
[Federal Register Volume 80, Number 20 (Friday, January 30, 2015)]
[Notices]
[Pages 5179-5182]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-01747]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74132; File No. SR-FICC-2014-11]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change To Amend the Government Securities 
Division Rulebook and the Mortgage Backed Securities Clearing Rules In 
Order To Move the Time of Novation With Respect to Certain Trades, 
Include Rules To Reflect Existing Processes, and Clarify Certain Rules 
To Reflect Current Practices

January 26, 2015.

I. Introduction

    On December 2, 2014, the Fixed Income Clearing Corporation 
(``FICC'') filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-FICC-2014-11 pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder.\2\ The proposed change was published for 
comment in the Federal Register on December 16, 2014.\3\ The Commission 
received no comment letters in response to the proposed rule change. 
For the reasons discussed below, the Commission is approving 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. 34-73805 (December 10, 
2014), 79 FR 74790 (December 16, 2014) (SR-FICC-2014-11).
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 II. Description

    The rule change, as proposed, moves the time of novation applicable 
to certain transactions submitted to FICC's Government Securities 
Division (``GSD'') and FICC's Mortgage Backed Securities Division 
(``MBSD'') to earlier in the clearing process in order to provide 
members with additional legal certainty, for purposes of members' 
regulatory capital requirements, that FICC will be the legal 
counterparty with respect to their guaranteed trades.
    Currently, FICC guarantees the settlement of a trade upon 
comparison, which generally occurs when FICC issues initial ``output'' 
to GSD netting members or MBSD clearing members, as applicable, 
indicating that their trades have compared,\4\ provided that the trade 
meets the requirements of the GSD Rulebook (``GSD Rules'') or the MBSD 
Rulebook (``MBSD Rules''), as applicable.\5\
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    \4\ In the case of GSD locked-in trades, comparison occurs upon 
receipt of the trade data submitted to FICC from the locked-in trade 
source. GSD Rule 6C.
    \5\ See GSD Rule 11B and MBSD Rule 5.
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    Novation, which refers to the termination of delivery, receive and 
related payment obligations between the original parties to the 
contract and the replacement of such obligations with identical 
obligations between each party and FICC, currently does not occur until 
later in the clearing and settlement process than comparison. Under the 
GSD Rules, novation currently occurs when subsequent ``netting output'' 
is issued to netting members (usually the day before settlement). Under 
the MBSD Rules, novation currently occurs when subsequent ``pool 
netting output'' is issued to clearing members (usually the day before 
settlement).
    FICC stated in its proposed rule change that it was proposing the 
rule change because it understood that, as its members (or their 
advisors) analyze their netting rights with respect to transactions 
cleared through FICC for purposes of regulatory capital requirements, 
it is beneficial for members that FICC become the legal counterparty at 
the point its guarantee attaches.

Time of Novation--Rule Changes

    Under the revised GSD Rules and MBSD Rules, as approved, novation 
will occur at comparison for netting eligible transactions (for GSD) 
and SBO-Destined Trades \6\ (for MBSD). This means that, at the point 
of trade comparison, FICC will both guarantee the settlement of the 
transactions (as it does today) and novate such transactions, becoming 
the legal counterparty to each submitting member with respect to such 
transactions.
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    \6\ The MBSD Rules define a ``SBO-Destined Trade'' as a to-be-
announced (``TBA'') transaction in the clearing system intended for 
TBA Netting in accordance with the provisions of the Rules. MBSD 
Rule 1. In a TBA transaction, members agree on a sale price, 
quantity, and the characteristics of the securities being sold, but 
they do not specify which particular securities will be delivered on 
the settlement date.
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    Under the revised GSD Rules, as approved pursuant to this rule 
change, all netting eligible transactions that compare in accordance 
with the GSD Rules will novate at the point of comparison.
    As amended by this proposal, pursuant to the MBSD Rules, only SBO-
Destined Trades, all of which are

