[Federal Register Volume 83, Number 171 (Tuesday, September 4, 2018)]
[Notices]
[Pages 44977-44984]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-19053]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83971; File No. SR-NSCC-2017-018]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Order Approving a Proposed Rule Change, as Modified by 
Amendment No. 1, To Amend the Loss Allocation Rules and Make Other 
Changes

August 28, 2018.
    On December 18, 2017, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-NSCC-2017-018 pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder \2\ to amend its loss allocation rules and 
make other conforming and technical changes.\3\ The proposed rule 
change was published for comment in the Federal Register on January 8, 
2018.\4\ 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.\5\ 
On March 20, 2018, the Commission instituted proceedings to determine 
whether to approve or disapprove the proposed rule change.\6\ 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.\7\ On June 28, 2018, NSCC filed Amendment No. 
1 to the proposed rule change to amend and replace in its entirety the 
proposed rule change as originally filed on December 18, 2017.\8\ The 
Commission did not receive any comments. This order approves the 
proposed rule change, as modified by Amendment No. 1 (hereinafter, 
``Proposed Rule Change'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On December 18, 2017, NSCC filed the proposed rule change as 
advance notice SR-NSCC-2017-806 with the Commission 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) of the Act (``Advance Notice''). 12 U.S.C. 
5465(e)(1) and 17 CFR 240.19b-4(n)(1)(i), respectively. The Advance 
Notice was published for comment in the Federal Register on January 
30, 2018. 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. 12 
U.S.C. 5465(e)(1)(H); Securities Exchange Act Release No. 82584 
(January 24, 2018), 83 FR 4377 (January 30, 2018) (SR-NSCC-2017-
806). On April 10, 2018, the Commission required additional 
information from NSCC pursuant to Section 806(e)(1)(D) of the 
Clearing Supervision Act, 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. 12 U.S.C. 5465(e)(1)(D); 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 
https://www.sec.gov/rules/sro/nscc-an.htm. On June 28, 2018, NSCC 
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, which was published in the Federal Register on August 6, 2018. 
Securities Exchange Act Release No. 83748 (July 31, 2018), 83 FR 
38375 (August 6, 2018) (SR-NSCC-2017-806). NSCC 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 https://www.sec.gov/rules/sro/nscc-an.htm since June 29, 2018. 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. 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 
https://www.sec.gov/rules/sro/nscc-an.htm. 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. 82428 (January 2, 2018), 
83 FR 897 (January 8, 2018) (SR-NSCC-2017-018).
    \5\ 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).
    \6\ Securities Exchange Act Release No. 82910 (March 20, 2018), 
83 FR 12968 (March 26, 2018) (SR-NSCC-2017-018).
    \7\ 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).
    \8\ Securities Exchange Act Release No. 83633 (July 13, 2018), 
83 FR 34227 (July 19, 2018) (SR-NSCC-2017-018) (``Notice of 
Amendment No. 1''). NSCC 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/nscc-an.htm since June 29, 
2018.
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I. Description

    The Proposed Rule Change consists of proposed changes to NSCC's 
Rules and Procedures (``Rules'') \9\ in order to (1) modify the loss 
allocation process; (2) align NSCC's loss allocation rule among the 
three clearing agencies of The Depository Trust & Clearing Corporation 
(``DTCC'')--The Depository Trust Company (``DTC''), Fixed Income 
Clearing Corporation (``FICC'') (including the Government Securities 
Division (``FICC/GSD'') and the Mortgage-Backed Securities Division 
(``FICC/MBSD'')), and NSCC (collectively, the ``DTCC Clearing 
Agencies''); \10\ (3) reduce the time within which NSCC is required to 
return a former Member's Clearing Fund deposit; 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

[[Page 44978]]

Notice can be found in the Notice of Amendment No. 1.\11\
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    \9\ Each capitalized term not otherwise defined herein has its 
respective meaning as set forth in the Rules, available at http://
www.dtcc.com/~/media/Files/Downloads/legal/rules/nscc_rules.pdf.
    \10\ 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.
    \11\ See Notice of Amendment No. 1, supra note 8.
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A. Changes to the Loss Allocation Process

