[Federal Register Volume 83, Number 27 (Thursday, February 8, 2018)]
[Notices]
[Pages 5658-5665]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-02543]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-82631; File No. SR-NSCC-2017-808]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Advance Notice, as Modified by 
Amendment No. 1, To Enhance the Calculation of the Volatility Component 
of the Clearing Fund Formula That Utilizes a Parametric Value-at-Risk 
Model and Eliminate the Market Maker Domination Charge

February 5, 2018.
    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, as amended (``Act''),\2\ notice is hereby given 
that on December 28, 2017, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') the advance notice SR-NSCC-2017-808. On January 10, 
2018, NSCC filed Amendment No. 1 to the advance notice.\3\ The advance 
notice, as modified by Amendment No. 1 (hereinafter, the ``Advance 
Notice'') is described in Items I, II and III below, which Items have 
been prepared by the clearing agency.\4\ The Commission is publishing 
this notice to solicit comments on the Advance Notice from interested 
persons.
---------------------------------------------------------------------------

    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ In Amendment No. 1 to the advance notice, NSCC amended and 
replaced in its entirety the originally filed confidential Exhibit 
3a with a new confidential Exhibit 3a in order to remove references 
to a practice that is not to be considered as part of this filing.
    \4\ On December 28, 2017, NSCC filed this Advance Notice as a 
proposed rule change (SR-NSCC-2017-020) with the Commission pursuant 
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4 
thereunder, 17 CFR 240.19b-4. On January 10, 2018, NSCC filed 
Amendment No. 1 to the proposed rule change to amend and replace in 
its entirety the originally filed confidential Exhibit 3a with a new 
confidential Exhibit 3a in order to remove references to a practice 
that is not to be considered as part of this filing. A copy of the 
proposed rule change, as modified by Amendment No. 1, is available 
at http://www.dtcc.com/legal/sec-rule-filings.
---------------------------------------------------------------------------

I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    The advance notice of NSCC consists of modifications to NSCC's 
Rules &

[[Page 5659]]

Procedures (``Rules'') \5\ in order to enhance the calculation of the 
volatility component of the Clearing Fund formula that utilizes a 
parametric Value-at-Risk (``VaR'') model (``VaR Charge'') by (1) adding 
an additional calculation utilizing the VaR model that incorporates an 
evenly-weighted volatility estimation, which would supplement the 
current calculation that utilizes the VaR model but incorporates an 
exponentially-weighted moving average (``EWMA'') volatility 
estimation,\6\ where the higher of the two calculations would be the 
core parametric result (``Core Parametric Estimation''); and (2) 
introducing two additional formulas to the calculation of the VaR 
Charge--the Gap Risk Measure and the Portfolio Margin Floor, where the 
results of these two calculations would be compared to the Core 
Parametric Estimation and the highest of the three would be a Member's 
final VaR Charge, as described in greater detail below.
---------------------------------------------------------------------------

    \5\ Capitalized terms not defined herein are defined in the 
Rules, available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
    \6\ As described in greater detail in the filing, an EWMA 
volatility estimation is an estimation of volatility that gives more 
weight to most recent market observations, where an evenly-weighted 
volatility estimation is an estimation of volatility that gives even 
weight to historic market observations.
---------------------------------------------------------------------------

    NSCC is also proposing to eliminate the existing Market Maker 
Domination component (``MMD Charge'') from the Clearing Fund formula, 
as described in greater detail below.

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

    While NSCC has not solicited or received any written comments 
relating to this proposal, NSCC has conducted outreach to Members in 
order to provide them with notice of the proposal. NSCC will notify the 
Commission of any written comments received by NSCC.

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

Description of Proposed Changes
    NSCC is proposing to enhance the calculation of the VaR Charge by 
introducing an additional estimation of volatility that would be 
incorporated into the VaR model, and introducing two additional 
calculations, the Gap Risk Measure and the Portfolio Margin Floor, that 
NSCC believes would collectively enhance its ability to mitigate market 
price risk. NSCC currently calculates the VaR Charge by applying a 
parametric VaR model that incorporates an EWMA volatility estimation. 
NSCC is proposing to introduce an additional calculation that also 
applies the parametric VaR model but replaces the EWMA volatility 
estimation with an evenly-weighted volatility estimation.\7\ The result 
of these two calculations using the parametric VaR model would be 
compared and the higher of the two would be the Core Parametric 
Estimation.
---------------------------------------------------------------------------

    \7\ See id.
---------------------------------------------------------------------------

    NSCC is also proposing to introduce two additional calculations to 
arrive at a final VaR Charge, the Gap Risk Measure and the Portfolio 
Margin Floor. NSCC would use the highest result between the Core 
Parametric Estimation, the Gap Risk Measure, when applicable, and the 
Portfolio Margin Floor calculations as a Member's final VaR Charge.\8\
---------------------------------------------------------------------------

    \8\ NSCC may calculate Members' VaR Charge on an intraday basis 
for purposes of monitoring the risks presented by Members' activity. 
These calculations would be also be performed using the proposed 
enhanced methodology.
---------------------------------------------------------------------------

    Each of the separate calculations would provide NSCC with a measure 
of the market price risk presented by the Net Unsettled Positions and 
Net Balance Order Unsettled Positions (for purposes of this filing, 
referred to collectively herein as ``Net Unsettled Positions'') \9\ in 
a Member's portfolio. Collectively, the proposed enhancements to the 
calculation of the VaR Charge would permit NSCC to more effectively 
cover its credit exposures and produce margin levels commensurate with 
the risks and particular attributes of each Member's portfolio, as 
described in greater detail below.
---------------------------------------------------------------------------

