[Federal Register Volume 59, Number 78 (Friday, April 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-9710]


[[Page Unknown]]

[Federal Register: April 22, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33911; File No. 600-27]

 

Self-Regulatory Organizations; Clearing Corporation for Options 
and Securities; Filing of Amendment to Application for Exemption From 
Registration as a Clearing Agency

April 15, 1994.
    On October 7, 1993, the Clearing Corporation for Options and 
Securities (``CCOS'')\1\ filed with the Securities and Exchange 
Commission (``Commission'') an amendment to its application for 
exemption from registration as a clearing agency\2\ pursuant to section 
17A of the Securities Exchange Act of 1934 (``Act''),\3\ and rule 
17Ab2-1 thereunder.\4\ The Commission is publishing this notice to 
solicit comments from interested persons concerning CCOS's amended 
exemption application. In preparing submissions on this matter, 
commentators are urged to review the text of the CCOS Release, attached 
as appendix A to this release,\5\ and CCOS's revised application, 
rules, and procedures, which are available from the Commission's Public 
Reference Room as described below. Commentators are advised not to rely 
solely on the terms of this release in preparing their comments.
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    \1\CCOS filed its application for exemption from registration as 
a clearing agency on December 14, 1992. See Securities Exchange Act 
Release No. 32481 (June 16, 1993), 58 FR 34105 [File No. 600-27] 
(``CCOS Release'') attached as Appendix A to this release.
    \2\Letter from Dennis Dutterer, Executive Vice President and 
General Counsel, Board of Trade Clearing Corporation (``BOTCC''), to 
Jonathan Katz, Secretary, Commission (October 6, 1993). Letter from 
Fred Grede, Vice President, Board of Trade of the City of Chicago 
(``CBOT''), to Brandon Becker, Director, Division of Market 
Regulation (``Division''), Commission (October 6, 1993).
    \3\15 U.S.C. 78q-1 (1988).
    \4\17 CFR 240.17Ab2-1 (1922).
    \5\Supra note 1.
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I. Introduction

    In its application for exemption from registration as a clearing 
agency, CCOS\6\ set forth its proposal to provide clearance and 
settlement services for government securities transactions executed 
through Chicago Board Brokerage, Inc. (``CBB''), a wholly-owned 
subsidiary of the Board of Trade of the City of Chicago (``CBOT'').\7\ 
Shortly after notice of the application appeared in the Federal 
Register, the CBOT terminated its business relationship with EJV 
Partners, L.P. (``EJV''), which was to provide the CBOT with a screen-
based proprietary trading system.\8\
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    \6\CCOS is a wholly-owned subsidiary of Board of Trade Clearing 
Corporation (``BOTCC'') which provides clearing services for futures 
and commodities transactions executed on the Board of Trade of the 
City of Chicago.
    CCOS previously filed two applications for registration as a 
clearing agency. In its first application, filed on October 14, 
1988, and subsequently withdrawn, CCOS proposed to clear exchange-
traded options issued by The Options Clearing Corporation (``OCC''). 
See Securities Exchange Act Release No. 27083 (August 1, 1989), 54 
FR 32410. In the second application, filed on October 21, 1991, CCOS 
proposed to clear over-the-counter options on government securities. 
This application also has been withdrawn. Letter from Dennis 
Dutterer, General Counsel, CCOS, to Jonathan Kallman, Associate 
Director, Division of Market Regulation, Commission (December 11, 
1992).
    \7\CBB will execute trades in government securities (unmatured, 
marketable debt securities in book-entry form that are direct 
obligations of the United States Government).
    \8\Letter from Frederick J. Grede, Vice President, CBOT, to 
Brandon Becker, Acting Director, Division, Commission (June 30, 
1993).
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    Substantially, CBOT, through CBB, created a proprietary electronic 
trading system which will perform the same functions in the system as 
those originally proposed to be performed by EJV. On October 6, 1993, 
CBOT informed the Commission of its intention to move forward with its 
proposal to offer electronically brokered cash transactions in U.S. 
Government securities and related products through CBB.\9\
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    \9\Supra note 2.
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II. Description of the Amended Proposal

A. Registration of CBB

    The original business plan proposed by the CBOT called for CBB to 
succeed to the broker-dealer registration of EJV. CBOT now intends to 
register CBB as a U.S. Government securities broker pursuant to Section 
15C of the Act\10\ and to proceed with CBB's membership with the 
National Association of Securities Dealers (``NASD'') as required by 
such Section.\11\
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    \10\15 U.S.C. 78o-5 (1988).
    \11\15 U.S.C. 78o-5(e)(1) (1988).
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    As described more fully in the CCOS Release, CBB's business will be 
limited to acting as an intermediary for U.S. Government securities 
transactions paired through the computer system.\12\ The system will 
permit the trading of cash securities, independently and in conjunction 
with CBOT futures on cash securities (also known as ``basis 
contracts''),\13\ and repurchase and reverse repurchase agreement 
contracts involving cash securities (``Dollar Rolls'')\14\ in cash 
securities. Under the CBB proposal, therefore, CBOT traders in cash 
securities will be able to buy and sell securities underlying CBOT 
futures contracts and through Dollar Rolls execute trades that help 
finance positions and promote inventory management.
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    \12\For a detailed description of the products traded through 
the CBB trading system, refer to the CCOS Release, supra note 1, at 
34105 and 34106.
    \13\A basis trade is a trade in which the participants agree to 
simultaneously buy/sell cash securities against the offsetting 
equivalent CBOT Treasury futures contract. The basis represents the 
price differential between a cash security and the futures delivery 
price.
    \14\In a Dollar Roll transaction, the seller of the contract 
delivers notes or bonds to the buyer in exchange for cash. 
Settlement occurs the same day. At the time of execution, the seller 
and buyer also agree to reverse the transaction at a price that 
includes a financing interest amount, with settlement occurring the 
next day.
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    CCOS will clear all transactions executed through CBB. CCOS's 
application for exemption, filed on Form CA-1, includes rules, 
procedures, and guidelines for the clearance and settlement of 
government securities. BOTCC, as sole owner and parent of CCOS, will 
guarantee CCOS's obligations arising under CCOS's rules, and the 
clearance and settlement services of CCOS will be modeled after 
established procedures currently utilized by BOTCC.\15\
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    \15\See CCOS Release, supra note 1.
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B. Development of Computer Facilities by CBB

    Undet the amended application, CBB will create, operate, and 
maintain the computer system that enables quotations to be entered and 
executed. CBB has developed trade matching software for U.S. Treasury 
bills, notes, and bonds, including when-issued securities, basis 
trades, and Dollar Rolls. The trade matching algorithm will be based on 
time priority according to price.
    Under the terms of the proposal any CCOS participant or affiliate 
of a CCOS participant who is also a CBOT member or member firm will be 
able to obtain a CBB trading terminal.\16\ Each CCOS participant will 
be required to enter into an agreement with CBB setting forth the terms 
and conditions of access to and use of CBB's terminals.\17\ A terminal 
operator will be able to view the video display to see the prices and 
quantities of anonymous bids and offers in the marketplace available 
for trading and to review its orders or trading activity.
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    \16\Participation in CCOS will be limited to members of BOTCC 
and members of the CBOT that are affiliated with members of BOTCC. 
See CCOS Release, supra note 1, note 16.
    \17\Only CBOT individual members, employees of individual 
members, and employees of CBOT member firms will be permitted to 
operate terminals. Each terminal will be uniquely identified in its 
communication with the central site, and each terminal operator will 
be assigned an identification number. CBB will maintain complete, 
time-sequenced electronic audit trails on all orders entered on, and 
all transactions executed through, the CBB trading system. The 
recorded activity will indicate, for a given order or transaction, 
the identity of the terminal operator entering, changing, or 
cancelling orders, the time such entry or change was effected, and 
the date, time, volume, security, and price of each transaction 
executed through the trading system.
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    CBB is developing several methods for market participants to access 
the CBB trading system.\18\ CBB proposes to: (1) Provide CBOT 
workstation terminals which will access the CBB trading system and 
include other market information and trading systems available through 
the CBOT;\19\ (2) provide an interface between CBB's central computer 
and a CBOT member's or member firm's internal computer network; and (3) 
provide access through an interface with quotation vendors.\20\
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    \18\See draft no-action letter on exchange registration from 
Mark Young, Kirkland & Ellis, to Brandon C. Becker, Esq., Director, 
Division, Commission, (December 1, 1993).
    \19\The CBB trading system is based on a modification of the 
CBOT's Project A trading system. Project A, available to CBOT 
members, is an electronic order entry facility developed for trading 
over a local area network (for example, within the CBOT building) 
the CBOT's futures contracts, options on futures contracts, and 
other financial products. The Project A system is designed to 
facilitate trading by active order matching or through the posting 
of bids/offers on an electronic bulletin board.
    \20\Quotation vendors will offer CBB trading screens and order 
entry capability through their terminals, which are served by 
national telecommunications networks. CBB will contract on a non-
exclusive basis with one or more quotation vendors, each having 
interactive capabilities, to carry the CBB system for use by CBOT 
members and member firms.
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III. Public Interest Statement

