[Federal Register Volume 85, Number 39 (Thursday, February 27, 2020)]
[Notices]
[Pages 11401-11406]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-03914]


=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88262; File No. SR-FICC-2019-007]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving a Proposed Rule Change Regarding the Close-Out and 
Funds-Only Settlement Processes Associated With the Sponsoring Member/
Sponsored Member Service

February 21, 2020.

I. Introduction

    On December 27, 2019, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ proposed rule change SR-
FICC-2019-007. The proposed rule change was published for comment in 
the Federal Register on January 10, 2020.\3\ The Commission did not 
receive any comment letters on the proposed rule change. For the 
reasons discussed below, the Commission is approving the proposed rule 
change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 87896 (January 6, 2020), 
85 FR 1354 (January 10, 2020) (SR-FICC-2019-007) (``Notice'').
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    FICC proposes to modify its Government Securities Division 
(``GSD'') Rulebook (``Rules'') \4\ in order to facilitate the 
submission of repurchase transactions (``repos'') with a scheduled 
final settlement date beyond the next Business Day after the initial 
settlement date (``term repo activity'') through the Sponsoring Member/
Sponsored Member Service (``Service'') \5\ by: (1) Providing a 
mechanism by which a Sponsoring Member may cause the termination and 
liquidation of a Sponsored Member's positions arising from trades 
between the Sponsoring Member and its Sponsored Member that have been 
novated to FICC; and (2) revising how FICC calculates the funds-only 
settlement obligations of Sponsored Members and Sponsoring Members with 
respect to Sponsored Member Trades that have haircuts \6\ in order to 
ensure that the calculation does not result in a return of the haircuts 
until final settlement. In addition, FICC proposes to make several 
clarifying and technical changes to the Rules.
---------------------------------------------------------------------------

    \4\ Capitalized terms not defined herein are defined in the 
Rules, available at http://www.dtcc.com/legal/rules-and-procedures.
    \5\ The Service is primarily governed by Rule 3A, supra note 4.
    \6\ As used herein, the term ``haircut'' refers to the amount of 
collateral in excess of the value of the cash due to the Sponsored 
Member client at the close leg of the Sponsored Member Trade.
---------------------------------------------------------------------------

A. Background

    FICC operates two divisions, GSD and the Mortgage Backed Securities 
Division (``MBSD''). GSD provides trade comparison, netting, risk 
management, settlement, and central counterparty services for the U.S. 
Government securities market. MBSD provides the same services for the 
U.S. mortgage-backed securities market. GSD and MBSD maintain separate 
sets of rules, margin models, and clearing funds. The proposed rule 
change relates solely to GSD.
    Under the GSD Rules, certain FICC members are permitted to act as 
``Sponsoring Members'' to sponsor into FICC membership qualified 
institutional buyers as defined by Rule 144A\7\ under the Securities 
Act of 1933, as amended (``Securities Act''),\8\ and certain legal 
entities that, although not organized as entities specifically listed 
in paragraph (a)(1)(i) of Rule 144A under the Securities Act, satisfy 
the financial requirements necessary to be qualified institutional 
buyers as specified in that paragraph (``Sponsored Members'').\9\
---------------------------------------------------------------------------

    \7\ 17 CFR 230.144A.
    \8\ 15 U.S.C. 77a et seq.
    \9\ Rule 3A (Sponsoring Members and Sponsored Members), supra 
note 4.
---------------------------------------------------------------------------

    A Sponsoring Member is permitted to submit to FICC, for comparison, 
novation, and netting, certain types of eligible securities 
transactions between itself and its Sponsored Members (``Sponsored 
Member Trades'').\10\ The Sponsoring Member is required to establish an 
omnibus account at FICC for its Sponsored Members' positions arising 
from such Sponsored Member Trades (``Sponsoring Member Omnibus 
Account''),\11\ which is separate from the Sponsoring Member's regular 
netting accounts. For operational and administrative purposes, FICC 
interacts solely with the Sponsoring Member as agent for purposes of 
the day-to-day satisfaction of its Sponsored Members' obligations to or 
from FICC, including their securities and funds-only settlement 
obligations.\12\ Additionally, for operational convenience, FICC 
calculates a single Net Settlement Obligation and Fail Net Settlement 
Obligation in each CUSIP for the Sponsoring Member Omnibus Account and 
associated Deliver Obligations and Receive Obligations.\13\ Such 
calculations do not affect the Sponsored Member's obligations, which 
are calculated in a manner that is generally consistent with how FICC 
calculates the obligations of its other members.\14\
---------------------------------------------------------------------------

