82 FR 37141 - Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing of Advance Notice To Expand the Application of the Family-Issued Securities Charge

SECURITIES AND EXCHANGE COMMISSION

Federal Register Volume 82, Issue 151 (August 8, 2017)

[Federal Register Volume 82, Number 151 (Tuesday, August 8, 2017)]
[Notices]
[Pages 37141-37144]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2017-16631]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81286; File No. SR-NSCC-2017-804]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Advance Notice To Expand the 
Application of the Family-Issued Securities Charge

August 2, 2017.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 (``Clearing 
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities 
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on July 
10, 2017, National Securities Clearing Corporation (``NSCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
advance notice SR-NSCC-2017-804 (``Advance Notice'') as described in 
Items I, II and III below, which Items have been prepared by the 
clearing agency.\3\ The Commission is publishing this notice to solicit 
comments on the Advance Notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ On July 10, 2017, NSCC filed this Advance Notice as a 
proposed rule change (SR-NSCC-2017-010) with the Commission pursuant 
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4, 
17 CFR 240.19b-4. A copy of the proposed rule change is available at 
http://www.dtcc.com/legal/sec-rule-filings.aspx.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    The Advance Notice consists of amendments to the NSCC Rules and 
Procedures (``Rules'') \4\ in order to (i) expand the application of 
NSCC's existing family-issued securities charge \5\ to apply to all 
Members, as described below, and (ii) include a definition of ``Family-
Issued Security'' as a security that was issued by a Member or by an 
affiliate of that Member, as described in greater detail below.
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    \4\ Terms not defined herein are defined in the Rules, available 
at www.dtcc.com/~/media/Files/Downloads/legal/rules/nscc_rules.pdf.
    \5\ The family-issued securities charge is currently described 
in Procedure XV, Section I.(B)(1) of the Rules, supra note 4.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, the clearing agency included 
statements concerning the purpose of and basis for the Advance Notice 
and discussed any comments it received on the Advance Notice. The text 
of these statements may be examined at the places specified in Item IV 
below. The clearing agency has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants, or Others

    NSCC has not received or solicited any written comments relating to 
this proposal. NSCC will notify the Commission of any written comments 
received by NSCC.

(B) Advance Notice Filed Pursuant to Section 806(e) of the Payment, 
Clearing, and Settlement Supervision Act

Description of Proposed Changes
    Currently, in calculating its Members' required deposits to the 
Clearing Fund, NSCC excludes positions in Family-Issued Securities of 
certain Members from its parametric volatility Clearing Fund component 
(``VaR Charge''), and instead charges an amount calculated by 
multiplying the absolute value of the long, net unsettled positions in 
that Member's Family-Issued Securities by a percentage that is no less 
than 40 percent (``FIS Charge''). The FIS Charge is currently only 
applied to Members that are rated 5, 6, or 7 on the Credit Risk Rating 
Matrix (``CRRM''). The proposed change would expand the application of 
the FIS Charge to the positions in Family-Issued Securities of all 
Members to help NSCC cover the specific wrong-way risk posed by Family-
Issued Securities, as described further below.\6\ Therefore, NSCC is 
proposing to amend (i) Rule 1 (Definitions and Descriptions) to add a 
definition of ``Family-Issued Security,'' and (ii) Procedure XV 
(Clearing Fund Formula and Other Matters) to expand the application of 
the FIS Charge to all Members by moving the description of FIS Charge 
from Section I.(B)(1) to Sections I.(A)(1) and I.(A)(2) in order to 
make clear that the FIS Charge would be included as a component of the 
Clearing Fund formula calculated for all Members.
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    \6\ Members that do not trade in Family-Issued Securities would 
not be subject to the FIS Charge.
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    As a central counterparty, NSCC occupies an important role in the 
securities settlement system by interposing itself between 
counterparties to financial transactions and thereby reducing the risk 
faced by participants and contributing to global financial stability. 
The effectiveness of a central counterparty's risk controls and the 
adequacy of its financial resources are critical to achieving these 
risk-reducing goals. In that context, NSCC continuously reviews its 
margining methodology in order to ensure the reliability of its 
margining in achieving the desired coverage. In order to be most 
effective, NSCC must take into consideration the risk characteristics 
specific to certain securities when margining those securities.
    Among the various risks that NSCC considers when evaluating the 
effectiveness of its margining methodology are its counterparty risks 
and identification and mitigation of ``wrong-way'' risk, particularly 
specific wrong-way risk, defined as the risk that an exposure to a 
counterparty is highly likely to increase when the creditworthiness of 
that counterparty deteriorates. \7\ NSCC has identified an exposure to 
specific wrong-way risk when it acts as central counterparty to a 
Member with respect to positions in Family-Issued Securities. In the 
event that a Member with unsettled long positions in Family-Issued 
Securities defaults, NSCC would close out those positions following a 
likely drop in the credit-worthiness of the issuer, possibly resulting 
in a loss to NSCC.
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    \7\ See Principles for financial market infrastructures, issued 
by the Committee on Payment and Settlement Systems and the Technical 
Committee of the International Organization of Securities 
Commissions 47 n.65 (April 2012), available at http://www.bis.org/publ/cpss101a.pdf.
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    In 2015, NSCC proposed to address its exposure to specific wrong-
way risk in two ways.\8\ First, NSCC proposed to apply the FIS Charge 
to its Members that are rated a 5, 6, or 7 on the CRRM (i.e., Members 
on the Watch List).\9\

