[Federal Register Volume 85, Number 203 (Tuesday, October 20, 2020)]
[Notices]
[Pages 66646-66656]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-23138]



[[Page 66646]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90181; File No. SR-NSCC-2020-016]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Amendment No. 2 and Order Granting Accelerated 
Approval of a Proposed Rule Change, as Modified by Amendment Nos. 1 and 
2, To Introduce the Margin Liquidity Adjustment Charge and Include a 
Bid-Ask Risk Charge in the VaR Charge

October 14, 2020.
    On July 30, 2020, National Securities Clearing Corporation 
(``NSCC'') 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-NSCC-2020-016 to add two new charges to NSCC's 
margin methodology.\3\ On August 13, 2020, NSCC filed Amendment No. 1 
to the proposed rule change, to make clarifications and corrections to 
the proposed rule change.\4\ The proposed rule change, as modified by 
Amendment No. 1, was published for public comment in the Federal 
Register on August 20, 2020.\5\ The Commission has received comment 
letters on the proposed rule change, as modified by Amendment No. 1.\6\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NSCC also filed the proposals contained in the proposed rule 
change as advance notice SR-NSCC-2020-804 with the Commission 
pursuant to Section 806(e)(1) of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act entitled the Payment, Clearing, and 
Settlement Supervision Act of 2010 (``Clearing Supervision Act''), 
12 U.S.C. 5465(e)(1), and Rule 19b-4(n)(1)(i) of the Act, 17 CFR 
240.19b-4(n)(1)(i).
    \4\ Amendment No. 1 made clarifications and corrections to the 
description of the proposed rule change and Exhibits 3 and 5 of the 
filing. On August 13, 2020, NSCC filed Amendment No. 1 to the 
advance notice to make similar clarifications and corrections to the 
advance notice.
    \5\ Securities Exchange Act Release No. 89558 (August 14, 2020), 
85 FR 51521 (August 20, 2020) (``Notice''). The advance notice, as 
modified by Amendment No. 1, was published for public comment in the 
Federal Register on September 4, 2020. Securities Exchange Act 
Release No. 89719 (September 1, 2020), 85 FR 55332 (September 4, 
2020) (File No. SR-NSCC-2020-804). The comment period for the 
advance notice, as modified by Amendment No. 1 closed on September 
21, 2020, and the Commission received no comments.
    \6\ Comments received are available at https://www.sec.gov/comments/sr-nscc-2020-016/srnscc2020016.htm.
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    On August 27, 2020, NSCC filed Amendment No. 2 to the proposed rule 
change to provide additional data for the Commission to consider in 
analyzing the proposed rule change.\7\ The proposed rule change, as 
modified by Amendment Nos. 1 and 2, is hereinafter referred to as the 
``Proposed Rule Change.'' On October 2, 2020, pursuant to Section 
19(b)(2) of the Act,\8\ the Commission designated a longer period 
within which to approve, disapprove, or institute proceedings to 
determine whether to approve or disapprove the Proposed Rule Change.\9\ 
The Commission is publishing this notice to solicit comments on 
Amendment No. 2 from interested persons and, for the reasons discussed 
below, to approve the Proposed Rule Change on an accelerated basis.
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    \7\ In Amendment No. 2, NSCC updated Exhibit 3 to the proposed 
rule change to include impact analysis data with respect to the 
proposed rule change. NSCC filed Exhibit 3 as a confidential exhibit 
to the proposed rule change pursuant to 17 CFR 240.24b-2. On August 
27, 2020, NSCC filed Amendment No. 2 to the advance notice to 
provide similar additional data for the Commission's consideration. 
The advance notice, as amended by Amendment Nos. 1 and 2, is 
hereinafter referred to as the ``Advance Notice.'' On October 2, 
2020, the Commission published notice of filing of Amendment No. 2 
and notice of no objection to the Advance Notice. Securities 
Exchange Act Release No. 90034 (September 28, 2020), 85 FR 62342 
(October 2, 2020) (File No. SR-NSCC-2020-804).
    \8\ 15 U.S.C. 78s(b)(2).
    \9\ Securities Exchange Act Release No. 90084 (October 2, 2020), 
85 FR 63607 (October 8, 2020).
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I. Description of the Proposed Rule Change

    First, the Proposed Rule Change would revise NSCC's Rules and 
Procedures (``Rules'') \10\ to introduce the Margin Liquidity 
Adjustment Charge (``MLA Charge'') as an additional margin component. 
Second, the Proposed Rule Change would revise the Rules to add a bid-
ask spread risk charge (``Bid-Ask Spread Charge'') to NSCC's margin 
calculations.
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    \10\ 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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A. Background

    NSCC provides central counterparty (``CCP'') services, including 
clearing, settlement, risk management, and a guarantee of completion 
for virtually all broker-to-broker trades involving equity securities, 
corporate and municipal debt securities, and certain other securities. 
In its role as a CCP, a key tool that NSCC uses to manage its credit 
exposure to its members is determining and collecting an appropriate 
Required Fund Deposit (i.e., margin) for each member.\11\ The aggregate 
of all members' Required Fund Deposits (together with certain other 
deposits required under the Rules) constitutes NSCC's Clearing Fund, 
which NSCC would access should a defaulted member's own Required Fund 
Deposit be insufficient to satisfy losses to NSCC caused by the 
liquidation of that member's portfolio.\12\
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    \11\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters) of the Rules (``Procedure XV''), supra 
note 10.
    \12\ See id.
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    Each member's Required Fund Deposit consists of a number of 
applicable components, which are calculated to address specific risks 
that the member's portfolio presents to NSCC.\13\ Generally, the 
largest component of a member's Required Fund Deposit is the volatility 
charge, which is intended to capture the risks related to the movement 
of market prices associated with the securities in a member's 
portfolio.\14\ NSCC's methodology for calculating the volatility charge 
of the Required Fund Deposit depends on the type of security. For most 
securities (e.g., equity securities), NSCC calculates the volatility 
charge 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, which addresses 
concentration risk that the largest non-index position can present 
within a member's portfolio, and (3) a portfolio margin floor 
calculation based on the market values of the long and short positions 
in the portfolio, which addresses risks that might not be adequately 
addressed with the other volatility charge calculations.\15\ For 
certain other securities (e.g., corporate and municipal bonds), NSCC's 
Rules apply a haircut-based volatility charge that is calculated by 
multiplying the absolute value of the positions by a percentage.\16\ 
The volatility charge is designed to calculate the potential losses on 
a portfolio over a three-day period of risk assumed necessary to 
liquidate the portfolio, within a 99 percent confidence level.\17\
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    \13\ See id.
    \14\ See id.
    \15\ See id.; see also Securities Exchange Act Release No. 82780 
(February 26, 2018), 83 FR 9035 (March 2, 2018) (File No. SR-NSCC-
2017-808); Securities Exchange Act Release No. 82781 (February 26, 
2018), 83 FR 9042 (March 2, 2018) (File No. SR-NSCC-2017-020).
    \16\ See id.
    \17\ See Notice, supra note 5 at 51522.
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    NSCC states that it regularly assesses market and liquidity risks 
as such risks relate to its margin methodology to evaluate whether 
margin levels are commensurate with the particular risk attributes of 
each relevant product, portfolio, and market.\18\ NSCC states

[[Page 66647]]

that the proposed MLA Charge and Bid-Ask Spread Charge are necessary 
for NSCC to effectively account for risks associated with certain types 
and attributes of member portfolios.\19\
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    \18\ See id.
    \19\ See id.
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B. Margin Liquidity Adjustment Charge

