
[Federal Register Volume 78, Number 117 (Tuesday, June 18, 2013)]
[Notices]
[Pages 36627-36630]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-14392]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69742; File No. SR-NSCC-2013-04]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Order Approving Proposed Rule Change in Connection With 
the Implementation of The Foreign Account Tax Compliance Act (FATCA)

June 12, 2013.
    On April 22, 2013, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change SR-NSCC-2013-04 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 8, 2013.\3\ The Commission 
did not receive comments on the proposed rule change. This order 
approves 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. 69497 (May 2, 2013), 78 
FR 26838 (May 8, 2013) (SR-NSCC-2013-04).
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I. Description

    NSCC is amending various NSCC rules ``in connection with the 
implementation of sections 1471 through 1474 of the Internal Revenue 
Code of 1986, as amended, which sections were enacted as part of the 
Foreign Account Tax Compliance Act, and the Treasury Regulations or 
other official interpretations thereunder (collectively ``FATCA'').'' 
\4\ In its filing with the Commission, NSCC provided information 
concerning FATCA background, implementation, and NSCC's proposed rule 
changes.
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    \4\ Id. at 26838.
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NSCC's Background Statement

    FATCA was enacted on March 18, 2010, as part of the Hiring 
Incentives to Restore Employment Act, and became effective, subject to 
transition rules, on January 1, 2013. The U.S. Treasury Department 
finalized and issued various implementing regulations (``FATCA

[[Page 36628]]

Regulations'') on January 17, 2013. FATCA generally requires foreign 
financial institutions (``FFIs'') \5\ to become ``participating FFIs'' 
by entering into agreements with the Internal Revenue Service 
(``IRS''). Under these agreements, FFIs are required to report to the 
IRS information on U.S. persons and entities that have (directly or 
indirectly) accounts with these FFIs. If an FFI does not enter into 
such an agreement with the IRS, FATCA will impose a 30% withholding tax 
on U.S.-source interest, dividends and other periodic amounts paid to 
such ``nonparticipating FFI'' (``Income Withholding''), as well as on 
the payment of gross proceeds arising from the sale, maturity, or 
redemption of securities or any instrument yielding U.S.-source 
interest and dividends (``Gross Proceeds Withholding,'' and, together 
with Income Withholding, ``FATCA Withholding''). The 30% FATCA 
Withholding taxes will apply to payments made to a nonparticipating FFI 
acting in any capacity, including payments made to a nonparticipating 
FFI that is not the beneficial owner of the amount paid and acting only 
as a custodian or other intermediary with respect to such payment. To 
the extent that U.S.-source interest, dividend, and other periodic 
amount or gross proceeds payments are due to a nonparticipating FFI in 
any capacity, a U.S. payor, such as NSCC, transmitting such payments to 
the nonparticipating FFI will be liable to the IRS for any amounts of 
FATCA Withholding that the U.S. payor should, but does not, withhold 
and remit to the IRS. According to NSCC, under FATCA, a U.S. payor, 
such as NSCC, could be required to deduct Income Withholding with 
regard to a participating FFI if either: (x) the participating FFI 
makes a statutory election to shift its withholding responsibility 
under FATCA to the U.S. payor; or (y) the U.S. payor is required to 
ignore the actual recipient and treat the payment as if made instead to 
certain owners, principals, customers, account holders or financial 
counterparties of the participating FFI. NSCC believes it is not in a 
position to accept this burden shift and is implementing preventive 
measures to protect itself against such a burden through the rule 
changes contained herein.
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    \5\ According to NSCC, non-U.S. financial institutions are 
referred to as ``foreign financial institutions'' or ``FFIs'' in the 
FATCA Regulations.
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    According to NSCC, as an alternative to FFIs entering into 
individual agreements with the IRS, the U.S. Treasury Department 
provided another means of complying with FATCA for FFIs which are 
resident in non-U.S. jurisdictions that enter into intergovernmental 
agreements (``IGA'') with the United States.\6\ Generally, such a 
jurisdiction (``FATCA Partner'') would pass laws to eliminate the 
conflicts of law issues that would otherwise make it difficult for FFIs 
in its jurisdiction to collect the information required under FATCA and 
transfer this information, directly or indirectly, to the United 
States. An FFI resident in a FATCA Partner jurisdiction would either 
transmit FATCA reporting to its local competent tax authority, which in 
turn would transmit the information to the IRS, or the FFI would be 
authorized/required by FATCA Partner law to enter into an FFI agreement 
and transmit FATCA reporting directly to the IRS. Under both IGA 
models, payments to such FFIs would not be subject to FATCA Withholding 
so long as the FFI complies with the FATCA Partner's laws mandated in 
the IGA.
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    \6\ NSCC states that as of the date of this proposed rule change 
filing, the United Kingdom, Mexico, Ireland, Switzerland, Spain, 
Norway, Denmark, Italy, and Germany have signed or initialed an IGA 
with the United States. The U.S. Treasury Department has announced 
that it is engaged in negotiations with more than 50 countries and 
jurisdictions regarding entering into an IGA.
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    According to NSCC, under the FATCA Regulations, (A) beginning 
January 1, 2014, NSCC will be required to do Income Withholding on any 
payments made to any nonparticipating FFI approved for membership by 
NSCC as of such date or thereafter, (B) beginning July 1, 2014, NSCC 
will be required to do Income Withholding on any payments made to any 
nonparticipating FFI approved for membership by NSCC prior to January 
1, 2014 and (C) beginning January 1, 2017, NSCC will be required to do 
Gross Proceeds Withholding on all nonparticipating FFIs, regardless 
when any such FFI's membership was approved.

