
[Federal Register Volume 78, Number 86 (Friday, May 3, 2013)]
[Notices]
[Pages 26093-26095]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-10508]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69470; File No. SR-FICC-2013-02]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Include Options on Interest 
Rate Futures Contracts With Maturities Not Longer Than Two Years In The 
One-Pot Cross-Margining Program Between the Government Securities 
Division and New York Portfolio Clearing, LLC

April 29, 2013.
    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 April 15, 2013, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II and III 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. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The proposed rule change would allow FICC to include options on 
interest rate futures contracts with maturities not longer than two 
years in the one-pot cross-margining program between FICC's Government 
Securities Division (``GSD'') and New York Portfolio Clearing, LLC 
(``NYPC'').\3\
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    \3\ NYPC is jointly owned by NYSE Euronext and The Depository 
Trust & Clearing Corporation.
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II. Clearing Agency'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.\4\
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    \4\ The Commission has modified the text of the summaries 
prepared by FICC.
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(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    (i) The purpose of the proposed rule change is to include options 
on interest rate futures contracts with maturities not longer than two 
years in the one-pot cross-margining program between the GSD and NYPC.
Background on NYPC and the FICC-NYPC One-Pot Cross-Margining Program
    NYPC is registered with the Commodity Futures Trading Commission 
(``CFTC'') as a derivatives clearing organization (``DCO'') pursuant to 
Section 5b of the Commodity Exchange Act and Part 39 of the CFTC 
regulations. NYPC launched operations on March 21, 2011, and currently 
clears U.S. dollar-denominated interest rate futures contracts. It 
plans to add options on interest rate futures to its set of products.
    Pursuant to FICC Rule Filing 2010-09,\5\ FICC offers ``single pot'' 
cross margining of certain positions cleared at NYPC and the GSD. This 
arrangement is reflected in a cross-margining agreement (``FICC-NYPC 
Cross-Margining Agreement'') between FICC and NYPC, which is a part of 
the GSD's rules. Specifically, certain GSD members may opt to combine 
within a single margin portfolio their positions at the GSD and their 
positions (or those of certain permitted affiliates) cleared at NYPC. 
Joint GSD-NYPC members or GSD members and their permitted affiliates 
who wish to participate in the one-pot program must execute the 
requisite cross-margining participant agreements, which are exhibits to 
the FICC-NYPC Cross-Margining Agreement.\6\
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    \5\ The Commission approved this rule filing on February 28, 
2011. See Exchange Act Release No. 34-63986 (February 28, 2011); 76 
FR 12144-02 (March 4, 2011) (SR-FICC-2010-09).
    \6\ GSD members and NYPC members are also permitted to cross 
margin in the single pot the activity of their market professional 
customers. See Exchange Act Release No. 34-66989 (May 15, 2012); 77 
FR 30032-02 (May 21, 2012) (SR-FICC-2012-03).
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    As noted in FICC Rule Filing 2010-09, FICC is responsible for 
performing the margin calculations in its capacity as the 
``Administrator'' under the terms of the FICC-NYPC Cross-Margining 
Agreement. Specifically, FICC determines the combined FICC Clearing 
Fund and NYPC Original Margin \7\ requirement for each cross-margining 
participant. The FICC-NYPC one-pot margin requirement for each 
participant is then allocated between FICC and NYPC in proportion to 
each clearing organization's respective ``stand-alone'' margin 
requirements--in other words, an amount reflecting the ratio of what 
each clearing organization would have required from that member if it 
were not participating in the cross-margining program (referred to as 
the ``Constituent Margin Ratio'' in the FICC-NYPC Cross-Margining 
Agreement). The FICC-NYPC Cross-Margining Agreement provides that 
either FICC or NYPC may, at any time, require additional margin to be 
deposited by a participant (above what is calculated under the FICC-
NYPC Cross-Margining Agreement) based upon the financial condition of 
the participant, unusual market conditions or other special 
circumstances. The standards that FICC proposed in Rule Filing 2010-09 
to use for these purposes are the standards contained within the GSD's 
rules currently, so that notwithstanding the calculation of a 
participant's Clearing Fund requirement pursuant to the FICC-NYPC 
Cross-Margining Agreement, FICC still retains the rights contained 
within the GSD's rules to require an additional Clearing Fund deposit 
under the circumstances specified in the GSD's rules. For example, the 
GSD's rules currently provide that, if a Dealer Netting Member \8\ 
falls below its minimum financial requirement, it shall be required to 
make an additional Clearing Fund deposit equal to the greater of (i) $1 
million or (ii) 25 percent of its Required Fund Deposit.\9\ In the 
event of the insolvency or default of a member that participates in the 
one-pot cross-margining arrangement, the positions in such member's 
FICC-NYPC one-pot portfolio (including, where applicable, the positions 
of its permitted margin affiliate at NYPC) will be liquidated by FICC 
and NYPC as a single portfolio, and the liquidation proceeds will be 
applied to the defaulting member's obligations to FICC and NYPC in 
accordance with the provisions of the FICC-NYPC Cross-Margining 
Agreement. The FICC-NYPC Cross-Margining Agreement provides for the 
sharing of losses by FICC and NYPC in the event that the one-pot 
portfolio margin deposits of a defaulting participant are not 
sufficient to cover the losses resulting from the liquidation of that 
participant's trades and positions, which is covered in detail in FICC 
Rule Filing 2010-09, and is reflected in the terms of the FICC-NYPC 
Cross-Margining Agreement.
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    \7\ Original Margin is the NYPC equivalent of the Clearing Fund.
    \8\ The GSD's rules define the term ``Dealer Netting Member'' as 
``a Registered Government Securities Dealer that is admitted to 
membership in the Netting System pursuant to these Rules, and whose 
membership in the Netting System has not been terminated . . . '' 
GSD Rulebook, Rule 2A, Section 2.
    \9\ The GSD's rules define the term ``Required Fund Deposit'' as 
``the amount a Netting Member is required to deposit to the Clearing 
Fund.'' GSD Rulebook, Rule 1.

