
[Federal Register Volume 78, Number 3 (Friday, January 4, 2013)]
[Notices]
[Pages 792-795]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-31670]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68549; File No. SR-NSCC-2012-10]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Proposed Rule Change To Eliminate the 
Offset of Its Obligations With Institutional Delivery Transactions that 
Settle at The Depository Trust Company for the Purpose of Calculating 
Its Clearing Fund Under Procedure XV of Its Rules & Procedures

December 28, 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 December 17, 2012, the National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change described in Items I, II and 
III below, which Items have been prepared primarily by NSCC. 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. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    NSCC proposes to modify its Rules & Procedures (``Rules'') to 
eliminate the offset of NSCC obligations with institutional delivery 
(``ID'') transactions that settle at the Depository Trust Company 
(``DTC'') for the purpose of calculating the NSCC clearing fund 
(``Clearing Fund'') under Procedure XV of the Rules.

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, NSCC 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. NSCC 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 NSCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

(a) Proposal Overview
    A primary objective of NSCC's Clearing Fund is to have on deposit 
from each applicable Member assets sufficient to satisfy losses that 
may otherwise be incurred by NSCC as the result of the default of the 
Member and the resultant close out of that Member's unsettled positions 
under NSCC's trade guaranty. Each Member's Clearing Fund required 
deposit is calculated daily pursuant to a formula set forth in 
Procedure XV of the Rules 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 Procedure XV.\4\
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    \4\ In addition to those described in this filing, Clearing Fund 
components also include (i) A mark-to-market component which, with 
certain exclusions, takes into account any difference between the 
contract price and market price for net positions of each security 
in a Member's portfolio through settlement; (ii) a ``special 
charge'' in view of price fluctuations in or volatility or lack of 
liquidity of any security; (iii) an additional charge relating to a 
Member's outstanding fail positions; (iv) a ``specified activity 
charge'' for transactions scheduled to settle on a shortened 
settlement cycle (i.e., less than T+3 or T+3 for ``as-of'' 
transactions); (v) an additional charge that NSCC may require of 
Members on surveillance status; and (vii) an ``Excess Capital 
Premium'' that takes into account the degree to which a Member's 
collateral requirement compares to the Member's excess net capital 
by applying a charge if a Member's Required Deposit, minus any 
amount applied from the charges described in (ii) and (iii) above, 
is above its required capital.
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    The Value-at-Risk component, or ``VaR'', is a core component of 
this formula and 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.\5\ The 
Market Maker Domination component, or ``MMDOM'', is charged to Market 
Makers,\6\ or firms that clear for them. In calculating the MMDOM, if 
the sum of the absolute values of net unsettled positions in a security 
for which the firm in question makes a market is greater than that 
firm's excess net capital, NSCC may then charge the firm an amount 
equal to such excess or the sum of each of the absolute values of the 
affected net unsettled positions, or a combination of both. MMDOM 
operates to identify concentration within a given CUSIP.
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    \5\ NSCC's equity VaR model assumes a 99% confidence interval, 
uses a 150-day historical look-back period, and assumes a three-day 
liquidation period. In effect, NSCC assumes the market conditions 
observed over the past 150 days are predictive of the market 
conditions expected over the course of the next three business days. 
Pursuant to Procedure XV, NSCC may exclude from the VaR charge ``Net 
Unsettled Positions in classes of securities whose volatility is (x) 
less amendable to statistical analysis, such as OTC Bulletin Board 
or Pink Sheet issues or issues trading below a designated dollar 
threshold, or (y) amendable to generally accepted statistical 
analysis in a complex manner, such as municipal or corporate 
bonds.'' The charge for such positions is determined by multiplying 
the absolute value of the positions by a pre-determined percentage.
    \6\ As used in Procedure XV, the term Market Maker means a firm 
that is registered by FINRA as a Market Maker.
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    Pursuant to Procedure XV of the Rules, NSCC may calculate the VaR 
and MMDOM components of a Member's Clearing Fund requirement after 
taking into account any offsetting pending (i.e., non-fail) ID 
transactions that have been confirmed and/or affirmed through an 
institutional delivery system acceptable to NSCC (typically Omgeo LLC 
(``Omgeo''), a joint venture of the Depository Trust and Clearing 
Corporation and Thomson Reuters) (``ID Offset'').\7\ NSCC is proposing 
to eliminate the ID Offset from its Clearing Fund calculations in order 
to eliminate the market risk that, in the event NSCC ceases to act for 
a Member with pending ID transactions, it may be unable to complete 
those pending ID transactions in the time frame contemplated by its 
current Clearing Fund calculations and, as a result, may have 
insufficient margin in its Clearing Fund.
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    \7\ The changes proposed by this rule filing will not impact 
NSCC's ID Net Service.
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    NSCC reviews its risk management processes against federal 
securities laws and rulemaking promulgated by the Commission, and 
applicable regulatory and industry guidelines, including, but not 
limited to the Principles for Financial Market Infrastructures 
(``PFMI'') of the Committee on Payment and Settlement Systems and the 
Technical Committee of the International Organization of Securities 
Commissions (``CPSS-IOSCO'').\8\ In accordance with Commission 
rules,\9\ specifically Rule 17Ad-22(b)(1) addressing measurement and 
management of credit exposures, Rule 17Ad-22(b)(2) addressing margin 
requirements, and Rule 17Ad-22(d)(11) addressing default procedures, 
and also in accordance with the PFMIs, this proposed rule change should 
enhance NSCC's ability to more effectively