    NSCC's loss allocation rules currently provide that in the event 
NSCC ceases to act \12\ 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 NSCC may 
access under the Rules, are the first source of funds NSCC 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 NSCC will apply the following available 
resources, in the following order: (1) As provided in Addendum E of the 
Rules, NSCC's corporate contribution of at least 25 percent of NSCC's 
retained earnings existing at the time of a Member impairment, or such 
greater amount as the Board of Directors may determine; and (2) if a 
loss still remains, as provided in Rule 4, the required Clearing Fund 
deposits of non-defaulting Members on the date of default.
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    \12\ When NSCC restricts a Member's access to services 
generally, NSCC is said to have ``ceased to act'' for the Member. 
Rule 46 (Restrictions on Access to Services) sets out the 
circumstances under which NSCC may cease to act for a Member, and 
Rule 18 (Procedures for When the Corporation Declines or Ceases to 
Act) sets out the types of actions NSCC may take when it ceases to 
act for a Member. Supra note 9.
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    Pursuant to current Section 5 of Rule 4, if, as a result of 
applying the Clearing Fund deposit of a Member, the Member's actual 
Clearing Fund deposit is less than its Required Deposit, it will be 
required to eliminate such deficiency in order to satisfy its Required 
Deposit amount. Pursuant to current Section 4 of Rule 4, Members can 
also be assessed for non-default losses incident to the operation of 
the clearance and settlement business of NSCC. Pursuant to current 
Section 8 of Rule 4, Members may withdraw from membership within 
specified timeframes after a loss allocation charge to limit their 
obligation for future assessments.
    NSCC proposes to change the manner in which each of the aspects of 
the loss allocation process described above would be employed. The 
proposal 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.
    NSCC proposes six key changes to enhance NSCC's loss allocation 
process. Specifically, NSCC proposes to make changes regarding (1) the 
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
    Addendum E of the Rules currently provides that NSCC will 
contribute no less than 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 impaired Member's Clearing Fund 
deposit. Under the proposal, NSCC 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 NSCC General Business Risk 
Capital Requirement.\13\
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    \13\ NSCC 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 NSCC's critical operations, and (3) an amount 
determined based on an analysis of NSCC's estimated operating 
expenses for a six month period.
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    NSCC's General Business Risk Capital Requirement, as defined in 
NSCC's Clearing Agency Policy on Capital Requirements,\14\ is, at a 
minimum, equal to the regulatory capital that NSCC is required to 
maintain in compliance with Rule 17Ad-22(e)(15) under the Act.\15\ The 
proposed Corporate Contribution would be held in addition to NSCC's 
General Business Risk Capital Requirement.
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    \14\ 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).
    \15\ 17 CFR 240.17Ad-22(e)(15).
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    Under the current Addendum E of the Rules, NSCC 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 NSCC as result of a Member's impairment. This 
option would be retained and expanded under the proposal so that NSCC 
can voluntarily apply amounts greater than the Corporate Contribution 
against any loss or liability (including non-default losses) of NSCC, 
if the Board of Directors, in its sole discretion, believes such to be 
appropriate under the factual situation existing at the time.
    Currently, the Rules do not require NSCC to contribute its retained 
earnings to losses and liabilities other than those from Member 
impairments. Under the proposal, NSCC 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 defined in the proposed 
change, and would be a mandatory contribution by NSCC prior to any 
allocation of the loss among NSCC's Members.\16\
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    \16\ NSCC does not propose to apply the Corporate Contribution 
if the Clearing Fund is used as a liquidity resource; however, if 
NSCC uses the Clearing Fund as a liquidity resource for more than 30 
calendar days, as set forth in proposed Section 2 of Rule 4, then 
NSCC would have to consider the amount used as a loss to the 
Clearing Fund incurred as a result of a Defaulting Member Event and 
allocate the loss pursuant to proposed Section 4 of Rule 4, which 
would then require the application of a Corporate Contribution.
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    As proposed, if the Corporate Contribution is fully or partially 
used against a loss or liability relating to an Event Period, the 
Corporate Contribution would be reduced to the remaining unused amount, 
if any, during the following 250 business days in order to permit NSCC 
to replenish the Corporate Contribution.\17\ Under the proposal, 
Members would receive notice of any such reduction to the Corporate 
Contribution.
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    \17\ NSCC states that 250 business days would be a reasonable 
estimate of the time frame that NSCC would be required to replenish 
the Corporate Contribution by equity in accordance with NSCC'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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(2) Event Period
    NSCC states that in order to clearly define the obligations of NSCC 
and its 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, NSCC 
proposes to introduce the concept of an Event Period to the 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. 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 in one or

