[Federal Register Volume 85, Number 9 (Tuesday, January 14, 2020)]
[Notices]
[Pages 2197-2202]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-00366]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87911; File No. SR-NSCC-2019-801]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Advance Notice To Enhance National 
Securities Clearing Corporation's Haircut-Based Volatility Charge 
Applicable to Municipal Bonds

January 8, 2020.
    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\ notice is hereby given that on 
December 13, 2019, National Securities Clearing Corporation (``NSCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
advance notice SR-NSCC-2019-801 (``Advance Notice'') as described in 
Items I, II and III below, which Items have been prepared by the 
clearing agency.\3\ The Commission is publishing this notice to solicit 
comments on the Advance Notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ On December13, 2019, NSCC filed this Advance Notice as a 
proposed rule change (SR-NSCC-2019-004) with the Commission pursuant 
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4 
thereunder, 17 CFR 240.19b-4. A copy of the proposed rule change is 
available at http://www.dtcc.com/legal/sec-rule-filings.aspx.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This Advance Notice consists of amendments to NSCC's Rules & 
Procedures (``Rules'') \4\ in order to enhance NSCC's haircut-based 
volatility charge applicable to municipal bonds (the ``Bond Haircut''). 
References to the Bond Haircut in this document refer only to that 
charge as applied to municipal bonds. The proposed changes are 
described in greater detail below.
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    \4\ Capitalized terms not defined herein are defined in the 
Rules, available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, the clearing agency included 
statements concerning the purpose of and basis for the Advance Notice 
and discussed any comments it received on the Advance Notice. The text 
of these statements may be examined at the places specified in Item IV 
below. The clearing agency has prepared summaries, set forth in 
sections A and B below, of the most significant aspects of such 
statements.

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

    NSCC has not received or solicited any written comments relating to 
this proposal. NSCC will notify the Commission of any written comments 
received by NSCC.

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

Description of Proposed Changes
    NSCC is proposing a number of enhancements to NSCC's Bond Haircut, 
as described in greater detail below.
The Required Fund Deposit and the Bond Haircut
    As part of its market risk management strategy, NSCC manages its 
credit exposure to Members by determining

[[Page 2198]]

