
[Federal Register Volume 81, Number 140 (Thursday, July 21, 2016)]
[Notices]
[Pages 47466-47469]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-17200]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-78347; File No. SR-FICC-2016-003]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Describe the Blackout 
Period Exposure Charge That May Be Imposed on GCF Repo Participants

July 15, 2016.
    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 July 12, 2016, 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 by the clearing agency. 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 amend the Government Securities 
Division (``GSD'') Rulebook (the ``GSD Rules'') \3\ to include a margin 
charge increase (the ``Blackout Period Exposure Charge'' as further 
described below) that may be imposed on Netting Members that 
participate in the GCF Repo[supreg] service (``GCF Repo 
Participants''). The charge would be imposed at the beginning of each 
month for GCF Repo Participants whose portfolios experience backtesting 
deficiencies attributable to such Participants' use of mortgage-backed 
securities (``MBS'') as collateral for GCF Repo Transactions. The 
charge is designed to mitigate FICC's exposure resulting from potential 
decreases in the collateral value of MBS pools that occur during the 
monthly Blackout Period (as defined and discussed below). The proposed 
rule change would amend GSD Rule 1 (Definitions) to add certain defined 
terms and would amend Section 1b of GSD Rule 4 (Clearing Fund and Loss 
Allocations) to include the Blackout Period Exposure Charge and the 
manner in which FICC determines and imposes such charge. FICC is filing 
this proposed rule change in order to provide transparency in the GSD 
Rules with respect to this existing charge.
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    \3\ The GSD Rules are available at http://www.dtcc.com/legal/rules-and-procedures. Capitalized terms used herein and not 
otherwise defined shall have the meaning assigned to such terms in 
the GSD Rules.
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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, the clearing agency 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. The clearing agency has prepared summaries, 
set forth in sections (A), (B), and (C) below, of the most significant 
aspects of such statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

1. Purpose
    The proposed rule change provides transparency in the GSD Rules 
with respect to the Blackout Period Exposure Charge, which FICC may 
temporarily impose on a GCF Repo Participant as part of such GCF Repo 
Participant's Required Fund Deposit. FICC imposes the Blackout Period 
Exposure Charge where FICC determines, based on prior backtesting 
deficiencies of such GCF Repo Participant's Required Fund Deposit, that 
the GCF Repo Participant may experience a deficiency due to reductions 
in the notional value of the MBS used by such GCF Repo Participant to 
collateralize its GCF Repo trading activity that occur during the 
monthly Blackout Period. Because this reduction in notional value that 
occurs during the Blackout Period is not reflected on GCF Clearing 
Agent Banks' collateral reports to FICC until after the Blackout Period 
ends, the value of GCF Repo Participants' collateral may be overstated 
during this period, creating an exposure for FICC that may not be 
covered by such Participants' Required Fund Deposits. The Blackout 
Period Exposure Charge is designed to mitigate that risk to FICC.

[[Page 47467]]

