
[Federal Register Volume 82, Number 176 (Wednesday, September 13, 2017)]
[Notices]
[Pages 43054-43056]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-19375]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81545; File No. SR-NSCC-2017-804]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection to an Advance Notice To Expand the 
Application of the Family-Issued Securities Charge

September 7, 2017.
    On July 10, 2017, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2017-804 (``Advance Notice'') 
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) \2\ under the Securities 
Exchange Act of 1934 (``Exchange Act'').\3\ The Advance Notice was 
published for comment in the Federal Register on August 8, 2017.\4\ The 
Commission did not receive any comments on the Advance Notice. This 
publication serves as notice that the Commission does not object to the 
changes set forth in the Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1). The Financial Stability Oversight 
Council designated NSCC a systemically important financial market 
utility on July 18, 2012. See Financial Stability Oversight Council 
2012 Annual Report, Appendix A, http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. Therefore, NSCC is 
required to comply with the Clearing Supervision Act and file 
advance notices with the Commission. See 12 U.S.C. 5465(e).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78s(b)(1).
    \4\ Securities Exchange Act Release No. 81286 (August 2, 2017), 
82 FR 37141 (August 8, 2017) (SR-NSCC-2017-804) (``Notice''). NSCC 
also filed a related proposed rule change with the Commission 
pursuant to Section 19(b)(1) of the Exchange Act and Rule 19b-4 
thereunder, seeking approval of changes to its rules necessary to 
implement the Advance Notice. 15 U.S.C. 78s(b)(1) and 17 CFR 
240.19b-4, respectively. The proposed rule change was published in 
the Federal Register on July 31, 2017. Securities Exchange Act 
Release No. 81203 (July 25, 2017), 82 FR 35563 (July 31, 2017) (SR-
NSCC-2017-010). The Commission did not receive any comments on that 
proposal.
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I. Description of the Advance Notice

