
[Federal Register Volume 82, Number 176 (Wednesday, September 13, 2017)]
[Notices]
[Pages 43061-43063]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-19379]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81550; File No. SR-NSCC-2017-010]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Order Approving Proposed Rule Change 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'') proposed rule change SR-NSCC-2017-010 (``Proposed Rule 
Change'') 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 31, 
2017.\3\ The Commission did not receive any comments on the Proposed 
Rule Change. For the reasons discussed below, the Commission approves 
the Proposed Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 81203 (July 25, 2017), 
82 FR 35563 (July 31, 2017) (SR-NSCC-2017-010) (``Notice''). NSCC 
also filed a related advance notice with the Commission pursuant to 
Section 806(e)(1) of the Payment, Clearing, and Settlement 
Supervision Act of 2010 and Rule 19b-4(n)(1) under the Act. 15 
U.S.C. 5465(e)(1) and 17 CFR 240.19b-4(n)(1). The advance notice was 
published in the Federal Register on August 2, 2017. Securities 
Exchange Act Release No. 81286 (August 2, 2017), 82 FR 37141 (August 
8, 2017) (SR-NSCC-2017-804). The Commission did not receive any 
comments on that proposal.
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I. Description of the Proposed Rule Change

    The Proposed Rule Change is a proposal by NSCC to further address 
specific wrong-way risk \4\ 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'').\5\ 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.\6\ 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.\7\ 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.\8\ As described in detail below, 
NSCC proposes in the Proposed Rule Change 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.\9\
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    \4\ 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.
    \5\ Notice, 82 at 35563-64. 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. Notice, 82 at 35563.
    \6\ Notice, 82 at 35563. 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.
    \7\ Notice, 82 at 35564.
    \8\ Id.
    \9\ Id.
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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'').\10\ 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.\11\ 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.\12\ 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.\13\ 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.\14\
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    \10\ Id.
    \11\ Id. 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. See Section I(B)(1) of Procedure XV of NSCC's Rules, 
available at http://dtcc.com/~/media/Files/Downloads/legal/rules/
nscc_rules.pdf.
    \12\ Notice, 82 at 35564. 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. Id.
    \13\ Id.
    \14\ Id.
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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

[[Page 43062]]

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 Proposed Rule Change 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.\15\
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    \15\ Id. 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. Securities Exchange Act Release No. 75768 
(August 27, 2015), 80 FR 53219, 53220 (September 2, 2015) (SR-NSCC-
2015-003).
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II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act 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 rules and regulations thereunder applicable to such 
organization.\16\ After carefully considering the Proposed Rule Change, 
the Commission finds that the Proposed Rule Change is consistent with 
the requirements of the Act and the rules and regulations thereunder 
applicable to NSCC. In particular, the Commission believes the proposal 
is consistent with Section 17A(b)(3)(F) of the Act,\17\ as well as 
Rules 17Ad-22(e)(4)(i) and 17Ad-22(e)(6)(i) and (e)(6)(v) 
thereunder.\18\
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    \16\ 15 U.S.C. 78s(b)(2)(C).
    \17\ 15 U.S.C. 78q-1(b)(3)(F).
    \18\ 17 CFR 240.17Ad-22(e)(4)(vi); (e)(6)(i); and (e)(6)(v).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, in part, that the rules 
of a clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions, and to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible.\19\ The 
Commission believes that the Proposed Rule Change is consistent with 
the requirements of Section 17A(b)(3)(F) of the Act for the reasons set 
forth below.
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    \19\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that the proposal is designed to promote 
the prompt and accurate clearance and settlement of securities 
transactions. As described above, the proposal would provide for the 
collection by NSCC of margin amounts that contemplate and help address 
the specific wrong-way risk presented by all Members. In doing so, the 
proposal would help ensure that NSCC 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 to continue 
providing prompt and accurate clearance and settlement of securities 
transactions in the event of a Member default.
    The Commission believes also that the proposal is designed to 
assure the safeguarding of securities and funds which are in the 
custody or control of NSCC or for which it is responsible. 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 
assure the safeguarding of securities and funds which are in the 
custody or control of NSCC by mitigating the risk that NSCC would 
suffer a loss from a Member default, and reducing Members' exposure to 
clearing fund losses from the specific wrong-way risk that NSCC faces 
from Member transactions in family-issued securities. Therefore, for 
the reasons stated above, the Commission believes that the Proposed 
Rule Change is consistent with the requirements of Section 17A(b)(3)(F) 
of the Act.\20\
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    \20\ Id.
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B. Consistency With Rule 17Ad-22(e)(4)(i)

    The Commission believes that the Proposed Rule Change is consistent 
with Rule 17Ad-22(e)(4)(i) under the 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.\21\
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    \21\ 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 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 Act.\22\
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    \22\ Id.
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C. Consistency With Rule 17Ad-22(e)(6)(i) and (e)(6)(v)

    The Commission believes that the Proposed Rule Change is consistent 
with Rule 17Ad-22(e)(6)(i) and (e)(6)(v) under the Act, which require, 
in part, that NSCC establish, implement,

[[Page 43063]]

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.\23\
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    \23\ 17 CFR 240.17Ad-22(e)(6)(i) and (e)(6)(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 Proposed Rule Change are consistent 
with Rule 17Ad-22(e)(6)(i) and (e)(6)(v) under the Act.\24\
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    \24\ Id.
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the Act, in 
particular the requirements of Section 17A of the Act \25\ and the 
rules and regulations promulgated thereunder.
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    \25\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that proposed rule change SR-NSCC-2017-010 be and hereby is APPROVED as 
of the date of this order or the date of a notice by the Commission 
authorizing NSCC to implement its related advance notice proposal (SR-
NSCC-2017-804), whichever is later.\26\ 
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    \26\ In approving the Proposed Rule Change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \27\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\27\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-19379 Filed 9-12-17; 8:45 am]
 BILLING CODE 8011-01-P


