
[Federal Register Volume 88, Number 155 (Monday, August 14, 2023)]
[Notices]
[Pages 55100-55104]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-17302]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98086; File No. SR-NSCC-2022-015]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Order Approving a Proposed Rule Change To Make Certain 
Enhancements to the Gap Risk Measure and the VaR Charge

August 8, 2023.

I. Introduction

    On December 2, 2022, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-NSCC-2022-015 (the ``Proposed 
Rule Change'') 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 
December 21, 2022,\3\ and the Commission has received one comment 
regarding the changes proposed in the Proposed Rule Change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 96511 (Dec. 15, 
2022), 87 FR 78157 (Dec. 21, 2022) (File No. SR-NSCC-2022-015) 
(``Notice of Filing'').
    \4\ Comments are available at https://www.sec.gov/comments/sr-nscc-2022-015/srnscc2022015.htm.
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    On January 24, 2023, pursuant to section 19(b)(2) of the Act,\5\ 
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.\6\ On March 20, 2023, the 
Commission instituted proceedings, pursuant to section 19(b)(2)(B) of 
the Act,\7\ to determine whether to approve or disapprove the Proposed 
Rule Change.\8\ On June 8, 2023, the Commission designated a longer 
time period, pursuant to section 19(b)(2)(B)(ii)(II) of the Act,\9\ to 
determine whether to approve or disapprove the Proposed Rule 
Change.\10\
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    \5\ 15 U.S.C. 78s(b)(2).
    \6\ Securities Exchange Act Release No. 96740 (Jan. 24, 2023), 
88 FR 5953 (Jan. 30, 2023) (File No. SR-NSCC-2022-015).
    \7\ 15 U.S.C. 78s(b)(2)(B).
    \8\ Securities Exchange Act Release No. 97171 (Mar. 20, 2023), 
88 FR 17898 (Mar. 24, 2023) (File No. SR-NSCC-2022-015).
    \9\ 15 U.S.C 78s(b)(2)(B)(ii)(II).
    \10\ Securities Exchange Act Release No. 97671 (June 8, 2023), 
88 FR 38926 (June 14, 2023 (File No. SR-NSCC-2022-015).
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    For the reasons discussed below, the Commission is approving the 
Proposed Rule Change.

II. Description of the Proposed Rule Change \11\
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    \11\ Capitalized terms not defined herein are defined in NSCC's 
Rules & Procedures (``Rules''), available at https://www.dtcc.com/~/
media/Files/Downloads/legal/rules/nscc_rules.pdf.
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    NSCC provides clearing, settlement, risk management, central 
counterparty services, and a guarantee of completion for virtually all 
broker-to-broker trades involving equity securities, corporate and 
municipal debt securities, and unit investment trust transactions in 
the U.S. markets. A key tool that NSCC uses to manage its credit 
exposure to its members is collecting an appropriate amount of margin 
(i.e., collateral) from each member.\12\
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    \12\ Pursuant to its Rules, NSCC uses the term ``Required Fund 
Deposit'' to denote margin or collateral collected from its members. 
See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund Formula 
and Other Matters) of the Rules, supra note 11.
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A. Overview of NSCC's Margin Methodology

