[Federal Register Volume 59, Number 90 (Wednesday, May 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-11339]


[[Page Unknown]]

[Federal Register: May 11, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33984; File No. SR-GSCC-94-1]

 

Self-Regulatory Organizations; Government Securities Clearing 
Corp.; Order Approving Proposed Rule Change Relating to the Comparison 
and Netting of Members' Treasury Auction Purchases

May 2, 1994.
    On January 26, 1994, Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change pursuant to section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'').\1\ On February 18, 1994, 
GSCC filed Amendment No. 1 to the proposed rule change.\2\ The 
Commission published notice of the proposed rule change in the Federal 
Register on March 10, 1994.\3\ The Commission received one comment 
letter in response to this notice.\4\ As discussed below, the 
Commission is approving the proposed rule change.
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    \1\15 U.S.C. 78s(b) (1988).
    \2\Letter from Jeffrey F. Ingber, General Counsel, GSCC to Jack 
Drogin, Branch Chief, Division of Market Regulation, Commission 
(February 15, 1994).
    \3\Securities Exchange Act Release No. 33703 (March 2, 1994), 59 
FR 11345.
    \4\Letter from Gerald Murphy, Fiscal Assistant Secretary, U.S. 
Department of the Treasury to Jonathan G. Katz, Secretary, 
Commission (April 5, 1994).
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I. Description

    The proposed rule change modifies GSCC's rules to allow GSCC to 
accept and report data on proprietary purchases of Treasury notes, 
bills, and bonds made at auction by members of GSCC's netting system; 
to net the purchases with when-issued trades of such members in the 
member securities; and to deliver purchased securities through GSCC's 
clearing mechanism (the ``auction takedown system''). GSCC has 
established links with the Federal Reserve Banks of New York, Chicago, 
and San Francisco in order to provide the auction takedown system, and 
will establish links with other Federal Reserve Banks as needed. GSCC 
intends to implement the auction takedown system in the Spring of 1994.
    The proposed rule change also authorizes GSCC to establish a 
mechanism for accepting data on members' trades in eligible securities 
from sources such as exchanges and other clearing corporations on a 
``locked-in'' basis. This means that GSCC members would be obligated to 
accept trades as reported by such sources and GSCC would treat such 
data, under its rules, as if they were the successful results of GSCC's 
comparison of trade data submissions from buying and selling members.