    \9\ ``Net Unsettled Positions'' and ``Net Balance Order 
Unsettled Positions'' refer to net positions that have not yet 
passed their settlement date, or did not settle on their settlement 
date. See Procedure XV (Clearing Fund Formula and Other Matters) of 
the Rules, supra note 4.
---------------------------------------------------------------------------

    NSCC is also proposing to eliminate the existing MMD Charge from 
the Clearing Fund formula. When the MMD Charge was first introduced, it 
was developed to only address concentration risks presented by Net 
Unsettled Positions in certain securities that are traded by firms that 
are designated Market Makers, as described in greater detail below. 
Given this limited scope of application of this charge, and because 
NSCC believes it more effectively addresses the risks this charge was 
designed to address through other risk management measures, including 
the proposed Gap Risk Measure calculation of the VaR Charge, NSCC is 
proposing to eliminate the MMD Charge.
    Each of these proposed changes is described in more detail below.
(i) Overview of the Required Deposit and NSCC's Clearing Fund
    As part of its market risk management strategy, NSCC manages its 
credit exposure to Members by determining the appropriate Required 
Deposits to the Clearing Fund and monitoring its sufficiency, as 
provided for in the Rules.\10\ The Required Deposit serves as each 
Member's margin. The objective of a Member's Required Deposit is to 
mitigate potential losses to NSCC associated with liquidation of such 
Member's portfolio in the event that NSCC ceases to act for such Member 
(hereinafter referred to as a ``default'').\11\ The aggregate of all 
Members' Required Deposits constitutes the Clearing Fund of NSCC, which 
it would access should a defaulting Member's own Required Deposit be 
insufficient to satisfy losses to NSCC caused by the liquidation of 
that Member's portfolio.
---------------------------------------------------------------------------

    \10\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters), supra note 4. NSCC's market risk 
management strategy is designed to comply with Rule 17Ad-22(e)(4) 
under the Act, where these risks are referred to as ``credit 
risks.'' 17 CFR 240.17Ad-22(e)(4).
    \11\ The Rules set out the circumstances under which NSCC may 
cease to act for a Member and the types of actions it may take. For 
example, NSCC may suspend a firm's membership with NSCC or prohibit 
or limit a Member's access to NSCC's services in the event that 
Member defaults on a financial or other obligation to NSCC. See Rule 
46 (Restrictions on Access to Services) of the Rules, supra note 4.
---------------------------------------------------------------------------

    Pursuant to NSCC's Rules, each Member's Required Deposit amount 
consists of a number of applicable components, each of which is 
calculated to address specific risks faced by NSCC, as identified 
within Procedure XV of the Rules.\12\ The volatility component of each 
Member's Required Deposit is designed to measure market price 
volatility and is calculated for Members' Net Unsettled Positions. The 
volatility component is designed to capture the market price risk 
associated with each Member's portfolio at a 99th percentile

[[Page 5660]]

level of confidence. The VaR Charge is the volatility component 
applicable to most Net Unsettled Positions,\13\ and usually comprises 
the largest portion of a Member's Required Deposit. Procedure XV of the 
Rules currently provides that the VaR Charge shall be calculated in 
accordance with a generally accepted portfolio volatility margin model 
utilizing assumptions based on reasonable historical data and an 
appropriate volatility range.\14\ As such, NSCC currently calculates a 
Member's VaR Charge utilizing the VaR model, which incorporates an EWMA 
volatility estimation.
---------------------------------------------------------------------------

    \12\ Supra note 4.
    \13\ As described in Procedure XV, Section I(A)(1)(a)(ii) and 
(iii) and Section I(A)(2)(a)(ii) and (iii) of the Rules, Net 
Unsettled Positions in certain securities are excluded from the VaR 
Charge and instead charged a volatility component that is calculated 
by multiplying the absolute value of those Net Unsettled Positions 
by a percentage. Supra note 4.
    \14\ Procedure XV, Section I(A)(1)(a)(i) and Section 
I(A)(2)(a)(i) of the Rules, supra note 4.
---------------------------------------------------------------------------

    Currently, Members' Required Deposits may also include an MMD 
Charge, applicable only to Members that are Market Makers and Members 
that clear for Market Makers.\15\ As described in greater detail below, 
the MMD Charge is imposed when these Members hold a Net Unsettled 
Position that is greater than 40 percent of the overall unsettled long 
position (sum of each clearing broker's net long position) in that 
security in the Continuous Net Settlement (``CNS'') system.\16\
---------------------------------------------------------------------------

    \15\ As used herein, ``Market Maker'' means a member firm of the 
Financial Industry Regulatory Authority, Inc. (``FINRA'') that is 
registered by FINRA as a Market Maker pursuant to FINRA's rules, 
available at http://finra.complinet.com/en/display/display.html.
    \16\ See Rule 11 (CNS System) and Procedure VII (CNS Accounting 
Operation), supra note 4.
---------------------------------------------------------------------------

