
[Federal Register Volume 77, Number 131 (Monday, July 9, 2012)]
[Notices]
[Pages 40398-40399]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-16653]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67336; File No. SR-FICC-2012-04]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving 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

July 2, 2012.

I. Introduction

    On May 15, 2012, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2012-04 pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder.\2\ The proposed rule change was published for comment in 
the Federal Register on May 31, 2012.\3\ The Commission received no 
comment letters regarding the proposal. For the reasons discussed 
below, the Commission is granting approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 34-67059 (May 24, 2012), 
77 FR 32153 (May 31, 2012). In its filing with the Commission, FICC 
included a detailed statement regarding the purposes of and basis 
for the proposed rule change. See id.
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II. Description

    This proposed rule change relates to the use of implied volatility 
indicators in the clearing fund formula of FICC's Government Securities 
Division (``GSD''). As discussed in FICC's filing with the Commission, 
a primary objective of GSD's clearing fund (``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

[[Page 40399]]

amends 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 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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    The proposed rule change clarifies 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 also clarifies the ability of GSD to 
adjust its volatility calculations as needed to improve the performance 
of the model in periods of market volatility. It therefore assists GSD 
to maintain the requisite confidence level notwithstanding those market 
conditions.
    As an example of one such adjustment to the volatility model, GSD 
will apply a multiplier (``Augmented Volatility Adjustment 
Multiplier'') to the VaR Charge. The Augmented Volatility Adjustment 
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 Augmented 
Volatility Adjustment 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 
Augmented Volatility Adjustment Multiplier that may be applied to the 
Members' VaR Charge on a weekly basis.\9\ 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 Augmented Volatility Adjustment Multiplier to 
all of its Members in circumstances it deems warrant such a waiver.\10\
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    \9\ FICC GSD will reserve the right to recalculate the 
multiplier more frequently than weekly in volatile market 
conditions.
    \10\ FICC GSD plans to apply a cap to the Augmented Volatility 
Adjustment 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.

III. Discussion

    Section 19(b)(2)(B) of the Act \11\ 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. In particular, Section 17A(b)(3)(F) of 
the Act \12\ requires, among other things, 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 that are in the custody or control of such 
clearing agency or for which it is responsible. The proposed rule 
change would clarify 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. The use of these 
indicators should assist GSD in its efforts to ensure the efficacy of 
its volatility margin methodology in highly volatile markets and, 
thereby, reduce GSD's and its Members' exposure to the losses of a 
defaulting Member.
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    \11\ 15 U.S.C. 78s(b)(2)(B).
    \12\ 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 with the requirements of Section 17A of the Act, as well 
as with the rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) \13\ of the 
Act, that the proposed rule change (File No. SR-FICC-2012-04) be, and 
hereby is, approved.\14\
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    \13\ 15 U.S.C. 78s(b)(2).
    \14\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition and 
capital formation. See 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-16653 Filed 7-6-12; 8:45 am]
BILLING CODE 8011-01-P


