
[Federal Register Volume 82, Number 70 (Thursday, April 13, 2017)]
[Notices]
[Pages 17901-17906]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-07451]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80394; File No. SR-DTC-2017-801]


Self-Regulatory Organizations; The Depository Trust Company; 
Notice of Filing of Advance Notice To Address and Update Practices and 
Policies With Respect to the Credit Risk Rating Matrix and Make Other 
Changes

April 7, 2017.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 (``Clearing 
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities 
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on March 
22, 2017, The Depository Trust Company (``DTC'') filed with the 
Securities and Exchange Commission (``Commission'') the advance notice 
SR-DTC-2017-801 (``Advance Notice'') as described in Items I, II and 
III below, which Items have been prepared by DTC.\3\ The Commission is 
publishing this notice to solicit comments on the Advance Notice from 
interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ On March 22, 2017, DTC filed this Advance Notice as a 
proposed rule change (SR-DTC-2017-002) with the Commission pursuant 
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4, 
17 CFR 240.19b-4. A copy of the proposed rule change is available at 
http://www.dtcc.com/legal/sec-rule-filings.aspx.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This Advance Notice consists of proposed modifications to DTC's 
Rules, By-Laws and Organization Certificate (``Rules'').\4\ The 
proposed rule change would amend Rules 1 and 2 in order to (i) address 
and update DTC's practices and policies with respect to the existing 
matrix (hereinafter referred to as the ``Credit Risk Rating Matrix'' or 
``CRRM''), which was, as described in an earlier DTC rule filing,\5\ 
developed by DTC to assign a credit rating to certain Participants 
(``CRRM-Rated Participants'') by evaluating the risks posed by CRRM-
Rated Participants to DTC and its Participants from providing services 
to these CRRM-Rated Participants and (ii) make other amendments to the 
Rules to provide more transparency and clarity regarding DTC's current 
ongoing membership monitoring process.
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    \4\ Capitalized terms not defined herein are defined in the 
Rules, available at www.dtcc.com/~/media/Files/Downloads/legal/
rules/dtc_rules.pdf.
    \5\ See Securities Exchange Act Release No. 53655 (April 14, 
2006), 71 FR 20428 (April 20, 2006) (SR-DTC-2006-03) (order of the 
Commission) approving a proposed rule change (``2006 Rule Change'') 
of DTC to amend the criteria used by DTC to place Participants on 
surveillance status, including, but not limited to DTC's application 
of the CRRM and the placement of lower rated CRRM-Rated Participants 
on an internal list in order to be monitored more closely (``Watch 
List'').
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, the clearing agency included 
statements concerning the purpose of and basis for the Advance Notice 
and discussed any comments it received on the Advance Notice. 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 and B below, of the most significant aspects of such 
statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants, or Others

    Written comments relating to this proposal have not been solicited 
or received. DTC will notify the Commission of any written comments 
received by DTC.

(B) Advance Notice Filed Pursuant to Section 806(e) of the Payment, 
Clearing and Settlement Supervision Act

Nature of the Proposed Change
    The proposed rule change would amend Rules 1 and 2 in order to (i) 
address and update DTC's practices and policies with respect to the 
CRRM and (ii) provide more transparency and clarity regarding DTC's 
current membership monitoring process. In this regard, the proposed 
rule change would (i) add proposed definitions for the terms ``Credit 
Risk Rating Matrix'' and ``Watch List'' to Rule 1 (Definitions), as 
discussed below and (ii) amend Rule 2 (Participants and Pledgees) to 
(A) clarify a provision in Section 1 relating to the types of 
information a Participant must provide to DTC upon DTC's request for 
the Participant to demonstrate its