    NSCC employs daily backtesting to determine the adequacy of each 
Member's Required Deposit. NSCC compares the Required Deposit \17\ for 
each Member with the simulated liquidation gains/losses using the 
actual positions in the Member's portfolio, and the historical security 
returns. NSCC investigates the cause(s) of any backtesting 
deficiencies. As part of this investigation, NSCC pays particular 
attention to Members with backtesting deficiencies that bring the 
results for that Member below the 99 percent confidence target (i.e., 
greater than two backtesting deficiency days in a rolling twelve-month 
period) to determine if there is an identifiable cause of repeated 
backtesting deficiencies.
---------------------------------------------------------------------------

    \17\ For backtesting comparisons, NSCC uses the Required Deposit 
amount without regard to the actual collateral posted by the Member.
---------------------------------------------------------------------------

    Further, as a part of its model performance review, and consistent 
with its regulatory requirements, NSCC regularly assesses its risks as 
they relate to its model assumptions, parameters, and sensitivities, 
including those of its parametric VaR model, to evaluate whether margin 
levels are commensurate with the particular risk attributes of each 
relevant product, portfolio, and market.\18\ As part of NSCC's model 
performance monitoring, NSCC management analyzes and evaluates the 
continued effectiveness of its parametric VaR model in order to 
identify any weaknesses, and determine whether, and which, enhancements 
may be necessary to its formulas, parameters or assumptions to improve 
margin coverage.
---------------------------------------------------------------------------

    \18\ See 17 CFR 240.17Ad-22(e)(6)(i), (vi).
---------------------------------------------------------------------------

    The proposed changes to the calculation of the VaR Charge, 
described below, are a result of NSCC's regular review of the 
effectiveness of its margining methodology.
(ii) Enhancements to the VaR Charge
    Adding an Evenly-Weighted Volatility Estimation to the VaR Model. 
To calculate the VaR Charge, NSCC uses a parametric VaR model that 
currently only incorporates an EWMA volatility estimation. The EWMA 
volatility estimation is considered front-weighted as it assigns more 
weight to most recent market observations based on the assumption that 
the most recent price history would have more relevance to, and 
therefore is a better measure of, current market price volatility 
levels. A calculation using this EWMA volatility estimation is 
responsive to changing market volatility, and, because NSCC's Member-
level model backtesting results have generally remained above a 99th 
percentile level of confidence over a 10-year performance window, NSCC 
believes this calculation continues to be an effective measurement of 
price volatility for the majority of Net Unsettled Positions that are 
subject to the VaR Charge. More specifically, NSCC believes its 
backtesting results show that this calculation has been proven to be 
effective for calculating the price volatility of large diversified 
portfolios, which represent the majority of Net Unsettled Positions 
that are subject to the VaR Charge.
    However, NSCC believes this calculation may not adequately cover a 
rapid change in market price volatility levels, including, for example, 
a drop in portfolio volatility in a stabilizing market. Additionally, 
NSCC has observed poorer backtesting coverage for those Members with 
less diversified portfolios in atypical market conditions.
    In estimating volatility, the EWMA volatility estimation gives 
greater weight to more recent market observations, and effectively 
diminishes the value of older market observations. However, volatility 
in equity markets often rapidly revert to pre-volatile levels, and then 
are followed by a subsequent spike in volatility. So, while a 
calculation that relies exclusively on the EWMA volatility estimation 
can capture changes in volatility that emerge from a progressively calm 
or non-volatile market, it may cause a reactive decrease in margin that 
does not adequately capture the risks related to a rapid shift in 
market price volatility levels. Alternatively, an evenly-weighted 
volatility estimation would continue to give even weight to all 
historical volatility observations in the look-back period (described 
below), and would prevent margin from decreasing too quickly.
    Therefore, in order to more adequately cover a rapid change in 
market price volatility levels and the risks presented by less 
diversified portfolios in its calculation of the VaR Charge, NSCC is 
proposing to add another calculation of the VaR Charge utilizing its 
parametric VaR model that would incorporate an evenly-weighted 
volatility estimation. NSCC believes an additional calculation using a 
volatility estimation that gives even weight to market observations 
over a set look-back period would allow it to more adequately address 
risks related to a rapid shift in general market price volatility 
levels, which can occur as a result of either idiosyncratic, issuer 
events (also referred to as ``gap risk events''),\19\ or are due to 
specific characteristics of a Member's portfolio based on their size, 
balance, direction, concentration, or the degree of correlation with 
broad market returns.
---------------------------------------------------------------------------

    \19\ Gap risk events may include, for example, earning reports, 
management changes, merger announcements, insolvency, or other 
unexpected, issuer-specific events.
---------------------------------------------------------------------------

    The proposed calculation incorporating an evenly-weighted 
volatility estimation would give equal weight to price observations 
over a look-back period of at least 253 days. NSCC analyzed the impact 
of using a look-back period of various lengths and determined that a 
look-back period of at least 253 days would provide NSCC with an 
adequate view of recent, past market observations in estimating 
volatility to meet its backtesting performance targets, and wouldn't 
result in unnecessarily high margin calculations. NSCC would weigh 
these considerations periodically to determine

