[Federal Register Volume 85, Number 62 (Tuesday, March 31, 2020)]
[Notices]
[Pages 17929-17932]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-06598]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88469; File No. SR-NSCC-2020-801]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection To Advance Notice To Enhance the 
Calculation of the Family-Issued Securities Charge

March 25, 2020.
    On January 28, 2020, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2020-801 (``Advance Notice'') 
pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, entitled Payment, Clearing 
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'') 
\1\ and Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 
1934 (``Exchange Act'') \3\ to amend the calculation of NSCC's existing 
margin charge applied to long positions in Family-Issued Securities \4\ 
to address certain risk presented by these positions. The Advance 
Notice was published for public comment in the

[[Page 17930]]

Federal Register on February 27, 2020,\5\ and the Commission has 
received no comments regarding the changes proposed in the Advance 
Notice.\6\ This publication serves as notice of no objection to the 
Advance Notice.
---------------------------------------------------------------------------

    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ Terms not defined herein are defined in NSCC's Rules and 
Procedures (``Rules''), available at http://www.dtcc.com/~/media/
Files/Downloads/legal/rules/nscc_rules.pdf.
    \5\ Securities Exchange Act Release No. 88267 (Feb. 24, 2020), 
85 FR 11437 (Feb. 27, 2020) (SR-NSCC-2020-801) (``Notice of 
Filing''). On January 28, 2020, NSCC also filed a related proposed 
rule change (SR-NSCC-2020-002) with the Commission pursuant to 
Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder 
(``Proposed Rule Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-
4, respectively. In the Proposed Rule Change, which was published in 
the Federal Register on February 18, 2020, NSCC seeks approval of 
proposed changes to its rules necessary to implement the Advance 
Notice. Securities Exchange Act Release No. 88163 (Feb. 11, 2020), 
85 FR 8964 (Feb. 18, 2020). The comment period for the related 
Proposed Rule Change filing closed on March 10, 2020.
    \6\ Since the proposal contained in the Advance Notice was also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the Proposed Rule Change or the Advance Notice.
---------------------------------------------------------------------------

I. The Advance Notice

A. Background

    NSCC provides clearing, settlement, risk management, central 
counterparty services, and a guarantee of completion for virtually all 
broker-to-broker trades involving equity securities, corporate and 
municipal debt securities, and certain other securities. NSCC manages 
its credit exposure to its Members by determining an appropriate 
Required Fund Deposit for each Member, which serves as each Member's 
margin.\7\ The aggregate of all NSCC Members' Required Fund Deposits 
(together with certain other deposits required under the Rules) 
constitutes NSCC's Clearing Fund, which NSCC would access should a 
Member default and that Member's Required Fund Deposit, upon 
liquidation, is insufficient to satisfy NSCC's losses.
---------------------------------------------------------------------------

    \7\ Terms not defined herein are defined in NSCC's Rules and 
Procedures (``Rules''), available at http://www.dtcc.com/~/media/
Files/Downloads/legal/rules/nscc_rules.pdf. See Rule 4 (Clearing 
Fund) and Procedure XV (Clearing Fund Formula and Other Matters) of 
the Rules.
---------------------------------------------------------------------------

    Each Member's Required Fund Deposit consists of a number of 
applicable components, each of which is calculated to address specific 
risks faced by NSCC.\8\ NSCC states that it regularly assesses the 
market, liquidity, and other risks that its margining methodologies are 
designed to mitigate to evaluate whether margin levels are commensurate 
with the particular risk attributes of each relevant product, 
portfolio, and market.\9\ Such risks include risks introduced by its 
counterparties or Members. In particular, NSCC seeks to identify and 
mitigate its exposures to specific wrong-way risk (``SWWR''), which is 
the risk that an exposure to a counterparty is highly likely to 
increase when the creditworthiness of that counterparty deteriorates. 
Such risk would arise when NSCC acts as central counterparty to a 
Member with unsettled long positions in securities that were issued by 
a Member or an affiliate of that Member (``Family-Issued Securities''). 
If that Member defaults, NSCC would seek to cover its losses by closing 
out the unsettled Family-Issued Securities long positions. However, 
because the Member default would also likely lead to a drop in the 
creditworthiness of the Member and, therefore, the value of the Family-
Issued Securities, NSCC would likely not be able to completely cover 
its losses in closing out those positions.
---------------------------------------------------------------------------

