
[Federal Register Volume 79, Number 105 (Monday, June 2, 2014)]
[Notices]
[Pages 31360-31361]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-12648]



[[Page 31360]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72260; File No. SR-NSCC-2014-802]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing Amendment No. 1 and No Objection to 
Advance Notice, as Modified by Amendment No. 1, To Enhance NSCC's 
Existing Parametric Value-at-Risk Margining Model

May 27, 2014.

I. Introduction

    On March 28, 2014, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2014-802 (``Advance Notice'') 
pursuant to Section 806(e)(1) of the Payment, Clearing, and Settlement 
Supervision Act of 2010 (``Clearing Supervision Act'') \1\ and Rule 
19b-4(n)(1)(i) of the Securities Exchange Act of 1934 (``Exchange 
Act'').\2\ The Advance Notice was published in the Federal Register on 
April 21, 2014.\3\ The Commission did not receive any comment letters 
to the Advance Notice. On May 6, 2014, NSCC filed Amendment No. 1 to 
the Advance Notice (``Amendment''). This publication serves as notice 
of filing of Amendment No. 1 and no objection to the Advance Notice, as 
amended (``Amended Advance Notice'').
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ Release No. 34-71945 (Apr. 15, 2014), 79 FR 22174 (Apr. 21, 
2014).
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II. Description of the Amended Advance Notice

A. Background

    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 (``VaR''). 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 (e.g., three days), within a given 
level of confidence (e.g., 99%).
    NSCC performs back testing to measure the performance of Members' 
portfolios against the calculated VaR margin requirements for those 
portfolios. Over the past few years, the results of those tests have 
shown that while the NSCC's VaR margin component has remained mostly 
above its 99 percent coverage target when tested over a longer time 
horizon (e.g., a 12-month rolling window), coverage fell below the 99 
percent target in a few instances where the tests were conducted over a 
shorter time horizon (e.g., a 1-month window).
    Historically, parametric VaR models have computed risk on the 
assumption that the distributional return of an equity portfolio is 
normal. However, the increased frequency of market volatility in recent 
years has stressed the performance of parametric VaR models and has 
called into question that assumption. In other words, certain risks, 
such as ``fat-tail risk,'' may not be properly addressed by parametric 
VaR models that are based solely on the assumption of a normal return 
distribution, as demonstrated by NSCC's back testing results. As such, 
industry participants have begun to move away from the use of assuming 
normal distributions for asset returns in parametric VaR models and, 
instead, have begun to use other distributions, such as Student's t-
distributions, that better account for fat-tail risk events. Therefore, 
with this Amended Advance Notice, NSCC will adjust its current VaR 
model to incorporate Student's t-distributions into the model in a 
manner specific to NSCC's needs, as described below.

B. Proposed Change

    The proposed change contained in the Amended Advance Notice will 
enhance NSCC's existing parametric VaR model by supplementing the 
current assumption of a normal return distribution for equity 
portfolios with a factor that utilizes the degrees of freedom (``DOF'') 
derived from a family of Student's t-distributions, which are more 
representative of the historically observed return distributions in the 
equities markets. NSCC will estimate periodically the DOF factor of the 
empirical t-distribution in the model by using daily return data from 
the S&P 500 over a historical window no shorter than 12-months. NSCC 
will then compute a multiplication factor that represents the magnitude 
of increase of t-distribution-based parametric VaR from the normal-
based parametric VaR. This multiplication factor will be applied to 
Members' VaR margin requirement.
    NSCC initially proposed in the Advance Notice to use its existing 
VaR model, with the normal distribution assumption, as a floor to the 
proposed model. However, under the Amendment, NSCC proposes not to use 
its current model as a floor but, instead, to set a floor on the DOF 
(i.e., set a lower bound on the DOF) in the proposed model that will 
serve the same function. By doing so, the Amended Advance Notice mimics 
the intent of the original proposal while ensuring that the amount of 
margin collected by NSCC during volatile market conditions is greater 
than the amount of margin computed under the existing and originally 
proposed methodologies.
    The proposed change contained in the Amended Advance Notice is 
expected to improve NSCC's back-testing performance over shorter time 
horizons, particularly during more volatile market environments, and it 
should enable NSCC's VaR model to better account for the higher degree 
of fat-tail risk observed in equities markets.

III. Commission Findings and Notice of No Objection

    Although the Clearing Supervision Act does not specify a standard 
of review for advance notices, the Commission believes that the stated 
purpose of the Clearing Supervision Act is instructive.\4\ The stated 
purpose of the Clearing Supervision Act is to mitigate systemic risk in 
the financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for designated 
systemically important financial market utilities (``SIFMU'').\5\
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    \4\ 12 U.S.C. 5461(b).
    \5\ Id.
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    Section 805(a)(2) of the Clearing Supervision Act 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.\6\ 
Section 805(b) of the Clearing Supervision Act states that the 
objectives and principles for the risk management standards prescribed 
under Section 805(a) shall be to:
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    \6\ 12 U.S.C. 5464(a)(2).
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     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.\7\
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    \7\ 12 U.S.C. 5464(b).

