[Federal Register Volume 60, Number 242 (Monday, December 18, 1995)]
[Notices]
[Pages 65076-65087]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30660]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36573; File No. 600-27]


Self-Regulatory Organizations; Clearing Corporation for Options 
and Securities; Order Approving Application for Exemption From 
Registration as a Clearing Agency

December 12, 1995.
    On December 14, 1992, the Clearing Corporation for Options and 
Securities (``CCOS'')1 filed with the Securities and Exchange 
Commission (``Commission'') 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 17Ab2-1 
thereunder.3 Notice of CCOS's application was published in the 
Federal Register on June 23, 1993.4 Fourteen comment letters were 
received in response to the notice of filing of the CCOS 
application.5 On October 7, 1993, CCOS filed an amendment to its 
application6 setting forth its intention to register Chicago Board 
Brokerage, Inc. (``CBB'') as a U.S. government securities broker 
pursuant to Section 15C of the Act7 and to proceed with CBB's 
membership with the National Association of Securities Dealers 
(``NASD'') as required by that section.8 Notice of the amendment 
was published in the Federal Register on April 22, 1994, to solicit 
comments.9 One hundred eleven comment letters were received in 
response to the notice of filing of the amendment.10 This Order 
grants CCOS's application for 

[[Page 65077]]
exemption from registration as a clearing agency subject to certain 
limitations and conditions as set forth below.

    \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'').
    \2\15 U.S.C. Sec. 78q-1 (1988).
    \3\17 CFR 240.17Ab2-1 (1994).
    \4\Securities Exchange Act Release No. 32481 (June 16, 1993), 58 
FR 34105 [File No. 600-27] (notice of filing of application for 
exemption from registration as a clearing agency) (``CCOS 
Release'').
    \5\A complete list of comment letters for File No. 600-27 is 
available for review in the Commission's Public Reference Room.
    \6\Letter from Dennis Dutterer, Executive Vice President and 
General Counsel, 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).
    \7\15 U.S.C. Sec. 78o-5 (1988).
    \8\15 U.S.C. Sec. 78o-5(e)(1) (1988).
    \9\Securities Exchange Act Release No. 33911 (April 15, 1994) 59 
FR 19263 [File No. 600-27] (notice of filing of amendment to 
application for exemption from registration as a clearing agency).
    \10\Supra note 5.
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I. Description

A. Trade Clearance and Settlement

1. Overview
    CCOS will provide clearance and settlement facilities for trades 
executed by CBB and its customers in the CBB trading system.11 As 
described in the amendment,12 CBB's business will be limited to 
acting as an intermediary for U.S. government securities transactions 
paired through its computer system.13

    \11\CBB is a wholly-owned subsidiary of the CBOT and has 
requested no-action relief from the Commission staff with respect to 
the operation of the automated trading system for government 
securities. Letter from Mark D. Young, Kirkland and Ellis, Counsel 
for CBB, to Richard R. Lindsey, Division Director, Commission 
(December 11, 1995). The staff issued a no-action letter to CBB 
granting the relief requested and the Commission is issuing this 
order based on its belief that CBB is in compliance with the terms 
and conditions of the no-action letter. Letter from Richard R. 
Lindsey, Division Director, Commission, to Mark D. Young, Kirkland 
and Ellis, Counsel for CBB (December 12, 1995).
    \12\Supra note 6.
    \13\The government securities listed for purchase or sale 
through the CBB system will consist of U.S. Treasury bills, notes, 
and bonds in their various maturities which are deliverable under 
financial futures contracts traded on the CBOT.
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    The CBB trading system is designed to offer CBOT members an 
opportunity to execute a customized package of transactions related to 
Treasury futures contracts traded on the CBOT.14 The system will 
permit the trading of government securities, independently and in 
conjunction with CBOT futures on government securities (``basis 
trades''),15 and repurchase and reverse repurchase agreement 
contracts in government securities (``dollar rolls'').16 Using the 
CBB trading system, therefore, CBOT traders in government securities 
will be able to buy and sell the government securities underlying CBOT 
futures contracts and using dollar rolls will be able to execute trades 
that help inventory management. CBB will execute transactions for 
system participants as broker. All trades will be effected through the 
CBB's electronic network. The settlement date for outright purchase and 
sale transactions will be the next business day except for when-issued 
(``WI'') securities which will settle on the day of issuance by the 
U.S. Treasury.

