
[Federal Register Volume 77, Number 105 (Thursday, May 31, 2012)]
[Notices]
[Pages 32153-32155]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-13150]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67059; File No. SR-FICC-2012-04]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Clarify the Ability of the 
Government Securities Division To Use Implied Volatility Indicators as 
Part of the Volatility Model in Its Clearing Fund Formula

May 24, 2012.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder \2\ notice is hereby given that 
on May 15, 2012, Fixed Income Clearing Corporation (``FICC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II 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 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Government Securities Division (``GSD'') of FICC proposes to 
amend the definition of VaR Charge in Rule 1 to clarify the ability of 
FICC GSD to use implied volatility indicators as part of the volatility 
model in its clearing fund formula.

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.\3\
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    \3\ The Commission has modified the text of the summaries 
prepared by FICC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    A primary objective of GSD's Clearing Fund \4\ is to have on 
deposit from each applicable Member \5\ assets sufficient to satisfy 
losses that may otherwise be incurred by GSD as the result of the 
default of the Member and the resultant close out of that Member's 
unsettled positions under GSD's trade guaranty. The required Clearing 
Fund deposit of each Member is calculated twice daily \6\ pursuant to a 
formula set forth in Section 1b of GSD Rule 4 designed to provide 
sufficient funds to cover this risk of loss. The Clearing Fund formula 
accounts for a variety of risk factors through the application of a 
number of components, each described in Section 1b of GSD Rule 4.
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    \4\ FICC GSD Rule 1--Definitions provides that ``[t]he term 
`Clearing Fund' means the Clearing Fund established by the 
Corporation pursuant to these Rules, which shall be comprised of the 
aggregate of all Required Fund Deposits and all other deposits, 
including Cross-Guaranty Repayment Deposits, to the Clearing Fund.''
    \5\ FICC GSD Rule 1--Definitions provides that ``[t]he term 
`Member' means a Comparison-Only Member or a Netting Member. The 
term `Member' shall include a Sponsoring Member in its capacity as a 
Sponsoring Member and a Sponsored Member, each to the extent 
specific in Rule 3A.''
    \6\ A Member's Clearing Fund deposit may also be recalculated on 
an intraday basis as needed.
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    The volatility component of the Clearing Fund formula is designed 
to calculate the amount of money that may be lost on a portfolio over a 
given period of time assumed necessary to liquidate the portfolio 
within a given level of confidence. Pursuant to Section 1b of Rule 4, 
GSD may calculate the volatility component on a value at risk charge 
(``VaR Charge'') ``utilizing such assumptions (including confidence 
levels) and based on such historical data as [GSD] deems reasonable, 
and shall cover such range of historical volatility as [GSD] from time 
to time deems appropriate.'' \7\ FICC believes that Section 1b of Rule 
4 therefore provides GSD with the flexibility to adjust the calculation 
of the volatility component of its Clearing Fund formula as needed to 
react to changes in market conditions, including through the use of 
such assumptions and data as it deems appropriate within its VaR 
Charge.
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    \7\ FICC GSD Rule 1--Definitions defining the term VaR Charge in 
relevant part.
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    The historical simulation model currently used to calculate the VaR 
Charge in GSD's Clearing Fund formula is driven by historical data 
observed in the fixed-income market. While the model weighs the data it 
uses in favor of more recent observations, it is still limited in its 
ability to quickly reflect sudden changes in market volatility, which 
may lead to the collection of insufficient margin during periods of 
sudden market volatility.
    GSD's Clearing Fund formula, in particular the VaR Charge, provides 
GSD with the discretion to adjust the model assumptions and data as 
necessary to react to these market conditions. To enhance the model's 
performance, additional information and other observable market data, 
including data derived from financial products with future maturity 
dates, thus may be incorporated into or utilized by the volatility 
model, including data observed in implied volatility indicators that 
are derived from historical prices of financial products that have 
maturity dates in the future (such as the 1-year option on the 10-year 
swap rate). For the avoidance of doubt, this proposed rule change would 
amend the definition of VaR Charge to make clear that the assumptions 
and data utilized in calculating the VaR Charge may be based on 
observable market data, which may include