[[Page 5661]]

an appropriate look-back period that is at least 253 days.
    NSCC would perform both calculations using the parametric VaR 
model--one using the existing EWMA volatility estimation and an 
additional calculation using the proposed evenly-weighted volatility 
estimation--and would use the highest result of these calculations as 
the Core Parametric Estimation in connection with calculating a 
Member's VaR Charge. NSCC believes that, while the existing EWMA 
calculation provides adequate responsiveness to increasing market 
volatility, as described above, the proposed evenly-weighted 
calculation would be better at covering the risk of a rapid change in 
market volatility levels by retaining market observations from the 
entire historical data set. Therefore, by using both calculations and 
selecting the higher result, NSCC would be able to more effectively 
cover its credit exposures and mitigate the risk presented by different 
market conditions in arriving at a final Core Parametric Estimation.
    In order to implement the proposed change, NSCC would amend 
Procedure XV of the Rules by creating a new subjection (I) to Sections 
I(A)(1)(a)(i) and I(A)(2)(a)(i) of the Rules, which would define the 
Core Parametric Estimate as the higher result of two calculations--and 
EWMA calculation and the proposed evenly-weighted calculation--both 
utilizing the parametric VaR model.
    Gap Risk Measure. NSCC is also proposing to introduce the Gap Risk 
Measure as an additional calculation that, when applicable, would be 
used to determine a Member's final VaR Charge.
    The proposed Gap Risk Measure would be calculated to address the 
risks presented by a portfolio that is more susceptible to the effects 
of gap risk events due to the idiosyncratic nature of the Net Unsettled 
Positions in that portfolio. For example, the proposed calculation 
would address the risk that a gap risk event affects the price of a 
security in which a portfolio holds a Net Unsettled Position that 
represents more than a certain percent of the entire portfolio's value, 
such that the event could impact the entire portfolio's value. The 
proposed Gap Risk Measure would supplement the calculation of the Core 
Parametric Estimation because a parametric VaR model calculation is not 
designed to fully capture this specific risk presented by a 
concentrated position in a Member's portfolio.
    The proposed Gap Risk Measure would only be applied for a Member if 
the Net Unsettled Position with the largest absolute market value in 
the portfolio represents more than a certain percent of the entire 
portfolio's value (``concentration threshold''). NSCC is proposing a 
concentration threshold to the application of the Gap Risk Measure 
because its backtesting results have shown that portfolios with a Net 
Unsettled Position that represents a proportional value of the entire 
portfolio over 30 percent tend to have backtesting coverage below the 
target 99 percent confidence level. These results also show that these 
portfolios are more susceptible to the effects of gap risk events that 
the proposed calculation is designed to measure. Therefore, NSCC would 
only apply the Gap Risk Measure charge if the Net Unsettled Position 
with the largest absolute market value in a Member's portfolio 
represents more than 30 percent of that Member's entire portfolio 
value. NSCC would set 30 percent as the ceiling for the concentration 
threshold, and would evaluate the threshold periodically based on the 
Member's backtesting results during a time period of not less than the 
previous twelve months to determine if it may be appropriate to the 
threshold at a lower percent.
    Additionally, NSCC believes the risk of large, unexpected price 
movements, particularly those caused by a gap risk event, may have a 
greater impact on portfolios with large Net Unsettled Positions in 
securities that are susceptible to those events. Generally, index-based 
exchange-traded funds track closely to similar equity indices and are 
less prone to the effects of gap risk events. As such, if the 
concentration threshold is met, NSCC would calculate the Gap Risk 
Measure for Net Unsettled Positions in the portfolio, other than 
positions in index-based exchange traded funds (referred to herein for 
ease of reference as ``non-index Net Unsettled Positions'').\20\
---------------------------------------------------------------------------

    \20\ NSCC would use a third-party market provider to identify 
index-based exchange-traded funds. The third-party market provider 
would identify index-based exchange-traded funds as those with 
criteria that requires the portfolio returns to track to a broad 
market index. Exchange-traded funds that do not meet this criteria 
would not be considered index-based exchange-traded funds and would 
be included the Gap Risk Measure calculation.
---------------------------------------------------------------------------

    When applicable, NSCC would calculate the Gap Risk Measure by 
multiplying the gross market value of the largest non-index Net 
Unsettled Position in the portfolio by a percent of not less than 10 
percent.\21\ NSCC would determine such percent empirically as no less 
than the larger of the 1st and 99th percentiles of three-day returns of 
a set of CUSIPs that are subject to the VaR Charge pursuant to the 
Rules,\22\ giving equal rank to each to determine which has the highest 
movement over that three-day period. NSCC would use a look-back period 
of not less than ten years that includes a one-year stress period.\23\ 
If the one-year stress period overlaps with the look-back period, only 
the non-overlapping period would be combined with the look-back period. 
The result would then be rounded up to the nearest whole percentage.
---------------------------------------------------------------------------

    \21\ NSCC believes it is prudent to set a floor for the Gap Risk 
Measure charge, and has determined that a floor of 10 percent would 
appropriately align this charge with the charge that is applied to 
Net Unsettled Positions in certain securities that are excluded from 
the VaR Charge and instead charged a similar haircut-based 
volatility component. See supra note 12.
    \22\ Supra note 12.
    \23\ NSCC believes using a look-back period of not less than ten 
years that includes a one-year stress period would provide it with a 
stable risk measurement that incorporates a sufficient look-back 
period that would be appropriate for purposes of determining the 
appropriate percent to use in the calculation of the Gap Risk 
Measure.
---------------------------------------------------------------------------