    CCOS and BOTCC believe that the only changes the CBB business plan 
since the time of CCOS's application are that (1) the electronic 
trading system software utilized by CBB has been developed by CBB, 
rather than purchased from EJV, and (2) the terminals through which the 
trading system may be accessed will be via CBOT suppled work stations, 
via a direct connection to a member firm's internal computer network, 
or via a vendor distribution system as described above.\21\ CCOS 
represents that their procedures for clearance and settlement of CBB 
transactions and their membership criteria have not changed since the 
time of publication of the notice of filing of CCOS's application to 
the Commission. Therefore, CCOS believes that it is appropriate at this 
time for the Commission to consider its application for exemption from 
registration as a clearing agency.
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    \21\Supra note 2.
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IV. Solicitation of Comments

    You are invited to submit written data, views, and arguments 
concerning the foregoing application by May 23, 1994. Such written 
data, views, and arguments will be considered by the Commission in 
deciding whether to grant CCOS's request for exemption from 
registration.
    In the CCOS Release the Commission requested that commentators 
address certain questions regarding the effect of the CCOS exemptive 
application upon the national clearance and settlement system. 
Specifically, the Commission invited commentators to address whether: 
(10) the Commission should require an applicant for exemption from 
registration as a clearing agency to meet standards substantially 
similar to those required of registrants to assure that the fundamental 
goals of the Act (i.e., safe and sound clearance and settlement) are 
not undermined, (2) registration of CCOS would result in increased 
competition among broker-dealers, including greater access to the 
government securities market by persons other than primary dealers, and 
among clearing agencies in the clearing of transactions in government 
securities, (3) the proposal would impose any burden on competition 
that is inappropriate under the Act, (4) CCOS's application raises the 
question of whether the establishment of multiple government securities 
clearing corporations is consistent with Section 17A of the Act, 
including whether one-account settlement could be attained with 
multiple clearing agencies and the effect of market stress on a 
multiple clearing system, (5) the manner in which multiple clearing 
facilities for cash securities and affiliated clearing facilities for 
cash securities and futures contracts on those securities could 
efficiently integrate those systems, (6) the proposed margin 
calculations and procedures adequately address the risks of the 
proposal, (7) relying on BOTCC as guarantor of CCOS's obligations, 
rather than a clearing fund or similar alternatives, ensures system 
liquidity, and (8) an order granting an exemption should contain 
certain clearing volume limits.\22\
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    \22\For a detailed analysis of these issues, see the CCOS 
Release, supra note 1, at 34108.
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    The Commission is concerned that because of the termination of the 
CBOT/EJV business relationship, commentators did not address the 
systemic concerns raised in the above questions during the previous 
comment period. Therefore, the Commission again invites the 
commentators to address the questions raised above and those raised in 
the CCOS Release.
    Persons desiring to make written submissions should file six copies 
thereof with the Secretary, Securities and Exchange Commission, 450 
Fifth Street NW., Washington, DC 20549. Reference should be made to 
File No. 600-27. Copies of the application and all written comments 
will be available for inspection at the Commission's Public Reference 
Room.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.

Appendix A

Securities and Exchange Commission
[Release No. 34-32481; File No. 600-27]
Self-Regulatory Organizations; Clearing Corporation for Options and 
Securities; Filing of Application for Exemption From Registration as a 
Clearing Agency
June 16, 1993.
    On December 14, 1992, the Clearing Corporation for Options and 
Securities (``CCOS'')\1\ filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC'') an application for exemption 
from registration as a clearing agency pursuant to section 17A of the 
Securities Exchange Act of 1934 (``Act'')\2\ and rule 27Ab2-1 
thereunder.\3\ The Commission is publishing this notice to solicit 
comments from interested persons.
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    \1\CCOS is a wholly-owned subsidiary of the Board of Trade 
Clearing Corporation (``BOTCC'') which provides clearing services 
for futures and commodities transactions executed on the Board of 
Trade of the City of Chicago (``CBOT'').
    CCOS previously filed two applications for registration as a 
clearing agency. In its first application, filed on October 14, 
1988, CCOS proposed to clear exchange-traded options issued by The 
Options Clearing Corporation. See Securities Exchange Act Release 
No. 27083 (August 1, 1989), 54 FR 32410. That application 
subsequently was withdrawn. Letter from Dennis Dutterer, Executive 
Vice-President and General Counsel, BOTCC, to Jerry Carpenter, 
Branch Chief, Division of Market Regulation, Commission (November 6, 
1991). In the second application, filed on October 21, 1991, CCOS 
proposed to clear over-the-counter options on government securities. 
This application also has been withdrawn. Letter from Dennis 
Dutterer, General Counsel, CCOS, to Jonathan Kallman, Associate 
Director, Division of Market Regulation, Commission (December 11, 
1992).
    In this regard, the Commission staff will discuss the issues 
raised by this application, which involves transactions in and 
clearing of related cash government securities and futures 
positions, with the Commodity Futures Trading Commission, the Board 
of Governors of the Federal Reserve System and the Department of the 
Treasury. This release does not address the application of the 
Commodity Exchange Act to issues discussed in this release.
    \2\15 U.S.C. 78q-1 (1988).
    \3\17 CFR 240.17Ab2-1 (1992).
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I. Introduction

    CCOS is proposing to provide clearance and settlement services for 
government securities transactions executed through Chicago Board 
Brokerage, Inc. (``CBB'').\4\ CCOS's application for exemption, filed 
on Form CA-1, includes rules, procedures, and guidelines for the 
clearance and settlement of government securities. BOTCC, as sole owner 
and parent of CCOS, will guarantee CCOS's obligations arising under 
CCOS's rules, and the clearance and settlement services of CCOS will be 
modeled after established procedures currently utilized by BOTCC.
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    \4\ CBB will be a registered broker-dealer under the Act and is 
a wholly-owned subsidiary of the CBOT. As discussed below, CBB will 
execute trades in government securities (unmatured, marketable debt 
securities in book-entry form that are direct obligations of the 
United States Government).
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    CCOS is seeking an exemption from registration as a clearing agency 
to permit CCOS to provide what it believes to be an innovative and 
important service related to the futures markets and the market for 
U.S. Treasury securities (``cash securities''). CCOS intends to file an 
application for registration as a clearing agency in the near 
future.\5\
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    \5\The Commission will publish notice of that filing in 
accordance with section 19(a)(1) of the Act at the appropriate time.
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II. Description of Proposal