[[Page 5180]]

included in the TBA Netting process and must be submitted to the Pool 
Netting process,\7\ will novate at the point of comparison. Other types 
of transactions, including Trade-for-Trade Transactions \8\ and 
Specified Pool Trades,\9\ will continue to be guaranteed at comparison, 
as they are today, but FICC will not novate such transactions at 
comparison. Instead, such transactions will be treated as they are 
today: (1) To the extent Trade-for-Trade Transactions are included in 
the Pool Netting process,\10\ FICC will novate such Transactions once 
the Pool Netting \11\ process is completed and (2) Specified Pool 
Trades, which are not included in the TBA Netting process nor the Pool 
Netting process, are not novated today (they settle outside of FICC 
between the submitting counterparties) and will continue to not be 
novated under the proposal.\12\
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    \7\ MBSD conducts two separate netting processes to consolidate 
settlement obligations and reduce the number of securities and the 
amount of cash that must be exchanged to settle transactions. TBA 
Netting is the process used to net SBO-Destined Trades that have 
compared in accordance with the MBSD Rules. TBA Netting is conducted 
before particular securities (``pools'') are identified to the SBO-
Destined Trades. Pool Netting, which occurs after MBSD clearing 
members allocate pools to transactions, is the process used to 
aggregate and match offsetting pool delivery obligations submitted 
by MBSD clearing members to satisfy their settlement obligations. 
MBSD Rules 6 and 7. An MBSD clearing member may submit a transaction 
to Pool Netting even if such transaction was not submitted for TBA 
Netting. The rule change includes the addition of a new Section 7 to 
MBSD Rule 8 stating that each clearing member must submit to FICC 
for inclusion in Pool Netting each SBOO and SBON Trade to which such 
clearing member is a party. The terms ``SBOO Trade'' and ``SBON 
Trade'' are defined in MBSD Rule 1, as amended by this rule change. 
Section 7 of MBSD Rule 8 has been added to reflect MBSD's existing 
requirements and practices.
    \8\ The MBSD Rules define ``Trade-for-Trade Transaction'' as a 
TBA transaction submitted to FICC not intended for TBA Netting in 
accordance with the provisions of the Rules. MBSD Rule 1.
    \9\ The MBSD Rules define ``Specified Pool Trades'' as a trade 
in which all required pool data, including the pool number to be 
delivered on the contractual settlement date, are agreed upon by the 
clearing member at the time of execution. MBSD Rule 1.
    \10\ Trade-for-Trade Transactions that are not submitted to the 
Pool Netting process must be settled outside of FICC between the 
submitting counterparties.
    \11\ As noted in SR-FICC-2008-01, a clearing member that has a 
trade that was matched with a stipulation (``Stip Trade'') would not 
submit such trade for Pool Netting. Pool Netting creates delivery 
obligations based off the net position of clearing members without 
regard to the original counterparty relationship. With a Stip Trade, 
the buyer and seller will want to ensure the receipt or delivery, as 
applicable, is maintained between themselves to ensure that the 
other party adheres to the stipulated terms. Securities Exchange Act 
Release No. 34-66550 (March 9, 2012), 77 FR 15155 (March 14, 2014) 
(SR-FICC-2008-01). Therefore, as with the current process, FICC does 
not expect to novate Stip Trades.
    \12\ MBSD Rule 10.
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    In order to effectuate this change in the time of novation as 
described above, the rule change adds language to the GSD Rules (new 
Section 8 of Rule 5) and the MBSD Rules (new Section 13 of Rule 5) that 
states that FICC will guarantee and novate applicable transactions upon 
comparison, subject to the parameters set forth in the rule change, as 
proposed. Conforming changes also will be made to GSD Rule 3A, GSD Rule 
6B, GSD Rule 6C, GSD Rule 11, GSD Rule 14, GSD Rule 20, GSD Rule 21A, 
Rule 22B, MBSD Rule 6, MBSD Rule 8, MBSD Rule 10, MBSD Rule 11 and MBSD 
Rule 17A. In addition, the definition of ``novation'' in both GSD Rule 
1 and MBSD Rule 1 is clarified to reflect that delivery, receive and 
related payment obligations between members will be terminated and 
replaced with identical obligations to and from FICC at the point in 
time that the trade is compared in accordance with the applicable 
Rules.
    The rule change, as approved, makes clear that under the MBSD Rules 
certain settlement obligations continue to be settled between the 
settlement counterparties and not vis-[agrave]-vis FICC; these are the 
obligations that are not included in the Pool Netting process pursuant 
to MBSD Rule 8 (Pool Netting). The rule change does not change this 
existing process. However, because the rule change moves the time of 
novation up to the time of comparison for certain MBSD transactions, 
the rule change (in MBSD Rule 5, Section 2) makes clear that the 
settlement counterparties continue to settle with each other but do so 
on behalf of FICC for those transactions that are novated to FICC.
    According to FICC, the proposal to move the time of novation as 
noted above does not change FICC's risk exposures. Because FICC 
currently guarantees eligible trades upon comparison, FICC already 
assumes responsibility for settling such trades at the point of 
comparison. According to FICC, adding legal novation at the point of 
comparison does not increase FICC's obligations and therefore, does not 
require any changes to FICC's risk management processes. In addition, 
FICC notes that the rule change does not change FICC's operational 
processes.

