[Federal Register Volume 83, Number 169 (Thursday, August 30, 2018)]
[Notices]
[Pages 44331-44340]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-18865]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83951; File No. SR-FICC-2017-806]


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

August 27, 2018.
    On December 18, 2017, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-FICC-2017-806 pursuant to Section 806(e)(1) of Title 
VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act 
entitled the Payment, Clearing, and Settlement Supervision Act of 2010 
(``Clearing Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the 
Securities Exchange Act of 1934 (``Act'') \2\ to amend the loss 
allocation rules and make other conforming and technical changes.\3\ 
The

[[Page 44332]]

advance notice was published for comment in the Federal Register on 
January 30, 2018.\4\ In that publication, the Commission also extended 
the review period of the advance notice for an additional 60 days, 
pursuant to Section 806(e)(1)(H) of the Clearing Supervision Act.\5\ On 
April 10, 2018, the Commission required additional information from 
FICC pursuant to Section 806(e)(1)(D) of the Clearing Supervision 
Act,\6\ which tolled the Commission's period of review of the advance 
notice until 60 days from the date the information required by the 
Commission was received by the Commission.\7\ 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 filed on December 18, 
2017.\8\ On July 6, 2018, the Commission received a response to its 
request for additional information in consideration of the advance 
notice, which, in turn, added a further 60 days to the review period 
pursuant to Section 806(e)(1)(E) and (G) of the Clearing Supervision 
Act.\9\ The Commission did not receive any comments. This publication 
serves as notice that the Commission does not object to the proposed 
changes set forth in the advance notice, as modified by Amendment No. 1 
(hereinafter, ``Advance Notice'').
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ On December 18, 2017, FICC filed the advance notice as 
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''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, 
respectively. The Proposed Rule Change was published in the Federal 
Register on January 8, 2018. 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. 
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. 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. Securities Exchange Act 
Release No. 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, which was 
published in the Federal Register on July 19, 2018. Securities 
Exchange Act Release No. 83631 (July 13, 2018), 83 FR 34193 (July 
19, 2018) (SR-FICC-2017-022). FICC submitted a courtesy copy of 
Amendment No. 1 to the Proposed Rule Change through the Commission's 
electronic public comment letter mechanism. Accordingly, Amendment 
No. 1 to the Proposed Rule Change has been publicly available on the 
Commission's website at https://www.sec.gov/rules/sro/ficc.htm since 
June 29, 2018. The Commission did not receive any comments. The 
proposal, as set forth in both the advance notice and the Proposed 
Rule Change, each as modified by Amendments No. 1, shall not take 
effect until all required regulatory actions are completed.
    \4\ Securities Exchange Act Release No. 82583 (January 24, 
2018), 83 FR 4358 (January 30, 2018) (SR-FICC-2017-806) 
(``Notice'').
    \5\ 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. See Notice, supra note 4.
    \6\ 12 U.S.C. 5465(e)(1)(D).
    \7\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); see Memorandum 
from the Office of Clearance and Settlement Supervision, Division of 
Trading and Markets, titled ``Commission's Request for Additional 
Information,'' available at http://www.sec.gov/rules/sro/ficc-an.shtml.
    \8\ Securities Exchange Act Release No. 83748 (July 31, 2018), 
83 FR 38375 (August 6, 2018) (SR-FICC-2017-806) (``Notice of 
Amendment No. 1''). FICC submitted a courtesy copy of Amendment No. 
1 to the advance notice through the Commission's electronic public 
comment letter mechanism. Accordingly, Amendment No. 1 to the 
advance notice has been publicly available on the Commission's 
website at http://www.sec.gov/rules/sro/ficc-an.shtml since June 29, 
2018.
    \9\ 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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I. Description of the Advance Notice