NSCC's Statement on FATCA Implementation

    According to NSCC, in preparation for FATCA's implementation, FFIs 
are being asked to identify their expected FATCA status as a condition 
of continuing to do business. Customary legal agreements in the 
financial services industry already contain provisions allocating the 
risk of any FATCA Withholding tax that will need to be collected, and 
requiring that, upon FATCA's effectiveness, foreign counterparties must 
certify (and periodically recertify) their FATCA status using the 
relevant tax forms that the IRS has announced it will provide.\7\ 
Advance disclosure by an FFI client or counterparty would permit a 
withholding agent to readily determine whether it must, under FATCA, 
withhold on payments it makes to the FFI. If an FFI fails to provide 
appropriate compliance documentation to a withholding agent, such FFI 
would be presumed to be a nonparticipating FFI and the withholding 
agent will be obligated to withhold on certain payments.
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    \7\ For example, credit agreements now routinely require foreign 
lenders to agree to provide certifications of their FATCA status 
under approved IRS forms to U.S. borrowers, and subscription 
agreements for alternative investment funds that are anticipated to 
earn U.S.-source income are routinely requiring similar covenants.
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    NSCC states that FATCA will require NSCC to deduct FATCA 
Withholding on payments to certain members and limited members arising 
from certain transactions processed by NSCC on behalf of such 
members.\8\ Because FATCA treats any entity holding financial assets 
for the account of others as a ``financial institution,'' NSCC believes 
that almost all of its members and limited members which are treated as 
non-U.S. entities for federal income tax purposes, including those 
members and limited members that are U.S. branches of non-U.S. 
entities, will likely be FFIs under FATCA (collectively, ``FFI 
Members'').\9\ NSCC says that as a result, it will be liable to the IRS 
for any failures to withhold correctly under FATCA on payments made to 
its FFI Members.
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    \8\ According to NSCC, FFI members and limited members resident 
in IGA countries that are compliant with the terms of applicable 
IGAs should not be subject to FATCA Withholding.
    \9\ Currently, only a small percentage of NSCC's members and 
limited members are treated as non-U.S. entities for federal income 
tax purposes.
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    In light of this, NSCC has evaluated its existing systems and 
services to determine whether and how it may comply with its FATCA 
obligations. As a result of this evaluation, NSCC has determined that 
its existing systems cannot process the new FATCA Withholding 
obligations with regard to the securities transactions processed by it, 
as no similar withholding obligation of this magnitude has ever been 
imposed upon it to date, and NSCC has therefore not built its systems 
to support such an obligation.
    In addition, NSCC states that the vast majority of the transactions 
that are processed at NSCC are processed through its Continuous Net 
Settlement (``CNS'') System. CNS is NSCC's core netting, allotting, and 
fail-control engine. Within CNS, each security and related money 
settlement obligation is