    A member's margin is designed to mitigate potential losses to NSCC 
associated with the liquidation of the member's portfolio in the event 
that member defaults.\13\ The aggregate of all members' margin deposits 
(together with certain other deposits required under the Rules) 
constitutes NSCC's clearing fund. NSCC would access its clearing fund 
should a defaulting member's own margin and resources at NSCC be 
insufficient to satisfy losses to NSCC caused by the liquidation of 
that member's portfolio.\14\
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    \13\ Under NSCC's Rules, a default would generally be referred 
to as a ``cease to act'' and could encompass a number of 
circumstances, such as a member's failure to make a margin payment 
on time. See Rule 46 (Restrictions on Access to Services) of the 
Rules, supra note 11.
    \14\ See Rule 4, supra note 11.
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    NSCC employs daily backtesting to determine the sufficiency of each 
member's margin, by simulating the liquidation gains or losses using 
the actual unsettled positions in the member's portfolio, and the 
actual historical returns for each security held in the portfolio. A 
backtesting deficiency would result if the liquidation losses were 
greater than the member's margin. NSCC investigates the causes of any 
backtesting deficiencies, paying particular attention to members with 
backtesting deficiencies that bring the results for that member below 
the 99 percent confidence target (i.e., greater than two backtesting 
deficiency days in a rolling twelve-month period) to determine if there 
is an identifiable cause of repeat backtesting deficiencies.\15\ NSCC 
also evaluates whether multiple members may experience backtesting 
deficiencies for the same underlying reason.\16\
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    \15\ See National Securities Clearing Corporation, Disclosure 
Framework for Covered Clearing Agencies and Financial Market 
Infrastructures, at 61 (Dec. 2022), available at https://www.dtcc.com/legal/policy-and-compliance.
    \16\ See id.
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    Each member's margin consists of a number of applicable components, 
each of which is calculated to address specific risks faced by 
NSCC.\17\ Each member's start of day required fund deposit is 
calculated overnight, based on the member's prior end-of-day net 
unsettled positions.\18\ NSCC notifies members early the following 
morning, and members are required to make deposits by approximately 
10:00 a.m. EST.\19\
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    \17\ See Procedure XV of the Rules, supra note 11.
    \18\ See Procedure XV, Sections II(B) of the Rules, supra note 
11.
    \19\ See id. The Rules provide that required deposits to the 
clearing fund are due within one hour of demand, unless otherwise 
determined by NSCC. Id.
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    Generally, the largest portion of a member's margin is the 
volatility component. The volatility component is designed to reflect 
the amount of money that could be lost on a portfolio over a given 
period within a 99th percentile level of confidence. This component 
represents the amount assumed necessary to absorb losses while 
liquidating the member's portfolio.
    NSCC's methodology for calculating the volatility component of a 
member's required fund deposit depends on the type of security and 
whether the security has sufficient pricing or trading history for NSCC 
to robustly estimate the volatility component using statistical 
techniques. Generally, for most securities (e.g., equity securities), 
NSCC calculates the volatility component using, among other things, a 
parametric Value at Risk (``VaR'') model, which results in a ``VaR 
Charge.'' \20\ The VaR Charge usually comprises the largest portion of 
a member's required fund deposit.
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    \20\ See Sections I(A)(1)(a)(i) and I(A)(2)(a)(i) of Procedure 
XV of the Rules, supra note 11.
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B. Current Treatment of Gap Risk in NSCC's Margin Methodology

    Under NSCC's current Rules, one of the potential methods of 
calculating the

[[Page 55101]]