    \10\ Rule 1, definition of ``Sponsored Member Trade''; Rule 3A, 
Sections 6(b) and 7(a), supra note 4. Securities Exchange Act 
Release No. 85470 (March 29, 2019), 84 FR 13328 (April 4, 2019) (SR-
FICC-2018-013) expanded the definition of ``Sponsored Member Trade'' 
to include certain types of eligible securities transactions between 
a Sponsored Member and a FICC member other than the Sponsoring 
Member. However, this proposed rule change applies only to Sponsored 
Member Trades between the Sponsoring Member and its Sponsored 
Member.
    \11\ Rule 1, definition of ``Sponsoring Member Omnibus 
Account,'' supra note 4.
    \12\ Rule 3A, Sections 5, 6, 7, 8, and 9, supra note 4.
    \13\ Rule 3A, Section 8(b), supra note 4. See also Rule 3A, 
Section 7(a), supra note 4.
    \14\ Rule 3A, Section 7, supra note 4.
---------------------------------------------------------------------------

    Sponsoring Members are also responsible for providing FICC with a 
Sponsoring Member Guaranty, whereby the Sponsoring Member guarantees to 
FICC the payment and performance by its Sponsored Members of their 
obligations under the Rules.\15\ Although Sponsored Members are 
principally liable to FICC for their own settlement obligations under 
the Rules, the Sponsoring Member Guaranty requires the Sponsoring 
Member to satisfy those settlement obligations on behalf of a Sponsored 
Member if the Sponsored

[[Page 11402]]

Member defaults and fails to perform its settlement obligations.\16\
---------------------------------------------------------------------------

    \15\ Section 2(c) of Rule 3A states: ``Each Netting Member to 
become a Sponsoring Member shall also sign and deliver to [FICC] a 
Sponsoring Member Guaranty. . . .'' A ``Sponsoring Member Guaranty'' 
is defined in Rule 1 as ``a guaranty . . . that a Sponsoring Member 
delivers to [FICC] whereby the Sponsoring Member guarantees to 
[FICC] the payment and performance by its Sponsored Members of their 
obligations under [the] Rules, including, without limitation, all of 
the securities and funds-only settlement obligations of its 
Sponsored Members under [the] Rules.'' Rule 1; Rule 3A, Section 
2(c), supra note 4.
    \16\ Id.
---------------------------------------------------------------------------

    Although the Rules currently permit Sponsoring Members to submit 
term repo activity within the Service,\17\ most of the Sponsored Member 
Trades submitted to FICC by Sponsoring Members have a scheduled 
settlement date of the next Business Day after the initial settlement 
date (i.e., overnight repo). FICC believes that certain provisions of 
the Rules discourage the submission of term repo activity within the 
Service, as discussed more fully below.
---------------------------------------------------------------------------

    \17\ Rule 3A, Section 5, supra note 4.
---------------------------------------------------------------------------

B. Termination and Liquidation of Defaulting Sponsored Member Positions

    The Rules governing the termination and liquidation of a defaulting 
member provide that if FICC ceases to act for a member (including a 
Sponsored Member), FICC will close-out the defaulting member's 
positions by (i) establishing a Final Net Settlement Position for each 
Eligible Netting Security with a distinct CUSIP equal to the net of all 
outstanding Deliver Obligations and Receive Obligations of the member 
in respect of the security, and (ii) taking market action to liquidate 
such Final Net Settlement Position.\18\
---------------------------------------------------------------------------

    \18\ Rule 22A, Section 2(b); Rule 3A, Sections 13(c) and 15(b), 
supra note 4.
---------------------------------------------------------------------------

    The Rules require a Sponsoring Member to advise FICC of 
circumstances that would require FICC to cease to act for a Sponsored 
Member.\19\ Under the current Rules, FICC has the exclusive ability to 
terminate and liquidate a Sponsored Member's positions, even though the 
relevant Sponsoring Member is responsible for the Sponsored Member's 
payment and performance in respect of such positions.\20\ The current 
Rules do not allow a Sponsoring Member to terminate or liquidate any 
Sponsored Member Trades.\21\ FICC states that the inability of 
Sponsoring Members to terminate and liquidate Sponsored Member Trades 
is inconsistent with comparable intermediated relationships.\22\ FICC 
states that in the context of such other intermediated relationships, 
the intermediary is typically permitted to terminate and liquidate the 
positions of a client that the intermediary guarantees if an event of 
default or other similar circumstance occurs under the agreement 
between the intermediary and the client.\23\ In such scenarios, the 
intermediary's ability to terminate and liquidate its client's 
positions is not dependent on a third party's determination that a 
certain circumstance or event has occurred.\24\ Instead, the 
intermediary and the client bilaterally agree to the circumstances and 
events that give rise to an event of default allowing the intermediary 
to terminate or liquidate the guaranteed positions.\25\
---------------------------------------------------------------------------