    By calculating this charge as a percent of the gross market value 
of the largest non-index Net Unsettled Position that exceeds the set 
threshold, NSCC believes the proposed Gap Risk Measure would allow it 
to capture the risk that a gap risk event affects the price of a 
security in which the Member holds a concentrated position and, due to 
the disproportionate value of this position in the Member's portfolio, 
the impact of that event affects the entire portfolio. This 
calculation, as an additional measure for the VaR Charge, would permit 
NSCC to assess an adequate amount of margin to cover the gap risks not 
captured by the parametric VaR model calculations. As such, the 
proposed calculation would contribute to NSCC's goal of producing 
margin levels commensurate with the risks and particular attributes of 
each Member's portfolio.
    In order to implement this proposed change, NSCC would amend 
Procedure XV of the Rules by creating a new subjection (II) to Sections 
I(A)(1)(a)(i) and I(A)(2)(a)(i) of the Rules, which would describe the 
calculation of the Gap Risk Measure.
    Portfolio Margin Floor. NSCC is also proposing to introduce the 
Portfolio Margin Floor as an additional calculation that, when 
applicable, would be used to determine a Member's final VaR Charge.
    The proposed Portfolio Margin Floor would be calculated to address 
risks that may not be adequately accounted for in the other 
calculations of the VaR Charge by operating as a floor to, or minimum 
amount of, the final VaR Charge. A parametric VaR model may result in a 
low VaR Charge for balanced portfolios. For example, in

[[Page 5662]]

circumstances where the gross market value of a Member's Net Unsettled 
Positions is high and the cost of liquidation in the event that Member 
defaults could also be high, the parametric VaR model may not 
adequately measure the potential costs of liquidation. The proposed 
charge would be based on the balance and direction of Net Unsettled 
Positions in the Members' portfolio and is designed to be proportional 
to the market value of the portfolio. In this way, the Portfolio Margin 
Floor would allow NSCC to more effectively cover its credit exposures.
    The Portfolio Margin Floor would be the sum of two separate 
calculations, both of which would measure the market value of the 
portfolio based on the direction of Net Unsettled Positions in that 
portfolio. In this way, the calculation would effectively set a floor 
on the VaR Charge based on the composition of the portfolio and would 
mitigate the risk that low price volatility in portfolios with either 
large gross market values or large net directional market values could 
hinder NSCC's ability to effectively liquidate or hedge the Member's 
portfolio in three business days.
    First, NSCC would calculate the net directional market value of the 
portfolio by calculating the absolute difference between the market 
value of the long Net Unsettled Positions and the market value of the 
short Net Unsettled Positions in the portfolio,\24\ and then 
multiplying that amount by a percentage. Such percentage would be 
determined by examining the annual historical volatility levels of 
benchmark equity indices over a historical look-back period, as a 
standard and generally accepted reference that incorporates sufficient 
data history. Second, NSCC would calculate the balanced market value of 
the portfolio by taking the lowest market value of either (i) the long 
Net Unsettled Positions, or (ii) the short Net Unsettled Positions in 
the portfolio,\25\ and then multiplying that value by a percentage. 
Such percentage would generally be a fraction of the percentage used in 
the calculation of the net directional market value of the portfolio 
and would be an amount that covers the transaction costs and other 
basis risks present for the Net Unsettled Positions in that 
portfolio.\26\
---------------------------------------------------------------------------

    \24\ For example, if the market value of the long Net Unsettled 
Positions is $100,000, and the market value of the short Net 
Unsettled Positions is $200,000, the net directional market value of 
the portfolio is $100,000.
    \25\ For example, if the market value of the long Net Unsettled 
Positions is $100,000, and the market value of the short Net 
Unsettled Positions is $110,000, the balanced market value of the 
portfolio is $100,000.
    \26\ NSCC would use a third-party market provider to identify 
these transaction costs and other basis risks.
---------------------------------------------------------------------------

    NSCC would add the results of these two calculations to arrive at 
the final Portfolio Margin Floor amount. The sum of these two 
calculations would provide a minimum VaR Charge by effectively 
establishing a margin floor for certain portfolios that may not be 
effectively assessed in the other calculations of the VaR Charge. NSCC 
would compare the Portfolio Margin Floor result with the Gap Risk 
Measure, when applicable, and the Core Parametric Estimation and would 
use the highest of the three calculations as the final VaR Charge for 
each Member, as applicable.
    In order to implement this proposed change, NSCC would amend 
Procedure XV of the Rules by creating a new subjection (III) to 
Sections I(A)(1)(a)(i) and I(A)(2)(a)(i) of the Rules, which would 
describe the calculation of the Portfolio Margin Floor.
(iii) Eliminating the MMD Charge
    Finally, NSCC is proposing to eliminate the MMD Charge from its 
Clearing Fund calculation. The MMD Charge is an existing component of 
the Clearing Fund formula and is calculated for Members that are Market 
Makers and Members that clear for Market Makers.\27\ The charge was 
introduced during a period of rapid growth in the adaptation of the 
internet, and was developed to address the risks presented by 
concentrated positions held specifically by Market Makers. The MMD 
Charge is described in Procedure XV of the Rules, which provides that, 
if the Market Maker (either the Member or the correspondent of the 
Member) holds a Net Unsettled Position that is greater than 40 percent 
of the overall unsettled long position (sum of each clearing broker's 
net long position) in that security in the CNS system, NSCC may impose 
the MMD Charge. NSCC calculates the MMD charge as the sum of each of 
the absolute values of the Net Unsettled Positions in these securities, 
less the reported amount of excess net capital for that Member.\28\ The 
MMD charge is designed to address dominated securities that are 
susceptible to marketability and liquidation impairment because of the 
relative size of the Net Unsettled Positions that NSCC would have to 
liquidate or hedge in the case of Member default.
---------------------------------------------------------------------------

