspection and copying at the principal office of FICC 
and on FICC's Web site at http://www.ficc.com. 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-FICC-2005-18 and should be submitted on 
or before January 20, 2005.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\14\
---------------------------------------------------------------------------

    \14\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Nancy M. Morris,
Secretary.
 [FR Doc. E5-8299 Filed 1-4-06; 8:45 am]

BILLING CODE 8010-01-P