[[Page 44979]]

more rounds, subject to the limitations of loss allocation as explained 
below.\18\
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    \18\ NSCC 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 NSCC 
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 loss or liability arising from or relating to a Declared Non-
Default Loss Event, an Event Period would begin on the day that NSCC 
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. 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 NSCC, 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.\19\
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    \19\ Under the proposal, each Member that is a 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 
Members (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. NSCC may continue the loss allocation process in successive 
rounds until all losses from the Event Period are allocated among 
Members that have not submitted a Loss Allocation Withdrawal Notice in 
accordance with proposed Section 6 of Rule 4.
    Each loss allocation would be communicated to Members by the 
issuance of a notice that advises each Member of the amount being 
allocated to it (``Loss Allocation Notice''). Each Member's 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 Member has been a Member (each 
Member's ``Average RFD''), divided by (2) 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 Member in that 
round has five business days from the issuance of such first Loss 
Allocation Notice for the round to notify NSCC of its election to 
withdraw from membership with NSCC pursuant to proposed Section 6 of 
Rule 4, and thereby benefit from its Loss Allocation Cap.\20\ In other 
words, the proposed change would link the Loss Allocation Cap to a 
round in order to provide Members 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 Members that 
have not submitted a Loss Allocation Withdrawal Notice, in accordance 
with proposed Section 6 of Rule 4, would be subject to further loss 
allocation with respect to that Event Period.
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    \20\ Pursuant to current Section 8 of Rule 4, the time period 
for a Member to give notice of its election to terminate its 
business with NSCC in respect of a pro rata charge is 10 business 
days after receiving notice of a pro rata charge. Supra note 9. NSCC 
states that it would be appropriate to shorten such time period from 
10 business days to five business days because NSCC needs timely 
notice of which Members would remain in its membership for purposes 
of calculating the loss allocation for any subsequent round. NSCC 
states that five business days would provide Members with sufficient 
time to decide whether to cap their loss allocation obligations by 
withdrawing from their membership in NSCC.
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    NSCC's current loss allocation provisions provide that if a charge 
is made against a Member's actual Clearing Fund deposit, and as result 
thereof the Member's deposit is less than its Required Deposit, the 
Member will, upon demand by NSCC, be required to replenish its deposit 
to eliminate the deficiency within such time as NSCC shall require. 
Under the proposal, Members would receive two business days' notice of 
a loss allocation, and be required to pay the requisite amount no later 
than the second business day following the issuance of such notice.\21\
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    \21\ NSCC 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 
NSCC to address losses in a timely manner.
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(4) Look-Back Period
    Currently, the Rules calculate a Member's pro rata share for 
purposes of loss allocation based on the Member's activity in each of 
the various services or Systems offered by NSCC.\22\ NSCC states that 
it would be more appropriate to determine a Member's pro rata share of 
losses and liabilities based on the amount of risk that the Member 
brings to NSCC, which is represented by the Member's Required Deposit 
(NSCC proposes that ``Required Deposits'' be renamed ``Required Fund 
Deposits,'' as described below). Accordingly, NSCC proposes to 
calculate each Member's pro rata share of losses and liabilities to be 
allocated in any round (as described above) to be equal to (1) the 
Member's Average RFD divided by (2) the sum of Average RFD amounts for 
all Members that are subject to loss allocation in such round. The 
proposed rule would define a Member's Average RFD as the average of the 
Member's Required Fund Deposit for the 70 business days \23\ preceding 
the first day of the applicable Event Period or such shorter period of 
time that the Member has been a Member. Additionally, if a Member 
withdraws from membership pursuant to proposed

[[Page 44980]]

