[Federal Register Volume 83, Number 151 (Monday, August 6, 2018)]
[Notices]
[Pages 38393-38413]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16709]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83747; File No. SR-FICC-2017-806]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Amendment No. 1 to an Advance Notice To Amend the 
Loss Allocation Rules and Make Other Changes

July 31, 2018.
    On December 18, 2017, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-FICC-2017-806 (``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'') and 
Rule 19b-4(n)(1)(i) under the Securities Exchange Act of 1934 
(``Act'').\1\ The

[[Page 38394]]

notice of filing and extension of the review period of the Advance 
Notice was published for comment in the Federal Register on January 30, 
2018.\2\
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    \1\ 12 U.S.C. 5465(e)(1) and 17 CFR 240.19b-4(n)(1)(i), 
respectively. On December 18, 2017, FICC filed the Advance Notice as 
a proposed rule change (SR-FICC-2017-022) with the Commission 
pursuant to Section 19(b)(1) of the Act and Rule 19b-4 thereunder 
(``Proposed Rule Change''). (17 CFR 240.19b-4 and 17 CFR 240.19b-4, 
respectively.) The Proposed Rule Change was published in the Federal 
Register on January 8, 2018. See Securities Exchange Act Release No. 
82427 (January 2, 2018), 83 FR 854 (January 8, 2018) (SR-FICC-2017-
022). On February 8, 2018, the Commission designated a longer period 
within which to approve, disapprove, or institute proceedings to 
determine whether to approve or disapprove the Proposed Rule Change. 
See Securities Exchange Act Release No. 82670 (February 8, 2018), 83 
FR 6626 (February 14, 2018) (SR-DTC-2017-022; SR-FICC-2017-022; SR-
NSCC-2017-018). On March 20, 2018, the Commission instituted 
proceedings to determine whether to approve or disapprove the 
Proposed Rule Change. See Securities Exchange Act Release No. 82909 
(March 20, 2018), 83 FR 12990 (March 26, 2018) (SR-FICC-2017-022). 
On June 25, 2018, the Commission designated a longer period for 
Commission action on the proceedings to determine whether to approve 
or disapprove the Proposed Rule Change. Therefore, September 5, 2018 
is the date by which the Commission should either approve or 
disapprove the Proposed Rule Change. See Securities Exchange Act 
Release Nos. 83510 (June 25, 2018), 83 FR 30791 (June 29, 2018) (SR-
DTC-2017-022; SR-FICC-2017-022; SR-NSCC-2017-018). On June 28, 2018, 
FICC filed Amendment No. 1 to the Proposed Rule Change. See 
Securities Exchange Act Release No. 83631 (July 13, 2018), 83 FR 
34193 (July 19, 2018) (SR-FICC-2017-022). As of the date of this 
release, the Commission has not received any comments on the 
Proposed Rule Change.
    \2\ Securities Exchange Act Release No. 82583 (January 24, 
2018), 83 FR 4358 (January 30, 2018) (SR-FICC-2017-806). Pursuant to 
Section 806(e)(1)(H) of the Clearing Supervision Act, the Commission 
may extend the review period of an advance notice for an additional 
60 days, if the changes proposed in the advance notice raise novel 
or complex issues, subject to the Commission providing the clearing 
agency with prompt written notice of the extension. 12 U.S.C. 
5465(e)(1)(H). The Commission found that the Advance Notice raised 
complex issues and, accordingly, extended the review period of the 
Advance Notice for an additional 60 days until April 17, 2018, 
pursuant to Section 806(e)(1)(H). Id.
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    On April 10, 2018, the Commission required additional information 
from FICC pursuant to Section 806(e)(1)(D) of the Clearing Supervision 
Act, which tolled the Commission's period of review of the Advance 
Notice.\3\ On June 28, 2018, FICC filed Amendment No. 1 to the Advance 
Notice to amend and replace in its entirety the Advance Notice as 
originally submitted on December 18, 2017, and on July 6, 2018, 
submitted a response to the Commission's request for additional 
information in consideration of the Advance Notice, which added a 
further 60-days to the review period pursuant to Section 806(e)(1)(E) 
and (G) of the Clearing Supervision Act.\4\
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    \3\ 12 U.S.C. 5465(e)(1)(D). The Commission's memo regarding 
Commission's Request for Additional Information and the tolled due 
date has been publicly available on the Commission's website at 
http://www.sec.gov/rules/sro/ficc-an.shtml.
    \4\ To promote the public availability and transparency of its 
post-notice amendment, FICC submitted a copy of Amendment No. 1 
through the Commission's electronic public comment letter mechanism. 
Accordingly, Amendment No. 1 has been posted on the Commission's 
website at http://www.sec.gov/rules/sro/ficc-an.shtml and thus been 
publicly available since June 29, 2018. 12 U.S.C. 5465(e)(1)(E) and 
(G); see Memorandum from the Office of Clearance and Settlement 
Supervision, Division of Trading and Markets, titled ``Response to 
the Commission's Request for Additional Information,'' available at 
http://www.sec.gov/rules/sro/ficc-an.shtml.
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    The Advance Notice, as amended by Amendment No. 1, is described in 
Items I and II below, which Items have been prepared by FICC. The 
Commission is publishing this notice to solicit comments on the Advance 
Notice, as amended by Amendment No. 1, from interested persons.

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

    This Advance Notice consists of proposed modifications to FICC's 
Government Securities Division (``GSD'') Rulebook (``GSD Rules'') and 
Mortgage-Backed Securities Division (``MBSD'' and, together with GSD, 
the ``Divisions'' and, each, a ``Division'') Clearing Rules (``MBSD 
Rules,'' and collectively with the GSD Rules, the ``Rules'') in order 
to amend provisions in the Rules regarding loss allocation as well as 
make other changes, as described in greater detail below.\5\
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    \5\ Capitalized terms not defined herein are defined in the GSD 
Rules, available at http://www.dtcc.com/~/media/Files/Downloads/
legal/rules/ficc_gov_rules.pdf, and the MBSD Rules, available at 
www.dtcc.com/~/media/Files/Downloads/legal/rules/
ficc_mbsd_rules.pdf.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

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

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

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

Description of Amendment No. 1
    This filing constitutes Amendment No. 1 (``Amendment'') to Advance 
Notice previously filed by FICC on December 18, 2017.\6\ This Amendment 
amends and replaces the Advance Notice in its entirety. FICC submits 
this Amendment in order to further clarify the operation of the 
proposed rule changes on loss allocation by providing additional 
information and examples. In particular, this Amendment would:
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    \6\ See Securities Exchange Act Release No. 82583 (January 24, 
2018), 83 FR 4358 (January 30, 2018) (SR-FICC-2017-806).
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    (i) Clarify which Tier One Netting Members and Tier One Members 
would be subject to loss allocation with respect to Defaulting Member 
Events (as defined below and in the proposed rule change) and Declared 
Non-Default Loss Events (as defined below and in the proposed rule 
change) occurring during an Event Period (as defined below and in the 
proposed rule change). Specifically, pursuant to the Amendment, 
proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would provide that 
each Tier One Netting Member or Tier One Member, as applicable, that is 
a Tier One Netting Member or Tier One Member on the first day of an 
Event Period would be obligated to pay its pro rata share of losses and 
liabilities arising out of or relating to each Defaulting Member Event 
(other than a Defaulting Member Event with respect to which it is the 
Defaulting Member (as defined below and in the proposed rule change)) 
and each Declared Non-Default Loss Event occurring during the Event 
Period. Proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would also 
make it clear that any Tier One Netting Member or Tier One Member, as 
applicable, for which FICC ceases to act on a non-Business Day, 
triggering an Event Period that commences on the next Business Day, 
would be deemed to be a Tier One Netting Member or Tier One Member, as 
applicable, on the first day of that Event Period.
    (ii) Clarify the obligations and Loss Allocation Cap (as defined 
below and in the proposed rule change) of a Tier One Netting Member or 
a Tier One Member, as applicable, that withdraws from membership in 
respect of a loss allocation round. Specifically, pursuant to the 
Amendment, proposed Section 7b of GSD Rule 4 and MBSD Rule 4 would 
provide that the Tier One Netting Member or Tier One Member, as 
applicable, would nevertheless remain obligated for its pro rata share 
of losses and liabilities with respect to any Event Period for which it 
is otherwise obligated under GSD Rule 4 or MBSD Rule 4, as applicable; 
however, its aggregate obligation would be limited to the amount of its 
Loss Allocation Cap as fixed in the round for which it withdrew.
    (iii) Clarify that a member would be obligated to FICC for all 
losses and liabilities incurred by FICC arising out of or relating to 
any Defaulting Member Event with respect to the member. Specifically, 
pursuant to the Amendment, proposed Section 7 of GSD Rule 4 and MBSD 
Rule 4 would provide that each member would be obligated to FICC for 
the entire amount of any loss or liability incurred by FICC arising out 
of or relating to any Defaulting Member Event with respect to such 
member.
    (iv) Clarify that, although a Defaulting Member would not be 
allocated a ratable share of losses and liabilities arising out of or 
relating to its own Defaulting Member Event, it would remain obligated 
to FICC for all such losses and liabilities. Specifically, pursuant to 
the Amendment, proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would 
provide that no loss allocation under GSD Rule 4 or MBSD Rule 4, as 
applicable, would constitute a waiver of any claim FICC may have 
against a GSD Member or MBSD Member, as applicable, for any loss or 
liability to which the GSD Member or MBSD Member is subject under the 
GSD Rules

[[Page 38395]]

or MBSD Rules, as applicable, including, without limitation, any loss 
or liability to which it may be subject under GSD Rule 4 or MBSD Rule 
4, as applicable.
    In addition, pursuant to the Amendment, FICC is making other 
clarifying and technical changes to the proposed rule change, as 
proposed herein.
Nature of the Proposed Change
    The primary purpose of this proposed rule change is to amend GSD's 
and MBSD's loss allocation rules in order to enhance the resiliency of 
the Divisions' loss allocation processes so that each Division can take 
timely action to address multiple loss events that occur in succession 
during a short period of time (defined and explained in detail below). 
In connection therewith, the proposed rule change would (i) align the 
loss allocation rules of the three clearing agencies of The Depository 
Trust & Clearing Corporation (``DTCC''), namely The Depository Trust 
Company (``DTC''), National Securities Clearing Corporation (``NSCC''), 
and FICC (collectively, the ``DTCC Clearing Agencies''), so as to 
provide consistent treatment, to the extent practicable and 
appropriate, especially for firms that are participants of two or more 
DTCC Clearing Agencies, (ii) increase transparency and accessibility of 
the loss allocation rules by enhancing their readability and clarity, 
(iii) amend language regarding FICC's use of MBSD Clearing Fund, and 
(iv) make conforming and technical changes.
(i) Background
    Central counterparties (``CCPs'') play a key role in financial 
markets by mitigating counterparty credit risk on transactions between 
market participants. CCPs achieve this by providing guaranties to 
participants and, as a consequence, are typically exposed to credit 
risks that could lead to default losses. In addition, in performing its 
critical functions, a CCP could be exposed to non-default losses that 
are otherwise incident to the CCP's clearance and settlement business.
    A CCP's rulebook should provide a complete description of how 
losses would be allocated to participants if the size of the losses 
exceeded the CCP's pre-funded resources. Doing so provides for an 
orderly allocation of losses, and potentially allows the CCP to 
continue providing critical services to the market and thereby results 
in significant financial stability benefits. In addition, a clear 
description of the loss allocation process offers transparency and 
accessibility to the CCP's participants.
Current FICC Loss Allocation Process
    As CCPs, FICC's Divisions' loss allocation processes are key 
components of their respective risk management processes. Risk 
management is the foundation of FICC's ability to guarantee settlement 
in each Division, as well as the means by which FICC protects itself 
and its members from the risks inherent in the clearance and settlement 
process. FICC's risk management processes must account for the fact 
that, in certain extreme circumstances, the collateral and other 
financial resources that secure FICC's risk exposures may not be 
sufficient to fully cover losses resulting from the liquidation of the 
portfolio of a member for whom a Division has ceased to act.\7\
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    \7\ GSD is permitted to cease to act for (i) a GSD Member 
pursuant to GSD Rule 21 (Restrictions on Access to Services) and GSD 
Rule 22 (Insolvency of a Member), (ii) a Sponsoring Member pursuant 
to Section 14 and Section 16 of GSD Rule 3A (Sponsoring Members and 
Sponsored Members), and (iii) a Sponsored Member pursuant to Section 
13 and Section 15 of GSD Rule 3A (Sponsoring Members and Sponsored 
Members). MBSD is permitted to cease to act for an MBSD Member 
pursuant to MBSD Rule 14 (Restrictions on Access to Services) and 
MBSD Rule 16 (Insolvency of a Member). GSD Rule 22A (Procedures for 
When the Corporation Ceases to Act) and MBSD Rule 17 (Procedures for 
When the Corporation Ceases to Act) set out the types of actions 
FICC may take when it ceases to act for a member. Supra note 5.
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    The GSD Rules and the MBSD Rules each currently provide for a loss 
allocation process through which both FICC (by applying up to 25% of 
its retained earnings in accordance with Section 7(b) of GSD Rule 4 and 
Section 7(c) of MBSD Rule 4) and its members would share in the 
allocation of a loss resulting from the default of a member for whom a 
Division has ceased to act pursuant to the Rules. The GSD Rules and the 
MBSD Rules also recognize that FICC may incur losses outside the 
context of a defaulting member that are otherwise incident to each 
Division's clearance and settlement business.
    The current GSD and MBSD loss allocation rules provide that, in the 
event the Division ceases to act for a member, the amounts on deposit 
to the Clearing Fund from the defaulting member, along with any other 
resources of, or attributable to, the defaulting member that FICC may 
access under the GSD Rules or the MBSD Rules (e.g., payments from 
Cross-Guaranty Agreements), are the first source of funds the Division 
would use to cover any losses that may result from the closeout of the 
defaulting member's guaranteed positions. If these amounts are not 
sufficient to cover all losses incurred, then each Division will apply 
the following available resources, in the following loss allocation 
waterfall order:

    First, as provided in the current Section 7(b) of GSD Rule 4 and 
Section 7(c) of MBSD Rule 4, FICC's corporate contribution of up to 
25 percent of FICC's retained earnings existing at the time of the 
failure of a defaulting member to fulfill its obligations to FICC, 
or such greater amount as the Board of Directors may determine; and
    Second, if a loss still remains, use of the Clearing Fund of the 
Division and assessing the Division's Members in the manner provided 
in GSD Rule 4 and MBSD Rule 4, as the case may be. Specifically, 
FICC will divide the loss ratably between Tier One Netting Members 
and Tier Two Members with respect to GSD, or between Tier One 
Members and Tier Two Members with respect to MBSD, based on original 
counterparty activity with the defaulting member. Then the loss 
allocation process applicable to Tier One Netting Members or Tier 
One Members, as applicable, and Tier Two Members will proceed in the 
manner provided in GSD Rule 4 and MBSD Rule 4, as the case may be.