[[Page 36629]]

netted to one net security and/or payment position per member, 
including FFI Members, with NSCC as its central counterparty. CNS 
maintains an orderly flow of security and money balances, providing 
clearance and settlement for equities, corporate bonds, unit investment 
trusts and municipal bonds that are eligible for book entry delivery at 
The Depository Trust Company (``DTC''), an affiliate of NSCC.
    Further, NSCC's related Money Settlement Service provides for net 
money settlement with regard to payments attributable to CNS, as well 
as with regard to payments attributable to other NSCC-processed 
transactions, including mutual fund and insurance transactions. Money 
settlement at NSCC occurs at the end of the day and, from an 
operational perspective, is centralized with DTC's end-of-day money 
settlement in order to provide common NSCC members/DTC participants 
with consolidated reporting and a single point of access for all 
settlement information. Throughout the day, debit and credit data 
generated by member activity are recorded in the settlement system. At 
the end of the processing day, the data is summarized by product 
category (e.g., CNS, mutual funds, etc.) and netted to produce an 
aggregate debit or credit for each member. Similarly, DTC activity is 
also recorded and netted. Following the determination of final net 
numbers for each NSCC member and/or DTC participant, these amounts are 
further netted to produce a consolidated net settlement obligation. So, 
for example, a member with a settlement debit at NSCC, which member is 
also a DTC participant, will have that debit netted against its 
settlement credit at DTC. Settling banks, who may settle on behalf of 
multiple NSCC members and/or DTC participants, must separately 
acknowledge the respective settlement balances of their customer 
members/participants at each clearing agency. The consolidated net 
balances of their respective member/participant customers are then 
further netted to produce a single net-net settling bank consolidated 
debit or credit. Settlement of these net-net balances occurs through 
use of the Federal Reserve's National Settlement Service, whereby DTC, 
on its own behalf and as NSCC's settlement agent, submits instructions 
to have the Federal Reserve accounts of the settling banks charged for 
their net-net debit balances and credited with their net-net credit 
balances. NSCC believes that this net-net settlement functionality 
could make FATCA Withholding virtually impossible, or, at the very 
least, would create onerous efficiency and liquidity issues for both 
NSCC and its membership.
    NSCC believes that undertaking FATCA Withholding, given NSCC's net-
net settlement functionality, could require NSCC in certain 
circumstances to resort to a draw on NSCC's clearing fund (``Clearing 
Fund'') in order to fund FATCA Withholding taxes with regard to 
nonparticipating FFI Members in non-FATCA Partner jurisdictions 
whenever the net credit owed to such FFI Member is less than the 30% 
FATCA tax. For example, if a nonparticipating FFI (in a non-FATCA 
Partner jurisdiction) is owed a $100M payment from the sale of U.S. 
securities, but such nonparticipating FFI is in a net debit position at 
the end of that day because of NSCC's net settlement functionality and 
end-of-day crediting and debiting, there would be no payment to this 
FFI Member from which NSCC can withhold. In this example, NSCC would 
likely need to fund the $30M FATCA Withholding tax until such time as 
the FFI Member can reimburse NSCC and, as NSCC has no funds for this 
purpose, it likely would require a draw on the Clearing Fund.\10\ NSCC 
would need to consider an increase in the amount of cash required to be 
deposited into the Clearing Fund, either by FFI Members or perhaps all 
of its members, which would reduce such member's liquidity and could 
have significant systemic effects. The amount of the FATCA Withholding 
taxes would be removed from market liquidity, which could lead to 
increased risk of member failure and increased financial instability.