the appropriate Required Fund Deposit for each Member and monitoring 
its sufficiency, as provided for in the Rules.\5\ The Required Fund 
Deposit serves as each Member's margin. The objective of a Member's 
Required Fund Deposit is to mitigate potential losses to NSCC 
associated with liquidation of the Member's portfolio in the event NSCC 
ceases to act for that Member (hereinafter referred to as a 
``default'').\6\ The aggregate of all Members' Required Fund Deposits, 
together with certain other deposits required under the Rules, 
constitute the Clearing Fund of NSCC, which it would access should a 
defaulting Member's own Required Fund Deposit be insufficient to 
satisfy losses to NSCC caused by the liquidation of that Member's 
portfolio.
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    \5\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters) of the Rules (``Procedure XV''), supra 
note 4. NSCC's market risk management strategy is designed to comply 
with Rule 17Ad-22(e)(4) under the Act, where these risks are 
referred to as ``credit risks.'' 17 CFR 240.17Ad-22(e)(4).
    \6\ The Rules identify when NSCC may cease to act for a Member 
and the types of actions NSCC may take. For example, NSCC may 
suspend a firm's membership with NSCC or prohibit or limit a 
Member's access to NSCC's services in the event that Member defaults 
on a financial or other obligation to NSCC. See Rule 46 
(Restrictions on Access to Services) of the Rules, supra note 4.
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    Pursuant to the Rules, each Member's Required Fund Deposit amount 
consists of a number of applicable components, each of which is 
calculated to address specific risks faced by NSCC, as identified 
within Procedure XV.\7\ Generally, the largest component of Members' 
Required Fund Deposits is the volatility component. The volatility 
component is designed to calculate the amount of money that could be 
lost on a portfolio over a given period of time assumed necessary to 
liquidate the portfolio, within a 99% confidence level.
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    \7\ Procedure XV, supra note 4.
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    NSCC has two methodologies for calculating the volatility 
component. For the majority of Net Unsettled Positions,\8\ NSCC 
calculates the volatility component as the greater of (1) the larger of 
two separate calculations that utilize a parametric Value at Risk 
(``VaR'') model, (2) a gap risk measure calculation based on the 
largest non-index position in a portfolio that exceeds a concentration 
threshold, and (3) a portfolio margin floor calculation based on the 
market values of the long and short positions in the portfolio (``VaR 
Charge'').\9\ Pursuant to Sections I(A)(1)(a)(ii) and I(A)(2)(a)(ii) of 
Procedure XV, certain positions in certain classes of securities, 
including municipal bonds, are excluded from the calculation of the VaR 
Charge and are instead charged a haircut-based volatility component 
that is calculated by multiplying the absolute value of such positions 
by a percentage designated by NSCC which shall not be less than 2%.\10\
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    \8\ ``Net Unsettled Positions'' and ``Net Balance Order 
Unsettled Positions'' refer to net positions that have not yet 
passed their settlement date, or did not settle on their settlement 
date, and are referred to collectively in this filing as Net 
Unsettled Positions. NSCC does not take into account any offsets, 
such as inventory held at other clearing agencies, when determining 
Net Unsettled Positions for the purpose of calculating the 
volatility component. See Procedure XV, supra note 4.
    \9\ Sections I(A)(1)(a)(i) and I(A)(2)(a)(i) of Procedure XV, 
supra note 4.
    \10\ Sections I(A)(1)(a)(ii) and I(A)(2)(a)(ii) of Procedure XV, 
supra note 4.
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Existing Municipal Bond Haircut Methodology
    The existing methodology for calculating the Bond Haircut is 
described in Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of 
Procedure XV.\11\ In order to determine the current Bond Haircut, 