    \19\ Rule 3A, Section 15(a), supra note 4.
    \20\ Rule 3A, Section 13(c) and 15(b), supra note 4.
    \21\ Id.
    \22\ Notice, supra note 3 at 1355.
    \23\ Id.
    \24\ Id.
    \25\ Id.
---------------------------------------------------------------------------

    FICC states that the inability of a Sponsoring Member to terminate 
and liquidate its defaulting Sponsored Member's positions discourages 
term repo activity within the Service.\26\ Specifically, under the 
current Rules, when a Sponsored Member defaults, FICC currently 
controls the termination and liquidation of the Sponsored Member's 
positions.\27\ As such, during the time it would take FICC to terminate 
and liquidate the Sponsored Member's positions, the Sponsoring Member 
would effectively be forced to extend credit to the defaulting 
Sponsored Member under the Sponsored Member Guaranty if the positions 
involved term repo activity. Such a scenario could cause the Sponsoring 
Member to incur additional capital requirements until such time as FICC 
terminates and liquidates the Sponsored Member's positions.\28\ 
Additionally, since FICC currently controls the termination and 
liquidation of the Sponsored Member's positions, FICC sets the 
applicable price, timing, and types of liquidation or hedging 
transactions. However, the Sponsoring Member would also likely enter 
into one or more transactions with third parties to hedge its own 
performance obligations under the Sponsoring Member Guaranty. 
Therefore, the Sponsoring Member would be exposed to potential risks 
associated with pricing and timing differences between its actions and 
those taken by FICC in the aftermath of a Sponsored Member default. 
FICC believes that these circumstances discourage Sponsoring Members 
from engaging in term repo activity within the Service.\29\
---------------------------------------------------------------------------

    \26\ Id.
    \27\ Rule 3A, Section 13(c) and 15(b), supra note 4.
    \28\ Id.
    \29\ Notice, supra note 3 at 1355-56.
---------------------------------------------------------------------------

    In order to encourage and facilitate term repo activity within the 
Service, FICC proposes to amend the Rules to allow a Sponsoring Member 
to terminate and liquidate a defaulting Sponsored Member's positions 
arising from Sponsored Member Trades.\30\ Specifically, in the event 
(i) a Sponsoring Member triggers the termination of a Sponsored 
Member's positions, or (ii) FICC ceases to act for the Sponsored Member 
and the Sponsoring Member does not continue to perform the obligations 
of the Sponsored Member, both the Sponsored Member's positions and the 
Sponsoring Member's corresponding positions arising from the Sponsored 
Member Trades would be terminated. The Sponsoring Member would 
calculate a net liquidation value of such terminated positions (i.e., 
Final Net Settlement Positions), whose liquidation values would be paid 
either to or by the Sponsored Member by or to the Sponsoring 
Member.\31\ The Final Net Settlement Position would equal the net of 
all outstanding Deliver Obligations and Receive Obligations of the 
Sponsored Member or Sponsoring Member with respect to each security 
with a distinct CUSIP number.
---------------------------------------------------------------------------

    \30\ The proposal would only cover Sponsored Member Trades 
between a Sponsored Member and its Sponsoring Member. See supra note 
9. Additionally, the proposal would not cover scenarios in which 
FICC has ceased to act for the relevant Sponsoring Member or in the 
event of a FICC default. Such scenarios would be governed by current 
Rules 22A and 22B, respectively. Notice, supra note 3 at 1356-57.
    \31\ FICC intended that the proposal for the Sponsoring Member 
to establish the Final Net Settlement Position would align with 
current Rule 22A, which provides for FICC to establish the Final Net 
Settlement Position when it ceases to act for a member.
---------------------------------------------------------------------------