    Specifically, the applicable Division will first assess each Tier 
One Netting Member or Tier One Member, as applicable, an amount up to 
$50,000, in an equal basis per such member. If a loss remains, the 
Division will allocate the remaining loss ratably among Tier One 
Netting Members or Tier One Members, as applicable, in accordance with 
the amount of each Tier One Netting Member's or Tier One Member's, as 
applicable, respective average daily Required Fund Deposit over the 
prior twelve (12) months. If a Tier One Netting Member or Tier One 
Member, as applicable, did not maintain a Required Fund Deposit for 
twelve (12) months, its loss allocation amount will be based on its 
average daily Required Fund Deposit over the time period during which 
such member did maintain a Required Fund Deposit.
    Pursuant to current Section 7(g) of GSD Rule 4 and MBSD Rule 4, if, 
as a result of the Division's application of the Required Fund Deposit 
of a member, a member's actual Clearing Fund deposit is less than its 
Required Fund Deposit, it will be required to eliminate such deficiency 
in order to satisfy its Required Fund Deposit amount. In addition to 
losses that may result from the closeout of the defaulting member's 
guaranteed positions, Tier One Netting Members or Tier One Members, as 
applicable, can also be assessed for non-default losses incident to 
each Division's clearance and settlement business, pursuant to current 
Section 7(f) of GSD Rule 4 and MBSD Rule.
    The Rules of both Divisions currently provide that Tier Two Members 
are only subject to loss allocation to the extent they traded with the 
defaulting member and their trades resulted in a liquidation loss. FICC 
will assess Tier Two

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Members ratably based on their loss as a percentage of the entire 
remaining loss attributable to Tier Two Members.\8\ Tier Two Members 
are required to pay their loss allocation obligations in full and 
replenish their Required Fund Deposits as needed and as applicable. The 
current Rule provisions which provide for loss allocation of non-
default losses incident to each Division's clearance and settlement 
business (i.e., Section 7(f) of GSD Rule 4 and MBSD Rule 4) do not 
apply to Tier Two Members.
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    \8\ GSD Rule 3B, Section 7 (Loss Allocation Obligations of CCIT 
Members) provides that CCIT Members will be allocated losses as Tier 
Two Members and will be responsible for the total amount of loss 
allocated to them. With respect to CCIT Members with a Joint Account 
Submitter, loss allocation will be calculated at the Joint Account 
level and then applied pro rata to each CCIT Member within the Joint 
Account based on the trade settlement allocation instructions. Supra 
note 5.
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Overview of the Proposed Rule Changes
A. Changes To Enhance Resiliency of GSD's and MBSD's Loss Allocation 
Processes
    In order to enhance the resiliency of GSD's and MBSD's loss 
allocation processes, FICC proposes to change the manner in which each 
of the aspects of the loss allocation waterfall described above would 
be employed. GSD and MBSD would retain the current core loss allocation 
process following the application of the defaulting member's resources, 
i.e., first, by applying FICC's corporate contribution, and second, by 
pro rata allocations to Tier One Netting Members or Tier One Members, 
as applicable, and Tier Two Members. However, GSD and MBSD would 
clarify or adjust certain elements and introduce certain new loss 
allocation concepts, as further discussed below. The proposal would 
also retain the types of losses that can be allocated to Tier One 
Netting Members or Tier One Members, as applicable, and Tier Two 
Members as stated above. In addition, the proposed rule change would 
address the loss allocation process as it relates to losses arising 
from or relating to multiple default or non-default events in a short 
period of time, also as described below.
    Accordingly, FICC is proposing five (5) key changes to enhance each 
Division's loss allocation process:
(1) Changing the Calculation and Application of FICC's Corporate 
Contribution
    As stated above, Section 7(b) of GSD Rule 4 and Section 7(c) of 
MBSD Rule 4 currently provide that FICC will contribute up to 25% of 
its retained earnings (or such higher amount as the Board of Directors 
shall determine) to a loss or liability that is not satisfied by the 
defaulting member's Clearing Fund deposit. Under the proposal, FICC 
would amend the calculation of its corporate contribution from a 
percentage of its retained earnings to a mandatory amount equal to 50% 
of the FICC General Business Risk Capital Requirement.\9\ FICC's 
General Business Risk Capital Requirement, as defined in FICC's 
Clearing Agency Policy on Capital Requirements,\10\ is, at a minimum, 
equal to the regulatory capital that FICC is required to maintain in 
compliance with Rule 17Ad-22(e)(15) under the Act.\11\ The proposed 
Corporate Contribution (as defined below and in the proposed rule 
change) would be held in addition to FICC's General Business Risk 
Capital Requirement.
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    \9\ FICC calculates its General Business Risk Capital 
Requirement as the amount equal to the greatest of (i) an amount 
determined based on its general business profile, (ii) an amount 
determined based on the time estimated to execute a recovery or 
orderly wind-down of FICC's critical operations, and (iii) an amount 
determined based on an analysis of FICC's estimated operating 
expenses for a six (6) month period.
    \10\ See Securities Exchange Act Release No. 81105 (July 7, 
2017), 82 FR 32399 (July 13, 2017) (SR-FICC-2017-007).
    \11\ 17 CFR 240.17Ad-22(e)(15).
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    Currently, the Rules do not require FICC to contribute its retained 
earnings to losses and liabilities other than those from member 
defaults. Under the proposal, FICC would apply its corporate 
contribution to non-default losses as well. The proposed Corporate 
Contribution would apply to losses arising from Defaulting Member 
Events and Declared Non-Default Loss Events (as such terms are defined 
below and in the proposed rule change), and would be a mandatory 
contribution by FICC prior to any allocation of the loss among the 
applicable Division's members.\12\ As proposed, if the Corporate 
Contribution is fully or partially used against a loss or liability 
relating to an Event Period by one or both Divisions, the Corporate 
Contribution would be reduced to the remaining unused amount, if any, 
during the following two hundred fifty (250) Business Days in order to 
permit FICC to replenish the Corporate Contribution.\13\ To ensure 
transparency, all GSD Members and MBSD Members would receive notice of 
any such reduction to the Corporate Contribution. There would be one 
FICC Corporate Contribution, the amount of which would be available to 
both Divisions and would be applied against a loss or liability in 
either Division in the order in which such loss or liability occurs, 
i.e., FICC would not have two separate Corporate Contributions, one for 
each Division. In the event of a loss or liability relating to an Event 
Period, whether arising out of or relating to a Defaulting Member Event 
or a Declared Non-Default Loss Event, attributable to only one 
Division, the Corporate Contribution would be applied to that Division 
up to the amount then available. If a loss or liability relating to an 
Event Period, whether arising out of or relating to a Defaulting Member 
Event or a Declared Non-Default Loss Event, occurs simultaneously at 
both Divisions, the Corporate Contribution would be applied to the 
respective Divisions in the same proportion that the aggregate Average 
RFDs (as defined below and in the proposed rule change) of all members 
in that Division bear to the aggregate Average RFDs of all members in 
both Divisions.\14\
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    \12\ The proposed rule change would not require a Corporate 
Contribution with respect to the use of each Division's Clearing 
Fund as a liquidity resource; however, if FICC uses a Division's 
Clearing Fund as a liquidity resource for more than 30 calendar 
days, as set forth in proposed Section 5 of GSD Rule 4 and MBSD Rule 
4, then FICC would have to consider the amount used as a loss to the 
respective Division's Clearing Fund incurred as a result of a 
Defaulting Member Event and allocate the loss pursuant to proposed 
Section 7 of Rule 4, which would then require the application of 
FICC's Corporate Contribution.
    \13\ FICC believes that two hundred and fifth (250) Business 
Days would be a reasonable estimate of the time frame that FICC 
would require to replenish the Corporate Contribution by equity in 
accordance with FICC's Clearing Agency Policy on Capital 
Requirements, including a conservative additional period to account 
for any potential delays and/or unknown exigencies in times of 
distress.
    \14\ FICC believes that if a loss or liability relating to an 
Event Period, whether arising out of or relating to a Defaulting 
Member Event or a Declared Non-Default Loss Event, occurs 
simultaneously at both Divisions, allocating the Corporate 
Contribution ratably between the two Divisions based on the 
aggregate Average RFDs of their respective members is appropriate 
because the aggregate Average RFDs of all members in a Division 
represent the amount of risks that those members bring to FICC over 
the look-back period of seventy (70) Business Days.
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    As compared to the current approach of applying ``up to'' a 
percentage of retained earnings to defaulting member losses, the 
proposed Corporate Contribution would be a fixed percentage of FICC's 
General Business Risk Capital Requirement, which would provide greater 
transparency and accessibility to members. The proposed Corporate 
Contribution would apply not only towards losses and liabilities 
arising out of or relating to Defaulting Member Events but also those 
arising out of or relating to Declared Non-Default Loss Events, which 
is consistent with the current industry guidance that ``a CCP should 
identify the amount of its own resources to be applied towards

[[Page 38397]]

losses arising from custody and investment risk, to bolster confidence 
that participants' assets are prudently safeguarded. '' \15\
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    \15\ See Resilience of central counterparties (CCPs): Further 
guidance on the PFMI, issued by the Committee on Payments and Market 
Infrastructures and the International Organization of Securities 
Commissions, at 42 (July 2017), available at www.bis.org/cpmi/publ/d163.pdf.
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    Under current Section 7(b) of GSD Rule 4 and Section 7(c) of MBSD 
Rule 4, FICC has the discretion to contribute amounts higher than the 
specified percentage of retained earnings, as determined by the Board 
of Directors, to any loss or liability incurred by FICC as result of 
the failure of a Defaulting Member to fulfill its obligations to FICC. 
This option would be retained and expanded under the proposal so that 
it would be clear that FICC can voluntarily apply amounts greater than 
the Corporate Contribution against any loss or liability (including 
non-default losses) of the Divisions, if the Board of Directors, in its 
sole discretion, believes such to be appropriate under the factual 
situation existing at the time.
    The proposed rule changes relating to the calculation and 
application of Corporate Contribution are set forth in proposed 
Sections 7 and 7a of GSD Rule 4 and Sections 7 and 7a of MBSD Rule 4, 
as further described below.
(2) Introducing an Event Period
    In order to clearly define the obligations of each Division and its 
respective Members regarding loss allocation and to balance the need to 
manage the risk of sequential loss events against members' need for 
certainty concerning their maximum loss allocation exposures, FICC is 
proposing to introduce the concept of an ``Event Period'' to the GSD 
Rules and the MBSD Rules to address the losses and liabilities that may 
arise from or relate to multiple Defaulting Member Events and/or 
Declared Non-Default Loss Events that arise in quick succession in a 
Division. Specifically, the proposal would group Defaulting Member 
Events and Declared Non-Default Loss Events occurring in a period of 
ten (10) Business Days (``Event Period'') for purposes of allocating 
losses to Members of the respective Divisions in one or more rounds (as 
described below), subject to the limitations of loss allocation set 
forth in the proposed rule change and as explained below.\16\ In the 
case of a loss or liability arising from or relating to a Defaulting 
Member Event, an Event Period would begin on the day one or both 
Divisions notify their respective members that FICC has ceased to act 
\17\ for the GSD Defaulting Member and/or the MBSD Defaulting Member 
(or the next Business Day, if such day is not a Business Day). In the 
case of a loss or liability arising from or relating to a Declared Non-
Default Loss Event, an Event Period would begin on the day that FICC 
notifies members of the respective Divisions of the Declared Non-
Default Loss Event (or the next Business Day, if such day is not a 
Business Day). If a subsequent Defaulting Member Event or Declared Non-
Default Loss Event occurs during an Event Period, any losses or 
liabilities arising out of or relating to any such subsequent event 
would be resolved as losses or liabilities that are part of the same 
Event Period, without extending the duration of such Event Period. An 
Event Period may include both Defaulting Member Events and Declared 
Non-Default Loss Events, and there would not be separate Event Periods 
for Defaulting Member Events or Declared Non-Default Loss Events 
occurring during overlapping ten (10) Business Day periods.
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    \16\ FICC believes that having a ten (10) Business Day Event 
Period would provide a reasonable period of time to encompass 
potential sequential Defaulting Member Events or Declared Non-
Default Loss Events that are likely to be closely linked to an 
initial event and/or a severe market dislocation episode, while 
still providing appropriate certainty for members concerning their 
maximum exposure to mutualized losses with respect to such events.
    \17\ Supra note 7.
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    The amount of losses that may be allocated by each Division, 
subject to the required Corporate Contribution, and to which a Loss 
Allocation Cap would apply for any member that elects to withdraw from 
membership in respect of a loss allocation round, would include any and 
all losses from any Defaulting Member Events and any Declared Non-
Default Loss Events during the Event Period, regardless of the amount 
of time, during or after the Event Period, required for such losses to 
be crystallized and allocated.\18\
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    \18\ As discussed below, each Tier One Netting Member or Tier 
One Member, as applicable, that is a Tier One Netting Member or Tier 
One Member on the first day of an Event Period would be obligated to 
pay its pro rata share of losses and liabilities arising out of or 
relating to each Defaulting Member Event (other than a Defaulting 
Member Event with respect to which it is the Defaulting Member) and 
each Declared Non-Default Loss Event occurring during the Event 
Period.
---------------------------------------------------------------------------

    The proposed rule changes relating to the implementation of an 
Event Period are set forth in proposed Section 7 of GSD Rule 4 and 
Section 7 of MBSD Rule 4, as further described below.
(3) Introducing the Concept of ``Rounds'' and Loss Allocation Notice
    Pursuant to the proposed rule change, a loss allocation ``round'' 
would mean a series of loss allocations relating to an Event Period, 
the aggregate amount of which is limited by the sum of the Loss 
Allocation Caps of affected Tier One Netting Members or Tier One 
Members, as applicable (a ``round cap''). When the aggregate amount of 
losses allocated in a round equals the round cap, any additional losses 
relating to the applicable Event Period would be allocated in one or 
more subsequent rounds, in each case subject to a round cap for that 
round. FICC may continue the loss allocation process in successive 
rounds until all losses from the Event Period are allocated among Tier 
One Netting Members or Tier One Members, as applicable, that have not 
submitted a Loss Allocation Withdrawal Notice (as defined below and in 
the proposed rule change) in accordance with proposed Section 7b of GSD 
Rule 4 or MBSD Rule 4.

    Each loss allocation would be communicated to Tier One Netting 
Members or Tier One Members, as applicable, by the issuance of a notice 
that advises the Tier One Netting Members or Tier One Members, as 
applicable, of the amount being allocated to them (``Loss Allocation 
Notice''). Each Tier One Netting Member's or Tier One Member's, as 
applicable, pro rata share of losses and liabilities to be allocated in 
any round would be equal to (i) the average of its Required Fund 
Deposit for the seventy (70) business days preceding the first day of 
the applicable Event Period or such shorter period of time that the 
member has been a member (each member's ``Average RFD''), divided by 
(ii) the sum of Average RFD amounts of all members subject to loss 
allocation in such round.
    Each Loss Allocation Notice would specify the relevant Event Period 
and the round to which it relates. The first Loss Allocation Notice in 
any first, second, or subsequent round would expressly state that such 
Loss Allocation Notice reflects the beginning of the first, second, or 
subsequent round, as the case may be, and that each Tier One Netting 
Member or Tier One Member, as applicable, in that round has five (5) 
Business Days from the issuance of such first Loss Allocation Notice 
for the round to notify FICC of its election to withdraw from 
membership with GSD or MBSD, as applicable, pursuant to proposed 
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, and thereby 
benefit from its Loss Allocation Cap.\19\ The ``Loss Allocation Cap'' 
of a

[[Page 38398]]

Tier One Netting Member or Tier One Member, as applicable, would be 
equal to the greater of (x) its Required Fund Deposit on the first day 
of the applicable Event Period and (y) its Average RFD.
---------------------------------------------------------------------------

    \19\ Pursuant to current Section 7(g) of GSD Rule 4 and MBSD 
Rule 4, the time period for a member to give notice, pursuant to 
Section 13 of GSD Rule 3 and MBSD Rule 3, of its election to 
terminate its membership in GSD or MBSD, as applicable, in respect 
of an allocation arising from any Remaining Loss allocated by FICC 
pursuant to Section 7(d) of GSD Rule 4 or Section 7(e) of MBSD Rule 
4, as applicable, and any Other Loss, is the Close of Business on 
the Business Day on which the loss allocation payment is due to 
FICC. Current Section 13 of GSD Rule 4 and MBSD Rule 4 requires a 
10-day notice period. Supra note 5.
    FICC believes that it is appropriate to shorten such time period 
from 10 days to five (5) Business Days because FICC needs timely 
notice of which Tier One Netting Members or Tier One Members, as 
applicable, would remain in its membership for purpose of 
calculating the loss allocation for any subsequent round. FICC 
believes that five (5) Business Days would provide Tier One Netting 
Members or Tier One Members, as applicable, with sufficient time to 
decide whether to cap their loss allocation obligations by 
withdrawing from their membership in GSD or MBSD, as applicable.
---------------------------------------------------------------------------