[[Page 17902]]

satisfactory financial condition and operational capability, including 
its risk management practices with respect to services of DTC utilized 
by the Participant for another Person and (B) add a new Section 10 to 
include provisions relating to the monitoring, surveillance and review 
of Participants, including, but not limited to, the application of the 
CRRM and proposed enhancements to the CRRM, as further discussed below.
(i) Background
    DTC occupies an important role in the securities settlement system 
by, among other things, providing services for the settlement of book-
entry transfer and pledge of interests in eligible deposited securities 
and net funds settlement, in connection with which Participants may 
incur net funds settlement obligations to DTC. DTC uses the CRRM, the 
Watch List and the enhanced surveillance to manage and monitor default 
risks of Participants on an ongoing basis, as discussed below. The 
level and frequency of such monitoring for a Participant is determined 
by the Participant's risk of default as assessed by DTC. Participants 
that are deemed by DTC to pose a heightened risk to DTC and its 
Participants are subject to closer and more frequent monitoring.
Existing Credit Risk Rating Matrix
    Pursuant to the 2006 Rule Change, all Participants that are either 
U.S. broker-dealers or U.S. banks are assigned a rating generated 
solely based on quantitative factors by entering financial data of 
those Participants into an internally generated credit rating matrix, 
i.e., the CRRM.\6\ All other types of Participants are monitored by 
credit risk staff using financial criteria deemed relevant by DTC but 
would not be assigned a rating by the CRRM.\7\
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    \6\ See 2006 Rule Change, SR-DTC-2006-03, 71 FR 20428, which 
explained that the ratings assigned by the CRRM were generated using 
financial data extracted from standard regulatory reports of U.S. 
broker-dealers and banks. A small number of U.S. banks which 
submitted standard regulatory reports were not assigned a rating 
because they did not take deposits or make loans, and therefore the 
regulatory reports of these banks did not contain information on 
asset quality and/or liquidity, which was a data component used in 
the CRRM. Id. However, the 2006 Rule Change provided DTC with 
discretion to continue to ``evaluate the matrix methodology and its 
effectiveness and make such changes as it deems prudent and 
practicable within such time frames as it determines to be 
appropriate.'' Id. DTC has continued to evaluate the CRRM and has 
determined that the CRRM is the most effective method available to 
it to evaluate the default risk presented by any U.S. bank that 
submits regulatory reports, including a bank whose reports exclude 
certain data components as mentioned above. Accordingly, DTC applies 
the CRRM to assign ratings to any U.S. bank that submits regulatory 
reports, including those that were not covered by the CRRM in 2006, 
as reflected in the proposed rule change.
    \7\ In the 2006 Rule Change, DTC noted that these Participants 
would be monitored by credit risk staff by reviewing similar 
criteria as those reviewed for Participants included on the matrix 
but such review would occur outside of the matrix process. Id.
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    The 2006 Rule Change explained that credit risk staff could 
downgrade a particular Participant's credit rating based on various 
qualitative factors. An example of such qualitative factors might be 
that the Participant in question received a qualified audit opinion on 
its annual audit. DTC noted in the 2006 Rule Change that in order to 
protect DTC and its other Participants, it was important that credit 
risk staff maintain the discretion to downgrade a Participant's credit 
rating on the CRRM and thus subject the Participant to closer 
monitoring.
    The current CRRM is comprised of two credit rating models--one for 
the U.S. broker-dealers and one for the U.S. banks--and generates 
credit ratings for the relevant Participants based on a 7-point rating 
system, with ``1'' being the strongest credit rating and ``7'' being 
the weakest credit rating.
    Over time, the current CRRM has not kept pace with DTC's evolving 
Participant membership base and heightened expectations from regulators 
and stakeholders for robustness of financial models. Specifically, the 
current CRRM only generates credit ratings for those Participants that 
are U.S. banks or U.S. broker-dealers that file standard reports with 
their regulators, which currently comprise 80% of Participants; foreign 
banks and trust companies currently account for 5% of Participants.\8\ 
The number of Participants that are foreign banks or trust companies 
increased from 12 in 2012 to 13 in 2017, and is expected to continue to 
grow over the coming years. Foreign banks and trust companies are 
typically large global financial institutions that have complex 
businesses and conduct a high volume of activities. Although foreign 
banks and trust companies are not currently rated by the CRRM, they are 
monitored by DTC's credit risk staff using financial criteria deemed 
relevant by DTC and can be placed on the Watch List if they experience 
a financial change that presents risk to DTC. Given the increase in the 
number of foreign bank Participants in recent years, there is a need to 
formalize DTC's credit risk evaluation process of the foreign bank or 
trust company Participants by assigning credit ratings to them in order 
to better facilitate the comparability of credit risks among 
Participants.\9\
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    \8\ As of March 16, 2017, there are 251 Participants, of which 
50 (or 20%) are U.S. banks, 151 (or 60%) are U.S. broker-dealers and 
13 (or 5%) are foreign banks or trust companies.
    \9\ DTC noted in the 2006 Rule Change that the CRRM is applied 
across DTC and its affiliated clearing agencies, NSCC and FICC. 
Specifically, in order to run the CRRM, credit risk staff uses the 
financial data of the applicable DTC Participants in addition to 
data of applicable members of NSCC and FICC. In this way, each 
applicable DTC Participant is rated against other applicable members 
of NSCC and FICC. See 2006 Rule Change, SR-DTC-2006-03, 71 FR 20428.
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    As mentioned above, a Participant's credit rating is currently 
based solely upon quantitative factors. It is only after the CRRM has 
generated a credit rating with respect to a Participant that such 
Participant's credit rating may be downgraded manually by credit risk 
staff, after taking into consideration relevant qualitative factors. 
The inability of the current CRRM to take into account qualitative 
factors requires frequent and manual overrides by credit risk staff, 
which may result in inconsistent and/or incomplete credit ratings for 
Participants.
    Furthermore, the current CRRM uses a relative scoring approach and 
relies on peer grouping of Participants to calculate the credit rating 
of a Participant. This approach is not ideal because a Participant's 
credit rating can be affected by changes in its peer group even if the 
Participant's financial condition is unchanged.
Proposed Credit Risk Rating Matrix Enhancements
    To improve the coverage and the effectiveness of the current CRRM, 
DTC is proposing three enhancements to the CRRM. The first proposed 
enhancement would expand the scope of CRRM coverage by enabling the 
CRRM to generate credit ratings for Participants that are foreign banks 
or trust companies and that have audited financial data that is 
publicly available. The second proposed enhancement would incorporate 
qualitative factors into the CRRM and therefore is expected to reduce 
the need and the frequency of manual overrides of Participant credit 
ratings. The third enhancement would replace the relative scoring 
approach currently used by CRRM with a statistical approach to estimate 
the absolute probability of default of each Participant.

