
[Federal Register Volume 81, Number 200 (Monday, October 17, 2016)]
[Notices]
[Pages 71545-71548]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-24982]


=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79077; File No. SR-FICC-2016-003)


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

October 11, 2016.
    On July 12, 2016, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2016-003 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 July 21, 2016.\3\ The Commission received no 
comments on the proposed rule change. On August 30, 2016, the 
Commission designated a longer period within which to approve the 
proposed rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether to approve or disapprove the proposed 
rule change.\4\ For the reasons discussed below, the Commission is 
approving the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 34-78347 (July 15, 
2016), 81 FR 47466 (July 21, 2016) (SR-FICC-2016-003) (``Notice'').
    \4\ Securities Exchange Act Release No. 78720 (August 30, 2016), 
81 FR 61271 (September 6, 2016).
---------------------------------------------------------------------------

I. Description of the Proposed Rule Change

    FICC proposes to amend the Government Securities Division (``GSD'') 
Rulebook (the ``GSD Rules'') \5\ to include a margin charge increase 
(the ``Blackout Period Exposure Charge'' as further described below) 
that is imposed on Netting Members that participate in the GCF 
Repo[supreg] service (``GCF Repo Participants''). Specifically, the 
proposed rule change would amend GSD Rule 1 (Definitions) to include 
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, as described in detail below.\6\
---------------------------------------------------------------------------

    \5\ 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.
    \6\ The description of the proposed rule change herein is based 
on the statements prepared by FICC in the Notice. Notice, supra note 
3, 81 FR 47466-47469.
---------------------------------------------------------------------------

A. GCF Repo Service and the Required Fund Deposit

    FICC states that 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 cover their repurchase 
obligations by allocating collateral to FICC's account at the GCF Repo 
Participant's GCF Clearing Agent Bank.\7\ FICC accepts mortgage-backed 
securities (``MBS'') securities for such collateral allocations.\8\ 
Additionally, FICC collects Required Fund Deposits from all Netting 
Members (including GCF Repo Participants) to help protect FICC against 
losses that could be realized in the event of a Netting Member's 
default.
---------------------------------------------------------------------------

    \7\ GSD Rule 20 Section 3.
    \8\ Id.
---------------------------------------------------------------------------

    The Required Fund Deposit serves as each Netting Member's margin. 
FICC states that 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.
    FICC determines the adequacy of each Netting Member's Required Fund 
Deposit through daily backtesting. FICC compares each Netting Member's

[[Page 71546]]

Required Fund Deposit to the simulated liquidation gains and losses 
based on the positions in the Netting Member's portfolio, including the 
allocated collateral of GCF Repo Participants, and the 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 a 99 percent confidence level (i.e., greater than 
two deficiency days in a rolling twelve-month period) \9\ 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.
---------------------------------------------------------------------------

    \9\ FICC explains that each deficiency reduces backtesting 
coverage by 0.4 percent (1 exception/250 observation days). 
Accordingly, three deficiencies in a 12-month period would decrease 
backtesting coverage to 98.8 percent.
---------------------------------------------------------------------------

B. MBS and the Blackout Period

    FICC only accepts MBS that are issued and guaranteed by U.S. 
government-sponsored entities (``GSEs''). Because MBS are composed of 
pools of mortgages, whose principal balances decrease over time because 
of scheduled and unscheduled payments by mortgagors, MBS notional 
values decrease 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.\10\ The period between the last business day 
of the prior month (``Record Date'') and the date on which the GSE 
releases its new Pool Factors (``Factor Date'') is known as the 
``Blackout Period.'' \11\ FICC states that during the Blackout Period, 
MBS values may be overstated because they do not capture reductions in 
the principal balances of the MBS as described above.
---------------------------------------------------------------------------

    \10\ FICC explains that 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.
    \11\ The Factor Date is typically the fourth or fifth business 
day of each calendar month.
---------------------------------------------------------------------------

    FICC states 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. FICC states that 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

    FICC states that the objective of the Blackout Period Exposure 
Charge is to increase Required Fund Deposits by an amount sufficient to 
maintain backtesting coverage above the 99 percent confidence threshold 
for GCF Repo Participants that are likely to experience backtesting 
deficiencies on the basis described above. 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.
    FICC examines each impacted GCF Repo Participant's historical 
backtesting deficiencies to identify the two largest deficiencies that 
occurred during a rolling 12-month look-back period. FICC then 
identifies an amount equal to the midpoint between the two largest 
historical deficiencies for such GCF Repo Participant as the 
presumptive Blackout Period Exposure Charge amount, subject to 
adjustment as further described below.\12\ FICC identified 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) which FICC believes provides a reasonable buffer 
above the historically observed minimum increase necessary to achieve 
99 percent coverage.
---------------------------------------------------------------------------

    \12\ FICC states that 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 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.
---------------------------------------------------------------------------

    FICC states that the resulting Blackout Period Exposure Charge is 
added to the VaR Charge for such GCF Repo Participant pursuant to 
FICC's risk-based margining methodology, but that the charge is only 
imposed during the Blackout Period (i.e., until the GCF Repo 
Participant's GCF Clearing Agent Bank updates the Pool Factors it uses 
to value MBS collateral).\13\ FICC further states that 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.
---------------------------------------------------------------------------

    \13\ The GCF Clearing Agent Banks typically have a one-day lag 
in updating their databases with the most recent Pool Factor 
information.
---------------------------------------------------------------------------