A. Trade Clearance and Settlement

    As noted above, CCOS is proposing to provide clearance and 
settlement facilities for trades executed by CBB and its customers in 
the CBB trading system. The CBB trading system is designed to offer 
CBOT members an opportunity to execute a customized package of 
transactions related to Treasury futures contracts currently traded on 
the CBOT. CBB will execute the transaction as riskless principal, 
becoming the counterparty both to the buyer and to the seller. All 
trades will be effected through the CBB's electronic network.\6\
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    \6\Each participant of CBB will obtain trading terminals having 
a CPU, video display monitor, specialized keypad, and a printer, 
which will be linked by datalines to a central computer facility 
operated by EJV Partners, L.P. (``EJV''). In order to obtain a 
terminal, the CCOS participant or non-CCOS CBOT member will be 
required to enter into a ``customer agreement'' with CBB, which sets 
out the terms and conditions of access to and use of the terminals. 
In addition, an employee of a CCOS participant firm or a non-CCOS 
CBOT member or its employee obtaining a terminal will be required to 
obtain a certification that the CCOS participant clearing its 
transactions will be responsible for the acts of the CCOS 
participant employee, non-CCOS CBOT member, or non-CCOS CBOT member 
employee. Because each terminal is uniquely identified in its 
communications with the central site, CBB will know the identity of 
the customer entering each order through a terminal, i.e., the 
identity of the CCOS participant, CCOS participant employee, non-
CCOS CBOT member, or non-CCOS CBOT member employee to which the 
terminal has been made available. CCOS participants or non-CCOS CBOT 
members may establish agent terminals designed to enter quotations 
for multiple customers who are identified by subaccount numbers. CBB 
will maintain complete, time-sequenced electronic audit trails on 
all orders entered on, and all transactions executed through, the 
system. The recorded activity will indicate, for a given order or 
transaction, the identity of the customer entering, changing or 
cancelling orders, and the time and terminal through which such 
entry or change was effected, and the date, time, volume, security, 
customer, and price of each transaction executed through the system. 
Upon execution of an order, the customer will receive an electronic 
confirmation of the transaction, which can be printed out in hard 
copy on a dedicated printer connected to the customer's terminal.
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    The system will permit the trading of cash securities, 
independently and in conjunction with CBOT futures on cash securities 
(also known as ``basis contracts''),\7\ and repurchase and reverse 
repurchase agreement contracts involving cash securities (``Dollar 
Rolls'')\8\ in cash securities. Under the CBB proposal, therefore, CBOT 
traders in cash securities will be able to buy and sell securities 
underlying CBOT futures contracts and through Dollar Rolls execute 
trades that help position and inventory management.
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    \7\A basis trade is a trade in which the participants agree to 
simultaneously buy/sell cash securities against the offsetting 
equivalent CBOT Treasury futures contract. The basis represents the 
price differential between a cash security and the futures delivery 
price.
    \8\In a Dollar Roll transaction, the seller of the contract 
delivers notes or bonds to the buyer in exchange for cash. 
Settlement occurs the same day. At the same time of execution, the 
seller and buyer also agree to reverse the transaction at a price 
that includes a financing interest amount, with settlement occurring 
the next day.
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    The cash securities listed for purchase or sale will consist of 
Treasury bills (with more than fourteen days to maturity), notes, and 
bonds, in their various maturities, deliverable under financial futures 
contracts traded on the CBOT. The settlement date for outright purchase 
and sale transactions will be the next business day, except for when-
issued (``WI'') securities,\9\ which will settle on the day of issuance 
by the U.S. Treasury.
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    \9\CBB will offer WI securities for forward purchase and sale. 
WI securities are those securities that the U.S. Treasury has 
announced it will sell in a public auction on a specific date in the 
near future or that have been auctioned but not settled. WI 
securities trade in the secondary market from the time the U.S. 
Treasury announces their scheduled auction through the actual 
issuance of the securities. The Treasury announces the auction date, 
the maturity date of the securities, and the par amount to be 
auctioned. WI securities trade on the basis of yield to first call, 
instead of price, because the coupon rate for the securities is not 
determined until the auction.
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    The system will permit users to execute basis trades as a single 
transaction where the price will reflect the spread in basis points 
between the futures contract and the underlying cash securities; the 
cash securities will be priced at a certain number of basis points 
above or below the futures contract.\10\
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    \10\The futures leg of the basis trade will take the last 
reported trade price from the CBOT trading floor as the futures 
transaction price. The transaction ticket for the cash leg of basis 
trades will include the commission charges and accrued interest. 
Settlement for the cash leg will occur on the next business day in 
the same manner as outright cash trades.
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    Dollar Roll transactions are designed to facilitate the financing 
of cash securities or the loaning of excess funds in exchange for cash 
securities.\11\ Dollar Rolls will result in the creation of two 
simultaneous outright cash trades. For trades executed during the 
morning session, the first leg will be for same day (``T'') settlement 
and the second leg will be for next day (``T+1'') settlement. Dollar 
Rolls executed in the afternoon session will settle the first leg on 
T+1 and the second leg on the following business day (``T+2). CBB will 
have one trading session for Dollar Rolls from the opening of trading, 
8 a.m. to 11 a.m., and an afternoon session for Dollar Rolls from 3:15 
p.m. to 5 p.m.\12\
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    \11\The CBB terminals will list the Dollar Roll spreads by 
bidding and offering financing rates reflecting the annualized 
interest rate paid or received on the transaction. The transaction 
amount or value price on the trade date will reflect the settlement 
value of the first leg of the Dollar Roll. The settlement value is 
the funds required to make or take delivery of the security. The 
transaction amount for the second leg of the Dollar Roll will 
reflect the fact that the holder of the overnight bond will not earn 
the coupon interest during the term of the transaction.
    \12\Unless otherwise noted, all times stated are Eastern 
Standard Time.
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    Under the proposal, CBB will submit computer matched trades to CCOS 
on a real time basis so that trade data executed through CBB 
immediately flows to CCOS. CCOS will perform all clearance and 
settlement functions for transactions in cash securities, including: 
Delivery versus payment processing, position consolidation, and 
original and variation margin calculation and processing as discussed 
below. BOTCC will enter into a cross-margining agreement with CCOS that 
will allow common participants to combine cash securities and futures 
positions for cross-margining purposes.\13\ BOTCC will act as guarantor 
of CCOS's obligations arising under CCOS's rules and will provide 
collection and payment services for CCOS variation and original margin 
payments.
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    \13\All cash securities positions traded through CBB will be 
held in the participants cross-margin account at CCOS. Futures 
positions generated by CBB basis trades for proprietary accounts are 
automatically placed in the cross-margin account at BOTCC while 
futures positions from customer basis trades executed through CBB by 
participants will not be permitted to be placed in the cross-margin 
account but will be transferred to the participants' BOTCC customer 
account. Participants may allocate futures from their BOTCC 
proprietary futures account to their BOTCC/CCOS cross-margin account 
to hedge unsettled cash securities, thereby reducing risk and 
original margin requirements.
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    CCOS will net for each participant all delivery obligations of the 
same CUSIP number. All delivery versus payment calculations will be 
monitored and controlled by CCOS, and the delivery instructions sent to 
the settlement bank (The Bank of New York) will reflect the daily 
settlement value marked to the market. Delivery and payment will occur 
through the Fedwire system. Thus, all CCOS participants must establish 
clearing arrangements with a bank having access to Fedwire. CCOS will 
carry forward any fails to deliver securities on a cumulative basis, 
after making those obligations to market value and collecting, as 
necessary, additional variations margin.
    The settlement prices for cash securities will be based upon the 
cash market indications at the close of futures trading (3 p.m.) plus 
the accrued interest amounts for each security.\14\ CCOS will mark all 
net cash deliverable positions\15\ to the settlement values.
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    \14\Initially, the cash market indications for settlement prices 
will be provided by EJV.
    \15\The net cash deliverable position will reflect all 
outstanding cash positions, including outright trades, cash legs 
from basis trades, and Dollar Rolls. These positions will be 
reported to members by CUSIP number and settlement date. CCOS will 
have two daily processing cycles for determining net cash positions, 
mid-day and end of day. A participant with a same day delivery 
requirement because of a Dollar Roll transaction will be considered 
to have delivered in that position and the net cash deliverable 
position for that security will not be included in the mid-day 
original margin calculations. Any failed same day delivery 
obligations will be accounted for in the end of day processing 
cycle.
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B. System Safeguards