A. Enable the CRRM To Generate Credit Ratings for Foreign Bank or Trust 
Company Participants

    The current CRRM is comprised of two credit rating models--one for 
the U.S. broker-dealers and one for the U.S. banks. DTC is proposing to 
enhance the CRRM by adding an additional credit

[[Page 17903]]

rating model for the foreign banks and trust companies. The additional 
model would expand the scope of Participants to which the CRRM would 
apply to include foreign banks and trust companies that have audited 
financial data that is publicly available. The CRRM credit rating of a 
foreign bank or trust company that is a Participant would be based on 
quantitative factors, including size, capital, leverage, liquidity, 
profitability and growth, and qualitative factors, including market 
position and sustainability, information reporting and compliance, 
management quality, capital management and business/product diversity. 
By enabling the CRRM to generate credit ratings for these Participants, 
the enhanced CRRM would provide more comprehensive credit risk coverage 
of DTC's membership base.
    With the proposed enhancement to the CRRM as described above, 
applicable foreign bank or trust company Participants would be included 
in the CRRM process and be evaluated more effectively and efficiently 
because financial data with respect to these foreign bank or trust 
company Participants could be extracted from data sources in an 
automated form.\10\
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    \10\ In the 2006 Rule Change, DTC noted that these Participants 
would be monitored by credit risk staff by reviewing similar 
criteria as those reviewed for Participants included on the CRRM, 
but such review would occur outside of the CRRM process. Id.
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    After the proposed enhancement, CRRM would be able to generate 
credit ratings on an ongoing basis for all Participants that are U.S. 
banks, U.S. brokers-dealers and foreign banks and trust companies, 
which together represent approximately 85% of Participants.\11\
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    \11\ As of March 16, 2017, there are 37 Participants that would 
not be rated by the enhanced CRRM, as proposed, because they are 
central securities depositories, securities exchanges, government 
sponsored entities, central counterparties, central banks and U.S. 
trust companies that do not file Call Reports (as defined below).
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B. Incorporate Qualitative Factors Into the CRRM