    After a first round of loss allocations with respect to an Event 
Period, only Tier One Netting Members or Tier One Members, as 
applicable, that have not submitted a Loss Allocation Withdrawal Notice 
in accordance with proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as 
applicable, would be subject to further loss allocation with respect to 
that Event Period.
    The amount of any second or subsequent round cap may differ from 
the first or preceding round cap because there may be fewer Tier One 
Netting Members or Tier One Members, as applicable, in a second or 
subsequent round if Tier One Netting Members or Tier One Members, as 
applicable, elect to withdraw from membership with GSD or MBSD, as 
applicable, as provided in proposed Section 7b of GSD Rule 4 or MBSD 
Rule 4, as applicable, following the first Loss Allocation Notice in 
any round.
    For example, for illustrative purposes only, after the required 
Corporate Contribution, if FICC has a $5 billion loss determined with 
respect to an Event Period and the sum of Loss Allocation Caps for all 
Tier One Netting Members or Tier One Members, as applicable, subject to 
the loss allocation is $4 billion, the first round would begin when 
FICC issues the first Loss Allocation Notice for that Event Period. 
FICC could issue one or more Loss Allocation Notices for the first 
round until the sum of losses allocated equals $4 billion. Once the $4 
billion is allocated, the first round would end and FICC would need a 
second round in order to allocate the remaining $1 billion of loss. 
FICC would then issue a Loss Allocation Notice for the $1 billion and 
this notice would be the first Loss Allocation Notice for the second 
round. The issuance of the Loss Allocation Notice for the $1 billion 
would begin the second round.
    The proposed rule change would link the Loss Allocation Cap to a 
round in order to provide Tier One Netting Members or Tier One Members, 
as applicable, the option to limit their loss allocation exposure at 
the beginning of each round. As proposed and as described further 
below, a Tier One Netting Member or Tier One Member, as applicable, 
could limit its loss allocation exposure to its Loss Allocation Cap by 
providing notice of its election to withdraw from membership within 
five (5) Business Days after the issuance of the first Loss Allocation 
Notice in any round.
    The proposed rule changes relating to the implementation of 
``rounds'' and Loss Allocation Notices are set forth in proposed 
Section 7 of GSD Rule 4 and Section 7 of MBSD Rule 4, as further 
described below.
(4) Implementing a Revised ``Look-Back'' Period To Calculate a Member's 
Loss Allocation Pro Rata Share and Its Loss Allocation Cap
    Currently, the GSD Rules and the MBSD Rules calculate a Tier One 
Netting Member's or a Tier One Member's pro rata share for purposes of 
loss allocation based on the member's average daily Required Fund 
Deposit over the prior twelve (12) months (or such shorter period as 
may be available in the case of a member which has not maintained a 
deposit over such time period). The Rules currently do not anticipate 
the possibility of more than one Defaulting Member Event or Declared 
Non-Default Loss Event in quick succession.
    GSD and MBSD are proposing to calculate each Tier One Netting 
Member's or Tier One Member's, as applicable, pro rata share of losses 
and liabilities to be allocated in any round (as described above and in 
the proposed rule change) to be equal to (i) the member's Average RFD 
divided by (ii) the sum of Average RFD amounts for all members that are 
subject to loss allocation in such round.
    Additionally, as described above and in the proposed rule change, 
if a Tier One Netting Member or Tier One Member, as applicable, 
withdraws from membership pursuant to proposed Section 7b of GSD Rule 4 
or MBSD Rule 4, as applicable, GSD and MBSD are proposing that the 
member's Loss Allocation Cap be equal to the greater of (i) its 
Required Fund Deposit on the first day of the applicable Event Period 
or (ii) its Average RFD.
    FICC believes that employing a revised look-back period of seventy 
(70) Business Days instead of twelve (12) months to calculate a Tier 
One Netting Member's or a Tier One Member's, as applicable, loss 
allocation pro rata share and Loss Allocation Cap is appropriate, 
because FICC recognizes that the current look-back period of twelve 
(12) months is a very long period during which a member's business 
strategy and outlook could have shifted significantly, resulting in 
material changes to the size of its portfolios. A look-back period of 
seventy (70) Business Days would minimize that issue yet still would be 
long enough to enable FICC to capture a full calendar quarter of such 
members' activities and smooth out the impact from any abnormalities 
and/or arbitrariness that may have occurred.
    The proposed rule changes relating to the implementation of the 
revised look-back period are set forth in proposed Section 7 of GSD 
Rule 4 and Section 7 of MBSD Rule 4, as further described below.
(5) Capping Withdrawing Members' Loss Allocation Exposure and Related 
Changes
    Currently, pursuant to Section 7(g) of GSD Rule 4 and MBSD Rule 4, 
a member can withdraw from membership in order to avail itself of a cap 
on loss allocation if the member notifies FICC via a written notice, in 
accordance with Section 13 of GSD Rule 3 or MBSD Rule 3, as applicable, 
of its election to terminate its membership. Such notice must be 
provided by the Close of Business on the Business Day on which the loss 
allocation payment is due to FICC and, if properly provided to FICC, 
would limit the member's liability for a loss allocation to its 
Required Fund Deposit for the Business Day on which the notification of 
allocation is provided to the member.\20\ As discussed above, the 
proposed rule change would continue providing members the opportunity 
to limit their loss allocation exposure by offering withdrawal options; 
however, the cap on loss allocation would be calculated differently and 
the associated withdrawal process would also be modified as it relates 
to withdrawals associated with the loss allocation process. In 
particular, the proposed rule change would shorten the withdrawal

[[Page 38399]]

notification period from 10 days to five (5) Business Days, as further 
described below.
---------------------------------------------------------------------------

    \20\ Current Section 13 of GSD Rule 3 and MBSD Rule 3 requires a 
member to provide FICC with 10 days written notice of the member's 
termination; however, FICC, in its discretion, may accept such 
termination within a shorter notice period. Supra note 5.
---------------------------------------------------------------------------

    As proposed, if a member timely provides notice of its withdrawal 
from membership in respect of a loss allocation round, the maximum 
amount of losses it would be responsible for would be its Loss 
Allocation Cap,\21\ provided that the member complies with the 
requirements of the withdrawal process in proposed Section 7b of GSD 
Rule 4 and Section 7b of MBSD Rule 4.
---------------------------------------------------------------------------

    \21\ If a member's Loss Allocation Cap exceeds the member's 
then-current Required Fund Deposit, it must still cover the excess 
amount.
---------------------------------------------------------------------------

    Currently, pursuant to Section 7(g) of GSD Rule 4 and MBSD Rule 4, 
if notification is provided to a member that an allocation has been 
made against the member pursuant to GSD Rule 4 or MBSD Rule 4, as 
applicable, and that application of the member's Required Fund Deposit 
is not sufficient to satisfy such obligation to make payment to FICC, 
the member is required to deliver to FICC by the Close of Business on 
the next Business Day, or by the Close of Business on the Business Day 
of issuance of the notification if so determined by FICC, that amount 
which is necessary to eliminate any such deficiency, unless the member 
elects to terminate its membership in FICC. To increase transparency of 
the timeframe under which FICC would require funds from members to 
satisfy their loss allocation obligations, FICC is proposing that 
members would receive two (2) Business Days' notice of a loss 
allocation, and members would be required to pay the requisite amount 
no later than the second Business Day following issuance of such 
notice.\22\ Members would have five (5) Business Days \23\ from the 
issuance of the first Loss Allocation Notice in any round of an Event 
Period to decide whether to withdraw from membership.
---------------------------------------------------------------------------

    \22\ FICC believes that allowing members two (2) Business Days 
to satisfy their loss allocation obligations would provide Members 
sufficient notice to arrange funding, if necessary, while allowing 
FICC to address losses in a timely manner.
    \23\ Supra note 19.
---------------------------------------------------------------------------

    Each round would allow a Tier One Netting Member or Tier One 
Member, as applicable, the opportunity to notify FICC of its election 
to withdraw from membership after satisfaction of the losses allocated 
in such round. Multiple Loss Allocation Notices may be issued with 
respect to each round to allocate losses up to the round cap.
    Specifically, the first round and each subsequent round of loss 
allocation would allocate losses up to a round cap of the aggregate of 
all Loss Allocation Caps of those Tier One Netting Members or Tier One 
Members, as applicable, included in the round. If a Tier One Netting 
Member or Tier One Member, as applicable, provides notice of its 
election to withdraw from membership, it would be subject to loss 
allocation in that round, up to its Loss Allocation Cap. If the first 
round of loss allocation does not fully cover FICC's losses, a second 
round will be noticed to those members that did not elect to withdraw 
from membership in the previous round; however, as noted above, the 
amount of any second or subsequent round cap may differ from the first 
or preceding round cap because there may be fewer Tier One Netting 
Members or Tier One Members, as applicable, in a second or subsequent 
round if Tier One Netting Members or Tier One Members, as applicable, 
elect to withdraw from membership with GSD or MBSD, as applicable, as 
provided in proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as 
applicable, following the first Loss Allocation Notice in any round.
    Pursuant to the proposed rule change, in order to avail itself of 
its Loss Allocation Cap, a Tier One Netting Member or Tier One Member, 
as applicable, would need to follow the requirements in proposed 
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, which would 
provide that the Tier One Netting Member or Tier One Member, as 
applicable, must: (i) Specify in its Loss Allocation Withdrawal Notice 
an effective date of withdrawal, which date shall not be prior to the 
scheduled final settlement date of any remaining obligations owed by 
the member to FICC, unless otherwise approved by FICC, and (ii) as of 
the time of such member's submission of the Loss Allocation Withdrawal 
Notice, cease submitting transactions to FICC for processing, clearance 
or settlement, unless otherwise approved by FICC.
    As proposed, a Tier One Netting Member or a Tier One Member, as 
applicable, that withdraws in compliance with proposed Section 7b of 
GSD Rule 4 or MBSD Rule 4, as applicable, would remain obligated for 
its pro rata share of losses and liabilities with respect to any Event 
Period for which it is otherwise obligated under GSD Rule 4 or MBSD 
Rule 4, as applicable; however, its aggregate obligation would be 
limited to the amount of its Loss Allocation Cap (as fixed in the round 
for which it withdrew).
    The proposed rule changes are designed to enable FICC to continue 
the loss allocation process in successive rounds until all of FICC's 
losses are allocated. To the extent that the Loss Allocation Cap of a 
Tier One Netting Member or Tier One Member, as applicable, exceeds such 
member's Required Fund Deposit on the first day of an Event Period, 
FICC may in its discretion retain any excess amounts on deposit from 
the member, up to the Loss Allocation Cap of a Tier One Netting Member 
or Tier One Member, as applicable.
    The proposed rule changes relating to capping withdrawing members' 
loss allocation exposure and related changes to the withdrawal process 
are set forth in proposed Sections 7 and 7b of GSD Rule 4 and Sections 
7 and 7b of MBSD Rule 4, as further described below.

B. Changes To Align Loss Allocation Rules

    The proposed rule changes would align the loss allocation rules, to 
the extent practicable and appropriate, of the three DTCC Clearing 
Agencies so as to provide consistent treatment, especially for firms 
that are participants of two or more DTCC Clearing Agencies. As 
proposed, the loss allocation waterfall and certain related provisions, 
e.g., returning a former member's Clearing Fund, would be consistent 
across the DTCC Clearing Agencies to the extent practicable and 
appropriate. The proposed rule changes of FICC that would align loss 
allocation rules of the DTCC Clearing Agencies are set forth in 
proposed Sections 1, 5, 6, 10, and 11 of GSD Rule 4 and MBSD Rule 4, as 
further described below.

C. Clarifying Changes Relating to Loss Allocation

    The proposed rule changes are intended to make the provisions in 
the Rules governing loss allocation more transparent and accessible to 
members. In particular, FICC is proposing the following changes 
relating to loss allocation to clarify members' obligations for 
Declared Non-Default Loss Events.
    Aside from losses that FICC might face as a result of a Defaulting 
Member Event, FICC could incur non-default losses incident to each 
Division's clearance and settlement business.\24\ The GSD Rules and the 
MBSD Rules currently permit FICC to apply Clearing Fund to non-default 
losses.\25\ Section 5

[[Page 38400]]

of GSD Rule 4 and MBSD Rule 4 provides that the use of Clearing Fund 
deposits is limited to satisfaction of losses or liabilities of FICC, 
which includes losses or liabilities that are otherwise incident to the 
operation of the clearance and settlement business of FICC, although 
the application of Clearing Fund to such losses or liabilities is more 
limited under MBSD Rule 4 when compared to GSD Rule 4.\26\ Section 7(f) 
of GSD Rule 4 and MBSD Rule 4 provides that any loss or liability 
incurred by the Corporation incident to its clearance and settlement 
business arising other than from a Remaining Loss shall be allocated 
among Tier One Netting Members or Tier One Members, as applicable, 
ratably, in accordance with their Average Required Clearing Fund 
Deposits.\27\
---------------------------------------------------------------------------

    \24\ Non-default losses may arise from events such as damage to 
physical assets, a cyber-attack, or custody and investment losses.
    \25\ Arguably there is an ambiguity created by the first 
paragraph of Section 7 in both GSD Rule 4 and MBSD Rule 4, which 
suggests that losses or liabilities may only be allocated in a 
member default scenario, while Section 5 in both GSD Rule 4 and MBSD 
Rule 4 makes it clear that the applicable Division's Clearing Fund 
may be used to satisfy non-default losses.
    \26\ Section 5 of GSD Rule 4 provides that ``The use of the 
Clearing Fund deposits shall be limited to satisfaction of losses or 
liabilities of the Corporation . . . otherwise incident to the 
clearance and settlement business of the Corporation . . .'' Supra 
note 5.
     Section 5 of MBSD Rule 4 provides that ``The use of the 
Clearing Fund deposits and assets and property on which the 
Corporation has a lien on shall be limited to satisfaction of losses 
or liabilities of the Corporation . . . otherwise incident to the 
clearance and settlement business of the Corporation with respect to 
losses and liabilities to meet unexpected or unusual requirements 
for funds that represent a small percentage of the Clearing Fund . . 
.'' Supra note 5.
    \27\ Section 7(f) of GSD Rule 4 provides that ``Any loss or 
liability incurred by the Corporation incident to its clearance and 
settlement business . . . arising other than from a Remaining Loss 
(hereinafter, an ``Other Loss'') shall be allocated among Tier One 
Netting Members, ratably, in accordance with the respective amounts 
of their Average Required FICC Clearing Fund Deposits. Supra note 5.
     Section 7(f) of MBSD Rule 4 provides that ``Any loss or 
liability incurred by the Corporation incident to its clearance and 
settlement business. . .arising other than from a Remaining Loss 
(hereinafter, an ``Other Loss''), shall be allocated among Tier One 
Members, ratably, in accordance with the respective amounts of their 
Average Required Clearing Fund Deposits. Supra note 5.
---------------------------------------------------------------------------

    If there is a failure of FICC following a non-default loss, such 
occurrence would affect members in much the same way as a failure of 
FICC following a Defaulting Member Event. Accordingly, FICC is 
proposing rule changes to enhance the provisions relating to non-
default losses by clarifying members' obligations for such losses and 
aligning the non-default loss provisions in the GSD Rules and the MBSD 
Rules.
    Specifically, for both the GSD Rules and the MBSD Rules, FICC is 
proposing enhancement of the governance around non-default losses that 
would trigger loss allocation to Tier One Netting Members or Tier One 
Members, as applicable, by specifying that the Board of Directors would 
have to determine that there is a non-default loss that may be a 
significant and substantial loss or liability that may materially 
impair the ability of FICC to provide clearance and settlement services 
in an orderly manner and will potentially generate losses to be 
mutualized among the Tier One Netting Members or Tier One Members, as 
applicable, in order to ensure that FICC may continue to offer 
clearance and settlement services in an orderly manner. The proposed 
rule change would provide that FICC would then be required to promptly 
notify members of this determination (a ``Declared Non-Default Loss 
Event''). In addition, FICC is proposing to better align the interest 
of FICC with those of its members by stipulating a mandatory Corporate 
Contribution apply to a Declared Non-Default Loss Event prior to any 
allocation of the loss among members, as described above. Additionally, 
FICC is proposing language to clarify members' obligations for Declared 
Non-Default Loss Events.
    Under the proposal, FICC would clarify the Rules of both Divisions 
to make clear that Tier One Netting Members or Tier One Members, as 
applicable, are subject to loss allocation for non-default losses 
(i.e., Declared Non-Default Loss Events under the proposal) and Tier 
Two Members are not subject to loss allocation for non-default losses.
    The proposed rule changes relating to Declared Non-Default Loss 
Events and members' obligations for such events are set forth in 
proposed Section 7 of GSD Rule 4 and Section 7 of MBSD Rule 4, as 
further described below.

D. Amending Language Regarding FICC's Use of MBSD Clearing Fund

    The proposed rule change would delete language currently in Section 
5 of MBSD Rule 4 that limits certain uses by FICC of the MBSD Clearing 
Fund to ``unexpected or unusual'' requirements for funds that represent 
a ``small percentage'' of the MBSD Clearing Fund. FICC believes that 
these limiting phrases (which appear in connection with FICC's use of 
MBSD Clearing Fund to cover losses and liabilities incident to its 
clearance and settlement business outside the context of an MBSD 
Defaulting Member Event as well as to cover certain liquidity needs) 
are vague and imprecise, and should be replaced in their entirety. 
Specifically, FICC is proposing to delete the limiting language with 
respect to FICC's use of MBSD Clearing Fund to cover losses and 
liabilities incident to its clearance and settlement business outside 
the context of an MBSD Defaulting Member Event so as to not have such 
language be interpreted as impairing FICC's ability to access the MBSD 
Clearing Fund in order to manage non-default losses. FICC is also 
proposing to delete the limiting language with respect to FICC's use of 
MBSD Clearing Fund to cover certain liquidity needs because the effect 
of the limitation in this context is confusing and unclear.
    The proposed rule changes relating to FICC's use of MBSD Clearing 
Fund are set forth in proposed Section 5 of MBSD Rule 4, as further 
described below.
    The foregoing changes as well as other changes (including a number 
of conforming and technical changes) that FICC is proposing in order to 
improve the transparency and accessibility of the Rules are described 
in detail below.

E. Loss Allocation Waterfall Comparison

    The following example \28\ illustrates the differences between the 
current and proposed loss allocation provisions:
---------------------------------------------------------------------------

    \28\ For purposes of this example, FICC has assumed that no 
losses have arisen that apply to Tier Two Netting Members, Tier Two 
Members, or CCIT Members.
---------------------------------------------------------------------------

    Assumptions:
    (i) Firms A, B, and X are each a GSD Netting Member and an MBSD 
Clearing Member and are referred to as Member A, Member B, and Member 
X, respectively.
    (ii) Member A defaults on a Business Day (Day 1). On the same day, 
FICC ceases to act for Member A and notifies members of the cease to 
act. After liquidating Member A's portfolio and applying Member A's 
Clearing Fund deposit, FICC has a total loss of $350 million, with $200 
million in GSD and $150 million in MBSD.
    (iii) Member X voluntarily retires from membership five (5) 
Business Days after FICC ceases to act for Member A (Day 6).
    (iv) Member B defaults seven (7) Business Days after FICC ceases to 
act for Member A (Day 8). On the same day, FICC ceases to act for 
Member B and notifies members of the cease to act. After liquidating 
Member B's portfolio and applying Member B's Clearing Fund deposit, 
FICC has a total loss of $350 million, with $200 million in GSD and 
$150 million in MBSD.
    (v) The current FICC loss provisions require FICC to contribute up 
to 25% of its retained earnings as a corporate contribution. For the 
purposes of this example, it is assumed that FICC will contribute 25% 
of its retained earnings. The amount of FICC's retained earnings is 
$176 million.
    (vi) FICC's General Business Risk Capital Requirement is $98 
million.