VaR Charge relies on a measure of gap risk. It does not accrue for all 
portfolios, but instead only serves as the VaR Charge if it is the 
largest of three potential calculations.\21\
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    \21\ Specifically, the VaR Charge is the greatest of (1) the 
larger of two separate calculations based on different underlying 
estimates that utilize a parametric VaR model, which addresses the 
market risk of a member's portfolio (referred to as the core 
parametric estimation), (2) the gap risk calculation, 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 
component calculations.
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    Gap risk events have been generally understood as idiosyncratic 
issuer events (for example, earning reports, management changes, merger 
announcements, insolvency, or other unexpected, issuer-specific events) 
that cause a rapid shift in price volatility levels. The gap risk 
charge was designed to address the risk presented by a portfolio that 
is more susceptible to the effects of gap risk events, i.e., those 
portfolios holding positions that represent more than a certain percent 
of the entire portfolio's value, such that the event could impact the 
entire portfolio's value.\22\
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    \22\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of 
Procedure XV of the Rules, supra note 11. See also Exchange Act 
Release Nos. 82780 (Feb. 26, 2018), 83 FR 9035 (Mar. 2, 2018) (SR-
NSCC-2017-808); 82781 (Feb. 26, 2018), 83 FR 9042 (Mar. 2, 2018) 
(SR-NSCC-2017-020) (``Initial Filing'').
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    The current gap risk charge applies only if a member's overall net 
unsettled non-index position with the largest absolute market value in 
the portfolio represents more than a certain percent of the entire 
portfolio's value, that is, if the net unsettled position exceeds a 
specified ``concentration threshold.'' The concentration threshold can 
be set no higher than 30 percent and is evaluated periodically based on 
members' backtesting results over a twelve month look-back period, and 
it is currently set at 5%.\23\ NSCC's Rules currently calculate a gap 
risk charge only for ``non-index'' positions, meaning positions in the 
portfolio other than positions in ETFs that track diversified indices. 
This is because index-based ETFs that track closely to diversified 
indices are generally considered less prone to the effects of gap risk 
events.
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    \23\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of 
Procedure XV of the Rules, supra note 11; see Important Notice a9055 
(Sept. 27, 2021), at https://www.dtcc.com/-/media/Files/pdf/2021/9/27/a9055.pdf (notifying members that the concentration threshold had 
been changed from 10% to 5%).
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    The risk of large, unexpected price movements, particularly those 
caused by a gap risk event, are more likely to have a greater impact on 
portfolios with large net unsettled positions in securities that are 
susceptible to those events. Generally, index-based ETFs that track 
closely to diversified indices are less prone to the effects of gap 
risk events. Therefore, if the concentration threshold is met, NSCC 
currently calculates the gap risk charge for positions in the portfolio 
other than positions in ETFs that track diversified indices, referred 
to as ``non-index positions.''
    To calculate the gap risk charge, NSCC multiplies the gross market 
value of the largest non-index net unsettled position in the portfolio 
by a gap risk haircut, which can be no less than 10 percent (``gap risk 
haircut'').\24\ Currently, NSCC determines the gap risk haircut 
empirically as no less than the larger of the 1st and 99th percentiles 
of three-day returns of a set of CUSIPs that are subject to the VaR 
Charge pursuant to the Rules, giving equal rank to each to determine 
which has the highest movement over that three-day period. NSCC uses a 
look-back period of not less than ten years plus a one-year stress 
period, and if the one-year stress period overlaps with the look-back 
period, only the non-overlapping period would be combined with the 
look-back period. The resulting haircut is then rounded up to the 
nearest whole percentage and applied to the largest non-index net 
unsettled position to determine the gap risk charge.
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    \24\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of 
Procedure XV of the Rules, supra note 11.
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C. Proposed Changes to NSCC's Gap Risk Charge

    NSCC is proposing to make the following changes to the gap risk 
charge: (1) make the gap risk charge an additive component of the 
member's total VaR Charge when it is applicable, rather than being 
applied as the applicable VaR Charge only when it is the largest of 
three separate calculations, (2) adjusting the gap risk charge to be 
based on the two largest positions in a portfolio, rather than based on 
the single largest position, (3) changing the floor of the gap risk 
haircut from 10 percent to 5 percent for the largest position, adding a 
floor of the gap risk haircut of 2.5 percent for the second largest 
position, and providing that gap risk haircuts would be determined 
based on backtesting and impact analysis, (4) amending which ETF 
positions are excluded from the gap risk charge to more precisely 
include ETFs that are more prone to gap risk, i.e., are non-
diversified, and (5) making certain technical and clarifying changes 
regarding the gap risk charge.
    First, NSCC is proposing to make the result of the gap risk charge 
calculation an additive component of a member's total VaR Charge, 
rather than applicable as the VaR Charge only when it is the highest 
result of three calculations. Under the proposal, the VaR Charge would 
be equal to the sum of (1) the greater of either the core parametric 
estimation or the portfolio margin floor calculation, neither of which 
is changing in this proposal,\25\ and (2) the gap risk charge 
calculation. Rather than being applied only when the gap risk charge 
exceeds the other two calculations, the gap risk charge calculation 
would apply every time the top two positions exceed the concentration 
threshold and would always be a portion of the overall VaR Charge in 
such circumstances. NSCC states that making this charge additive could 
improve its ability to mitigate idiosyncratic risks that it could face 
through the collection of the VaR Charge.\26\ Based on impact studies, 
NSCC believes this broader application together with the other proposed 
changes outlined below would better protect against more idiosyncratic 
risk scenarios than the current methodology.\27\
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    \25\ See note 23 supra.
    \26\ See Notice of Filing, supra note 3, 87 FR at 78159.
    \27\ Id.
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    Second, NSCC is proposing to make the gap risk charge rely upon the 
absolute values of the two largest non-diversified net unsettled 
positions, as opposed to using the absolute value of only the single 
largest non-diversified net unsettled position. Therefore, the gap risk 
charge would be calculated by first multiplying each of the two largest 
non-diversified net unsettled positions with a gap risk haircut, and 
then adding the sum of the resulting products. The gap risk charge 
would be applicable if that sum of the resulting products exceeded the 
concentration threshold.\28\ NSCC states that applying the gap risk 
charge to the two largest non-diversified positions in the portfolio 
would cover