Section 6 of Rule 4, NSCC proposes that the 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.
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    \22\ NSCC states that its current loss allocation rules pre-date 
NSCC's move to a risk-based margining methodology.
    \23\ NSCC states that having a look-back period of 70 business 
days is appropriate because it would be long enough to enable NSCC 
to capture a full calendar quarter of a Member's activities, 
including quarterly option expirations, and smooth out the impact 
from any abnormalities and/or arbitrariness that may have occurred, 
but not too long that the Member's business strategy and outlook 
could have shifted significantly, resulting in material changes to 
the size of its portfolios.
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    NSCC states that employing a backward-looking average to calculate 
a Member's loss allocation pro rata share and Loss Allocation Cap would 
disincentivize Member behavior that could heighten volatility or reduce 
liquidity in markets in the midst of a financial crisis. Specifically, 
NSCC states that the proposed look-back period would discourage a 
Member from reducing its settlement activity during a time of stress 
primarily to limit its loss allocation pro rata share, which, as 
proposed, would now be based on the Member's average settlement 
activity over the look-back period rather than its settlement activity 
at a point in time that the Member may not be able to estimate. 
Similarly, NSCC states that taking a backward-looking average into 
consideration when determining a Member's Loss Allocation Cap would 
also deter a Member from reducing its settlement activity during a time 
of stress primarily to limit its Loss Allocation Cap.
(5) Loss Allocation Withdrawal Notice and Loss Allocation Cap
    NSCC's current loss allocation rules allow a Member to withdraw if 
the Member notifies NSCC, within 10 business days after receipt of 
notice of a pro rata charge, of its election to terminate its 
membership and thereby avail itself of a cap on loss allocation. The 
proposed change would shorten the withdrawal notification period from 
10 business days to five business days, and would also change the 
beginning of such notification period from the receipt of the notice of 
a pro rata charge to the issuance of the notice.\24\ Each round would 
allow a Member the opportunity to notify NSCC 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.
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    \24\ NSCC states that setting the start date of the withdrawal 
notification period to the date of issuance of a notice would 
provide a single withdrawal timeframe that would be consistent 
across the Members.
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    Pursuant to the proposed change, in order to avail itself of its 
Loss Allocation Cap, a Member would be able to elect to withdraw from 
membership by following the requirements in proposed Section 6 of Rule 
4: (1) Specify in its Loss Allocation Withdrawal Notice (as defined 
below) an effective date of withdrawal, which date shall be no later 
than 10 business days following the last day of the applicable Loss 
Allocation Withdrawal Notification Period (as defined below) (i.e., no 
later than 10 business days after the fifth business day following the 
first Loss Allocation Notice in that round of loss allocation); \25\ 
(2) cease all activity that would result in transactions being 
submitted to NSCC for clearance and settlement for which such Member 
would be obligated to perform, where the scheduled final settlement 
date would be later than the effective date of the Member's withdrawal; 
and (3) ensure that all clearance and settlement activity for which 
such Member is obligated to NSCC is fully and finally settled by the 
effective date of the Member's withdrawal, including, without 
limitation, by resolving by such date all fails and buy-in obligations.
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    \25\ NSCC states that having an effective date of withdrawal 
that is not later than 10 business days following the last day of 
the Loss Allocation Withdrawal Notification Period would provide 
Members with a reasonable period of time to wind down their 
activities at NSCC while minimizing any uncertainty typically 
associated with a longer withdrawal period.
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    Under the current Rules, a Member's cap on loss allocation is its 
Required Deposit as fixed immediately prior to the time of the pro rata 
charge. Under the proposal, 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 Members included in the 
round. In addition, a Member that withdraws in compliance with proposed 
Section 6 of Rule 4 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 Rule 4; \26\ however, its aggregate 
obligation would be limited to the amount of its Loss Allocation Cap as 
fixed in the round for which it withdrew.\27\ If the first round of 
loss allocation does not fully cover NSCC's losses, a second round 
would 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 Members in a second or subsequent round if 
Members elect to withdraw from membership with NSCC as provided in 
proposed Section 6 of Rule 4 following the first Loss Allocation Notice 
in any round. To the extent that a Member's Loss Allocation Cap exceeds 
the Member's Required Fund Deposit on the first day of the applicable 
Event Period, NSCC may in its discretion retain any excess amounts on 
deposit from the Member, up to the Member's Loss Allocation Cap.
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    \26\ For the avoidance of doubt, pursuant to Section 13(d) of 
Rule 4(A) (Supplemental Liquidity Deposits), a Special Activity 
Supplemental Deposit of a Member may not be used to calculate or be 
applied to satisfy any pro rata charge pursuant to Section 4 of Rule 
4. Supra note 9.
    \27\ If a Member's Loss Allocation Cap exceeds the Member's 
then-current Required Fund Deposit, it must still cover the excess 
amount.
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(6) Declared Non-Default Loss Event
    Aside from losses that NSCC might face as a result of a Defaulting 
Member Event, NSCC could incur non-default losses incident to its 
clearance and settlement business.\28\ The Rules currently permit NSCC 
to apply the Clearing Fund to non-default losses. Specifically, 
pursuant to Section 2(b) of Rule 4,\29\ NSCC can use the Clearing Fund 
to satisfy losses or liabilities of NSCC incident to the operation of 
the clearance and settlement business of NSCC. Section II of Addendum K 
of the Rules provides additional details regarding the application of 
the Clearing Fund to losses outside of a System.
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    \28\ Non-default losses may arise from events such as damage to 
physical assets, a cyber-attack, or custody and investment losses.
    \29\ Current Section 2(b) of Rule 4 provides that ``the use of 
the Clearing Fund . . . shall be limited to satisfaction of losses 
or liabilities of the Corporation incident to the operation of the 
clearance and settlement business of the Corporation other than 
losses and liabilities of a System.'' Supra note 9.
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    NSCC proposes to enhance the governance around non-default losses 
that would trigger loss allocation to Members 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 NSCC to provide clearance and 
settlement services in an orderly manner and would potentially generate 
losses to be mutualized among the Members in order to ensure that NSCC 
may continue to offer clearance and settlement services in an orderly 
manner. The proposed change would provide that NSCC would then be 
required to promptly notify Members of this determination, which would 
be referred to as a Declared Non-Default Loss Event. In addition, NSCC 
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, as described above. Additionally, NSCC proposes 
language to clarify Members' obligations for Declared Non-Default Loss 
Events.