    The Advance Notice is a proposal by NSCC to further address 
specific wrong-way risk \5\ that is present when NSCC acts as central 
counterparty to a transaction with an NSCC member (``Member'') where 
the underlying securities are securities issued by such Member or an 
affiliate of such Member (``family-issued securities'').\6\ Currently, 
NSCC applies a targeted margin charge to address the specific wrong-way 
risk of family-issued securities transactions (``FIS Charge'') where 
the Member is on NSCC's Watch List.\7\ NSCC believes that Members on 
the Watch List present a higher credit risk (i.e., a greater risk of 
defaulting on their settlement obligations), compared to Members not on 
the Watch List. As such, the family-issued securities of Members on the 
Watch List currently receive a FIS Charge because of the increased 
credit risk presented by such Members. As described in detail below, 
NSCC proposes in the Advance Notice to expand the application of the 
FIS Charge to all Members, regardless of a Member's Watch List status, 
but still maintain a higher FIS Charge for Members that present a 
greater credit risk to NSCC, such as Members on the Watch List.
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    \5\ Specific wrong-way risk is the risk that an exposure to a 
counterparty is highly likely to increase when the creditworthiness 
of that counterparty is deteriorating. See Principles for financial 
market infrastructures, issued by the Committee on Payment and 
Settlement Systems and the Technical Committee of the International 
Organization of Securities Commissions 47 n.65 (April 2012), 
available at http://www.bis.org/publ/cpss101a.pdf.
    \6\ As part of this proposal, NSCC proposes to define in its 
rules that, for a given Member, a family-issued security is a 
security that was issued by such Member or an affiliate of such 
Member.
    \7\ As part of its ongoing monitoring of its membership, NSCC 
utilizes an internal credit risk rating matrix to rate its risk 
exposures to its Members based on a scale from 1 (the strongest) to 
7 (the weakest). Members that fall within the weakest three rating 
categories (i.e., 5, 6, and 7) are placed on NSCC's ``Watch List'' 
and, as provided under NSCC's Rules and Procedures (``Rules''), may 
be subject to enhanced surveillance or additional margin charges. 
See Section 4 of Rule 2B and Section I(B)(1) of Procedure XV of 
NSCC's Rules, available at http://dtcc.com/~/media/Files/Downloads/
legal/rules/nscc_rules.pdf.
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    Currently, in calculating a Watch List Member's overall margin 
charge (i.e., a Watch List Member's required deposit to NSCC's clearing 
fund), NSCC excludes the Member's net, unsettled long position in 
family-issued securities from the volatility component of the margin 
calculation (``VaR Charge''). Instead, for such unsettled long 
positions, NSCC calculates the required margin (i.e., the FIS Charge) 
by multiplying the position value by a set percentage, which is 
determined based on a Member's rating on NSCC's internal credit risk 
rating matrix.\8\ NSCC applies this separate margin calculation to deal 
with specific wrong-way risk that arises from these positions because 
NSCC has to liquidate the unsettled family-issued security long 
positions in the Member's portfolio to manage the default.\9\ Given 
that the Member's default would likely adversely affect NSCC's ability 
to liquidate such positions at full value (because the value of the 
family-issued securities will decline in response to the Member's 
default), NSCC applies the FIS Charge to try to address the risk of a 
shortfall. According to NSCC, the FIS Charge constitutes a more 
conservative approach to collecting margin on family-issued security 
positions than what may be achieved by applying the VaR Charge, which 
does not recognize the relationship between the Member and the family-
issued securities.
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    \8\ More specifically, fixed-income securities that are family-
issued securities are charged a rate of no less than 80 percent for 
firms that are rated 6 or 7 on the credit risk rating matrix, and no 
less than 40 percent for firms that are rated 5 on the credit risk 
rating matrix. Equity securities that are family-issued securities 
are charged a rate of 100 percent for firms that are rated 6 or 7 on 
the credit risk rating matrix, and no less than 50 percent for firms 
that are rated 5 on the credit risk rating matrix.
    \9\ In a default scenario, NSCC would receive the family-issued 
securities from a Member's guaranteed long transactions and would 
have to liquidate the holding to unwind NSCC's position.
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    Although the risk of default by Members that are not on the Watch 
List is lower than Members on the Watch List, NSCC believes that it is 
appropriate to apply the FIS Charge to all Members because all Members' 
long positions in family-issued securities present specific wrong-way 
risk. However, the proposal would still maintain the relation between 
the FIS Charge and the Member's risk of default (i.e., the Member's 
credit risk), while at the same time addressing the difference in risk 
posed by equity and fixed-income securities. As such, NSCC proposes in 
the Advance Notice to apply the FIS Charge to fixed-income securities 
that are family-issued securities of non-Watch List Members at a rate 
of no less than 40 percent, and to equities that are family-issued 
securities of non-Watch

[[Page 43055]]

List Members at a rate of no less than 50 percent.\10\
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    \10\ According to NSCC, it calibrated the FIS Charge rates based 
on historical corporate-issue recovery-rate data. The rate 
applicable to equities is higher than the rate applicable to fixed-
income securities because NSCC determined that equities present a 
greater risk than fixed-income securities of having a value at or 
near zero when a Member defaults. The Commission understands that 
NSCC calculated the 40 and 50 percent rates based on a weighted 
value of the probability of a Member defaulting and the potential 
loss that NSCC may realize when liquidating family-issued securities 
after a Member default.
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II. Discussion and Commission Findings