    Although FICC uses the midpoint between the two largest historical 
Blackout Period deficiencies for a GCF Repo Participant as the Blackout 
Period Exposure Charge in most cases, FICC retains discretion to adjust 
the charge based on other relevant circumstances, such as 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. FICC 
states that the Participant may avoid or decrease the charge by 
notifying FICC in writing of its intent to remove or reduce its use of 
MBS in collateral allocations, followed by the actual removal or 
reduction of MBS 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 of the morning 
Clearing Fund call on the Record Date through and including the 
intraday

[[Page 71547]]

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 uncovered credit exposures 
resulting from overvalued MBS collateral during Blackout Period. FICC 
repeats this process 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.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \14\ 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. The Commission finds that the proposed 
rule change is consistent with Section 17A(b)(3)(F) of the Act \15\ and 
Rules 17Ad-22(b)(1) and (2) thereunder, as discussed below.\16\
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78s(b)(2)(C).
    \15\ 15 U.S.C. 78q-1(b)(3)(F).
    \16\ 17 CFR 240.17Ad-22(b)(1)-(2).
---------------------------------------------------------------------------

    Section 17A(b)(3)(F) 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.\17\ As a central counterparty (``CCP''), FICC is 
exposed to losses that could arise out of the default of one of its 
Netting Members, such as a GCF Repo Participant. As explained above, 
FICC attempts to cover such potential losses through the collection of 
daily Required Fund Deposits (i.e., margin) from its Netting Members, 
including GCF Repo Participants. Consequently, failure to accurately 
calculate Required Fund Deposits could expose FICC to losses in excess 
of the margin collected and, thus, jeopardize the securities and funds 
in FICC's custody or control.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    As described above, FICC determined that the Required Fund Deposits 
collected from GCF Repo Participants during monthly Blackout Periods 
may not accurately reflect decreases in the value of MBS underlying the 
GCF Repo transactions and, therefore, the Required Fund Deposits 
collected may be inadequate to cover the losses that could arise if a 
GCF Repo Participant defaulted. The Blackout Period Exposure Charge is 
specifically designed to address that risk. The charge is sized based 
on certain backtesting deficiencies of GCF Repo Participants. Where 
FICC identifies deficiencies related to the use of MBS underlying GCF 
Repo transactions, the Blackout Period Exposure Charge may be applied 
and, in turn, FICC would collect more margin. Therefore, 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.
    Rule 17Ad-22(b)(1) requires a clearing agency that performs CCP 
services 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.\18\ FICC's Blackout 
Period Exposure Charge is calculated and imposed to cover potential 
credit exposures to certain GCF Repo Participants during monthly 
Blackout Periods, under normal market conditions.\19\ As described 
above, FICC estimates the Blackout Period Exposure Charge based on a 
GCF Repo Participant's backtesting results. Specifically, FICC 
calculates the Blackout Period Exposure Charge as the midpoint between 
a GCF Participant's two largest deficiencies over the past twelve 
months, which, as designed, incorporates a buffer to help ensure that 
FICC maintain margin coverage at or above the 99 percent confidence 
threshold during monthly Blackout Periods. Therefore, because the 
proposed rule change will help FICC limit its potential losses from the 
default of certain GCF Repo Participants during monthly Blackout 
Periods, under normal market conditions, the proposed rule change is 
consistent with Rule 17Ad-22(b)(1).
---------------------------------------------------------------------------

    \18\ 17 CFR 240.17Ad-22(b)(1).
    \19\ As used in Rule 17Ad-22(b)(1), normal market conditions are 
conditions in which the expected movement of the price of cleared 
securities would produce changes in a clearing agency's exposures to 
its participants that would be expected to breach margin 
requirements or other risk control mechanisms only one percent of 
the time (i.e., a 99 percent confidence threshold). 17 CFR 240.17Ad-
22(a)(4).
---------------------------------------------------------------------------

    Rule 17Ad-22(b)(2) requires a clearing agency that performs CCP 
services 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 and use risk-
based models and parameters to set margin requirements.\20\ As 
described above, FICC limits its exposure to Netting Members, including 
GCF Participants, by collecting margin (i.e., Required Fund Deposit), 
which is sized using a risk-based margin methodology. The Blackout 
Period Exposure Charge is a component of a GCF Repo Participant's daily 
Required Fund Deposit and is sized based on the GCF Repo Participant's 
backtesting deficiencies, as described above. The charge is designed to 
address the potential increased exposure that FICC may face if the MBS 
collateral underlying a GCF Repo Participant's transactions decreases 
during a monthly Blackout Period, under normal market conditions. 
Therefore, because the proposed rule change will help FICC limit its 
exposure to GCG Repo Participants during monthly Blackout Periods, 
under normal market conditions, by collecting more margin, as needed, 
the proposed rule change is consistent with Rule 17Ad-22(b)(2) under 
the Act.
---------------------------------------------------------------------------

    \20\ 17 CFR 240.17Ad-22(b)(2).
---------------------------------------------------------------------------

III. 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,\21\ and the rules and 
regulations thereunder.
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that the proposed rule change (SR-FICC-2016-003) be, and 
hereby is, APPROVED.\23\
---------------------------------------------------------------------------

    \22\ 15 U.S.C. 78s(b)(2).
    \23\ 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).


[[Page 71548]]


---------------------------------------------------------------------------

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\24\
---------------------------------------------------------------------------

    \24\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-24982 Filed 10-14-16; 8:45 am]
 BILLING CODE 8011-01-P