[[Page 44981]]

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. Accelerated Return of Former Member's Clearing Fund Deposit

    NSCC proposes to reduce the time in which NSCC may retain a 
Member's Clearing Fund deposit. Specifically, NSCC proposes that if a 
Member gives notice to NSCC of its election to withdraw from 
membership, NSCC would return the Member's Actual Deposit in the form 
of (1) cash or securities within 30 calendar days and (2) Eligible 
Letters of Credit within 90 calendar days, after all of the Member's 
transactions have settled and all matured and contingent obligations to 
NSCC, for which the Member was responsible while a Member, have been 
satisfied, except that NSCC may retain for up to two years the Actual 
Deposits from Members who have Sponsored Accounts at DTC.
    NSCC states that shortening the time for the return of a Member's 
Clearing Fund deposit would be helpful to firms that have exited NSCC, 
so that such firms could have use of the deposits sooner than under the 
current Rules. However, such return would only occur if all obligations 
of the terminating Member to NSCC have been satisfied, which would 
include both matured as well as contingent obligations.

D. Conforming and Technical Changes

    NSCC proposes to make various conforming and technical changes 
necessary to harmonize the remaining current Rules with the proposed 
changes. The proposed defined terms in the loss allocation process 
would be included in Rule 1 (Definitions and Descriptions), and 
obsolete terms would be replaced with the proposed terms. In addition, 
the rule numbers appear in the remaining current Rules would be updated 
to reflect the changes made by the proposal. NSCC further proposes to 
modify its Voluntary Termination process to avoid any potential 
conflicts with the loss allocation process.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \30\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that the proposed rule change is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to such 
organization. After careful review, the Commission finds that the 
Proposed Rule Change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to NSCC. In particular, 
the Commission finds that the Proposed Rule Change is consistent with 
Section 17A(b)(3)(F) of the Act,\31\ Rule 17Ad-22(e)(4)(viii) under the 
Act,\32\ Rule 17Ad-22(e)(13) under the Act,\33\ and Rules 17Ad-
22(e)(23)(i) and (ii) under the Act.\34\
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    \30\ 15 U.S.C. 78s(b)(2)(C).
    \31\ 15 U.S.C. 78q-1(b)(3)(F).
    \32\ 17 CFR 240.17Ad-22(e)(4)(viii).
    \33\ 17 CFR 240.17Ad-22(e)(13).
    \34\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, in part, that a 
registered clearing agency have rules designed to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency, to remove impediments to and perfect 
the mechanism of a national system for the prompt and accurate 
clearance and settlement of securities transactions, and to protect 
investors and the public interest.\35\
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    \35\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that the proposal to change the loss 
allocation process is designed to assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency. 
As described above, NSCC proposes to make a number of changes to its 
loss allocation process as described above. First, NSCC would modify 
the calculation of its Corporate Contribution to apply a mandatory 
fixed percentage of its General Business Risk Capital Requirement as 
compared to the current Rules that provide for a ``no less than'' 
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. 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 NSCC's Corporate Contribution would be applied to help 
address a loss, and allow NSCC to better anticipate and prepare for 
potential risk exposures that may arise during an Event Period.
    Second, as described above, NSCC 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. These proposed changes are designed to allow NSCC to calculate a 
Member's pro rata share of losses and liabilities based on the amount 
of risk that the Member brings to NSCC. Moreover, using a look-back 
period to determine a Member's loss allocation obligation is designed 
to deter Members from reducing their settlement activities during a 
time of stress primarily to limit their Loss Allocation Caps. As a 
result of these changes, the Commission believes that NSCC should be in 
a better position to manage its risk by curtailing the chance that 
reduced settlement activities contribute to higher volatility or lower 
liquidity during an already stressed period.
    Third, as described above, NSCC 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 NSCC incurs a loss or 
liability, NSCC will initiate its current loss allocation process by 