[[Page 55102]]

concurrent gap moves involving more than one concentrated position, 
adding more flexibility and coverage.\29\
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    \28\ As noted in Section II.B above, the concentration threshold 
is currently set at 5%, and the Rules define the concentration 
threshold as no more than 30 percent of the value of the entire 
portfolio. See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of 
Procedure XV of the Rules, supra note 11. The proposed changes would 
clarify that the concentration threshold is not fixed at 30 percent 
by defining concentration threshold as a percentage designated by 
NSCC of the value of the entire portfolio and determined by NSCC 
from time to time, and that shall be no more than 30 percent. NSCC 
believes this proposed change will help clarify that the 
concentration threshold could change from time to time but could not 
be set to be more than 30 percent. See Notice of Filing, supra note 
3, 87 FR at 78161.
    \29\ See Notice of Filing, supra note 3, 87 FR at 78160.
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    Third, NSCC proposes to revise the calculation of the gap risk 
haircut in response to making the proposal an additive component of a 
member's VaR Charge. Currently, the gap risk haircut is determined by 
selecting the largest of the 1st and 99th percentiles of three-day 
returns of a composite set of equities, using a look-back period of not 
less than 10 years plus a one year stress period.\30\ NSCC believes 
that this methodology results in implicit overlapping of the risk 
covered by the core parametric VaR and the gap risk charge.\31\ Because 
the proposal would make the gap risk charge an additive component to 
the VaR Charge rather than a substitutive component, NSCC does not 
believe that the current methodology for the gap risk haircut would 
result in an appropriate level of margin.\32\ Under the proposal, NSCC 
would determine and calibrate the concentration threshold and the gap 
risk haircut periodically based on backtesting and impact analysis. 
NSCC states that the concentration threshold and the gap risk haircuts 
would be selected from various combinations of concentration thresholds 
and gap risk haircuts based on backtesting and impact analysis across 
all member portfolios, initially using a five year look-back 
period.\33\ NSCC believes that this would provide more flexibility to 
set the parameters from time to time to provide improved backtesting 
performance, broader coverage for idiosyncratic risk scenarios and 
flexibility for model tuning to balance performance and cost 
considerations.\34\
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    \30\ Id. at 78161.
    \31\ See id.
    \32\ Id.
    \33\ Id.
    \34\ Id.
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    In addition, NSCC proposes to revise the determination of the gap 
risk haircut in response to the proposal's inclusion of the two largest 
non-diversified net unsettled positions, as opposed to only the one, 
and to its additive nature. Currently, the percent that is applied to 
the largest non-index net unsettled position in the portfolio is no 
less than 10 percent.\35\ Because of the proposal's shift to including 
the two largest positions, NSCC believes it is appropriate to set a 
lower floor for the gap risk haircut that applies to the largest of 
those two positions.\36\ Moreover, because the gap risk charge would 
now be additive and would apply more frequently, NSCC believes that the 
flexibility to set a lower floor for the largest position would be 
appropriate.\37\
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    \35\ Id.
    \36\ Id.
    \37\ Id.
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    Specifically, NSCC is proposing to lower the gap risk haircut that 
would be applied to the largest non-diversified net unsettled position 
to be a percent that is no less than 5 percent. The gap risk haircut 
that would be applied to the second largest non-diversified net 
unsettled position in the portfolio would be no larger than the gap 
risk haircut that would be applied to the largest non-diversified net 
unsettled position and would be subject to a floor of 2.5 percent. NSCC 
states that, upon implementation of the proposed rule change, NSCC 
would set the concentration threshold at 10%, apply a gap risk haircut 
on the largest non-diversified net unsettled position of 10% and a gap 
risk haircut on the second largest non-diversified net unsettled 
position of 5%.\38\ NSCC would set the concentration threshold and the 