    \27\ See Procedure XV, Section I(A)(1)(d) of the Rules, supra 
note 4.
    \28\ NSCC does not apply the excess net capital offset for 
Members rated 7 on the Credit Risk Rating Matrix. See Procedure XV, 
Sections I(A)(1)(d) and I(A)(2)(c) of the Rules, supra note 4.
---------------------------------------------------------------------------

    Since the MMD Charge was implemented, the U.S. equities market has 
evolved with improved price transparency, access across exchange 
venues, and participation by market liquidity providers to reduce the 
risks that the charge was designed to address. Further, NSCC believes 
the MMD Charge may not effectively address concentration risk because 
(1) it only applies to Net Unsettled Positions in certain dominated 
securities, as described above and currently in Procedure XV of the 
Rules; (2) it does not address concentration risk presented by Net 
Unsettled Positions in securities that are not listed on NASDAQ or in 
securities traded by firms that are not Market Makers; and (3) it does 
not account for concentration in market capitalization categories.
    NSCC also believes that the proposed enhancements to the VaR 
Charge, specifically the introduction of an evenly-weighted volatility 
measure and the calculation of the Gap Risk Measure, would provide it 
with more effective measures of risks related to concentrated positions 
in its Members' portfolios. Subject to applicable thresholds, these 
proposed risk measures would be applicable to all Members as part of 
the calculation VaR Charge, and would not, like the MMD Charge, be 
limited to positions held by Market Makers. Further, as a threshold-
based calculation, the Gap Risk Measure would provide NSCC with a more 
appropriate measure of the potential risk presented by a large Net 
Unsettled Position in a portfolio. Therefore, NSCC believes that these 
proposed enhancements to the VaR Charge and other existing risk 
management measures (described below) would provide it with more 
effective measures of the risks presented by concentrated positions, 
and, as such, it is appropriate to eliminate the MMD Charge.
    In order to implement this proposed change, NSCC would amend 
Procedure XV of the Rules by removing subsection (d) of Section I(A)(1) 
and subsection (c) of Section I(A)(2) of the Rules, and renumbering the 
subsequent subsections accordingly.
(iv) Mitigating Risks of Concentrated Positions
    For the reasons described above, NSCC believes that the proposed 
enhancements to its VaR Charge would allow it to better measure and 
mitigate the risks presented by certain Net Unsettled Positions, 
including the risk presented to NSCC when those positions are 
concentrated in a

[[Page 5663]]

particular security. One of the risks presented by a Net Unsettled 
Position concentrated in an asset class is that NSCC may not be able to 
liquidate or hedge the Net Unsettled Positions of a defaulted Member in 
the assumed timeframe at the market price in the event of a Member 
default. Because NSCC relies on external market data in connection with 
monitoring exposures to its Members, the market data may not reflect 
the market impact transaction costs associated with the potential 
liquidation as the concentration risk of a Net Unsettled Position 
increases. However, NSCC believes that, through the proposed changes 
and through existing risk management measures,\29\ it would be able to 
effectively measure and mitigate risks presented when a Member's Net 
Unsettled Positions are concentrated in a particular security.
---------------------------------------------------------------------------

    \29\ For example, pursuant to existing authority under Procedure 
XV, Sections I(A)(1)(e) and I(A)(2)(d) of the Rules (to be re-
numbered pursuant this advance notice to Sections I(A)(1)(d) and 
I(A)(2)(c) of Procedure XV of the Rules), NSCC may require an 
additional payment as part of a Member's Required Deposit in the 
event it observes price fluctuations in or volatility or lack of 
liquidity of any security that are not otherwise addressed by its 
VaR Charge or the other components of the Clearing Fund. An example 
of where this additional payment may be required is in circumstances 
where NSCC identifies an exposure that is not adequately addressed 
by its margining methodology. Supra note 4.
---------------------------------------------------------------------------

    NSCC will continue to evaluate its exposures to these risks. Any 
future, proposed changes to the margining methodology to address such 
risks would be subject to a separate proposed rule change pursuant to 
Section 19(b)(1) of the Act,\30\ and the rules thereunder, and advance 
notice pursuant to Section 806(e)(1) of the Clearing Supervision 
Act,\31\ and the rules thereunder.
---------------------------------------------------------------------------

    \30\ 15 U.S.C. 78s(b)(1).
    \31\ 12 U.S.C. 5465(e)(1).
---------------------------------------------------------------------------