Formalization of Existing Processes

    In addition, the rule changes formalize the following existing 
processes:
     Section 7 of MBSD Rule 8 is added to state that all SBOO 
Trades and SBON Trades \13\ must be submitted to Pool Netting.
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    \13\ The terms ``SBOO Trade'' and ``SBON Trade'' are defined in 
MBSD Rule 1, as amended by this proposal.
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     MBSD Rules 15 and 16 are revised to clarify that, upon the 
insolvency of a member's original counterparty to a compared trade, 
such member cannot unilaterally modify its obligations with respect to 
transactions originally entered with such counterparty. In the MBSD 
Rules, because certain trades are not novated and will continue to not 
be novated under this proposal, the rule change makes clear that upon a 
cease to act with respect to a member by FICC, the solvent member to a 
compared trade with the defaulting member may not unilaterally act with 
respect to such trade.
    These changes are not intended to change FICC's current operations 
or processes.

Clarification To Reflect Current Processes

    In addition, the rule change clarifies certain GSD and MBSD Rules 
to reflect actual practices and requirements as follows:
     MBSD Rule 17 is revised to clarify that when FICC ceases 
to act for a member, FICC may dispose of such member's Trade-for-Trade 
Transactions based upon their generic terms. These changes are not 
intended to change FICC's current operations or processes.

Specific Changes

    With respect to the GSD Rules, the proposed changes are as follows:
     The term ``Interactive Submission Method'' is revised to 
correct a typographical error.
     For clean-up and clarification purposes, the term 
``Novation'' is revised to reflect that delivery, receive and related 
payment obligations between GSD netting members will be terminated and 
replaced with identical obligations to and from FICC at the point in 
time that the trade is compared in accordance to the GSD Rules.
     Rule 3A, Sections 2(i), 7(a), 7(d), 14(c), and 16(a) are 
revised to reflect that trades submitted by Sponsored Members \14\ will 
novate to FICC at the time that such trades receive FICC's guaranty of 
settlement.
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    \14\ The term ``Sponsored Member'' means any Person that has 
been approved by FICC to be sponsored into membership by a 
Sponsoring Member pursuant to Rule 3A. GSD Rule 1.
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     Rule 5 is revised to include a new Section 8 entitled 
``Novation and Guaranty of Compared Trades,'' which provides for the 
following: (1) Compared trades that meet the

[[Page 5181]]

