

[Federal Register: March 29, 2006 (Volume 71, Number 60)]
[Notices]               
[Page 15781-15784]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29mr06-142]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53534; File No. SR-FICC-2005-18]

 
Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change To Enhance the Repo Collateral 
Substitution Process of FICC's Government Securities Division

March 21, 2006.

I. Introduction

    On September 30, 2005, the Fixed Income Clearing Corporation 
(``FICC'') filed with the Securities and Exchange Commission 
(``Commission'') and on December 20, 2005, amended proposed rule change 
SR-FICC-2005-18 pursuant to section 19(b)(1) of the Securities Exchange 
Act of 1934 (``Act'').\1\ Notice of the proposal was published in the 
Federal Register on January 5, 2006.\2\ No comment letters were 
received. On March 20, 2006, FICC filed an amendment to the proposed 
rule

[[Page 15782]]

change.\3\ For the reasons discussed below, the Commission is approving 
the proposed rule change as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 53036 (December 29, 
2005), 71 FR 629.
    \3\ The amendment, as noted below, is not substantive and did 
not require republication of the notice.
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II. Description

    In general, FICC is enhancing the repo collateral substitution 
process of its Government Securities Division (``GSD''). The rule 
change: (i) Permits the repo dealer or repo broker, as appropriate, to 
submit a substitution notification to FICC without information about 
the replacement collateral, (ii) revises the repo collateral 
substitution process deadline and fee schedule, and (iii) implements 
certain risk management measures and technical changes.

A. 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 provided as part of a repo transaction with replacement 
collateral. With respect to a brokered transaction, typically the repo 
dealer notifies the broker that it wishes to substitute the repo 
collateral before it specifically identifies the replacement 
collateral.\4\ The repo broker then contacts the reverse repo dealer 
and informs it that a repo collateral substitution process is being 
initiated. The reverse repo dealer then sends the original repo 
collateral to FICC. However, since under FICC's current system the repo 
dealer's substitution notification that it must send to FICC must 
contain information about the replacement collateral, often the 
substitution notification is not delivered to FICC by 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 original and replacement collateral 
frequently are delivered to FICC before FICC is able to forward the 
collateral to the appropriate party. This leaves FICC in an overdraft 
position at the clearing bank, which can cause expense and risk to FICC 
and to its members and can cause settlement processing delays.
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    \4\ With respect to a non-brokered repo transaction, the repo 
dealer would contact the reverse repo dealer directly about the repo 
collateral substitution.
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    The rule change permits 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 
upon receipt of the substitution notification so the original 
collateral will no longer linger in FICC's account.\5\
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    \5\ 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 added to the rules to reflect that information 
on the replacement collateral will be contained in a separate 
submission to FICC.
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B. Revised Repo Collateral Substitution Process Deadline and Fee 
Schedule

    The rule change in repo processing requires a revision to GSD's 
schedule of time frames. Currently, there is a two-tiered deadline for 
a repo party to submit a substitution notification and associated late-
fee.\6\ The rule change establishes: (i) An 11 a.m. Eastern Time 
deadline \7\ 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 rule change also establishes a two-
tiered deadline for a repo party to submit replacement collateral 
information and an associated late-fee schedule. The deadlines for 
submission of replacement collateral information are: (i) 12 p.m. 
Eastern Time and (ii) 12:30 p.m. Eastern Time. The 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.\8\
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    \6\ The current deadlines are 12 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.
    \7\ The proposed 11 a.m. Eastern Time deadline will not be 
extended on high-volume days.
    \8\ The 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.''
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    In order to accommodate members' preparations to comply with the 
time frames contained herein, the proposed changes to the schedule of 
time frames and applicable late-fees will be implemented at a later 
date than the other rule changes contained in this filing. FICC will 
announce the implementation of the proposed schedule of time frames by 
Important Notice at least thirty calendar days prior to implementation. 
Until such implementation, currently existing time frames and late-fees 
applied to repo collateral substitutions shall remain in effect.