[[Page 38401]]

    Current Loss Allocation:
    Under the current loss allocation provisions, with respect to the 
losses arising out of Member A's default, FICC will contribute a total 
of $44 million ($176 million * 25%) from retained earnings,\29\ with 
approximately $25 million ($44 million * ($200 million/$350 million)) 
for GSD and approximately $19 million ($44 million * ($150 million/$350 
million)) for MBSD. FICC will then allocate the remaining GSD loss of 
$175 million ($200 million - $25 million) to GSD Tier One Netting 
Members and the remaining MBSD loss of $131 million ($150 million - $19 
million) to MBSD Tier One Members.
---------------------------------------------------------------------------

    \29\ The retained earnings are applied to the respective 
Divisions in the same proportion that the losses of that Division 
bear to the total losses of both Divisions.
---------------------------------------------------------------------------

    With respect to losses arising out of Member B's default, FICC will 
contribute a total of approximately $33 million (($176 million - $44 
million) * 25%) from retained earnings, with approximately $19 million 
($33 million * ($200 million/$350 million)) for GSD and approximately 
$14 million ($33 million * ($150 million/$350 million)) for MBSD. FICC 
will then allocate the remaining GSD loss of $181 million ($200 million 
- $19 million) to GSD Tier One Netting Members and the remaining MBSD 
loss of $136 million ($150 million - $14 million) to MBSD Tier One 
Members.
    Altogether, with respect to losses arising out of defaults of 
Member A and Member B, FICC will contribute a total of approximately 
$77 million of retained earnings, with approximately $44 million for 
GSD and approximately $33 million for MBSD. FICC will allocate losses 
of $356 million to GSD Tier One Netting Members and $267 million to 
MBSD Tier One Members.
    Proposed Loss Allocation:
    Under the proposed loss allocation provisions, a Defaulting Member 
Event with respect to Member A's default would have occurred on Day 
One, and a Defaulting Member Event with respect to Member B's default 
would have occurred on Day 8. Because the Defaulting Member Events 
occurred during a 10-business day period, they would be grouped 
together into an Event Period for purposes of allocating losses to 
members. The Event Period would begin on the 1st business day and end 
on the 10th business day.
    With respect to losses arising out of Member A's default, FICC 
would apply a Corporate Contribution of $49 million ($98 million * 
50%),\30\ with approximately $32 million ($49 million * ($10 billion/
$15.2 billion)) for GSD and approximately $17 million ($49 million * 
($5.2 billion/$15.2 billion)) for MBSD. FICC would then allocate the 
remaining GSD loss of $168 million ($200 million-$32 million) to GSD 
Tier One Netting Members and the remaining MBSD loss of $133 million 
($150 million-$17 million) to MBSD Tier One Members. With respect to 
losses arising out of Member B's default, FICC would not apply a 
Corporate Contribution since it would have already contributed the 
maximum Corporate Contribution of 50% of its General Business Risk 
Capital Requirement. With respect to losses arising out of Member B's 
default, FICC would allocate the GSD loss of $200 million to GSD Tier 
One Netting Members and the MBSD loss of $150 million to MBSD Tier One 
Members. Because Member X was a member in both Divisions on the first 
day of the Event Period, Member X would be subject to loss allocation 
with respect to all events occurring during the Event Period, even if 
the event occurred after its retirement. Therefore, Member X would be 
subject to loss allocation with respect to Member B's default.
---------------------------------------------------------------------------

    \30\ The Corporate Contribution would be applied to the 
respective Divisions in the same proportion that the aggregate 
Average RFDs of all members in that Division bear to the aggregate 
Average RFDs of all members in both Divisions. For the purposes of 
this example, FICC has assumed that the aggregate Average RFDs of 
all GSD members is $10 billion and the aggregate Average RFDs of all 
MBSD members is $5.2 billion.
---------------------------------------------------------------------------

    Altogether, with respect to losses arising out of defaults of 
Member A and Member B, FICC would apply a Corporate Contribution of $49 
million, with approximately $32 million for GSD and approximately $17 
million for MBSD. FICC would allocate losses of $368 million to GSD 
Tier One Netting Members and $283 million to MBSD Tier One Members.
    The principal differences in the above example are due to (i) the 
proposed changes to the calculation and application of the Corporate 
Contribution and (ii) the proposed introduction of an Event Period.
(ii) Detailed Description of the Proposed Rule Changes Related to Loss 
Allocation

A. Proposed Changes to GSD Rule 4 (Clearing Fund and Loss Allocation) 
and MBSD Rule 4 (Clearing Fund and Loss Allocation)

Overview of GSD Rule 4 and MBSD Rule 4
    GSD Rule 4 and MBSD Rule 4 currently address Clearing Fund 
requirements and loss allocation obligations, as well as permissible 
uses of the Clearing Fund. These Rules address the various Clearing 
Fund calculations for each Division's Clearing Fund and set forth 
rights, obligations and other aspects associated with each Division's 
Clearing Fund, as well as each Division's loss allocation process. GSD 
Rule 4 and MBSD Rule 4 are each currently organized into 12 sections. 
Sections of these Rules that FICC is proposing to change are described 
below.
Section 1 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 1 of GSD Rule 4 and MBSD Rule 4 set forth the 
requirement that each GSD Netting Member and each MBSD Clearing Member 
make and maintain a deposit to the Clearing Fund at the minimum level 
set forth in the respective Rule 4 and note that the timing of such 
payment is set forth in another section of the respective Rule 4. 
Current Section 1 of the respective rule also provides that the 
deposits to the Clearing Fund will be held by FICC or its designated 
agents. Current Section 1 of MBSD Rule 4 also defines the term 
``Transaction'' for purposes of MBSD Rule 4 and references a Member's 
obligation to replenish the deficit in its Required Fund Deposit if it 
is charged by FICC under certain circumstances.
    FICC is proposing to rename the subheading of Section 1 of Rule 4 
in both the GSD Rules and MBSD Rules from ``General'' to ``Required 
Fund Deposits'' and to restructure the wording of the provisions for 
clarity and readability.
    Under the proposed rule change, Section 1 of GSD Rule 4 and Section 
1 of MBSD Rule 4 would continue to have the same provisions as they 
relate to Netting Members or Clearing Members, as applicable, except 
for the following: (i) the language throughout the sections would be 
reorganized, streamlined and clarified, and (ii) language would be 
added regarding additional deposits maintained by the Netting Members 
or Clearing Members, as applicable, at FICC, and highlight for members 
that such additional deposits would be deemed to be part of the 
Clearing Fund and the member's Actual Deposit (as discussed below and 
as defined in the proposed rule change) but would not be deemed to be 
part of the member's Required Fund Deposit.
    The proposed language regarding maintenance of a member's Actual 
Deposit would also make it clear that FICC will not be required to 
segregate such deposit, but shall maintain books and records concerning 
the assets that

[[Page 38402]]

constitute each member's Actual Deposit.
    In addition, FICC proposes a technical change to update a cross 
reference in Section 1 of GSD Rule 4 and MBSD Rule 4.
    Furthermore, in Section 1 of MBSD Rule 4, FICC is proposing to move 
the definition of ``Transactions'' to proposed Section 2(a) of MBSD 
Rule 4, where the first usage of ``Transactions'' in MBSD Rule 4 
appears. FICC is also proposing to delete the last sentence in Section 
1 of MBSD Rule 4, which references a Member's obligation to replenish 
the deficit in its Required Fund Deposit if it is charged by FICC under 
certain circumstances, because it would no longer be relevant under the 
proposed rule change to Section 7 of MBSD Rule 4, as FICC would require 
members to pay their loss allocation amounts instead of charging their 
Required Fund Deposits for Clearing Fund losses.
Section 2 of GSD Rule 4 and MBSD Rule 4
    Current Section 2 of GSD Rule 4 and MBSD Rule 4 set forth more 
detailed requirements pertaining to members' Required Fund Deposits. 
FICC is proposing to rename the subheadings in these sections from 
``Required Fund Deposit'' to ``Required Fund Deposit Requirements'' in 
order to better reflect the purpose of this section.
    In addition, FICC is proposing to expand the definition of ``Legal 
Risk'' in both the GSD and MBSD provisions (current Section 2(e) of GSD 
Rule 4 and Section 2(f) of MBSD Rule 4) by revising the parameters of 
Legal Risk so that it would not be limited to laws applicable to a 
member's insolvency or bankruptcy, as FICC believes that Legal Risk may 
arise outside the context of an insolvency or bankruptcy event 
regarding a member, and FICC should be permitted to adequately protect 
itself in those non- insolvency/bankruptcy circumstances as well.
    For better organization of Rule 4, FICC is also proposing to 
relocate the provision on minimum Clearing Fund cash requirements 
(current Section 2(b) of GSD Rule 4 and Section 2(d) of MBSD Rule 4) to 
the section in each of GSD Rule 4 and MBSD Rule 4 dealing specifically 
with the form of Clearing Fund deposits (proposed Section 3 of GSD Rule 
4 and MBSD Rule 4). This would necessitate the re-lettering of the 
provisions in Section 2. In addition, as stated above, the provision 
regarding the definition of ``Transactions'' for purposes of MBSD Rule 
4 would be moved to proposed Section 2(a) from current Section 1.
    FICC is proposing technical changes to correct typographical errors 
in current Section 2 of GSD Rule 4.
Sections 3, 3a and 3b of GSD Rule 4 and MBSD Rule 4
    Currently, Sections 3, 3a and 3b of GSD Rule 4 and MBSD Rule 4 
address the permissible form of Clearing Fund deposits and contain 
detailed requirements regarding each form. FICC is proposing changes to 
improve the readability of these sections.
    In addition, for better organization of the subject matter, FICC is 
proposing to move certain paragraphs from one section to another, 
including (i) moving clauses (b) and (d) in current Section 2 of GSD 
Rule 4 and MBSD Rule 4, respectively, to proposed Section 3 of GSD Rule 
4 and MBSD Rule 4 and (ii) moving the last paragraph of current Section 
3 in GSD Rule 4 and MBSD Rule 4 to proposed Section 3b of GSD Rule 4 
and MBSD Rule 4.
    Under the proposed rule change, FICC is also proposing to update 
the cash investment provision in Section 3a of GSD Rule 4 and MBSD Rule 
4 to reflect the Clearing Agency Investment Policy adopted by FICC \31\ 
and to define Clearing Fund Cash as (i) cash deposited by a Netting 
Member or Clearing Member, as applicable, as part of its Actual 
Deposit, (ii) the proceeds of (x) any loans made to FICC secured by the 
pledge by FICC of Eligible Clearing Fund Securities pledged to FICC or 
(y) any sales of Eligible Clearing Fund Securities pledged to FICC, 
(iii) cash receipts from any investment of, repurchase or reverse 
repurchase agreements relating to, or liquidation of, Clearing Fund 
assets, and (iv) cash payments on Eligible Letters of Credit. Lastly, 
FICC is proposing technical changes to correct typographical errors in 
current Section 3 of MBSD Rule 4 and current Section 3b of GSD Rule 4.
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    \31\ See Securities Exchange Act Release No. 79528 (December 12, 
2016), 81 FR 91232 (December 16, 2016) (SR-FICC-2016-005). The 
Clearing Agency Investment Policy (the ``Policy'') governs the 
management, custody, and investment of cash deposited to the GSD and 
MBSD Clearing Funds, the proprietary liquid net assets (cash and 
cash equivalents) of FICC and other funds held by FICC. The Policy 
sets forth guiding principles for the investment of those funds, 
which include adherence to a conservative investment philosophy that 
places the highest priority on maximizing liquidity and avoiding 
risk, as well as mandating the segregation and separation of funds. 
The Policy also addresses the process for evaluating credit ratings 
of counterparties and identifies permitted investments within 
specified parameters. In general, assets are required to be held by 
regulated and creditworthy financial institution counterparties and 
invested in financial instruments that, with respect to the GSD and 
MBSD Clearing Funds, may include deposits with banks, including the 
Federal Reserve Bank of New York, collateralized reverse-repurchase 
agreements, direct obligations of the U.S. government and money-
market mutual funds.
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Section 4 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 4 of GSD Rule 4 and MBSD Rule 4 address the 
granting of a first priority perfected security interest by each 
Netting Member or Clearing Member, as applicable, in all assets and 
property placed by the member in the possession of FICC (or its agents 
acting on its behalf). FICC is not proposing any substantive changes to 
these sections except for streamlining the provisions for readability 
and clarity, and adding ``Actual Deposit'' as a defined term to refer 
to Eligible Clearing Fund Securities, funds and assets pledged to FICC 
to secure any and all obligations and liabilities of a Netting Member 
or a Clearing Member, as applicable, to FICC.
Section 5 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 5 of GSD Rule 4 and MBSD Rule 4 describe the use 
of each Division's Clearing Fund. FICC is proposing to rename the 
subheading of this section from ``Use of Deposits and Payments'' to 
``Use of Clearing Fund'' to better reflect the purpose of the section.
    Under the proposed rule change, FICC is also proposing changes to 
streamline this section for clarity and readability and to align the 
GSD Rules and MBSD Rules. Specifically, FICC is proposing to delete the 
first paragraph of current Section 5 of GSD Rule 4 and MBSD Rule 4 and 
replace it with clearer language that sets forth the permitted uses of 
each Division's Clearing Fund. Specifically, the proposed Section 5 of 
GSD Rule 4 and MBSD Rule 4 provides that each Division's Clearing Fund 
would only be used by FICC (i) to secure each member's performance of 
obligations to FICC, including, without limitation, each member's 
obligations with respect to any loss allocations as set forth in 
proposed Section 7 of GSD Rule 4 and MBSD Rule 4 and any obligations 
arising from a Cross-Guaranty Agreement pursuant to GSD Rule 41 or MBSD 
Rule 32, as applicable, or a Cross-Margining Agreement pursuant to GSD 
Rule 43, (ii) to provide liquidity to FICC to meet its settlement 
obligations, including, without limitation, through the direct use of 
cash in the GSD Clearing Fund or MBSD Clearing Fund, as applicable, or 
through the pledge or rehypothecation of pledged Eligible Clearing Fund 
Securities in order to secure liquidity, and (iii) for investment as 
set forth in proposed Section 3a of GSD Rule 4 and MBSD Rule 4.

[[Page 38403]]