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    The addition of options on interest rate futures to the one-pot 
cross-margining arrangement does not require any changes to the terms 
of the FICC-NYPC Cross-Margining Agreement. FICC will continue to act 
as the Administrator for purposes of margin calculations. The sharing 
of loss provisions in the FICC-NYPC Cross-Margining Agreement that 
would apply in the event of a participant's default will remain 
unchanged under this proposal.
Proposal To Include Options on Interest Rate Futures in the One-Pot 
Cross-Margining Arrangement
    FICC proposes to add options on interest rate futures contracts 
with maturities not longer than two years to the one-pot cross-
margining arrangement. NYPC will act as the DCO for such products.
    Options on interest rate futures are a long-standing, standardized 
product traded and cleared by futures exchanges \10\ around the globe, 
including the Chicago Mercantile Exchange (``CME'').\11\ The key risks 
associated with adding options on interest rate futures to the one-pot 
cross-margining arrangement relate to the ability of FICC and NYPC to 
properly model, test and monitor the risks that options on interest 
rate futures present to the clearing organizations. Consistent with 
FICC's quantitative policy for new initiatives, any new models or 
enhancements are subject to external review before they are utilized. 
The options proposal has followed this protocol, and the team of 
external reviewers has tested the models and validated their 
methodology.
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    \10\ Exchanges that list options on interest rate futures 
include the following: (i) CME (US); (ii) CBOT (a subsidiary of 
CME); (iii) BM&F (Brazil); (iv) NYSE LIFFE (UK); (v) Eurex 
(Germany); (vi) ASX (Australia); (vii) Montreal Exchange (Canada); 
(viii) SGX (Singapore); and (ix) TFX (Japan).
    \11\ Options on interest rate futures are currently included in 
the ``two-pot'' cross-margining arrangement between FICC and the 
CME. The cross-margining agreement between FICC and the CME is 
incorporated in the GSD's Rules and may be found on the DTCC Web 
site, www.dtcc.com.
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    In the case of options on interest rate futures that are physically 
deliverable, the addition of options on interest rate futures to the 
one-pot cross-margining arrangement will not alter the manner in which 
physical deliveries occur. Upon exercise or assignment of an option, 
the resulting futures position will be treated as a traded futures 
contract, with the same delivery obligations if the resulting futures 
position is not closed out prior to delivery. In general, delivery of 
U.S. Treasury futures can be submitted to FICC by NYPC on a locked-in 
basis and processed in accordance with FICC's rules (when these are 
submitted to FICC, they are no longer futures contracts but rather are 
in the form of buy-sells eligible for processing at the GSD).
    FICC will submit a separate rule filing to the Commission for the 
inclusion in the single pot of longer-dated interest rate options 
products. FICC will also conduct appropriate testing and analysis of 
the options model and, consistent with FICC's quantitative policy for 
new initiatives, submit the model for external review.
Risk Considerations Regarding the Proposal To Include Options on 
Interest Rate Futures in the One-Pot Cross-Margining Arrangement
    The methodology for managing risk for options on interest rate 
futures to be included in the one-pot cross-margining arrangement has 
three pillars: (i) Value-at-Risk (``VaR'') with historical simulation, 
(ii) the Barone-Adesi & Whaley (``BAW'') approximation, and (iii) the 