municipal bonds are categorized into tenor-based groups (i.e., based on 
remaining time to maturity) and separately categorized by municipal 
sector. Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of Procedure 
XV provide that NSCC shall establish a percentage applicable to each 
tenor-based group and pursuant to those sections NSCC has established a 
percentage (which is not less than 2%) for each tenor-based group which 
is used to calculate the haircut-based charge applicable to that 
group.\12\ For municipal bonds rated higher than BBB+, NSCC has 
established a tenor-based haircut for each tenor-based group. For 
example, a municipal bond rated above BBB+ with 3 years to maturity and 
$10MM short position, will be subject to the 2-5 years tenor-based 
group haircut (5%) which will be applied to the absolute market value 
of the positions resulting in $500K haircut-based charge.
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    \11\ Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of 
Procedure XV, supra note 4.
    \12\ Id.
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    Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of Procedure XV 
provide that NSCC shall assign each municipal sector a risk factor.\13\ 
For municipal bonds rated lower than a pre-determined threshold, which 
shall be no lower than BBB+, and non-rated municipal bonds, NSCC has 
established a percentage based on a sector-based risk factor which is 
also applied to the tenor-based haircut. For example, a municipal bond 
in the healthcare sector, rated BBB+ or lower with 3 years to maturity 
and $10MM short position, will be subject to the 2-5 years tenor-based 
group haircut (5%) multiplied by the sector-based factor (1.2), 
resulting in 6% haircut-based charge of $600K. This additional sector-
based risk factor is added because variable risk factors exist between 
municipal sectors based on the various industries in which the bonds 
are issued and the source of repayment for the bonds. For instance, 
general obligation bonds are typically backed by the taxing power of 
their issuer and repaid from general taxes whereas transportation or 
healthcare-related bonds may be repaid from funds from a specific 
project based on the revenues of the project. Such risk factor is based 
on the sector index's spread to a benchmark index.\14\ NSCC uses a 
vendor to match bonds to particular sectors. If a municipal bond does 
not fit within any particular sector, the highest sector-based risk 
factor is applied to such municipal bond. Currently, the highest 
sector-based risk factor is 2.6 used for bonds in the housing sector.
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    \13\ Id.
    \14\ The ``spread'' is the difference in the yield curve of the 
sector index to the yield curve of a benchmark index which is 
indicative of the added risk presented by the sector.
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Enhancements to Municipal Bond Haircut Methodology
    NSCC regularly assesses its market and liquidity risks, as such 
risks are related to its margining methodologies, to evaluate whether 
margin levels are commensurate with the particular risk attributes of 
each relevant product, portfolio, and market. In connection with such 
regular reviews, NSCC has determined based on impact studies that, 
under current market conditions, the current margin levels with respect 
to municipal bonds using the current methodology exceed the levels 
necessary to offset the risks with respect to these securities. Based 
on impact studies, NSCC has determined that changes to its current 
methodology for municipal bonds would result in margin levels that are 
lower and more commensurate with the risk attributes of those 
securities. In particular, as described below, NSCC is proposing to 
replace the municipal sector-based risk factor for lower rated 
municipal bonds with a percentage derived using the historical returns 
of applicable benchmark indices.
    NSCC is proposing the following enhancements to the methodology 
used for calculating the Bond Haircut.
    First, NSCC is proposing to re-calibrate the Bond Haircut not less 
frequently than annually. Sections I(A)(1)(a)(iii)(B) and 
I(A)(2)(a)(iii)(B) of