    \14\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.
    \15\A basis trade is a trade in which the participants agree to 
simultaneously buy or sell government securities against the 
offsetting equivalent CBOT treasury futures contract. The basis 
represents the price differential between a government security and 
the futures delivery price.
    \16\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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    Under the terms of the proposal, any CCOS participant or any 
customer of a CCOS participant that is also a CBOT member or member 
firm (hereinafter collectively referred to as a CBOT member) will be 
able to obtain a CBB trading terminal.17 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. Using a 
CBB terminal, a terminal operator will be able to view the terminal 
displays to see the prices and quantities of current bids and offers, 
which are displayed on an anonymous basis, and to review its trading 
activity.

    \17\The Board of Directors of CCOS may permit other clearing 
agencies registered with the Commission or that are exempted from 
registration by the Commission access to some or all of the services 
offered by CCOS according to terms and conditions prescribed by the 
Board of Directors. Clearing agencies that are granted access to 
CCOS's services pursuant to CCOS Rule 309 will not be considered 
participants of CCOS under the rules except as determined by the 
Board of Directors. Letter from John C. Hiatt, President and Chief 
Executive Officer, BOTCC, to Jonathan Kallman, Associate Director, 
Commission (September 13, 1994).
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    CBB is developing several methods for market participants to access 
the CBB trading system. CBB will: (1) provide CBOT work station 
terminals which will access the CBB trading system and include other 
market information and trading systems available through the 
CBOT;18 (2) provide an interface between CBB's central computer 
and a CBOT member's internal computer network; and (3) provide access 
through an interface with quotation vendors.19

    \18\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 to allow 
trading over a local area network (for example, within the CBOT 
building) of 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.
    \19\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 
nonexclusive basis with one or more quotation vendors, each having 
interactive capabilities, to carry the CBB system for use by CBOT 
members.
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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 government securities. 
The government securities will be priced at a certain number of basis 
points above or below the futures contract.20

    \20\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 government 
securities leg of basis trades will include the commission charges 
and accrued interest. Settlement for the government securities leg 
will occur on the next business day in the same manner as outright 
government securities trades.
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    The system also will provide users with the ability to execute 
dollar roll transactions. Dollar roll transactions are designed to 
facilitate the financing of government securities through the lending 
of government securities in exchange for cash and to facilitate the 
lending of funds in exchange for government securities.21 Dollar 
rolls will result in the creation of two simultaneous government 
trades.

    \21\The CBB terminals will list the dollar roll spreads through 
bid and offer financing rates reflecting the annualized interest 
rates paid or received on the transactions. 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 
amount of 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.
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    CBB will have a morning trading session for dollar rolls from the 
opening of trading at 8:00 a.m. to 11:00 a.m. and an afternoon session 
for dollar rolls from 3:15 p.m. to 5:00 p.m.22 For dollar rolls 
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. For dollar rolls executed during the afternoon session, the 
first leg will settle on T+1, and the second leg will settle on the 
following business day (``T+2'').