Stochastic Alpha, Beta, Rho (``SABR'') Volatility Model.
    The historical-simulation-based VaR model proposed for options on 
interest rate futures to be included in the one-pot cross-margining 
arrangement is the same model utilized in the current one-pot cross-
margining arrangement between NYPC and the GSD described in FICC Rule 
Filing 2010-09. The backbone of this VaR model--namely, the three-day/
one-day liquidation period assumption for cash and derivatives 
positions, respectively; the 99th percentile confidence level; and the 
one-year look-back period and the use of a linear interpolation/front-
weighting mechanism to arrive at the 99 percent threshold from 
simulated profits and losses--will remain the same when options on 
interest rate futures are added to FICC-NYPC one-pot portfolios.
    The BAW approximation is the pricing function that FICC and NYPC 
will use to estimate analytically the value of options on interest rate 
futures within the Black-Scholes-Merton framework. The SABR volatility 
model will be used to estimate volatility curves for various options 
series.
    As stated above, a three-day liquidation period is assumed for cash 
positions cleared by FICC, whereas a one-day liquidation period is 
assumed for futures positions cleared by NYPC. Options on interest rate 
futures in the one-pot cross-margining arrangement will also be subject 
to a one-day liquidation requirement due to the similar liquidity of 
these products compared to futures. This is also consistent with CFTC 
requirements. In addition, each cross-margining participant's FICC-NYPC 
one-pot margin requirement is subject to a daily back test, and a 
``coverage component'' is applied and charged to the participant in the 
event the daily back test reflects insufficient coverage. Options on 
interest rate futures in the one-pot cross-margining arrangement will 
be subject to this daily testing.
    The one-pot FICC-NYPC VaR model will account for the non-linear 
risk posed by the addition of options on interest rate futures to the 
one-pot cross-margining arrangement by performing full revaluation of 
such options using BAW and SABR. As options on interest rate futures 
can exhibit magnified exposure in extreme market conditions, FICC is 
proposing to employ the additional tools described below:
1. Minimum Margin Charge for Portfolios Including Options
    Similar to the practice that FICC's Mortgage-Backed Securities 
Division uses to address potential mark-to-market offset of margin 
requirements, FICC and NYPC are proposing to apply a floor margin 
charge of five basis points of the gross market value of positions in 
options on interest rate futures to the unadjusted Required Fund 
Deposit of GSD Netting Members with one-pot portfolios that include 
options on interest rate futures. Therefore, for GSD Netting Members 
with one-pot portfolios that include options on interest rate futures, 
their minimum Required Fund Deposit will be the greater of: (i) The 
current minimum Required Fund Deposit as prescribed in GSD Rule 4, 
Section 2; or (ii) the proposed floor margin charge.
2. Short Option Minimum Charge
    To address the risk associated with short positions in deep out-of-
the-money (``OTM'') options, FICC and NYPC propose to introduce a short 
option minimum (``SOM'') for options on interest rate futures in the 
one-pot cross-margining arrangement. The SOM will apply only to options 
on interest rate futures with a settlement price of ``cabinet.'' \12\ 
These options demonstrate minimum price volatility in normal market 
conditions, but may potentially become volatile when market conditions 
change dramatically. In light of the losses that such options may 
cause, an