gap risk haircuts based on backtesting and impact analysis in 
accordance with NSCC's model risk management practices and governance 
set forth in the Model Risk Management Framework.\39\ NSCC would 
provide notice to members by important notice of the concentration 
threshold and gap risk haircuts that it would be applying.
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    \38\ Id.
    \39\ See Exchange Act Release Nos. 81485 (Aug. 25, 2017), 82 FR 
41433 (Aug. 31, 2017) (File No. SR-NSCC-2017-008); 84458 (Oct. 19, 
2018), 83 FR 53925 (Oct. 25, 2018) (File No. SR-NSCC-2018-009); 
88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-NSCC-
2020-008); 92381 (July 13, 2021), 86 FR 38163 (July 19, 2021) (File 
No. SR-NSCC-2021-008); and 94272 (Feb. 17, 2022), 87 FR 10419 (Feb. 
24, 2022) (File No. SR-NSCC-2022-001). NSCC's model risk management 
governance procedures include daily backtesting of model 
performance, periodic sensitivity analyses of models and annual 
validation of models. They would also provide for review of the 
concentration threshold and the gap risk haircuts at least annually.
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    Fourth, NSCC is proposing to amend what positions are excluded from 
the gap risk charge calculation. Currently, only ``non-index'' 
positions and index-based exchange-traded products that track a narrow 
market index are included in the gap risk charge.\40\ Under the 
proposal, this would be revised to refer to ``non-diversified'' 
positions instead of non-index positions. The rule text would specify 
that NSCC would exclude ETF positions from the calculation (that is, it 
would consider them diversified) if the positions have characteristics 
that indicate that they are less prone to the effects of gap risk 
events, including whether the ETF positions track to an index that is 
linked to a broad based market index, contain a diversified underlying 
basket, are unleveraged or track to an asset class that is less prone 
to gap risk. NSCC states that the proposed change would result in 
certain non-index based ETFs being excluded from the gap risk charge 
whereas they are currently included, such as unleveraged U.S. dollar 
based ETFs.\41\ NSCC also states that this proposed change would 
provide greater transparency to members regarding which positions are 
excluded from this calculation.\42\
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    \40\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of 
Procedure XV of the Rules, supra note 11. See also Initial Filing, 
supra note 22.
    \41\ See Notice of Filing, supra note 3, 87 FR at 78160.
    \42\ Id. NSCC states that it uses a third-party provider to 
identify ETFs that meet its criteria of being diversified. See id.
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    NSCC states that certain ETFs, both index based and non-index 
based, are less prone to the effects of gap risk events as a result of 
having certain characteristics and, therefore, are less likely to pose 
idiosyncratic risks that the gap risk charge is designed to 
mitigate.\43\ By contrast, based on the proposed methodology, NSCC 
would include certain commodity ETFs in the gap risk charge that track 
to an index that is not a broad-based diversified commodity index; such 
ETFs are not currently subject to the gap risk charge, but would be 
subject going forward.
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    \43\ Id.
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    Fifth, NSCC would make certain technical and clarifying changes 
regarding the gap risk charge, as detailed in the Notice of Filing.\44\
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    \44\ See id. at 78161-62 (describing technical changes (i) 
regarding the gap risk charge for securities financing transactions 
cleared by NSCC, the methodology of which already includes the gap 
risk charge as an additive component to margin and which would not 
change as a result of this proposal, (ii) to make clear that the gap 
risk charge applies to Net Unsettled Positions, (iii) to remove an 
unnecessary reference, (iv) to reflect that NSCC considers impact 
analysis when determining and calibrating the concentration 
threshold and gap risk haircuts, and (v) to make other technical 
changes for clarity).
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \45\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to such organization. After carefully considering the 
proposed rule change, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the