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manage its credit exposures to participants, help ensure that it is 
able to cover its credit exposures to its participant for all products 
through an effective, risk-based margin system, limit NSCC's exposures 
and losses, and enhance protections against market risk that may arise 
when it ceases to act for a Member with open ID transaction activity.
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    \8\ CPSS-IOSCO PFMI (April 2012), available at http://www.bis.org/publ/cpss101a.pdf.
    \9\ Securities and Exchange Commission Release No. 34-68080; 
File No. S7-08-11 (available at http://www.sec.gov/rules/final/2012/34-68080.pdf), to be effective on January 2, 2013.
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ID Transactions
    The parties involved in an institutional trade include the 
institutional investor (such as mutual funds, insurance companies, 
hedge funds, bank trust departments, and pension funds), the investment 
manager (who enters trade orders on behalf of institutional investors), 
the buying broker and the selling broker, and custodian banks.\10\ 
Trades between the buying broker and the selling broker are typically 
settled through NSCC's Continuous Net Settlement system (``CNS'').\11\
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    \10\ Prime broker ID transactions settling at NSCC are not 
included in the ID Offset, as they are included in the Member's NSCC 
activity once such transactions are affirmed, and, therefore, are 
not addressed in this filing. The ID transactions included in the ID 
Offset and described in this rule filing are activity that is held 
in custody at a bank.
    \11\ CNS is NSCC's core netting and allotting system, where all 
eligible compared and recorded transactions for a particular 
settlement date are netted by issue into one net long (buy) or net 
short (sell) position, and NSCC becomes the contra-party for 
settlement purposes, assuming the obligation of its Members that are 
receiving securities to receive and pay for those securities, and 
the obligation of Members that are delivering securities to make the 
delivery.
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    Before ID trades are sent to DTC, where they settle delivery versus 
payment, the trade allocation details are matched between the executing 
broker and the institutional investor. After an executing broker has 
provided a final notice of execution associated with the client's 
order, most institutional clients will provide trade allocation details 
to the executing broker using a service provided by Omgeo. When the 
executing broker accepts and processes the trade allocations, an 
electronic confirmation is provided through Omgeo's TradeSuite service 
to the institutional investor or its agent (typically the institutional 
client's custodian bank) for affirmation. Omgeo links with the various 
parties to institutional trades to provide real-time central matching 
capabilities, electronically comparing trade details and notifying 
parties of any exceptions. After the trade allocation details are 
affirmed, the trade is considered matched and institutional delivery 
details are sent to DTC for settlement.
    Completion of the money and securities settlement of institutional 
trades occurs at DTC. Because investment managers are not participants 
of and do not have direct accounts at DTC, their securities are held in 
custodial accounts with banks who are participants at DTC. Therefore, 
when the institutional delivery details for confirmed and affirmed ID 
trades are sent to DTC from Omgeo, the delivering investment manager's 
custodian bank, or broker, as the case may be, must authorize the 
delivery, generating a deliver order that will settle in accordance 
with DTC's rules.
    NSCC Risk Management receives a daily feed from Omgeo, including 
both ID trades that have only been confirmed as well as those that have 
also been affirmed. For purposes of the ID Offset, NSCC includes ID 
trades that are confirmed and/or affirmed on trade date (T) and those 
ID trades which have been affirmed on T+1 and remain affirmed through 
settlement date (SD).
ID Offset
    Procedure XV currently allows for a Member's net unsettled NSCC 
position in a particular CUSIP to be compared to any pending ID 
transactions settling at DTC for potential offset for purposes of 
calculating the VaR and the MMDOM components of a Member's Clearing 
Fund requirement, defined as the ID Offset. The ID Offset is based on 
the assumption that, in the event of a Member insolvency, NSCC will be 
able to close out any trades for which there is a corresponding ID 
transaction settling at DTC by completing that ID transaction. 
Therefore, the VaR and the MMDOM components are calculated after taking 
into account any offsetting pending (i.e., non-fail) ID transactions 
that have been confirmed and/or affirmed, reducing the Clearing Fund 
requirement for those Members with ID transactions. ID transactions are 
included in the ID Offset only if they are on the opposite side of the 
market from the Member's net NSCC position (i.e., only if they reduce 
that net position).
Potential Inability To Complete ID Transactions
    Generally, when NSCC ceases to act for a Member, it is obligated, 
for those transactions to which the trade guaranty has attached, to pay 
for deliveries made by non-defaulting Members that are due, through 
CNS, to the failed Member (``Long Allocations'') on the day of 
insolvency and the days following. As described above, the current 
calculation of the VaR and MMDOM components of NSCC's Clearing Fund are 
based on the assumption that, in the event of a Member default, NSCC 
will be able to complete the pending ID transactions that were used to 
offset that Member's unsettled NSCC position. If NSCC is unable to 
complete the ID transactions as contemplated by this calculation, then 
NSCC may need to liquidate a portfolio that could be substantially 
different than the portfolio that NSCC collected Clearing Fund for, 
leaving NSCC potentially under collateralized and exposed to market 
risk.
    There are a number of reasons why NSCC may not be able to complete 
an insolvent Member's open ID transactions. First, NSCC does not 
guarantee ID transactions and completion of these transactions by the 
counterparty of the ID transaction, which is not a Member of NSCC, is 
voluntary. Further, the institutional customer is not a Member of NSCC, 
is not bound by NSCC's Rules, and is not party to any legally binding 
contract with NSCC that requires the institutional customer or its 
custodian to complete the transaction. Finally, based on news that a 
Member may be in distress or insolvent, the institutional customer or 
its investment advisor may feel compelled to take immediate market 
action with respect to the institutional buy or sell transaction, in 
order to reduce its market risk; this effectively eliminates the option 
for NSCC to complete these transactions, either entirely or on the 
timetable assumed by the Clearing Fund calculation.
    While NSCC's Risk Management systems net ID transactions by CUSIP 
across all settlement days for the purposes of the ID Offset, ID 
transactions settle trade by trade between the executing broker and the 
custodian. As a result, the netted ID position used to offset the NSCC 
position could potentially be comprised of thousands of individual 
trades with hundreds of different counterparties. It would be time 
consuming for NSCC to contact each counterparty individually to get 
their agreement to complete ID transactions, which would delay the 
determination of the portfolio requiring liquidation in the event of a 
cease to act, and thus hold up the prompt close out of the defaulter's 
open positions, exposing NSCC to additional market risk not covered by 
the margin collected.
Implementation Time Frame
    Following Commission approval, in order to mitigate the impact of 
this proposed rule change, NSCC proposes to implement the changes set 
forth in this filing on over an 18-month period. On a date no earlier 
than 10 days