    NSCC's current margin methodology does not account for the risk of 
a potential increase in costs that NSCC could incur when liquidating a 
defaulted member's portfolio that contains a concentration of large 
positions, as compared to the overall market, in a particular security 
or group of securities sharing a similar risk profile.\20\ In a member 
default, liquidating such large positions within a potentially 
compressed timeframe \21\ (e.g., in a fire sale) could have an impact 
on the underlying market, resulting in price moves that increase NSCC's 
risk of incurring additional liquidation costs. Therefore, NSCC 
designed the MLA Charge to address this specific risk.\22\
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    \20\ See Notice, supra note 5 at 51522-23.
    \21\ NSCC's risk models assume the liquidation occurs over a 
period of three business days. See Notice, supra note 5 at 51523.
    \22\ See id.
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    The MLA Charge would be based on comparing the market value of 
member portfolio positions in specified asset groups \23\ to the 
available trading volume of those asset groups. If the market value of 
a member's positions in a certain asset group is large in comparison to 
the available trading volume of that asset group,\24\ then it is more 
likely that NSCC would have to manage reduced marketability and 
increased liquidation costs for those positions during a member default 
scenario. Specifically, NSCC's margin methodology would assume for each 
asset group that a certain share of the market can be liquidated 
without price impact.\25\ Aggregate positions in an asset group which 
exceed this share are generally considered as large and would therefore 
incur application of the MLA Charge to anticipate and address those 
increased costs.
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    \23\ The specified asset groups would include (1) equities 
(excluding equities defined as Illiquid Securities pursuant to the 
Rules), (2) Illiquid Securities, (3) unit investment trusts, or 
UITs, (4) municipal bonds (including municipal bond exchange-traded 
products, or ``ETPs''), and (5) corporate bonds (including corporate 
bond ETPs). NSCC would then further segment the equities asset group 
into the following subgroups: (i) Micro-capitalization equities, 
(ii) small capitalization equities, (iii) medium capitalization 
equities, (iv) large capitalization equities, (v) treasury ETPs, and 
(vi) all other ETPs. See id.
    \24\ NSCC states that it would determine average daily trading 
volume by reviewing data that is made publicly available by the 
Securities Industry and Financial Markets Association (``SIFMA''), 
at https://www.sifma.org/resources/archive/research/statistics. See 
id.
    \25\ NSCC would establish the particular share for each asset 
group or subgroup based on empirical research which includes the 
simulation of asset liquidation over different time horizons. See 
Notice, supra note 5 at 51523-25.
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    For each position in a market capitalization subgroup of the 
equities asset group, NSCC would calculate the market impact cost by 
multiplying four components: (1) An impact cost coefficient that is a 
multiple of the one-day market volatility of that subgroup and is 
designed to measure impact costs, (2) the gross market value of the 
position in that subgroup, (3) the square root of the gross market 
value of the position in that subgroup in the portfolio divided by an 
assumed percentage of the average daily trading volume of that 
subgroup, and (4) a measurement of the relative weight of the position 
in that subgroup of the portfolio. With respect to the fourth 
component, NSCC states that this measurement would include aggregating 
the weight of each CUSIP in that position relative to the weight of 
that CUSIP in the subgroup, such that a portfolio with fewer positions 
in a subgroup would have a higher measure of concentration for that 
subgroup.\26\
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    \26\ NSCC would calculate the relative weight by dividing the 
absolute market value of a single CUSIP in the member's portfolio by 
the total absolute market value of that portfolio. See Notice, supra 
note 5 at 51523-24.
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    For each position in the municipal bond, corporate bond, Illiquid 
Securities and UIT asset groups, and for positions in the treasury ETP 
and other ETP subgroups of the equities asset group, NSCC would 
calculate the market impact cost by multiplying three components: (1) 
An impact cost coefficient that is a multiple of the one-day market 
volatility of that asset group or subgroup, (2) the gross market value 
of the position in that asset group or subgroup, and (3) the square 
root of the gross market value of the position in that asset group or 
subgroup in the portfolio divided by an assumed percentage of the 
average daily trading volume of that subgroup.\27\
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    \27\ See supra note 24.
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    For each asset group or subgroup, NSCC would compare the calculated 
market impact cost to a portion of the volatility charge that is 
allocated to positions in that asset group or subgroup.\28\ If the 
ratio of the calculated market impact cost to the applicable one-day 
volatility charge is greater than a threshold, NSCC would apply an MLA 
Charge to that asset group or subgroup.\29\ If the ratio of these two 
amounts is equal to or less than this threshold, NSCC would not apply 
an MLA Charge to that asset group or subgroup. The threshold would be 
based on an estimate of the market impact cost that is incorporated 
into the calculation of the applicable one-day volatility charge, such 
that NSCC would only apply an MLA Charge when the calculated market 
impact cost exceeds this threshold.
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    \28\ For purposes of this calculation, NSCC would use a portion 
of the applicable volatility charge that is based on a one-day 
assumed period of risk and calculated by applying a simple square-
root of time scaling, referred to in this advance notice as ``one-
day volatility charge.'' See Notice, supra note 5 at 51524. Any 
changes that NSCC deems appropriate to this assumed period of risk 
would be subject to NSCC's model risk management governance 
procedures set forth in the Clearing Agency Model Risk Management 
Framework (``Model Risk Management Framework''). See Securities 
Exchange Act Release Nos. 81485 (August 25, 2017), 82 FR 41433 
(August 31, 2017) (File No. SR-NSCC-2017-008); 84458 (October 19, 
2018), 83 FR 53925 (October 25, 2018) (File No. SR-NSCC-2018-009); 
88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-NSCC-
2020-008).
    \29\ NSCC would set the initial threshold at 0.4, because 
approximately 40 percent of the one-day volatility charge currently 
addresses market impact costs. NSCC would review this threshold from 
time to time and any changes that NSCC deems appropriate would be 
subject to NSCC's model risk management governance procedures set 
forth in the Model Risk Management Framework. See id.
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    When applicable, an MLA Charge for each asset group or subgroup 
would be calculated as a proportion of the product of (1) the amount by 
which the ratio of the calculated market impact cost to the applicable 
one-day volatility charge exceeds the threshold, and (2) the one-day 
volatility charge allocated to that asset group or subgroup.
    For each portfolio, NSCC would total the MLA Charges for positions 
in each of the subgroups of the equities asset group to determine an 
MLA Charge for the positions in the equities asset group. NSCC would 
then total the MLA Charge for positions in the equities asset group 
together with each of the MLA Charges for positions in the other asset 
groups to determine a total MLA Charge for a member.
    In certain circumstances, NSCC may be able to partially mitigate 
the risks that the MLA Charge is designed to address by extending the 
time period for liquidating a defaulted member's portfolio beyond the 
three day period. Accordingly, the Proposed Rule Change also describes 
a method that NSCC would use to reduce a member's total MLA Charge when 
the volatility charge component of the member's margin increases beyond 
a specified point. Specifically, NSCC would reduce the member's MLA 
Charge where the market impact cost of a particular portfolio, 
calculated as part of determining the MLA Charge, would be large 
relative to the one-day volatility

[[Page 66648]]

charge for that portfolio (i.e., a portion of the three-day assumed 
margin period of risk). When the ratio of calculated market impact cost 
to the one-day volatility charge is lower, NSCC would not adjust the 
MLA Charge. However, as the ratio gets higher, NSCC would reduce the 
MLA Charge. NSCC designed this reduction mechanism to avoid assessing 
unnecessarily large MLA Charges.\30\
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    \30\ See Notice, supra note 5 at 51524.
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    On a daily basis, NSCC would calculate the final MLA Charge for 
each member (if applicable), to be included as a component of each 
member's Required Fund Deposit.
    Finally, NSCC would amend the Rules to add the MLA Charge to the 
list of Clearing Fund components that are excluded from the calculation 
of the Excess Capital Premium charge.\31\ The Excess Capital Premium is 
imposed on a member when the member's Required Fund Deposit exceeds its 
excess net capital. NSCC states that including the MLA Charge in the 
calculation of the Excess Capital Premium could lead to more frequent 
and unnecessary Excess Capital Premium charges, which is not the 
intended purpose of the Excess Capital Premium charge and could place 
an unnecessary burden on members.\32\
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    \31\ See Section I.(B)(2) of Procedure XV, supra note 10.
    \32\ See Notice, supra note 5 at 51524.
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C. Bid-Ask Spread Charge