(1) Participation Standards
    Participants in CCOS will be required to meet initial and 
continuing financial and operational standards, as determined by the 
CCOS board of directors and administered by CCOS management. CCOS will 
monitor each participant's financial condition as measured by its 
financial stability, the level and quality of its earnings, and other 
generally accepted measures of liquidity, capital adequacy, and 
profitability. In addition, CCOS will require each member to maintain 
personnel and facilities adequate to ensure the expeditious and orderly 
transaction of business with CCOS or other participants. Participation 
in CCOS will be limited to members of BOTCC and members of the CBOT 
that are affiliated with members of BOTCC.\16\
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    \16\BOTCC's by-laws require BOTCC members to be CBOT members, 
approved by the CBOT board of directors for BOTCC membership. In 
addition, the BOTCC board of directors sets, from time to time, 
BOTCC membership requirements, including, but not limited to, 
financial and operational requirements, continuing compliance with 
CBOT and BOTCC rules, financial and other reporting, and such other 
factors as the BOTCC board may consider necessary or appropriate in 
assessing an applicant's suitability for participation in BOTCC. 
BOTCC also has the authority to require additional capital on a 
discretionary basis and parental guarantees on member proprietary 
positions. See, e.g., BOTCC By-Law 401.
    Minimum financial requirements for CBOT futures commission 
merchants (``FCMs'') include Adjusted Net Capital (as defined in 
CBOT's rules) of the greater of $250,000 or 4 percent of the funds 
required to be segregated and the foreign futures and options 
secured amount pursuant to the Commodities Exchange Act, 7 U.S.C. 1, 
et seq. (1988), exclusive of the market value of commodity options 
purchased by option customers on or subject to the rules of a 
contract market up to the amount of customer funds in such option 
customer's account, plus an amount equal to guarantee deposits with 
clearing organizations, other than the CBOT, to the extent those 
assets cannot be used for margin purposes. The minimum financial 
requirements for CBOT broker-dealer/FCM members are similar to those 
for FCMs, although the broker dealers/FCMs also are subject to 
Commission rule 15c3-1(a), 17 CFR 240.15c3-1(a) (1992), limitations. 
CBOT Rules, Chapter 2, Rule 201.
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(2) Margin Payment/Collection
    CCOS proposes to adopt, as one of its principal safeguards, a 
practice of collecting original and variation margin on participant 
obligations. CCOS proposes to adopt, in essence, the margin calculation 
and payment time frames currently used by BOTCC in connection with its 
clearance of CBOT futures contracts, modified to address specific 
aspects of the government securities market. Thus, for risk management 
purposes, CCOS\17\ will convert cash securities to futures contract 
equivalents and then calculate original and variation margin. CCOS will 
calculate margin requirements at least twice daily, reflecting activity 
from 8 a.m. to 1:30 p.m. and activity from 1:30 p.m. to 5 p.m. CCOS\18\ 
will collect margin deficiencies from participants at 4 p.m. and 7:40 
a.m. on T+1, and will retain the authority to collect additional margin 
at any time.
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    \17\BOTCC, as facilities manager, will perform all margin 
calculations pursuant to a cross-margining agreement on positions in 
the cross-margining account for the benefit of both CCOS and BOTCC.
    \18\BOTCC, as facilities manager, will perform all margin 
collection/payment functions on behalf of CCOS. CCOS will collect 
commissions and settlement payments through its agent, the Bank of 
New York.
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    Original margin is a performance bond on all positions that will be 
delivered and not otherwise offset before delivery. The performance 
bond for all trades generally will be collected at 7:40 a.m. on T+1. 
The second requirement, variation margin, is a mark to the market 
payment, collected on a twice daily basis to account for changes in the 
value of the positions before the delivery process.
    Original margin requirements will be calculated at 2:30 p.m. for 
trades executed from the 8 a.m. opening until 1:30 p.m. The original 
margin will be updated at 4 a.m. on T+1 to include trades executed from 
1:30 p.m. on T until 4 a.m. on T+1, \19\ and the total original margin 
requirement will be collected at 7:40 a.m. on T+1. In the event a 
clearing member fails to perform obligations to CCOS, the original 
margin will be used to cover any financial liabilities which may result 
from the failed obligation.
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    \19\Up until 4 a.m., CCOS will permit transactions executed on 
the Globex Trading System to be included in the cross-margin account 
for the regular 7:40 a.m. original and variation margin pay/collect.
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    For mid-day processing at 3 p.m., CCOS will establish a settlement 
value for cash securities trades executed between 8 a.m. and 1:30 p.m. 
CCOS will mark new positions from their transaction value, established 
at the execution of the trade, to the settlement value, \20\ reflecting 
gains or losses in the interim period, and CCOS will mark open 
positions that were previously marked to the prior day's settlement 
value to the new settlement value.\21\ CCOS will calculate each 
participant's variation margin pay/collect amount and transmit the data 
to BOTCC for margin payment or collection. Payment or collection 
amounts for each participant will include the combined variation 
effects of the cash and futures positions in the participant's cross-
margined account. Participants will pay or collect midday variation 
margin in same-day funds by 4 p.m. each day, through their settlement 
banks. BOTCC will pay out 80% of variation gains in excess of original 
margin deficits\22\ and will collect 100% of variation losses.
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    \20\Settlement values will reflect the settlement price 
established twice a day (obtained from EJV) and will include accrued 
interest, but will not include commissions and finance charges from 
Dollar Rolls.
    \21\The transaction value provided by CBB to CCOS will include 
the accrued interest paid or received on each transaction. For 
normal deliveries the accrued interest at the time of the 
transaction and at marking to market are the same amount, but for 
failed deliveries the seller will have to pay the incremental 
accrued interest for each day the fail continues. The daily 
variation margin payments will include this incremental accrued 
interest.
    \22\CCOS will withhold distribution of any variation margin gain 
from participants with original margin requirement deficits.
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    Trades executed from 1:30 p.m. through the end of the day's trading 
session, 5 p.m., will be marked to the 3 p.m. settlement value, and the 
variation margin on the entire position will be calculated at the end 
of the day. Participants will pay or collect the second variation 
margin obligation the following morning at 7:40 a.m. CCOS will send 
delivery instructions for normal settlement of cash securities 
transactions executed on T to the participants' settlement banks at 
11:30 a.m. on T+1.\23\
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    \23\Participants may transact Dollar Rolls (with same-day 
settlement for the first leg) between 8 a.m. and 11 a.m. on T+1 to 
offset delivery obligations due to settle on T+1.
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(3) Margin Calculation
    CCOS believes cross-margined cash securities and futures products 
have essentially the same market and credit risks. Therefore, in 
establishing the original margin (or performance bond) for cash 
securities it clears, CCOS will use the original margin rates for 
futures contracts\24\ established by the Board of Governors of BOTCC 
following recommendations of the BOTCC Margin Committee.\25\
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    \24\BOTCC collects clearing member margin on a portfolio, or 
net, basis, reflecting the overall risk to the clearing corporation 
associated with the totality of contracts in that clearing member's 
portfolio. BOTCC uses a portfolio-based simulation model, the 
Standard Portfolio Analysis (``SPAN'') system, which establishes 
parameters to collect original margins based on the simulated losses 
of clearing member portfolios under various scenarios.
    \25\The BOTCC Margin Committee is comprised of five of the nine 
Governors of the BOTCC Board of Governors. All nine Governors are 
owners of officers of BOTCC clearing member firms. The BOTCC Margin 
Committee meets once a month or at the call of the BOTCC Board 
Chairman or the Margin Committee Chairman. The Committee bases its 
recommendation upon review by BOTCC and CBOT staff of the conditions 
of the market place, including: statistical analysis of central 
tendencies, dispersion, and correlations between price changes of 
different commodities. Additionally, the Committee draws upon the 
experiences of its members and uses their judgment to predict market 
conditions in the near future. From this information, the Margin 
Committee will typically set margin rates that cover approximately 
the 95th percentile of absolute daily price changes over the 
previous one, three, and six month periods.
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    Original margin represents a performance bond that both buyers and 
sellers must post when entering the market to assure that their 
respective contractual obligations will be satisfied. In order to 
margin cash securities and futures positions in a parallel fashion, 
CCOS will convert cash securities to their futures-equivalents prior to 
original margin determination. CCOS will convert cash securities 
positions to future-equivalents based upon conversion factors, as 
published by the CBOT, for the nearest futures delivery month and the 
futures contract par amounts (face values).\26\ CCOS will net the 
futures-equivalent positions of all cash securities deliverable into 
each futures contract to produce a net cash futures-equivalent position 
for each futures contract.\27\ An example of the effect of the proposed 
margin system on a hypothetical portfolio is attached as Exhibit A.