    \22\Unless otherwise noted, all times stated are Eastern 
Standard Time.
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    CBB will match member trades and will submit the matched trades to 
CCOS on a real time basis so that trade data executed through CBB 
immediately flows to CCOS.23 CCOS will perform the 

[[Page 65078]]
clearance and settlement functions for transactions executed through 
CBB, including: delivery versus payment processing, position 
consolidation, and original and variation margin calculation and 
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processing as discussed below.
    \23\CBB will create, operate, and maintain the computer system 
that enables orders 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.
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2. CCOS & BOTCC Cross-Margining Agreement
    CCOS and BOTCC will establish a cross-margining arrangement whereby 
all CCOS members, all of which are BOTCC members or CBOT members 
affiliated with a BOTCC member, will hold certain futures and 
government securities cleared by the respective clearing organizations 
in special cross-margin accounts.24 All futures positions will be 
held at BOTCC, and all government securities will be held at CCOS. 
Government securities and futures held in the cross-margin accounts at 
the respective clearing organization will be margined as if held in a 
single account based upon the net risk of the positions. To facilitate 
the cross-margining arrangement, CCOS and BOTCC will establish 
procedures whereby CCOS and BOTCC each will have a security interest in 
the positions held in the cross-margin accounts to secure all 
obligations of the clearing members arising in connection with those 
positions.
    \24\Because all CCOS members are also BOTCC members or CBOT 
members affiliated with a BOTCC member, all accounts at CCOS are 
cross-margin accounts.
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B. System Safeguards
1. Margin Payment/Collection
    CCOS will adopt, as one of its principal safeguards, a practice of 
collecting original margin and variation margin on participant 
obligations.25 In essence, CCOS will use the margin calculation 
and payment time frames currently used by BOTCC in connection with its 
clearance of CBOT futures contracts.26 CCOS will modify BOTCC's 
margining system to address risks specific to the U.S. government 
securities market.

    \25\Original margin represents a performance bond that both 
buyers and sellers must post when executing trades to assure that 
their respective contractual obligations will be satisfied. 
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.
    \26\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.
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    CCOS will calculate margin requirements at least twice daily, with 
one calculation reflecting trading activity occurring from the 8:00 
a.m. opening to 1:30 p.m. and with another calculation reflecting 
trading activity from 1:30 p.m. to 5:00 p.m. CCOS will collect margin 
deficiencies arising from participants' morning trading activity at 
4:00 p.m. on that trade date (``T'') and will collect margin 
deficiencies arising from participants' afternoon trading activities at 
7:40 a.m. on T+1. In the event a clearing member fails to perform its 
obligations to CCOS, the original margin will be used to cover any 
financial liabilities which may result from the failed obligation. CCOS 
will retain the authority to collect additional margin at any 
time.27

    \27\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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    In order to margin government securities and futures positions in a 
parallel fashion, CCOS will convert government securities to futures 
contract equivalents prior to original margin determination.28 
CCOS will convert government securities positions to futures-
equivalents based upon conversion factors established and published by 
the CBOT for the most similar futures delivery month and the most 
similar futures contract par amounts (i.e., face values).29 CCOS 
will net the futures-equivalent positions of all government securities 
deliverable with the corresponding futures contracts to produce a net 
futures-equivalent position.30 The performance bond for all trades 
generally will be collected at 7:40 a.m. on T+1.

    \28\In establishing the original margin for government 
securities it clears, CCOS began with the premise that cross-
margined government securities and futures products have essentially 
the same market and credit risks. Therefore, CCOS will use the 
original margin rates for futures contracts established by the Board 
of Governors of BOTCC following recommendations of the BOTCC Risk 
Management Committee.
    The BOTCC Risk Management Committee is comprised of five of the 
nine Governors of the BOTCC Board of Governors. All nine Governors 
are owners or officers of BOTCC clearing member firms. The BOTCC 
Risk Management Committee meets once a month or at the call of the 
BOTCC Board Chairman or the Risk Management 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 judgement 
to predict market conditions in the near future. From this 
information, the Risk Management Committee will typically set margin 
rates that cover approximately the 99th percentile of absolute daily 
price changes over the previous one, three, and six month periods.
    \29\The formula for the conversion of government securities is:
    Futures-Equivalents=Government Securities Par 
Amounts x Conversion FactorFutures Par Amount
    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 two bonds, Bond X and Bond Y. 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 (Bond Y could have greater coupon rates or a 
longer period 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. 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 is then divided by 100,000 (each 
futures contract equals $100,000) to give the number of futures 
contracts equal to the bond.
    \30\Futures on government 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.
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    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 government securities and futures 
positions in the participant's cross-margined account. Participants 
will pay or collect midday variation margin in same-day funds by 4:00 
p.m. each day, through their settlement banks. BOTCC will pay out 80% 
of variation gains in excess of original margin deficits31 and 
will collect 100% of variation losses.