    The Advance Notice consists of proposed changes 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'') \10\ in 
order to (1) modify each Division's loss allocation process; (2) align 
the Divisions' loss allocation rules with the three clearing agencies 
of The Depository Trust & Clearing Corporation (``DTCC'')--The 
Depository Trust Company (``DTC''), National Securities Clearing 
Corporation (``NSCC''), and FICC (collectively, the ``DTCC Clearing 
Agencies''); \11\ (3) amend the MBSD Rules regarding the use of the 
MBSD's Clearing Fund; and (4) make conforming and technical changes. 
Each of these proposed changes is described below. A detailed 
description of the specific rule text changes proposed in this Advance 
Notice can be found in the Notice of Amendment No. 1.\12\
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    \10\ Each capitalized term not otherwise defined herein has its 
respective meaning as set forth 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.
    \11\ DTCC is a user-owned and user-governed holding company and 
is the parent company of DTC, FICC, and NSCC. DTCC operates on a 
shared services model with respect to the DTCC Clearing Agencies. 
Most corporate functions are established and managed on an 
enterprise-wide basis pursuant to intercompany agreements under 
which it is generally DTCC that provides a relevant service to a 
DTCC Clearing Agency.
    \12\ See Notice of Amendment No. 1, supra note 8.
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A. Changes to the Loss Allocation Process

    The GSD Rules and the MBSD Rules each currently provide for a loss 
allocation process through which both FICC (by applying up to 25 
percent 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 \13\ 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.\14\ 
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.
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    \13\ The term ``Member'' is defined in both the GSD Rules and 
the MBSD Rules, and has a different meaning under each. See supra 
note 10. In the Notice of Amendment No. 1, FICC used ``member'' to 
refer to both the Members of GSD and MBSD. See Notice of Amendment 
No. 1, supra note 8.
    \14\ GSD is permitted to cease to act for (1) a GSD Member 
pursuant to GSD Rule 21 (Restrictions on Access to Services) and GSD 
Rule 22 (Insolvency of a Member), (2) a Sponsoring Member pursuant 
to Section 14 and Section 16 of GSD Rule 3A (Sponsoring Members and 
Sponsored Members), and (3) 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 10.
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    The current GSD and MBSD loss allocation rules provide that, in the 
event the Division ceases to act for a member, the amount 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 order: (1) 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 (2) 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.
    Pursuant to current Rules, 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

[[Page 44333]]