C. Risk Management Measures and Technical Changes

    Generally, FICC is implementing certain measures to address the 
risk presented to it by the failure of a party to submit in a timely 
manner information regarding the replacement collateral to FICC. 
Specifically, FICC is: (i) Increasing the clearing fund calculation of 
the repo dealer and allowing margining with respect to replacement 
collateral based on applicable generic CUSIP numbers only \9\ and (ii) 
imposing mark-to-market consequences on both the repo dealer and the 
reverse dealer with respect to unknown replacement collateral.
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    \9\ 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.
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1. Clearing Fund Calculation and Permissible Margin Offsets
    With respect to the calculation of the repo dealer's clearing fund 
requirement, FICC is assigning a value of 150 percent of the contract 
value of the original securities collateral to a repo transaction where 
FICC has not received information regarding the replacement 
collateral.\10\ FICC also is applying 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 15 years and 16 days or greater. 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 15 years and 16 days or greater, FICC will use 
the existing margin factor of 1.450 (applicable to

[[Page 15783]]

category 1 members with positions in non-zeros).\11\
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    \10\ New subsection 3(f) is being 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.
    \11\ 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 to receive credit 
forward mark adjustment payments, the applicable margin factor under 
the proposed rule change would be 2.0.
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    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 against a long net settlement position in Treasury Offset Class 
B, the applicable disallowance factor table provides that 30 percent of 
this offset will be disallowed.\12\ For offset purposes under the 
proposed rule change, FICC is defining two new offset classes to 
capture the generic CUSIP numbers that can be assigned to unknown 
replacement collateral. These new offset classes are 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 between Offset Classes 
H and h or between Offset Classes H or h and any other existing GSD 
Offset Class.
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    \12\ As originally filed, FICC mistakenly stated that 20 percent 
of the offset would be disallowed. In its March 20, 2006, amendment, 
FICC changed this to 30 percent to accurately reflect the 
disallowance factor for such securities.
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2. Modified Mark-to-Market Calculation
    FICC also is calculating a modified mark-to-market obligation with 
respect to the replacement collateral and imposing this on both the 
repo dealer and the reverse repo dealer in the case where a generic 
CUSIP number is used for underlying collateral. 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.\13\ 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 
is 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).\14\
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    \13\ 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.
    \14\ The following new definitions effect this change: Accrued 
Repo Interest-to-Date, Repo Interest Rate Differential, and Forward 
Unallocated Sub Mark.
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3. Technical Changes
    Additionally, FICC is making certain technical changes to its GSD 
rules relating to repo collateral substitutions and repo transactions 
generally.
    a. 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 are deleted to reflect actual 
operating practice.
    b. 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 are deleted to reflect actual operating practice and also to 
make the rule consistent with the proposed changes.
    c. 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.
    d. 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 aligns 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.
    e. 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 by 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.

III. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization.\15\ Section 17A(b)(3)(F) of the Act requires that the 
rules of a clearing agency be designed to promote the prompt and 
accurate clearance and settlement of securities transactions and to 
assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible.\16\ The Commission finds that FICC's rule change is 
consistent with these requirements. By revising its repo substitution 
rules to more accurately reflect industry practice, FICC's proposed 
rule change should result in repo substitution transactions being 
completed in a more timely

[[Page 15784]]

manner. FICC's proposed rule change also includes revised risk 
management measures (e.g., revised clearing fund calculation and margin 
offsets) to address potential risk resulting from the revised repo 
substitution rules. As such, FICC's proposed rule change also should 
result in FICC being able to safeguard securities and funds which are 
in its possession and control or for which it is responsible.
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    \15\ 15 U.S.C. 78s(b).
    \16\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular section 17A of the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\17\ that the proposed rule change (File No. SR-FICC-2005-18) be 
and hereby is approved.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-4527 Filed 3-28-06; 8:45 am]

BILLING CODE 8010-01-P