applying its retained earnings and allocating losses. However, 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 NSCC start the loss 
allocation process separately for each loss event. Having multiple loss 
allocation calculations and notices from NSCC and withdrawal notices 
from Members after multiple sequential loss events could cause heighten 
operational complexity and, therefore, risk for NSCC, since NSCC would 
have to process and track multiple notices while performing its other 
critical operations during a time of significant stress.

[[Page 44982]]

    Therefore, the Commission believes that the proposed change to 
introduce an Event Period would provide a more defined and transparent 
structure, compared to the current loss allocation process described 
immediately above, helping to reduce complexity in and the resources 
needed to effectuate the process, thus mitigating operational risk. 
Overall, such an improved structure should enable both NSCC and each 
Member to more effectively manage the risks and potential financial 
obligations presented by sequential Defaulting Member Events 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 NSCC and Members how 
NSCC 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 NSCC 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 
current loss allocation approach laid out in NSCC's Rules by providing 
for a loss allocation round, a Loss Allocation Notice process, a Loss 
Allocation Withdrawal Notice process, and a Loss Allocation Cap. 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 the first Loss Allocation Notice for the round to notify NSCC of its 
election to withdraw from membership with NSCC, 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 NSCC issues a first round Loss Allocation 
Notice to pay the amount specified in the notice.
    The Commission believes that the 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 NSCC'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, NSCC 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 NSCC. 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 NSCC to address losses in a timely manner.
    Fifth, as described above, NSCC 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 NSCC to provide its services in an 
orderly manner. NSCC also proposes to provide that NSCC would then be 
required to promptly notify Members of this determination and start the 
loss allocation process concerning the loss stemming from a Declared 
Non-Default Loss Event. The Commission believes that these 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 NSCC to provide a notice to Members of the 
decision. The Commission further believes that an orderly and 
transparent procedure should result in a risk management process at 
NSCC that is more robust as a result of enhanced governance around 
NSCC's response to non-default losses.
    Collectively, the Commission believes that the proposed changes to 
NSCC's loss allocation process would provide greater transparency, 
certainty, and efficiency to NSCC regarding the amount of resources and 
the instances in which NSCC would apply the 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 the transparency, certainty, and efficiency would afford NSCC 
better predictability regarding its risk exposure, and in turn, would 
allow a risk management process at NSCC that is more effectively 
responsive to such events and would improve NSCC's ability to continue 
to operate in a safe and sound manner during such events. Therefore, 
the Commission believes that these proposed changes would better equip 
NSCC to assure the safeguarding of securities and funds which are in 
the custody or control of NSCC.
    In addition, the Commission believes that the proposed rule changes 
to align NSCC's loss allocation rules with the loss allocation rules of 
the other DTCC Clearing Agencies, to the extent practicable and 
appropriate, are designed to remove impediments to and perfect the 
mechanism of a national system for the prompt and accurate clearance 
and settlement of securities transactions. As described above, the 
alignment of NSCC's loss allocation rules with the other NSCC Clearing 
Agencies 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, by removing potential unnecessary 
complexities and confusion due to different loss allocation rules of 
the DTCC Clearing Agencies, the Commission believes that the proposal 
is designed to remove impediments to and perfect the mechanism of a 
national system for the prompt and accurate clearance and settlement of 
securities transactions.
    Finally, the Commission believes that the proposed rule change to 
(1) reduce the time within which NSCC is required to return a former 
Member's Clearing Fund deposit that is cash or securities from 90 days 
to 30 calendar days, and (2) make conforming and technical changes 
necessary to harmonize the current Rules with the proposed changes are 
designed to protect investors and the public interest. First,