accordance with the amount of each Tier One Netting Member's or Tier 
One Member's respective average daily Required Fund Deposit over the 
prior 12 months. If a Tier One Netting Member or Tier One Member, as 
applicable, did not maintain a Required Fund Deposit for 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, the member 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 4.
    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 Members ratably based on their loss as a 
percentage of the entire remaining loss attributable to Tier Two 
Members.\15\ 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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    \15\ 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 10.
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    FICC proposes to change the manner in which each of the aspects of 
the loss allocation process described above would be employed. GSD and 
MBSD would clarify or adjust certain elements and introduce certain new 
loss allocation concepts, as further discussed below. In addition, the 
proposal 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.
    FICC proposes six key changes to enhance each Division's loss 
allocation process. Specifically, FICC proposes to make changes to each 
Division regarding (1) its Corporate Contribution, (2) the Event 
Period, (3) the loss allocation round and notice, (4) the look-back 
period, (5) the loss allocation withdrawal notice and cap, and (6) the 
governance around non-default losses, each of which is discussed below.
(1) 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 
percent 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 
percent of the FICC General Business Risk Capital Requirement.\16\ 
FICC's General Business Risk Capital Requirement, as defined in FICC's 
Clearing Agency Policy on Capital Requirements,\17\ 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.\18\ The proposed 
Corporate Contribution would be held in addition to FICC's General 
Business Risk Capital Requirement.
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    \16\ FICC calculates its General Business Risk Capital 
Requirement as the amount equal to the greatest of (1) an amount 
determined based on its general business profile, (2) an amount 
determined based on the time estimated to execute a recovery or 
orderly wind-down of FICC's critical operations, and (3) an amount 
determined based on an analysis of FICC's estimated operating 
expenses for a six month period.
    \17\ See Securities Exchange Act Release No. 81105 (July 7, 
2017), 82 FR 32399 (July 13, 2017) (SR-DTC-2017-003, SR-NSCC-2017-
004, SR-FICC-2017-007).
    \18\ 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 would be a mandatory contribution by FICC prior to any 
allocation of the loss among the applicable Division's members.\19\ 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 250 Business Days in order 
to permit FICC to replenish the Corporate Contribution.\20\ To ensure 
transparency, all GSD Members and MBSD Members would receive notice of 
any such reduction to the Corporate Contribution.
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    \19\ The proposed 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.
    \20\ FICC states that 250 Business Days would be a reasonable 
estimate of the time frame that FICC would be required 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.
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    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. In other words, FICC would not have two separate 
Corporate Contributions 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 of all members in that 
Division bear to the aggregate Average RFDs of all members in both 
Divisions.\21\
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    \21\ FICC states 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 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.
    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.
(2) Event Period
    FICC states that 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 proposes 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 within a period 
of 10 Business Days (``Event Period'') for purposes of allocating 
losses to members of the respective Divisions in one or more rounds, 
subject to the limitations of loss allocation as explained below.\22\
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    \22\ FICC states that having a 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.
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    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 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 10 Business Day periods.
    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.\23\
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    \23\ Under the proposal, 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.
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(3) Loss Allocation Round and Loss Allocation Notice
    Under the proposal, 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 in accordance with proposed Section 7b of GSD Rule 4 
or MBSD Rule 4.
    Each loss allocation would be communicated to each Tier One Netting 
Member or Tier One Member, as applicable, by the issuance of a notice 
that advises the Tier One Netting Member or Tier One Member, as 
applicable, of the amount being allocated to it (``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 (1) the average of its Required Fund 
Deposit for the 70 Business Days preceding the first day of the 
applicable Event Period or such shorter period of time that the Tier 
One Netting Member or Tier One Member, as applicable, has been a member 
(each member's ``Average RFD''), divided by (2) the sum of Average RFD 
amounts of all Tier One Netting Members or Tier One Members, as 
applicable, 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 
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.\24\ In other words, the proposed

[[Page 44335]]

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. 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.
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    \24\ 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 10.
    FICC states that it is appropriate to shorten such time period 
from 10 days to five 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 
states that five 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.
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    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. Under the proposal, FICC is 
proposing that members would receive two 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.\25\
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    \25\ FICC states that allowing members two 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.
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(4) Look-Back Period
    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 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.
    GSD and MBSD propose 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 to be equal to (1) the Tier 
One Netting Member's or Tier One Member's, as applicable, Average RFD 
divided by (2) the sum of Average RFD amounts for all Tier One Netting 
Members or a Tier One Members, as applicable, that are subject to loss 
allocation in such round. Additionally, 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 such member's Loss Allocation Cap be equal 
to the greater of (1) its Required Fund Deposit on the first day of the 
applicable Event Period or (2) its Average RFD.
    FICC states that employing a revised look-back period of 70 
Business Days instead of 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 states 
that the current look-back period of 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. FICC states that a look-back period of 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.
(5) Loss Allocation Withdrawal Notice and Loss Allocation Cap
    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 
member's 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. 
Current Section 13 of GSD Rule 3 and MBSD Rule 3 require 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. 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.
    Under the proposal, a Tier One Netting Member or Tier One Member, 
as applicable, would be able to limit its loss allocation exposure to 
its Loss Allocation Cap by providing notice of its election to withdraw 
from membership within five Business Days from the issuance of the 
first Loss Allocation Notice in any round of an Event Period. 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. 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,\26\ 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. The proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as 
applicable, would provide that the Tier One Netting Member or Tier One 
Member, as applicable, must (1) 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 (2) 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.
---------------------------------------------------------------------------

    \26\ If a member's Loss Allocation Cap exceeds the member's 
then-current Required Fund Deposit, it must still cover the excess 
amount.
---------------------------------------------------------------------------