    In addition, as proposed, the enhanced CRRM would blend both 
qualitative factors and quantitative factors to produce a credit rating 
for each applicable Participant in relation to the Participant's credit 
risk. For U.S. and foreign banks and trust companies, the enhanced CRRM 
would use a 70/30 weighted split between quantitative and qualitative 
factors to generate credit ratings. For U.S. broker-dealers, the weight 
split between quantitative and qualitative factors would be 60/40. 
These weight splits have been chosen by DTC based on the industry best 
practice as well as research and sensitivity analysis conducted by DTC. 
DTC would review and adjust the weight splits as well as the 
quantitative and qualitative factors, as needed, based on recalibration 
of the CRRM to be conducted by DTC approximately every three to five 
years.
    Although there are advantages to measuring credit risk 
quantitatively, quantitative evaluation models alone are incapable of 
fully capturing all credit risks. Certain qualitative factors may 
indicate that a Participant is or will soon be undergoing financial 
distress, which may in turn signal a higher default exposure to DTC and 
its other Participants. As such, a key enhancement being proposed to 
the CRRM is the incorporation of relevant qualitative factors into each 
of the three credit rating models mentioned above. By including 
qualitative factors in the three credit rating models, the enhanced 
CRRM would capture risks that would otherwise not be accounted for with 
quantitative factors alone.\12\ Adding qualitative factors to the CRRM 
would not only enable it to generate more consistent and comprehensive 
credit ratings for applicable Participants, but it would also help 
reduce the need and frequency of manual credit rating overrides by the 
credit risk staff because overrides would likely only be required under 
more limited circumstances.\13\
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    \12\ The initial set of qualitative factors that would be 
incorporated into the CRRM includes (a) for U.S. broker dealers, 
market position and sustainability, management quality, capital 
management, liquidity management, geographic diversification, 
business/product diversity and access to funding, (b) for U.S. 
banks, environment, compliance/litigation, management quality, 
liquidity management and parental demands and (c) for foreign banks 
and trust companies, market position and sustainability, information 
reporting and compliance, management quality, capital management and 
business/product diversity.
    \13\ Once a Participant is assigned a credit rating, if 
circumstances warrant, credit risk staff would still have the 
ability to override the CRRM-issued credit rating by manually 
downgrading such rating as they do today. To ensure a conservative 
approach, the CRRM-issued credit ratings cannot be manually 
upgraded.
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C. Shifting From Relative Scoring to Absolute Scoring

    As proposed, the enhanced CRRM would use an absolute scoring 
approach and rank each Participant based on its individual probability 
of default rather than the relative scoring approach that is currently 
in use. This proposed change is designed to have a Participant's CRRM-
generated credit rating reflect an absolute measure of the 
Participant's default risk and eliminate any potential distortion of a 
Participant's credit rating from the Participant's peer group that may 
occur under the relative scoring approach used in the existing CRRM.