1. The Auction Takedown Service

a. Eligible Securities
    Only auction purchases meeting two conditions are eligible for 
inclusion in GSCC's auction takedown system. First, the purchase must 
be of a security with an issue date one or more business days after the 
auction date. Second, only proprietary purchases are eligible. The 
auction bid submitted to the Federal Reserve Ban must not include a 
customer's or client's name on the tender form or on an attachment to 
the tender form.\5\
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    \5\Even if the client or customer is a GSCC netting member, the 
trade will still be ineligible.
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b. Necessary Authorizations
    Prior to its first eligible auction purchase, a GSCC member must 
authorize GSCC to receive data on the member's auction purchase from 
the applicable Federal Reserve Bank.\6\ If a GSCC netting member does 
not provide the authorization, GSCC would not allow the participant to 
remain a netting member. The GSCC member also must provide to the 
applicable Federal Reserve Bank an authorization to provide to the 
applicable Federal Reserve Bank an authorization to provide GSCC with 
the data on the member's auction purchase and an authorization to 
deliver the auction purchase to GSCC's agent bank.\7\
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    \6\The applicable Federal Reserve Bank would be the bank to 
which the GSCC member intends to submit its bid.
    \7\Currently, The Bank of New York has been designated as agent 
bank for Treasury notes; Chemical Bank has been designated as agent 
bank for all other products.
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C. Receipt of Data by GSCC
    In the afternoon or evening of the day of a U.S. Department of 
Treasury (``Treasury'') auction, the Federal Reserve Banks will 
transmit to GSCC information, on a per-CUSIP basis, regarding which 
netting members received auction awards of eligible securities and the 
amount and value of those awards at each yield. The auction award data 
will be deemed to be a compared trade; the contra-party will not submit 
any data on the trade. GSCC will report the auction trade to the 
purchasing member as part of the daily comparison output, and the trade 
will be binding on the member at that time.\8\
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    \8\Procedures will be established that will provide the Federal 
Reserve Banks with a unilateral capability to cancel incorrect data 
and to provide new, correct data, as necessary. A member can 
generate a cancellation and correction request to the Federal 
Reserve Banks if it believes an error had been made. The requested 
adjustment will be made only if it is acted upon by a Federal 
Reserve Bank.
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d. Netting
    After the auction award is reported to the GSCC member, the 
position will go directly into GSCC's netting system. GSCC will treat 
the award, for settlement purposes, in the same manner as a compared 
trade which will be netted with a member's compared secondary market 
trades in the same CUSIP to establish net settlement positions. GSCC 
will then report to the member the net position (deliver, receive, or 
take no action) and net payment obligation. Once netted, GSCC will be 
obligated to accept from the applicable Federal Reserve Bank delivery 
of each member's auction purchase and pay for such purchase, through 
its agent banks. Pending delivery on issue date, GSCC will collect 
clearing fund margin and forward mark allocation payment\9\ amounts 
based on the net settlement position taking into account auction 
purchases. In addition, GSCC will collect clearance difference amounts 
on an intra-day basis for any money differences that arise as a result 
of the pairing off of auction purchases with fail obligations.\10\
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    \9\In connection with this filing, GSCC is changing its formula 
for calculating the forward mark allocation (``FMA'') payment 
obligation. Except for category 1 inter-dealer broker netting 
members, who do not have an FMA payment obligation, all netting 
members will have their FMA payment obligation calculated based on 
the entire debit mark.
    \10\This money difference will arise if the average auction 
price is higher than the market value, with the result that the 
settlement value will be set at the average auction price. In such a 
case, if the net long position for the auction securities is paired 
off with a fail net short position in the same CUSIP (which would 
have a settlement value equal to the lower market value), there will 
be a money difference reflecting an amount owed to GSCC by the 
member.
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e. Delivery
    Each Federal Reserve Bank will deliver the auction purchases to the 
clearing bank designated by GSCC for such purpose. Early in the day on 
issue date, GSCC will provide its agent banks with instructions for 
receipt and delivery so that the auction purchases can be received 
against payment from the Federal Reserve Banks and redelivered to GSCC 
members against payment automatically and virtually instantaneously.
    GSCC will pay the Federal Reserve Banks for the auction awards at 
the award price. GSCC will redeliver the auction awards to GSCC members 
against payment of the settlement value,\11\ equal to the greater of 
the system (market) value for the position or the average auction price 
for such auction purchase. This adjustment is necessary to permit GSCC 
to net auction awards with when-issued and forward settling trades in 
the same security.
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    \11\The settlement value, a new concept, is the system (market) 