[[Page 37142]]

Today, following implementation of the FIS Phase 1 Rule Change, the FIS 
Charge is applied by excluding positions in Family-Issued Securities of 
those Members from NSCC's VaR Charge, and instead charging an amount 
calculated by multiplying the absolute value of the long net unsettled 
positions in that Member's Family-Issued Securities by a 
percentage.\10\ That percentage is no less than 40 percent and up to 
100 percent, and is determined by NSCC based on the Member's rating on 
the CRRM and on the type of Family-Issued Securities submitted to NSCC. 
As such, under Procedure XV (1) fixed income securities that are 
Family-Issued Securities are charged a haircut rate of no less than 80 
percent for Members that are rated 6 or 7 on the CRRM, and no less than 
40 percent for Members rated 5 on the CRRM; and (2) equity securities 
that are Family-Issued Securities are charged a haircut rate of 100 
percent for Members that are rated 6 or 7 on the CRRM, and no less than 
50 percent for Members that are rated 5 on the CRRM. Members that have 
a rating on the CRRM of 1 through 4 are not currently subject to the 
FIS Charge. As stated above, Family-Issued Securities present NSCC with 
specific wrong-way risk such that, in the event that a Member with 
unsettled long positions in Family-Issued Securities defaults, NSCC 
would close out those positions following a likely drop in the credit-
worthiness of the issuer, possibly resulting in a loss to NSCC. 
Therefore, the FIS Charge is applied to the unsettled long positions in 
Family-Issued Securities, which are the positions that NSCC would close 
out following a Member default, as opposed to the short positions in 
net unsettled securities. The haircut rates were calibrated based on 
historical corporate issue recovery rate data, and address the risk 
that the Family-Issued Securities of a Member would be devalued in the 
event of that Member's default.
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    \8\ See Securities Exchange Act Release No. 76077 (October 5, 
2015), 80 FR 61256 (October 9, 2015), (SR-NSCC-2015-003) (``FIS 
Phase 1 Rule Change'').
    \9\ As part of its ongoing monitoring of its membership, NSCC 
utilizes the CRRM to rate its risk exposures to its Members based on 
a scale from 1 (the strongest) to 7 (the weakest). Members that fall 
within the higher risk rating categories (i.e., 5, 6, and 7) are 
placed on NSCC's ``Watch List,'' and may be subject to enhanced 
surveillance or additional margin charges, as permitted under the 
Rules. See Rule 2B, Section 4 and Procedure XV, Section I.(B)(1) of 
the Rules, supra note 4. See also Securities Exchange Act Release 
No. 80734 (May 19, 2017), 82 FR 24174 (May 25, 2017), (SR-DTC-2017-
002, SR-FICC-2017-006, SR-NSCC-2017-002) (approving proposed changes 
to the CRRM methodology).
    \10\ Procedure XV (Clearing Fund Formula and Other Matters), 
Section I.(B)(1), supra note 4.
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    The FIS Charge is currently applied only to Members on the Watch 
List because these Members present a heightened credit risk to NSCC or 
have demonstrated higher risk related to their ability to meet 
settlement, and, as such, at the time the FIS Phase 1 Rule Change was 
proposed, NSCC believed there was a clear and more urgent need to 
address NSCC's exposure to specific wrong-way risk presented by these 
Members' positions in Family-Issued Securities.
    Second, NSCC proposed to further evaluate its exposure to wrong-way 
risk presented by positions in Family-Issued Securities by reviewing 
the impact of expanding the application of the FIS Charge to positions 
in Family-Issued Securities of all Members.\11\ Following its 
evaluation, NSCC has determined that the risk characteristics to be 
considered when margining Family-Issued Securities extend beyond 
Members' creditworthiness. More specifically, exposure to specific 
wrong-way risk is based on the correlation to the default of the issuer 
Member, and NSCC may face this risk with respect to positions in 
Family-Issued Securities of all of its Members, not only those Members 
on the Watch List. As such, in order to more effectively mitigate its 