    The Sponsoring Member would liquidate the Final Net Settlement 
Positions by establishing a ``Sponsored Member Liquidation Amount'' and 
a ``Sponsoring Member Liquidation Amount,'' which would be identical 
to, but in the opposite direction of, each other.\32\ If a Sponsored 
Member Liquidation Amount is due to FICC, the Sponsoring Member would 
be obligated to pay such Sponsored Member Liquidation Amount to FICC 
under the Sponsoring Member Guaranty, and this obligation would 
automatically be set off against the obligation of FICC to pay the 
corresponding Sponsoring Member Liquidation Amount to the Sponsoring 
Member. By virtue of such setoff, the Sponsored Member's obligation to 
FICC would be discharged, as would FICC's obligation to the Sponsoring 
Member. The Sponsoring Member may, however, have a reimbursement claim 
against the Sponsored Member in an amount equal

[[Page 11403]]

to the Sponsored Member Liquidation Amount.\33\
---------------------------------------------------------------------------

    \32\ Therefore, if FICC were to owe the Sponsored Member 
Liquidation Amount to the Sponsored Member, the Sponsoring Member 
would owe the Sponsoring Member Liquidation Amount to FICC. By the 
same token, if the Sponsored Member were to owe the Sponsored Member 
Liquidation Amount to FICC, FICC would owe the Sponsoring Member the 
Sponsoring Member Liquidation Amount. In all instances, FICC would 
owe and be owed the same amount of money. Notice, supra note 3 at 
1357.
    \33\ Such reimbursement claim would not be governed by the 
Rules, but instead, would be subject to the terms of the bilateral 
agreement between the Sponsoring Member and Sponsored Member. Id.
---------------------------------------------------------------------------

    If a Sponsored Member Liquidation Amount were owed by FICC to the 
Sponsored Member, the Sponsoring Member would satisfy that obligation 
by transferring the Sponsored Member Liquidation Amount to the account 
at the Funds-Only Settling Member Bank at which the Sponsoring Member 
maintains Funds-Only Settlement Amounts related to its Sponsored Member 
Omnibus Account. To the extent the Sponsoring Member makes such a 
transfer, it would discharge FICC's obligation to transfer the 
Sponsored Member Liquidation Amount to the Sponsored Member and the 
Sponsoring Member's corresponding obligation to transfer the Sponsoring 
Member Liquidation Amount to FICC. FICC would not, as a practical 
matter, be involved in the settlement of the foregoing liquidating 
transactions (i.e., FICC would not need to take any market action), 
because the termination of the Sponsored Member's positions and the 
corresponding Sponsoring Member's positions would leave FICC flat.
    The proposal also provides that the Sponsoring Member would 
indemnify FICC for any claim by a Sponsored Member arising out of the 
Sponsoring Member's calculation of the net liquidation value. Finally, 
the proposal includes a provision that a Sponsoring Member may take a 
security interest in FICC's obligations to the Sponsored Member. Such 
security interest would not impose new obligations on FICC, but could 
allow the Sponsoring Member to direct FICC to submit payments due to 
the Sponsored Member to the Sponsoring Member, so that the Sponsoring 
Member can apply such amounts to the Sponsored Member's unsatisfied 
obligations to the Sponsoring Member. The proposal would also provide 
that FICC's security interest in the Sponsored Member's assets \34\ 
would be subordinated to the Sponsoring Member's security interest. 
However, as noted above, if a Sponsored Member Liquidation Amount is 
due to FICC, the Sponsoring Member would be obligated to pay such 
Sponsored Member Liquidation Amount to FICC under the Sponsoring Member 
Guaranty, and this obligation would automatically be set off against 
the obligation of FICC to pay the corresponding Sponsoring Member 
Liquidation Amount to the Sponsoring Member. As such, the Sponsored 
Member's obligation to FICC would be discharged (as would FICC's 
obligation to the Sponsoring Member), and FICC would not need to look 
to the Sponsored Member or its assets for performance in respect of the 
terminated positions.
---------------------------------------------------------------------------

    \34\ Under the current Rules, each Sponsored Member grants to 
FICC a security interest in all assets and property placed by the 
Sponsored Member in the possession of FICC in order to secure the 
obligations of the Sponsored Member to FICC. Rule 3A, Section 8(g), 
supra note 4. This security interest provides FICC with credit 
support in the event that it must terminate and liquidate the 
Sponsored Member's positions and assert a claim against the 
Sponsored Member. Notice, supra note 3 at 1358.
---------------------------------------------------------------------------

