
[Federal Register Volume 78, Number 69 (Wednesday, April 10, 2013)]
[Notices]
[Pages 21433-21435]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08306]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69301; File No. SR-NSCC-2012-810]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection to Advance Notice Filing 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

April 4, 2013.

I. Introduction

    On December 18, 2012, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2012-810 (``Advance Notice'') 
pursuant to Section 806(e) of Title VIII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act''),\1\ entitled 
the Payment, Clearing, and Settlement Supervision Act of 2010 
(``Clearing Supervision Act'' or ``Title VIII'') and Rule 19b-4(n) of 
the Securities Exchange Act of 1934 (``Exchange Act''). The Advance 
Notice was published in the Federal Register on January 17, 2013.\2\ 
The Commission received two comment letters to the Advance Notice from 
one commenter.\3\ NSCC responded to both comment letters.\4\ This 
publication serves as notice of no objection to the Advance Notice.
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    \1\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ Release No. 34-68621 (Jan. 10, 2013), 78 FR 3960 (Jan. 17, 
2013). NSCC also filed a proposed rule change pursuant to Section 
19(b)(1) of the Exchange Act on December 17, 2012 seeking Commission 
approval to permit NSCC to change its rules to reflect the proposed 
change described herein. The Commission published notice of the 
proposed rule change on December 28, 2012. Release No. 34-68549 
(Dec. 28, 2012), 78 FR 792 (Jan. 4, 2013). The Commission extended 
the period of review of the proposed rule change on February 5, 
2013. Release No. 34-68829 (Feb. 5, 2013), 78 FR 9751 (Feb. 11, 
2013).
    \3\ Comment Letter from Lek Securities Corporation dated January 
25, 2013 (http://sec.gov/comments/sr-nscc-2012-810/nscc2012810-1.pdf), and Comment Letter from Lek Securities Corporation dated 
March 18, 2013 (http://sec.gov/comments/sr-nscc-2012-810/nscc2012810-3.pdf) (collectively, the ``Lek Letters'').
    \4\ Response Letter from NSCC dated February 22, 2013 (http://sec.gov/comments/sr-nscc-2012-810/nscc2012810-2.pdf), and Response 
Letter from NSCC dated March 21, 2013 (http://sec.gov/comments/sr-nscc-2012-810/nscc2012810-4.pdf).
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II. Analysis

    NSCC filed the Advance Notice to permit it to make rule changes to 
its Rules & Procedures (``Rules'') designed 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 its Rules, as discussed below.

A. ID Offset

    NSCC maintains a Clearing Fund to have on deposit assets sufficient 
to satisfy losses that may otherwise be incurred by NSCC as the result 
of the default of an NSCC member (``Member'') and the resulting 
closeout of that Member's unsettled positions under NSCC's trade 
guaranty. Each Member is required to contribute to the Clearing Fund 
pursuant to a formula calculated daily. The Clearing Fund formula 
accounts for a variety of risk factors through the application of a 
number of components, including Value-at-Risk

[[Page 21434]]

(``VaR'') \5\ and Market Maker Domination (``MMDOM'').\6\
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    \5\ The VaR component of the Clearing Fund calculation is a core 
component of the formula and is designed to calculate the amount of 
money that may be lost on a portfolio over a given period of time 
that is assumed necessary to liquidate the portfolio, within a given 
level of confidence. See Release No. 34-68621 (Jan. 10, 2013), 78 FR 
3960 (Jan. 17, 2013).
    \6\ The MMDOM component of the Clearing Fund calculation is 
charged to market makers 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. See Release No. 34-68621 (Jan. 
10, 2013), 78 FR 3960 (Jan. 17, 2013).
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    NSCC currently calculates the VaR and MMDOM components of a 
Member's Clearing Fund required deposit after allowing for a Member's 
net unsettled NSCC positions in a particular CUSIP to be offset by any 
pending ID transactions settling at DTC in the same CUSIP, which have 
been confirmed and/or affirmed through an institutional delivery system 
acceptable to NSCC (``ID Offset'').\7\ ID Offset is based on the 
assumption that in the event of a Member's insolvency NSCC will be able 
to close out any trade for which there is a corresponding ID 
transaction settling at DTC by completing that ID transaction.\8\
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    \7\ For purposes of the ID Offset, NSCC includes ID transactions 
that are confirmed and/or affirmed on trade date, as well as ID 
transactions affirmed one day after trade date and remain affirmed 
through settlement date. See Release No. 34-68621 (Jan. 10, 2013), 
78 FR 3960 (Jan. 17, 2013).
    \8\ 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 the net position). See Release 
No. 34-68621 (Jan. 10, 2013), 78 FR 3960 (Jan. 17, 2013).
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B. Potential Inability To Complete ID Transactions