[[Page 2199]]

Procedure XV currently provide that each municipal sector is assigned a 
risk factor no less frequently than annually.\15\ As discussed above 
and below, the enhanced methodology for calculating Bond Haircuts would 
no longer include the straight risk factor by sector. The re-
calibration of the Bond Haircut not less frequently than annually would 
replace the assignment of a straight risk factor no less frequently 
than annually. NSCC believes that the periodic re-calibration would 
help ensure that NSCC is reviewing the Bond Haircut with enough 
regularity to ensure that the margin levels are commensurate with the 
particular risk attributes of municipal bonds.
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    \15\ Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of 
Procedure XV, supra note 4.
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    While the proposed rule change would provide that NSCC would re-
calibrate not less frequently than annually, NSCC would initially re-
calibrate the Bond Haircut on a quarterly basis. NSCC could change how 
often it recalibrates from time to time based on its regular review of 
margining methodologies; provided, that it would recalibrate not less 
frequently than annually pursuant to the proposed rule change. Changes 
to the frequency of calibration would be subject to NSCC's risk 
management practices which would require, among other things, approval 
by the DTCC Model Risk Governance Committee (``MRGC'').\16\
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    \16\ See Securities Exchange Act Release No. 81485 (August 25, 
2017), 82 FR 41433 (August 31, 2017) (File No. SR-NSCC-2017-008) 
(describes the adoption of the Clearing Agency Model Risk Management 
Framework (``Model Risk Management Framework'') of NSCC which sets 
forth the model risk management practices of NSCC) and Securities 
Exchange Act Release No. 84458 (October 19, 2018), 83 FR 53925 
(October 25, 2018) (File No. SR-NSCC-2018-009) (amends the Model 
Risk Management Framework). The Model Risk Management Framework 
describes the model management practices adopted by NSCC, which have 
been designed to assist NSCC in identifying, measuring, monitoring, 
and managing the risks associated with the design, development, 
implementation, use, and validation of ``models'' which would 
include the methodology for the Bond Haircut. Id.
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    Second, municipal bonds would be grouped into tenor-based groups 
and by credit rating, and municipal bonds that are rated BBB+ or lower, 
or that are not rated, would also be separately categorized by 
municipal sector. NSCC would then establish a percentage haircut for 
each group based on the (1) the historical returns of applicable 
benchmark indices, such as tenor-based indices (i.e., based on time to 
maturity), municipal bond sector-based indices, and high-yield indices; 
(2) a pre-determined look-back period, which shall not be shorter than 
10 years; and (3) a pre-determined calibration percentile, which shall 
not be less than 99%.
    For municipal bonds that are rated higher than BBB+, NSCC is 
proposing to use a tenor-based index (i.e., based on time to maturity) 
as the applicable benchmark index. While the proposed rule change would 
provide that NSCC would base such percentage for bonds that are rated 
higher than BBB+ on historical returns of applicable benchmark indices, 
such as tenor-based indices (i.e., based on time to maturity), 
municipal bond sector-based indices, and high-yield indices; NSCC would 
initially base the percentage derived from a benchmark municipal tenor-
based index over a 3-day price return from the index. NSCC could change 
which applicable benchmark indices it uses and the applicable period 
for the price return used in the calculation from time to time based on 
its regular review of margining methodologies. Changes to the frequency 
of calibration would be subject to NSCC's risk management practices 
which would require, among other things, approval by the MRGC.\17\
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    \17\ See note 16.
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    For municipal bonds that are rated BBB+ or lower, or are not rated, 
NSCC is proposing to use a percentage derived from the maximum of the 
applicable tenor-based index, municipal bond sector-based indices and a 
high-yield index. Rather than multiply the tenor-based haircut by a 
straight risk factor for each municipal sector, as is done under the 
current methodology, the Bond Haircut for these lower rated or non-
rated municipal bonds would be determined by using the maximum percent 
derived from either the applicable tenor-based index, the municipal 
bond sector-based indices or a high yield index. The enhancement would 
account for risks represented by the tenor, sector and high-yield 
characteristics that may be presented by these municipal bonds by using 
the maximum percent that is derived from either a tenor-based index, 
sector-based indices or a high yield index, rather than addressing 
these risks by multiplying the percent derived from a tenor-based index 
by a straight sector-based risk factor. Based on analysis of the impact 
studies, NSCC believes that the use of a risk factor based on the 
tenor-based index, municipal bond sector-based indices and a high-yield 
index would result in lower margins with respect to these securities 
that are sufficient to offset the risks with respect to these 
securities.
    While the proposed rule change would provide that NSCC would base 
such percentage on historical returns of applicable benchmark indices, 
such as tenor-based indices (i.e., based on time to maturity), 
municipal bond sector-based indices, and high-yield indices; NSCC would 
initially base the percentage derived from a tenor-based index, 
municipal bond sector-based indices and a high-yield index over a 3-day 
price return from the indices. NSCC could change which applicable 
benchmark indices it uses and the applicable period for the price 
return used in the calculation from time to time based on its regular 
review of margining methodologies in accordance with its risk 
management practices which would require, among other things, approval 
by the MRGC.\18\
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    \18\ See note 16.
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    In extraordinary circumstances, a certain municipality or issuer 
may present unique risks beyond the calibrated tenor, sector and high-
yield factors. For example, the market price risk for issues of a 
municipality facing technical default following a natural disaster may 
not be fully captured due to the liquidity profile of municipal 
securities. Therefore, NSCC would reserve the right to apply the 
highest haircut of all municipal bonds to a specific issuer in such 
instances. NSCC would apply the highest haircut in accordance with its 
risk management practices, including approval by an officer of NSCC in 
the risk management department, following a review of the circumstances 
facing the municipality and a finding that the market price movement 
raises risks that are not accounted for by the Bond Haircut 
methodology.
    Finally, the recalibration of the Bond Haircut would apply a pre-
determined look-back period. NSCC would initially apply a look-back 
period of a 10-year rolling window plus a one calendar year ``worst 
case scenario'' stress period. NSCC believes this look-back period is 
appropriate because it would capture relevant data and is adequate to 
cover enough market activity, while not diluting the ``tail'' with an 
abundance of data.\19\
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    \19\ NSCC believes that a 10-year window with a one-year stress 
period is typically long enough to capture at least two recent 
market cycles. NSCC believes that data over a longer period will 
``flatten'' out the results because recent volatile periods will be 
offset by non-volatile periods, making the more recent volatility 
appear less significant.
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    While the proposed rule change would provide that NSCC would apply 
a pre-determined look-back period, which shall not be shorter than 10 
years, NSCC would initially apply a look-back period of a 10-year 
rolling window plus a one calendar year ``worst case scenario'' stress 
period. NSCC could

[[Page 2200]]