[[Page 55103]]

rules and regulations thereunder applicable to NSCC. In particular, the 
Commission finds that the proposed rule change is consistent with 
section 17A(b)(3)(F) \46\ of the Act and Rules 17Ad-22(e)(4)(i) and 
(e)(6)(i) thereunder.\47\
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    \45\ 15 U.S.C. 78s(b)(2)(C).
    \46\ 15 U.S.C. 78q-1(b)(3)(F).
    \47\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to, among other things, 
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, and protect investors and promote the public interest.\48\
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    \48\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that the proposed changes to the 
calculation of the gap risk charge described in section II.C above 
should allow NSCC to ensure that it continues to collect margin 
sufficient to address the risks posed by its members' portfolios. Based 
on its review of the confidential information provided by NSCC and 
reviewed by the Commission, including the impact study demonstrating 
the collective impact of the proposed changes on the margin collected 
both at the overall clearing agency level and on a member-by-member 
basis and on NSCC's backtesting performance,\49\ the proposed changes 
with respect to the calculation of the gap risk charge provide better 
margin coverage than the current methodology.
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    \49\ NSCC submitted more detailed results of the impact study as 
confidential Exhibit 3 to the Proposed Rule Change. NSCC requested 
confidential treatment of Exhibit 3 pursuant to 5 U.S.C. 552(b)(4) 
and 552(b)(8) and 17 CFR. 200.80(b)(4) and 200.80(b)(8). A commenter 
raised a concern regarding redacted portions of the filing, which 
consisted of certain supporting exhibits filed confidentially as 
Exhibit 3 to the filing. See https://www.sec.gov/comments/sr-nscc-2022-015/srnscc2022015-320658.htm. NSCC asserted that this exhibit 
to the filing was entitled to confidential treatment because it 
contains: (i) trade secrets and commercial information that is 
privileged or confidential and which, if disclosed, would be 
accessible to the DTCC Companies' competitors and could result in 
substantial competitive injury to the DTCC Companies; and (ii) non-
public, confidential information prepared for use by Commission 
staff. Under section 23(a)(3) of the Exchange Act, the Commission is 
not required to make public statements filed with the Commission in 
connection with a proposed rule change of a self-regulatory 
organization if the Commission could withhold the statements from 
the public in accordance with the Freedom of Information Act 
(``FOIA''), 5 U.S.C. 552. 15 U.S.C. 78w(a)(3). The Commission has 
reviewed the documents for which NSCC requests confidential 
treatment and concludes that they could be withheld from the public 
under the FOIA. FOIA Exemption 4 protects confidential commercial or 
financial information. 5 U.S.C. 552(b)(4). Under Exemption 4, 
information is confidential if it ``is both customarily and actually 
treated as private by its owner and provided to government under an 
assurance of privacy.'' Food Marketing Institute v. Argus Leader 
Media, 139 S. Ct. 2356, 2366 (2019). Based on its review of the 
materials submitted, the Commission believes that the information is 
the type that would not customarily be disclosed to the public. 
Specifically, this information consists of an impact study analyzing 
the effect that the changes to NSCC's margin methodology would have 
on each member's individual margin requirement to NSCC; information 
regarding NSCC's analysis and development of the particular changes 
to the margin methodology, including its consideration of potential 
alternative haircuts and thresholds; and excerpts from NSCC's non-
public detailed margin methodology. In addition, by requesting 
confidential treatment, NSCC had an assurance of privacy because the 
Commission generally protects information that can be withheld under 
Exemption 4. Thus, the Commission has determined to accord 
confidential treatment to the confidential exhibits.
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    The Commission believes that making the gap risk charge an additive 
component, as opposed to a potential substitutive option applicable 
only if it exceeds other methodologies for determining the VaR Charge, 
should help NSCC better protect against more idiosyncratic risk 
scenarios in concentrated portfolios than the current methodology. In 
addition, adjusting the gap risk calculation to take into account the 
two largest positions, as well as to apply two separate haircuts based 
on backtesting and impact analysis with floors set forth in the Rules, 
should allow NSCC to cover concurrent gap moves involving more than one 
concentrated position. Moreover, modifying the criteria for ETF 
positions subject to the gap risk charge based on whether they are non-
diversified rather than whether they are non-index would allow NSCC to 
more accurately determine which ETFs should be included and excluded 
from the gap risk charge based on characteristics that indicate that 
such ETFs are more or less prone to the effects of gap risk events, 
thereby providing more accurate coverage of the potential exposure 
arising from such positions.
    For these reasons, the Commission believes that the Proposed Rule 
Change should enable NSCC to better manage its exposure to portfolios 
with identified concentration risk, thereby limiting its exposure to 
members in the event of a member default. The proposal should help 
ensure that, in the event of a member default, NSCC's operation of its 
critical clearance and settlement services would not be disrupted 
because of insufficient financial resources. Accordingly, the 
Commission finds that NSCC's proposal should help NSCC to continue 
providing prompt and accurate clearance and settlement of securities 
transactions, consistent with section 17A(b)(3)(F) of the Act.
    Moreover, as described in Section II.A above, NSCC would access the 
mutualized clearing fund should a defaulted member's own margin be 
insufficient to satisfy losses to NSCC caused by the liquidation of 
that member's portfolio. Because NSCC's proposal to amend its 
calculation of the gap risk charge should help ensure that NSCC has 
collected sufficient margin from members, the proposed changes would 
also help minimize the likelihood that NSCC would have to access the 
clearing fund, thereby limiting non-defaulting members' exposure to 
mutualized losses. The Commission believes that by helping to limit the 
exposure of NSCC's non-defaulting members to mutualized losses, the 
proposed changes should help NSCC assure the safeguarding of securities 
and funds which are in its custody or control, consistent with section 
17A(b)(3)(F) of the Act.\50\
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    \50\ 15 U.S.C. 78q-1(b)(3)(F).
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    Finally, as described in section II.C above, the proposed rule 
changes would amend the Rules to incorporate technical and clarifying 
changes regarding the gap risk charge. These changes should help ensure 
that NSCC's members understand how the gap risk charge would be 
determined, thereby improving transparency. The Commission believes 
that such changes would ensure that the Rules are accurate and clear to 
NSCC's members, thus promoting prompt and accurate clearance and 
settlement, which is consistent with section 17A(b)(3)(F) of the 
Act.\51\
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    \51\ Id.
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B. Consistency With Rule 17Ad-22(e)(4)(i) Under the Exchange Act