D. Watch List and Enhanced Surveillance

    In addition to the Watch List, DTC also maintains an enhanced 
surveillance list (referenced herein and in the proposed rule text as 
``enhanced surveillance'') for membership monitoring. The enhanced 
surveillance list is generally used when Participants are undergoing 
drastic and unexpected changes in their financial conditions or 
operation capabilities and thus are deemed by DTC to be of the highest 
risk level and/or warrant additional scrutiny due to DTC's ongoing 
concerns about these Participants. Accordingly, Participants that are 
subject to enhanced surveillance are reported to DTC's management 
committees and are also regularly reviewed by a cross-functional team 
comprised of senior management of DTC. More often than not, 
Participants that are subject to enhanced surveillance are also on the 
Watch List. The group of Participants that is subject to enhanced 
surveillance is generally much smaller than the group on the Watch 
List. The enhanced surveillance list is an internal tool for DTC that 
triggers increased monitoring of a Participant above the monitoring 
that occurs when a Participant is on the Watch List.
    A Participant could be placed on the Watch List either based on its 
credit rating of 5, 6 or 7, which can either be generated by the CRRM 
or from a manual downgrade, or when DTC deems such placement as 
necessary to protect DTC and its Participants. In contrast, a 
Participant would be subject to enhanced surveillance only when close 
monitoring of the Participant is deemed necessary to protect DTC and 
its Participants.
(ii) Detailed Description of the Proposed Rule Changes
    The 2006 Rule Change, while setting forth the procedures DTC 
follows with regard to the CRRM and the Watch List, did not incorporate 
these procedures into the text of the Rules. Pursuant to the proposed 
rule change, DTC would amend the Rules to incorporate the CRRM with the 
enhancements proposed above, including (1) the use of both quantitative 
and qualitative factors in generating credit ratings for CRRM-Rated 
Participants, (2) the expansion of the scope of CRRM coverage to enable 
the CRRM to generate credit ratings for Participants that are (a) U.S. 
banks that file the Consolidated Report of

[[Page 17904]]

Condition and Income (``Call Report''), (b) U.S. broker-dealers that 
file the Financial and Operational Combined Uniform Single Report 
(``FOCUS Report'') or the equivalent with their regulators, or (c) 
foreign banks or trust companies that have audited financial data that 
is publicly available and (3) that the CRRM would use an absolute 
scoring approach and rank each Participant based on its individual 
probability of default (rather than the relative scoring approach that 
is currently in use). Also, the proposed rule change would define the 
CRRM and the Watch List and add rule text to provide more transparency 
and clarity regarding DTC's current ongoing membership monitoring 
process.
    In this regard, the proposed rule change would (i) add proposed 
definitions for CRRM and Watch List to Rule 1 (Definitions) and (ii) 
amend Rule 2 (Participants and Pledgees) (A) Section 1 to clarify a 
provision relating to the types of information a Participant must 
provide to DTC upon DTC's request for the Participant to demonstrate 
its satisfactory financial condition and operational capability, 
including its risk management practices with respect to services of DTC 
utilized by the Participant for another Person or Persons and (B) to 
add a new Section 10 to include provisions relating to the monitoring, 
surveillance and review of Participants, including, but not limited to, 
the application of the CRRM and proposed enhancements to the CRRM, as 
further discussed below.

A. Proposed Changes to Rule 1 (Definitions)

    The proposed rule change would amend Rule 1 to add definitions for 
the CRRM and the Watch List.
    The proposed definition of the CRRM would provide that the term 
``Credit Risk Rating Matrix'' means a matrix of credit ratings of 
Participants as specified in the proposed new Section 10(a) of Rule 2. 
As proposed, the definition would state that the CRRM is developed by 
DTC to evaluate the credit risk such Participants pose to DTC and its 
Participants and is based on factors determined to be relevant by DTC 
from time to time, which factors are designed to collectively reflect 
the financial and operational condition of a Participant. The proposed 
definition would also state that these factors include (i) quantitative 
factors, such as capital, assets, earnings and liquidity and (ii) 
qualitative factors, such as management quality, market position/
environment and capital and liquidity risk management.
    The proposed definition of the Watch List would provide that the 
term ``Watch List'' means, at any time and from time to time, the list 
of Participants whose credit ratings derived from the CRRM are 5, 6 or 
7, as well as Participants that, based on DTC's consideration of 
relevant factors, including those that would be set forth in the 
proposed new Section 10 of Rule 2 (described below), are deemed by DTC 
to pose a heightened risk to DTC and its Participants.

B. Proposed Changes to Section 1 of Rule 2 (Participants and Pledgees)

    Section 1 of Rule 2 provides, among other things, that upon the 
request of DTC, a Participant shall furnish to DTC information 
sufficient to demonstrate its satisfactory financial condition and 
operational capability. The proposed rule change would, by way of 
example, clarify that the types of information that DTC may require in 
this regard include, but are not limited to, such information as DTC 
may request regarding the businesses and operations of the Participant 
and its risk management practices with respect to services of DTC 
utilized by the Participant for another Person.