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, its stated purpose is instructive: To 
mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically important financial market utilities and 
strengthening the liquidity of systemically important financial market 
utilities.\11\ Section 805(a)(2) of the Clearing Supervision Act \12\ 
authorizes the Commission to prescribe risk management standards for 
the payment, clearing, and settlement activities of designated clearing 
entities engaged in designated activities for which the Commission is 
the supervisory agency. Section 805(b) of the Clearing Supervision Act 
\13\ provides the following objectives and principles for the 
Commission's risk management standards prescribed under Section 805(a):
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    \11\ See 12 U.S.C. 5461(b).
    \12\ 12 U.S.C. 5464(a)(2).
    \13\ 12 U.S.C. 5464(b).
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     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act \14\ and Section 17A of the 
Exchange Act (``Rule 17Ad-22'').\15\ Rule 17Ad-22 requires registered 
clearing agencies to establish, implement, maintain, and enforce 
written policies and procedures that are reasonably designed to meet 
certain minimum requirements for their operations and risk management 
practices on an ongoing basis.\16\ Therefore, it is appropriate for the 
Commission to review proposed changes in advance notices against the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act \17\ and 
against Rule 17Ad-22.\18\
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    \14\ 12 U.S.C. 5464(a)(2).
    \15\ 15 U.S.C. 78q-1.
    \16\ 17 CFR 240.17Ad-22.
    \17\ 12 U.S.C. 5464(b).
    \18\ 17 CFR 240.17Ad-22.
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    The Commission believes the proposal in the Advance Notice is 
consistent with the objectives and principles described in Section 
805(b) of the Act,\19\ and Rule 17Ad-22, in particular Rule 17Ad-
22(e)(4)(i) \20\ and Rule 17Ad-22(e)(6)(i) and (v) \21\ under the 
Exchange Act, as described in detail below.
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    \19\ 12 U.S.C. 5464(b).
    \20\ 17 CFR 240.17Ad-22(e)(4)(i).
    \21\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    As discussed below, the Commission believes that the changes 
proposed in the Advance Notice are consistent with Section 805(b) of 
the Clearing Supervision Act because they: (i) Are designed to reduce 
systemic risk; (ii) are designed to support the stability of the 
financial system; (iii) are designed to promote robust risk management; 
and (iv) are consistent with promoting safety and soundness.
    The Commission believes that the proposal is designed to help 
promote robust risk management. As described above, the FIS Charge is 
calculated and collected to help mitigate NSCC's loss exposure to 
specific wrong-way risk that NSCC may face when liquidating family-
issued security positions that are depreciating in value in response to 
a Member's default. By expanding the FIS Charge to family-issued 
security transactions presented to NSCC by all Members, the proposal 
would assist NSCC in collecting margin and maintaining a clearing fund 
amount that more accurately reflects NSCC's overall risk exposure to 
its Members. Therefore, the proposal is designed to help better promote 
robust risk management at NSCC by reducing NSCC's loss exposure to the 
specific wrong-way risk that NSCC faces from Member transactions in 
family-issued securities.
    The Commission also believes that the proposal is designed to 
promote safety and soundness, as well as support the stability of the 
financial system, and reduce systemic risk. By providing for the 
collection by NSCC of margin amounts that contemplate and help address 
the specific wrong-way risk presented by all Members, the proposal 
would assist NSCC in helping to ensure that it maintains sufficient 
margin in the event that a Member holding family-issued securities 
defaults and such positions significantly decrease in value. Without 
this increased margin, NSCC is at a greater risk of not having enough 
margin to offset potential losses from the reduced value of family-
issued securities in a default scenario. Such losses could threaten 
NSCC's ability to continue operations of its critical clearance and 
settlement services. Because the proposal would generally increase the 
level of financial resources available to NSCC, better enabling NSCC to 
continue operating in default scenarios, the proposal would help NSCC 
operate more safely and soundly and reduce the systemic risk associated 
with NSCC not providing critical clearance and settlement services in 
the event of a Member default. Therefore, the Commission believes that 
the changes proposed in the Advance Notice are consistent with Section 
805(b) of the Clearing Supervision Act.\22\
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    \22\ Id.
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B. Consistency With Rule 17Ad-22(e)(4)(i)