    \31\CCOS will withhold distribution of any variation margin 
gains from participants with original margin requirement deficits.

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2. Settlement Values
    At 3:00 p.m., CCOS will establish a settlement value for government 
securities trades executed between 8:00 a.m. and 1:30 p.m. That value 
will be based on the prices collected at 2:30 p.m. from GovPx, a 
government securities pricing vendor. CCOS will mark new positions from 
their transaction value,32 which will be 

[[Page 65079]]
established at the execution of the trade, to their settlement 
value,33 which will reflect 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.

    \32\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.
    \33\Settlement values will reflect the settlement price 
established twice a day and will include accrued interest but will 
not include commissions and finance charges from dollar rolls.
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    Trades executed from 1:30 p.m. through the 5:00 p.m. end of the 
day's trading session will be marked to the 3:00 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 government 
securities transactions executed on T to the participants' settlement 
banks at 11:30 a.m. on T+1.34
    \34\Participants may transact dollar rolls (with same-day 
settlement for the first leg) between 8:00 a.m. and 11:00 a.m. on 
T+1 to offset delivery obligations due to settle on T+1.
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3. Loss Allocation and Liquidity Sources
    CCOS will begin operations with an initial capitalization of $2 
million. Together with CCOS's earnings, BOTCC will commit to provide 
CCOS with additional capital as necessary to cover CCOS's continuing 
costs of operations. Because CCOS will rely on BOTCC for certain 
liquidity resources and because BOTCC's capital and credit lines are 
committed to its futures business, BOTCC has agreed to dedicate 
specific credit and financial resources to CCOS, and CCOS and BOTCC 
have established a framework for allocating losses arising from cross-
margined accounts between the two entities.
    With respect to liquidity, CCOS will establish a committed credit 
facility which will be guaranteed by BOTCC. The credit facility 
initially will be $5 million and will be increased in increments of $5 
million for each $1 billion increase in CCOS's daily average net 
settlements of government securities transactions over a ninety day 
period. When the credit facility reaches $30 million as a result of 
daily average net settlements of government securities reaching $6 
billion, CCOS will review the size of the credit facility in 
consultation with the Division staff.35

    \35\As discussed below, $6 billion is the maximum average daily 
net settlements of transactions in government securities agreed to 
by CCOS and the Division during the exemptive period. Also as agreed 
to by CCOS and the Division, CCOS's operations will be limited to a 
maximum of $24 billion average daily net settlements of dollar 
rolls.
    These limits represent approximately five percent or less of 
government securities and average daily volumes in dollar rolls. The 
Commission believes these limits are appropriate at this time in 
that they are large enough to allow CCOS to commence effective 
operations yet of a limited nature that allows the Commission to 
observe the effects of the CCOS clearing and settlement activities 
on the government securities market.
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    With respect to loss allocation, under the cross-margining 
arrangement between CCOS and BOTCC, all government securities positions 
cleared by CCOS will be maintained in a cross-margin account for which 
BOTCC and CCOS have agreed to assume joint responsibility in the event 
that a default or failure to settle occurs and there is a shortfall in 
that account. BOTCC and CCOS each are guaranteeing up to 50% of the 
obligations owed to each other with respect to a defaulting 
participant's cross-margin account after use of the original margin 
deposits of the participant and proceeds from the liquidation of the 
participant's positions. Therefore, CCOS will have adequate resources 
to protect itself and to fulfill its settlement obligations for a loss 
up to at least $60 million.36
    \36\I.e., $30 million from CCOS's guaranteed credit facilities 
(repayment of which is guaranteed by BOTCC) plus $30 million from 
BOTCC under its guarantee of cross-margining losses.
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II. Comment Letters
    Public comment both supported and opposed CCOS's 
application.37 More than sixty commenters, including several 
common members of the Government Securities Clearing Corporation 
(``GSCC'') and CCOS, supported the proposal. More than forty commenters 
opposed the proposal, raising three basic arguments as to why the 
Commission should deny the exemption request.38 These arguments 
include the potential fragmentation of clearance and settlement 
facilities for the U.S. Treasury market the concern that exempting CCOS 
will mean ineffective and unequal regulation of clearing facilities for 
those securities, and the concern that approval of CCOS will not 
promote fair competition among clearing agencies. CCOS filed several 
responses to the comments.39