    The bid-ask spread refers to the difference between the observed 
market price that a buyer is willing to pay for a security and the 
observed market price at which a seller is willing to sell that 
security. NSCC faces the risk of potential bid-ask spread transaction 
costs when liquidating the securities in a defaulted member's 
portfolio. However, NSCC's current margin methodology does not account 
for this risk of potential bid-ask spread transaction costs to NSCC in 
connection with liquidating a defaulted member's portfolio. Therefore, 
NSCC designed the Bid-Ask Spread Charge to address this deficiency in 
its current margin methodology.
    The Bid-Ask Spread Charge would be haircut-based and tailored to 
different groups of assets that share similar bid-ask spread 
characteristics. NSCC would assign each asset group a specified bid-ask 
spread haircut rate (measured in basis points (``bps'')) that would be 
applied to the gross market value of the portfolio's positions in that 
particular asset group. NSCC would calculate the product of the gross 
market value of the portfolio's positions in a particular asset group 
and the applicable basis point charge to obtain the bid-ask spread risk 
charge for these positions. NSCC would total the applicable bid-ask 
spread risk charges for each asset group in a member's portfolio to 
calculate the member's final Bid-Ask Spread Charge.
    NSCC determined the proposed initial haircut rates based on an 
analysis of bid-ask spread transaction costs using (1) the results of 
NSCC's annual member default simulation and (2) market data sourced 
from a third-party data vendor. NSCC's proposed initial haircut rates 
are listed in the table below:

------------------------------------------------------------------------
                                                                Haircut
                         Asset group                             (bps)
------------------------------------------------------------------------
Large and medium capitalization equities.....................        5.0
Small capitalization equities................................       12.3
Micro-capitalization equities................................       23.1
ETPs.........................................................        1.5
------------------------------------------------------------------------

    NSCC proposes to review the haircut rates annually.\33\ Based on 
analyses of recent years' simulation exercises, NSCC does not 
anticipate that these haircut rates would change significantly year 
over year.\34\ NSCC may also adjust the haircut rates following its 
annual model validation review, to the extent the results of that 
review indicate the current haircut rates are not adequate to address 
the risk presented by transaction costs from a bid-ask spread.\35\
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    \33\ See Notice, supra note 5 at 51525.
    \34\ See id.
    \35\ All proposed changes to the haircuts would be subject to 
NSCC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See supra note 28.
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D. Description of Amendment No. 2

    In Amendment No. 2, NSCC updated Exhibit 3 to the Proposed Rule 
Change to include impact analysis data with respect to the Proposed 
Rule Change. Specifically, Amendment No. 2 includes impact studies for 
various time periods detailing the average and maximum MLA and Bid-Ask 
Charges for each member, by both percentage and amount. NSCC filed 
Exhibit 3 as a confidential exhibit to the Proposed Rule Change 
pursuant to 17 CFR 240.24b-2.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \36\ 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 NSCC. In particular, the Commission finds that the 
Proposed Rule Change is consistent with Sections 17A(b)(3)(F) and 
(b)(3)(I) \37\ of the Act and Rules 17Ad-22(e)(4) and (e)(6) 
thereunder.\38\
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    \36\ 15 U.S.C. 78s(b)(2)(C).
    \37\ 15 U.S.C. 78q-1(b)(3)(F) and (b)(3)(I).
    \38\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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A. Consistency With Section 17A(b)(3)(F)

    Section 17A(b)(3)(F) of the Act requires, in part, that the rules 
of a clearing agency, such as NSCC, be designed to promote the prompt 
and accurate clearance and settlement of securities transactions, 
assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible, remove impediments to and perfect the mechanism of a 
national system for the prompt and accurate clearance and settlement of 
securities transactions, and, in general, to protect investors and the 
public interest.\39\ The Commission believes that the Proposed Rule 
Change is consistent with Section 17A(b)(3)(F) of the Act.
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    \39\ 15 U.S.C. 78q-1(b)(3)(F).
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    First, as described above in Section I.A and B, NSCC's current 
margin methodology does not account for the potential increase in 
market impact costs that NSCC could incur when liquidating a defaulted 
member's portfolio where the portfolio contains a concentration of 
large positions in a particular security or group of securities sharing 
a similar risk profile. In addition, as described above in Section I.C, 
NSCC's margin methodology does not account for the risk of potential 
bid-ask spread transaction costs when liquidating the securities in a 
defaulted member's portfolio. NSCC proposes to address these risks by 
adding the MLA Charge and Bid-Ask Spread Charge, respectively, to its 
margin methodology.\40\
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    \40\ The Commission notes that the other clearing agencies it 
regulates have charges to account for these types of risks in their 
margin methodologies, and that addressing these types of risks has 
received a great deal of industry focus in recent years.
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    NSCC designed the MLA Charge and Bid-Ask Spread Charge to ensure 
that NSCC collects margin amounts sufficient to manage NSCC's risk of 
incurring costs associated with liquidating defaulted member 
portfolios. Based on its review of the Proposed Rule Change, including 
confidential

[[Page 66649]]

Exhibit 3 thereto,\41\ the Commission understands that the proposed MLA 
Charge and Bid-Ask Spread Charge would generally provide NSCC with 
additional resources to manage potential losses arising out of a member 
default. As discussed above, NSCC designed the MLA Charge and Bid-Ask 
Spread Charge, respectively, to reflect two distinct and specific risks 
presented to NSCC: (1) The risk associated with liquidating a defaulted 
member's portfolio that holds concentrated positions in securities 
sharing similar risk profiles; as well as (2) the risks associated with 
the bid-ask spread costs relevant to the securities in the defaulted 
member's portfolio. As a result, any margin increases that result from 
the MLA and the Bid-Ask Spread Charges are limited to address those 
respective risks. This targeted increase in available financial 
resources should decrease the likelihood that losses arising out of a 
member default stemming from the liquidation of concentrated positions 
or bid-ask spreads would cause NSCC to exhaust its financial resources 
and threaten the operation of its critical clearance and settlement 
services. Accordingly, the Commission believes that the Proposed Rule 
Change should help NSCC to continue providing prompt and accurate 
clearance and settlement of securities transactions in the event of a 
member default.
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    \41\ Specifically, the confidential Exhibit 3 submitted by NSCC 
includes, among other things, impact studies for various time 
periods detailing the average and maximum MLA and Bid-Ask Spread 
Charges for each member, by both percentage and amount, a detailed 
methodology describing the calculation of the MLA and Bid-Ask Spread 
Charges, and information regarding how NSCC determined the 
appropriate methodology.
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    Second, as discussed above, in a member default scenario, NSCC 
would access its Clearing Fund should the defaulted member's own 
Required Fund Deposit be insufficient to satisfy losses to NSCC caused 
by the liquidation of that member's portfolio. NSCC proposes to add the 
MLA Charge and Bid-Ask Spread Charge to its margin methodology to 
augment its ability to manage the potential costs of liquidating a 
defaulted member's portfolio by collecting additional margin to cover 
such costs. This, in turn, could reduce the possibility that NSCC would 
need to mutualize among the non-defaulting members a loss arising out 
of the close-out process. Reducing the potential for loss mutualization 
could, in turn, reduce the potential knock-on effects to non-defaulting 
members, their customers, and NSCC arising out of a member default. 
Accordingly, the Commission believes the Proposed Rule Change would 
promote the safeguarding of securities and funds which are in the 
custody or control of NSCC or for which NSCC is responsible, consistent 
with Section 17A(b)(3)(F) of the Act.
    One commenter argues that the Proposed Rule Change is not in the 
public interest and would harm investors and small businesses by 
dampening small business capital formation and liquidity and 
discouraging trading activity, as discussed more fully below.\42\ The 
Commission disagrees that the proposal is not in the public interest. 
The Commission believes that the proposal should help protect investors 
and the public interest by mitigating some of the risks presented by 
NSCC as a CCP. Because a defaulting member could place stresses on NSCC 
with respect to NSCC's ability to meet its clearance and settlement 
obligations upon which the broader financial system relies, it is 
important that NSCC has a strong margin methodology to limit NSCC's 
credit risk exposure in the event of a member default. As described 
above, the Proposed Rule Change would add two charges specifically 
designed to address risks that are not currently addressed in NSCC's 
margin methodology related to: (1) The potential costs that NSCC may 
incur when liquidating a portfolio that is concentrated in a particular 
security or group of securities with a similar risk profile, and (2) 
the potential costs that NSCC may incur to cover the bid-ask spread 
when liquidating a portfolio. These changes should help ensure that 
NSCC collects sufficient margin that is more commensurate with the 
risks associated with the potential concentration and bid-ask spread 
liquidation costs identified above, and thus more effectively cover its 
credit exposures to its members. By collecting margin that more 
accurately reflects the risk characteristics of such portfolios and the 
bid-ask spreads of securities they contain (i.e., the potential 
associated costs of liquidating such portfolios), NSCC would be in a 
better position to absorb and contain the spread of any losses that 
might arise from a member default. Therefore, the proposal is designed 
to reduce the possibility that NSCC would need to call for additional 
resources from non-defaulting members due to a member default, which 
could inhibit the ability of these non-defaulting members to facilitate 
securities transactions. Accordingly, the Commission believes that the 
proposal is designed to protect investors and the public interest by 
mitigating some of the risks presented by NSCC as a CCP.\43\
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    \42\ Letter from James C. Snow, President/CCO, Wilson-Davis & 
Co., Inc. (received September 30, 2020) at 1 (``Wilson-Davis 
Letter'').
    \43\ See Securities Exchange Act Release No. 78961 (September 
28, 2016), 81 FR 70786, 70849 (October 13, 2016) (``While central 
clearing generally benefits the markets in which it is available, 
clearing agencies can pose substantial risk to the financial system 
as a whole, due in part to the fact that central clearing 
concentrates risk in the clearing agency.'').
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    One commenter asserts that the proposal dampens capital formation 
and liquidity and that firms and investors would stop participating in 
trades because of the proposal.\44\ Specifically, the commenter states 
that broker-dealers would not be able to trade securities issued by 
small companies because the ``insurance requirement'' would be too 
high. In addition, the commenter states that investors would be 
dissuaded from trading in such securities. Overall, the commenter 
argues that the Proposed Rule Change is inconsistent with the 
Commission's mission of facilitating capital formation.
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    \44\ Wilson-Davis Letter at 4-5.
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    First, with respect to the comment regarding liquidity and capital 
formation, the Commission believes that limiting NSCC's exposure to its 
members by allowing NSCC to collect margin to address the two risks 
that are not currently addressed would benefit members due to NSCC's 
decreased exposure to losses resulting from a member default. 
Effectively mitigating such risks would, in turn, reduce the likelihood 
that NSCC would have to call on its members to contribute additional 
resources, which otherwise could be used by its members to facilitate 
securities transactions thereby providing liquidity to the securities 
markets. Thus, the Commission believes that NSCC's proposal, by helping 
non-defaulting members preserve their financial resources, could 
promote liquidity provision in such circumstances because these 
resources would be available to facilitate securities transactions.
    Nevertheless, the Commission acknowledges that the proposal could 
result in an increase in the margin required to be collected from a 
member, which, in turn, may result in such member incurring additional 
costs to access needed liquidity. Despite these potential impacts, the 
Commission is not persuaded that the Proposed Rule Change would have a 
negative effect on small business capital formation such that it would 
be inconsistent with the public interest or, more broadly, the 
Commission's mission. To the extent that members incur funding costs