    \26\The formula for the conversion of cash securities is:
    Since bonds being delivered into futures contract obligations 
will have greater or lesser value than the futures, the conversion 
factor is a means of equating bonds with various coupons and 
maturity dates with the standard bond set by BOTCC. The standard 
bond, which is equal to the corresponding future, has an 8% coupon 
and a conversion factor of 1.
    For example, assume there are three bonds, Bond X, Bond Y, and 
Bond Z. Bond X is the standard bond having an 8% yield to maturity 
and conversion factor of 1 (Bond X is equal to the corresponding 
future). Bond Y is worth 1.5 times Bond X and Bond Z is worth 1.75 
times Bond X (Bonds Y and Z could have greater coupon rates or 
longer periods to maturity). If the future is trading at 85 then 
Bond X is worth 85 and Bond Y is worth 1.5 times 85. Therefore, 1.5 
is the conversion factor for Bond Y and 1.75 is the conversion 
factor for Bond Z. In order to determine the number of futures that 
equate with Bond Y, the face amount of Bond Y is multiplied by the 
conversion factor, producing the futures value amount. The futures 
value amount when divided by 100,000 (each futures contract equals 
$100,000) yields the number of futures contracts equal to the bond.
    \27\Futures on cash securities act as an index of the many bonds 
deliverable into them. Treasury bonds (``T-bonds'') having at least 
fifteen years remaining to maturity are deliverable into the T-bond 
future. Ten-year Treasury notes (``T-notes'') must have maturities 
between six and one-half and ten years to be deliverable into the 
ten-year T-note future. Five-year T-note futures accept Treasury 
notes with time to maturity between four years; three months and 
five years, three months. Two-year notes having maturities between 
one year, nine months and two years are deliverable into the two-
year T note future.

                                                                                                                                                        
                                                                         Cash Par Amounts X Conversion Factor                                           
                                        Futures-Equivalents=     ----------------------------------------------------                                   
                                                                                  Futures Par Amount                                                    
                                                                                                                                                        

(4) Credit Enhancement
    In addition to collecting margin from participants for open 
positions, CCOS proposes to rely on the assets and credit of its 
parent, BOTCC, to meet any liquidity demands CCOS may incur. Under the 
proposed system, BOTCC will guarantee all of CCOS's obligations to 
participants arising under CCOS's rules. CCOS intends for the BOTCC 
guarantee to take the place of a clearing fund composed of participant 
contributions of cash or liquid securities.\28\
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    \28\BOTCC, as a commodities clearing corporation, guarantees the 
settlement of all futures and options contracts traded on the CBOT 
and cleared by BOTCC. BOTCC will extend this guarantee to the 
obligations of CCOS. BOTCC has total shareholders' equity of over 
$110 million, including current assets of over $109 million with the 
large majority in U.S. Treasury bills and notes. Its current 
liabilities are approximately $3.5 million. In addition, BOTCC has 
credit enhancement facilities in place in the form of lines of 
credit totalling $300 million. See 1992 BOTCC Annual Report [File 
No. 600-27].
    As a general rule, the Commission has recommended that a 
clearing agency have a clearing fund which (1) is composed of 
contributions based on a formula applicable to all users; (2) is in 
cash or highly liquid securities; and (3) is limited in the purpose 
for which it may be used. Securities Exchange Act Release No. 16900 
(June 17, 1980), 45 FR 41920. Its use should be limited to 
protecting participants and the clearing agency from participant 
defaults and unusual, significant clearing agency losses. Id.
    The Commission has permitted a clearing agency, Delta Government 
Options Corp. (``Delta''), to register without a clearing fund. 
There, the Commission relied on other factors to determine that 
Delta's risk management system was adequate despite the lack of a 
clearing fund. See Securities Exchange Release No. 26450 (January 
12, 1989), 54 FR 2010.
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III. Public Interest Statement

    CCOS believes that granting CCOS an exemption from clearing agency 
registration during the period before full registration is granted is 
critical to enabling CBB to enter the cash government securities 
business. CCOS maintains that the CCOS/CBB business plan will provide 
increased access to the cash securities markets through an integrated 
electronic transaction and margin system, which, CCOS believes, lowers 
transaction costs, creates processing and cash flow efficiencies, 
provides credit enhancement, ensures fairness and price transparency, 
and provides a complete audit trail. CCOS asserts that these 
efficiencies are created because of the computerization that will 
eliminate back-office paperwork and shorten settlement cycles by 
decreasing the time required for order entry, trade matching, netting, 
and telecommunication to the appropriate clearing agency.
    CCOS believes that the CCOS/CBB trading and clearance systems will 
enable persons other than primary dealers to participate in the 
government securities market while controlling counterparty risk. Also, 
the CCOS/CBB system will preserve a key feature of the existing 
interdealer broker system: anonymous trading without substantial 
counterparty risk.
    CCOS believes further that the ability to net (cross-margin) 
original and variation margin with respect to futures positions cleared 
at BOTCC and cash securities positions cleared at CCOS will eliminate 
duplicative performance bond requirements that do not reflect 
collective market risk, exemplifying the type of link mandated by 
section 17A(a)(1)(D) of the Act.\29\ Furthermore, CCOS believes that 
these links are consistent with Congress's direction to the SEC in the 
Market Reform Act of 1990\30\ to facilitate linked or coordinated 
facilities for clearance and settlement of securities, options, 
futures, options on futures, and commodity options. Also, by applying 
same-day margining and cash flow conventions of the futures market to 
cash transactions, CCOS believes it will further ``the development of a 
modern, nationwide system for the safe and efficient handling of 
securities transactions in a manner which best serves the financial 
community and investing public.''\31\ Finally, because the SEC will 
impose and monitor certain volume limits during the period CCOS 
operates under exemption from registration, CCOS believes that its 
operations will not present increased risk to the marketplace.
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    \29\15 U.S.C. 17A(a)(1)(D)(1988).
    \30\Market Reform Act of 1990, Pub. L. No. 101-432, 104 Stat. 
963 (1990) (``Market Reform Act'').
    \31\Conference Report to Accompany S. 249, H.R. Rep. No 229, 
94th Cong., 1st Sess. 102 (May 19, 1975).
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IV. Specific Request for Comments

A. Statutory Standards

    Section 17A of the Act directs the Commission to develop a national 
clearance and settlement system through, among other things, the 
registration and regulation of clearing agencies. The statutory scheme 
contemplates that clearing agencies not only provide clearance and 
settlement functions consistent with statutory goals, but also that 
those clearing agencies, as self-regulatory organizations, exercise 
certain regulatory functions in furtherance of other statutory goals. 
In fostering the development of a national clearance and settlement 
system generally and in overseeing clearing agencies in particular, 
section 17A authorizes and directs the Commission to promote and 
facilitate certain goals with due regard for: The public interest, the 
protection of investors, the safeguarding of securities and funds, and 
maintenance of fair competition among brokers, dealers, clearing 
agencies, and transfer agents.\32\ Further, section 17A, as amended by 
the Market Reform Act, directs the Commission to use its authority to 
facilitate the establishment of linked or coordinated facilities for 
clearance and settlement of transactions in securities, securities 
options, contracts of sale for future delivery and options thereon, and 
commodity options.\33\
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    \32\For legislative history concerning Section 17A of the Act, 
See, e.g., Report of Senate Comm. on Housing and Urban Affairs, 
Securities Acts Amendments of 1975: Report to Accompany S. 249, S. 
Rep. No. 75, 94th Cong., 1st Sess. 4 (1975); Conference Comm. Report 
to Accompany S. 249, Joint Explanatory Statement of Comm. of 
Conference, H.R. Rep. No. 229, 94th Cong., 1st Sess. 102 (1975).
    \33\Market Reform Act of 1990, section 5, amending section 
17A(a)(2) of the Securities Exchange Act of 1934, 15 U.S.C. 78q-1 
(1990).
---------------------------------------------------------------------------

    Section 17A(b)(1) of the Act authorizes the Commission to exempt 
applicants from some or all of the requirements of section 17A if it 
finds such exemptions are consistent with the public interest, the 
protection of investors, and the purposes of Section 17A, including the 
prompt and accurate clearance and settlement of securities transactions 
and the safeguarding of securities and funds. Historically, the 
Commission has never exercised its authority to exempt an applicant 
entirely from the requirements of section 17A of the Act. The 
Commission has, however, granted newly registered clearing agencies 
narrowly drawn, temporary exemptions from specific statutory 
requirements imposed by section 17A, in a manner that achieves 
statutory goals.\34\
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    \34\See e.g., order approving Government Securities Clearing 
Corporation's (``GSCC'') temporary registration as a clearing agency 
where the Commission temporarily exempted GSCCC from compliance with 
section 17A(b)(3)(C) of the Act. Securities Exchange Act Release No. 
25749 (May 24, 1988), 53 FR 19839.
---------------------------------------------------------------------------