C. Proposed New Section 10 of Rule 2

    The proposed rule change would add a new Section 10 of Rule 2 to 
include provisions relating to the monitoring, surveillance and review 
of Participants, including, but not limited to, the application of, and 
the proposed enhancements to, the CRRM. In this regard, the proposed 
new Section 10 of Rule 2 would provide that:
    (1) All Participants would be monitored and reviewed by DTC on an 
ongoing and periodic basis, which may include monitoring of news and 
market developments and review of financial reports and other public 
information.
    (2)(i) A Participant that is (A) qualified to be a Participant 
pursuant to (x) Rule 3, Section 1(d) and files the Call Report (i.e., a 
U.S. Bank) or (y) Rule 3, Section 1(h)(ii) and files the FOCUS Report 
or the equivalent with its regulator (i.e., a U.S. broker-dealer) or 
(B) a foreign bank or trust company qualified to be a Participant 
pursuant to Section 2 of the Policy Statement on the Admission of 
Participants and that has audited financial data that is publicly 
available, would be assigned a credit rating by DTC in accordance with 
the CRRM. The proposed rule change would also provide that a 
Participant's credit rating will be reassessed each time the 
Participant provides DTC with requested information pursuant to Section 
1 of Rule 2, or as may be otherwise required under the Rules and 
Procedures \14\ (including proposed new Section 10 of Rule 2).
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    \14\ Pursuant to Section 1 of Rule 1, the term ``Procedures'' 
means the Procedures, service guides, and regulations of DTC adopted 
pursuant to Rule 27, as amended from time to time. Rules, supra note 
4.
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    (ii) Because the factors used as part of the CRRM may not identify 
all risks that a CRRM-Rated Participant may present to DTC, DTC may, in 
its discretion, override the CRRM-Rated Participant's credit rating 
derived from the CRRM to downgrade that Participant. In this regard, 
the proposed rule change would provide that (A) such a downgrading may 
result in the Participant being placed on the Watch List, and/or it may 
subject the Participant to enhanced surveillance based on relevant 
factors, including those described in paragraph (4) below and (B) DTC 
may also take such additional actions with regard to the Participant as 
are permitted by the Rules and Procedures.
    (3) Participants other than CRRM-Rated Participants would not be 
assigned a credit rating by the CRRM but may be placed on the Watch 
List and/or may be subject to enhanced surveillance based on relevant 
factors, including those described in paragraph (4) below, as DTC deems 
necessary to protect it and its Participants.
    (4) The factors to be considered by DTC as proposed in paragraphs 
(2)(ii) and (3) above would include, but would not be not limited to, 
(i) news reports and/or regulatory observations that raise reasonable 
concerns relating to the Participant, (ii) reasonable concerns around 
the Participant's liquidity arrangements, (iii) material changes to the 
Participant's organizational structure, (iv) reasonable concerns of DTC 
about the Participant's financial stability due to particular facts and 
circumstances, such as material litigation or other legal and/or 
regulatory risks, (v) failure of the Participant to demonstrate 
satisfactory financial condition or operational capability or if DTC 
has a reasonable concern regarding the Participant's ability to 
maintain applicable participation standards and (vi) failure of the 
Participant to provide information required by DTC to assess risk 
exposure posed by the Participant's activity (including information 
requested by DTC pursuant to Section 1 of Rule 2).
    (5) A Participant being subject to enhanced surveillance or being 
placed on the Watch List would result in more thorough monitoring of 
the Participant's financial condition and/or operational capability, 
which could include, for example, on-site visits or additional due