[[Page 66650]]

associated with additional margin, they may choose to distribute these 
costs across transactions in all securities for which they make markets 
rather than allocate those costs only to transactions in securities 
that require additional margin. Thus, the fact that members have 
flexibility in how they allocate costs could mitigate negative impacts, 
if any, on the liquidity and capital formation of a particular subset 
of issuers.
    Both the MLA Charge and the Bid-Ask Spread Charge would apply to 
all securities cleared and settled at NSCC and would not be directed to 
any particular group of securities. The MLA Charge would only apply to 
portfolios where the market value of a member's positions in a certain 
asset group is large in comparison to the available trading volume of 
that asset group. Thus, the application of the charge depends on the 
particular mix of securities within the specified asset groups in a 
member's portfolio and does not depend solely on the presence of 
particular types of securities. The Bid-Ask Spread Charge would apply 
to all the securities in a member's portfolio and would not apply only 
to a particular type of security. The Commission acknowledges that the 
haircuts that would determine the Bid-Ask Spread Charge would, in part, 
consider the nature of the security, with the highest haircut 
percentages applicable to micro-cap and small-cap securities. However, 
based on its consideration of NSCC's determination of the haircut 
schedule, as informed by NSCC's analysis of bid-ask spread transaction 
costs using (1) the results of NSCC's annual member default simulation, 
and (2) market data sourced from a third-party data vendor, the 
Commission believes that the haircut schedule is appropriate given that 
such securities likely would exhibit larger bid-ask spreads, making the 
higher haircut more conservative and consistent with NSCC's regulatory 
requirements to collect margin commensurate with the risks presented by 
the securities.
    Further, the Commission is not persuaded by the commenter's 
generalized statements on the potential impact on small business 
capital formation that could result from implementation of the Proposed 
Rule Change, which are lacking any specific data or analysis in support 
thereof. The Commission acknowledges the possibility that, as the 
commenter asserted, issuers of securities in smaller companies may 
experience a reduction in liquidity because of the increased margin 
requirements applicable to transactions in such securities. 
Nevertheless, the Commission believes that small business issuers that 
are more liquid could benefit from greater access to capital to the 
extent that the proposal leads to a net increase in demand for more 
liquid securities and a net decrease in demand for less liquid 
securities. Further, the Commission does not agree with the commenter 
that investors would be dissuaded from trading in such securities. The 
Commission is aware of research suggesting that the stock prices of 
smaller companies fall in response to a reduction in liquidity until 
such securities provide an adequate desired return for investors.\45\ 
Thus, as long as stock prices can adjust to reflect the reduced 
liquidity, affected small issuers may still be able to attract capital 
from investors, albeit at a higher cost that appropriately reflects the 
risks inherent in the clearance and settlement of the securities they 
issue. Moreover, to the extent that investment decisions are driven by 
other factors, such as the future prospects of specific companies, 
there might be no decrease in access to capital or little change in 
cost.
---------------------------------------------------------------------------

    \45\ See, e.g., Viral Acharya and Lasse H. Pedersen, 2005, Asset 
pricing with liquidity risk, Journal of Financial Economics 77(2) 
375-410.
---------------------------------------------------------------------------

    In addition, the commenter's arguments ignore the potential 
benefits to small businesses when their securities are eligible for 
central clearing by NSCC. As do other clearing agencies, NSCC provides 
a number of services that mitigate risk, reduce costs, and enhance 
processing efficiencies for the securities markets, market 
participants, issuers (including small issuers), and investors. By 
reducing NSCC's risk exposure to its members and thus the likelihood of 
its failure, the proposal helps ensure that NSCC would continue to 
provide such services, which would benefit securities markets, market 
participants, issuers (including small issuers), and investors. Thus, 
the commenter does not take into account any potential positive impacts 
on small business capital formation that may arise as a result of the 
Proposed Rule Change.
    Second, the Commission is not persuaded that the Proposed Rule 
Change will not protect investors solely because of the potential for 
increased costs. The Commission notes that although the proposal may 
result in an increase in margin requirements for particular portfolios 
(as a result of the MLA Charge) and to reflect the bid-ask spread (as a 
result of the Bid-Ask Spread Charge), such an increase is designed to 
allow NSCC to reduce the risks when liquidating a portfolio in the 
event of a member default. As a result, NSCC should be more resilient 
so that it can satisfy its obligations as a CCP, which facilitates the 
protection of investors by helping to ensure that investors receive the 
proceeds from their securities transactions. In addition, as discussed 
earlier, the Commission believes that the proposal should help protect 
investors and the public interest by mitigating some of the risks 
presented by NSCC as a CCP.
    Therefore, notwithstanding the potential unspecified impact on 
capital formation in smaller and less liquid markets, as described 
above, the Commission believes that, in light of the potential benefits 
to investors arising from the Proposed Rule Change and the overall 
improved risk management at NSCC, the Proposed Rule Change is designed 
to protect investors and the public interest, consistent with Section 
17A(b)(3)(F) of the Act.
    Finally, one commenter asserted that the Proposed Rule Change would 
add impediments to the national system for clearance and settlement 
because it would create more complicated algorithms that slow the 
clearance process, burdens settlement and harms investors, firms and 
small businesses.\46\ Based on the Commission's review of the materials 
that NSCC has filed in connection with this Proposed Rule Change and 
its general knowledge of the information technology systems and 
infrastructure in place at NSCC, the Commission concludes that the 
Proposed Rule Change would not slow the clearance and settlement 
process at NSCC. The Proposed Rule Change is designed to enable NSCC to 
address two risks that are not currently reflected in its margin 
methodology. The proposal introduces the MLA Charge as an additional 
margin component, and adds a Bid-Ask Spread Charge to NSCC's margin 
calculations. The Commission believes that these new margin charges 
will better enable NSCC to establish a risk-based margin system that 
(1) considers and produces margin levels commensurate with the risks 
associated with liquidating member portfolios in a default scenario, 
including decreased marketability of a portfolio's securities due to 
large positions in securities sharing similar risk profiles and bid-ask 
transaction costs, and (2) uses an appropriate method for measuring 
credit exposure that accounts for such risk factors and portfolio 
effects.\47\ The operation of the risk-based margin