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following notice to Members by Important Notice (``Initial 
Implementation Date''), NSCC proposes to eliminate the ID Offset from 
ID transactions that have only been confirmed, but have not yet been 
affirmed. At this time, NSCC will continue to apply the ID Offset to ID 
transactions that have been affirmed. During the 12-month period 
following the Initial Implementation Date, NSCC will discuss with 
Members, whose business will be affected by the elimination of the ID 
Offset, mechanisms to mitigate this impact.
    Beginning on a date approximately 12 months from the Initial 
Implementation Date, and no earlier than 10 days following notice to 
Members by Important Notice, NSCC will eliminate from the ID Offset all 
affirmed ID transactions that have reached settlement date at the time 
the Clearing Fund calculations are run. Three months later, or 
approximately 15 months following the Initial Implementation Date, and 
on a date no earlier than 10 days following notice to Members by 
Important Notice, NSCC will eliminate from the ID Offset all affirmed 
ID transactions that have reached either settlement date or the day 
prior to settlement date. Finally, on a date approximately 18 months 
following the Initial Implementation Date, and no earlier than 10 days 
following notice to Members by Important Notice, NSCC will eliminate 
the ID Offset entirely for all ID transactions. Members will be advised 
of each proposed implementation date through issuance of NSCC Important 
Notices, which are publically available at www.dtcc.com.
    The table below illustrates this proposed implementation schedule:

