[Federal Register Volume 85, Number 198 (Tuesday, October 13, 2020)]
[Notices]
[Pages 64539-64542]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-22476]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90101; File No. SR-FICC-2020-010]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving a Proposed Rule Change To Describe Key Components of 
the Mortgage-Backed Securities Division Stress Testing Program

October 6, 2020.

I. Introduction

    On August 11, 2020, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2020-010, pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder.\2\ The proposed rule change was published for comment in 
the Federal Register on August 25, 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.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 89616 (August 19, 2020), 
85 FR 52387 (August 25, 2020) (SR-FICC-2020-010) (``Notice'').
    \4\ On January 21, 2020, FICC filed a portion of this proposed 
rule change that is subject to Section 806(e)(1)(A) of Title VIII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act 
entitled the Payment, Clearing, and Settlement Supervision Act of 
2010 (``the Clearing Supervision Act'') and Rule 19b-4(n)(1)(i) 
under the Act, as an advance notice with the Commission (the 
``Advance Notice Filing''). 12 U.S.C. 5465(e)(1); 17 CFR 240.19b-
4(n)(1)(i); Release No. 88266 (February 24, 2020), 85 FR 11413 
(February 27, 2020) (SR-FICC-2020-801). The Commission issued a 
notice of no objection to the Advance Notice Filing on March 13, 
2020. See Release No. 88382 (March 13, 2020), 85 FR 15830 (March 19, 
2020) (SR-FICC-2020-801). A copy of the Advance Notice Filing and 
the Commission's notice of no objection are available at: http://www.dtcc.com/legal/sec-rule-filings.aspx.
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II. Description of the Proposed Rule Change

    The proposed rule change consists of a proposal to amend the FICC 
Mortgage-Backed Securities Division (``MBSD'') Clearing Rules (``MBSD 
Rules'') \5\ to include a new section that would describe the purpose 
and the key components of MBSD's stress testing program. The proposed 
rule change would also provide that vendor-supplied data would be used 
in the stress testing program, and that a back-up calculation would be 
used in the event the vendor fails to provide FICC with the vendor-
sourced data. The proposed changes are further described below.
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    \5\ Capitalized terms used herein and not otherwise defined 
shall have the meanings assigned to such terms in the MBSD Rules, 
available at: www.dtcc.com/legal/rules-and-procedures.aspx.
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A. Background

    MBSD provides trade comparison, netting, risk management, 
settlement, and central counterparty services for the U.S. mortgage-
backed securities market. FICC manages its credit exposures to its 
Clearing Members by collecting an appropriate amount of margin 
(referred to in the MBSD Rules as Required Fund Deposit) from each 
Clearing Member.\6\ The aggregate of all Clearing Members' margin 
amounts (together with certain other deposits required under the MBSD 
Rules) constitutes MBSD's Clearing Fund, which FICC would access should 
a Clearing Member default with insufficient margin to satisfy any FICC 
losses caused by the liquidation of the defaulting Clearing Member's 
portfolio.\7\
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    \6\ See MBSD Rule 4, supra note 5.
    \7\ Id.

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[[Page 64540]]