    FICC believes that the proposal to provide Sponsoring Members with 
the ability to terminate and liquidate a defaulting Sponsored Member's 
positions would remove the potential risks to Sponsoring Members 
described above stemming from the exclusive ability of FICC to 
terminate and liquidate the Sponsored Member's positions under the 
current Rules. With this new ability, in the context of a Sponsored 
Member default involving term repo activity, the Sponsoring Member 
would control the termination and liquidation of the Sponsored Member's 
positions. In contrast to the current Rules, the Sponsoring Member 
would not be compelled to shoulder risks and extend credit to its 
defaulting Sponsored Member during the time it would otherwise take 
FICC to terminate and liquidate the Sponsored Member's positions. 
Therefore, FICC believes that the proposal would encourage and 
facilitate term repo activity within the Service.\35\
---------------------------------------------------------------------------

    \35\ Notice, supra note 3 at 1356.
---------------------------------------------------------------------------

C. Haircuts on Sponsored Member Trades

    In some Sponsored Member Trades, a Sponsoring Member may choose to 
post to its Sponsored Member client a haircut. Similarly in some 
circumstances, a Sponsoring Member may choose to collect a haircut from 
its Sponsored Member client to mitigate the Sponsoring Member's 
exposure under the Sponsoring Member Guaranty. In both scenarios, the 
intent of the parties is for the haircut recipient to retain the 
haircut for the duration of the Sponsored Member Trade, which, in the 
context of term repo activity, would be the scheduled final settlement 
date beyond the next Business Day after the initial settlement date. 
FICC states that Sponsoring Members and Sponsored Members might have 
accounting considerations that would favor facilitating the posting of 
haircuts through FICC's systems.\36\ However, under the current Rules 
regarding FICC's funds-only settlement process, a Sponsored Member or 
Sponsoring Member that received a haircut at the Start Leg of a 
Sponsored Member Trade would be required to transfer an amount of cash 
equal to the haircut (plus or minus any interim mark-to-market 
movements) on the next Business Day after the Start Leg has 
settled.\37\ Specifically, FICC's standard funds-only settlement 
process involves marking to market twice each Business Day all 
positions associated with term repo activity, including any Sponsored 
Member Trade with a Close Leg that is scheduled to occur two or more 
Business Days after the settlement of the Start Leg.\38\ FICC 
calculates a ``Collateral Mark'' equal to the absolute value of the 
difference between (i) a Sponsored Member Trade's Contract Value (i.e., 
the dollar value at which it is due to finally settle), and (ii) its 
Market Value (i.e., FICC's system price of the securities underlying 
the transaction). This Collateral Mark is incorporated into the 
calculation of certain of the Funds-Only Settlement Amounts 
payable.\39\ When the Market Value exceeds the Contract Value, the 
Collateral Mark is negative for, and thus payable by, the party with a 
Net Short Position (i.e., the party required to deliver securities at 
final settlement). Therefore, the purpose of the haircut would be 
frustrated because if the haircut is returned before final settlement 
of a Sponsored Member Trade, the party that was supposed to retain the 
haircut for the duration of that trade would cease to be over-
collateralized, thus defeating the contractual intent of the parties.
---------------------------------------------------------------------------

    \36\ Notice, supra note 3 at 1358.
    \37\ Rule 13, supra note 4.
    \38\ Id.
    \39\ Id.
---------------------------------------------------------------------------

    FICC proposes to amend the Rules to ensure that haircuts in the 
scenario described above are not returned until final settlement. 
Specifically, FICC would amend Section 9(a) of Rule 3A to provide that, 
if the parties to a Sponsored Member Trade agree for such Sponsored 
Member Trade to have a haircut, then any Funds-Only Settlement Amount 
applicable to such Sponsored Member Trade that includes a Collateral 
Mark would be calculated without regard for the Collateral Mark. Such 
Collateral Mark would be replaced by either a ``Haircut Deficit'' or 
``Haircut Surplus.'' A Haircut Deficit would exist if the amount by 
which the Market Value as of the settlement date of the Start Leg 
exceeded the Contract Value of the Close Leg (the ``Initial Haircut'') 
is