    Generally, when NSCC ceases to act for a Member, it is obligated, 
for those transactions that it has guaranteed, to pay for deliveries 
made by non-defaulting Members that are due to the failed Member on the 
day they are due. If NSCC is unable to complete the ID transactions as 
contemplated by the current Clearing Fund calculation, then NSCC may 
need to liquidate a portfolio that could be substantially different 
than the portfolio for which NSCC collected its Clearing Fund, leaving 
NSCC potentially under-collateralized and exposed to market risk.
    A defaulting Member's pending ID transactions may not be completed 
for a number of reasons. Completion of an ID transaction by its 
institutional counterparty is voluntary because that counterparty is 
not a Member, which means it is not bound by NSCC's Rules and is not 
party to any legally binding contract with NSCC that requires it or its 
custodian to complete the transaction. Moreover, based on news that a 
Member may be in distress or insolvent, the institutional counterparty 
or its investment adviser may take immediate market action with respect 
to the ID transaction, in order to reduce its market risk, which 
effectively eliminates the option for NSCC to complete the 
transactions. Finally, ID transactions settle trade-by-trade between 
the executing broker and the custodian; the netted ID positions used to 
offset the NSCC position could be comprised of thousands of individual 
trades with hundreds of different counterparties. In the event of a 
Member default, it could be time consuming for NSCC to contact the 
counterparties individually to get their agreement to complete the ID 
transactions. Even if NSCC were to get all of the counterparties to 
agree to complete the ID transactions, this could delay the prompt 
closeout of the defaulter's open positions and possibly expose NSCC to 
additional market risk in excess of the Clearing Fund.
    Due to the risk that, in the event it ceases to act for a Member 
with pending ID transactions, NSCC may be unable to complete the 
pending ID transactions in the timeframe contemplated by its current 
Clearing Fund calculations and, as a result, may have insufficient 
margin in its Clearing Fund, as described above, NSCC will eliminate 
the ID Offset calculation from the VaR and MMDOM components of a 
Member's Clearing Fund requirement deposit.

C. Implementation Schedule

    In order to mitigate the impact of this rule change on its Members, 
NSCC will implement the changes set forth in the Advance Notice over an 
18-month period. On a date no earlier than 10 days following notice to 
Members by Important Notice (``Initial Implementation Date''), NSCC 
will eliminate ID Offset from ID transactions that have only been 
confirmed, but have not yet been affirmed. 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 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 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 ID Offset entirely for all ID transactions. 
Members will be advised of each proposed implementation date through 
issuance of NSCC Important Notices, which are publicly available at 
www.dtcc.com.

III. Discussion

    Although Title VIII does not specify a standard of review for an 
Advance Notice, the stated purpose of Title VIII is instructive.\9\ The 
stated purpose of Title VIII is to mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for systemically-
important financial market utilities (``FMUs'') and providing an 
enhanced role for the Federal Reserve Board in the supervision of risk 
management standards for systemically-important FMUs.\10\
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    \9\ 12 U.S.C. 5461(b).
    \10\ Id.
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    Section 805(a)(2) of the Clearing Supervision Act \11\ authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing, and settlement activities of designated clearing entities and 
financial institutions engaged in designated activities for which it is 
the supervisory agency or the appropriate financial regulator. Section 
805(b) of the Clearing Supervision Act \12\ states that the objectives 
and principles for the risk management standards prescribed under 
Section 805(a) shall be to:
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    \11\ 12 U.S.C. 5464(a)(2).
    \12\ 12 U.S.C. 5464(b).
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     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    The Commission adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act on October 22, 2012 
(``Clearing Agency Standards'').\13\ The Clearing Agency Standards 
became effective on January 2, 2013 and require clearing agencies that 
perform central counterparty (``CCP'') services to establish, 
implement, maintain, and

[[Page 21435]]