(i) Background
A. GCF Repo Service and the Required Fund Deposit
    The GCF Repo service enables GCF Repo Participants to trade general 
collateral repurchase agreements based on rate, term and underlying 
product throughout the day, without requiring intraday, trade-for-trade 
settlement on a delivery-versus-payment basis. On each trading day, GCF 
Repo Participants must allocate appropriate collateral to FICC's 
account at the GCF Repo Participant's GCF Clearing Agent Bank to cover 
their repurchase obligations.\4\ FICC accepts MBS as eligible 
securities for such collateral allocations.\5\ Additionally, FICC 
collects Required Fund Deposits from all Netting Members (including GCF 
Repo Participants) to protect FICC against losses in the event of a 
Netting Member's default.
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    \4\ GSD Rule 20 Section 3.
    \5\ Id.
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    The Required Fund Deposit serves as each Netting Member's margin. 
The objective of the Required Fund Deposit is to mitigate potential 
losses to FICC associated with liquidation of the Netting Member's 
portfolio in the event that FICC ceases to act for a Netting Member 
(hereinafter referred to as a ``default''). FICC determines Required 
Fund Deposit amounts using a risk-based margin methodology that is 
intended to capture market price risk. The methodology uses historical 
market moves to project or forecast the potential gains or losses on 
the liquidation of a defaulting Netting Member's portfolio, assuming 
that a portfolio would take three days to liquidate or hedge in normal 
market conditions. The projected liquidation gains or losses are used 
to determine the Netting Member's Required Fund Deposit, which is 
calculated to cover projected liquidation losses at a 99 percent 
confidence level. The aggregate of all Netting Members' Required Fund 
Deposits constitutes FICC's Clearing Fund, which FICC would be able to 
access should a defaulting Netting Member's own Required Fund Deposit 
be insufficient to satisfy losses to FICC caused by the liquidation of 
that Netting Member's portfolio.
    FICC employs daily backtesting to determine the adequacy of each 
Netting Member's Required Fund Deposit. FICC compares the Required Fund 
Deposit \6\ for each Netting Member with the simulated liquidation 
gains/losses using the actual positions in the Netting Member's 
portfolio, including the actual allocated collateral of GCF Repo 
Participants, and the actual historical security returns. FICC 
investigates the cause(s) of any deficiencies. As a part of this 
process, FICC pays particular attention to Netting Members with 
backtesting deficiencies that bring the results for that Netting Member 
below the 99 percent confidence target (i.e., greater than two 
deficiency days in a rolling twelve-month period) to determine if there 
is an identifiable cause of repeat deficiencies. FICC also evaluates 
whether multiple Netting Members may experience deficiencies for the 
same underlying reason.
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    \6\ For backtesting comparisons, FICC uses the Required Fund 
Deposit amount, without regard to the actual collateral posted by 
the Netting Member.
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B. MBS and the Blackout Period
    While there can be multiple factors that contribute to a 
deficiency, FICC has identified that GCF Repo Participants that pledge 
substantial amounts of MBS collateral in respect of their GCF Repo 
Transactions may experience backtesting deficiencies due to an 
overvaluation of MBS collateral that can occur during the Blackout 
Period (as further described below).
    FICC only accepts MBS that are issued and guaranteed by U.S. 
government-sponsored entities (``GSEs''). Because MBS are composed of 
pools of mortgages as to which the principal balances are reduced over 
time through scheduled and unscheduled payments by mortgagors, MBS 
notional values also reduce over time. Investors in MBS issued by the 
GSEs are informed of the amount of this reduction in value on a monthly 
basis when the GSEs release new ``Pool Factors'' for their MBS at the 
beginning of every month.\7\ The period between the last business day 
of the prior month (the ``Record Date'') and the date on which the GSE 
releases its new Pool Factors (the ``Factor Date'') is known as the 
``Blackout Period.'' \8\ During the Blackout Period, MBS values may be 
overstated because of uncertainty concerning the remaining principal 
balances of the MBS and thus the amount guaranteed by the issuing GSE.
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    \7\ Pool Factors are stated as a percentage amount of the 
initial aggregate face value of the security that remains unpaid on 
the underlying mortgage pool. For example, if the face amount of a 
mortgage-backed security were $100,000 and the stated pool factor 
were 0.4587, the remaining principal balance in the security to be 
paid to the investor would be $45,870.
    \8\ The Factor Date is typically the fourth or fifth business 
day of each calendar month.
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    FICC has identified that GCF Repo Participants may experience 
backtesting deficiencies during the Blackout Period if they allocate 
substantial amounts of MBS collateral to cover their repurchase 
obligations. Such deficiencies occur because the value of MBS 
collateral allocated to cover GCF Repo Participants' repurchase 
obligations may be overstated on the collateral reports delivered to 
FICC by the GCF Clearing Agent Banks, which rely on the prior month's 
Pool Factors to value MBS collateral pledged by GCF Repo Participants. 
The Blackout Period Exposure Charge is designed to mitigate the risk 
posed to FICC by such deficiencies by temporarily increasing such GCF 
Repo Participants' Required Fund Deposits.
C. Calculation of the Blackout Period Exposure Charge
    The objective of the Blackout Period Exposure Charge is to increase 
Required Fund Deposits for GCF Repo Participants that are likely to 
experience backtesting deficiencies on the basis described above by an 
amount sufficient to maintain such GCF Repo Participants' backtesting 
coverage above the 99 percent confidence threshold. Because the size of 
the backtesting deficiencies caused by this issue varies among impacted 
GCF Repo Participants, FICC must assess a Blackout Period Exposure 
Charge that is specific to each impacted GCF Repo Participant. To do 
so, FICC examines each impacted GCF Repo Participant's historical 
backtesting deficiencies to identify the two largest deficiencies that 
have occurred during the 12-month look-back period. FICC then employs 
an amount equal to the midpoint between the two largest historical 
deficiencies for such member as the presumptive Blackout Period 
Exposure Charge amount, subject to adjustment as further described 
below. Although an increase equal to the third largest historical 
deficiency would suffice to bring the GCF Repo Participant's 
historically-observed backtesting coverage above the 99 percent target 
\9\ if deficiencies due to Blackout Period exposures were the only 
deficiencies experienced, such an approach would fail to take into 
account potential changes in such GCF Repo Participant's MBS collateral 
pledges or other factors that could contribute to deficiencies during 
this period. Consequently, FICC has determined to use the midpoint 
between the two largest historical deficiencies as an amount that is 
(i) particular to the GCF Repo Participant and its use of MBS 
collateral and (ii) generally provides a reasonable buffer above the 
historically observed minimum increase necessary