[[Page 11404]]

greater than the amount by which the Market Value as of the time of 
measurement exceeds the Contract Value of the Close Leg (the ``Current 
Haircut''). Any Haircut Deficit would be payable by the party with a 
Net Long Position. A ``Haircut Surplus'' would exist if the Current 
Haircut exceeds the Initial Haircut, and any Haircut Surplus would be 
payable by the party with a Net Short Position. FICC would also amend 
Section 9(a) of Rule 3A to make clear that any Initial Haircut would be 
as agreed between the parties to the Sponsored Member Trade, and that 
FICC would not be under any obligation to verify the parties' agreement 
with respect to any Initial Haircut, and its calculation of the Initial 
Haircut would be conclusive and binding on the parties.
    FICC believes that the proposed changes described above would 
enable a Sponsoring Member and its Sponsored Member who intend for one 
of those two parties to remain over-collateralized for the duration of 
a Sponsored Member Trade to transfer a haircut between each other and 
allow such haircut to remain with the intended party until final 
settlement of the Sponsored Member Trade.\40\ As such, the proposal 
would encourage and facilitate term repo activity within the Service.
---------------------------------------------------------------------------

    \40\ Notice, supra note 3 at 1359.
---------------------------------------------------------------------------

D. Clarifications and Technical Changes

    FICC proposes to make several clarifications and technical changes 
to Rule 3A. First, FICC would add a parenthetical to Section 8(c) to 
clarify that the operational netting provisions of Section 8(b) do not 
substantively modify a Sponsored Member's obligations to FICC. Section 
8(b) provides that, for operational convenience, FICC calculates a 
single Net Settlement Position and Fail Net Settlement Position in each 
CUSIP for the Sponsoring Member's Sponsoring Member Omnibus 
Account.\41\ Section 8(c), in turn, provides that each Sponsored Member 
shall satisfy its allocable portion of the Deliver Obligations and 
Receive Obligations established for the Sponsoring Member Omnibus 
Account.\42\ Neither Section 8(b) nor Section 8(c) modifies the 
obligations of any Sponsored Member; rather, those provisions are 
simply designed for operational convenience. Each Sponsored Member 
still remains responsible for its Deliver Obligations Receive 
Obligations to and from FICC, which are calculated in accordance with 
Rule 3A, Section 7.\43\ The Sponsored Member's allocable portion of the 
Deliver Obligations and Receive Obligations of the Sponsoring Member 
Omnibus Account will always equal its Deliver Obligations and Receive 
Obligations to and from FICC, as calculated under Rule 3A, Section 
7.\44\ Therefore, in order to eliminate doubt regarding the extent of 
the Sponsored Member's obligations upon a termination and liquidation 
of a Sponsored Member's positions under the proposed rule change, FICC 
proposes to add a parenthetical to Section 8(c) to clarify that a 
Sponsored Member's allocable portion of the obligations established for 
the Sponsoring Member Omnibus Account are the obligations of the 
Sponsored Member, as calculated in Rule 3A, Section 7.
---------------------------------------------------------------------------

    \41\ Rule 3A, Section 8(b), supra note 4.
    \42\ Rule 3A, Section 8(c), supra note 4.
    \43\ Rule 3A, Section 7, supra note 4.
    \44\ Id.
---------------------------------------------------------------------------

    Second, FICC would add language at the end of Sections 8(c) and 
9(b) to clarify that, if a Sponsoring Member satisfies the net Deliver 
Obligations and Receive Obligations or the net Funds-Only Settlement 
Amount obligations of its Sponsoring Member Omnibus Account (including 
through the proposed setoff described above) before the Sponsoring 
Member receives corresponding performance from the Sponsored Member, 
such satisfaction would constitute performance by the Sponsoring Member 
under the Sponsoring Member Guaranty with respect to the relevant 
Sponsored Member's allocable portion of the Sponsoring Member Omnibus 
Account Deliver Obligations and Receive Obligations or Funds-Only 
Settlement Amount obligations. If a termination and liquidation were to 
occur, the Sponsoring Member would be required to perform on behalf of 
the Sponsored Member under the Sponsoring Member Guaranty. The added 
language at the end of Sections 8(c) and 9(b) is designed to ensure 
that, when the Sponsoring Member effects such performance, it would be 
entitled to reimbursement from the Sponsored Member.
    Third, in connection with the proposed changes to Rule 3A, Section 
9 regarding haircuts, FICC would make certain re-lettering and 
grammatical changes for clarity and readability. Finally, FICC would 
revise proposed Rule 3A, Section 9(c) to clarify that the Sponsored 
Member is responsible for satisfying the allocable portion of the 
Funds-Only Settlement Amount calculated for the Sponsoring Member 
Omnibus Account.