    \8\ Id.
    \9\ See Notice of Filing supra note 5, at 85 FR 11437.
---------------------------------------------------------------------------

    In order to address this particular form of SWWR, NSCC imposes a 
charge on all Members with unsettled long positions in their own 
Family-Issued Securities, called the FIS Charge, which is calculated by 
multiplying the value of the net unsettled long positions in Family-
Issued Securities by a certain percentage (``Haircut Rate''). 
Currently, the Haircut Rate applied in the FIS Charge calculation is 
based on a Member's rating category on NSCC's Credit Risk Rating Matrix 
(``CRRM''), which ranges from 1 to 7. NSCC utilizes the CRRM to 
evaluate its credit risk exposure to each Member; a higher CRRM rating 
represents a higher credit risk (i.e., a greater risk of defaulting on 
settlement obligations) and may cause a Member to be subject to 
enhanced surveillance or additional margin requirements.\10\
---------------------------------------------------------------------------

    \10\ See Rule 1 and Section 4 of Rule 2B of the Rules, supra 
note 8. See also Securities Exchange Act Release Nos. 80734 (May 19, 
2017), 82 FR 24177 (May 25, 2017) (SR-DTC-2017-002, SR-FICC-2017-
006, SR-NSCC-2017-002); and 80731 (May 19, 2017), 82 FR 24174 (May 
25, 2017) (SR-DTC-2017-801, SR-FICC-2017-804, SR-NSCC-2017-801).
---------------------------------------------------------------------------

    Currently, the applicable Haircut Rate for the FIS Charge depends 
on a Member's rating on the CRRM. Specifically, for Members that are 
rated 6 or 7 on the CRRM, the applicable Haircut Rate for net unsettled 
long positions in Family-Issued Securities shall be (1) at least 80 
percent for fixed income securities, and (2) 100 percent for equity 
securities. For Members that are rated 1 through 5 on the CRRM, the 
applicable Haircut Rate shall be (1) at least 40 percent for fixed 
income securities, and (2) at least 50 percent for equity 
securities.\11\
---------------------------------------------------------------------------

    \11\ See Procedure XV (Clearing Fund Formula and Other Matters) 
of the Rules, supra note 7.
---------------------------------------------------------------------------

B. Proposed Changes to FIS Charge

    In the Advance Notice, NSCC is proposing to revise the calculation 
of the FIS Charge to use the same Haircut Rate for all Members 
regardless of their CRRM rating category. Under the proposal, net 
unsettled long positions in (1) fixed income securities that are 
Family-Issued Securities are charged a Haircut Rate of no less than 80 
percent, and (2) equity securities that are Family-Issued Securities 
are charged a Haircut Rate of 100 percent.
    NSCC states that it may still be exposed to SWWR despite applying 
different Haircut Rates based on a Member's rating on the CRRM, and it 
can better mitigate its exposure to this risk by calculating the FIS 
Charge without considering Members' CRRM rating categories.\12\ 
According to NSCC, while the current methodology appropriately assumes 
that Members with a higher rating category on the CRRM present a 
heightened credit risk to NSCC or have demonstrated higher risk related 
to their ability to meet settlement, this methodology does not account 
for the risk that a Member may default due to unanticipated causes 
(referred to as a ``jump-to-default'' scenario) not captured by the 
CRRM.\13\ This is because the CRRM relies on historical data as a 
predictor of future risks,\14\ whereas jump-to-default scenarios are 
triggered by unanticipated causes that could not be predicted based on 
historical trends or data (e.g., instances of fraud or other bad 
actions by a Member's management). Therefore, NSCC represents that the 
proposed change is designed to cover SWWR arising from potential jump-
to-default scenarios by applying the higher applicable Haircut Rate in 
calculating the FIS Charge for all Members.\15\
---------------------------------------------------------------------------

    \12\ See Notice of Filing supra note 5, at 85 FR 11438.
    \13\ See id.
    \14\ See id.
    \15\ See id.
---------------------------------------------------------------------------

    The practical outcome of this proposed change is that for all 
Family Issued Securities, NSCC would apply a haircut equivalent to the 
current Haircut Rate for Members that are rated 6 or 7 on the CRRM 
regardless of whether a Member is rated at a 6 or 7. To implement this 
proposal, NSCC would amend Sections I.(A)(1)(a)(iv) and I.(A)(2)(a)(iv) 
of Procedure XV of the Rules.