[[Page 66651]]

system, as amended by the proposal, would not interfere with the 
clearance and settlement of securities transactions. As a result, the 
proposal should not slow the clearance process, burden settlement or 
harm investors, firms and small businesses. Instead, the Proposed Rule 
Change should help ensure that NSCC will continue to perform its vital 
role to settle transactions on time and at their agreed upon terms in 
the event of a member default, which will better protect investors, 
firms, small businesses, and the broader financial system. Moreover, 
the Commission does not believe that the Proposed Rule Change would 
impose any additional impediments on the national system of clearance 
and settlement; the fact that the application of the revised margin 
methodology may, in some instances, result in increased margin 
requirements (as discussed in more detail in Section II.B below) does 
not constitute the imposition of such an impediment.
---------------------------------------------------------------------------

    \46\ Id. at 1, 5.
    \47\ See Securities Exchange Act Release No. 90034 (September 
28, 2020), 85 FR 62342 (October 2, 2020) (File No. SR-NSCC-2020-
804).
---------------------------------------------------------------------------

    The commenter also argues that the Proposed Rule Change is an 
ineffective attempt by NSCC to address its credit risks.\48\ The 
commenter argues that NSCC could address the risk directly by modifying 
the settlement timeline. According to the commenter, if the NSCC 
proposed rules that would eliminate the two-day settlement cycle in 
favor of immediate, same-day electronic settlement, the market risk 
exposure would be eliminated. The Commission disagrees with the 
commenter. The securities industry transitioned to the current two-day 
settlement cycle on September 5, 2017, only after a multi-year, 
industry-wide initiative \49\ and the Commission's amendment of Rule 
15c6-1.\50\ Therefore, the commenter's suggestion that NSCC could 
unilaterally shorten the current two-day settlement to a same-day 
settlement cycle is not a feasible alternative to the Proposed Rule 
Change.
---------------------------------------------------------------------------

    \48\ Wilson-Davis Letter at 4.
    \49\ See Securities Exchange Act Release No. 78962 (September 
28, 2016), 81 FR 69240, 69254 (October 5, 2016) (``Discussion of 
Current Efforts To Shorten the Settlement Cycle in the U.S.'').
    \50\ See Securities Exchange Act Release No. 80295 (March 22, 
2017), 82 FR 15564 (March 29, 2017).
---------------------------------------------------------------------------

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

    Section 17A(b)(3)(I) of the Act requires that the rules of a 
clearing agency do not impose any burden on competition not necessary 
or appropriate in furtherance of the Act.\51\ This provision does not 
require the Commission to find that a proposed rule change represents 
the least anti-competitive means of achieving the goal. Rather, it 
requires the Commission to balance the competitive considerations 
against other relevant policy goals of the Act.\52\
---------------------------------------------------------------------------

    \51\ 15 U.S.C. 78q-1(b)(3)(I).
    \52\ See Bradford National Clearing Corp., 590 F.2d 1085, 1105 
(D.C. Cir. 1978).
---------------------------------------------------------------------------

    Both commenters argue that the Proposed Rule Change would 
disproportionately impact member firms with lower operating margins or 
higher costs of capital.\53\ The Commission acknowledges that the 
Proposed Rule Change could entail increased margin charges to some 
members, including members that invest in concentrated positions in 
securities sharing a common risk profile and members that invest in 
securities that have larger bid-ask spreads, which may include microcap 
and small cap securities. Nevertheless, as discussed above, the 
Proposed Rule Change would calculate the MLA Charge and Bid-Ask Spread 
Charge based on the composition of a member's portfolio, regardless of 
member size or type, and the charges would not target or apply solely 
to Illiquid Securities or securities with a smaller market 
capitalization. Instead, as discussed above in Sections I.B and I.C, 
both the MLA and Bid-Ask Spread Charges would serve to address 
particular potential costs that NSCC may incur when liquidating a 
portfolio in a member default. To the extent a particular member's 
margin would increase under the Proposed Rule Change, that increase 
would be based on the mix of securities that make up the member's 
portfolio and NSCC's requirement to collect margin to appropriately 
address the associated risks, which it currently does not do.
---------------------------------------------------------------------------

    \53\ See Wilson-Davis Letter at 4-5; Letter from Cass Sanford, 
Associated General Counsel, OTC Markets Group (September 11, 2020) 
at 2 (``OTC Letter''). One commenter further states that the 
Proposed Rule Change would double its required margin, based on an 
impact study it received from NSCC. (Wilson-Davis Letter at 2.) The 
commenter states that the impact study covered only one quarter of 
information and concludes that NSCC is making this decision based 
solely on that analysis. NSCC responds that the impact study cited 
in the Wilson-Davis Letter did not include any potential impacts of 
the Proposed Rule Change because that impact study was provided by 
NSCC to Wilson-Davis in connection with the separate Illiquid 
Securities Proposal. NSCC states that it conducted member outreach 
in August 2020, providing members with, among other things, an 
impact study on the Proposed Rule Change based on data from the 
first quarter of 2020. NSCC further states that the data show a 
total margin increase to NSCC members by an average of 5.3% from the 
proposed MLA Charge and by an average of 3.6% from the proposed Bid-
Ask Spread Charge. See Letter from Timothy J. Cuddihy, Managing 
Director, DTCC Financial Risk Management (October 7, 2020) (``NSCC 
Letter'') at 2. Additionally, the confidential materials filed by 
NSCC as part of the Proposed Rule Change include an analysis of the 
impacts of both charges, by member, over the year-long time period 
June 2019 through May 2020. Based on the Commission's review of the 
impact analysis, the Proposed Rule Change would not cause any NSCC 
member's volatility charge to double.
---------------------------------------------------------------------------

    In addition, the Commission acknowledges that the impact of 
increased margin requirements may present higher costs to some members 
relative to others due to a number of factors, such as access to 
liquidity resources, cost of capital, business model, and applicable 
regulatory requirements. These higher relative burdens may weaken 
certain members' competitive positions relative to other members. 
However, some members, particularly those most affected by the change, 
may respond to increased margin requirements by adjusting their 
liquidity management and business models, such as by holding less 
concentrated positions or shifting liquidity provision towards 
securities that are less likely to incur the proposed charges.\54\ Such 
effects may mitigate competitive effects on members. Moreover, the 
Commission also notes that NSCC is required to manage the risk 
presented by each member by establishing a risk-based margin 
system.\55\ NSCC's members include a large and diverse population of 
entities. By participating in NSCC, each member is subject to the same 
margin methodology which is designed to satisfy NSCC's regulatory 
obligation to manage the risk presented by its members.
---------------------------------------------------------------------------

    \54\ See Section II.A infra (discussing capital formation).
    \55\ See 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    Moreover, the Commission believes that the Proposed Rule Change 
would not impose a burden on competition that is not necessary or 
appropriate in furtherance of the Act. As discussed above, NSCC faces 
the risk of liquidation costs when a member's portfolio contains large 
positions in securities sharing similar risk profiles. Similarly, NSCC 
faces the risk of costs that would materialize in connection with the 
bid-ask spread of the securities in a member's portfolio. Such costs 
are currently unaccounted for in NSCC's current margin methodology. 
NSCC has provided impact analyses demonstrating that the Proposed Rule 
Change would result in margin levels that better reflect the risks 
associated with (1) concentrated large positions in securities sharing 
a similar risk profile, and (2) bid-ask spread transaction costs than 
NSCC's current margin methodology. Since certain securities and 
portfolio compositions present NSCC with unique liquidation risks, the 
Commission believes it is appropriate