[[Page 17905]]

diligence information requests from DTC. In this regard, the proposed 
rule change would provide that DTC may require a Participant placed on 
the Watch List and/or subject to enhanced surveillance to make more 
frequent financial disclosures, including, without limitation, interim 
and/or pro forma reports. The proposed rule change would also provide 
that Participants that are subject to enhanced surveillance would also 
be reported to DTC's management committees and regularly reviewed by a 
cross-functional team comprised of senior management of DTC. The 
proposed rule change would further provide that DTC may also take such 
additional actions with regard to any Participant (including a 
Participant placed on the Watch List and/or subject to enhanced 
surveillance) as are permitted by the Rules and Procedures.
Implementation Timeframe
    Pending Commission approval, DTC expects to implement this proposal 
promptly. Participants would be advised of the implementation date of 
this proposal through issuance of a DTC Important Notice.
Expected Effect on Risks to the Clearing Agency, Its Participants and 
the Market
    The proposed rule changes would mitigate Participant credit risk 
posed to DTC from Participant activity by allowing DTC to more 
accurately monitor the creditworthiness and risk profile of its 
Participants. The enhanced CRRM would provide a more robust credit 
rating methodology by incorporating qualitative factors and adopting an 
absolute scoring approach. Both of these enhancements would improve 
DTC's ability to monitor the credit risk of its Participants and are 
expected to lessen the frequency of manual overrides. The enhanced CRRM 
would also expand the coverage Participants by providing credit ratings 
for Participants that are foreign banks or trust companies, which are 
not covered under the existing CRRM.
    By mitigating credit risk to DTC as described above, the enhanced 
CRRM would also mitigate risk for Participants because lowering the 
risk profile for DTC would in turn lower the risk exposure that 
Participants may have with respect to DTC in its role as a securities 
settlement system.
Management of Identified Risks
    The proposed rule changes are designed to mitigate credit risk for 
DTC from Participant activity and to provide greater clarity and 
transparency to DTC's Participants regarding the risk management 
approach used by DTC in this regard.
    The enhanced CRRM would improve DTC's ability to monitor the 
probability of default for Participants that are rated by the CRRM and 
is expected to lessen the need and the frequency of manual downgrades 
due to the anticipated improvement in the accuracy of the credit 
ratings generated by the enhanced CRRM.
    DTC employs a risk-based approach to conducting monitoring and 
review of its Participants by using the CRRM to identify higher risk 
Participants. Once identified, DTC would place these Participants on 
the Watch List, which would result in more frequent review by DTC of 
these Participants than the other Participants. For Participants that 
are placed on the Watch List, DTC would conduct more thorough 
monitoring of these Participants' financial condition and/or 
operational capability, which could include, for example, on-site 
visits or additional due diligence information requests.
    The enhanced CRRM would also expand the coverage of Participants by 
providing credit ratings for foreign banks and trust companies, which 
are not currently rated under the existing CRRM. The addition of these 
entities would allow DTC to employ its risk-based approach to identify 
those higher risk Participants for additional monitoring with more 
efficiency (by reducing the need for manual overrides) and 
effectiveness (by generating a more comprehensive and accurate credit 
rating after taking into account both quantitative and qualitative 
factors and adopting the absolute scoring approach).
    Thus, the enhanced CRRM would help DTC to identify those 
Participants that could present credit risk to DTC, which then would 
allow DTC to better manage the potential risks from these Participants.
Consistency With the Clearing Supervision Act
    The proposed enhancements to the CRRM as described in detail above 
would be consistent with Section 805(b) of the Clearing Supervision 
Act.\15\ The objectives and principles of Section 805(b) of the 
Clearing Supervision Act include, among other things, the promotion of 
robust risk management.\16\
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    \15\ 12 U.S.C. 5464(b)
    \16\ Id.
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    By enhancing the CRRM to enable it to assign credit ratings to 
Participants that are foreign banks or trust companies and that have 
audited financial data that is publicly available, the proposed rule 
change would expand the CRRM's applicability to a wider group of 
Participants, which would improve DTC's membership monitoring process 
and promote robust risk management, consistent with the objectives and 
principles of Section 805(b) of the Clearing Supervision Act cited 
above.
    Similarly, by enhancing the CRRM to enable it to incorporate 
qualitative factors when assigning a Participant's credit rating, the 
proposed change would enable DTC to take into account relevant 
qualitative factors in an automated and more effective manner when 
monitoring the credit risks presented by the Participants, which would 
improve DTC's membership monitoring process overall and promote robust 
risk management, consistent with the objectives and principles of 
Section 805(b) of the Clearing Supervision Act cited above.
    Likewise, by enhancing the CRRM to shift from a relative scoring 
approach to an absolute scoring approach when assigning a Participant's 
credit rating, the proposed rule change would enable DTC to generate 
credit ratings for Participants that are more reflective of the 
Participants' default risk, which would improve DTC's membership 
monitoring process and promote robust risk management, consistent with 
the objectives and principles of Section 805(b) of the Clearing 
Supervision Act cited above.
    The proposed enhancements to the CRRM are consistent with Rule 
17Ad-22(e)(3)(i) under the Act, which was recently adopted by the 
Commission.\17\ Rule 17Ad-22(e)(3)(i) will require DTC to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to maintain a sound risk management framework for 
comprehensively managing risks that arise in or are born by DTC, which 
includes . . . systems designed to identify, measure, monitor and 
manage the range of risks that arise in or are borne by DTC.\18\ The 
proposed enhancements to the CRRM have been designed to assist DTC in 
identifying, measuring, monitoring and managing the credit risks to DTC 
posed by its Participants. The proposed enhancements to the CRRM 
accomplish this by (i) expanding the CRRM's