    The current first paragraph of Section 5 of GSD Rule 4 and MBSD 
Rule 4 provides that if FICC pledges, hypothecates, encumbers, borrows, 
or applies any part of the respective Division's Clearing Fund deposits 
to satisfy any liability, obligation, or liquidity requirements for 
more than thirty (30) days, FICC, at the Close of Business on the 30th 
day (or on the first Business Day thereafter) will consider the amount 
used as an actual loss to the respective Division's Clearing Fund and 
immediately allocate such loss in accordance with Section 7 of GSD Rule 
4 or MBSD Rule 4, as applicable. As proposed, FICC would retain this 
provision conceptually but replace it with clearer and streamlined 
language that provides that each time FICC uses any part of the 
respective Division's Clearing Fund for more than 30 calendar days to 
provide liquidity to FICC to meet its settlement obligations, 
including, without limitation, through the direct use of cash in the 
Clearing Fund or through the pledge or rehypothecation of pledged 
Eligible Clearing Fund Securities in order to secure liquidity, FICC, 
at the Close of Business on the 30th calendar day (or on the first 
Business Day thereafter) from the day of such use, would consider the 
amount used but not yet repaid as a loss to the Clearing Fund incurred 
as a result of a Defaulting Member Event and immediately allocate such 
loss in accordance with proposed Section 7 of GSD Rule 4 or MBSD Rule 
4, as applicable.
    The proposed rule change also includes deleting language currently 
in Section 5 of MBSD Rule 4 that limits certain uses by FICC of the 
MBSD Clearing Fund to ``unexpected or unusual'' requirements for funds 
that represent a ``small percentage'' of the MBSD Clearing Fund. FICC 
believes that these limiting phrases (which appear in connection with 
FICC's use of MBSD Clearing Fund to cover losses and liabilities 
incident to its clearance and settlement business outside the context 
of an MBSD Defaulting Member Event as well as to cover certain 
liquidity needs) are vague and imprecise, and should be replaced in 
their entirety. Specifically, FICC is proposing to delete the limiting 
language with respect to FICC's use of MBSD Clearing Fund to cover 
losses and liabilities incident to its clearance and settlement 
business outside of an MBSD Defaulting Member Event so as to not have 
such language be interpreted as impairing FICC's ability to access the 
MBSD Clearing Fund in order to manage non-default losses. FICC is also 
proposing to delete the limiting language with respect to FICC's use of 
MBSD Clearing Fund to cover certain liquidity needs because the effect 
of the limitation in this context is confusing and unclear.
    In addition, FICC is proposing to delete the last paragraph in 
current Section 5 of GSD Rule 4 and MBSD Rule 4 because these 
paragraphs address the application of a member's deposits to the 
applicable Clearing Fund to cover the allocation of a loss or liability 
incurred by FICC. These paragraphs would no longer be relevant, 
because, under the proposed Section 7 of GSD Rule 4 and MBSD Rule 4 
(discussed below), FICC would not apply the member's deposit to the 
Clearing Fund unless the member does not satisfy payment of its 
allocated loss amount within the required timeframe. These paragraphs 
also currently include provisions regarding other agreements, such as a 
Cross-Guaranty Agreement, that pertain to a Defaulting Member, and such 
provisions would now be covered by proposed Section 6 of GSD Rule 4 and 
MBSD Rule 4.
Section 6 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 6 of GSD Rule 4 and MBSD Rule 4 are reserved for 
future use. FICC is proposing to use this section for provisions 
relating to the application of deposits to the respective Division's 
Clearing Fund and other amounts held by FICC to a Defaulting Member's 
obligations.
    FICC is proposing to add a subheading of ``Application of Clearing 
Fund Deposits and Other Amounts to Defaulting Members' Obligations'' to 
Section 6 of GSD Rule 4 and MBSD Rule 4. Under the proposed rule 
change, for better organization by subject matter, FICC is also 
proposing to relocate certain provisions to these sections from the 
respective current Section 7 of GSD Rule 4 and MBSD Rule 4, which 
addresses FICC's application of Clearing Fund deposits and other assets 
held by FICC securing a Defaulting Member's obligations to FICC.
    For additional clarity and for consistency with the loss allocation 
rules of the other DTCC Clearing Agencies, FICC proposes to add a 
provision which makes it clear that, if FICC applies a Defaulting 
Member's Clearing Fund deposits, FICC may take any and all actions with 
respect to the Defaulting Member's Actual Deposits, including 
assignment, transfer, and sale of any Eligible Clearing Fund 
Securities, that FICC determines is appropriate.
Sections 7, 7a and 7b of GSD Rule 4 and MBSD Rule 4
    Current Section 7 of GSD Rule 4 and MBSD Rule 4 contains FICC's 
current loss allocation waterfall for losses or liabilities incurred by 
FICC. With respect to any loss or liability incurred by FICC as the 
result of the failure of a Defaulting Member to fulfill its obligations 
to FICC, the loss allocation waterfall for each Division currently 
provides:
    (i) Application of any Clearing Fund deposits and other collateral 
held by FICC securing a Defaulting Member's obligations to FICC and 
additional resources as are applicable to the Defaulting Member.
    (ii) If a loss or liability remains after the application of the 
Defaulting Member's collateral and resources, FICC would apply up to 
25% of FICC's existing retained earnings, or such higher amount as the 
Board of Directors determines.
    (iii) If a loss or liability still remains after the application of 
the retained earnings, FICC would apply the loss or liability to 
members as follows:
    (a) If the remaining loss or liability is attributable to Tier One 
Netting Members or Tier One Members, as applicable, then FICC will 
allocate such loss or liability to Tier One Netting Members or Tier One 
Members, as applicable, by assessing the Required Fund Deposit 
maintained by each such member an amount up to $50,000, in an equal 
basis per Tier One Netting Member or Tier One Member, as applicable.
    (b) If the remaining loss or liability is attributable to Tier Two 
Members, then FICC will allocate such loss or liability to Tier Two 
Members based upon their trading activity with the Defaulting Member 
that resulted in a loss.
    (iv) If there is any loss or liability that still remains after the 
application of (ii) and (iii) above that is attributable to Tier One 
Netting Members or Tier One Members, as applicable, then FICC will 
allocate such loss or liability among Tier One Netting Members or Tier 
One Members, as applicable, ratably based on the amount of each Tier 
One Netting Member's or Tier One Member's Required Fund Deposit and 
based on the average daily level of such deposit over the prior twelve 
(12) months (or such shorter period as may be available if the member 
has not maintained a deposit over such time period).
    Current Section 7(f) of GSD Rule 4 and MBSD Rule 4 also provides 
that Other Losses shall be allocated among Tier One Netting Members or 
Tier One Members, as applicable, ratably in

[[Page 38404]]

accordance with the respective amounts of each Tier One Netting 
Member's or Tier One Member's Required Fund Deposit and based on the 
average daily level of such deposit over the prior twelve (12) months 
(or such shorter period as may be available if the member has not 
maintained a deposit over such time period).
    Currently, pursuant to Section 7(e) of GSD Rule 4, an Inter-Dealer 
Broker Netting Member, or a Non-IDB Repo Broker with respect to 
activity in its Segregated Broker Account, will not be subject to an 
aggregate allocation loss for any single loss-allocation event that 
exceeds $5 million. FICC believes that it is appropriate for GSD to 
retain this cap under the proposed rule change because the Inter-Dealer 
Broker Netting Members are required to limit their business as provided 
in Section 8(e) of GSD Rule 3, which would in turn minimize the 
potential losses or liabilities that could be incurred by FICC from 
Inter-Dealer Broker Netting Members.\32\ FICC believes that it is also 
appropriate for GSD to retain this cap under the proposed rule change 
for Non-IDB Repo Brokers because their activity in their respective 
Segregated Broker Accounts would be subject to similar limitations as 
the Inter-Dealer Broker Netting Members. However, the proposal would 
apply the cap to an Event Period instead of a single loss event in 
order to conform with the concept of the Event Period under the 
proposal. FICC believes applying the cap to an Event Period would 
continue to reasonably represent the risk profiles of the Inter-Dealer 
Broker Netting Members, and Non-IDB Repo Brokers with respect to their 
Segregated Broker Accounts, because they submit affirmed trades from 
their systems to GSD, with each trade already matched to the 
counterparty that will ultimately deliver or receive the securities. 
Therefore, Inter-Dealer Broker Netting Members, and Non-IDB Repo 
Brokers with respect to their Segregated Broker Accounts, do not 
generally maintain positions with FICC and present minimal risk to 
FICC. FICC is also proposing technical changes to replace (i) the term 
``Segregated Broker Account'' with ``Segregated Repo Account'' and (ii) 
the term ``Non-IDB Broker'' with ``Non-IDB Repo Broker,'' both of which 
are the correct terms defined in GSD Rule 1.
---------------------------------------------------------------------------

    \32\ Pursuant to Section 8(e) of GSD Rule 3, an Inter-Dealer 
Broker Netting Member is required to (A) limit its business to 
acting exclusively as a broker, (B) conduct all of its business in 
Repo Transactions with Netting Members, and (C) conduct at least 90 
percent of its business in transactions that are not Repo 
Transactions with Netting Members. If an Inter-Dealer Broker Netting 
Member fails to comply with these requirements, then the Inter-
Dealer Broker Netting Member shall be considered by FICC as a Dealer 
Netting Member. Supra note 5.
---------------------------------------------------------------------------

    Current Section 7(g) of GSD Rule 4 and MBSD Rule 4 further provides 
that if the Required Fund Deposit of the member being allocated the 
loss is not sufficient to satisfy its loss allocation obligation, the 
member is required to deliver to FICC an amount that is necessary to 
eliminate the deficiency by the Close of Business on the next Business 
Day, or by the Close of Business on the Business Day of issuance of the 
notification if so determined by FICC. Under the current Rules, a 
member may elect to terminate its membership, which would limit its 
loss allocation to the amount of its Required Fund Deposit for the 
Business Day on which the notification of such loss allocation is 
provided to the member. If the member does not elect to terminate its 
membership and fails to satisfy its Required Fund Deposit within the 
timeframe specified in the Rules, FICC will cease to act generally with 
regard to such member pursuant to GSD Rules 21 and 22A or MBSD Rules 14 
and 17, as applicable, and may take disciplinary action against such 
member pursuant to GSD Rule 48 or MBSD Rule 38, as applicable.
    Current Section 7(h) of GSD Rule 4 and MBSD Rule 4 requires FICC to 
promptly notify members and the Commission of the amount involved and 
the causes if a Remaining Loss or Other Loss occurs. In addition, 
current Section 7(i) of GSD Rule 4 and MBSD Rule 4 also provides that 
any increase in Clearing Fund deposit as required by subsection (f) of 
current Section 2 of GSD Rule 4 or provisions of MBSD Rule 4 regarding 
special charges or other premiums will not be taken into account when 
calculating loss allocation based on a GSD Member's Average Required 
FICC Clearing Fund Deposit amount or an MBSD Member's Average Required 
Fund Deposit amount, as applicable, under current Section 7 of GSD Rule 
4 and MBSD Rule 4.
    Under the proposed rule change, FICC is proposing to rename the 
subheading of Section 7 of GSD Rule 4 and MBSD Rule 4 to ``Loss 
Allocation Waterfall, Off-the-Market Transactions.'' In addition, FICC 
is proposing to restructure its loss allocation waterfall as described 
below.
    For better organization of the subject matter, FICC is proposing to 
move certain paragraphs from one section to another, including (i) 
relocating the last sentence of current Section 7(h) of GSD Rule 4 and 
MBSD Rule 4 regarding recovery of allocated losses or liabilities by 
FICC to the fifth paragraph of proposed Section 7 of GSD Rule 4 and 
MBSD Rule 4, (ii) relocating from current Section 7(a) of GSD Rule 4 
and MBSD Rule 4 provisions which address FICC's application of Clearing 
Fund deposits and other assets held by FICC securing a Defaulting 
Member's obligations to FICC to proposed Section 6 of GSD Rule 4 and 
MBSD Rule 4, (iii) relocating from current Section 7 of GSD Rule 4 to 
proposed Section 6 of GSD Rule 4 the provision regarding FICC's right 
to treat certain payments to an FCO under a Cross-Margining Guaranty as 
a loss to be allocated, (iv) relocating the provisions in current 
Section 7(i) of GSD Rule 4 and MBSD Rule 4 regarding certain increases 
in Clearing Fund deposits not being taken into account when calculating 
loss allocation so that such provisions would come right after the loss 
allocation calculation provision, with an updated reference to proposed 
renumbered Sections 2(d) and 2(e) in GSD Rule 4 and MBSD Rule 4, 
respectively, and (v) relocating the provision regarding withdrawing 
members reapplying to become members \33\ in the second paragraph of 
current Section 7(g) of GSD Rule 4 and

[[Page 38405]]

MBSD Rule 4 to come right after the paragraph regarding the election of 
a Tier One Netting Member or Tier One Member, as applicable, to 
withdraw from membership in proposed Section 7 of GSD Rule 4 and MBSD 
Rule 4. Furthermore, in order to enhance readability and clarity, FICC 
is proposing a number of changes to streamline the language in these 
provisions.
---------------------------------------------------------------------------

    \33\ Current Section 7(g) of GSD Rule 4 provides that a Member 
that elects to terminate its membership pursuant to alternative (ii) 
in Section 7(g) of GSD Rule 4 in lieu of being liable to pay an 
additional assessment amount above its Required Fund Deposit shall 
not be eligible to re-apply to become a Comparison-Only Member or a 
Netting Member unless, prior to submitting such application, it 
makes the payment to FICC provided for in alternative (i) in Section 
7(g) of GSD Rule 4, together with interest on that amount at the 
average of the Federal Funds Rate plus one percent, calculated from 
the date on which the Remaining Loss or Other Loss was incurred by 
FICC until the date of such payment. Supra note 5.
    Current Section 7(g) of MBSD Rule 4 provides that a Member that 
elects to terminate its membership pursuant to alternative (ii) in 
Section 7(g) of MBSD Rule 4 in lieu of being liable to pay an 
additional assessment amount above its Required Fund Deposit shall 
not be eligible to re-apply to become a Clearing Member unless, 
prior to submitting such application, it makes the payment to FICC 
provided for in alternative (i) in Section 7(g) of MBSD Rule 4, 
together with interest on that amount at the average of the Federal 
Funds Rate plus one percent, calculated from the date on which the 
Remaining Loss or Other Loss was incurred by FICC until the date of 
such payment. Supra note 5.
    The condition for re-application was historically in the rules 
of Government Securities Clearing Corporation (``GSCC'') (FICC's 
predecessor) to solidify GSCC's membership base and thereby 
discourage members from withdrawing from membership during a time of 
stress solely to avoid their loss allocation obligations. This 
condition was later incorporated into the GSD Rules and MBSD Rules. 
In the interest of continuing to encourage members to remain in FICC 
central clearing in order to preserve the robustness of the Treasury 
and mortgage-backed securities markets, FICC would like to retain 
this condition for re-application in the GSD and MBSD Rules as is. 
As the provision applies to a remote contingency and, without an 
immediate business need, NSCC and DTC would prefer not to add this 
provision at this time.
---------------------------------------------------------------------------

    In Section 7 of GSD Rule 4 and MBSD Rule 4, as applicable, FICC is 
proposing to make it clear that no loss allocation under proposed GSD 
Rule 4 or proposed MBSD Rule 4, as applicable, would constitute a 
waiver of any claim FICC may have against a member for any losses or 
liabilities to which the member is subject under the Rules, including, 
without limitation, any loss or liability to which it may be subject 
under proposed GSD Rule 4 or proposed MBSD Rule 4, as applicable. FICC 
is proposing this change to preserve its legal rights and to make it 
clear to members that loss allocation under proposed GSD Rule 4 and 
proposed MBSD Rule 4 would not be deemed as FICC waiving any claims it 
may have against a member for any losses or liabilities to which the 
member is subject under the Rules.
    Under the proposal, Section 7 of GSD Rule 4 and MBSD Rule 4 would 
make clear that the loss allocation waterfall applies to losses and 
liabilities (i) arising out of or relating to a default of a member or 
(ii) otherwise incident to the clearance and settlement business of 
FICC (i.e., non-default losses). The loss allocation waterfall would be 
triggered if FICC incurs a loss or liability arising out of or relating 
to a Defaulting Member Event or a Declared Non-Default Loss Event.
    As proposed, Section 7 of GSD Rule 4 and MBSD Rule 4 would provide 
that, for the purposes of GSD Rule 4 or MBSD Rule 4, as applicable, the 
term ``Defaulting Member'' would mean a GSD Member or MBSD Member, as 
applicable, for which FICC has ceased to act pursuant to GSD Rule 21 or 
GSD Rule 22,\34\ or MBSD Rule 14 or MBSD Rule 16,\35\ as applicable, 
the term ``Defaulting Member Event'' would mean the determination by 
FICC to cease to act for a GSD Member or MBSD Member, as applicable, 
pursuant to GSD Rule 21 or GSD Rule 22, or MBSD Rule 14 or MBSD Rule 
16, as applicable, and the term ``Declared Non-Default Loss Event'' 
would mean the determination by the Board of Directors that a loss or 
liability incident to the clearance and settlement business of FICC may 
be a significant and substantial loss or liability that may materially 
impair the ability of FICC to provide clearance and settlement services 
in an orderly manner and will potentially generate losses to be 
mutualized among members in order to ensure that FICC may continue to 
offer clearance and settlement services in an orderly manner.
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    \34\ FICC may cease to act for a GSD Member pursuant to any of 
the circumstances set forth under GSD Rule 21 (Restrictions on 
Access to Services) or GSD Rule 22 (Insolvency of a Member). Supra 
note 5.
    \35\ FICC may cease to act for an MBSD Member pursuant to any of 
the circumstances set forth under MBSD Rule 14 (Restrictions on 
Access to Services) or MBSD Rule 16 (Insolvency of a Member). Supra 
note 5.
---------------------------------------------------------------------------

    As proposed, each member would be obligated to FICC for the entire 
amount of any loss or liability incurred by FICC arising out of or 
relating to any Defaulting Member Event with respect to such member. 
Under the proposal, to the extent that such loss or liability is not 
satisfied pursuant to proposed Section 6 of GSD Rule 4 or MBSD Rule 4, 
as applicable, FICC would apply a Corporate Contribution thereto and 
charge the remaining amount of such loss or liability ratably to other 
members, as provided in proposed Section 7 of GSD Rule 4 and MBSD Rule 
4.
    Under proposed Section 7 of GSD Rule 4 and MBSD Rule 4, the loss 
allocation waterfall would begin with a corporate contribution from 
FICC (``Corporate Contribution''), as is the case under the current 
Rules, but in a different form than under the current Section 7 of GSD 
Rule 4 and MBSD Rule 4 described above. Today, Section 7(b) of GSD Rule 
4 and Section 7(c) of MBSD Rule 4 provide that, if FICC incurs any loss 
or liability as the result of the failure of a Defaulting Member to 
fulfill its obligations to FICC, FICC will contribute up to 25% of its 
existing retained earnings (or such higher amount as the Board of 
Directors shall determine), to such loss or liability; however, no 
corporate contribution from FICC is currently required for losses 
resulting other than those from Member impairments. Under the proposal, 
FICC would add a proposed new Section 7a to GSD Rule 4 and MBSD Rule 4 
with a subheading of ``Corporate Contribution'' and define FICC's 
Corporate Contribution with respect to any loss allocation pursuant to 
proposed Section 7 of GSD Rule 4 or MBSD Rule 4, whether arising out of 
or relating to a Defaulting Member Event or a Declared Non-Default Loss 
Event, as an amount that is equal to fifty (50) percent of the amount 
calculated by FICC in respect of its General Business Risk Capital 
Requirement as of the end of the calendar quarter immediately preceding 
the Event Period.\36\ The proposed rule change would specify that 
FICC's General Business Risk Capital Requirement, as defined in FICC's 
Clearing Agency Policy on Capital Requirements,\37\ is, at a minimum, 
equal to the regulatory capital that FICC is required to maintain in 
compliance with Rule 17Ad-22(e)(15) under the Act.\38\
---------------------------------------------------------------------------

    \36\ Supra note 9.
    \37\ Supra note 10.
    \38\ Supra note 11.
---------------------------------------------------------------------------