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    \10\ NSCC notes that the FATCA Regulations provide that 
``clearing organizations,'' which settle money on a net basis, may 
withhold on a similar net basis for FATCA purposes. However, the 
end-of-day net settlement amounts, which are attributable to the 
sales and dispositions of many different securities as well as 
debits and credits for other items, would likely not qualify for the 
special FATCA netting rule. Additionally, as discussed above, each 
of NSCC's member's end-of-day money settlement obligation is cross-
netted with such member's respective money settlement obligation at 
DTC, and therefore, qualifying as a ``clearing organization'' under 
FATCA would still not prevent the possibility that NSCC would need 
to fund FATCA Withholding taxes from the Clearing Fund. Even if the 
end-of-day net-net settlement amount would qualify as the correct 
amount from which to do FATCA Withholding, the liquidity risks 
described herein are still present. This is because the sheer dollar 
value attributable to NSCC's net daily payments among NSCC and 
members means that withholding FATCA tax from such net settlement 
payments, in any material proportion, would likely reduce liquidity 
and thus increase financial instability.
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    For the reasons explained above and the following additional 
reasons, NSCC is amending its rules to implement preventive measures 
that would generally require all of NSCC's (i) existing members and 
limited members that are treated as non-U.S. entities for federal tax 
income purposes and (ii) any applicants applying to become members or 
limited members, that are treated as non-U.S. entities for federal 
income tax purposes to be participating FFIs because NSCC believes 
that:
     Undertaking FATCA Withholding by NSCC (even if possible) 
would make it economically unfeasible for affected FFI Members to 
engage in transactions involving U.S. securities. It would likely also 
quickly cause a significant negative impact on such FFI Members' 
liquidity because such withholding taxes would be imposed on the very 
large sums that NSCC pays to such FFI Members. Furthermore, FFI Members 
would be burdened with extra costs and the negative impact on liquidity 
caused by the likely need to substantially increase the amount of cash 
required to be deposited into the Clearing Fund.
     The cost of implementing a FATCA Withholding system for a 
small number of nonparticipating FFI Members would be substantial and 
disproportionate to the related benefit. Under the Model I IGA form and 
its executed versions with various FATCA Partners, NSCC would not be 
required to withhold with regard to FFI residents in such FATCA Partner 
jurisdictions. Accordingly, NSCC's withholding obligations under FATCA 
would effectively be limited to nonparticipating FFI Members in non-
FATCA Partner jurisdictions. Since the cost of developing and 
maintaining a complex FATCA Withholding system would be passed on to 
NSCC's members at large, it may burden members that otherwise comply 
with, or are not subject to, FATCA Withholding.
     As briefly noted above, absent this current action and in 
order to avoid counterparty credit risk, NSCC would likely require each 
of the nonparticipating FFI Members in non-FATCA Partner jurisdictions 
to make initial or additional cash deposits to the Clearing Fund as 
collateral for the approximate potential FATCA tax liability of such 
nonparticipating FFI Member or otherwise adjust required deposits to 
the Clearing Fund. The amount of such deposits, which could amount to 
billions of dollars, would be removed from market liquidity.
     From the nonparticipating FFI Member's perspective, having 
30% of its payments withheld and sent to the IRS would have a severe 
negative impact on such nonparticipating FFI Member's financial status. 
In many cases, the gross receipts would be for client accounts, and the 
nonparticipating FFI Member would need to make such accounts