enforce written policies and procedures that are reasonably designed to 
meet certain minimum requirements for their operations and risk 
management practices on an ongoing basis.\14\ As such, it is 
appropriate for the Commission to review Advance Notices against these 
risk management standards that the Commission promulgated under Section 
805(a) and the objectives and principles of these risk management 
standards as described in Section 805(b).
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    \13\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (Nov. 2, 
2012).
    \14\ The Clearing Agency Standards are substantially similar to 
the risk management standards established by the Board of Governors 
of the Federal Reserve System (``Board of Governors'') governing the 
operations of designated FMUs that are not clearing entities and 
financial institutions engaged in designated activities for which 
the Commission or the Commodity Futures Trading Commission is the 
Supervisory Agency. See Financial Market Utilities, 77 FR 45907 
(Aug. 2, 2012).
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    As a CCP, NSCC occupies an important role in the securities 
settlement system by interposing itself between counterparties to 
financial transactions, thereby reducing certain risks faced by Members 
and contributing to global financial stability. In this role, however, 
NSCC is necessarily subject to certain risks in the event of the 
default of a Member.
    NSCC's proposal to eliminate ID Offsets, as described above, is 
designed to help mitigate the risk that NSCC will be under-
collateralized if it ceases to act for a defaulting Member and is 
unable to complete the offsetting ID transactions in the time currently 
contemplated by its Clearing Fund calculation. Consistent with Section 
805(a), the Commission believes this proposal promotes robust risk 
management, as well as the safety and soundness of NSCC's operations, 
while reducing systemic risks and supporting the stability of the 
broader financial system, by improving NSCC's risk management systems 
in preparation for a possible Member default via a more accurate 
representation of risk in its Clearing Fund calculation. As discussed 
above, NSCC's calculation of its Clearing Fund margin will be more 
accurate in that it will not include an assumption of trade closeouts 
following a Member insolvency with respect to trades for which there is 
a corresponding ID transaction.
    Additionally, Commission Rule 17Ad-22(b)(1) regarding measurement 
and management of credit exposure,\15\ adopted as part of the Clearing 
Agency Standards,\16\ requires a CCP 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 under normal market conditions so that the operations of 
the CCP would not be disrupted and non-defaulting participants would 
not be exposed to losses that they cannot anticipate or control.\17\ 
Here, as described in detail above, NSCC's proposal to eliminate ID 
Offsets should help to limit its exposure and non-defaulting members' 
exposure to potential losses from a defaulting Member, while minimizing 
disruption to its CCP operations, by more accurately reflecting its 
risks in the calculation of its Clearing Fund margin.
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    \15\ 17 CFR 240.17Ad-22(b)(1).
    \16\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (Nov. 2, 
2012).
    \17\ 17 CFR 240.17Ad-22(b)(1).
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    Furthermore, Commission Rules 17Ad-22(d)(4) regarding 
identification and mitigation of operational risk,\18\ and 17Ad-
22(d)(11) regarding default procedures,\19\ also both adopted as part 
of the Clearing Agency Standards,\20\ require that registered clearing 
agencies ``establish, implement, maintain and enforce written policies 
and procedures reasonably designed to, as applicable: * * * Identify 
sources of operational risk and minimize them through the development 
of appropriate systems, controls, and procedures * * * '',\21\ and `` * 
* * establish default procedures that ensure that the clearing agency 
can take timely action to contain losses and liquidity pressures and to 
continue meeting its obligations in the event of a participant 
default,\22\ respectively. Here, as described in detail above, the 
elimination of ID Offsets should help NSCC better minimize settlement 
risks and better ensure that it can contain losses and liquidity 
pressures, and meet its obligations in a timely fashion, by more 
accurately accounting for those risks in a Clearing Fund calculation 
that is designed to satisfy potential losses in a timely manner.
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    \18\ 17 CFR 240.17Ad-22(d)(4).
    \19\ 17 CFR 240.17Ad-22(d)(11).
    \20\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (Nov. 2, 
2012).
    \21\ 17 CFR 240.17Ad-22(d)(4).
    \22\ 17 CFR 240.17Ad-22(d)(11).
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    In its assessment of the Advance Notice, the Commission assessed 
whether the issues raised by the Lek Letters relate to the level or 
nature of risks presented by NSCC's proposal, which is designed to 
mitigate risks to NSCC, as discussed above. After evaluating NSCC's 
responses to the Lek Letters, the Commission believes that the issues 
raised in the Lek Letters relate to the potential competitive effects 
of NSCC's proposal, not the level or nature of risks presented by 
it.\23\ As such, the issues raised by the Lek Letters are not 
considered within the context of this Notice of No Objection to the 
Advance Notice under Title VIII; rather, they are considered within an 
analysis of the proposal's consistency with Section 17A of the Exchange 
Act and the applicable rules and regulations thereunder, which the 
Commission did in its ``Order Approving Proposed Rule Change to 
Eliminate the Offset of [NSCC's] 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'' (File No. SR-NSCC-2012-10).\24\
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    \23\ See Lek Letters, supra note 3.
    \24\ See Release No. 34-69302 (Apr. 4, 2013).
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IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\25\ that the Commission does not object to 
the proposed rule change described in the Advance Notice (File No. SR-
NSCC-2012-810) and that NSCC be and hereby is authorized to implement 
the proposed rule change as of the date of this notice or the date of 
the ``Order Approving Proposed Rule Change to Eliminate the Offset of 
[NSCC's] 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'' (File 
No. SR-NSCC-2012-10),\26\ whichever is later.
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    \25\ 12 U.S.C. 5465(e)(1)(I).
    \26\ Release No. 34-69302 (Apr. 4, 2013).

By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-08306 Filed 4-9-13; 8:45 am]
BILLING CODE 8011-01-P