exposure to specific wrong-way risk, NSCC is proposing to apply the FIS 
Charge to positions in Family-Issued Securities of all Members.
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    \11\ FIS Phase 1 Rule Change, supra note 8.
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    In order to implement this proposal, NSCC would amend Procedure XV 
to move the FIS Charge from Section I.(B)(1), where it is currently 
described as an additional deposit for Members on surveillance, to 
Sections I.(A)(1) and (2), to include the FIS Charge as a component of 
the Clearing Fund formula that is calculated for each Member.\12\ Under 
the proposed change, the calculation of the FIS Charge would not change 
as applied to Members that are rated 5, 6, or 7 on the CRRM. NSCC is 
proposing to revise the description of the FIS Charge to include 
Members that are rated 1 through 4 on the CRRM.\13\ Specifically, NSCC 
is proposing to amend the description of the FIS Charge in Procedure XV 
such that (1) fixed-income securities that are Family-Issued Securities 
would be charged a haircut rate of no less than 80 percent for Members 
that are rated 6 or 7 on the CRRM, and no less than 40 percent for 
Members that are rated 1 through 5 on the CRRM; and (2) equities that 
are Family-Issued Securities would be charged a haircut rate of 100 
percent for Members rated 6 or 7 on the CRRM, and no less than 50 
percent for Members that are rated 1 through 5 on the CRRM.
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    \12\ Procedure XV, Sections I.(A)(1) and (2) and I.(B), supra 
note 4.
    \13\ Members that are not rated on the CRRM are not subject to 
the FIS Charge and would not be subject to the FIS Charge under the 
proposed change.
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    The proposed change would also amend NSCC Rule 1 (Definitions and 
Descriptions) to include a definition of Family-Issued Securities in 
order to provide more clarity to the Rules. Under the proposed change, 
``Family-Issued Security'' would be defined as a security that was 
issued by a Member or an affiliate of that Member.
Expected Effect on and Management of Risk
    By expanding the application of the FIS Charge to all Members, the 
proposed change would more allow NSCC to more effectively mitigate its 
exposure to specific wrong-way risk as posed by Family-Issued 
Securities. As described above, Family-Issued Securities present NSCC 
with specific wrong-way risk such that, in the event that a Member with 
unsettled long positions in Family-Issued Securities defaults, NSCC 
would close out those positions following a likely drop in the credit-
worthiness of the issuer, possibly resulting in a loss to NSCC. The FIS 
Charge addresses this risk by using haircut rates that are calibrated 
based on historical corporate issue recovery rate data, and address the 
risk that the Family-Issued Securities of a Member would be devalued in 
the event of that Member's default. Because NSCC may face specific 
wrong-way risk with respect to positions in Family-Issued Securities of 
all of its Members, the proposed change to expand the FIS Charge to all 
Members would reduce NSCC's exposure to specific wrong-way risk.
    By mitigating specific wrong-way risk for NSCC as described above, 
the proposed change would also mitigate risk for Members because 
lowering the risk profile for NSCC would in turn lower the risk 
exposure that Members may have with respect to NSCC in its role as a 
central counterparty.
Consistency With the Clearing Supervision Act
    The stated purpose of Title VIII of the Clearing Supervision Act is 
to mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically important financial market utilities and 
strengthening the liquidity of systemically important financial market 
utilities.\14\ Section 805(a)(2) of the Clearing Supervision Act \15\ 
also authorizes the Commission to prescribe risk management standards 
for the payment, clearing and settlement activities of designated 
clearing entities, like NSCC, for which the Commission is the 
supervisory agency. Section 805(b) of the Clearing Supervision Act \16\ 
states that the objectives and principles for risk management standards 
prescribed under Section 805(a) shall be to, among