    The Commission recognizes that clearing agencies, more than other 
self-regulatory organizations, pose systemic safety and soundness 
concerns. Accordingly, the Commission has published standards for 
clearing agency registration and exercises significant continuing 
oversight of all aspects of clearing agency operations and 
functions.\35\ The market crash in October 1987 and decline in October 
1989 demonstrated the central role of clearing agencies in U.S. 
securities markets in reducing risk, improving efficiency, and 
fostering investor confidence in the markets.\36\
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    \35\See Securities Exchange Act Release Nos. 16900 (June 17, 
1980), 45 FR 41920 (announcement of standards for the registration 
of clearing agencies (``Standards Release'')) and 20221 (September 
23, 1983), 48 FR 45167 (omnibus order granting full registration as 
clearing agencies to The Depository Trust Company, Stock Clearing 
Corporation of Philadelphia, Midwest Securities Trust Company, The 
Options Clearing Corporation, Midwest Clearing Corporation, Pacific 
Securities Depository, National Securities Clearing Corporation, and 
Philadelphia Depository Trust Company). See also Section 19 of the 
Act, 15 U.S.C. 78s (1988), and rule 19b-4, 17 CFR 240.19b-4 (1992), 
setting forth certain procedural requirements for registration and 
continuing Commission oversight of clearing agencies and other 
selfregulatory organizations.
    \36\Gerald Corrigan, President of the Federal Reserve Bank of 
New York (``FRBNY''), noted: ``[T]he greatest threat to the 
stability of the financial system as a whole [during the 1987 market 
break] was the danger of a major default in one of these clearing 
and settlement systems.'' Luncheon Address: Perspectives on Payment 
System Risk Reduction by E. Gerald Corrigan, President, FRBNY, 
reprinted in the U.S. Payment System: Efficiency, Risk and the Role 
of the Federal Reserve 129-30 (1990).
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    In light of the foregoing, the Commission preliminarily believes it 
is appropriate for applicants requesting exemption from clearing agency 
registration to meet the standards substantially similar to those 
required of registrants to assure that the fundamental goals of the Act 
(i.e., safe and sound clearance and settlement) will not be undermined. 
Thus, the Commission invites commentators to address whether the 
Commission should apply those standards, subject to appropriate 
modifications, in considering CCOS's application for exemption from 
clearing agency registration while assuring achievement of the goals of 
section 17A of the Act.
    The Commission also invites commentators to address whether 
granting the proposed exemption would further the goals of section 17A 
and whether attaching specific conditions to that exemption, if any, 
would be appropriate to further specific statutory goals. Specifically, 
would granting the exemption further the development of a national 
clearance and settlement system, promote linked and coordinated 
clearing facilities (among options, futures, and securities), and 
promote the maintenance of fair competition?

B. Fair Competition

    Section 17A of the Act requires the Commission, in exercising its 
authority under that Section, to have due regard for the maintenance of 
fair competition among clearing agencies.\37\ In addition, no clearing 
agency may be registered, if its rules ``impose any burden on 
competition not necessary or appropriate in furtherance of the 
purposes'' of the federal securities laws.\38\ The Commission therefore 
must consider an applicant's likely affect on competition and on the 
nation's securities markets in its review of any application to 
register as a clearing agency.\39\ Accordingly, to the extent that 
approval of CCOS's application for exemption from registration will 
restrain competition and, at the same time, benefit other statutory 
goals, the Commission must balance those benefits against the resulting 
restraint on competition. The Commission emphasizes that within the 
constraints of this balancing test, the Commission consistently has 
demonstrated its strong preference for eliminating barriers to 
competition.Where possible, the Commission has looked to regulatory or 
market discipline to create an atmosphere where competition may be 
expanded.
---------------------------------------------------------------------------

    \37\15 U.S.C. 78q-1(a)(2) (1988).
    \38\15 U.S.C. 78q-1(b)(3)(I) (1988).
    \39\See Bradford National Clearing Corporation v. S.E.C., 590 
F.2nd 1085 (D.C. Cir., 1978). The court noted:
    To the extent the legislation history provides any guidance to 
the Commission in taking competition concerns into consideration in 
its deliberations on the national clearing system, it merely 
requires the [Commission] to ``balance'' those concerns against all 
others that are relevant under the statute. Id at 1105.
---------------------------------------------------------------------------

    Consistent with this approach, the Commission invites commentators 
to address whether registration of CCOS would result in increased 
competition among broker-dealers, including greater access to the 
government securities market by persons other than primary dealers, and 
among clearing agencies, such as GSCC, in the clearing of transactions 
in government securities.\40\ Such competition may result in the 
development of improved systems capabilities, new services offered, and 
perhaps lower prices to participants.
---------------------------------------------------------------------------

    \40\Currently, the only registered clearing agency that offers a 
centralized, automated system for the clearance and settlement of 
trades in cash government securities is GSCC. GSCC offers comparison 
and netting services to members and functions as a risk assessment, 
credit risk reduction, and risk containment facility for eligible 
trades in government securities that are submitted to GSCC for 
comparison and netting. See Securities Exchange Act Release No. 
25749 (May 24, 1988), 53 FR 19639 (order approving the temporary 
registration of GSCC as a clearing agency).
---------------------------------------------------------------------------

    The Commission invites commentators to address whether the proposal 
would impose any burden on competition that is inappropriate under the 
Act. In particular, would CCOS's ability to offer cross-margin 
facilities to members for inter-market trades involving cash securities 
and futures have such a result if GSCC cannot offer its members cross-
margin facilities on the same terms and conditions as CCOS offers its 
members? If such a result would ensue, what if any steps should the 
Commission take to facilitate a level field of competition between CCOS 
and other clearing agencies? For example, should the Commission take 
steps to ensure that GSCC is given reasonable access to the open 
interest in particular futures or futures options products held by 
BOTCC or to any cross-lien arrangement for cash securities and futures 
products entered into between BOTCC and CCOS?

C. Common Clearing of Government Securities

    As stated above, section 17A directs the Commission to develop a 
national system for the prompt and accurate clearance and settlement of 
securities transactions. In carrying out this responsibility, the 
Commission is authorized and ordered to facilitate the establishment of 
linked or coordinated facilities for the clearance and settlement of 
securities, securities options, contracts of sale for future delivery 
and options thereon, and commodity options.\41\ This is largely 
because, as the Act states, ``the linking of all clearance and 
settlement facilities and the development of uniform standards and 
procedures for clearance and settlement will reduce unnecessary costs 
and increase the protection of investors and persons facilitating 
transactions by and on behalf of investors.''\42\
---------------------------------------------------------------------------

    \41\15 U.S.C. 78q-1(a)(2)(A)(ii) (1988).
    \42\15 U.S.C. 78q-1(a)(1)(D) (1988). Past Commission actions 
support this approach. For example, in 1973, the Commission directed 
the exchanges to develop a centralized system for the clearance and 
settlement of standardized options either through the formation of a 
resulting single clearing entity or through multiple interfaced 
entities. See Securities Exchange Act Release No. 11144 (December 
19, 1974), 39 FR 45333. (The exchanges proposed and the Commission 
approved the establishment of OCC as the sole entity for the 
clearance and settlement of standardized options.) The Commission 
believed the resulting single entity approach was consistent with 
Commission policy favoring one-account settlement. See Securities 
Exchange Act Release No. 10631 (February 7, 1974), 39 FR 9717.
    The Commission next addressed the structure of the national 
system for corporate debt and equity securities traded on exchanges, 
through NASDAQ facilities, and over-the-counter. In 1977, the New 
York Stock Exchange, American Stock Exchange, and the National 
Association of Securities Dealers clearing facilities merged into 
one entity, the National Securities Clearing Corporation (``NSCC''). 
In balancing the goal of clearing organization competition against 
enhanced broker-dealer competition, the Commission chose to place 
greater emphasis on the latter and to permit the proposed merger to 
occur, subject to the condition, among others, that NSCC establish 
interfaces, without fees, with other competing clearing 
organizations in support of the one-account settlement concept.
---------------------------------------------------------------------------