    As stated above, under the current Rules, the cap of a Tier One 
Netting Member or Tier One Member, as applicable, that provided a 
withdrawal notice would be its Required Fund Deposit for the Business 
Day on which the notification of allocation is provided to the member. 
Under the proposal, the Loss Allocation Cap of a Tier One Netting 
Member or Tier One Member, as applicable, would be equal to the greater 
of (1) its Required Fund Deposit on the first day of the applicable 
Event Period and (2) its Average RFD. Specifically, the first round and 
each subsequent round of loss allocation would allocate

[[Page 44336]]

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, 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.
    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.
    FICC states that the proposed 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.
(6) Declared Non-Default Loss Event
    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.\27\ The GSD Rules and the 
MBSD Rules currently permit FICC to apply Clearing Fund to non-default 
losses.\28\ Section 5 of GSD Rule 4 and MBSD Rule 4 provides that the 
use of the 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 the Clearing Fund to such 
losses or liabilities is more limited under MBSD Rule 4 when compared 
to GSD Rule 4.\29\ 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.\30\
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    \27\ Non-default losses may arise from events such as damage to 
physical assets, a cyber-attack, or custody and investment losses.
    \28\ The first paragraph of Section 7 in both GSD Rule 4 and 
MBSD Rule 4 is not clear and may suggest 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.
    \29\ 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 10.
     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 10.
    \30\ 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 (hereinafter, an ``Other Loss'') shall be allocated 
among [Tier One Netting Members/Tier One Members], ratably, in 
accordance with the respective amounts of their Average Required 
[FICC Clearing Fund Deposits/Clearing Fund Deposits]''. Supra note 
10.
---------------------------------------------------------------------------

    For both the GSD Rules and the MBSD Rules, FICC proposes 
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 
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 proposes to specify that a mandatory 
Corporate Contribution would apply to a Declared Non-Default Loss Event 
prior to any allocation of the loss among members. Additionally, FICC 
proposes 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.

B. Changes To Align the Loss Allocation Rules

    The proposed 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 for firms that are participants 
of multiple DTCC Clearing Agencies. As proposed, the loss allocation 
process and certain related provisions would be consistent across the 
DTCC Clearing Agencies to the extent practicable and appropriate.

C. Use of MBSD Clearing Fund

    The proposed 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 states 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, 
imprecise, and should be replaced in their entirety. Specifically, FICC 
proposes 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 proposes to delete the limiting

[[Page 44337]]

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.

D. Conforming and Technical Changes

    FICC proposes to make various conforming and technical changes 
necessary to harmonize the remaining current Rules with the proposed 
changes. Such changes include, but are not limited to: (1) Amending 
Rule 1 (Definitions; Governing Law) to add cross-references to proposed 
terms that would be defined in Rule 4; (2) inserting, deleting, or 
changing various terms for clarity and consistency; (3) modifying the 
voluntary termination provisions to ensure that termination provisions 
in the GSD Rules and the MBSD Rules are consistent, whether voluntary 
or in response to a loss allocation, are consistent with one another to 
the extent appropriate; and (4) deleting obsolete sections due to the 
proposal.

II. Discussion and Commission Findings

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, its stated purpose is instructive: To 
mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically important financial market utilities and 
strengthening the liquidity of systemically important financial market 
utilities.\31\
---------------------------------------------------------------------------

    \31\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    Section 805(a)(2) of the Clearing Supervision Act \32\ authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities 
engaged in designated activities for which the Commission is the 
supervisory agency. Section 805(b) of the Clearing Supervision Act \33\ 
provides the following objectives and principles for the Commission's 
risk management standards prescribed under Section 805(a):
---------------------------------------------------------------------------

    \32\ 12 U.S.C. 5464(a)(2).
    \33\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     To promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act \34\ and Section 17A of the 
Act \35\ (``Rule 17Ad-22'').\36\ Rule 17Ad-22 requires registered 
clearing agencies to establish, implement, maintain, and enforce 
written policies and procedures that are reasonably designed to meet 
certain minimum requirements for their operations and risk management 
practices on an ongoing basis.\37\ Therefore, it is appropriate for the 
Commission to review proposed changes in advance notices against the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act \38\ and 
against Rule 17Ad-22.\39\
---------------------------------------------------------------------------