    The Commission believes that the changes proposed in the Advance 
Notice are consistent with Rule 17Ad-22(e)(4)(i) under the Exchange 
Act, which requires, in part, that NSCC establish, implement, maintain 
and enforce written policies and procedures reasonably designed to 
effectively identify, measure, monitor, and manage its credit exposures 
to participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence.\23\
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    \23\ 17 CFR 240.17Ad-22(e)(4)(i).
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    As described above, NSCC is exposed to specific wrong-way risk 
where it acts as central counterparty for its Members for transactions 
in family-issued securities. The expanded application of the FIS Charge 
to all Members would help further mitigate NSCC's loss exposure to this 
risk. The charge is calculated and imposed based on the value and type 
of family-issued securities in each Member's portfolio and in 
consideration of the Members' credit rating, as calculated by NSCC's 
internal credit risk matrix. Although the FIS Charge may not fully 
reflect the recovery rate on a family-issue security when a Member 
defaults, the Commission understands that expanding the FIS Charge to 
non-Watch List Members, as proposed, would enable NSCC to collect more 
margin on such positions than would a VaR Charge, more accurately 
reflecting the risks those positions present. Thus, the

[[Page 43056]]

expanded FIS Charge is designed to help NSCC collect sufficient 
financial resources to help cover the specific risk exposure, with a 
high degree of confidence, which is presented by all Members seeking to 
clear and settle transactions in family-issued securities. Therefore, 
the Commission believes that the proposal to expand the FIS Charge to 
all Members is consistent with Rule 17Ad-22(e)(4)(i) under the Exchange 
Act.\24\
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    \24\ Id.
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C. Consistency With Rule 17Ad-22(e)(6)(i) and (v)

    The Commission believes that the changes proposed in the Advance 
Notice are consistent with Rule 17Ad-22(e)(6)(i) and (v) under the 
Exchange Act, which require, in part, that NSCC establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to cover its credit exposures to its participants by 
establishing a risk-based margin system that, at a minimum considers, 
and produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market; and uses an 
appropriate method for measuring credit exposure that accounts for 
relevant product risk factors and portfolio effects across 
products.\25\
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    \25\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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    As described above, NSCC faces specific wrong-way risk where it 
acts as central counterparty to Member transactions in family-issued 
securities. To help address this risk, NSCC applies the FIS Charge in 
calculating the Member's required margin. Specifically, the FIS Charge 
is a component of the margin that NSCC calculates and collects using a 
risk-based margin methodology that is designed to help maintain the 
coverage of NSCC's credit exposures to its Members at a confidence 
level of at least 99 percent. The FIS Charge is tailored to consider 
both the value and type of family-issued securities held by the Member, 
as well as the credit risk presented by the Member, as calculated by 
NSCC.
    However, currently, the FIS Charge is assessed only against Members 
on the Watch List because of the additional credit risk presented by 
such Members. Nevertheless, all Members, not just Members on the Watch 
List, present specific wrong-way risk. As such, NSCC proposes to expand 
the FIS Charge to all Members, while maintaining the relation between 
the FIS Charge and the Member's credit risk. Specifically, NSCC 
proposes to apply the FIS Charge to fixed-income securities that are 
family-issued securities of non-Watch List Members at a rate of no less 
than 40 percent, and to equities that are family-issued securities of 
non-Watch List Members at a rate of no less than 50 percent. Although 
NSCC proposes to apply a lesser percentage rate to non-Watch List 
Members than some Watch List Members, the proposed rate is designed to 
more accurately reflect the risks posed than what is reflected in a VaR 
Charge.
    Because the expanded FIS Charge also would be a tailored component 
of the margin that NSCC collects from non-Watch List Members to help 
cover NSCC credit exposure to such Members, as the charge would be 
based on different product risk factors with respect to equity and 
fixed-income securities, as described above, the Commission believes 
that the proposed changes in the Advance Notice are consistent with 
Rule 17Ad-22(e)(6)(i) and (v) under the Exchange Act.\26\
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    \26\ Id.
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\27\ that the Commission does not object to 
Advance Notice (SR-NSCC-2017-804) and that NSCC is authorized to 
implement the proposed change as of the date of this notice or the date 
of an order by the Commission approving the proposed rule change (SR-
NSCC-2017-010) that reflects rule changes that are consistent with this 
Advance Notice, whichever is later.
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    \27\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-19375 Filed 9-12-17; 8:45 am]
 BILLING CODE 8011-01-P