    \37\Supra note 5.
    \38\Commenters raised additional issues in opposition to CCOS's 
application. These issues included the concern that the introduction 
of CCOS as another government securities clearing agency would 
result in an increase in costs for U.S. Treasury brokers and the 
concern that in the future decisions at GSCC will be made based on 
the fear of losing potential customers to CCOS rather than based on 
the best interest of the participants. With regard to the first 
point, the Commission believes that if in fact any increase in costs 
results from granting CCOS's exemption application, the benefits to 
the government securities market, such as innovation arising from 
competition, will outweigh any such costs. With regard to the second 
point, while the Commission believes that GSCC will continue in the 
future to base its decisions on what is in the best interest of its 
participants and the government securities market and not on any 
fear of losing current or potential participants, commenters should 
be comforted by the fact that GSCC is subject to Section 19(b) of 
the Act which requires SROs to file with the Commission any proposed 
changes to their procedures, operations, or rules.
    \39\The comment letters and CCOS's responses are discussed in 
detail in the Discussion section of this order.
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    The Commission received two letters from the Commodity Futures 
Trading Commission (``CFTC'') regarding CCOS's application.40 
BOTCC, as a futures clearing organization, is subject to regulation by 
the CFTC under the Commodity Exchange Act (``CEA''); therefore, the 
Commission carefully considered the comments of the CFTC regarding 
CCOS's application. In its first letter to the Commission,41 the 
CFTC noted that because of its position as the regulator of BOTCC, it 
would have to consider and address the potential impact of CCOS's 
activity on the financial integrity of BOTCC and on the futures market 
for which it clears. Specifically, the CFTC was concerned with BOTCC's 
role as a guarantor of CCOS's obligations and the impact on BOTCC's 
financial integrity of any minimum capitalization or other requirements 
imposed on CCOS by the Commission.42 The CFTC also stated that any 
arrangements presenting cross-jurisdictional issues between the CFTC 
and the Commission would require approval by both agencies. This would 
include cross-margining programs, the imposition of clearing limits 
and/or minimum margin requirements, and futures/cash basis trades 
traded on the CBB and cleared through BOTCC and CCOS. The CFTC urged a 
cooperative effort between itself and the Commission to avoid 
duplicative or inconsistent regulation being imposed on the affected 
entities.

    \40\Letters from Jean A. Webb, Secretary, CFTC, to Jonathan G. 
Katz, Secretary, Commission (July 23, 1993 and May 31, 1994).
    \41\Letter from Jean A. Webb (July 23, 1993), supra note 40.
    \42\Ultimately, this concern was alleviated by changing the 
general BOTCC guarantee to a guarantee of a limited committed credit 
facility. Refer to ``BOTCC Guarantee'' above.
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    The CFTC's second letter43 responded to CCOS's amended 
application in which CBOT set forth its intention to register CBB as a 
government securities broker and its willingness to enter into certain 
linkage arrangements with GSCC. The CFTC noted that the proposal to 
enter into a linkage 

[[Page 65080]]
arrangement with GSCC could have positive effects on the government 
securities market, that the CBB/CCOS amended proposal could increase 
competition among market participants, that the CBB electronic trading 
system would provide government securities market participants with 
easier access to market information, and that the registration of CCOS 
as a clearing agency might lower the level of risk present in the 
government securities market. While the CFTC's comments were generally 
positive, it also reiterated its regulatory interests and the need to 
review the potential impact of the various arrangements on BOTCC's 
financial integrity and to assure compliance with the CEA.