change the look-back period from time to time based on its regular 
review of margining methodologies in accordance with its risk 
management practices which would require, among other things, approval 
by the MRGC.\20\
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    \20\ See note 16.
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Proposed Rule Changes to Procedure XV
    In order to implement the proposed enhancements to the Bond Haircut 
methodology described above, Sections I(A)(1)(a)(iii)(B) and 
I(A)(2)(a)(iii)(B) of Procedure XV would be revised to provide that: 
(i) Municipal bonds would be grouped by both ``remaining time to 
maturity'' and credit rating, and municipal bonds that are BBB+ or 
lower, or that are not rated, would be separately categorized by 
municipal sector, (ii) NSCC would establish the Bond Haircut 
percentages no less frequently than annually, (iii) the Bond Haircut 
percentage to be applied to municipal bonds would apply to each 
grouping of municipal bonds and (iv) the Bond Haircut percentage to be 
applied to municipal bonds would be based on (1) the historical returns 
of applicable benchmark indices, such as tenor-based indices (i.e., 
based on time to maturity), municipal bond sector-based indices, and 
high-yield indices; (2) a pre-determined look-back period; and (3) a 
pre-determined calibration percentile, which shall not be less than 
99%. In addition, Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of 
Procedure XV would be revised to remove the references to the municipal 
sector factor and the current application of the municipal sector 
factor in the last four sentences in Sections I(A)(1)(a)(iii)(B) and 
I(A)(2)(a)(iii)(B) of Procedure XV. A sentence would also be added to 
Sections I(A)(1)(a)(iii)(B) and I(A)(2)(a)(iii)(B) of Procedure XV to 
provide that in extraordinary circumstances where NSCC determines that 
a certain municipality or issuer of municipal bonds presents unique 
risks that are not captured by the grouping set forth in those 
subsections, NSCC may, in its discretion, apply the highest percentage 
being applied to any municipal bond group pursuant to those subsections 
to municipal bonds issued by such municipality or issuer.
Expected Effect on and Management of Risk
    NSCC believes that the proposed changes to enhance the Bond Haircut 
would enable NSCC to better limit its risk exposures to Members arising 
out of their Net Unsettled Positions.
    First, the proposal to enhance the methodology for determining the 
Bond Haircut would improve NSCC's ability to limit its risk exposures 
posed by Net Unsettled Positions in these municipal bonds by allowing 
it to (1) better identify the risks with respect to municipal bonds, 
and (2) calculate a volatility margin component that is appropriate for 
those risks.
    Second, the proposal to re-calibrate the Bond Haircut no less 
frequently than annually, to calibrate the percent to a pre-determined 
percentile that would be not be less than 99% and to apply a pre-
determined look back period would ensure that the Bond Haircut 
continues to accurately measure the risks presented by municipal bonds 
and to better limit its credit exposures posed by municipal bonds. The 
proposal would more appropriately address the risks presented by a Net 
Unsettled Position in municipal bonds by applying a calculation that 
more accurately measures the risks when determining the Bond Haircut to 
be used in that calculation. Therefore, by enabling NSCC to calculate 
and collect margin that more accurately reflects the risk 
characteristics of municipal bonds, these proposals would enhance 
NSCC's risk management capabilities.
    By providing NSCC with a more effective measurement of its 
exposures, as described above, the proposed change would also mitigate 
risk for Members because lowering the risk profile for NSCC would in 
turn lower the risk exposure that Members may have with respect to NSCC 
in its role as a central counterparty.
Consistency With the Clearing Supervision Act
    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, its stated purpose is instructive: To 
mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically important financial market utilities and 
strengthening the liquidity of systemically important financial market 
utilities.\21\
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    \21\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act \22\ authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like NSCC, and financial institutions engaged in designated activities 
for which the Commission is the supervisory agency or the appropriate 
financial regulator. Section 805(b) of the Clearing Supervision Act 
\23\ states that the objectives and principles for the risk management 
standards prescribed under Section 805(a) shall be to, among other 
things, promote robust risk management, promote safety and soundness, 
reduce systemic risks, and support the stability of the broader 
financial system. The Commission has adopted risk management standards 
under Section 805(a)(2) of the Clearing Supervision Act \24\ and 
Section 17A of the Exchange Act (``Covered Clearing Agency 
Standards'').\25\ The Covered Clearing Agency Standards require 
registered clearing agencies to establish, implement, maintain, and 
enforce written policies and procedures that are reasonably designed to 
meet certain minimum requirements for their operations and risk 
management practices on an ongoing basis.\26\
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    \22\ 12 U.S.C. 5464(a)(2).
    \23\ 12 U.S.C. 5464(b).
    \24\ 12 U.S.C. 5464(a)(2).
    \25\ See 17 CFR 240.17Ad-22(e).
    \26\ Id.
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(i) Consistency With Section 805(b) of the Clearing Supervision Act
    For the reasons described below, NSCC believes that the proposed 
changes in this advance notice are consistent with the objectives and 
principles of these risk management standards as described in Section 
805(b) of the Clearing Supervision Act and in the Covered Clearing 
Agency Standards.
    As discussed above, NSCC is proposing changes to the way it 
calculates the volatility component of the Clearing Fund as applied to 
Net Unsettled Positions in municipal bonds. The volatility charge is 
one of the components of its Members' Required Fund Deposits--a key 
tool that NSCC uses to mitigate potential losses to NSCC associated 
with liquidating a Member's portfolio in the event of Member default. 
NSCC believes the proposed changes are consistent with promoting robust 
risk management because they are designed to enable NSCC to better 
limit its exposure to Members in the event of a Member default.
    First, NSCC's proposal to re-calibrate the Bond Haircut no less 
frequently than annually, to calibrate the percent to a pre-determined 
percentile that would be not be less than 99% and to apply a pre-
determined look back period would better enable NSCC to limit its 
exposures to Net Unsettled Positions in municipal bonds. Second, the 
proposal to apply a risk factor based on a tenor-based index, municipal 
bond sector-based indices and a high-yield index for lower rated or 
non-rated municipal