[[Page 17906]]

applicability to a wider group of Participants to include Participants 
that are foreign banks or trust companies, (ii) enabling the CRRM to 
take into account relevant qualitative factors in an automated and more 
effective manner when monitoring the credit risks presented by 
Participants and (iii) enabling the CRRM to generate credit ratings for 
Participants that are more reflective of the Participants' default risk 
by shifting to an absolute scoring approach, all of which would improve 
DTC's membership monitoring process overall. Therefore, DTC believes 
the proposed enhancements to the CRRM would assist DTC in identifying, 
measuring, monitoring and managing risks that arise in or are born by 
DTC, consistent with the requirements of Rule 17Ad-22(e)(3)(i).
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    \17\ 17 CFR 240.17Ad-22(e)(3)(i). The Commission adopted 
amendments to Rule 17Ad-22, including the addition of new subsection 
17Ad-22(e), on September 28, 2016. See Securities Exchange Act 
Release No. 78961 (September 28, 2016), 81 FR 70786 (October 13, 
2016) (S7-03-14). DTC is a ``covered clearing agency'' as defined by 
the new Rule 17Ad-22(a)(5) and must comply with new subsection (e) 
of Rule 17Ad-22 by April 11, 2017. Id.
    \18\ Id.
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    The proposed rule change to Section 1 of Rule 2 with respect to the 
scope of information that may be requested by DTC from its Participants 
has been designed to be consistent with Rule 17Ad-22(e)(19) under the 
Act, which was recently adopted by the Commission.\19\ Rule 17Ad-
22(e)(19) will require DTC to establish, implement, maintain and 
enforce written policies and procedures reasonably designed to 
identify, monitor, and manage the material risk to DTC arising from 
arrangements in which firms that are indirect participants in DTC rely 
on the services provided by Participants to access DTC's payment, 
clearing, or settlement facilities.\20\ By expressly reflecting in the 
Rules what is already DTC's current practice associated with its 
request for information sufficient to demonstrate a Participant's 
satisfactory financial condition and operational capability to state 
that such request may include information regarding the businesses and 
operations of the Participant, as well as its risk management practices 
with respect to services of DTC utilized by the Participant for another 
Person, this proposed rule change would help enable DTC to have rule 
provisions that are reasonably designed to identify, monitor and manage 
the material risks to DTC arising from tiered participation 
arrangements consistent with Rule 17Ad-22(e)(19).
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    \19\ 17 CFR 240.17Ad-22(e)(19). Id.
    \20\ Id.
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III. Date of Effectiveness of the Advance Notice, and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date that the proposed change was filed with the Commission or (ii) the 
date that any additional information requested by the Commission is 
received. The clearing agency shall not implement the proposed change 
if the Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    The clearing agency shall post notice on its Web site of proposed 
changes that are implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether 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 Number SR- DTC-2017-801 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-DTC-2017-801. 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 DTC 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- DTC-2017-801 and should be submitted on 
or before April 28, 2017.

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-07451 Filed 4-12-17; 8:45 am]
 BILLING CODE 8011-01-P