Expected Effect on and Management of Risk
    NSCC believes that the proposed changes to enhance the calculation 
of the VaR Charge would enable NSCC to better limit its exposure to 
Members arising out of their Net Unsettled Positions. The proposal to 
enhance the calculation of the VaR Charge would enable NSCC to limit 
its credit exposures posed by portfolios whose risk characteristics are 
not effectively covered by the current VaR Charge. The proposal to add 
another calculation of the VaR Charge using the VaR model but 
incorporating an evenly-weighted volatility measure would permit NSCC 
to more effectively measure the risk of a rapid change in market price 
volatility, which may not be adequately covered by the calculation that 
incorporates an EWMA volatility estimation. The addition of the Gap 
Risk Measure, when applicable, and the Portfolio Margin Floor 
calculations would provide alternative measurements of the market price 
volatility of a Member's Net Unsettled Positions, enabling NSCC to 
assess a VaR Charge that accounts for risks related to gap risk events, 
and risks related to the unique compositions of securities within a 
Member's Net Unsettled Positions, respectively and as described in 
greater detail above. Therefore, by enabling NSCC to calculate and 
collect margin that more accurately reflects the risk characteristics 
of securities in its Members' Net Unsettled Positions, the proposal 
would enhance NSCC's risk management capabilities.
    NSCC's proposal to eliminate the MMD Charge would affect NSCC's 
management of risk by removing a component from the Clearing Fund 
calculations that has a limited scope, and was designed to address 
risks related to a Member's concentration risks that would be more 
adequately addressed by other proposed and existing risk management 
measures.
    By providing NSCC with a more effective measurement of its 
exposures, as described above, the proposed change would also mitigate 
risk for Members because lowering the risk profile for NSCC would in 
turn lower the risk exposure that Members may have with respect to NSCC 
in its role as a central counterparty.
Consistency With the Clearing Supervision Act
    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.\32\
---------------------------------------------------------------------------

    \32\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    Section 805(a)(2) of the Clearing Supervision Act \33\ authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like NSCC, and financial institutions engaged in designated activities 
for which the Commission is the supervisory agency or the appropriate 
financial regulator. Section 805(b) of the Clearing Supervision Act 
\34\ states that the objectives and principles for the risk management 
standards prescribed under Section 805(a) shall be to, among other 
things, 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 \35\ and 
Section 17A of the Exchange Act (``Covered Clearing Agency 
Standards'').\36\ The Covered Clearing Agency Standards require 
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.\37\
---------------------------------------------------------------------------

    \33\ 12 U.S.C. 5464(a)(2).
    \34\ 12 U.S.C. 5464(b).
    \35\ 12 U.S.C. 5464(a)(2).
    \36\ See 17 CFR 240.17Ad-22(e).
    \37\ Id.
---------------------------------------------------------------------------

(i) Consistency With Section 805(b) of the Clearing Supervision Act
    For the reasons described below, NSCC believes that the proposed 
changes in this advance notice are consistent with the objectives and 
principles of these risk management standards as described in Section 
805(b) of the Clearing Supervision Act and in the Covered Clearing 
Agency Standards.
    As discussed above, NSCC is proposing a number of changes to the 
way it calculates the VaR Charge, one of the components of its Members' 
Required Deposits--a key tool that NSCC uses to mitigate potential 
losses to NSCC associated with liquidating a Member's portfolio in the 
event of Member default. NSCC believes the proposed changes are 
consistent with promoting robust risk management because they are 
designed to enable NSCC to better limit its exposure to Members in the 
event of a Member default.
    First, NSCC's proposal to introduce an additional calculation using 
its parametric VaR model that uses an evenly-weighted volatility 
estimation would better enable NSCC to limit its exposures to Members 
by enhancing the calculation of the VaR Charge to better cover the risk 
of a rapid change in market price volatility levels, including, for 
example, a drop in portfolio volatility in a stabilizing market. 
Second, the proposal to introduce the Gap Risk Measure calculation as 
an additional measure of volatility in connection with the calculation 
of the VaR Charge would better enable NSCC

[[Page 5664]]

to limit its exposures to Members by more effectively capturing the 
risk that gap risk events impact the entire portfolio's value due to 
the idiosyncratic nature of the Net Unsettled Positions in that 
portfolio. Third, the proposal to introduce the Portfolio Margin Floor 
in its calculation of a Member's VaR Charge would enable NSCC to better 
limit its exposures to Members by better capturing the risks that may 
not be adequately accounted for in the other calculations of the VaR 
Charge. Finally, NSCC's proposal to eliminate the MMD Charge would 
enable NSCC to remove a component of the Required Deposit that provides 
NSCC with only a limited measure of risks presented by Net Unsettled 
Positions that are concentrated in certain securities, which NSCC 
believes it can more adequately measure through other proposed and 
existing risk management measures, as described above.
    Therefore, because the proposal is designed to enable NSCC to 
better limit its exposure to Members in the manner described above, 
NSCC believes it is consistent with promoting robust risk management.
    Furthermore, NSCC believes that the changes proposed in this 
advance notice are consistent with promoting safety and soundness, 
which, in turn, is consistent with reducing systemic risks and 
supporting the stability of the broader financial system, consistent 
with Section 805(b) of the Clearing Supervision Act.\38\ The proposed 
changes are designed to better limit NSCC's exposures to Members in the 
event of Member default. As discussed above, the proposed enhancements 
to the calculation of the VaR Charge would enable NSCC to view and 
respond more effectively to market price risk. The proposal to 
introduce an additional calculation of the VaR Charge using the VaR 
model that incorporates an evenly-weighted volatility measure, rather 
than an EWMA volatility estimation, would permit NSCC to more 
effectively measure the risk of a rapid change in market price 
volatility. The proposed Gap Risk Measure would provide NSCC with a 
more appropriate measure of the potential risk presented by a large Net 
Unsettled Position in a portfolio. The proposed Portfolio Margin Floor 
would ensure NSCC collects at least a minimum VaR Charge. Finally, 
removing the MMD Charge would help ensure the Clearing Fund calculation 
would not include unnecessary components that have only limited 
application, particularly where NSCC is able to better address the 
risks this charge was designed to address through other proposed and 
existing risk management measures.
---------------------------------------------------------------------------