[[Page 2201]]

bonds rather than a straight sector-based risk factor would better 
enable NSCC to limit its exposures to Members by basing this 
calculation on a more accurate measure of the risks relating to 
municipal bonds.
    Furthermore, NSCC believes that the changes proposed in this 
advance notice are consistent with promoting safety and soundness, 
which, in turn, is consistent with reducing systemic risks and 
supporting the stability of the broader financial system, consistent 
with Section 805(b) of the Clearing Supervision Act.\27\ The proposed 
changes are designed to better limit NSCC's exposures to Members in the 
event of Member default. As discussed above, the proposed enhancements 
to the Bond Haircut are designed to more accurately calculate the 
necessary margin relating to municipal bonds and would allow NSCC to 
limit its exposure to Members by applying a volatility component that 
is a more appropriate measure of volatility for Net Unsettled Positions 
in municipal bonds. The proposed enhancements to the Bond Haircut would 
allow NSCC to collect margin at levels that reflect the risk presented 
by Net Unsettled Positions in municipal bonds and would help NSCC limit 
its exposures to Members.
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    \27\ 12 U.S.C. 5464(b).
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    By better limiting NSCC's exposures to Members in the event of a 
Member default, the proposed changes are consistent with promoting 
safety and soundness, which, in turn, is consistent with reducing 
systemic risks and supporting the stability of the broader financial 
system.
(ii) Consistency With Rule 17Ad-22(e)(4)(i) and (e)(6)(i) and (v) Under 
the Act
    NSCC believes that the proposed changes are consistent with Rule 
17Ad-22(e)(4)(i) and (e)(6)(i) and (v), each promulgated under the 
Act.\28\
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    \28\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i) and (v).
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    Rule 17Ad-22(e)(4)(i) under the Act \29\ requires that NSCC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes, including 
by maintaining sufficient financial resources to cover its credit 
exposure to each participant fully with a high degree of confidence.
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    \29\ 17 CFR 240.17Ad-22(e)(4)(i).
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    As described above, NSCC believes that the proposed changes would 
help enable it to better identify, measure, monitor, and, through the 
collection of Members' Required Fund Deposits, manage its credit 
exposures to Members by maintaining sufficient resources to cover those 
credit exposures fully with a high degree of confidence. More 
specifically, the proposed changes to the methodology for Bond Haircuts 
to apply a risk factor based on multiple benchmark indices for lower 
rated or non-rated municipal bonds rather than a straight risk factor 
by sector would help allow NSCC to more accurately identify the credit 
exposure relating to Net Unsettled Positions in municipal bonds for 
purposes of applying an appropriate margin charge and to help provide 
NSCC with a more effective measure of the risks that may be presented 
to NSCC by positions in the securities. The proposed changes to (i) re-
calibrate the Bond Haircut no less frequently than annually, (ii) 
calibrate the percent to a pre-determined percentile that would not be 
less than 99% level, and (iii) apply a pre-determined look-back period 
would enable NSCC to apply the proposed enhanced methodology discussed 
above and to better monitor its credit exposure relating to Net 
Unsettled Positions in municipal bonds. By providing that NSCC would be 
required to re-calibrate the Bond Haircut no less frequently than 
annually, the proposed rule change would help ensure that NSCC would 
periodically review the Bond Haircut to ensure that it continued to 
accurately reflect the risks presented by municipal bonds. Finally, by 
reserving the right to apply the highest group factor in extraordinary 
circumstances, NSCC would help protect itself in circumstances where 
the assigned factor does not adequately account for risks presented by 
extraordinary events, such as natural disasters.
    Based on backtesting results in which the proposed methodology was 
applied, NSCC believes that the proposed changes would help allow it to 
collect Required Fund Deposits that are more accurate to offset the 
risks presented by municipal bonds and provide a better method of 
managing risks presented by those securities. Therefore, NSCC believes 
that the proposed changes would help enhance NSCC's ability to 
effectively identify, measure, monitor and manage its credit exposures 
and would help enhance its ability to maintain sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence. As such, NSCC believes the proposed changes 
are consistent with Rule 17Ad-22(e)(4)(i) under the Act.\30\
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    \30\ Id.
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    Rule 17Ad-22(e)(6)(i) under the Act \31\ requires that NSCC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market.
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    \31\ 17 CFR 240.17Ad-22(e)(6)(i).
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    The Required Fund Deposit is made up of risk-based components (as 
margin) that are calculated and assessed daily to limit NSCC's credit 
exposures to Members. NSCC is proposing changes that are designed to 
more effectively address risk characteristics of Net Unsettled 
Positions in municipal bonds by capturing risks more accurately by 
applying multiple indices. Rather than multiply the tenor-based haircut 
for lower rated bonds by a straight risk factor for each municipal 
sector, the Bond Haircut for lower rated or non-rated municipal bonds 
would be determined by using the maximum percent derived from either 
the tenor-based index, the municipal bond sector-based indices or a 
high yield index. Based on backtesting results, NSCC believes that 
deriving the percent using a maximum of the indices more accurately 
captures the risk of such municipal bonds that may be presented by 
tenor, sector and the higher yield of these securities compared to the 
present use of a straight sector-based risk factor. Based on such 
results, NSCC believes that these changes would help enable NSCC to 
produce margin levels that are more commensurate with the particular 
risk attributes of these securities. These proposed changes are 
designed to assist NSCC in maintaining a risk-based margin system that 
considers, and produces margin levels commensurate with, the risks and 
particular attributes of portfolios relating to municipal bonds, 
including risks and attributes related to tenor, municipal sector and 
higher yields. Therefore, NSCC believes the proposed change is 
consistent with Rule 17Ad-22(e)(6)(i) under the Act.\32\
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    \32\ Id.
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    Rule 17Ad-22(e)(6)(v) under the Act \33\ requires that NSCC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system