[[Page 36630]]

whole. Without receipt of full payment for its dispositions, the 
nonparticipating FFI Member would not have sufficient assets to fund 
its client accounts.
     These rule changes should not create business issues or be 
onerous to NSCC's membership because requiring FFIs to certify (and to 
periodically recertify) their FATCA status, and imposing the costs of 
non-compliance on them, are becoming standard market practice in the 
United States, separate and apart from membership in NSCC.

Rule Changes

    NSCC states that managing the risks inherent in executing 
securities transactions is a key component of NSCC's business. NSCC's 
risk tolerances (i.e., the levels of risk NSCC is prepared to confront, 
under a range of possible scenarios, in carrying out its business 
functions) are determined by the Board of Directors, in consultation 
with the Group Chief Risk Officer. NSCC uses a combination of risk 
management tools, including strict criteria for membership, to mitigate 
the risks inherent in its business.
    In line with its risk management focus, NSCC has determined that 
compliance with FATCA, so that NSCC shall not be responsible for FATCA 
Withholding, should be a general membership requirement (A) for all 
applicants that are treated as non-U.S. entities for federal income tax 
purposes, and (B) for all existing FFI Members.\11\ NSCC is amending 
its rules as follows:
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    \11\ NSCC may grant a waiver under certain circumstances, 
provided, however, that NSCC will not grant a waiver if it causes 
NSCC to be obligated to withhold under FATCA on gross proceeds from 
the sale or other disposition of any property.
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     Rule 1: adding ``FFI Member,'' ``FATCA,'' ``FATCA 
Certification,'' ``FATCA Compliance Date'' \12\ and ``FATCA Compliant'' 
as defined terms;
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    \12\ Although Income Withholding with regard to FFI Members 
approved for membership by NSCC prior to January 1, 2014 is first 
required under FATCA beginning July, 1 2014, the proposed amendments 
to NSCC rules would require such existing FFI Members to be FATCA 
compliant approximately 60 days prior to July 1, 2014 in order for 
NSCC to comply with its disciplinary and notice processes as set 
forth in NSCC rules.
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     Rule 2, Section 4: requiring that all FFI Members (both 
new and existing), in general: (i) Agree not to conduct any transaction 
or activity through NSCC if such FFI Member is not FATCA Compliant, 
(ii) certify and, as required under the timelines set forth under 
FATCA, periodically recertify, to NSCC that they are FATCA Compliant, 
and (iii) indemnify NSCC for any losses sustained by NSCC resulting 
from such FFI Member's failure to be FATCA Compliant;
     Rule 2A, Section 1.B.: adding FATCA Compliance as a 
qualification requirement for any applicant that will be an FFI Member;
     Rule 2A, Section 1.B., Foot Note 1: making a technical 
clarification to expressly include the policy statement set forth in 
Addendum O as other qualification standards that NSCC has promulgated 
with regard to certain applicants;
     Rule 2A, Section 1.C.: adding that each applicant must 
complete and deliver a FATCA Certification to NSCC as part of its 
membership application unless NSCC has waived this requirement with 
regard to membership type;
     Rule 2B, Section 1: making a technical clarification by 
adding a footnote to expressly include the policy statement set forth 
in Addendum O as qualifications and standards which are continuing 
membership requirements;
     Rule 2B, Section 2.B: specifying that failure to be FATCA 
Compliant creates a duty upon an FFI Member (both new and existing) to 
inform NSCC;
     Addendum O: requiring applicants that are subject to this 
Policy Statement (i) to be FATCA Compliant, (ii) to deliver to NSCC a 
FATCA Certification, and to periodically recertify such FATCA 
Certification, (iii) to agree not to submit any order for processing 
through NSCC if the applicant fails to be FATCA Compliant at any time, 
and (iv) to agree to indemnify NSCC for any losses sustained by NSCC 
resulting from the applicant's failure to be FATCA Compliant, as 
conditions to admission and continued membership.

II. Discussion

    Section 19(b)(2)(C) of the Act \13\ 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 rules and regulations thereunder applicable 
to such organization. Section 17A(b)(3)(F) of the Act \14\ requires the 
rules of a clearing agency to be designed to, among other things, 
promote the prompt and accurate clearance and settlement of securities 
transactions, assure the safeguarding of securities and funds which are 
in the custody or control of the clearing agency or for which it is 
responsible, and protect investors and the public interest. The 
Commission finds that NSCC's proposed rule change is consistent with 
these requirements because it is designed to comply with FATCA while 
eliminating uncertainty in funds settlement. Specifically, based on 
NSCC's representations, the Commission understands that the proposed 
rule change is designed codify NSCC's rules in a way that will allow 
NSCC to comply with FACTA without developing and maintaining a complex 
FATCA Withholding system and, as a result, it will eliminate 
uncertainty in funds settlement that NSCC believes will arise if NSCC 
is subject to FATCA Withholding.
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    \13\ 15 U.S.C. 78s(b)(2)(C).
    \14\ 12 U.S.C. 78q-1(b)(3)(F).
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    In approving this proposed rule change, the Commission is mindful 
of the IRS's jurisdiction respecting FATCA. This Order does not 
interpret FATCA. The Commission's approval of the proposed rule change 
in no way constitutes a determination or finding by the Commission that 
the proposed rule change complies with FATCA, which is under the 
purview of the IRS.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act \15\ and the 
rules and regulations thereunder.
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    \15\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-NSCC-2013-04) be, and it hereby is, 
approved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-14392 Filed 6-17-13; 8:45 am]
BILLING CODE 8011-01-P