[[Page 47468]]

to achieve 99 percent coverage. The resulting Blackout Period Exposure 
Charge is added to the VaR Charge for such GCF Repo Participant 
determined pursuant to FICC's risk-based margining methodology. The 
Blackout Period Exposure Charge is only imposed during the Blackout 
Period, until the GCF Repo Participant's GCF Clearing Agent Bank 
updates the Pool Factors it uses to value MBS collateral.\10\
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    \9\ Each deficiency reduces backtesting coverage by 0.4 percent 
(1 exception/250 observation days). Accordingly, an increase equal 
to the third largest deficiency would bring backtesting coverage up 
to 99.2 percent.
    \10\ The GCF Clearing Agent Banks typically have a one-day lag 
in updating their databases with the most recent Pool Factor 
information.
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    This charge is applicable only to those GCF Repo Participants that 
have two or more backtesting deficiencies that occurred during the 
Blackout Period and whose overall 12-month trailing backtesting 
coverage falls below the 99 percent coverage target.
    Although the midpoint between the two largest historical Blackout 
Period deficiencies for a GCF Repo Participant will be used as the 
Blackout Period Exposure Charge in most cases, under the proposed rule 
FICC retains discretion to adjust the charge amount based upon other 
circumstances that may be relevant for assessing whether an impacted 
GCF Repo Participant is likely to experience future Blackout Period 
backtesting deficiencies and the estimated size of such deficiencies. 
Examples of relevant circumstances include material differences in the 
two largest deficiencies, variability in a GCF Repo Participant's use 
of MBS for collateral allocation, and variability in the magnitude of 
Pool Factor changes for certain categories of MBS. Based on FICC's 
assessment of the impact of these circumstances on the likelihood of, 
and estimated size of, future Blackout Period deficiencies for a GCF 
Repo Participant, FICC may, in its discretion, adjust the Blackout 
Period Exposure Charge for such Participant to an amount that FICC 
determines to be more appropriate for maintaining such GCF Repo 
Participant's backtesting results above the 99 percent coverage 
threshold (including a reasonable buffer).
D. Communication With GCF Repo Participants and Imposition of the 
Charge
    If FICC determines that a Blackout Period Exposure Charge should 
apply to a GCF Repo Participant who was not assessed a Blackout Period 
Exposure Charge during the immediately preceding month or that the 
Blackout Period Exposure Charge applied to a GCF Repo Participant 
during the previous month should be increased, FICC will notify the 
Participant on or around the 25th calendar day of the month. This 
notification permits the Participant to avoid or decrease the charge by 
notifying FICC in writing of its intent to remove or reduce its use of 
MBS in collateral allocations during the Blackout Period. If such 
Participant elects not to adjust its portfolio (or fails to do so 
despite such notification to FICC), then FICC will impose a Blackout 
Period Exposure Charge as determined above.
    FICC imposes the Blackout Period Exposure Charge as an increase to 
each impacted GCF Repo Participant's Required Fund Deposit. The charge 
is imposed only during the Blackout Period: It is applied as of the 
morning Clearing Fund call on the Record Date through and including the 
intraday Clearing Fund call on the Factor Date, or until the Pool 
Factors have been updated to reflect the current month's Pool Factors 
in the GCF Clearing Agent Bank's collateral reports. Thereafter the 
charge is removed because updated MBS valuations are incorporated into 
FICC's risk-based margining methodology for the remainder of the month, 
alleviating the risk of potentially overvalued MBS collateral that 
occurs during Blackout Period. This process is repeated monthly.
    If changes in an impacted GCF Repo Participant's MBS collateral 
pledges over time materially reduce the Blackout Period Exposure Charge 
calculated pursuant to the procedures described above, FICC may in its 
discretion reduce the Blackout Period Exposure Charge and would so 
notify the Participant. If an impacted GCF Repo Participant's trailing 
12-month backtesting coverage exceeds 99 percent (without taking into 
account historically-imposed Blackout Period Exposure Charges), the 
Blackout Period Exposure Charge would be removed.
2. Statutory Basis
    Section 17A(b)(3)(F) \11\ of the Act, requires, in part, that the 
rules of a clearing agency be designed to assure the safeguarding of 
securities and funds that are within the custody or control of the 
clearing agency. Rule 17Ad-22(b)(1) under the Act requires a clearing 
agency 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 clearing agency would not be 
disrupted and non-defaulting participants would not be exposed to 
losses that they cannot anticipate or control.\12\ Rule 17Ad-22(b)(2) 
under the Act requires a clearing agency to maintain and enforce 
written policies and procedures reasonably designed to use margin 
requirements to limit its credit exposures to participants under normal 
market conditions.\13\ FICC's Blackout Period Exposure Charge is 
calculated and imposed to cover credit exposures estimated by FICC 
based on a GCF Repo Participant's trailing 12-month backtesting results 
with the goal of maintaining such Participant's Required Fund Deposit 
above the 99 percent coverage threshold. This management of FICC's 
credit exposures to GCF Repo Participants is consistent with Rule 17Ad-
22(b)(1) under the Act. Further, when it is imposed, the charge is a 
component of the applicable GCF Repo Participant's Required Fund 
Deposit, or margin, and is intended to maintain coverage of FICC's 
credit exposures to such GCF Repo Participant at a confidence level of 
at least 99 percent. This limits FICC's exposures to GCF Repo 
Participants under normal market conditions. It therefore is also 
consistent with Rule 17Ad-22(b)(2) under the Act.
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
    \12\ 17 CFR 240.17Ad-22(b)(1).
    \13\ 17 CFR 240.17Ad-22(b)(2).
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    By incorporating the Blackout Period Exposure Charge into the GSD 
Rules, the proposed change addresses an exposure that could subject 
FICC to potential losses under normal market conditions due to 
potentially overstated values of MBS pledged as collateral for GCF Repo 
Transactions in the event that a GCF Repo Participant defaults during 
the Blackout Period. Therefore, FICC believes the proposed rule change 
enhances the safeguarding of securities and funds that are in the 
custody or control of FICC, consistent with Section 17(b)(3)(F) of the 
Act.