[[Page 2202]]

that, at a minimum, uses an appropriate method for measuring credit 
exposure that accounts for relevant product risk factors and portfolio 
effects across products. NSCC is proposing to enhance the Bond Haircut 
because NSCC believes that the proposed methodology would help provide 
NSCC with a more effective measure of the credit exposure presented by 
municipal bonds. In particular, as described above, NSCC believes that 
the enhancements would result in a more effective measure of the tenor, 
sector and higher yield risks presented by municipal bonds that are 
rated BBB+ or lower, or are not rated. Therefore, NSCC believes the 
proposed change is consistent with Rule 17Ad-22(e)(6)(v) under the 
Act.\34\
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    \33\ 17 CFR 240.17Ad-22(e)(6)(v).
    \34\ 17 CFR 240.17Ad-22(e)(6)(v).
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III. Date of Effectiveness of the Advance Notice, and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date that the proposed change was filed with the Commission or (ii) the 
date that any additional information requested by the Commission is 
received. The clearing agency shall not implement the proposed change 
if the Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    The clearing agency shall post notice on its website of proposed 
changes that are implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the Advance 
Notice is consistent with the Clearing Supervision Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-NSCC-2019-801 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NSCC-2019-801. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the Advance Notice that are filed with the 
Commission, and all written communications relating to the Advance 
Notice between the Commission and any person, other than those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of NSCC and on DTCC's website 
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NSCC-2019-801 and should be submitted on 
or before January 29, 2020.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-00366 Filed 1-13-20; 8:45 am]
BILLING CODE 8011-01-P