[[Page 32154]]

implied market volatility indicators that are derived from historical 
prices of financial products that have maturity dates in the future, so 
as to enhance the performance of the model and enable GSD to more 
effectively achieve and maintain the confidence level required by 
regulatory and industry standards.\8\ Incorporation of such information 
into volatility calculations is a generally accepted practice for 
portfolio volatility models, currently used by other clearing agencies, 
and accordingly consistent with current rules of FICC.
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    \8\ The text of the proposed change to the definition of VaR 
Charge can be found in Exhibit 5 to proposed rule change SR-FICC-
2012-04 at http://www.dtcc.com/downloads/legal/rule_filings/2012/ficc/SR-FICC-2012-04.pdf.
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    GSD reviews its risk management processes against applicable 
regulatory and industry standards, including, but not limited to: (i) 
the Recommendations for Central Counterparties (``RCCP'') of the 
Committee on Payment and Settlement Systems and the Technical Committee 
of the International Organization of Securities Commissions (``CPSS-
IOSCO'') and (ii) the securities laws of the United States and rules 
promulgated by the Commission.
    CPSS-IOSCO RCCP Recommendation 4: Margin requirements recommends 
that a central counterparty (``CCP'') should maintain sufficient 
financial resources to cover potential exposures in normal market 
conditions.\9\ It also recommends that margin models and parameters 
should be regularly reviewed and back-tested to ensure a 99% coverage 
level is maintained.
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    \9\ Normal market conditions is defined in Explanatory Note to 
RCCP Recommendation 3 as ``price movements that produce changes in 
exposures that are expected to breach margin requirements or other 
risk control mechanisms only 1% of the time.''
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    CPSS-IOSCO Recommendation 3: Measurement and management of credit 
exposures recognizes the need for flexibility in the models underlying 
the calculation of margin requirements. To this point, the explanatory 
note to RCCP Recommendation 3 recognizes that, ``[t]he appropriate 
amount of data to use [in a CCP's margin formula] will vary from market 
to market and over time. If, for example, volatility rises, a CCP may 
want to use a short interval that better captures the new, higher 
volatility prevailing in its markets.'' \10\ Similarly, the Commission 
proposed Rule 17Ad-22(b)(2) which addresses the margin requirements of 
a clearing agency that performs CCP services and would require those 
clearing agencies to establish, implement, maintain and enforce written 
policies and procedures reasonably designed to use margin requirements 
to limit credit exposures to participants in normal market conditions 
and use risk-based models and parameters to set margin requirements and 
review them at least monthly.\11\ The Commission release that proposed 
Rule 17Ad-22(b)(2) states, ``[m]arket conditions and risks are 
constantly changing and therefore the models and parameters used by a 
clearing agency providing CCP services to set margin may not accurately 
reflect the needs of a clearing agency if they are permitted to remain 
static.'' \12\
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    \10\ Bank for International Settlements and International 
Organization of Securities Commissions, Recommendations for Central 
Counterparties (November 2004) available at www.bis.org/publ/cpss61.pdf.
    \11\ Exchange Act Release No. 34-64017 (March 3, 2011), 76 FR 
11472 (March 16, 2011); File No. S7-08-11.
    \12\ Id.
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    FICC believes that this proposed rule change would clarify that GSD 
at its discretion may utilize implied volatility indicators that are 
derived from historical prices of financial products that have maturity 
dates in the future among the assumptions and other observable market 
data as part of its volatility model. The proposal would also clarify 
the ability of GSD to adjust its volatility calculations as needed to 
improve the performance of the model in periods of market volatility. 
It would therefore assist GSD to maintain the requisite confidence 
level notwithstanding those market conditions. As such, FICC believes 
that it conforms to CPSS-IOSCO Recommendations 3 and 4, Commission 
proposed Rule 17Ad-22(b)(2), and Commission proposed Rule 17Ad-
22(b)(1).\13\
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    \13\ Commission proposed Rule 17Ad-22(b)(1) addresses the 
measurement and management of credit exposures by a clearing agency 
that performs CCP services and would require such a clearing agency 
to ``establish, implement, maintain and enforce written policies and 
procedures reasonably designed to measure its credit exposures to 
its participants at least once a day and limit its exposures to 
potential losses from defaults by its participants in normal market 
conditions so that the operations of the clearing agency would not 
be disrupted and non-defaulting participants would not be exposed to 
losses that they cannot anticipate or control.''
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    As an example of one such adjustment to the volatility model, GSD 
plans to apply a multiplier (the augmented volatility adjustment 
multiplier) to the VaR Charge. The multiplier is based on the levels of 
change in current and implied volatility measures. An advantage of this 
approach is that as volatility subsides in the market so will the 
effect of the multiplier on Members' margin requirements. The 
volatility measures will be determined by reference to the implied 
volatility of the 1-year option on the 10-year USD LIBOR swap rate and 
the historical volatility of the 10-year USD LIBOR swap rate. It is 
expected that GSD will provide its Members with advance notice of the 
multiplier that may be applied to the Members' VaR Charge on a weekly 
basis.\14\ By using a single fixed multiplier based on observable 
market data, Members will be able to predict the impact on their margin 
requirement. Although the augmented volatility adjustment multiplier 
will be automatically applied to each Member's VaR Charge, GSD may in 
its sole discretion determine to waive the application of the 
multiplier to all of its Members in circumstances it deems warrant such 
a waiver.\15\
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    \14\ FICC GSD will reserve the right to recalculate the 
multiplier more frequently than weekly in volatile market 
conditions.
    \15\ FICC GSD plans to apply a cap to the multiplier and 
initially the cap will be set at 2. FICC GSD will reserve the right 
to change the cap in its sole discretion.
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    FICC intends that this proposed rule change would be effective on a 
date no less than ten business days following an Important Notice to 
Members by FICC announcing any approval by the Commission.
    As a clearing agency that performs CCP services, FICC GSD believes 
that it occupies an important role in the securities settlement system 
by interposing itself between counterparties to financial transactions 
and thereby reducing risks faced by participants and contributing to 
global financial stability. FICC believes that the effectiveness of a 
CCP's risk controls and the adequacy of its financial resources are 
critical to achieving these risk-reducing goals. FICC believes this 
proposed rule change would assist GSD in its efforts to ensure the 
efficacy of its volatility margin methodology in highly volatile 
markets and, thereby, should reduce GSD's and its Members' exposure to 
the losses of a defaulting Member.
    FICC believes the proposed change is consistent with Section 17A of 
the Act \16\ and the rules and regulations thereunder because the 
proposed modifications would help assure the safeguarding of securities 
and funds which are in the custody or control of FICC or for which it 
is responsible by clarifying that FICC GSD's rules permit it to use 
implied volatility indicators that are derived from historical prices 
of financial products that have maturity dates in the future as part of 
the volatility model in its Clearing Fund formula.
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    \16\ 15 U.S.C. 78q-1.