    CCOS's application, in effect, raises the question of whether the 
establishment of multiple government securities clearing corporations 
is consistent with section 17A of the Act and one-account settlement. 
The introduction of multiple clearing agencies into the government 
securities markets could increase the risks entailed in liquidating 
defaulting participants. One of the benefits of a single clearing 
agency is centralized default administration. Accordingly, 
fragmentation of the government securities clearance and settlement 
system, particularly in light of the netting of government securities 
by GSCC, could impede the prompt resolution of member defaults.\43\ As 
the October 1987 break illustrated, an unexpected market move may cause 
a clearing member to default on its obligations to its clearing 
organization. Based on its experience in October 1987 and October 1989, 
the Commission believes that coordinating the prompt resolution of such 
a default is critical to maintaining the stability of a clearing 
corporation and its members.\44\
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    \43\Expeditious transfer of customer accounts, for example, may 
be more difficult with two government securities clearing agencies. 
This is but one example of areas where coordination will be more 
difficult.
    \44\See Division of Market Regulation, Market Analysis of 
October 13 and 16, 1989, Chapter 5 (December 1990).
---------------------------------------------------------------------------

    In addition, the Commission seeks comment on whether or not one-
account settlement can be achieved if CCOS's application is approved. 
Specifically, the Commission seeks comment on whether or not the 
different forms of netting by GSCC and CCOS\45\ would preclude one-
account settlement. Therefore, the Commission requests comment on 
whether it should approve or deny the CCOS application, which, if 
granted, would result in multiple clearing facilities for government 
securities.
---------------------------------------------------------------------------

    \45\In its effort to manage systemic risk in the clearance and 
settlement of government securities, GSCC seeks to reduce net 
settlement positions of participants by netting offsetting 
government securities transactions in the same CUSIP number, thereby 
eliminating delivery obligations. CCOS intends to hedge futures 
positions held by participants with the participant's futures-
equivalent cash government securities which have not settled, 
thereby recognizing for margining purposes the offsetting risks of 
the positions.
---------------------------------------------------------------------------

    Commentators should discuss applicable law and the costs and 
benefits of single versus multiple clearing facilities for government 
securities, including whether the risk exposure to individual clearing 
organizations would be increased by the fragmentation in the netting of 
cash securities. Finally, commentators should address the effects that 
market stress (e.g., high volume and volatility) likely would have on 
such a multiple clearing system.

D. Linkage of Multiple Clearing Systems

    Section 17A(a)(2)(A)(ii) of the Act\46\ specifically requires the 
Commission to ``facilitate the establishment of a national system of 
linked or coordinated facilities for clearance and settlement of 
transactions in securities, securities options, contracts of sale for 
futures delivery and options thereon, and commodity options.'' The 
Commission requests comment on the manner in which multiple clearing 
facilities for cash securities and affiliated clearing facilities for 
cash securities and futures contracts on those securities could 
efficiently integrate those systems. Commentators should address, 
without limitation: the manner in which clearing organizations would 
assure payment of obligations to other clearing organizations, the 
manner in which multiple clearing systems should respond to common 
member defaults and the default of a clearing organization, the manner 
in which multiple clearing systems should allocate costs associated 
with integration and services performed for one another, and the manner 
in which multiple clearing systems should operate net money settlement 
with their members and among themselves.
---------------------------------------------------------------------------

    \46\15 U.S.C. 78q-1(a)(2)(A)(ii) (1991).
---------------------------------------------------------------------------

    Specifically, the Commission asks that commentators address, 
without limitation, the proposed margin calculations and procedures, 
operational safeguards, and legal and other policy issues related to 
linking these markets. In this regard, commentators are asked to state 
specifically any benefits or risks the proposed system may pose to the 
clearance and settlement of government securities.

E. Risk Management

    As described in detail above, CCOS will treat cash securities, for 
risk management purposes, as futures contract equivalents, and then 
calculate original and variation margin. Consistent with this approach, 
CCOS intends to cross-margin cash securities positions it clears with 
futures contracts cleared by BOTCC. Commentators are asked to consider 
the proposed margin calculations and procedures, and address the 
perceived benefits and risks of the proposal. The Commission also seeks 
comment on whether, during the exemptive period, the Commission should 
require that CCOS impose margin rate floors below which the margin 
rates may not be lowered. The margin rate floors would apply to all 
original and maintenance margin rates for all futures, futures-
equivalent cash securities, and basis spreads, and include limits on 
intercommodity spread credits provided by CCOS. Further, the Commission 
invites commentators to address whether, given the unique role of BOTCC 
as a clearing agency for the futures contract market, it would be 
prudential and appropriate for BOTCC to represent that it will maintain 
minimum levels of margin during the exemptive period to insure safety 
and soundness in the clearance and settlement of government securities.
    The CCOS application would expand the group of participants trading 
in the government securities market. As discussed above, CCOS 
participants and non-CCOS CBOT members will be able to access the cash 
market through terminals located on the floor of the CBOT. Commentators 
are asked to address the perceived benefits and risks associated with 
expanding the base of participants in the government securities market. 
Commentators also should address the perceived risks posed to the 
national clearance and settlement system from permitting participants 
with relatively smaller capital bases than at present to trade in 
government securities.\47\
---------------------------------------------------------------------------

    \47\Supra note 16 and accompanying text.
---------------------------------------------------------------------------

    Like other clearing corporations, CCOS will assume all counterparty 
credit risk by guaranteeing all matched trades executed through CBB. 
The Commission believes that a clearing agency should be an adequately 
funded entity capable of providing the guarantee and performing risk 
management functions. While section 17A does not set standards for 
clearing agency capitalization, the Commission has required other 
clearing agencies to meet certain minimum requirements.\48\ As 
discussed above, the Commission generally recommends that a clearing 
agency have a clearing fund, use of which is limited to protecting 
participants and the clearing agency from participant defaults and 
unusual, significant clearing agency losses.\49\ In lieu of such 
clearing fund, BOTCC proposes to guarantee all of CCOS's obligations 
arising under CCOS's rules, and CCOS, therefore, proposes to rely on 
the assets and credit of its parent, BOTCC, to meet any liquidity 
demands CCOS may incur.\50\ Commentators are asked to address the 
perceived risks of relying on BOTCC as guarantor of CCOS's obligations, 
rather than a clearing fund or similar alternatives to ensure system 
liquidity. Specifically, the Commission seeks comment on appropriate 
levels of capitalization for CCOS and whether the BOTCC guarantee is 
sufficient, considering the extent of BOTCC's guaranteed obligations in 
the futures contract markets and other obligations, to meet the 
Commission's standards ensuring the safeguarding of securities and 
funds.
---------------------------------------------------------------------------

    \48\E.g., prior to its original temporary registration, GSCC 
represented to the Commission that the capital from its initial 
stock offering was intended to exceed $5 million. In addition to its 
contributed capital, GSCC maintains a clearing fund designed to: (1) 
Have on deposit from each netting member cash or other collateral 
sufficient to satisfy a loss as a result of that member's default 
and subsequent close-out of settlement positions; (2) maintain total 
assets in an amount sufficient to satisfy potential losses to GSCC 
resulting from the default of more than one member; and (3) ensure 
that GSCC has sufficiently liquidity at all times to meet its 
payment and delivery obligations. Securities Exchange Act Release 
No. 25740 (May 24, 1988), 53 FR 19839 and 27006 (July 7, 1989), 54 
FR 29798.
    \49\Supra note 28.
    \50\Although most clearing agencies employ some form of risk 
mutualization among participants, risk mutualization is not mandated 
by the Act. In those cases where the Commission has not required a 
clearing fund or risk mutualization, there have been credit 
enhancement facilities maintained by such clearing agency. See 
Securities Exchange Act Release No. 27611 (January 12, 1990), 55 FR 
1890 [File No. 600-24] (order granting temporary registration as a 
clearing agency to Delta Government Options Corporation).
---------------------------------------------------------------------------

    Finally, given the heightened concerns of safety and soundness in 
the approval of an application for exemption from registration as a 
clearing agency, the Commission seeks comment on whether an order 
granting an exemption should contain certain clearing volume limits. 
Such limits could provide a measure of protection during the exemptive 
period so that the clearance and settlement system for government 
securities would not be subject to unnecessary risks. Specifically, 
commentators should address the structure of such volume limits and the 
appropriate level of such limits.

V. Solicitation of Comments

    You are invited to submit written data, views, and arguments 
concerning the foregoing application by July 23, 1993. Such written 
data, views, and arguments will be considered by the Commission in 
deciding whether to grant CCOS's request for exemption from 
registration. Persons desiring to make written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549. Reference 
should be made to File No. 600-27. Copies of the application and all 
written comments will be available for inspection and copying at the 
Commission's Public Reference Room, 450 Fifth Street, NW., Washington, 
DC 20549.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\51\
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    \51\17 CFR 200.30-3(a)(16) (1992).
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Jonathan G. Katz,
Secretary.