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SOM charge will be applied to any short position in these options.
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    \12\ The minimum price increment for futures or options on 
futures is normally referred to as a ``tick.'' For options on 
futures whose value is less than one tick, trading and settlement in 
the options are allowed at a price that is less than a tick. This 
latter price is known as ``cabinet.''
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3. Out-of-the-Money Options Surcharge
    FICC and NYPC also propose to impose a surcharge on all OTM options 
positions in the one-pot cross-margining arrangement in order to 
address any potential biases in the BAW options pricing model described 
above. The amount of the surcharge will be determined by the moneyness 
of the options position.
4. Options Stress Testing
    In addition to the regular stress testing practices utilized by 
FICC and NYPC, monthly hypothetical implied volatility stress tests of 
FICC-NYPC one-pot portfolios, including options on interest rate 
futures, will be conducted in order to analyze specifically the non-
linear tail risks associated with options products.
Proposed Rule Changes
    FICC's proposal to add options on interest rate futures to the one-
pot cross-margining arrangement requires that Rule 4, Section 2 of the 
GSD's rulebook be changed to include a reference to the proposed 
minimum margin charge discussed above. Technical clarifications to 
certain GSD rules are also required in order to make it clear that 
options on interest rate futures will be included in the arrangement. 
Specifically, FICC is proposing to make technical clarifications to the 
following: (i) The definitions of ``CFTC-Recognized Clearing 
Organization'' and ``Eligible Positions'' set forth in Rule 1; (ii) 
Section 5a of GSD Rule 13, and (iii) subsection (b) of GSD Rule 29. As 
noted above, no changes are required to be made to the FICC-NYPC Cross-
Margining Agreement itself.
    (ii) FICC believes that the proposed rule change is consistent with 
the Act and the rules and regulations promulgated thereunder because it 
may further the available offsets among positions held at FICC and 
NYPC, thereby allowing a more efficient use of member collateral and 
promoting additional efficiencies in the marketplace. FICC believes the 
proposed rule change is therefore consistent with the Act and the rules 
and regulations promulgated thereunder because it supports the prompt 
and accurate clearance and settlement of securities transactions. FICC 
further believes that, as it will implement this proposed rule change 
using the enhanced risk-management measures discussed above, the 
proposed rule change will also be consistent with the Act because it 
will assure the safeguarding of the securities and funds in FICC's 
custody and control.

(B) Clearing Agency's Statement on Burden on Competition

    FICC does not believe that the proposed rule change will have any 
negative impact, or impose any burden, on competition that is not 
necessary or appropriate in furtherance of the purposes of the Act.

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Participants, Members, or Others

    Written comments relating to the proposed rule change have not yet 
been solicited or received. FICC will notify the Commission of any 
written comments received by FICC.

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.\13\ The clearing 
agency shall post notice on its Web site of proposed changes that are 
implemented.
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    \13\ FICC also filed the proposals contained in this proposed 
rule change as an advance notice pursuant to Section 806(e)(1) of 
the Clearing Supervision Act and Rule 19b-4(n)(1)(i) thereunder. 12 
U.S.C. 5465(e)(1); 17 CFR 240.19b-4(n)(1)(i). Proposed rule 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 rule 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. See 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 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 No. SR-FICC-2013-02 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 No. SR-FICC-2013-02. 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 of submission. 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 FICC 
and on FICC's Web site at http://dtcc.com/downloads/legal/rule_filings/2013/ficc/SR_FICC_2013_02.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 No. SR-FICC-2013-02 and should be submitted on or 
before May 24, 2013.

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-10508 Filed 5-2-13; 8:45 am]
BILLING CODE 8011-01-P