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[[Page 32155]]

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

    FICC does not believe that the proposed rule change would 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 on the proposed rule change have not yet been 
solicited or received.\17\ FICC will notify the Commission of any other 
written comments received by FICC.
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    \17\ FICC originally raised the prospect of the multiplier to 
the VaR charge to members in Important Notice GOV014.12 on January 
27, 2012, to which FICC received comments. The comments FICC 
received were: (i) That the Important Notice lacked key information, 
including a sample calculation and details surrounding the 
application of the multiplier; and (ii) whether the proposal would 
be detrimental to smaller firms. FICC notified the Commission of the 
substance of these comments.
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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 self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

Electronic Comments

     Use the Commissions Internet comment form (http://www.sec.gov/rules/sro.shtml) or
    Send an email to rule-comments@sec.gov. Please include File Number 
SR-FICC-2012-04 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FICC-2012-04. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the 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 Web site viewing and 
printing in the Commission's Public Reference Section, 100 F Street 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FICC and on FICC's 
Web site at http://www.dtcc.com/downloads/legal/rule_filings/2012/ficc/SR-FICC-2012-04.pdf.
    All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-FICC-2012-04 
and should be submitted on or before June 21, 2012.

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-13150 Filed 5-30-12; 8:45 am]
BILLING CODE 8011-01-P