Exhibit A

    As an example of the original margin calculation, assume a 
participant had both cash securities and futures contract positions in 
30-year T-bonds and futures contract positions in 10-year T-notes, as 
follows:

T-bonds
    Long 100 30-year T-bonds with an 8% annual yield (cash securities)
    Long 75 futures contracts, expiring in June, 1993, on 30-year T-
bonds with an 8% annual yield
    Short 80 futures contracts, expiring in September, 1993, on 30-year 
T-bonds with an 8% annual yield
    Short 20 futures contracts, expiring in December, 1993, on 30-year 
T-bonds with an 8% annual yield
    Long 10 futures contracts, expiring in March, 1994, on 30-year T-
bonds with an 8% annual yield

T-notes
    Short 150 futures contracts, expiring in March, 1994, on 10-year T-
notes with an 8% annual yield

    First, BOTCC will examine the 30-year T-bond futures and 30-year T-
bond futures-equivalent positions:

------------------------------------------------------------------------
                                                                   Mar. 
               Month 0                   June    Sept.    Dec.    (1994)
------------------------------------------------------------------------
+100..................................     +75      -80     -20      +10
------------------------------------------------------------------------

    The Month 0 futures are the cash securities stated as futures-
equivalent positions, which are assumed, for this example, to convert 
1:1 into futures positions. BOTCC will net the monthly futures and cash 
futures-equivalent positions to arrive at a net futures position 
(100+75-80-20+10=85).\1\ Next, the margin amount per future set by the 
BOTCC Margin Committee (currently, $1,500/30-year T-bond future) is 
multiplied by the net futures/futures-equivalent position.\2\

    \1\Since bonds being delivered into futures contract obligations 
will have greater or lesser value than the futures, the conversion 
factor is a means of equating bonds with various coupons and 
maturity dates with the standard bond set by BOTCC. The standard 
bond, which is equal to the corresponding future, has an 8% coupon 
and a conversion factor of 1. See supra note 27.
    \2\The commodity margin rate is the same for long or short 
positions, so the charge for a fixed number of contracts will be the 
same regardless of market position. For cash securities positions, 
the charge will apply to the positions after the conversion to 
futures-equivalents.
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(A) +85 x $1,500=$127,500

    The $127,500 is defined by BOTCC as the Maximum Loss on the 
participant's position in 30-year T-bonds and futures on 30-year T-
bonds.
    Second, BOTCC will examine the participant's 10-year T-note and T-
note futures position. As stated above, the participant has a 10-year 
T-note position of -150 March futures. Assume that the BOTCC Margin 
Committee has set a margin requirement of $1,000/10-year T-note future. 
The presumed ``Maximum Loss'' on the 10-year T-note futures would be:

(B) 150 x $1,000=$150,000

    Third, BOTCC will calculate an additional risk margin, accounting 
for futures spreads (i.e., intermonth netting) of 30-year T-bond 
futures positions, to reflect divergence in the correlation among 
futures contracts with different delivery dates. Excluding Month 0 T-
bond futures-equivalents,\3\
---------------------------------------------------------------------------

    \3\The Month 0 futures are the futures-equivalents of the cash 
30-year T-bonds, after conversion, pursuant to the above formula. 
Supra  note 26. Because the positions generally are subject to next-
day delivery and have been accounted for in other parts of the 
margin calculation process, BOTCC has excluded these positions from 
the intermonth spread additional margin calculations.

----------------------------------------------------------------------------------------------------------------
                                                            Mar.                                                
                                       (June)               1994                   Sept.                  Dec.  
----------------------------------------------------------------------------------------------------------------
                                             +75              +10  versus......        -80                   -20
=                                                     +85          versus......                  -100           
----------------------------------------------------------------------------------------------------------------

there is a total of 85 T-bond futures spreads in the intermonth netting 
and 15 naked short T-bond futures positions. Assuming the BOTCC Margin 
Committee has set a risk margin for intermonth spreads at $100 per 
spread, the additional margin for the intermonth spreads will be:

(C) 85 x $100=$8,500 (included in the final margin requirement)

    Fourth, BOTCC will determine if any basis spreads exist in 30-year 
T-bond futures by matching T-bond futures with the cash futures-
equivalent positions. In this example, the remaining -15 T-bond futures 
(naked short positions) are now offset against the cash futures-
equivalents\4\ to determine the margin for any basis spreads that exist 
in the portfolio. This reflects the potential divergence between cash 
and futures positions.

    \4\+100 from the example above.
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-15 (T-bond futures) versus +100 (Month 0 futures [cash T-bonds])

    Because there are more than 15 Month 0 futures contracts to offset 
the -15 futures contracts, there are 15 basis spreads for which, 
currently, the BOTCC Margin Committee has set a $50 per spread basis 
risk margin requirement.

(D) 15  x  $50 = $750 (included in final margin requirement)

    Fifth, BOTCC then conducts the same analysis for 10 year T-note 
futures. Because the portfolio in this example does not include cash or 
multi-month futures positions in 10 year T-notes, this step yields no 
change in margin requirements.
    Sixth, BOTCC will determine if the exposure in T-bond and T-note 
futures and futures-equivalent positions interact to reduce overall 
portfolio exposure. Thus, BOTCC will compare the participant's net 
commodity positions\5\ in 30-year T-bonds and 10-year T-notes and 
provide a margin credit\6\ for any offsets due to correlated short or 
long cash positions and short or long futures positions.\7\ For 
purposes of this example, assume that the BOTCC Margin Committee has 
calculated a 1:2 correlation in price volatility between futures on 30 
year T-bonds and futures on 10 year T-notes (i.e., futures on the 30-
year T-bonds are twice as volatile as, and are positively correlated 
with, futures on 10 year T-notes).\8\ In the example above, this 
operation results in 75 spreads between the futures-equivalents of the 
30 year T-bonds and the futures-equivalents of the 10-year T-notes.

    \5\The net commodity positions in T-bonds or T-notes are the 
positions remaining after the intermonth futures spreads and 
futures/futures-equivalents basis spreads have been netted out of 
the T-bond or T-note positions.
    \6\BOTCC will examine all of the clearing member's positions, 
including the five-year T-notes and two-year T-notes that the member 
holds. In the above example, the clearing member holds only 30 year 
T-bonds, futures on 30-year T-bonds, and futures on 10 year T-notes.
    \7\In order to establish the intercommodity spread credit, BOTCC 
staff analyzes the correlations between the various bills, notes, 
and bonds deliverable into the futures to determine their respective 
relationships. BOTCC and CCOS will review the margin rates on a 
monthly basis, and as needed, to respond to changes in market 
conditions.
    \8\BOTCC would pair each long position in one 30-year T-bond to 
two short positions in 10-year notes.
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+85 30 year T-bonds versus -150 10-year T-notes
= +85 T-bonds versus -75 T-bonds (two 10-year T-notes = 1 30 year T-
bond)
= 75 spreads, +10 outright T-bond futures-equivalents

    Thus, 75 T-bond futures-equivalents and 150 T-note futures are 
eligible for intercommodity spread credits. To address the potential 
for divergence in assumed correlations, BOTCC reduces the allowable 
credit by applying a ten percent deduction against the applicable 
original margin requirement. Thus, the intercommodity spread credit in 
the above example would be:

(E) 75  x  $1350 = $101,250 (T-note futures offset on T-bond futures)
(F) 150  x  $900 = $135,000 (T-bond futures offset on T-note futures)

    Summary: the margin requirement would be:

(A) $127,500 (Maximum Loss on +85 T-bonds, including cash positions on 
T-bonds)
(B) $150,000 (Maximum Loss on -150 T-notes, including cash positions on 
T-notes)
(C) $8,500 (85 intermonth T-bond futures spreads, not including cash 
positions on T-bonds)
(D) $750 (15 basis spreads [naked futures versus cash])
(E) -$101,205 (30-year T-bond margin credit, applying T-note futures 
positions to reduce futures margin requirements)
(F) -$135,000 (10-year T-note margin credit, applying T-bond futures 
and cash positions to offset T-note futures margin requirements)
=$50,500 Total Margin Requirement

[FR Doc. 94-9710 Filed 4-21-94; 8:45 am]
BILLING CODE 8010-01-M