requirements of the GSD Rules and were entered into in good faith will 
novate to FICC and FICC will guarantee the settlement for each such 
compared trade; (2) if a compared trade becomes uncompared or 
cancelled, FICC's guaranty and novation of such trade will be reversed 
and cancelled; (3) if a compared trade is modified after novation and 
such modification does not cause the trade to become uncompared, then 
the modification will cause a corresponding modification to the 
deliver, receive and related payment obligations between the GSD 
netting members and FICC; (4) at the time that a compared trade becomes 
novated, such trade ceases to be bound by any bilateral agreement 
between the parties with respect to the deliver, receive and related 
payment obligations, however, if the trade becomes uncompared or is 
cancelled, such trade shall be governed by the bilateral agreement that 
governed the trade prior to the novation; and (5) if a right of 
substitution was established by the parties to a repurchase 
transaction, such right will continue and be recognized by FICC after 
novation.
     Rule 6B, Section 4 deletes the provision which states that 
an uncompared trade will cease to be guaranteed by FICC because this 
concept is now covered in Rule 5, Section 8.
     Rule 6C, Section 10 deletes the provision which states 
that a locked-in trade that becomes uncompared will cease to be 
guaranteed by FICC because this concept is now covered in Rule 5, 
Section 8.
     Rule 6C, Section 11 deletes the provision which states 
that a netting eligible auction purchase that becomes uncompared will 
cease to be guaranteed by FICC because this concept is now covered in 
Rule 5, Section 8.
     Rule 6C, Section 12 deletes the provision which states 
that a GCF Repo Transaction \15\ that becomes uncompared will cease to 
be guaranteed by FICC because this concept is now covered in Rule 5, 
Section 8.
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    \15\ Pursuant to the GSD Rules, the term ``GCF Repo 
Transaction'' means a Repo Transaction involving generic CUSIP 
numbers the data on which are submitted to FICC on a locked-in-trade 
basis pursuant to the provisions of Rule 6C, for netting and 
settlement by FICC pursuant to the provisions of Rule 20. GSD Rule 
1.
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     Rule 11, Section 6 is revised to reflect that (1) novation 
occurs at comparison; and (2) at netting, the previously novated 
deliver, receive and related payment obligations between the netting 
members and FICC will be terminated and replaced by net deliver, 
receive and related payment obligations as listed in the report made 
available by FICC to the netting members.
     Rule 11B is revised to correct typographical errors.
     Rule 14, Section 3 is revised to reflect that (1) novation 
occurs at comparison; and (2) at netting, the previously novated 
deliver, receive and related payment obligations between the netting 
members and FICC created by Forward Trades will be terminated and 
replaced by net deliver, receive and related payment obligations as 
listed in the report made available by FICC to the netting members.
     Rule 20, Section 5 is revised to reflect that with respect 
to GCF Repo Transactions, novation will occur at comparison in 
accordance with Rule 5, Section 8.
     Rule 21A is revised to incorporate the concept of 
novation.
     Rule 22B included a sentence providing that upon FICC's 
default, trades that had compared would be deemed novated. Because the 
GSD Rules are being revised to reflect that novation occurs at 
comparison, this sentence is no longer necessary. As a result, it is 
being deleted in connection with this rule change.
    With respect to the MBSD Rules, the changes are as follows:
     For clean-up and clarification purposes, the term 
``Novation'' is revised to reflect that delivery, receive and related 
payment obligations between MBSD clearing members will be terminated 
and replaced with identical obligations to and from FICC in accordance 
with the MBSD Rules.
     The term ``SBO Contra-Side Member'' is revised to correct 
a typographical error.
     The term ``SBO Net-Out Position'' is revised to clarify 
that the term is used in connection with offsetting purchase and sale 
SBO-Destined Trades that were originally between different clearing 
members (but, once novated at comparison, are between such members and 
FICC).
     The term ``SBO Net-Out Unit'' is being deleted because 
this term is not used in the MBSD Rules.
     The term ``SBO Netted Position'' is revised to clarify 
that the term is used in connection with offsetting purchase and sale 
SBO-Destined Trades that were originally between the same clearing 
members (but, once novated at comparison, are between such members and 
FICC).
     The term ``SBON Trade'' is revised to correct a 
typographical error.
     The term ``SBOO Trade'' is revised to correct a 
typographical error.
     Rule 5, Section 1 is revised to correct a typographical 
error.
     Rule 5, Section 2 is revised to reflect that (1) 
transactions that are not novated pursuant to this proposal (pursuant 
to new Section 13 of Rule 5 discussed below) and not netted and novated 
through the Pool Netting system will be settled directly between the 
members; and (2) transactions novated pursuant to new Section 13 of 
Rule 5 and not thereafter netted through the Pool Netting system 
pursuant to Rule 8 will settle between members on behalf of FICC.
     Rule 5, Section 12 is revised to correct a typographical 
error.
     Rule 5 includes a new Section 13 entitled ``Novation'' 
which states the following: (1) FICC will guarantee and novate SBO-
Destined Trades that meet the requirement of the MBSD Rules and have 
been entered into in good faith; (2) FICC will not novate SBO-Destined 
Trades that are partially compared; (3) to the extent a partially 
compared SBO-Destined Trade becomes fully compared, FICC will novate 
such trade; (4) if a trade becomes uncompared or cancelled, the 
guaranty and novation of such transaction shall be reversed; (5) at the 
time that an SBO-Destined Trade is novated to FICC, such trade shall 
cease to be bound by any bilateral agreement between the parties to the 
trade with respect to the deliver, receive and related payment 
obligations, however, if the trade becomes uncompared or is cancelled, 
such trade shall be governed by the bilateral agreement that governs 
such trade prior to the novation.
     Rule 6, Sections 1(a), (b) and (c) are revised to take 
into account the fact that SBO-Destined Trades are novated upon 
comparison and are, therefore, legally between MBSD clearing members 
and FICC after comparison.
     Rule 8, Section 6 is revised to take into account the fact 
that SBO-Destined Trades are novated upon comparison and are, 
therefore, legally between MBSD clearing members and FICC after 
comparison.
     Rule 8 includes a new Section 7 which is entitled 
``Obligation to Submit SBOO and SBON Trades to Pool Netting.'' This 
Section reflects MBSD's current requirement and current practice that 
clearing members are required to submit all SBOO Trades and SBON Trades 
for inclusion in the Pool Netting system.
     Rule 10, Section 2 is revised to clarify that clearing 
members are required to submit a notification of settlement for SBO 
Trades that are novated at comparison and processed through the TBA 
Netting system but that are not thereafter submitted to the Pool 
Netting system.