    As proposed, if FICC applies the Corporate Contribution to a loss 
or liability arising out of or relating to one or more Defaulting 
Member Events or Declared Non-Default Loss Events relating to an Event 
Period, then for any subsequent Event Periods that occur during the two 
hundred fifty (250) Business Days thereafter,\39\ the Corporate 
Contribution would be reduced to the remaining unused portion of the 
Corporate Contribution amount that was applied for the first Event 
Period. Proposed Section 7a of both GSD Rule 4 and MBSD Rule 4 would 
require FICC to notify members of any such reduction to the Corporate 
Contribution.
---------------------------------------------------------------------------

    \39\ Supra note 13.
---------------------------------------------------------------------------

    Proposed Section 7a to GSD Rule 4 and MBSD Rule 4 would also make 
clear that there would be one FICC Corporate Contribution, the amount 
of which would be available to both Divisions and would be applied 
against a loss or liability in either Division in the order in which 
such loss or liability occurs, i.e., FICC would not have two separate 
Corporate Contributions, one for each Division. As proposed, in the 
event of a loss or liability relating to an Event Period, whether 
arising out of or relating to a Defaulting Member Event or a Declared 
Non-Default Loss Event, attributable to only one Division, the 
Corporate Contribution would be applied to that Division up to the 
amount then available. Under the proposal, if a loss or liability 
relating to an Event Period, whether arising out of or relating to a 
Defaulting Member Event or a Declared Non-Default Loss Event, occurs 
simultaneously at both Divisions, the Corporate Contribution would be 
applied to the respective Divisions in the same proportion that the 
aggregate Average RFDs of all members in that Division bears to the 
aggregate Average RFDs of all members in both Divisions.\40\
---------------------------------------------------------------------------

    \40\ Supra note 14.
---------------------------------------------------------------------------

    Currently, the Rules do not require FICC to contribute its retained 
earnings

[[Page 38406]]

to losses and liabilities other than those from member defaults. Under 
the proposal, FICC would expand the application of its corporate 
contribution beyond losses and liabilities as the result of the failure 
of a Defaulting Member to fulfill its obligations to FICC. The proposed 
Corporate Contribution would apply to losses or liabilities relating to 
or arising out of Defaulting Member Events and Declared Non-Default 
Loss Events, and would be a mandatory loss contribution by FICC prior 
to any allocation of the loss among the applicable Division's members.
    Current Section 7(b) of GSD Rule 4 and Section 7(c) of MBSD Rule 4 
provide FICC the option to contribute amounts higher than the specified 
percentage of retained earnings as determined by the Board of 
Directors, to any loss or liability incurred by FICC as the result of 
the failure of a Defaulting Member to fulfill its obligations to FICC. 
This option would be retained and expanded under the proposal to also 
cover non-default losses. Proposed Section 7a of GSD Rule 4 and MBSD 
Rule 4 would provide that nothing in the Rules would prevent FICC from 
voluntarily applying amounts greater than the Corporate Contribution 
against any FICC loss or liability, whether arising out of or relating 
to a Defaulting Member Event or a Declared Non-Default Loss Event, if 
the Board of Directors, in its sole discretion, believes such to be 
appropriate under the factual situation existing at the time.
    Proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would provide that 
FICC shall apply the Corporate Contribution to losses and liabilities 
that arise out of or relate to one or more Defaulting Member Events 
and/or (ii) Declared Non-Default Loss Events that occur within an Event 
Period. The proposed rule change also provides that if losses and 
liabilities with respect to such Event Period remain unsatisfied 
following application of the Corporate Contribution, FICC would 
allocate such losses and liabilities to members, as described below.
    As proposed, Section 7 of GSD Rule 4 and MBSD Rule 4 would retain 
the differentiation in allocating losses to Tier One Netting Members or 
Tier One Members, as applicable, and Tier Two Members. Specifically, as 
is the case today, losses or liabilities that arise out of or relate to 
one or more Defaulting Member Events would be attributable to Tier One 
Netting Members or Tier One Members, as applicable, and Tier Two 
Members, while losses or liabilities that arise out of or relate to one 
or more Declared Non-Default Loss Events would only be attributable to 
Tier One Netting Members or Tier One Members, as applicable. Tier Two 
Members would not be subject to loss allocation with respect to 
Declared Non-Default Loss Events.
    Under the proposal, FICC would delete the provision in current 
Section 7(h) of GSD Rule 4 and MBSD Rule 4 that requires FICC to 
promptly notify members and the Commission of the amounts involved and 
the causes if a Remaining Loss or Other Loss occurs because such 
notification would no longer be necessary under the proposed rule 
change. Under the proposed rule change, FICC would notify members 
subject to loss allocation of the amounts being allocated to them in 
one or more Loss Allocation Notices for both Defaulting Member Events 
and Declared Non-Default Loss Events. As such, in order to conform to 
the proposed rule change, FICC is proposing to eliminate the 
notification to members regarding the amounts involved and the causes 
if a Remaining Loss or Other Loss occurs that is required under current 
Section 7(h) of GSD Rule 4 and MBSD Rule 4. FICC is also proposing to 
delete the notification to the Commission regarding the amounts 
involved and the causes if a Remaining Loss or Other Loss occurs as 
required in the same section. While as a practical matter, FICC would 
notify the Commission of a decision to loss allocate, FICC does not 
believe such notification needs to be specified in the Rules.
    In addition, FICC is proposing to clarify the provision related to 
Off-the-Market Transactions so that it is clear that loss or liability 
of FICC in connection with the close-out or liquidation of an Off-the-
Market Transaction in the portfolio of a Defaulting Member would be 
allocated to the Member that was the counterparty to such transaction.
Tier One Netting Members/Tier One Members
    For Tier One Netting Members or Tier One Members, as applicable, 
proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would establish the 
concept of an ``Event Period'' to provide for a clear and transparent 
way of handling multiple loss events occurring in a period of ten (10) 
Business Days, which would be grouped into an Event Period.\41\ As 
stated above, both Defaulting Member Events or Declared Non-Default 
Loss Events could occur within the same Event Period.
---------------------------------------------------------------------------

    \41\ Supra note 16.
---------------------------------------------------------------------------

    Under the proposal, an Event Period with respect to a Defaulting 
Member Event would begin on the day FICC notifies members that it has 
ceased to act for the Defaulting Member (or the next Business Day, if 
such day is not a Business Day). In the case of a Declared Non-Default 
Loss Event, an Event Period would begin on the day that FICC notifies 
members of the Declared Non-Default Loss Event (or the next Business 
Day, if such day is not a Business Day). If a subsequent Defaulting 
Member Event or Declared Non-Default Loss Event occurs during an Event 
Period, any losses or liabilities arising out of or relating to any 
such subsequent event would be resolved as losses or liabilities that 
are part of the same Event Period, without extending the duration of 
such Event Period.
    Proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would also retain 
the requirement of loss allocation among Tier One Netting Members or 
Tier One Members, as applicable, if a loss or liability remains after 
the application of the Corporate Contribution, as described above. In 
contrast to the current Section 7 where FICC would assess the Required 
Fund Deposits of Tier One Netting Members or Tier One Members, as 
applicable, to allocate losses, under the proposal, FICC would require 
Tier One Netting Members or Tier One Members, as applicable, to pay 
their loss allocation amounts (leaving their Required Fund Deposits 
intact).\42\ Loss allocation obligations would continue to be 
calculated based upon a Tier One Netting Member's or Tier One Member's, 
as applicable, pro rata share of losses and liabilities (although the 
pro rata share would be calculated differently than it is today), and 
Tier One Netting Members or Tier One Members, as applicable, would 
still

[[Page 38407]]

retain the ability to voluntarily withdraw from membership and cap 
their loss allocation obligation (although the loss allocation 
obligation would also be calculated differently than it is today).
---------------------------------------------------------------------------

    \42\ FICC believes that shifting from the two-step methodology 
of applying the respective Division's Clearing Fund and then 
requiring members to immediately replenish it to requiring direct 
payment would increase efficiency, while preserving the right to 
charge the member's Clearing Fund deposits in the event the member 
does not timely pay. Such a failure to pay would trigger recourse to 
the Clearing Fund deposits of the member under proposed Section 6 of 
GSD Rule 4 or MBSD Rule 4, as applicable. In addition, this change 
would provide greater stability for FICC in times of stress by 
allowing FICC to retain the respective Division's Clearing Fund, its 
critical prefunded resource, while charging loss allocations. FICC 
believes doing so would allow FICC to cover the respective 
Division's current credit exposures to its Members at all times. By 
retaining the GSD and MBSD Clearing Funds as proposed, FICC could 
use the Clearing Funds to secure the performance obligations of 
Members to their respective Division, including their payment 
obligation for any loss allocation, while maintaining access to 
prefunded resources. By being able to manage the respective 
Division's current credit exposures throughout the loss allocation 
process, FICC would be able to continue to provide its critical 
operations and services during what would be expected to be a 
stressful period.
---------------------------------------------------------------------------

    The proposed rule change to Section 7 of GSD Rule 4 and MBSD Rule 4 
would clarify that each Tier One Netting Member or Tier One Member, as 
applicable, that is a Tier One Netting Member or Tier One Member on the 
first day of an Event Period would be obligated to pay its pro rata 
share of losses and liabilities arising out of or relating to each 
Defaulting Member Event (other than a Defaulting Member Event with 
respect to which it is the Defaulting Member) and each Declared Non-
Default Loss Event occurring during the Event Period. The proposal 
would make it clear that any Tier One Netting Member or Tier One 
Member, as applicable, for which FICC ceases to act on a non-Business 
Day, triggering an Event Period that commences on the next Business 
Day, shall be deemed to be a Tier One Netting Member or Tier One 
Member, as applicable, on the first day of that Event Period.
    Under the proposed rule change, a loss allocation ``round'' would 
mean a series of loss allocations relating to an Event Period, the 
aggregate amount of which is limited by the round cap. When the 
aggregate amount of losses allocated in a round equals the round cap, 
any additional losses relating to the applicable Event Period would be 
allocated in one or more subsequent rounds, in each case subject to a 
round cap for that round. FICC may continue the loss allocation process 
in successive rounds until all losses from the Event Period are 
allocated among Tier One Netting Members or Tier One Members, as 
applicable, that have not submitted a Loss Allocation Withdrawal Notice 
in accordance with proposed Section 7b of GSD Rule 4 or MBSD Rule 4.
    As proposed, each loss allocation would be communicated to the Tier 
One Netting Members or Tier One Members, as applicable, by the issuance 
of a Loss Allocation Notice. Under the proposal, each Tier One Netting 
Member's or Tier One Member's, as applicable, pro rata share of losses 
and liabilities to be allocated in any round would be equal to (i) the 
member's Average RFD divided by (ii) the sum of Average RFD amounts of 
all members subject to loss allocation in such round.
    Each Loss Allocation Notice would specify the relevant Event Period 
and the round to which it relates. The first Loss Allocation Notice in 
any first, second, or subsequent round would expressly state that such 
Loss Allocation Notice reflects the beginning of the first, second, or 
subsequent round, as the case may be, and that each Tier One Netting 
Member or Tier One Member, as applicable, in that round has five (5) 
Business Days from the issuance of such first Loss Allocation Notice 
for the round to notify FICC of its election to withdraw from 
membership with GSD or MBSD, as applicable, pursuant to proposed 
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, and thereby 
benefit from its Loss Allocation Cap.\43\ As proposed, the ``Loss 
Allocation Cap'' of a Tier One Netting Member or a Tier One Member, as 
applicable, would be equal to the greater of (x) its Required Fund 
Deposit on the first day of the applicable Event Period and (y) its 
Average RFD.
---------------------------------------------------------------------------

    \43\ Supra note 19.
---------------------------------------------------------------------------

    FICC is proposing to clarify that after a first round of loss 
allocation with respect to an Event Period, only Tier One Netting 
Members or Tier One Members, as applicable, that have not submitted a 
Loss Allocation Withdrawal Notice in accordance with proposed Section 
7b of GSD Rule 4 or MBSD Rule 4, as applicable, would be subject to 
further loss allocation with respect to that Event Period.
    As proposed, each such member's pro rata share of losses and 
liabilities to be allocated in any round would be equal to (i) the 
member's Average RFD, divided by (ii) the sum of the Average RFD 
amounts of all members subject to loss allocation in such round. Each 
such member would have a maximum payment obligation with respect to any 
loss allocation round that would be equal to the greater of (x) its 
Required Fund Deposit on the first day of the applicable Event Period 
or (y) its Average RFD (such amount would be each member's ``Loss 
Allocation Cap''). Therefore, the sum of the Loss Allocation Caps of 
the members subject to loss allocation would constitute the maximum 
amount that FICC would be permitted to allocate in each round. FICC 
would retain the loss allocation limit of $5 million for Inter-Dealer 
Broker Netting Members, or Non-IDB Repo Brokers with respect to 
activities in their Segregated Broker Accounts, as discussed above.
    As proposed, Section 7 of GSD Rule 4 and MBSD Rule 4, would also 
provide that, to the extent that a Tier One Netting Member's or Tier 
One Member's, as applicable, Loss Allocation Cap exceeds such member's 
Required Fund Deposit on the first day of the applicable Event Period, 
FICC may, in its discretion, retain any excess amounts on deposit from 
the member, up to the Loss Allocation Cap of the Tier One Netting 
Member or Tier One Member, as applicable.
    As proposed, Tier One Netting Members or Tier One Members, as 
applicable, would have two (2) Business Days after FICC issues a first 
round Loss Allocation Notice to pay the amount specified in any such 
notice.\44\ On a subsequent round (i.e., if the first round did not 
cover the entire loss of the Event Period because FICC was only able to 
allocate up to the round cap), these members would also have two (2) 
Business Days after notice by FICC to pay their loss allocation amounts 
(again subject to their Loss Allocation Caps), unless the members have 
notified (or will timely notify) FICC of their election to withdraw 
from membership with respect to a prior loss allocation round.
---------------------------------------------------------------------------

    \44\ Supra note 22.
---------------------------------------------------------------------------

    Under the proposal, if a Tier One Netting Member or Tier One 
Member, as applicable, fails to make its required payment in respect of 
a Loss Allocation Notice by the time such payment is due, FICC would 
have the right to proceed against such member as a Defaulting Member 
that has failed to satisfy an obligation in accordance with proposed 
Section 6 of GSD Rule 4 or MBSD Rule 4 described above. Members who 
wish to withdraw from membership would be required to comply with the 
requirements in proposed Section 7b of GSD Rule 4 and MBSD Rule 4, 
described further below. Specifically, proposed Section 7 of GSD Rule 4 
and MBSD Rule 4 would provide that if, after notifying FICC of its 
election to withdraw from membership pursuant to proposed Section 7b of 
GSD Rule 4 or MBSD Rule 4, as applicable, the Tier One Netting Member 
or Tier One Member, as applicable, fails to comply with the provisions 
of proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, its 
notice of withdrawal would be deemed void and any further losses 
resulting from the applicable Event Period may be allocated against it 
as if it had not given such notice.
    FICC is proposing to delete the provisions in the current GSD Rule 
4 and MBSD Rule 4 that require FICC to assess the Required Fund Deposit 
maintained by each Tier One Netting Member or Tier One Member, as 
applicable, an amount up to $50,000, in an equal basis per such member, 
before allocating losses to Tier One Netting Members or Tier One 
Members, as applicable, ratably, in accordance with each such member's 
Required Fund Deposit and Average Required FICC Clearing Fund Deposit 
or Average Required Clearing Fund Deposit, as

[[Page 38408]]

applicable. FICC believes that in the event of a loss or liability, 
this assessment is unlikely to alleviate the need for loss 
mutualization and creates an unnecessary administrative burden for each 
Division. FICC believes that moving straight to the loss mutualization 
described herein would be more practical. This proposed change would 
also streamline each Division's loss allocation waterfall processes and 
align such processes with those of the other DTCC Clearing Agencies.
Tier Two Members
    FICC is not proposing any substantive change to the provisions 
regarding Tier Two Members in current Section 7 of GSD Rule 4 and MBSD 
Rule 4, except to (i) add a subheading of ``Tier Two Members'' in the 
beginning of these provisions for ease of identification and (ii) add a 
paragraph that makes it clear that if a Tier Two Member fails to make 
its required payment in respect of a Loss Allocation Notice by the time 
such payment is due, FICC would have the right to proceed against such 
member as a Defaulting Member that has failed to satisfy an obligation 
in accordance with proposed Section 6 of GSD Rule 4 or MBSD Rule 4 
described above, consistent with the proposed change regarding Tier One 
Netting Members or Tier One Members, as applicable.
Withdrawal From Membership
    Proposed Section 7b of GSD Rule 4 and MBSD Rule 4 would include the 
provisions regarding withdrawal from membership currently covered by 
Section 7(g) of GSD Rule 4 and MBSD Rule 4. FICC believes that 
relocating the provisions on withdrawal from membership as it pertains 
to loss allocation, so that it comes right after the section on the 
loss allocation waterfall, would provide for the better organization of 
GSD Rule 4 and MBSD Rule 4. As proposed, the subheading for Section 7b 
of GSD Rule 4 and MBSD Rule 4 would read ``Withdrawal Following Loss 
Allocation.''
    Currently, Section 7(g) of GSD Rule 4 and MBSD Rule 4 provides that 
a member may, pursuant to current Section 13 of GSD Rule 3 or MBSD Rule 
3, notify FICC by the Close of Business on the Business Day on which a 
payment in an amount necessary to cover losses allocated to such member 
after the application of its Required Fund Deposit is due, of its 
election to terminate its membership and thereby avail itself of a cap 
on loss allocation, which is currently its Required Fund Deposit as 
fixed on the Business Day the pro rata charge loss allocation 
notification is provided to such member.
    As stated above, under the proposed rule change, Section 7 of GSD 
Rule 4 and MBSD Rule 4 would provide that a Tier One Netting Member or 
a Tier One Member, as applicable, who wishes to withdraw from 
membership in respect of a loss allocation round must provide notice of 
its election to withdraw (``Loss Allocation Withdrawal Notice'') within 
five (5) Business Days from the issuance of the first Loss Allocation 
Notice in any round.\45\ In order to avail itself of its Loss 
Allocation Cap, such member would need to follow the requirements in 
proposed Section 7b of GSD Rule 4 and MBSD Rule 4, as applicable, which 
would provide that such member must: (i) Specify in its Loss Allocation 
Withdrawal Notice an effective date for withdrawal from membership, 
which date shall not be prior to the scheduled final settlement date of 
any remaining obligations owed by the member to FICC, unless otherwise 
approved by FICC, and (ii) as of the time of such member's submission 
of the Loss Allocation Withdrawal Notice, cease submitting transactions 
to FICC for processing, clearance or settlement, unless otherwise 
approved by FICC.
---------------------------------------------------------------------------