[[Page 66652]]

for NSCC to require members holding such securities or portfolio 
compositions to provide margin amounts commensurate with the identified 
risks. Thus, the Commission believes that the MLA Charge and Bid-Ask 
Spread Charge are margin requirements that represent an appropriate 
response to the risk characteristics of members' portfolio holdings, 
and not an undue burden on competition. Accordingly, the Commission 
believes that the Proposed Rule Change would help NSCC better maintain 
sufficient financial resources to cover its credit exposures to each 
member in full with a high degree of confidence. By helping NSCC to 
better manage its credit exposure, the Proposed Rule Change would help 
NSCC better mitigate the potential losses to NSCC associated with 
liquidating a member's portfolio in the event of a member default, in 
furtherance of NSCC's obligations under Section 17A(b)(3)(F) of the 
Act.
    Additionally, the Commission notes that in order to avoid excessive 
MLA Charges, NSCC has identified circumstances that would warrant 
reducing a member's MLA Charge when NSCC could otherwise partially 
mitigate the relevant risks by extending the time period for 
liquidating a defaulted member's portfolio beyond the three day period. 
The Commission views this specific contemplation by NSCC of a targeted 
reduction in the MLA Charge as a feature of the Proposed Rule Change 
that demonstrates an approach towards managing the relevant risks 
through appropriate (i.e., not simply ``larger'') margin requirements.
    Therefore, for the reasons stated above, the Commission believes 
that the Proposed Rule Change is consistent with the requirements of 
Section 17A(b)(3)(I) of the Act \56\ because any competitive burden 
imposed by the proposal is necessary or appropriate in furtherance of 
the Act.
---------------------------------------------------------------------------

    \56\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

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

    Rule 17Ad-22(e)(4)(i) 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.\57\
---------------------------------------------------------------------------

    \57\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    As described above in Section I.A and B, NSCC's current margin 
methodology does not account for the risk of a potential increase in 
market impact costs that NSCC could incur when liquidating a defaulted 
member's portfolio where the portfolio contains a large position in 
securities sharing similar risk profiles. Additionally, as described 
above, NSCC's current margin methodology does not account for the risk 
of potential bid-ask spread transaction costs when liquidating the 
securities in a defaulted member's portfolio. NSCC proposes to address 
such risks by adding the MLA Charge and Bid-Ask Spread Charge to its 
margin methodology. Adding these margin charges to NSCC's margin 
methodology should better enable NSCC to collect margin amounts 
commensurate with the risk attributes of a broader range of its 
members' portfolios than NSCC's current margin methodology. 
Specifically, the MLA Charge should better enable NSCC to manage the 
risk of increased costs to NSCC associated with the decreased 
marketability of a defaulted member's portfolio where the portfolio 
contains a large position in securities sharing similar risk profiles. 
Additionally, since NSCC's current margin methodology does not account 
for bid-ask spread transaction costs associated with liquidating a 
defaulted member's portfolio, the Bid-Ask Spread Charge should enable 
NSCC to manage such risks and costs.
    One commenter suggests that the Proposed Rule Change is duplicative 
of a separate NSCC proposal regarding Illiquid Securities that is 
currently pending before the Commission.\58\ The commenter argues that 
since both proposals include provisions that would affect margin levels 
with respect to Illiquid Securities, both proposals appear to address 
the same concerns. Therefore, the commenter suggests that instead of 
approving the Proposed Rule Change, the Commission should consolidate 
NSCC's associated Advance Notice together with the Illiquid Securities 
Proposal and extend the public comment period before the Commission 
makes a substantive determination. The Commission disagrees with the 
commenter. The Proposed Rule Change (and NSCC's associated Advance 
Notice) and the Illiquid Securities Proposal deal with separate and 
distinguishable aspects of NSCC's margin methodology, even if there is 
a group of Illiquid Securities to which both proposals would apply. The 
Illiquid Securities Proposal is designed to amend the method by which 
NSCC determines the appropriate volatility component of margin for a 
particular security, i.e., calculate appropriate margin to cover 
potential losses on a portfolio using historical, mid-point securities 
prices. The Proposed Rule Change is designed to address two specific 
risks that are not captured directly by historical mid-point security 
price movements that may arise specifically during the liquidation of a 
member's portfolio in the event of a default: (1) The potential added 
costs of liquidating large concentrated positions in a limited period 
of time, and (2) bid-ask spread transactions costs.
---------------------------------------------------------------------------

    \58\ OTC Markets Letter at 1-2 (citing Securities Exchange Act 
Release No. 88615 (April 9, 2020), 85 FR 21037 (April 15, 2020) (SR-
NSCC-2020-802) (``Illiquid Securities Proposal'')).
---------------------------------------------------------------------------

    Specifically, the Illiquid Securities Proposal seeks to, among 
other things, more accurately identify securities that exhibit illiquid 
characteristics for margin purposes and to establish a separate 
haircut-based method for determining the margin for Illiquid 
Securities. NSCC's methodology for calculating the volatility component 
of a member's margin depends on the type of securities in the member's 
portfolio. As stated above, for most securities (e.g., equity 
securities), NSCC calculates the volatility component using, among 
other things, a parametric VaR model, and the volatility component 
typically constitutes the largest portion of a member's required 
margin. However, securities with illiquid characteristics generally 
incur a wider degree of price variability and are less amenable to 
statistical analysis, and, as such, may merit a more conservative 
margining approach through a haircut-based method. The proposed 
haircut-based method is more conservative because it does not allow for 
inter-asset risk offsetting in the way that the VaR model does.
    Accordingly, for certain securities that are less amenable to the 
statistical analysis provided in the VaR model, including Illiquid 
Securities, NSCC currently calculates a haircut-based volatility 
component by multiplying the absolute value of a member's positions in 
such securities by a certain percentage. NSCC's pending Illiquid 
Securities Proposal would, among other things, establish a separate 
haircut-based method for determining the volatility component of the 
margin for Illiquid Securities. Thus, the Illiquid Securities Proposal 
would alter the way in which NSCC determines the appropriate margin for 
Illiquid Securities.
    In contrast, the Proposed Rule Change is not designed to define 
what

[[Page 66653]]

constitutes an Illiquid Security under NSCC's Rules, and it would not 
alter the methodology by which NSCC determines the volatility component 
of the margin for any particular securities, including Illiquid 
Securities. Instead, with respect to the MLA Charge, the Proposed Rule 
Change relates to a new margin charge add-on that, if triggered, 
applies to all securities cleared at NSCC (i.e., not solely to Illiquid 
Securities), and the proposed add-on is distinct from the underlying 
margin otherwise collected for all securities (including Illiquid 
Securities). Rather than addressing the volatility component of margin 
and the potential losses on a portfolio, as does the Illiquid 
Securities Proposal, the Proposed Rule Change is designed to address 
the discrete risks of a default liquidation scenario associated with 
(1) concentrated large positions in any type of security or group of 
securities sharing a similar risk profile, and (2) bid-ask spread 
transaction costs that are currently unaccounted for in NSCC's margin 
methodology. Moreover, the MLA Charge would not automatically be 
applied based on the security or type of security that is held; 
instead, it would only apply to concentrated positions that could be 
difficult to liquidate in a limited time in the event of a default. 
Because the Proposed Rule Change and the Illiquid Securities Proposal 
address wholly separate and distinct aspects of NSCC's margin 
methodology, the Commission disagrees with the commenter that the two 
proposals should be consolidated or otherwise disposed of together.
    The Commission believes that adding the MLA Charge and Bid-Ask 
Spread Charge to NSCC's margin methodology should enable NSCC to more 
effectively identify, measure, monitor, and manage its credit exposures 
in connection with liquidating a defaulted member's portfolio that may 
give rise to (1) decreased marketability due to large positions of 
securities sharing similar risk profiles, and (2) bid-ask spread 
transaction costs. Accordingly, the Commission believes that adding the 
MLA Charge and Bid-Ask Spread Charge to NSCC's margin methodology would 
be consistent with Rule 17Ad-22(e)(4)(i) because these new margin 
charges should better enable NSCC to maintain sufficient financial 
resources to cover NSCC's credit exposure to its members fully with a 
high degree of confidence.\59\
---------------------------------------------------------------------------

    \59\ Id.
---------------------------------------------------------------------------

D. Consistency With Rules 17Ad-22(e)(6)

    Rule 17Ad-22(e)(6)(i) 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.\60\ Rule 
17Ad-22(e)(6)(v) 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, uses an appropriate method for 
measuring credit exposure that accounts for relevant product risk 
factors and portfolio effects across products.\61\
---------------------------------------------------------------------------