III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \45\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and rules and regulations thereunder applicable 
to such organization. After carefully considering the proposed rule 
change, the Commission finds that the proposed rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to FICC. In particular, the 
Commission finds that the proposed rule change is consistent with 
Section 17A(b)(3)(F) of the Act,\46\ and Rule 17Ad-22(e)(21) 
promulgated under the Act,\47\ for the reasons described below.
---------------------------------------------------------------------------

    \45\ 15 U.S.C. 78s(b)(2)(C).
    \46\ 15 U.S.C. 78q-1(b)(3)(F).
    \47\ 17 CFR 240.17Ad-22(e)(21).
---------------------------------------------------------------------------

A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, in part, that the Rules 
of a clearing agency, such as FICC, be ``designed to promote the prompt 
and accurate clearance and settlement of securities transactions. . . 
.'' \48\
---------------------------------------------------------------------------

    \48\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    As stated above in Section II.B., under the current Rules, FICC has 
the exclusive ability to terminate and liquidate a defaulting Sponsored 
Member's positions; the current Rules do not allow a Sponsoring Member 
to terminate and liquidate any Sponsored Member Trades. The inability 
on the part of Sponsoring Members to terminate and liquidate its 
defaulting Sponsored Member's positions discourages term repo activity 
within the Service because during the time it would take FICC to 
terminate and liquidate the Sponsored Member's positions, the 
Sponsoring Member would effectively be forced to extend credit to the 
defaulting Sponsored Member under the Sponsored Member Guaranty. In 
such a scenario, the Sponsoring Member could incur additional capital 
requirements until FICC completes the termination and liquidation of 
the Sponsored Member's positions. Additionally, since under the current 
Rules, FICC sets the applicable price, timing, and types of liquidation 
or hedging transactions, the Sponsoring Member would be exposed to 
potential risks associated with pricing and timing differences between 
its own hedging transactions and those taken by FICC in the aftermath 
of a Sponsored Member default. To avoid exposing Sponsoring

[[Page 11405]]

Members to the foregoing risks, FICC proposes to amend the Rules to 
provide a mechanism whereby Sponsoring Members would control the 
termination and liquidation of their defaulting Sponsored Members' 
positions. By providing Sponsoring Members with greater ability to 
manage their risks associated with Sponsored Member Trades, the 
proposal would encourage Sponsoring Members to submit more term repo 
Sponsored Member Trades to FICC within the Service. Increasing the 
number of trades centrally-cleared by FICC would promote the prompt and 
accurate clearance and settlement of securities transactions because 
securities transactions that might otherwise be conducted bilaterally 
would benefit from FICC's risk management and guarantee of settlement. 
Accordingly, the Commission finds that FICC's proposal to provide a 
mechanism for Sponsoring Members to terminate and liquidate their 
defaulting Sponsored Members' positions should promote the prompt and 
accurate clearance and settlement of securities transactions, 
consistent with Section 17A(b)(3)(F) of the Act.\49\
---------------------------------------------------------------------------

    \49\ Id.
---------------------------------------------------------------------------

    As stated above in Section II.C., Sponsored Member Trades may 
involve a haircut from either the Sponsoring Member or the Sponsored 
Member. In the context of term repo activity, the intent of both the 
Sponsoring Member and the Sponsored Member is for the haircut recipient 
to retain the haircut until the scheduled final settlement date. 
However, the current Rules require the haircut to be returned before 
final settlement of the Sponsored Member Trade, which creates 
inefficiencies that discourage term repo activity within the Service. 
FICC proposes to amend the Rules to ensure that such haircuts are not 
returned until final settlement. As a result, the proposal would 
encourage and facilitate more term repo activity within the Service. 
Increasing the number of trades centrally-cleared by FICC would promote 
the prompt and accurate clearance and settlement of securities 
transactions because securities transactions that might otherwise be 
conducted bilaterally would benefit from FICC's risk management and 
guarantee of settlement. Accordingly, the Commission finds that FICC's 
proposal to ensure that such haircuts with respect to Sponsored Member 
Trades are not returned until final settlement should promote the 
prompt and accurate clearance and settlement of securities 
transactions, consistent with Section 17A(b)(3)(F) of the Act.\50\
---------------------------------------------------------------------------

    \50\ Id.
---------------------------------------------------------------------------