    \45\ Supra note 19.
---------------------------------------------------------------------------

    Proposed Section 7b of GSD Rule 4 and MBSD Rule 4 would provide 
that a Tier One Netting Member or a Tier One Member, as applicable, 
that withdraws in compliance with the requirements of proposed Section 
7b of GSD Rule 4 or MBSD Rule 4, as applicable, would nevertheless 
remain obligated for its pro rata share of losses and liabilities with 
respect to any Event Period for which it is otherwise obligated under 
proposed GSD Rule 4 or MBSD Rule 4, as applicable; however, the Tier 
One Netting Member's or Tier One Member's, as applicable, aggregate 
obligation would be limited to the amount of its Loss Allocation Cap 
(as fixed in the round for which it withdrew).
    FICC is proposing to include a sentence in proposed Section 7b of 
GSD Rule 4 and MBSD Rule 4 to make it clear that if the Tier One 
Netting Member or Tier One Member, as applicable, fails to comply with 
the requirements set forth in that section, its Loss Allocation 
Withdrawal Notice will be deemed void, and such member will remain 
subject to further loss allocations pursuant to proposed Section 7 of 
GSD Rule 4 and MBSD Rule 4 as if it had not given such notice.
    For better organization of the subject matter, FICC is also 
proposing to move the provision that covers members' obligations to 
eliminate any deficiency in their Required Fund Deposits from the last 
sentence in the first paragraph of current Section 7(g) of GSD Rule 4 
and MBSD Rule 4 to proposed Section 9 of GSD Rule 4 and MBSD Rule 4.
Section 8
    As proposed, Section 8 of GSD Rule 4 and MBSD Rule 4 would cover 
the provisions on the return of a member's Clearing Fund deposit that 
are currently covered by Section 10 of GSD Rule 4 and MBSD Rule 4. 
Proposed Section 8's subheading would be ``Return of Members' Clearing 
Fund Deposits.''
    FICC is proposing changes to streamline and enhance the clarity and 
readability of this section, including adding language to clarify that 
a member's obligations to FICC would include both matured as well as 
contingent obligations, but is otherwise retaining the substantive 
provisions of this section.
Section 9
    FICC is proposing to renumber Section 8 of GSD Rule 4 and MBSD Rule 
4, which addresses the timing of members' payment of the respective 
Division's Clearing Fund. Under the proposal, this section would be 
renumbered as Section 9 of GSD Rule 4 and MBSD Rule 4 and retitled to 
``Initial Required Fund Deposit and Changes in Members' Required Fund 
Deposits'' to better reflect the subject matter of this section.
    Currently, Section 8 of GSD Rule 4 and MBSD Rule 4 requires members 
to satisfy any increase in their Required Fund Deposit requirement 
within such time as FICC requires. FICC is proposing to clarify that at 
the time the increase becomes effective, the member's obligations to 
FICC will be determined in accordance with the increased Required Fund 
Deposit whether or not the member has satisfied such increased amount. 
FICC is also proposing to add language to clarify that (i) if FICC 
applies a GSD Netting Member's or an MBSD Clearing Member's Clearing 
Fund deposits as permitted pursuant to GSD Rule 4 or MBSD Rule 4, as 
applicable, FICC may take any and all actions with respect to the GSD 
Netting Member's or MBSD Clearing Member's Actual Deposit, including 
assignment, transfer, and sale of any Eligible Clearing Fund 
Securities, that FICC determines is appropriate, and (ii) if such 
application results in any deficiency in the GSD Netting Member's or 
MBSD Clearing Member's, as applicable, Required Fund Deposit, such 
member shall immediately replenish it. These clarifications are 
consistent with the

[[Page 38409]]

Divisions' rights as set forth in current Sections 4 and 11 of GSD Rule 
4 and current Sections 4 and 11 of MBSD Rule 4. In addition, the 
provisions in clause (ii) of the previous sentence is consistent with 
the requirements in current Section 1 of GSD Rule 4 and MBSD Rule 4 
that a member must maintain its Required Fund Deposit.
    As discussed above, for better organization of the subject matter, 
FICC is proposing to move the provision that covers members' 
obligations to eliminate any deficiency in their Required Fund Deposits 
from the last sentence in the first paragraph of current Section 7(g) 
of GSD Rule 4 and MBSD Rule 4 to proposed Section 9 of GSD Rule 4 and 
MBSD Rule 4.
Section 10
    Currently, Section 9 of GSD Rule 4 and MBSD Rule 4 addresses 
situations where a member has excess on deposit in the Clearing Fund 
(i.e., amounts above its Required Fund Deposit). The current provision 
provides that FICC will notify a member of any Excess Clearing Fund 
Deposit as FICC determines from time to time. Upon the request of a 
member, FICC will return an excess amount requested by a member that 
follows the formats and timeframe established by FICC for such request. 
The current provision makes clear that FICC may, in its discretion, 
withhold any or all of a member's Excess Clearing Fund Deposit (i) if 
the member has an outstanding payment obligation to FICC, (ii) if FICC 
determines that the member's anticipated activity over the next 90 
calendar days may reasonably be expected to be materially different 
than the prior 90 calendar days, or (iii) if the member has been placed 
on the Watch List. Section 9 also makes clear that the return of an 
Excess Clearing Fund Deposit to any member is subject to (i) such 
return of Excess Clearing Fund Deposit not being done in a manner that 
would cause the member to violate any other section of the Rules, (ii) 
such return not reducing the amount of the member's Cross-Guaranty 
Repayment Deposit to the Clearing Fund below the amount required to be 
maintained by the member pursuant to GSD Rule 41 or MBSD Rule 32, as 
applicable, and (iii) with respect to GSD Members only, such return not 
reducing the amount of a GSD Member's Cross-Margining Repayment Deposit 
to the Clearing Fund below the amount required to be maintained by the 
GSD Member pursuant to GSD Rule 43.
    FICC is proposing to renumber Section 9 as Section 10 for both GSD 
Rule 4 and MBSD Rule 4 and to retitle its subheading to ``Excess 
Clearing Fund Deposits'' to better reflect the subject matter of the 
provisions. FICC is not proposing any changes to this section except to 
streamline and clarify the provisions as well as to align GSD Rule 4 
and MBSD Rule 4, including adding a sentence to clarify that nothing in 
this section limits FICC's rights under Section 7 of GSD Rule 3 or 
Section 6 of MBSD Rule 3, as applicable.
Section 11
    Current Section 11 of GSD Rule 4 and MBSD Rule 4 provides that FICC 
has certain rights with respect to the Clearing Fund. FICC is proposing 
to add a sentence which would make it clear that GSD Rule 4 or MBSD 
Rule 4, as applicable, would govern in the event of any conflict or 
inconsistency between such rule and any agreement between FICC and any 
member. FICC believes that this proposed change would facilitate 
members' understanding of the Rules and their obligations thereunder. 
It would also align the Rules with the Rules and Procedures of NSCC so 
as to provide consistent treatment for firms that are members of both 
FICC and NSCC.\46\ Furthermore, in order to enhance the readability and 
clarity, FICC is proposing a number of changes to streamline the 
language in this section.
---------------------------------------------------------------------------

    \46\ See Section 12 of Rule 4 in NSCC's Rules and Procedures, 
available at http://www.dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
---------------------------------------------------------------------------

(ii) Other Proposed Rule Changes
    FICC is proposing changes to GSD Rule 1 (Definitions), GSD Rule 3 
(Ongoing Membership Requirements), GSD Rule 3A (Sponsoring Members and 
Sponsored Members), GSD Rule 3B (Centrally Cleared Institutional 
Triparty Service), GSD Rule 13 (Funds-Only Settlement), GSD Rule 18 
(Special Provisions for Repo Transactions), GSD Rule 21A (Wind-Down of 
a Netting Member), GSD Rule 22B (Corporation Default), GSD Rule 41 
(Cross Guaranty Agreements), GSD Rule 43 (Cross-Margining 
Arrangements), GSD Board Interpretations and Statements of Policy, and 
GSD Interpretive Guidance with Respect to Watch List Consequences. FICC 
is also proposing changes to MBSD Rule 1 (Definitions), MBSD Rule 3 
(Ongoing Membership Requirements), MBSD Rule 5 (Trade Comparison), MBSD 
Rule 11 (Cash Settlement), MBSD Rule 17A (Corporation Default), MBSD 
Rule 32 (Cross Guaranty Agreements), and MBSD Interpretive Guidance 
with Respect to Watch List Consequences. FICC is proposing changes to 
these Rules in order to conform them with the proposed changes to GSD 
Rule 4 and MBSD Rule 4, as applicable, as well as to make certain 
technical changes to these Rules, as further described below.
Adding Defined Terms
    Specifically, FICC is proposing to add the following defined terms 
to GSD Rule 1, in alphabetical order: Actual Deposit, Average RFD, CCIT 
Member Termination Date, CCIT Member Voluntary Termination Notice, 
Clearing Fund Cash, Corporate Contribution, Declared Non-Default Loss 
Event, Defaulting Member Event, Event Period, Excess Clearing Fund 
Deposit, Former Sponsored Members, Lender, Loss Allocation Cap, Loss 
Allocation Notice, Loss Allocation Withdrawal Notice, Sponsored Member 
Termination Date, Sponsored Member Voluntary Termination Notice, 
Sponsoring Member Termination Date, Sponsoring Member Voluntary 
Termination Notice, Termination Date, and Voluntary Termination Notice.
    FICC is also proposing to add the following defined terms to MBSD 
Rule 1, in alphabetical order: Actual Deposit, Average RFD, Clearing 
Fund Cash, Corporate Contribution, Declared Non-Default Loss Event, 
Defaulting Member Event, Event Period, Excess Clearing Fund Deposit, 
Lender, Loss Allocation Cap, Loss Allocation Notice, Loss Allocation 
Withdrawal Notice, Termination Date, and Voluntary Termination Notice.
Technical Changes
    In addition, FICC is proposing technical changes (i) to delete the 
defined term ``The Corporation'' in GSD Rule 1 and replace it with 
``Corporation'' in GSD Rule 1, (ii) to correct cross-references in 
Section 8 of MBSD Rule 5 and the definition of ``Legal Risk'' in GSD 
Rule 1, (iii) to update references to sections that would be changed 
under this proposal in Section 12 of GSD Rule 3, Sections 10 and 12(a) 
of GSD Rule 3A, Section 3(f) of GSD Rule 18, GSD Rule 21A, Sections 
3(a), 3(b) and 4 of GSD Rule 41, Section 6 of GSD Rule 43, GSD 
Interpretive Guidance with Respect to Watch List Consequences, Sections 
11, 14, and 15 of MBSD Rule 3, Section 3(b) of MBSD Rule 32, and MBSD 
Interpretive Guidance with Respect to Watch List Consequences, (iv) to 
update the reference to a subheading that would be changed under this 
proposal in Section 7 of GSD Rule 3B, and (v) to delete a reference to 
the Cross-Margining Agreement between FICC and NYPC that is no longer 
in effect. FICC believes that these proposed technical changes

[[Page 38410]]

would ensure the Rules remain clear and accurate, which would in turn 
allow Members to readily understand their obligations under the Rules.
Voluntary Termination
    FICC is also proposing changes to the voluntary termination 
provisions in GSD Rule 3, GSD Rule 3A, GSD Rule 3B, and MBSD Rule 3 in 
order to ensure that termination provisions in the GSD Rules and MBSD 
Rules, whether voluntary or in response to a loss allocation, are 
consistent with one another to the extent appropriate.
    Currently, the voluntary termination provisions in GSD Rule 3, GSD 
Rule 3A, GSD Rule 3B, and MBSD Rule 3 generally provide that a member 
may elect to terminate its membership by providing FICC with 10 days 
written notice of such termination. Such termination will not be 
effective until accepted by FICC, which shall be no later than 10 
Business Days after the receipt of the notice. FICC's acceptance shall 
be evidenced by a notice to FICC's members announcing the member's 
termination and the effective date of the termination (``Termination 
Date''), and that the terminating member will no longer be eligible to 
submit transactions to FICC as of the Termination Date.\47\ This 
provision also provides that a member's voluntary termination of 
membership shall not affect its obligations to FICC.
---------------------------------------------------------------------------

    \47\ Account(s) of a terminating member would generally be 
deactivated before the open of business on the Termination Date.
---------------------------------------------------------------------------

    Where appropriate, FICC is proposing changes to align the voluntary 
termination provisions in Section 13 of GSD Rule 3, Sections 2(i) and 
3(e) of GSD Rule 3A, Section 6 of GSD Rule 3B, and Section 14 of MBSD 
Rule 3 with the proposed new Section 7b of GSD Rule 4 and MBSD Rule 4, 
given that they all address termination of membership. Specifically, in 
Section 13 of GSD Rule 3, FICC is proposing that when a GSD Member 
elects to voluntarily terminate its membership by providing FICC a 
written notice of such termination (``Voluntary Termination Notice''), 
the GSD Member must specify in its Voluntary Termination Notice a 
desired date for its withdrawal from membership; provided, however, if 
the GSD Member is terminating its membership in GSD (i.e., not 
terminating its membership just in the Netting System), such date shall 
not be prior to the scheduled final settlement date of any remaining 
obligation owed by the GSD Member to FICC as of the time such Voluntary 
Termination Notice is submitted to FICC, unless otherwise approved by 
FICC. FICC is proposing to delete the provision that requires a member 
to provide FICC with 10 days written notice of the member's 
termination; however, FICC is retaining the provision that states 
termination will not be effective until accepted by FICC,\48\ which 
shall be no later than 10 Business Days after the receipt of the 
notice. FICC is also retaining the provision that states FICC's 
acceptance shall be evidenced by a notice to FICC's members announcing 
the member's termination and the Termination Date, and that the 
terminating member will no longer be eligible to submit transactions to 
FICC as of the Termination Date.
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    \48\ Unlike the Voluntary Termination Notice, the Loss 
Allocation Withdrawal Notice as proposed in Section 7b of GSD Rule 4 
and MBSD Rule 4 does not require explicit acceptance by FICC to be 
effective. FICC believes that requiring explicit acceptance of the 
Loss Allocation Withdrawal Notice could complicate the loss 
allocation process and potentially result in membership withdrawal 
being delayed as well as detract from the objective to have FICC 
know on a timely basis which members would remain subject to the 
subsequent rounds of loss allocation.
---------------------------------------------------------------------------