[[Page 17931]]

II. Discussion and Commission Findings

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, the stated purpose of the Clearing 
Supervision Act is instructive: to mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for SIFMUs and 
strengthening the liquidity of SIFMUs.\16\
---------------------------------------------------------------------------

    \16\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe regulations containing risk management 
standards for the payment, clearing, and settlement activities of 
designated clearing entities engaged in designated activities for which 
the Commission is the supervisory agency.\17\ Section 805(b) of the 
Clearing Supervision Act provides the following objectives and 
principles for the Commission's risk management standards prescribed 
under Section 805(a):\18\
---------------------------------------------------------------------------

    \17\ 12 U.S.C. 5464(a)(2).
    \18\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     To promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among others areas.\19\
---------------------------------------------------------------------------

    \19\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------

    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange Act (the ``Clearing Agency Rules'').\20\ The Clearing Agency 
Rules require, among other things, each covered clearing agency to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for its operations and risk management practices on an 
ongoing basis.\21\ As such, it is appropriate for the Commission to 
review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act. As 
discussed below, the Commission believes the proposal in the Advance 
Notice is consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act,\22\ and in Rules 17Ad-
22(e)(4)(i) \23\ and (e)(6)(i) and (v) \24\ of the Clearing Agency 
Rules.
---------------------------------------------------------------------------

    \20\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11). 
See also Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards''). NSCC is a ``covered clearing agency'' as 
defined in Rule 17Ad-22(a)(5).
    \21\ Id.
    \22\ 12 U.S.C. 5464(b).
    \23\ 17 CFR 240.17Ad-22(e)(4)(i).
    \24\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
---------------------------------------------------------------------------

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

    For the reasons discussed immediately below, the Commission 
believes that the Advance Notice is consistent with the stated 
objectives and principles of Section 805(b) of the Clearing Supervision 
Act.\25\ Specifically, as discussed below, the Commission believes that 
the changes proposed in the Advance Notice are consistent with 
promoting robust risk management, promoting safety and soundness, 
reducing systemic risks, and supporting the broader financial 
system.\26\
---------------------------------------------------------------------------

    \25\ 12 U.S.C. 5464(a)(2) and (b).
    \26\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    First, the Commission believes that the proposal is consistent with 
promoting robust risk management. NSCC faces SWWR when it acts as 
central counterparty to a Member with long positions in FIS. Although 
NSCC's current margin methodology addresses SWWR through imposition of 
the FIS Charge, it does not address SWWR associated with a jump-to-
default scenario. As described above, the proposal would address SWWR 
associated with a jump-to-default scenario by using the higher 
applicable Haircut Rate for all Members concerning their net unsettled 
long positions in Family-Issued Securities, regardless of the Members' 
CRRM rating category. As such, the proposal would address a risk not 
captured currently under NSCC's margin methodology and provide for more 
comprehensive risk management of NSCC's risks, consistent with the 
promotion of robust risk management.
    Second, the Commission believes that the proposal is consistent 
with the promotion of safety and soundness at NSCC. The collection of 
additional margin, by applying the higher applicable Haircut Rate in 
calculating the FIS Charge for all Members, would better enable NSCC to 
manage the potential losses arising out of a Member default. Holding 
additional resources to address such losses would promote NSCC's safety 
and soundness.
    Finally, the Commission believes that the proposal is consistent 
with reducing systemic risk and supporting the broader financial 
system. As discussed above, NSCC proposes to collect additional margin 
to collateralize exposures to SWWR associated with a jump-to-default 
scenario, which could reduce the probability that NSCC would mutualize 
a loss stemming from the close-out of a defaulted Member with net 
unsettled long positions in Family-Issued Securities. While unavoidable 
under certain circumstances, reducing the probability of loss 
mutualization during periods of market stress could lessen the 
transmission of financial risks arising from a Member default to non-
defaulting Members, their customers, and the broader market. Further, 
NSCC maintaining additional margin could further reduce the potential 
that NSCC would need to call for additional resources from Members in 
times of market stress. The Commission believes, therefore, that the 
proposal would be consistent with reducing systemic risk and supporting 
the stability of the broader financial system. Accordingly, and for the 
reasons stated above, the Commission believes the changes proposed in 
the Advance Notice are consistent with Section 805(b) of the Clearing 
Supervision Act.