    \60\ 17 CFR 240.17Ad-22(e)(6)(i).
    \61\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

    As described above in Section I.A and B, NSCC's current margin 
methodology does not account for the potential increase in market 
impact costs when liquidating a defaulted member's portfolio where the 
portfolio contains a large position in securities sharing similar risk 
profiles. NSCC proposes to address this risk by adding the MLA Charge 
to its margin methodologies. To avoid excessive MLA Charges and ensure 
margin requirements are commensurate with the relevant risks, NSCC also 
contemplates reducing a member's MLA Charge when NSCC could otherwise 
partially mitigate the relevant risks by extending the time period for 
liquidating a defaulted member's portfolio beyond the three day period.
    Additionally, as described above in Section I.C, NSCC's current 
margin methodology does not account for the risk of incurring bid-ask 
spread transaction costs when liquidating the securities in a defaulted 
member's portfolio. NSCC proposes to address this risk by adding the 
Bid-Ask Spread Charge to its margin methodology. Adding the MLA Charge 
and Bid-Ask Spread Charge to NSCC's margin methodology should better 
enable NSCC to collect margin amounts commensurate with the risk 
attributes of its members' portfolios than NSCC's current margin 
methodology. Specifically, the MLA Charge should better enable NSCC to 
manage the risk of increased costs to NSCC associated with the 
decreased marketability of a defaulted member's portfolio where the 
portfolio contains a large position in securities sharing similar risk 
profiles. Moreover, the proposal to reduce the MLA Charge when NSCC 
could otherwise partially mitigate the relevant risks demonstrates how 
the proposal provides an appropriate method for measuring credit 
exposure, in that it seeks to take into account the particular 
circumstances related to a particular portfolio when determining the 
MLA Charge. Additionally, since NSCC's current margin methodology does 
not account for bid-ask spread transaction costs associated with 
liquidating a defaulted member's portfolio, the Bid-Ask Spread Charge 
should enable NSCC to manage such risks.
    Accordingly, the Commission believes that adding the MLA Charge and 
Bid-Ask Spread Charge to NSCC's margin methodology would be consistent 
with Rules 17Ad-22(e)(6)(i) and (v) because these new margin charges 
should better enable NSCC to establish a risk-based margin system that 
(1) considers and produces relevant margin levels commensurate with the 
risks associated with liquidating member portfolios in a default 
scenario, including decreased marketability of a portfolio's securities 
due to large positions in securities sharing similar risk profiles and 
bid-ask transaction costs, and (2) uses an appropriate method for 
measuring credit exposure that accounts for such risk factors and 
portfolio effects.\62\
---------------------------------------------------------------------------

    \62\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
---------------------------------------------------------------------------

    One commenter argues that the Proposed Rule Change would burden 
members with margin requirements that are not commensurate with NSCC's 
actual risks, as evidenced by the lack of recent settlement losses, and 
instead are designed to mitigate imaginary risks.\63\ In addition, the 
commenter argues that NSCC has not provided evidence of the need for 
the Proposed Rule Change, again citing the lack of recent settlement 
losses. However, as discussed above, the Commission believes that the 
proposed changes to NSCC's margin methodology would enable it to 
collect margin appropriately tailored to two particular risks that are 
not currently addressed in the existing margin methodology. The 
Commission does not agree that the fact that NSCC has not suffered 
recent settlement losses obviates the need for the Proposed Rule 
Change. Rule 17Ad-22(e)(6)(iii) 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, 
calculates margin

[[Page 66654]]

sufficient to cover its potential future exposure to participants in 
the interval between the last margin collection and the close out of 
positions following a participant default.\64\ Potential future 
exposure is, in turn, defined as the maximum exposure estimated to 
occur at a future point in time with an established single-tailed 
confidence level of at least 99 percent with respect to the estimated 
distribution of future exposure.\65\ Thus, to be consistent with its 
regulatory requirements, NSCC must consider potential future exposure, 
which includes, among other things, losses associated with the 
liquidation of a defaulted member's portfolio. Based on its review and 
analysis of the Proposed Rule Change, including the confidential impact 
analyses demonstrating the overall effects that the proposed changes 
would have on the overall margin collected by NSCC and the confidential 
margin methodology (i.e., the specific details of how NSCC would 
calculate its margin requirements under the proposed changes), in 
conjunction with the Commission's supervisory observations, the 
Commission believes that the proposed changes would better enable NSCC 
to collect margin commensurate with the different levels of risk that 
members pose to NSCC as a result of their particular portfolio, which 
is consistent with Rule 17Ad-22(e)(6)(i), and to calculate margin 
sufficient to cover its potential future exposure to its participants, 
which is consistent with Rule 17Ad-22(e)(6)(iii).
---------------------------------------------------------------------------

    \63\ Wilson-Davis Letter at 3, 5.
    \64\ 17 CFR 240.17Ad-22(e)(6)(iii).
    \65\ 17 CFR 240.17Ad-22(a)(13).
---------------------------------------------------------------------------

E. Consistency With Rules 17Ad-22(e)(23)(ii)

    Rule 17Ad-22(e)(23)(ii) \66\ requires each covered clearing agency 
to establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to provide sufficient information to 
enable participants to identify and evaluate the risks, fees, and other 
material costs they incur by participating in the covered clearing 
agency.
---------------------------------------------------------------------------

    \66\ 17 CFR 240.17Ad-22(e)(23)(ii).
---------------------------------------------------------------------------

    Both commenters argue that the Proposed Rule Change fails to 
provide sufficient information to evaluate the necessity and impact of 
the proposal.\67\ Specifically, one commenter argues that the proposal 
provides no explanation as to why NSCC's current margin formula is 
inadequate or how the proposed methodology would limit NSCC's exposure 
in the event of a member default.\68\ Another commenter stated that the 
Proposed Rule Change does not comply with Rule 17Ad-22(e)(23)(ii), 
asserting that NSCC has not performed the ``requisite analysis'' or 
gathered sufficient data to fully understand the impact of the 
proposal.\69\
---------------------------------------------------------------------------