    \38\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    By better limiting NSCC's exposures to Members in the event of a 
Member default, the proposed changes are consistent with promoting 
safety and soundness, which, in turn, is consistent with reducing 
systemic risks and supporting the stability of the broader financial 
system.
(ii) Consistency With Rule 17Ad-22(e)(4)(i) and (e)(6)(i) and (v) Under 
the Act
    NSCC believes that the proposed changes are consistent with Rule 
17Ad-22(e)(4)(i) and (e)(6)(i) and (v), each promulgated under the 
Act.\39\
---------------------------------------------------------------------------

    \39\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i) and (v).
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(4)(i) under the Act \40\ 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.
---------------------------------------------------------------------------

    \40\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    As described above, the proposed changes would enable NSCC to 
better identify, measure, monitor, and, through the collection of 
Members' Required Deposits, manage its credit exposures to Members by 
maintaining sufficient resources to cover those credit exposures fully 
with a high degree of confidence. Each of the additional calculations 
that NSCC is proposing to introduce to enhance its methodology for 
calculating a Member's VaR Charge would provide NSCC with a more 
effective measure of the risks these calculations were designed to 
assess, as described above. As such, the proposed enhancements to the 
calculation of the VaR Charge would permit NSCC to more effectively 
identify, measure, monitor and manage its exposures to market price 
risk, and would enable it to better limit its exposure to potential 
losses from Member default. The proposal to use the highest result of 
each of the calculations as among the Core Parametric Estimation, the 
Gap Risk Measure and the Portfolio Margin Floor, would enable NSCC to 
manage its credit exposures by allowing it to collect and maintain 
sufficient resources to cover those exposures fully and with a high 
degree of confidence.
    Furthermore, removing the MMD Charge would enable NSCC to remove 
from the Clearing Fund calculations a component that is limited in 
scope and would allow it to address the risks presented by Net 
Unsettled Positions that are concentrated in certain securities more 
effectively by other Clearing Fund components and risk management 
measures.
    Therefore, the proposal would enhance NSCC's ability to effectively 
identify, measure and monitor its credit exposures and would enhance 
its ability to maintain sufficient financial resources to cover its 
credit exposure to each participant fully with a high degree of 
confidence. As such, NSCC believes the proposed changes are consistent 
with Rule 17Ad-22(e)(4)(i) under the Act.\41\
---------------------------------------------------------------------------

    \41\ Id.
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(6)(i) under the Act \42\ requires, 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. Rule 17Ad-22(e)(6)(v) under the Act \43\ requires, 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, uses an appropriate method for measuring credit exposure that 
accounts for relevant product risk factors and portfolio effects across 
products.
---------------------------------------------------------------------------

    \42\ 17 CFR 240.17Ad-22(e)(6)(i).
    \43\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

    The Required Deposits are made up of risk-based components (as 
margin) that, that are calculated and assessed daily to limit NSCC's 
credit exposures to Members. NSCC's proposal to enhance the calculation 
of its VaR Charge in order to more effectively address market price 
volatility would permit it to produce margin levels that are 
commensurate with the particular risk attributes, including risks 
related to rapid changes in market price volatility levels due to gap 
risk events, or risks related to a unique composition of securities 
within a portfolio, as described above. For example, the use of an 
evenly-weighted volatility estimation utilizing the VaR model, as an 
additional calculation of the VaR Charge, which gives equal weight to a 
long historical data set, rather than more

[[Page 5665]]

weight to recent observations, would permit NSCC to more effectively 
measure the risk of a rapid change in market price volatility. The 
addition of the Gap Risk Measure and the Portfolio Margin Floor would 
also provide NSCC with additional measurements of the market price 
volatility of a Member's Net Unsettled Position, enabling NSCC to 
assess a VaR Charge that accounts for the risks those charges are 
designed to address, as described above.
    Finally, NSCC is proposing to eliminate the MMD Charge because this 
component of the Clearing Fund has only a limited application and, as 
such, does not provide as effective a measurement of the risk presented 
by Net Unsettled Positions that are concentrated in certain securities 
as other proposed and existing risk management measures. Therefore, the 
proposal to eliminate this charge would enable NSCC to remove an 
unnecessary component from the Clearing Fund calculation, and would 
help NSCC to rely on an appropriate method of measuring its exposures 
to this risk.
    The proposed changes are designed to assist NSCC in maintaining a 
risk-based margin system that considers, and produces margin levels 
commensurate with, the risks and particular attributes of portfolios 
that exhibit idiosyncratic risk attributes, are more susceptible to 
price volatility caused by to gap risk events, and contain concentrated 
Net Unsettled Positions. Therefore, NSCC believes the proposed change 
is consistent with Rule 17Ad-22(e)(6)(i) and (v) under the Act.\44\
---------------------------------------------------------------------------

    \44\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
---------------------------------------------------------------------------

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 website 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 [email protected]. Please include 
File Number SR-NSCC-2017-808 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-NSCC-2017-808. 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 website (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 website 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 NSCC and on DTCC's website 
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NSCC-2017-808 and should be submitted on 
or before February 23, 2018.

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-02543 Filed 2-7-18; 8:45 am]
 BILLING CODE 8011-01-P