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[[Page 31361]]

    The Commission adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act \8\ (``Clearing Agency 
Standards''),\9\ which the Commission recently proposed to amend, in 
part, to establish additional standards.\10\ The Clearing Agency 
Standards became effective on January 2, 2013 and require registered 
clearing agencies to establish, implement, maintain, and 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.\11\ As such, it is appropriate for the 
Commission to review advance notices against the objectives and 
principles for risk management standards as described in Section 805(b) 
of the Clearing Supervision Act,\12\ as well as the applicable Clearing 
Agency Standards promulgated under Section 805(a) of the Clearing 
Supervision Act.\13\
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    \8\ 12 U.S.C. 5464(a)(2).
    \9\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (Nov. 2, 
2012).
    \10\ See Release No. 34-71699 (Mar. 12, 2014), 79 FR 16865 (Mar. 
26, 2014) proposing to amend Rule 17Ad-22 for covered clearing 
agencies.
    \11\ 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 SIFMUs 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).
    \12\ 12 U.S.C. 5464(b).
    \13\ 12 U.S.C. 5464(a).
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    The Amended Advance Notice's proposed change, as described above, 
is designed to enhance the VaR model that NSCC uses to calculate 
Clearing Fund requirements for its Members. Consistent with Section 
805(b) of the Clearing Supervision Act,\14\ the Commission believes 
that the Amended Advance Notice will help promote robust risk 
management and mitigate systemic risk by aligning more closely the 
assumptions utilized by NSCC's VaR model regarding distribution returns 
on equity portfolios with observed returns, which, in turn, will enable 
the calculation for Members' Clearing Fund margin requirements to 
better account for fat-tail risk events. This change should increase 
the financial resources available to NSCC at appropriate times and 
constitutes an improvement to its risk management practices.
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    \14\ See 12 U.S.C. 5464(b).
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    Commission Rule 17Ad-22(b)(2), adopted as part of the Clearing 
Agency Standards,\15\ requires a registered clearing agency that is 
also a central counterparty (``CCP'') to ``establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to . . . [u]se margin requirements to limit its credit 
exposures to participants under normal market conditions and use risk-
based models and parameters to set margin requirements and review such 
margin requirements and the related risk-based models and parameters at 
least monthly.'' \16\ Furthermore, Commission Rule 17Ad-22(b)(3), also 
adopted as part of the Clearing Agency Standards,\17\ requires, a 
registered CCP to ``establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to . . . [m]aintain 
sufficient financial resources to withstand, at a minimum, a default by 
the participant family to which it has the largest exposure in extreme 
but plausible market conditions. . . .'' \18\
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    \15\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (Nov. 2, 
2012).
    \16\ 17 CFR 240.17Ad-22(b)(2).
    \17\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219 (Nov. 2, 
2012).
    \18\ 17 CFR 240.17Ad-22(b)(3).
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    The proposed change contained in the Amended Advance Notice, as 
discussed above, furthers NSCC's compliance with Rules 17Ad-22(b)(2) 
and (b)(3) because the change will enable the assumptions used in 
NSCC's risk-based VaR model to better reflect fat-tailed event risk, 
thus leading to calculations of Members' Clearing Fund margin 
requirements that better reflect historically observed returns, 
increased deposits to NSCC's Clearing Fund at appropriate times, and 
increased resources available to NSCC in the event of a defaulting 
Member to which NSCC has the largest exposure in extreme market 
conditions.
    For the reasons stated above, the Commission does not object to the 
Amended Advance Notice.

IV. Solicitation of Comments to Amendment No. 1

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the Amendment No. 
1 to the Advance Notice is consistent with the Clearing Supervision 
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-NSCC-2014-802 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File No. SR-NSCC-2014-802. 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 Advance Notice that are filed 
with the Commission, and all written communications relating to the 
Advance Notice 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 the filing also will be available for inspection 
and copying at the principal office of NSCC and on NSCC's Web site 
(http://dtcc.com/legal/sec-rule-filings.aspx). 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-NSCC-2014-802 and should be submitted on or 
before June 23, 2014.

V. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\19\ that the Commission does not object to 
the proposed change described in advance notice SR-NSCC-2014-802, as 
modified by Amendment No. 1, and that NSCC be and hereby is authorized 
to implement the proposed change as of the date of this notice.
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    \19\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-12648 Filed 5-30-14; 8:45 am]
BILLING CODE 8011-01-P