[[Page 37143]]

other things, promote robust risk management.
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    \14\ 12 U.S.C. 5461(b).
    \15\ 12 U.S.C. 5464(a)(2).
    \16\ 12 U.S.C. 5464(b).
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    NSCC believes that the proposed change is consistent with Section 
805(b) of the Clearing Supervision Act because it is designed to 
promote robust risk management. By enhancing the margin methodology 
applied to Family-Issued Securities of all Members, the proposal would 
assist NSCC in collecting margin that more accurately reflects NSCC's 
exposure to a Member that clears Family-Issued Securities and would 
assist NSCC in its continuous efforts to improve the reliability and 
effectiveness of its risk-based margining methodology by taking into 
account specific wrong-way risk. By assisting NSCC in more effectively 
mitigating its exposure to specific wrong-way risk, the proposal is 
designed to promote robust risk management, consistent with Section 
805(b) of the Clearing Supervision Act.\17\
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    \17\ Id.
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    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act \18\ and Section 17A of the 
Act.\19\ Rule 17Ad-22 requires registered clearing agencies to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for their operations and risk management practices on an 
ongoing basis.\20\ For the reasons set forth below, NSCC believes the 
proposed change is consistent with Rules 17Ad-22(e)(4)(i), and 
(e)(6)(i) and (v), each promulgated under the Act.\21\
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    \18\ 12 U.S.C. 5464(a)(2).
    \19\ 17 CFR 240.17Ad-22 (``Rule 17Ad-22'').
    \20\ Id.
    \21\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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    Rule 17Ad-22(e)(4)(i) under the Act requires, in part, that each 
covered clearing agency establish, implement, maintain and enforce 
written policies and procedures reasonably designed to effectively 
identify, measure, monitor, and manage its credit exposures to 
participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence.\22\ The specific wrong-way risk presented by 
Family-Issued Securities is the risk that, in the event that a Member 
with unsettled long positions in Family-Issued Securities defaults, 
NSCC would close out those positions following a likely drop in the 
credit-worthiness of the issuer, possibly resulting in a loss to NSCC. 
The haircut rates of the FIS Charge more accurately reflect this risk 
because they were calibrated based on historical corporate issue 
recovery rate data, and, therefore, address the risk that the Family-
Issued Securities of a Member would be devalued in the event of that 
Member's default. In this way, NSCC has determined that the margining 
methodology used in calculating the FIS Charge more accurately reflects 
the risk characteristics of Family-Issued Securities than applying its 
VaR Charge, and would permit NSCC to more accurately identify, measure, 
monitor and manage its credit exposures to those Members with positions 
in Family-Issued Securities. Further, by expanding the application of 
the FIS Charge to all Members, the proposed change would assist NSCC in 
collecting and maintaining financial resources that reflect its credit 
exposures to those Members. Therefore, NSCC believes the proposed 
change is consistent with Rule 17Ad-22(e)(4)(i).
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    \22\ 17 CFR 240.17Ad-22(e)(4)(i).
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    Rule 17Ad-22(e)(6)(i) under the Act requires, in part, 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.\23\ Rule 17Ad-22(e)(6)(v) under the Act requires, in part, 
that each covered clearing agency that provides central counterparty 
services establish, implement, maintain and enforce written policies 
and procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, uses an appropriate method for measuring credit exposure that 
accounts for relevant product risk factors and portfolio effects across 
products.\24\
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    \23\ 17 CFR 240.17Ad-22(e)(6)(i).
    \24\ 17 CFR 240.17Ad-22(e)(6)(v).
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    As stated above, Family-Issued Securities present NSCC with 
specific wrong-way risk that, in the event that a Member with unsettled 
long positions in Family-Issued Securities defaults, NSCC would close 
out those positions following a likely drop in the credit-worthiness of 
the issuer, possibly resulting in a loss to NSCC. Therefore, the 
haircut rates were calibrated based on historical corporate issue 
recovery rate data, and address the risk that the Family-Issued 
Securities of a Member would be devalued in the event of that Member's 
default, and would more accurately reflect the risk characteristics of 
Family-Issued Securities than applying its VaR Charge. In this way, the 
proposal would assist NSCC in maintaining a risk-based margin system 
that considers, and produces margin levels commensurate with, the risks 
and particular attributes of Family-Issued Securities. Additionally, 
NSCC believes application of the FIS Charge to positions in Family-
Issued Securities of all Members is an appropriate method for measuring 
its credit exposures, because the FIS Charge accounts for the risk 
factors presented by these securities, i.e. the risk that these 
securities would be devalued in the event of a Member default. 
Therefore, NSCC believes the proposed change is consistent with Rule 
17Ad-22(e)(6)(i) and (v).

III. Date of Effectiveness of the Advance Notice, and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date that the proposed change was filed with the Commission or (ii) the 
date that any additional information requested by the Commission is 
received. The clearing agency shall not implement the proposed change 
if the Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    The clearing agency shall post notice on its Web site of proposed 
changes that are implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the Advance 
Notice

[[Page 37144]]

is consistent with the Clearing Supervision 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 [email protected]. Please include 
File Number SR-NSCC-2017-804 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-2017-804. 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 Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the Advance Notice that are filed 
with the Commission, and all written communications relating to the 
Advance Notice 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 Web site 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 the filing also will be available for inspection 
and copying at the principal office of NSCC and on DTCC's Web site 
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received 
will be posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NSCC-2017-804 and should be submitted on 
or before August 23, 2017.

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-16631 Filed 8-7-17; 8:45 am]
 BILLING CODE 8011-01-P