    \34\ 12 U.S.C. 5464(a)(2).
    \35\ 15 U.S.C. 78q-1.
    \36\ 17 CFR 240.17Ad-22.
    \37\ Id.
    \38\ 12 U.S.C. 5464(b).
    \39\ 17 CFR 240.17Ad-22.
---------------------------------------------------------------------------

A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the proposed changes in the Advance 
Notice are designed to help FICC promote robust risk management, 
promote safety and soundness, reduce systemic risks, and support the 
stability of the broader financial system as discussed below.
    FICC proposes to make the following changes to its loss allocation 
process as described above. First, for both the GSD Rules and the MBSD 
Rules, the proposed changes would modify the calculation of FICC's 
Corporate Contribution so that FICC would apply a mandatory fixed 
percentage of its General Business Risk Capital Requirement as compared 
to the current Rules which provide for a ``up to'' percentage of 
retained earnings. The proposed changes also would clarify that the 
proposed Corporate Contribution would apply to Declared Non-Default 
Loss Events, as well as Defaulting Member Events, on a mandatory basis 
prior to any allocation of the loss among Tier One Netting Members or 
Tier One Members, as applicable. The proposal would specify how the 
Corporate Contribution would be applied between Divisions. Moreover, 
the proposal specifies that if the Corporate Contribution is applied to 
a loss or liability relating to an Event Period, then for any 
subsequent Event Periods that occur during the 250 business days 
thereafter, the Corporate Contribution would be reduced to the 
remaining, unused portion of the Corporate Contribution. The Commission 
believes that these changes set clear expectations about how and when 
FICC's Corporate Contribution would be applied to help address a loss, 
and allow FICC to better anticipate and prepare for potential exposures 
that may arise during an Event Period.
    Second, as described above, FICC proposes to determine a member's 
loss allocation obligation based on the average of its Required Fund 
Deposit over a look-back period of 70 Business Days and to determine 
its Loss Allocation Cap based on the greater of its Required Fund 
Deposit or the average thereof over a look-back period of 70 Business 
Days. 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 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. These proposed changes are designed to allow 
FICC to calculate a member's pro rata share of losses and liabilities 
based on the amount of risk that the member brings to FICC, and cover a 
sufficient amount of time to measure such risk. The look-back period of 
70 Business Days is designed to be long enough to enable FICC to 
capture a full calendar quarter of members' activities and to smooth 
out the impact from any abnormalities that may have occurred, but not 
excessively long such that members' business strategy and outlook could 
have shifted significantly during the time period, resulting in 
material changes to the size of its portfolios. As a result of these 
changes, the Commission believes that FICC should be in a better 
position to manage its risk by using a look-back period that more 
accurately reflects the amount of risk that the member brings to FICC.
    Third, as described above, FICC proposes to introduce the concept 
of an Event Period, which would group Defaulting Member Events and 
Declared Non-Default Loss Events occurring within a period of 10 
Business Days for purposes of allocating losses to members in one or 
more rounds. Under the current Rules, every time each Division incurs a 
loss or liability, FICC will initiate its current loss allocation 
process by applying its retained earnings and allocating losses. The 
current Rules do not contemplate a situation where loss events occur in 
quick succession. Accordingly, even if multiple losses occur within a 
short period, the current Rules dictate that FICC start the loss 
allocation process separately for each loss event. Having multiple loss 
allocation calculations and notices from FICC and withdrawal