    FICC uses stress testing to test the sufficiency of its prefunded 
financial resources.\8\ In contrast to FICC's margin methodologies, 
which are designed to limit FICC's credit exposures under normal market 
conditions,\9\ FICC's stress testing methodologies are designed to 
quantify FICC's potential losses under extreme but plausible market 
conditions.\10\ Therefore, stress testing is designed to help FICC 
identify credit risks beyond those contemplated by FICC's margin 
methodologies, including credit exposures that might result from the 
realization of potential stress scenarios, such as extreme price 
changes, multiple defaults, or changes in other valuation inputs and 
assumptions.\11\ As a result, stress testing helps FICC identify the 
amount of financial resources necessary to cover its credit exposure 
under stress scenarios in extreme but plausible market conditions.\12\
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    \8\ On December 19, 2017, the Commission approved FICC's 
adoption of the Clearing Agency Stress Testing Framework (Market 
Risk), which among other things, sets forth the purpose of FICC's 
stress testing and describes certain methodologies FICC uses in its 
stress testing. Securities Exchange Act Release No. 82368 (December 
19, 2017), 82 FR 61082 (December 26, 2017) (SR-DTC-2017-005; SR-
FICC-2017-009; SR-NSCC-2017-006) (``Stress Testing Framework 
Order''). The Stress Testing Framework is an FICC rule, pursuant to 
Section 3(a)(27) of the Act, although it is not part of the MBSD 
Rules, and it has been filed confidentially with the Commission. See 
15 U.S.C. 78c(a)(27).
    \9\ See e.g., Securities Exchange Act Release No. 80253 (March 
15, 2017), 82 FR 14581, 14582 (March 21, 2017) (SR-FICC-2017-004) 
(notice of filing and immediate effectiveness of a proposed rule 
change to amend MBSD Rules with respect to the intraday mark-to-
market charge).
    \10\ See Stress Testing Framework Order, supra note 8 at 61083; 
Notice, supra note 3 at 52388.
    \11\ See id.; 17 CFR 240.17Ad-22(a)(17).
    \12\ See Stress Testing Framework Order, supra note 8 at 61083; 
Notice, supra note 3 at 52388.
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    The purpose and the key components of MBSD's stress testing 
program, among others, are provided in the Stress Testing 
Framework.\13\ FICC's stress testing methodologies have three key 
components: Risk identification, scenario development, and risk 
measurement and aggregation. The key components generally provide that 
FICC identifies the principal credit risk drivers, develops sets of 
extreme but plausible historical and hypothetical stress scenarios for 
the identified risk drivers, and calculates risk metrics for each 
Clearing Member's actual portfolio to estimate the profits and losses 
in connection with such Clearing Member's close-out under the chosen 
stress scenarios.\14\
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    \13\ See Stress Testing Framework Order, supra note 8 at 61082-
83.
    \14\ See Stress Testing Framework Order, supra note 8 at 61083; 
Notice, supra note 3 at 52388.
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B. MBSD's Stress Testing Program

    FICC proposes to include a new section in the MBSD Rules to provide 
the purpose and the key components of FICC's stress testing 
program.\15\ By including such description of the stress testing 
program in the MBSD Rules, which is a public document, FICC intends to 
make the current stress testing program transparent to its Clearing 
Members.\16\ Specifically, the proposed rule change provides that FICC 
uses stress testing to (1) test the sufficiency of the Clearing Fund 
against FICC's potential losses assuming the default of a Clearing 
Member with the largest credit exposure and its entire Affiliated 
Family under extreme but plausible market conditions, and (2) identify 
both (x) Clearing Members who may pose a greater market risk under 
certain market conditions, and (y) potential weaknesses in FICC's 
margin methodologies. The proposed rule change also provides that 
FICC's stress testing program has three key components.\17\ First, FICC 
analyzes the securities and risk exposures in its Clearing Members' 
portfolios to identify the principal market risk drivers and capture 
the risk sensitivity of the portfolios under stressed market 
conditions. Second, FICC develops a comprehensive set of scenarios 
including historical scenarios and hypothetical stress scenarios. 
Third, FICC calculates risk metrics for each Clearing Member's actual 
portfolio to estimate the profits and losses in connection with such 
Clearing Member's close out under the chosen stress scenarios.
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    \15\ The changes described in Section II.B. are consistent with 
the existing Framework.
    \16\ See Notice, supra note 3 at 52388.
    \17\ See id.
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C. Vendor-Supplied Data in MBSD's Stress Testing Program

    In connection with FICC's stress testing program, FICC proposes to 
use vendor-supplied data in MBSD's scenario development process, which 
is the second component of FICC's stress testing program, and the risk 
measurement and aggregation process, which is the third component of 
FICC's stress testing program.
(1) Historical Data in the Scenario Development Component
    The scenario development component involves FICC's construction of 
comprehensive and relevant sets of extreme but plausible historical and 
hypothetical stress scenarios for identified risk drivers. In its 
development of historical stress scenarios, FICC proposes to examine 
vendor-supplied historical risk factor \18\ time series data 
(``Historical Data'') to identify the largest historical changes of 
risk factors that influence the pricing of mortgage-backed securities.
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    \18\ Generally, the term ``risk factor'' (or ``risk driver'') 
means an attribute, characteristic, variable or other concrete 
determinant that influences the risk profile of a system, entity, or 
financial asset. Risk factors may be causes of risk or merely 
correlated with risk.
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    FICC proposes to use Historical Data because it believes that this 
data would explain the market price changes of To-Be-Announced 
(``TBA'') securities transactions cleared by MBSD.\19\ In addition, 
FICC believes that the data would (1) identify stress risk exposures 
under broad and varied market conditions, and (2) provide MBSD with a 
capability to design transparent scenarios.\20\
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    \19\ See Notice, supra note 3 at 52389.
    \20\ See id.
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(2) Historical Data and Security-Level Data in the Risk Measurement and 
Aggregation Component
    FICC represents that the risk measurement and aggregation process 
calculates risk metrics for each Clearing Member's actual portfolio to 
estimate the profits and losses in connection with such Clearing 
Member's close out under chosen stress scenarios.\21\ In connection 
with this calculation, FICC proposes to use a financial profit-and-loss 
calculation that leverages the Historical Data and the vendor-supplied 
security-level risk sensitivity \22\ data (``Security-Level Data''). 
The Security-Level Data is generated using the vendor's suite of 
security valuation models that includes an agency mortgage prepayment 
model and interest rate term structure model.\23\ FICC believes that 
the vendor's approach generates stable and robust Security-Level 
Data.\24\ Because the stress profits and losses calculation would 
include Security-Level Data, FICC believes that the calculated results 
would reflect results that are close to actual price changes for TBA 
securities during larger market moves, which are typical of stress 
testing scenarios.\25\
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    \21\ See id.
    \22\ The term ``sensitivity'' means the percentage value change 
of a security given each risk factor change.
    \23\ A prepayment model captures cash flow uncertainty as a 
result of unscheduled payments of principal (prepayments). An 
interest rate term structure model describes the relationship 
between interest rates of different maturities.
    \24\ See Notice, supra note 3 at 52389.
    \25\ See id.