    Rule 17Ad-22(e)(4)(i) under the Exchange Act requires that a 
covered clearing agency establish, implement, maintain and enforce 
written policies and procedures reasonably designed to effectively 
identify, measure, monitor, and manage its credit exposures to 
participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence.\52\
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    \52\ 17 CFR 240.17Ad-22(e)(4)(i).
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    Based on its review of the record, the Commission believes NSCC's 
proposal to broaden the scope of the gap risk charge and the related 
adjustments to its calculation could help improve NSCC's backtesting 
performance, provide

[[Page 55104]]

broader coverage for idiosyncratic risk scenarios, and could help 
address the potential increased risks NSCC may face related to its 
ability to liquidate a portfolio that is susceptible to such risks in 
the event of a member default. Specifically, the Commission has 
reviewed and analyzed NSCC's analysis of the improvements in its 
backtesting coverage,\53\ and agrees that the analysis demonstrates 
that the proposal would result in better backtesting coverage and, 
therefore, less credit exposure to its members.
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    \53\ See supra note 49.
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    Accordingly, the Commission believes that the proposal would enable 
NSCC to better manage its credit risks by allowing it to respond 
regularly and more effectively to any material deterioration of 
backtesting performances, market events, market structure changes, or 
model validation findings, thereby helping to ensure that NSCC can take 
steps to collect sufficient margin to maintain sufficient financial 
resources to cover its exposure to its members. Therefore, the 
Commission believes the Proposed Rule Change is consistent with Rule 
17Ad-22(e)(4)(i) under the Exchange Act.