value plus a delivery differential adjustment amount. In most 
instances, the delivery differential adjustment amount will be zero, 
GSCC will establish a higher delivery differential adjustment amount 
only under two circumstances. If the system (market) value is less 
than the average auction price, the delivery differential adjustment 
amount will be increased so that the settlement value equals the 
average auction price. In addition, GSCC may adjust the delivery 
differential adjustment amount if the member is subject to higher 
than normal surveillance status and if, in the opinion of senior 
GSCC management, the potential for such member to fail to meet its 
settlement obligations to GSCC is higher than normal. See Letter 
from Jeffrey F. Ingber, General Counsel, GSCC to Jack Drogin, Branch 
Chief, Commission (February 15, 1994). GSCC agrees that, to the 
extent practicable, it will consult with the Commission prior to 
adjusting the delivery differential adjustment amount for a member 
who is on surveillance status. GSCC will follow up any oral 
notification with a written notification and will continue to 
consult with the Commission during the time that GSCC exercises this 
authority. Memorandum to File from Christine Sibille, Attorney, 
Commission (April 25, 1994).
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    The normal GSCC delivery process should provide members with timely 
delivery of their auction awards to the extent that members have net 
long positions consisting of auction securities. Because members could 
be flat or short with respect to other GSCC members and long with 
respect to non-GSCC dealers or their customers, GSCC will provide a 
mechanism for ensuring timely delivery of needed auction purchases to a 
member who, as a result of its secondary market trading, will have on 
issue date a net short or flat position, or a long position that is 
smaller than the amount of auction purchases that it requires.\12\ 
Under this procedure, no later than the evening of the second business 
day prior to issue date,\13\ each such member can request that GSCC 
deliver to it auction purchases made by such member on a CUSIP-by-CUSIP 
basis (``Priority Delivery Request''). GSCC will split such member's 
existing net settlement position into a long position equal to the 
level of the requested delivery, and an offsetting short position. For 
purposes of calculating a member's required clearing fund deposit, a 
priority delivery request will be treated as if it were a net long 
position if it is greater than the member's actual net long position.
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    \12\GSCC will monitor the use of this mechanism to ensure that 
only members who need immediate delivery of auction securities are 
requesting the priority delivery.
    \13\For auctions that are held on the business day immediately 
prior to issue date, the request must be made by no later than on 
the auction date.
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    GSCC will establish the following auction award delivery 
priorities: first to members to fulfill Priority Delivery Requests; 
next to members with net long positions to the extent comprised of 
auction purchases; and then to members with net long positions that 
remain unfilled, on an equal basis, in $50 million increments.\14\
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    \14\The maximum par amount of securities that can be delivered 
over FedWire is $50 million. GSCC delivers the securities at the 
maximum amount for operational ease, to provide a more efficient 
method to distribute securities.
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f. Participant Failure
    In the event that a member with an auction award fails, on or prior 
to issue date, GSCC could incur a loss above the amount of collateral 
it holds from that member in liquidating the member's positions. The 
Treasury will not be liable for assessment for any loss that occurs as 
a result of the auction purchase. Instead, pursuant to its arrangement 
with the Treasury, GSCC will have the right to refuse delivery from a 
Federal Reserve Bank on issue date of all or a portion of the auction 
purchases of a GSCC member if certain conditions exist.
    A netting member who made the auction purchase in a CUSIP must 
remain in a long position in that CUSIP. GSCC must have reasonable 
cause to believe, based on the information it has received, that the 
member cannot or will not timely take delivery of and fully pay for 
auction purchase amounts due it from GSCC. GSCC must have determined 
from its analysis and prevailing market conditions that there is 
reasonable cause to believe that, if it were to liquidate the member's 
position, GSCC would incur a loss that would not be covered by the 
margin deposited by the member with GSCC and/or profits from the 
liquidation of other positions of the member. GSCC can specify the 
amount of auction purchases on which it will not take delivery, which 
amount may not exceed the member's net long position in that CUSIP.
    GSCC must notify the appropriate Federal Reserve Bank, in a 
mutually acceptable manner, of its exercise of this right by no later 
than 8:30 a.m. New York time on the relevant issue date. The failing 
member will remain responsible for the payment of such securities 
pursuant to the terms established by the Treasury.
    If GSCC incurs a residual loss as the result of the liquidation of 
a member's auction purchase, the loss will be allocated in the same 
manner as any other allocation of loss. The loss will be spread among 
all of the netting members that the failed member did business with on 
or prior to the day of default.