    \67\ See OTC Letter at 2; Wilson-Davis Letter at 1, 4-5.
    \68\ See OTC Letter at 2.
    \69\ See Wilson-Davis Letter at 2-3. Contrary to the commenter's 
implication, Rule 17Ad-22(e)(23) does not prescribe any specific 
data or analysis that a covered clearing agency, like NSCC, must 
perform when making changes to its margin methodology. Moreover, as 
discussed above in note 41, NSCC has provided confidential impact 
analyses covering a one-year time period to demonstrate the 
potential impact of the Proposed Rule Change on its members.
     In addition, the commenter references Rule 17Ad-22(e)(23)(iii), 
which requires a covered clearing agency, like NSCC, to establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to provide basic transaction volume and values. 
See Wilson-Davis Letter at 2. However, the information described by 
the commenter would not constitute basic data on transaction volumes 
and values, as required by the rule, and instead would appear to 
refer to more detailed analysis of the impacts of particular margin 
methodologies. Moreover, NSCC publicly provides data on transaction 
volumes and values in its quantitative disclosures, which are 
available at https://www.dtcc.com/legal/policy-and-compliance.
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    The Commission disagrees with the commenters that the Proposed Rule 
Change does not provide sufficient information to understand the 
potential costs associated with participating in NSCC, based on the 
materials reflected in the Proposed Rule Change.\70\ When considering 
the issues raised in the Proposed Rule Change, the Commission 
thoroughly reviewed (1) the Proposed Rule Change, including the 
supporting exhibits that provided, among other things, confidential 
impact analyses regarding the proposals in the Proposed Rule Change; 
(2) the comment letters; and (3) the Commission's own understanding of 
NSCC's margin methodology, with which the Commission has experience 
from its general supervision of NSCC. Based on its review of these 
materials, the Commission believes that, as described in the Notice, 
NSCC has done exactly what the commenters seek, in that the proposal 
explains why the current methodology is inadequate (i.e., it does not 
address these particular risks), and how the proposed methodology would 
address this issue (i.e., by including add-on charges designed to 
address these particular risks). As described in the Notice and noted 
above, NSCC's current margin methodology neither accounts for the risk 
of a potential increase in market impact costs that NSCC could incur 
when liquidating a defaulted member's portfolio that contains a 
concentration of large positions, as compared to the overall market, 
nor does NSCC's current margin methodology account for this risk of 
potential bid-ask spread transaction costs in connection with 
liquidating a defaulted member's portfolio. The Proposed Rule Change is 
designed to address these specific risks and limit NSCC's exposure in 
the event of a member default.
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    \70\ One commenter argues that the proposal is generally 
unclear, overly technical and complicated, inappropriately relies on 
information provided by NSCC to the Commission confidentially, and 
thus prevents the public from fully evaluating and providing 
meaningful comment on the proposal. As stated above, the Commission 
believes that the proposal adequately explains why the current 
methodology is inadequate (i.e., it does not address certain 
specific risks), and how the proposed methodology would address this 
issue (i.e., via the MLA Charge and Bid-Ask Spread Charge). 
Additionally, the Commission does not believe that the Proposed Rule 
Change is overly technical and complicated. The process of measuring 
the risks involved with various member portfolio compositions to 
determine appropriate margin levels is technical, complex, and does 
not distill into a simple formula. Instead, the process often must 
utilize sophisticated risk models and calculations. NSCC has 
described the methodology that it would use to determine the margin 
to address these specific risks with sufficient specificity to allow 
a member to understand the types of portfolios that would be subject 
to an additional MLA Charge and to understand the haircuts that 
would apply to determine the Bid-Ask Spread Charge.
     Moreover, the Commission believes that NSCC appropriately 
submitted Exhibit 3 to the filing confidentially because it includes 
detailed member-level margin data and other proprietary information. 
Under its Rules, NSCC is not permitted to disclose member-level 
information. See Rule 49 of the Rules, supra note 10. NSCC requested 
confidential treatment of such materials and its underlying detailed 
methodology documentation, consistent with the applicable regulatory 
requirements. See 17 CFR 240.24b-2.
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    The Proposed Rule Change describes how NSCC would determine the MLA 
and Bid-Ask Spread Charges. For both charges, the Proposed Rule Change 
identifies the relevant asset groupings that NSCC would utilize. For 
the MLA Charge, NSCC has described how the charge would depend on 
whether a member holds large aggregate positions in an asset group. 
Thus, a member should be able to consider whether its positions would 
likely trigger the MLA Charge in light of the relevant holdings in its 
portfolio. For the Bid-Ask Spread Charge, NSCC has identified that the 
charge would be determined by application of a haircut and provided a 
schedule of the applicable haircuts. Thus, a member should be able to 
understand what the charge would be for a particular security. In 
addition, NSCC represented that in August 2020, NSCC provided all its 
Members with the results of an impact study regarding the potential 
impacts of both the Illiquid Securities Proposal and the MLA Proposal 
and clearly delineated between the impacts of these separate

[[Page 66655]]

proposals.\71\ NSCC also included a written summary of the MLA Proposal 
and offered to schedule a call to discuss these proposals and their 
potential impacts.\72\ Moreover, NSCC has provided impact analyses 
demonstrating that the Proposed Rule Change would result in margin 
levels that better reflect the risks associated with (1) concentrated 
large positions in securities sharing a similar risk profile, and (2) 
bid-ask spread transaction costs than NSCC's current margin 
methodology. Accordingly, the Commission believes that NSCC has 
demonstrated the operation and impact of the Proposed Rule Change, 
i.e., that it would help NSCC better maintain sufficient financial 
resources to cover its credit exposures to each member in full with a 
high degree of confidence.
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    \71\ NSCC Letter at 2.
    \72\ Id. More generally, NSCC stated that it routinely reaches 
out to members that may be impacted by its proposals. This outreach 
includes impact study results and an offer to discuss those results 
and the underlying proposal. Id.
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    Moreover, to provide transparency and assist members in 
understanding their margin requirements, NSCC maintains the NSCC Risk 
Management Reporting application on the Participant Browser Service 
(``PBS'') and the NSCC Risk Client Portal (``Portal''), which will 
include this Proposed Rule Change once it is implemented.\73\ The PBS 
is a member-accessible website portal for accessing reports and other 
disclosures. The Risk Management Reporting application enables a member 
to view and download margin requirement information and component 
details, including issue-level margin information related to start of 
day volatility charges and mark-to-market, intraday exposure, and other 
components. Members are able to view and download spreadsheets that 
contain market amounts for current clearing positions and the 
associated volatility charges. In addition, NSCC represents that the 
Portal provides members the ability, for information purposes, to view 
and analyze certain risks relating to their portfolios, including 
calculators to assess the risks and margin impacts of certain 
activities and to compare their portfolios to historical and average 
values.
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    \73\ See Letter from Timothy J. Cuddihy, Managing Director DTCC 
Financial Risk Management, submitted in response to comments on the 
Illiquid Securities Proposal, available at, https://www.sec.gov/comments/sr-nscc-2020-802/srnscc2020802.htm.
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    NSCC further maintains the NSCC Client Calculator on the Portal 
that provides functionality for members to enter ``what-if'' position 
data and to recalculate their volatility charges to determine margin 
impact pre-trade. In other words, this calculator allows members to see 
the impact to the volatility charge if specific transactions are 
executed, or to anticipate the impact of an increase or decrease to a 
current clearing position. Using this calculator, members have the 
ability to download the Client Calculator portfolio detail to modify a 
current margin portfolio, upload the portfolio to run a margin 
calculation, and view position level outputs in order to make informed 
risk management and execution decisions.
    Taken together, these tools should allow members to understand how 
these charges would affect their portfolios. Accordingly, 
notwithstanding the comments, the Commission believes that the Proposed 
Rule Change is not inconsistent with Rule 17Ad-22(e)(23)(ii).\74\
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    \74\ 17 CFR 240.17Ad-22(e)(23)(ii).
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning whether Amendment No. 2 is consistent with the 
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-2020-016 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-2020-016. 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 Proposed Rule Change that are filed with 
the Commission, and all written communications relating to the Proposed 
Rule Change 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 such filings will also be available for inspection 
and copying at the principal office of NSCC and NSCC's website at 
https://www.dtcc.com/legal.
    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-2020-016 and should be 
submitted on or before November 10, 2020.

IV. Accelerated Approval of the Proposed Rule Change, as Modified by 
Amendment No. 2

    The Commission finds good cause, pursuant to Section 
19(b)(2)(C)(iii) of the Act,\75\ to approve the Proposed Rule Change, 
as modified by Amendment Nos. 1 and 2, prior to the thirtieth day after 
the date of publication of Amendment No. 2 in the Federal Register. As 
noted above, in Amendment No. 2, NSCC updated the confidential Exhibit 
3 to the Proposed Rule Change to include impact analysis data with 
respect to the Proposed Rule Change. Specifically, Amendment No. 2 
includes impact studies for various time periods detailing the average 
and maximum MLA and Bid-Ask Charges for each member, by both percentage 
and amount. The Commission believes that the member-level data in 
Amendment No. 2 warrants confidential treatment. Amendment No. 2 
neither modifies the Proposed Rule Change as originally published in 
any substantive manner, nor does Amendment No. 2 affect any rights or 
obligations of NSCC or its members. Instead, Amendment No. 2 provides 
the Commission with information necessary to evaluate whether the 
Proposed Rule Change is consistent with the Act. Accordingly, the 
Commission finds good cause, pursuant to Section 19(b)(2)(C)(iii) of 
the Act,\76\ to approve the Proposed Rule Change, as modified by 
Amendment Nos. 1 and 2, prior to the thirtieth day after the date of 
publication of notice of Amendment No. 2 in the Federal Register.
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    \75\ 15 U.S.C. 78s(b)(2)(C)(iii).
    \76\ Id.
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V. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change, as modified by

[[Page 66656]]

Amendment Nos. 1 and 2, is consistent with the requirements of the Act 
and in particular with the requirements of Section 17A of the Act \77\ 
and the rules and regulations promulgated thereunder.
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    \77\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\78\ that Proposed Rule Change SR-NSCC-2020-016, as modified by 
Amendment Nos. 1 and 2, be, and hereby is, approved on an accelerated 
basis.\79\
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    \78\ 15 U.S.C. 78s(b)(2).
    \79\ In approving the proposed rule change, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f). See also supra note 43 and 
accompanying text.
    \80\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\80\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-23138 Filed 10-19-20; 8:45 am]
BILLING CODE 8011-01-P