[[Page 44338]]

notices from members after multiple sequential loss events could cause 
operational risk to FICC, since multiple notices may cause confusion at 
a time of significant stress.
    The Commission believes that the proposed change to introduce an 
Event Period would improve upon the current loss allocation process 
described immediately above. Specifically, the introduction of an Event 
Period would provide a more defined and transparent structure than the 
current loss allocation process. Such an improved structure should 
enable both FICC and each member to more effectively manage the risks 
and potential financial obligations presented by sequential Defaulting 
Member Events and/or Declared Non-Default Loss Events that are likely 
to arise in quick succession and could be closely linked to an initial 
event and/or market dislocation episode. In other words, the proposed 
Event Period structure should help clarify and define for both FICC and 
its members how FICC would initiate a single defined loss allocation 
process to cover all loss events within 10 Business Days. As a result, 
all loss allocation calculation and notices from FICC and potential 
withdrawal notices from members would be tied back to one Event Period 
instead of each individual loss event.
    Fourth, as described above, the proposal would improve upon the 
approach laid out in FICC's current Rules by providing for a loss 
allocation round, a Loss Allocation Notice process, a Loss Allocation 
Withdrawal Notice process, and a Loss Allocation Cap, for both the GSD 
Rules and the MBSD Rules. A loss allocation round would be a series of 
loss allocations relating to an Event Period, the aggregate amount of 
which would be limited by the round cap. When the losses allocated in a 
round equals the round cap, any additional losses relating to the Event 
Period would be allocated in subsequent rounds until all losses from 
the Event Period are allocated among members. Each loss allocation 
would be communicated to members by the issuance of a Loss Allocation 
Notice. Each member in a loss allocation round would have five 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 
FICC, and thereby benefit from its Loss Allocation Cap. The Loss 
Allocation Cap of a member would be equal to the greater of its 
Required Fund Deposit on the first day of the applicable Event Period 
and its Average RFD. Members would have two Business Days after FICC 
issues a first round Loss Allocation Notice to pay the amount specified 
in such notice.
    The Commission believes that those four proposed changes, to (1) 
establish a specific Event Period, (2) continue the loss allocation 
process in successive rounds, (3) clearly communicate with its members 
regarding their loss allocation obligations, and (4) effectively 
identify continuing members for the purpose of calculating loss 
allocation obligations in successive rounds, are designed to make 
FICC's loss allocation process more certain. In addition, the changes 
are designed to provide members with a clear set of procedures that 
operate within the proposed loss allocation structure, and provide 
increased predictability and certainty regarding members' exposures and 
obligations. Furthermore, by grouping all loss events within 10 
business days, the loss allocation process relating to multiple loss 
events can be streamlined. With enhanced certainty, predictability, and 
efficiency, FICC would then be able to better manage its risks from 
loss events occurring in quick succession, and members would be able to 
better manage their risks by deciding whether and when to withdraw from 
membership and limit their exposures to FICC. Furthermore, the proposed 
changes are designed to reduce liquidity risk to members by providing a 
two-day window to arrange funding to pay for loss allocation, while 
still allowing FICC to address losses in a timely manner.
    Fifth, as described above, for both the GSD Rules and the MBSD 
Rules, FICC proposes to clarify the governance around Declared Non-
Default Loss Events by providing 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 its services in an orderly manner. FICC also 
proposes to provide that FICC would then be required to promptly notify 
members of this determination. In addition, FICC proposes to apply a 
mandatory Corporate Contribution to a Declared Non-Default Loss Event 
prior to any allocation of the loss among members.
    The Commission believes that the immediately above described 
changes should provide an orderly and transparent procedure to allocate 
a non-default loss by requiring the Board of Directors to make a 
definitive decision to announce an occurrence of a Declared Non-Default 
Loss Event, and requiring FICC to provide a notice to members of such 
decision. The Commission further believes that an orderly and 
transparent procedure should result in a risk management process at 
FICC that is more robust as a result of enhanced governance around 
FICC's response to non-default losses, thereby promoting safety and 
soundness.
    Collectively, the Commission believes that the proposed changes to 
FICC's loss allocation process would provide greater transparency, 
certainty, and efficiency to both FICC and members regarding the amount 
of resources and the instances in which FICC would apply such resources 
to address risks arising from Defaulting Member Events and Declared 
Non-Default Loss Events, which could occur in quick succession. The 
Commission believes that such transparency, certainty, and efficiency 
would allow better predictability to FICC and its members regarding 
their exposures, and in turn, would allow a risk management process at 
FICC and its members that is more robust in response to such events and 
would improve their ability to continue to operate and recover in a 
safe and sound manner during such events. Therefore, the Commission 
believes that the proposal promotes robust risk management as well as 
safety and soundness.
    In addition to the key changes discussed above, FICC proposes 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. Further, FICC proposes 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 Commission believes that the 
proposed change to delete certain vague and imprecise limiting language 
that could impair 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, is designed to promote robust 
risk management by allowing FICC to use MBSD Clearing Fund to manage 
its risk. In addition, the Commission believes that the change is 
designed to promote safety and soundness by enhancing 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