2. Locked-In Trades

    The proposed rule change establishes a facility permitting GSCC to 
treat trade data received from designated sources other than a Federal 
Reserve Bank, such as exchanges or clearing corporations, as locked-in 
trades.\15\
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    \15\Proposals to extend this facility to organizations other 
than Federal Reserve Banks should be submitted for Commission review 
under section 19(b) of the Act prior to establishing links with 
other locked-in trade sources.
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a. Reporting of Locked-In Trade Data
    GSCC will accept trade data from a locked-in trade source without 
matching it with data provided by a member. GSCC will report these 
locked-in trades to members as part of its daily comparison output. For 
purposes of GSCC's rules, locked-in trades will be considered as 
compared trades and will be as valid, binding, and enforceable as 
comparisons issued based on a match of corresponding data submitted to 
GSCC by two members.
    Each member that makes an eligible locked-in trade will be 
obligated to provide GSCC with authorization for GSCC to receive data 
on the locked-in trade from the locked-in trade source. A locked-in 
trade source can correct or delete a previously submitted trade by 
providing appropriate instructions to GSCC. If the locked-in trade 
source is not a party to the trade, GSCC may delete or correct the data 
upon receipt of matching instructions from each member that is a party 
to the trade.
b. Netting
    Subject to the terms and conditions that GSCC agrees to with the 
locked-in trade source, GSCC may exclude any locked-in trade from its 
netting system. Each netting member that makes a locked-in trade that 
is eligible for netting and settlement by GSCC must provide GSCC and 
the locked-in trade source with authorization for GSCC to receive and 
the locked-in trade source to transmit data on the locked-in trade.