    As stated above in Section II.D., FICC proposes several 
clarifications and technical changes to Rule 3A. FICC states that these 
changes are designed to enhance clarity and transparency regarding the 
Service.\51\ Having transparent and clear Rule provisions regarding the 
Service should enable members to better understand the operation of the 
Service, and should also provide members with increased predictability 
and certainty regarding their rights and obligations. Such increased 
predictability and certainty regarding their rights and obligations may 
encourage Sponsoring Members to submit a greater number of securities 
transactions to be centrally-cleared by FICC. Increasing the number of 
trades centrally-cleared by FICC would promote the prompt and accurate 
clearance and settlement of securities transactions because securities 
transactions that might otherwise be conducted bilaterally would 
benefit from FICC's risk management and guarantee of settlement. 
Accordingly, the Commission finds that FICC's proposed clarifications 
and technical changes should promote the prompt and accurate clearance 
and settlement of securities transactions, consistent with Section 
17A(b)(3)(F) of the Act.\52\
---------------------------------------------------------------------------

    \51\ Notice, supra note 3 at 1360.
    \52\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

B. Consistency With Rule 17Ad-22(e)(21) Under the Act

    Rule 17Ad-22(e)(21) under the Act requires that each covered 
clearing agency, such as FICC, ``establish, implement, maintain and 
enforce written policies and procedures reasonably designed to . . . be 
efficient and effective in meeting the requirements of its participants 
and the markets it serves. . . .'' \53\
---------------------------------------------------------------------------

    \53\ 17 CFR 240.17Ad-22(e)(21).
---------------------------------------------------------------------------

    As stated above in Section II.B., the current Rules do not allow a 
Sponsoring Member to terminate and liquidate any Sponsored Member 
Trades. The inability on the part of Sponsoring Members to terminate 
and liquidate its defaulting Sponsored Member's positions discourages 
term repo activity within the Service because during the time it would 
take FICC to terminate and liquidate the Sponsored Member's positions, 
the Sponsoring Member would effectively be forced to extend credit to 
the defaulting Sponsored Member under the Sponsored Member Guaranty. In 
such a scenario, the Sponsoring Member could incur additional capital 
requirements until FICC completes the termination and liquidation of 
the Sponsored Member's positions. Additionally, since under the current 
Rules, FICC sets the applicable price, timing, and types of liquidation 
or hedging transactions, the Sponsoring Member would be exposed to 
potential risks associated with pricing and timing differences between 
its own hedging transactions and those taken by FICC in the aftermath 
of a Sponsored Member default. To avoid exposing Sponsoring Members to 
the foregoing risks, FICC proposes to amend the Rules to provide a 
mechanism whereby Sponsoring Members would control the termination and 
liquidation of their defaulting Sponsored Members' positions. By 
providing Sponsoring Members with greater ability to manage their risks 
associated with Sponsored Member Trades, the proposal would enhance 
FICC's Rules in a manner that meets the needs of Sponsoring Members and 
Sponsored Members.
    Additionally, as stated above in Section II.C., the current Rules 
require haircuts with respect to term repo Sponsored Member Trades to 
be returned before final settlement, which discourages term repo 
activity within the Service. FICC proposes to amend the Rules to ensure 
that such haircuts are not returned until final settlement. As a 
result, the proposal would encourage and facilitate term repo activity 
within the Service by ensuring that haircuts with respect to Sponsored 
Member Trades are not returned until final settlement in a manner 
consistent with the intent of the Sponsoring Member and Sponsored 
Member. For the reasons described in this Section III.B., the 
Commission finds FICC's proposals to (i) provide a mechanism for 
Sponsoring Members to terminate and liquidate their defaulting 
Sponsored Members' positions, and (ii) ensure that haircuts with 
respect to term repo Sponsored Member Trades are not returned until 
final settlement would constitute policies and procedures reasonably 
designed to be efficient and effective in meeting the requirements of 
FICC's members and the relevant markets FICC serves, consistent with 
Rule 17Ad-22(e)(21) under the Act.\54\
---------------------------------------------------------------------------

    \54\ Id.
---------------------------------------------------------------------------

IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act 
and, in particular, with the requirements of

[[Page 11406]]

Section 17A of the Act \55\ and the rules and regulations promulgated 
thereunder.
---------------------------------------------------------------------------

    \55\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\56\ that proposed rule change SR-FICC-2019-007, be, and hereby is, 
approved.\57\
---------------------------------------------------------------------------

    \56\ 15 U.S.C. 78s(b)(2).
    \57\ In approving the proposed rule change, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \58\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\58\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-03914 Filed 2-26-20; 8:45 am]
 BILLING CODE 8011-01-P