C. Consistency With Rule 17Ad-22(e)(6)(i) Under the Exchange Act

    Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that each 
covered clearing agency that provides central counterparty services 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market.\54\
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    \54\ 17 CFR 240.17Ad-22(e)(6)(i).
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    The Commission understands that, as described above, the proposal 
as a whole is designed to enable NSCC to more effectively address the 
risks presented by members' concentrated positions in securities more 
prone to gap risk events and to produce margin levels that are more 
commensurate with the particular risk attributes of these concentrated 
holdings, including the market price risk of liquidating large 
positions in securities that are more prone to gap risk events. The 
Commission believes that the proposal would improve NSCC's ability to 
consider, and produce margin levels commensurate with, the risks and 
particular attributes presented by a portfolio that meets the 
concentration threshold and, therefore, is more susceptible to the 
impacts of idiosyncratic risks.
    First, the Commission believes that broadening the gap risk charge 
to an additive feature of the VaR Charge and using the two largest non-
diversified positions would help NSCC to more effectively manage the 
idiosyncratic risks of portfolios with concentrated holdings. 
Specifically, the proposed changes should result in an overall increase 
of margin for members that have positions subject to the gap risk 
charge.\55\
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    \55\ The impact study indicated that the proposed changes would 
have resulted in a 10.88% increase for the daily total VaR Charge on 
average and would have resulted in a 4.89% increase in the daily 
total clearing fund on average during that period. See Notice of 
Filing, supra note 3, 87 FR at 78158. In addition, the Commission 
reviewed confidential materials submitted to the Commission, which 
included more granular information, at a member level, of the 
impacts of this proposal as compared to the current methodology. See 
note 49 supra.
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    Second, given the proposed additive nature of the gap risk charge, 
the Commission believes the adjustments to the gap risk charge 
calculation (i.e., establishing floors for the gap risk haircuts 
applicable to the two largest positions) are reasonably designed to 
cover NSCC's exposure to members arising from gap risks. The Commission 
believes the adjustments to the gap risk charge calculation are 
reasonable because the record shows the proposal should improve NSCC's 
ability to mitigate against idiosyncratic risks that NSCC may face when 
liquidating a portfolio that contains a concentration of positions, 
while balancing NSCC's consideration of the potential costs to members 
that may be subject to the gap risk charge.\56\ The Commission believes 
that the established floors for the two haircuts should also help 
ensure that the gap risk charge collects margin sufficient to cover the 
potential exposure in a gap risk event.
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    \56\ As part of the confidential materials submitted to the 
Commission, NSCC provided analysis of alternative potential haircuts 
and thresholds that it considered when developing the proposal. See 
note 49 supra. The Commission's review of those materials further 
supports its belief as to the reasonableness of this aspect of the 
proposal.
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    Third, by providing additional specific objective criteria to 
determine which positions would be subject to the gap risk charge, the 
Commission believes that NSCC should be able to better identify those 
securities that may be more prone to idiosyncratic risks. Specifically, 
the proposal should ensure that ETFs identified as non-diversified 
(whether index-based or not) and therefore more prone to idiosyncratic 
risks will be subject to the gap risk charge.
    Taken together, the Commission believes that the proposal should 
permit NSCC to calculate a gap risk charge that is more appropriately 
designed to address the gap risks presented by concentrated positions 
in portfolios. Accordingly, the Commission believes the proposal is 
consistent with Rule 17Ad-22(e)(6)(i) under the Exchange Act because it 
is designed to assist NSCC in maintaining a risk-based margin system 
that considers, and produces margin levels commensurate with, the risks 
and particular attributes of portfolios with identified concentration 
risks.\57\
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    \57\ 17 CFR 240.17Ad-22(e)(6)(i).
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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 \58\ and 
the rules and regulations promulgated thereunder.
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    \58\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to section 19(b)(2) of the Act 
\59\ that proposed rule change SR-NSCC-2022-015, be, and hereby is, 
approved.\60\
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    \59\ 15 U.S.C. 78s(b)(2).
    \60\ In approving the Proposed Rule Change, the Commission 
considered its impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\61\
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    \61\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-17302 Filed 8-11-23; 8:45 am]
BILLING CODE 8011-01-P