[[Page 44983]]

the Commission believes that the reduction in time to return the 
deposits would enable firms that have exited NSCC to have access to 
their funds sooner than under the current Rules. While acknowledging 
that the reduction in time could lesson NSCC's flexibility in liquidity 
management for the period between 31 calendar days and 90 days, the 
Commission believes that NSCC's procedures would continue to protect 
NSCC and its clearance and settlement services because a Member's 
Clearing Fund deposit would only be returned if all obligations of the 
terminating Member to NSCC have been satisfied. Therefore, NSCC could 
maintain necessary coverage for possible claims arising in connection 
with the NSCC activities of a former Member. Second, the conforming and 
technical changes are designed to provide clear and coherent Rules 
concerning loss allocation process to NSCC and its Members. The 
Commission believes that clear and coherent Rules should help enhance 
the ability of NSCC and Members to more effectively plan for, manage, 
and address the risks and financial obligations that loss events 
present to NSCC and its Members. Accordingly, the Commission believes 
that these two changes are designed to protect investors and the public 
interest by (1) reducing financial risks for NSCC's former Members, and 
(2) providing clear and coherent Rules to NSCC and Members.
    For the reasons above, the Commission believes that the Proposed 
Rule Change is consistent with Section 17A(b)(3)(F) of the Act.\36\
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    \36\ 15 U.S.C. 78q-1(b)(3)(F).
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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 \37\ 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.\38\
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    \37\ 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 NSCC 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, NSCC is a covered clearing agency.
    \38\ 17 CFR 240.17Ad-22(e)(4)(viii).
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    As described above, the proposal would revise the loss allocation 
process to address how NSCC would manage loss events, including 
Defaulting Member Events. Under the proposal, if losses arise out of or 
relate to a Defaulting Member Event, NSCC would first apply its 
Corporate Contribution. If those 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 NSCC's credit exposures 
to its Members, by addressing allocation of credit losses.
    Therefore, the Commission believes that NSCC's proposal is 
consistent with Rule 17Ad-22(e)(4)(viii) under the Act.\39\
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    \39\ Id.
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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.\40\
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    \40\ 17 CFR 240.17Ad-22(e)(13).
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    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 NSCC 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 NSCC 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 NSCC's proposal is 
consistent with Rule 17Ad-22(e)(13) under the Act.\41\
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    \41\ Id.
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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.\42\ 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.\43\
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    \42\ 17 CFR 240.17Ad-22(e)(23)(i).
    \43\ 17 CFR 240.17Ad-22(e)(23)(ii).
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    As described above, the proposal would publicly disclose how NSCC'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 
NSCC'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 NSCC's default 
rules and procedures, and (2) provide sufficient information to enable 
Members to identify and evaluate the risks by participating in NSCC.
    Therefore, the Commission believes that NSCC's proposal is 
consistent with

[[Page 44984]]

Rules 17Ad-22(e)(23)(i) and (ii) under the Act.\44\
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    \44\ 17 CFR 240.17Ad-22(e)(23)(i) and (ii).
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act \45\ and the 
rules and regulations thereunder.
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    \45\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\46\ that proposed rule change SR-NSCC-2017-018, as modified by 
Amendment No. 1, be, and it hereby is, approved \47\ as of the date of 
this order or the date of a notice by the Commission authorizing NSCC 
to implement advance notice SR-NSCC-2017-806, as modified by Amendment 
No. 1, whichever is later.
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    \46\ 15 U.S.C. 78s(b)(2).
    \47\ In approving the Proposed Rule Change, the Commission has 
considered the Proposed Rule Change's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \48\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\48\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-19053 Filed 8-31-18; 8:45 am]
 BILLING CODE 8011-01-P