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[[Page 64541]]

D. Back-Up Stress Testing Calculation

    Finally, FICC proposes to implement a back-up calculation that it 
would use in the event the vendor fails to provide FICC with the 
vendor-sourced data described above. Specifically, if the vendor fails 
to provide any data or a significant portion of the data in accordance 
with the timeframes to which FICC and the vendor agreed, FICC would use 
the most recently available data on the first day that such disruption 
occurs. If FICC and the vendor expect that the vendor would resume 
providing data within five business days, FICC would determine whether 
to calculate the daily stress testing calculation using the most 
recently available data or a back-up calculation, described below. If 
FICC and the vendor expect that the data disruption would extend beyond 
five days, FICC would utilize the back-up calculation.

E. Delayed Implementation of the Proposed Rule Change

    FICC proposes to implement the proposed rule change within 45 
Business Days after the Commission's approval of this proposed rule 
change. Prior to the effective date, FICC would add legends to the MBSD 
Rules to state that the specified changes to the MBSD Rules have been 
approved but not yet implemented, and to provide the date such approved 
changes would be implemented. The legends would also include the file 
number of the approved proposed rule change and state that once 
implemented, the legends would automatically be removed from the MBSD 
Rules.

III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \26\ 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 the rules and regulations thereunder 
applicable to such organization. After careful consideration, 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,\27\ as well as Rule 17Ad-22(e)(4)(iii) and (iv) thereunder \28\ 
for the reasons described below.
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    \26\ 15 U.S.C. 78s(b)(2)(C).
    \27\ 15 U.S.C. 78q-1(b)(3)(F).
    \28\ 17 CFR 240.17Ad-22(e)(4)(iii) and (iv).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, in part, that the rules 
of a registered clearing agency, such as FICC, be designed to promote 
the prompt and accurate clearance and settlement of securities 
transactions, and, in general, to protect investors and the public 
interest.\29\
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    \29\ Id.
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    First, as described in Section II.B., the proposed rule change 
would incorporate a new section explaining the purpose and the three 
key components of the stress testing program, which is currently 
included in the Stress Testing Framework. By incorporating the purpose 
and the key components of the stress testing program in the MBSD Rules, 
the proposed rule change would provide FICC stakeholders with a better 
understanding of what the stress testing program is designed to 
accomplish and how FICC manages its credit exposures. The Commission 
therefore believes that this aspect of the proposed rule change is 
consistent with Section 17A(b)(3)(F), in that this increased 
transparency would protect investors and the public interest.
    Second, as described in Section II.C., FICC proposes to use vendor-
supplied data in MBSD's scenario development process and the risk 
measurement and aggregation process. The Commission believes that 
vendor-supplied data should allow FICC to identify and analyze risk 
exposures under a broad and varied range of stressed market conditions, 
which should, in turn, help FICC identify the amount of financial 
resources necessary to cover its credit exposure under stress scenarios 
in extreme but plausible market conditions. The Commission further 
believes that the use of vendor-supplied data should enable FICC to 
perform a robust assessment of the stress profits and losses 
calculation, identify and address potential risks with risks with 
respect to specific Clearing Members and their affiliates, and in turn, 
should help FICC ensure that it is collecting adequate prefunded 
financial resources to cover its potential losses resulting from the 
default of clearing members and their affiliates under extreme but 
plausible market conditions.
    Moreover, as described in Section II.D., FICC proposes to use a 
back-up calculation in the event the vendor fails to provide FICC with 
the vendor-sourced data. The Commission believes that the back-up 
calculation is designed to provide FICC with a reasonable alternative 
method for calculating stress profit-and-loss in the event of an 
interruption in the vendor-sourced data feed. By providing FICC with a 
reasonable alternative method for conducting stress testing, the 
Commission believes that the proposed back-up calculation is designed 
to help FICC avoid gaps in assessing the sufficiency of its prefunded 
financial resources due to the inability of particular data.
    Taken together, the Commission believes that these aspects of the 
proposed rule change, as described in Sections II.C. and II.D., should 
better enable FICC to evaluate and manage the credit risk presented by 
its Clearing Members. The Commission believes that the proposed rule 
change is designed to improve FICC's ability to meet its requirement to 
maintain sufficient prefunded financial resources at a minimum to 
enable FICC to cover the default of the Clearing Member (including 
relevant affiliates) that would potentially cause the largest aggregate 
credit exposure for FICC in extreme but plausible conditions, as 
required under Rule 17Ad-22(e)(4)(iii).\30\ Accordingly, the Commission 
believes that the proposed rule change should help FICC to continue 
providing prompt and accurate clearance and settlement of securities 
transactions even in extreme but plausible historical and hypothetical 
stress scenarios, consistent with Section 17A(b)(3)(F) of the Act.\31\
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    \30\ 17 CFR 240.17Ad-22(e)(4).
    \31\ Id.
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B. Consistency With Rule 17Ad-22(e)(4)(iii) and (vi)