[[Page 5182]]

     Rule 11, Section 1 is revised to take into account the 
fact that SBO Trades are novated upon comparison and are, therefore, 
legally between MBSD clearing members and FICC after comparison.
     Rule 15 is revised to clarify the current process with 
respect to transactions submitted to and compared by FICC, whereby in 
the event a member's original counterparty becomes insolvent, such 
member cannot unilaterally modify its obligations with respect to 
transactions originally entered with such counterparty.
     Rule 16 is revised to clarify the current process with 
respect to transactions submitted to and compared by FICC, whereby in 
the event a member's original counterparty becomes insolvent, such 
member cannot unilaterally modify its obligations with respect to 
transactions originally entered with such counterparty.
     Rule 17, Section 2 is revised to clarify the current 
process whereby when FICC ceases to act for a clearing member, such 
member's Trade-for-Trade Transactions \16\ may be disposed of based 
upon their generic terms such as agency, product, coupon rate and 
maturity. The other changes are typographical corrections.
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    \16\ Including ``stip'' trades and any other TBA transactions 
not intended for TBA Netting.
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     Rule 17A is revised to clarify that in the event of FICC's 
default, novation is deemed to have occurred with respect to all 
transactions at the time such transactions are compared, whether or not 
such transactions are SBO-Destined Trades that would otherwise have 
been novated at comparison. The other changes to this provision are 
grammatical corrections.

III. Discussion

    Section 19(b)(2)(C) of the Act \17\ 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 the rules and regulations thereunder 
applicable to such organization. Section 17A(b)(3)(F) of the Act \18\ 
requires, among other things, that the rules of a clearing agency be 
designed to achieve several goals, including promoting the prompt and 
accurate clearance and settlement of securities transactions and, to 
the extent applicable, derivative agreements, contracts, and 
transactions.
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    \17\ 15 U.S.C. 78s(b)(2)(C).
    \18\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission concludes that the proposed rule change is 
consistent with the requirements of Section 17A(b)(3)(F) of the Act, 
and the rules and regulations thereunder, because by moving novation 
for trades that enter GSD's Netting system and MBSD's TBA Netting 
system, the rule change, as approved, should clarify FICC's 
responsibilities to its members and remove potential uncertainty that 
previously existed due to a mismatch between the time of guaranty and 
the time of novation. As a result, such clarity should further 
facilitate the prompt and accurate clearance and settlement of 
securities transactions.

IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
particularly those set forth in Section 17A,\19\ and the rules and 
regulations thereunder.
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    \19\ 15 U.S.C. 78q-1.
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    IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-FICC-2014-11) be, and hereby 
is, APPROVED.\21\
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    \20\ 15 U.S.C. 78s(b)(2).
    \21\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. See 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2015-01747 Filed 1-29-15; 8:45 am]
BILLING CODE 8011-01-P