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

    FICC does not believe that the proposed rule change imposes any 
burden on competition that is not necessary or appropriate.\14\ The 
proposed charge is necessary for FICC to limit its exposure to 
potential losses from defaults by its participants, and it is imposed 
on GCF Repo Participants on an individualized basis in an amount 
reasonably calculated to maintain their Required Fund Deposits above 
FICC's 99 percent coverage threshold. The charge only applies to GCF 
Repo Participants that use MBS collateral pledges in an amount that 
generates Blackout Period backtesting deficiencies specific to such GCF 
Repo Participants.

[[Page 47469]]

FICC employs reasonable methods to calculate and impose an 
individualized charge in an amount designed to maintain each impacted 
GCF Repo Participant's future backtesting coverage above the 99 percent 
coverage threshold, including a reasonable buffer. Additionally, prior 
to imposing the Blackout Period Exposure Charge, FICC notifies each 
impacted GCF Repo Participant and provides it the opportunity to adjust 
its use of MBS collateral pledges in order to avoid having the charge 
applied to its Required Fund Deposit or to reduce the amount of such 
charge.
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    \14\ 15 U.S.C. 78q-1(b)(3)(I).
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(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants, or Others

    FICC has not received any written comments relating to this 
proposal. FICC will notify the Commission of any written comments 
received.

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.

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 consistent with 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 Number SR-FICC-2016-003 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FICC-2016-003. 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 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 the filing also will be available 
for inspection and copying at the principal office of FICC and on 
DTCC'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 Number SR-FICC-2016-003 and 
should be submitted on or before August 11, 2016.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-17200 Filed 7-20-16; 8:45 am]
BILLING CODE 8011-01-P