[[Page 44339]]

address losses, liabilities or liquidity needs to meet its settlement 
obligations.
    Finally, FICC proposes to align the loss allocation rules of the 
DTCC Clearing Agencies to the extent practicable and appropriate. The 
alignment is designed to help provide consistent treatment for firms 
that are participants of multiple DTCC Clearing Agencies. The 
Commission believes that providing consistent treatment through 
consistent procedures among the DTCC Clearing Agencies would help firms 
that participate in multiple DTCC Clearing Agencies from encountering 
unnecessary complexities and confusion stemming from differences in 
procedures regarding loss allocation processes, particularly at times 
of significant stress. Accordingly, the Commission believes that the 
change is designed to reduce systemic risk and support the stability of 
the broader financial system.
    Therefore, for all of the reasons stated above, the Commission 
believes that the changes proposed in the Advance Notice are consistent 
with the objectives and principles of Section 805(b) of the Clearing 
Supervision Act.\40\
---------------------------------------------------------------------------

    \40\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

B. Consistency With Rule 17Ad-22(e)(4)(viii)

    Rule 17Ad-22(e)(4)(viii) under the Act requires, in part, that a 
covered clearing agency \41\ establish, implement, maintain and enforce 
written policies and procedures reasonably designed to effectively 
identify, measure, monitor, and manage its credit exposures to 
participants and those arising from its payment, clearing, and 
settlement processes, including by addressing allocation of credit 
losses the covered clearing agency may face if its collateral and other 
resources are insufficient to fully cover its credit exposures.\42\
---------------------------------------------------------------------------

    \41\ A ``covered clearing agency'' means, among other things, a 
clearing agency registered with the Commission under Section 17A of 
the Exchange Act (15 U.S.C. 78q-1 et seq.) that is designated 
systemically important by the Financial Stability Oversight Counsel 
(``FSOC'') pursuant to the Clearing Supervision Act (12 U.S.C. 5461 
et seq.). See 17 CFR 240.17Ad-22(a)(5) and (6). On July 18, 2012, 
FSOC designated FICC as systemically important. U.S. Department of 
the Treasury, ``FSOC Makes First Designations in Effort to Protect 
Against Future Financial Crises,'' available at https://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx. 
Therefore, FICC is a covered clearing agency.
    \42\ 17 CFR 240.17Ad-22(e)(4)(viii).
---------------------------------------------------------------------------

    As described above, the proposal would revise the loss allocation 
process to address how FICC would manage loss events, including 
Defaulting Member Events. Under the proposal, if losses arise out of or 
relate to a Defaulting Member Event, FICC would first apply its 
Corporate Contribution. If such funds prove insufficient, the proposal 
provides for allocating the remaining losses to the remaining members 
through the proposed process. Accordingly, the Commission believes that 
the proposal is reasonably designed to manage FICC's credit exposures 
to its members, by addressing allocation of credit losses.
    Therefore, the Commission believes that FICC's proposal is 
consistent with Rule 17Ad-22(e)(4)(viii) under the Act.\43\
---------------------------------------------------------------------------

    \43\ Id.
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(13)