3. Other Revisions

    Under GSCC's rules, a forward settling trade is eligible for GSCC's 
netting system only if the trade settles within less than a certain 
number of days after comparison by GSCC. For example, only trades that 
settle fifteen days or less after comparison currently are eligible for 
GSCC's netting system. The proposed rule change amends GSCC Rule 11, 
section 2 to permit GSCC to establish the maximum number of business 
days between comparison and settlement by a separately published 
schedule. GSCC will file with the Commission, pursuant to section 
19(b)(3)(A) of the Act, any proposals to change this time period.\16\ 
GSCC's rules also have been amended to allow GSCC to net fail deliver 
obligations and fail receive obligations with any other receive 
obligations and deliver obligations.
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    \16\Memorandum to File from Christine Sibille, Attorney, 
Commission (April 25, 1994).
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II. Comments

    As noted above, in response to the notice published in the Federal 
Register, the Treasury provided the Commission with comments in support 
of the proposal. The Treasury believes that including Treasury auction 
purchases in a multilateral netting system could be beneficial to the 
efficiency of the government securities market. In addition, the 
Treasury believes that the proposal would enable GSCC to improve its 
risk management by providing a more complete picture of its members' 
positions.

III. Discussion

    The Commission believes the proposed rule change is consistent with 
section 17A of the Act, and, therefore, is approving the proposal. 
Specifically, the Commission believes the proposal is consistent with 
section 17A(b)(3)(F)\17\ of the Act in that it promotes the prompt and 
accurate clearance and settlement of securities transactions, fosters 
cooperation and coordination with persons engaged in clearance and 
settlement of securities transactions, and removes impediments to the 
national system for the prompt and accurate clearance and settlement of 
securities transactions.
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    \17\15 U.S.C. 78q-1(b)(3)(F) (1988).
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    In the 1992 Joint Report on the Government Securities Market 
(``Joint Report''), the Commission, the Treasury, and the Board of 
Governors of the Federal Reserve System recommended several 
enhancements to GSCC's system.\18\ One such enhancement was the 
inclusion of auction take-down activity in GSCC's netting system, since 
the benefits of netting would increase as more trades are included in 
the net. The Joint Report concluded that if the auction takedown 
proposal were implemented, ``additional information on the overall 
distribution process required to settle Treasury auction purchases and 
on the true net settlement positions of members during a when-issued 
period would be available at GSCC. GSCC's proposal is especially 
significant in light of the risk to the Treasury resulting from the 
auction settlement process and the use of autocharge agreements. GSCC's 
proposal would reduce the risk to the Treasury to the extent that GSCC 
assumes responsibility for auction purchases that are netted against 
when-issued sales.''\19\
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    \18\U.S. Department of Treasury, Board of Governors of the 
Federal Reserve System, and Securities and Exchange Commission, 
Joint Report on the Government Securities Marketplace (January 
1992). The recommendations are (1) automated comparison of 
repurchase agreements; (2) inclusion of auction take down activity 
and yield-based trades in GSCC's netting system; (3) increase in 
categories of GSCC membership; and (4) confirmation systems for non-
dealer, institutionalized customers.
    \19\Joint Report at 30. With this approval, all but two of the 
recommended enhancements to GSCC's system will have been 
implemented. Only the first recommendation, automated comparison of 
repurchase agreements, and the last recommendation, confirmation 
systems for institutionalized customers, have not been implemented.
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    The proposal provides a more efficient method of clearing and 
settling auction securities. GSCC members will be able to access 
information on the securities awarded to them through GSCC's reporting 
system, and will have the securities delivered and paid for through 
GSCC's clearance system. The processing required will be reduced since 
the Federal Reserve Banks will provide information and securities to, 
and receive payment from, one source, GSCC, for all GSCC members. By 
channeling the payment and delivery obligations through one source (and 
reducing those obligations through netting), the clearance process will 
be made more efficient.
    Currently, the proposal only covers purchases of Treasury 
securities that settle one or more business days after the auction 
date. This limitation is needed because of the limitations in GSCC's 
system. However, the number of Treasury securities that settle on the 
same day as auction date is so small that this limitation should not 
have a significant effect on the national clearance system.\20\
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    \20\During all of 1993 and 1994, no Treasury securities have 
settled on the same day as the auction date. Memorandum to File from 
Christine Sibille, Attorney, Commission (April 25, 1994).
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    In addition, the proposal only covers proprietary purchases. If a 
GSCC member were to fail, GSCC would still accept auction awards to the 
extent covered by the GSCC member's short position. If a GSCC member's 
customer purchases were included in the proposal, there is a 
possibility that a customer's purchase would be used to satisfy the 
failed member's short position rather than delivered to the customer. 
Once the auction takedown proposal has been implemented, there will be 
opportunities to study means of including customer trades without undue 
risk to the customer. Until such time, the Commission believes that it 
is reasonable to exclude customer trades.\21\
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    \21\Approximately 15% of the securities awarded to GSCC members 
are customer purchases. Memorandum to File from Christine Sibille, 
Attorney, Commission (April 25, 1994).
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    The proposal would change GSCC's settlement pricing to accommodate 
introduction of auction positions. These changes will serve two 
functions. First, it will ensure that GSCC never delivers auction 
purchases for less than the amount it paid for the securities. Second, 
it will provide GSCC with a risk control measure when a member is 
subject to higher than normal surveillance status. This should help 
GSCC address the risk of liquidity problems, and enhance GSCC's ability 
to safeguard funds and securities.
    The proposal also provides a general mechanism for GSCC to accept 
locked-in trade data from sources other than a Federal Reserve Bank. By 
accepting the trades directly from a locked-in trade source (such as an 
exchange), the process of clearing and settling the locked-in trade is 
made more efficient. The GSCC member does not have to duplicate input 
of the data, submitting the data once to the locked-in trade source and 
once to GSCC. Instead, the information flows directly to GSCC, thereby 
lessening the risk of incorrect or incomplete submissions, or 
unconfirmed trades.
    The proposal extends the benefits of GSCC's centralized, automated 
netting system to netting members' auction securities purchases. By 
including auction securities in GSCC's netting system, the level of 
potential netting is increased and the number of required movements of 
securities are reduced.\22\ Netting of auction securities also may have 
the effect of increasing a member's liquidity. Previously, a GSCC 
member with a short position would have its required margin payments 
calculated based on its short position, even if it had an offsetting 
long position in auction purchases. Once the positions are netted, the 
member's margin payments will be calculated based on the position after 
taking into account the auction purchases, perhaps creating a lower 
margin payment. The additional liquidity may assist in the prompt and 
accurate clearance and settlement of securities transactions. In this 
manner, the proposal removes impediments to the national system for the 
prompt and accurate clearance and settlement of securities 
transactions, and fosters cooperation and coordination with persons 
engaged in clearance and settlement of securities transactions.
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    \22\In March 1994, GSCC's netting system received $289 billion 
in daily average buy/sell dollars. This amount was netted to result 
in $65 billion in average daily receive and deliver obligations. In 
effect, GSCC netted out approximately 77% of the dollar obligations 
of members.
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IV. Conclusion

    For the reasons stated above, the Commission finds that the 
proposed rule change is consistent with section 17A of the Act.
    It is therefore ordered, Pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (SR-GSCC-94-01) be, and hereby is, 
approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-11339 Filed 5-10-94; 8:45 am]
BILLING CODE 8010-01-M