     Proposed Implementation Schedule for Elimination of ID Offsets
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                 Action                      Scheduled implementation
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Eliminate from ID Offset those ID        Following approval of rule
 transactions that have only been         filing, and on a date no
 confirmed, but have not yet been         earlier than 10 days following
 affirmed.                                notice to Members by Important
                                          Notice (``Initial
                                          Implementation Date'').
Eliminate from ID Offset all affirmed    12 months following the Initial
 ID transactions that have reached        Implementation Date, and on a
 Settlement Date (``SD'').                date no earlier than 10 days
                                          following notice to Members by
                                          Important Notice.
Eliminate from ID Offset all affirmed    15 months following the Initial
 ID transactions that have reached SD     Implementation Date, and on a
 and the day prior to SD (SD-1).          date no earlier than 10 days
                                          following notice to Members by
                                          Important Notice.
Eliminate from ID Offset all ID          18 months following the Initial
 transactions.                            Implementation Date , and on a
                                          date no earlier than 10 days
                                          following notice to Members by
                                          Important Notice.
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Proposed Rule Changes
    NSCC proposes to amend Procedure XV to eliminate the ID Offset from 
calculation of the VaR and Market Maker Domination components of a 
Member's Clearing Fund requirement as currently provided for in, with 
respect to CNS transactions, Section I(A)(1)(a)(i) and Section 
I(A)(1)(d), and, with respect to Balance Order transactions, Section 
I(A)(2)(a)(i) and Section I(A)(2)(c).
    (b) As a central counterparty, NSCC occupies an important role in 
the securities settlement system by interposing itself between 
counterparties to financial transactions and thereby reducing the risk 
faced by participants and contributing to global financial stability. 
In this role, however, NSCC is necessarily subject to certain risks in 
the event of the default or failure of a Member. NSCC believes that the 
proposed rule change should help mitigate the risk that NSCC will be 
under collateralized when it ceases to act for that Member and is 
unable to complete the Member's ID transactions in the time frame 
contemplated by its Clearing Fund calculation. As such, NSCC believes 
the proposal is consistent with the requirements of the Act, 
specifically Section 17A(b)(3)(F),\12\ and the rules and regulations 
thereunder applicable to NSCC, specifically Rule 17Ad-22(b)(1) 
addressing measurement and management of credit exposures, Rule 17Ad-
22(b)(2) addressing margin requirements, and Rule 17AD-22(d)(11) 
addressing default procedures.\13\
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    \12\ 15 U.S.C. 78q-1(b)(3)(F).
    \13\ Securities and Exchange Commission Release No. 34-68080; 
File No. S7-08-11 (available at http://www.sec.gov/rules/final/2012/34-68080.pdf), to be effective on January 2, 2013.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    NSCC believes that the proposed rule change will not impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. The rule change will mitigate 
the market risk that may arise after NSCC has ceased to act for that 
Member if it is unable to complete the ID transactions in the time 
frame contemplated by its Clearing Fund calculation, leaving NSCC 
potentially under collateralized. By mitigating its exposure to this 
market risk, NSCC believes that the proposed rule change should 
contribute to the goal of financial stability in the event of Member 
default, and will render not unreasonable or inappropriate any burden 
on competition that the changes could be regarded as imposing.
    Further, NSCC intends to implement this rule change over an 
extended period of time, as described herein, allowing Members to 
address any impact this change may have on their business. This 
implementation schedule is designed to be fair and not 
disproportionately impact any Members more than others, and the 
proposal to implement this rule change over an extended period of time 
will provide all impacted Members with time to identify mechanisms to 
mitigate the impact of this proposal on their business.

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

    While written comments relating to the proposed rule change have 
not yet been solicited, NSCC has received a letter on behalf of certain 
Members seeking further review of the impact of the proposed rule 
change, and consideration of alternatives. NSCC notified the Commission 
of the contents of the letter and promptly delivered a response to 
those Members addressing their concerns. A Member working group has 
been established to discuss mechanisms for impacted Members to

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mitigate the potential impact of the rule changes described in this 
filing.

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 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.\14\ The clearing 
agency shall post notice on its Web site of proposed changes that are 
implemented.
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    \14\ NSCC also filed the proposals contained in this proposed 
rule change as an advance notice Pursuant to Section 806(e)(1) of 
the Payment, Clearing, and Settlement Supervision Act of 2010 
(``Clearing Supervision Act'') and Rule 19b-4(n)(1)(i) thereunder. 
12 U.S.C. 5465(e)(1); 17 CFR 240.19b-4(n)(i). Proposed changes filed 
under the Clearing Supervision Act may be implemented either: at the 
time the Commission notifies the clearing agency that it does not 
object to the proposed change and authorizes its implementation, or, 
if the Commission does not object to the proposed rule change, 
within 60 days of the later of (i) the date that the advance notice 
was filed with the Commission or (ii) the date that any additional 
information requested by the Commission is received. 12 U.S.C. 
5465(e)(1)(G).
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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 rule-comments@sec.gov. Please include 
File Number SR-NSCC-2012-10 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-NSCC-2012-10. 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 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 such filings also will be available 
for inspection and copying at the principal office of NSCC and on 
NSCC's Web site at http://www.dtcc.com/downloads/legal/rule_filings/2012/nscc/NSCC-2012-10.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-NSCC-2012-10 and should be submitted on or before 
January 25, 2013.

    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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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-31670 Filed 1-3-13; 8:45 am]
BILLING CODE 8011-01-P