    Rule 17Ad-22(e)(4)(iii) requires that a covered clearing agency, 
such as FICC, 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, by 
maintaining additional financial resources at the minimum to enable it 
to cover a wide range of foreseeable stress scenarios that include, but 
are not limited to, the default of the participant family that would 
potentially cause the largest aggregate credit exposure for the covered 
clearing agency in extreme but plausible market conditions.\32\ Rule 
17Ad-22(e)(4)(vi) requires that a covered clearing agency, such as 
FICC, effectively identify, measure, monitor, and manage its credit 
exposures to participants and those arising from its payment, clearing, 
and settlement processes, by testing the sufficiency of

[[Page 64542]]

its total financial resources available by conducting stress testing of 
its total financial resources once each day using standard 
predetermined parameters and assumptions.\33\
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    \32\ 17 CFR 240.17Ad-22(e)(4)(iii).
    \33\ 17 CFR 240.17Ad-22(e)(4)(vi).
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    As described in Section II.C., FICC proposes to use vendor-supplied 
data, including Historical Data and Security-Level Data, in MBSD's 
scenario development process and the risk measurement and aggregation 
process. Historical Data would identify stress risk exposures under 
broad and varied market conditions and provide FICC with an enhanced 
capability to design more transparent scenarios.\34\ Security-Level 
Data would provide stable and robust data that would enable FICC to 
calculate stress profits and losses that is more accurate.\35\ In 
addition, as described in Section II.D., FICC proposes to use a back-up 
calculation in the event the vendor fails to provide data to FICC.
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    \34\ See Notice, supra note 3 at 52389.
    \35\ See id.
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    The Commission believes that the proposal is consistent with Rule 
17Ad-22(e)(4)(iii) because it should better enable FICC to assess its 
ability to maintain sufficient financial resources to cover a wide 
range of foreseeable stress scenarios that include the default of the 
member (including relevant affiliates) that would potentially cause 
FICC's largest aggregate credit exposure in extreme but plausible 
conditions.\36\ Additionally, the Commission believes FICC's proposed 
stress testing methodology is consistent with Rule 17Ad-22(e)(4)(vi) 
because it should enable FICC to test the sufficiency of its minimum 
financial resources by conducting stress testing using standard 
predetermined parameters and assumptions.\37\
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    \36\ 17 CFR 240.17Ad-22(e)(4)(iii).
    \37\ 17 CFR 240.17Ad-22(e)(4)(vi).
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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 Section 17A of the Act 
\38\ and the rules and regulations promulgated thereunder.
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    \38\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\39\ that proposed rule change SR-FICC-2020-010, be, and it hereby is, 
approved.\40\
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    \39\ 15 U.S.C. 78s(b)(2).
    \40\ In approving the proposed rule change, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \41\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\41\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-22476 Filed 10-9-20; 8:45 am]
BILLING CODE 8011-01-P