    As an example, Member A submits a Voluntary Termination Notice to 
GSD on April 1st indicating its desired termination date is June 15th. 
GSD would accept such termination request by issuing a notice to GSD 
Members within 10 Business Days from April 1st; such notice would 
provide that the effective date of Member A's GSD membership 
termination is June 15th. In contrast, if Member A submits a Voluntary 
Termination Notice on April 1st and indicates its desired termination 
date is April 5th, GSD would either (i) accept such termination notice 
by issuing a notice to GSD Members on or before April 5th, and such 
notice would provide that the effective date of Member A's GSD 
membership termination is April 5th or (ii) if GSD requires additional 
time to process the termination, GSD would accept such termination 
notice by issuing notice to GSD Members after April 5th but still 
within 10 Business Days from April 1st; and such notice would provide 
that the effective date of Member A's GSD membership termination as a 
date after April 5th.
    The proposed change to Section 13 of GSD Rule 3 would also provide 
that if any trade is submitted to FICC either by the withdrawing GSD 
Member or its authorized submitter that is scheduled to settle on or 
after the Termination Date, the GSD Member's Voluntary Termination 
Notice would be deemed void and the GSD Member would remain subject to 
the GSD Rules as if it had not given such notice. Furthermore, FICC is 
proposing to add a sentence to Section 13 of GSD Rule 3 to refer GSD 
Members to Section 8 of GSD Rule 4 regarding provisions on the return 
of a GSD Member's Clearing Fund deposit and to specify that if an Event 
Period were to occur after a Tier One Netting Member has submitted its 
Voluntary Termination Notice but prior to the Termination Date, in 
order for such Tier One Netting Member to benefit from its Loss 
Allocation Cap pursuant to Section 7 of GSD Rule 4, the Tier One 
Netting Member would need to comply with the provisions of Section 7b 
of GSD Rule 4 and submit a Loss Allocation Withdrawal Notice, which 
notice, upon submission, would supersede and void any pending Voluntary 
Termination Notice previously submitted by the Tier One Netting 
Member.\49\ As an example, if an Event Period occurs after submission 
of the Voluntary Termination Notice by a Tier One Netting Member or 
Tier One Member, as applicable, but prior to the Termination Date, and 
the Tier One Netting Member or Tier One Member, as applicable, does not 
subsequently submit a Loss Allocation Withdrawal Notice as proposed in 
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, then the Tier 
One Netting Member or Tier One Member, as applicable, would not benefit 
from its Loss Allocation Cap, i.e., the Tier One Netting Member or Tier 
One Member, as applicable, would remain obligated for its pro rata 
share of losses and liabilities with respect to any Event Period that 
commenced prior to the Termination Date.
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    \49\ Loss Allocation Caps would not apply to Tier Two Netting 
Members and Tier Two Members because the loss allocation obligations 
of Tier Two Netting Members and Tier Two Members are already capped 
to the liquidation losses that resulted from their trading activity 
with the Defaulting Member. Tier Two Netting Members and Tier Two 
Members are required to pay their loss allocation obligations in 
full.
---------------------------------------------------------------------------

    Parallel changes are also being proposed to Section 2(i) of GSD 
Rule 3A and Section 14 of MBSD Rule 3 with additional language in 
Section 2(i) of GSD Rule 3A and Section 14 of MBSD Rule 3 making it 
clear that the acceptance by FICC of a member's Voluntary Termination 
Notice shall be no later than ten (10) Business Days after the receipt 
of such notice from the member, in order to provide certainty to 
members as well as to align these sections with the current Section 13 
of GSD Rule 3.
    With respect to Section 3(e) of GSD Rule 3A and Section 6 of GSD 
Rule 3B, changes similar to the ones described above in the previous 
paragraph are also being proposed for Sponsored Members and CCIT 
Members, except there would

[[Page 38411]]

be no references to the return of a member's Clearing Fund deposits and 
to Loss Allocation Caps because they would not apply to these member 
types. In addition, FICC is proposing a technical change in Section 6 
of GSD Rule 3B to reflect a defined term that would be changed under 
this proposal.
Other MBSD Proposed Rule Changes
    FICC is proposing to delete Section 15 of MBSD Rule 3 because FICC 
believes that this section is akin to a loss allocation provision and 
therefore would no longer be necessary under the proposed rule change, 
as the scenarios envisioned by Section 15 of MBSD Rule 3 would be 
governed by the proposed loss allocation provisions in MBSD Rule 4.
Other GSD Proposed Rule Changes
    Under the proposal, Section 12(c) of GSD Rule 3A would also be 
revised to incorporate the concept of the Loss Allocation Cap and to 
reference the applicable proposed sections in GSD Rule 4 that would 
apply when a Sponsoring Member elects to terminate its status as a 
Sponsoring Member.
    FICC is also proposing to delete an Interpretation of the Board of 
Directors of the Government Securities Clearing Corporation (the 
predecessor to GSD), which currently clarifies certain provisions of 
GSD Rule 4 and the extent to which the GSD Clearing Fund and other 
required deposits of GSD Netting Members may be applied to a loss or 
liability incurred by FICC. FICC is proposing this deletion because 
this interpretation would no longer be necessary following the proposed 
rule change. This is because the proposed rule change to GSD Rule 4 
would cover the extent to which the GSD Clearing Fund and other 
collateral or assets of GSD Netting Members would be applied to a loss 
or liability incurred by FICC.
Other GSD Proposed Rule Changes and MBSD Proposed Rule Changes
    FICC is proposing changes to Section 11 of GSD Rule 4 and MBSD Rule 
4. Specifically, FICC is proposing to replace ``letters of credit'' 
with ``Eligible Letters of Credit,'' which is already a defined term in 
the Rules. In addition, FICC is proposing to specify that a reference 
to 30 days means 30 calendar days.
    FICC is proposing to delete ``Remaining Loss'' and ``Other Loss'' 
in Sections 12(a) and 12(b) of GSD Rule 3A, Section 5 of GSD Rule 13, 
Section 4 of GSD Rule 41, Section 6 of GSD Rule 43, Section 9(o) of 
MBSD Rule 11, and Section 4 of MBSD Rule 32 because these terms would 
no longer be used under the proposed GSD Rule 4 and MBSD Rule 4, and to 
add clarifying language that conforms to the proposed changes to GSD 
Rule 4 and MBSD Rule 4.
    In addition, FICC is proposing changes to GSD Rule 22B (Corporation 
Default) and MBSD Rule 17A (Corporation Default). FICC is proposing to 
relocate the interpretational parenthetical in each rule to come right 
after the reference to GSD Rule 22A and MBSD Rule 17. FICC is proposing 
this change because, in the event of a Corporation Default, the 
portfolio of each GSD Member or MBSD Member, as applicable, would be 
closed out in the same way as the portfolio of a GSD Defaulting Member 
or MBSD Defaulting Member, i.e., by applying the close out procedures 
of GSD Rule 22A (Procedures for When the Corporation Ceases to Act) or 
MBSD Rule 17 (Procedures for When the Corporation Ceases to Act), as 
applicable. In addition, in the proposed GSD Rule 22B and MBSD Rule 
17A, FICC is proposing to add a reference to the loss allocation 
provisions of GSD Rule 4 and MBSD Rule 4 and delete references to 
specific sections of GSD Rule 4 and MBSD Rule 4, because those sections 
are being modified under the proposed rule change.
Member Outreach
    Beginning in August 2017, FICC conducted outreach to Members in 
order to provide them with advance notice of the proposed changes. As 
of the date of this filing, no written comments relating to the 
proposed changes have been received in response to this outreach. The 
Commission will be notified of any written comments received.
Implementation Timeframe
    Pending Commission approval, FICC expects to implement this 
proposal within two (2) Business Days after approval. Members would be 
advised of the implementation date of this proposal through issuance of 
a FICC Important Notice.
Expected Effect on Risks to the Clearing Agency, its Participants and 
the Market
    FICC believes that the proposed rule changes to enhance the 
resiliency of each Division's loss allocation process and to delete 
certain limiting language regarding FICC's use of MBSD Clearing Fund 
would reduce the risk of uncertainty to FICC, each Division's members 
and the market overall. Specifically, by modifying the calculation of 
FICC's corporate contribution, FICC would apply a mandatory fixed 
percentage of its General Business Risk Capital Requirement (as 
compared to the current Rules which provide for ``up to'' a percentage 
of retained earnings), which would provide greater transparency and 
accessibility to members as to how much FICC would contribute in the 
event of a loss or liability. By modifying the application of FICC's 
corporate contribution to apply to Declared Non-Default Loss Events, in 
addition to Defaulting Member Events, on a mandatory basis, FICC would 
expand the application of its corporate contribution beyond losses and 
liabilities from member defaults, which would better align the 
interests of FICC with those of its respective Division's members by 
stipulating a mandatory application of the Corporate Contribution to a 
Declared Non-Default Loss Event prior to any allocation of the loss 
among Tier One Netting Members or Tier One Members, as applicable. 
Taken together, these proposed rule changes would enhance the overall 
resiliency of each Division's loss allocation process by enhancing the 
calculation and application of FICC's Corporate Contribution, which is 
one of the key elements of each Division's loss allocation process. 
Moreover, by providing greater transparency and accessibility to 
members, as stated above, the proposed rule changes regarding the 
Corporate Contribution, including the proposed replenishment period and 
proposed allocation of FICC Corporate Contribution between Divisions, 
would allow members to better assess the adequacy of each Division's 
loss allocation process.
    By introducing the concept of an Event Period, FICC would be able 
to group Defaulting Member Events and Declared Non-Default Loss Events 
occurring in a period of ten (10) Business Days for purposes of 
allocating losses to members. FICC believes that the Event Period would 
provide a defined structure for the loss allocation process to 
encompass potential sequential Defaulting Member Events or Declared 
Non-Default Loss Events that are likely to be closely linked to an 
initial event and/or market dislocation episode. Having this structure 
would enhance the overall resiliency of FICC's loss allocation process 
because FICC would be better equipped to address losses that may arise 
from multiple Defaulting Member Events and/or Declared Non-Default Loss 
Events that arise in quick succession. Moreover, the proposed Event 
Period structure would provide certainty for members concerning their 
maximum exposure to

[[Page 38412]]

mutualized losses with respect to such events.
    By introducing the concept of ``rounds'' (and accompanying Loss 
Allocation Notices) and applying this concept to the timing of loss 
allocation payments and the member withdrawal process in connection 
with the loss allocation process, FICC would (i) set forth a defined 
amount that it would allocate to members during each round (i.e., the 
round cap), (ii) advise members of loss allocation obligation 
information as well as round information through the issuance of Loss 
Allocation Notices, and (iii) provide members with the option to limit 
their loss allocation exposure after the issuance of the first Loss 
Allocation Notice in each round. These proposed rule changes would 
enhance the overall resiliency of FICC's loss allocation process 
because they would enable FICC to continue the loss allocation process 
in successive rounds until all of FICC's losses are allocated and 
enable FICC to identify continuing members for purposes of calculating 
subsequent loss allocation obligations in successive rounds. Moreover, 
the proposed rule changes would define for members a clear manner and 
process in which they could cap their loss allocation exposure to FICC.
    By implementing a revised ``look-back'' period to calculate a 
member's loss allocation obligations and its Loss Allocation Cap, FICC 
would be able to capture a full calendar quarter of the member's 
activities and smooth out the impact from any abnormalities and/or 
arbitrariness that may have occurred. By determining a member's loss 
allocation obligations based on the average of its Required Fund 
Deposit over a look-back period and its Loss Allocation Cap based on 
the greater of its Required Fund Deposit or the average thereof over a 
look-back period, FICC would be able to calculate a member's pro rata 
share of losses and liabilities based on the amount of risk that the 
member brings to FICC. These proposed rule changes would enhance the 
overall resiliency of each Division's loss allocation process because 
they would align a member's loss allocation obligation and its Loss 
Allocation Cap with the amount of risk that the member brings to FICC.
    By deleting certain vague and imprecise limiting language that 
could be interpreted as impairing FICC's ability to access the MBSD 
Clearing Fund to cover losses and liabilities incident to its clearance 
and settlement business outside the context of an MBSD Defaulting 
Member Event, as well as to cover certain liquidity needs, the proposed 
rule change to amend FICC's permitted use of MBSD Clearing Fund would 
enhance FICC's ability to ensure that it can continue its operations 
and clearance and settlement services in an orderly manner in the event 
that it would be necessary or appropriate for FICC to access MBSD 
Clearing Fund deposits to address losses, liabilities or liquidity 
needs to meet its settlement obligations.
Management of Identified Risks
    FICC is proposing the rule changes as described in detail above in 
order to enhance the resiliency of each Division's loss allocation 
process and provide transparency and accessibility to its respective 
members regarding each Division's loss allocation process.
Consistency With the Clearing Supervision Act
    The proposed rule change would be consistent with Section 805(b) of 
the Clearing Supervision Act.\50\ The objectives and principles of 
Section 805(b) of the Clearing Supervision Act are to promote robust 
risk management, promote safety and soundness, reduce systemic risks, 
and support the stability of the broader financial system.\51\
---------------------------------------------------------------------------

    \50\ 12 U.S.C. 5464(b).
    \51\ Id.
---------------------------------------------------------------------------

    The proposed rule change would enhance the resiliency of each 
Division's loss allocation process by (1) modifying the calculation and 
application of FICC's corporate contribution, (2) introducing an Event 
Period, (3) introducing the concept of ``rounds'' (and accompanying 
Loss Allocation Notices) and applying this concept to the timing of 
loss allocation payments and the member withdrawal process in 
connection with the loss allocation process, and (4) implementing a 
revised ``look-back'' period to calculate a member's loss allocation 
obligation and its Loss Allocation Cap. Together, these proposed rule 
changes would (i) create greater certainty for members regarding each 
Division's obligation towards a loss, (ii) more clearly specify each 
Division's and its respective members' obligations toward a loss and 
balance the need to manage the risk of sequential defaults and other 
potential loss events against members' need for certainty concerning 
their maximum exposures, and (iii) provide members the opportunity to 
limit their exposure to FICC by capping their exposure to loss 
allocation. Reducing the risk of uncertainty to FICC, each Division's 
members and the market overall would promote robust risk management, 
promote safety and soundness, reduce systemic risks, and support the 
stability of the broader financial system. Therefore, FICC believes 
that the proposed rule change to enhance the resiliency of each 
Division's loss allocation process is consistent with the objectives 
and principles of Section 805(b) of the Clearing Supervision Act cited 
above.
    By deleting certain vague and imprecise limiting language that 
could be interpreted as impairing FICC's ability to access the MBSD 
Clearing Fund to cover losses and liabilities incident to its clearance 
and settlement business outside the context of an MBSD Defaulting 
Member Event, as well as to cover certain liquidity needs, the proposed 
rule change to amend FICC's permitted use of MBSD Clearing Fund would 
enhance FICC's ability to ensure that it can continue its operations 
and clearance and settlement services in an orderly manner in the event 
that it would be necessary or appropriate for FICC to access MBSD 
Clearing Fund deposits to address losses, liabilities or liquidity 
needs to meet its settlement obligations. Enabling FICC to continue its 
operations and clearance and settlement services in an orderly manner 
under such circumstances would promote robust risk management, promote 
safety and soundness, reduce systemic risks, and support the stability 
of the broader financial system. Therefore, FICC believes that this 
proposed rule change is consistent with the objectives and principles 
of Section 805(b) of the Clearing Supervision Act cited above.
    The proposed rule change is also consistent with Rules 17Ad-
22(e)(13) and 17Ad-22(e)(23)(i), promulgated under the Act.\52\ Rule 
17Ad-22(e)(13) under the Act requires, in part, that FICC establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to ensure each Division has the authority and 
operational capacity to take timely action to contain losses and 
continue to meet its obligations.\53\ As described above, the proposed 
rule changes to (1) modify the calculation and application of FICC's 
corporate contribution, (2) introduce an Event Period, (3) introduce 
the concept of ``rounds'' (and accompanying Loss Allocation Notices) 
and apply this concept to the timing of loss allocation payments and 
the member withdrawal process in connection with the loss allocation 
process, and (4) implement a revised ``look-back'' period to calculate 
a member's loss allocation obligation and its Loss Allocation Cap, 
taken together,

[[Page 38413]]

are designed to enhance the resiliency of each Division's loss 
allocation process. Having a resilient loss allocation process would 
help ensure that each Division can effectively and timely address 
losses relating to or arising out of either the default of one or more 
members or one or more non-default loss events, which in turn would 
help each Division contain losses and continue to meet its clearance 
and settlement obligations. Therefore, FICC believes that the proposed 
rule changes to enhance the resiliency of each Division's loss 
allocation process are consistent with Rule 17Ad-22(e)(13) under the 
Act.
---------------------------------------------------------------------------

    \52\ 17 CFR 240.17Ad-22(e)(13) and (e)(23)(i).
    \53\ 17 CFR 240.17Ad-22(e)(13).
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(23)(i) under the Act requires FICC to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to publicly disclose all relevant rules and 
material procedures, including key aspects of each Division's default 
rules and procedures.\54\ The proposed rule changes to (i) align the 
loss allocation rules of the DTCC Clearing Agencies, (ii) improve the 
overall transparency and accessibility of the provisions in the Rules 
governing loss allocation and (iii) make conforming and technical 
changes, would not only ensure that each Division's loss allocation 
rules are, to the extent practicable and appropriate, consistent with 
the loss allocation rules of other DTCC Clearing Agencies, but also 
would help to ensure that each Division's loss allocation rules are 
transparent and clear to members. Aligning the loss allocation rules of 
the DTCC Clearing Agencies would provide consistent treatment, to the 
extent practicable and appropriate, especially for firms that are 
participants of two or more DTCC Clearing Agencies. Having transparent 
and clear loss allocation rules would enable members to better 
understand the key aspects of each Division's default rules and 
procedures and provide members with increased predictability and 
certainty regarding their exposures and obligations. As such, FICC 
believes that the proposed rule changes to align the loss allocation 
rules of the DTCC Clearing Agencies as well as to improve the overall 
transparency and accessibility of each Division's loss allocation rules 
are consistent with Rule 17Ad-22(e)(23)(i) under the Act.
---------------------------------------------------------------------------

    \54\ 17 CFR 240.17Ad-22(e)(23)(i).
---------------------------------------------------------------------------

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.
    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. 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-FICC-2017-806 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number SR-FICC-2017-806. 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 FICC 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-FICC-2017-806 and should be submitted on 
or before August 21, 2018.

    By the Commission.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2018-16709 Filed 8-3-18; 8:45 am]
 BILLING CODE 8011-01-P