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

    Rule 17Ad-22(e)(4)(i) under the Act requires that each covered 
clearing agency 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.\27\
---------------------------------------------------------------------------

    \27\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    As described above, NSCC is exposed to SWWR where it acts as 
central counterparty for its Members' transactions in Family-Issued 
Securities. Applying the same higher Haircut Rate to all Members with 
net long unsettled positions in Family-Issued Securities, regardless of 
their rating on the CRRM, would help further mitigate NSCC's SWWR 
exposures, especially in a jump-to-default scenario. Therefore, 
applying the same Haircut Rate in the FIS charge calculation is 
designed to help NSCC collect sufficient financial resources to help 
cover its credit exposures, with a high degree of confidence, to those 
Members seeking to clear and settle transactions in Family-Issued 
Securities. Therefore, the Commission believes the

[[Page 17932]]

proposed change is consistent with Rule 17Ad-22(e)(4)(i).\28\
---------------------------------------------------------------------------

    \28\ Id.
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(6)(i) and (v)

    Rule 17Ad-22(e)(6)(i) under the Act requires that each covered 
clearing agency that provides central counterparty services 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.\29\ Rule 17Ad-22(e)(6)(v) under the Act requires that each 
covered clearing agency that provides central counterparty services 
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, uses an appropriate method for measuring credit exposure that 
accounts for relevant product risk factors and portfolio effects across 
products.\30\
---------------------------------------------------------------------------

    \29\ 17 CFR 240.17Ad-22(e)(6)(i).
    \30\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

    As described above, NSCC faces SWWR in jump-to-default scenarios 
where it acts as central counterparty to Member transactions in Family-
Issued Securities. This risk is present regardless of a Member's rating 
on the CRRM. However, the current methodology assumes that Members with 
a higher rating on the CRRM present a heightened credit risk to NSCC 
and applies a higher Haircut Rate to such Members. This distinction 
does not take into account the SWWR that would manifest in a jump-to-
default scenario. As such, NSCC proposes to apply the same higher 
Haircut Rate to all Members. This proposal would improve NSCC's ability 
to mitigate its exposure to SWWR in a jump-to-default scenario, thereby 
helping NSCC to maintain a risk-based margin system that considers, and 
produces margin levels commensurate with, the risks and particular 
attributes of net unsettled long positions in Family-Issued Securities. 
Therefore, the Commission believes that the proposal would be 
consistent with Rule 17Ad-22(e)(6)(i).\31\
---------------------------------------------------------------------------

    \31\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    Additionally, because the enhanced FIS Charge would be a component 
of the margin that NSCC collects from its Members to help cover NSCC 
credit exposure to the Members, and because the charge would be based 
on different product risk factors with respect to equity and fixed-
income securities, it would be part of an appropriate method for 
measuring credit exposure that accounts for relevant product risk 
factors and portfolio effects across products, as described above. 
Therefore, the Commission believes the proposed change is consistent 
with Rule 17Ad-22(e)(6)(v).\32\
---------------------------------------------------------------------------

    \32\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission does not object to 
Advance Notice (SR-NSCC-2020-801) and that NSCC is authorized to 
implement the proposal as of the date of this notice or the date of an 
order by the Commission approving proposed rule change SR-NSCC-2020-
002, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-06598 Filed 3-30-20; 8:45 am]
BILLING CODE 8011-01-P