    Rule 17Ad-22(e)(13) under the Act requires, in part, that a covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to ensure the covered 
clearing agency has the authority to take timely action to contain 
losses and liquidity demands and continue to meet its obligations.\44\
---------------------------------------------------------------------------

    \44\ 17 CFR 240.17Ad-22(e)(13).
---------------------------------------------------------------------------

    As described above, the proposal would establish a more detailed 
and structured loss allocation process by (1) modifying the calculation 
and application of the Corporate Contribution; (2) introducing an Event 
Period; (3) introducing a loss allocation round and notice process; (4) 
implementing a look-back period to calculate a member's loss allocation 
obligation; (5) modifying the withdrawal process and the cap of 
withdrawing member's loss allocation exposure; and (6) providing the 
governance around a non-default loss. The Commission believes that each 
of these proposed changes helps establish a more transparent and clear 
loss allocation process and authority of FICC to take certain actions, 
such as announcing a Declared Non-Default Loss Event, within the loss 
allocation process. Further, having a more transparent and clear loss 
allocation process as proposed would provide clear authority to FICC to 
allocate losses from Defaulting Member Events and Declared Non-Default 
Loss Events and take timely actions to contain losses, and continue to 
meet its clearance and settlement obligations.
    Therefore, the Commission believes that FICC's proposal is 
consistent with Rule 17Ad-22(e)(13) under the Act.\45\
---------------------------------------------------------------------------

    \45\ Id.
---------------------------------------------------------------------------

D. Consistency With Rule 17Ad-22(e)(23)(i) and (ii)

    Rule 17Ad-22(e)(23)(i) under the Act requires that a covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to publicly disclose all 
relevant rules and material procedures, including key aspects of its 
default rules and procedures.\46\ Rule 17Ad-22(e)(23)(ii) under the Act 
requires that a covered clearing agency establish, implement, maintain 
and enforce written policies and procedures reasonably designed to 
provide sufficient information to enable participants to identify and 
evaluate the risks, fees, and other material costs they incur by 
participating in the covered clearing agency.\47\
---------------------------------------------------------------------------

    \46\ 17 CFR 240.17Ad-22(e)(23)(i).
    \47\ 17 CFR 240.17Ad-22(e)(23)(ii).
---------------------------------------------------------------------------

    As described above, the proposal would publicly disclose how FICC's 
Corporate Contribution would be calculated and applied. In addition, 
the proposal would establish and publicly disclose a detailed procedure 
in the Rules for loss allocation. More specifically, the proposed 
changes would establish an Event Period, loss allocation rounds, a 
look-back period to calculate each member's loss allocation obligation, 
a withdrawal process followed by a loss allocation process, and a Loss 
Allocation Cap that would apply to members after withdrawal. 
Additionally, the proposal would align the loss allocation rules across 
the DTCC Clearing Agencies to help provide consistent treatment, and 
clarify that non-default losses would trigger loss allocation to 
members. The proposal would also provide for and make known to members 
the procedures to trigger a loss allocation procedure, contribute 
FICC's Corporate Contribution, allocate losses, and withdraw and limit 
member's loss exposure. Accordingly, the Commission believes that the 
proposal is reasonably designed to (1) publicly disclose all relevant 
rules and material procedures concerning key aspects of FICC's default 
rules and procedures, and (2) provide sufficient information to enable 
members to identify and evaluate the risks by participating in FICC.
    Therefore, the Commission believes that FICC's proposal is 
consistent with Rules 17Ad-22(e)(23)(i) and (ii) under the Act.\48\
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    \48\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act,\49\ that the Commission does not object to 
advance notice SR-FICC-2017-806, as modified by Amendment No. 1, and 
that FICC is authorized to implement the proposal as

[[Page 44340]]

of the date of this notice or the date of an order by the Commission 
approving proposed rule change SR-FICC-2017-022, as modified by 
Amendment No. 1, whichever is later.
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    \49\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-18865 Filed 8-29-18; 8:45 am]
 BILLING CODE 8011-01-P