    \43\Letter from Jean A. Webb (May 31, 1994), supra note 40.
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    The Commission recognizes the validity of the CFTC's concerns and 
understands the importance of coordinating efforts among all regulators 
concerned with the government securities market. The Commission will 
continue to coordinate with these regulatory agencies to safeguard one 
of the world's largest securities markets.
III. Discussion
A. Overview
    The Commission is granting CCOS's application for exemption subject 
to the conditions described below. The Commission believes such action 
is consistent with the Act including the goals of fostering cooperation 
and coordination with persons engaged in the clearance and settlement 
of securities transactions, removing impediments to and perfecting the 
mechanism of a national system for the prompt and accurate clearance 
and settlement of securities transactions, and protecting investors and 
the public interest.
    As noted above, CCOS proposes to provide clearing facilities in 
support of CBB's and CBOT's proposals. CBB's proposed automated trading 
system for government securities represents an effort to make 
government securities more readily available to CBOT members that trade 
futures on government securities and thereby improves the efficiency of 
arbitrage between the futures and cash markets and potentially 
increases liquidity in both of those markets. Traders in these markets 
often are called upon to accept position or market risks from 
participants in the market for government securities. The market for 
U.S. Treasury bonds, bills, and notes is the deepest, most liquid 
market in the world. While these securities are traded all over the 
world, the primary U.S. marketplace involves a core group of dealers, 
brokers' brokers, banks, and institutional investors that trade 
extensively among themselves over-the-counter. These market 
participants often rely on futures markets, such as the CBOT, for their 
derivative products as a way to transfer to traders on these markets 
position and market risks related to U.S. government securities. 
Traders on the futures exchanges, in turn, must be able to buy and sell 
government securities to help manage their own risk and position 
exposures efficiently.
    Approval of the CCOS application will allow CCOS and its parent, 
BOTCC, to provide the clearance and settlement services that are 
necessary to support the CBB and CBOT proposals. This in turn should 
help foster greater integration of clearing facilities that serve the 
futures market and the underlying cash markets and should facilitate 
the development of cross-margin facilities between those markets. BOTCC 
already has extensive arrangements with its clearing bank network to 
receive and deliver government securities among its clearing members, 
and its clearing members maintain government securities at those banks 
for their proprietary and customer accounts. As described above, CCOS 
plans to build on those arrangements in providing its services in 
support of CBB. Exempting CCOS from clearing agency registration should 
allow CBB to move forward with its proposal and should allow CCOS and 
BOTCC to obtain greater experience in managing risk exposures before 
taking on self-regulatory responsibilities that would otherwise 
accompany clearing agency registration.
    Because many of CCOS's likely users are GSCC members and use GSCC's 
services to clear and settle trades among themselves, a linkage among 
CCOS, BOTCC, and GSCC to facilitate efficient clearance of trades is 
essential.44 To this end, the Boards of Directors of GSCC, BOTCC, 
and CCOS have been requested to establish a joint user committee to 
settle the outstanding linkage and cross-margining issues and to report 
to the GSCC, BOTCC, and CCOS Boards the committee's proposal for 
linkage and cross-margining within three months of formation of the 
committee.45

    \44\Market Reform Act of 1990, S. Rep. 101-300 at 58-62. 
President's Working Group on Financial Markets, Interim Report, 
Appendix D (May 1988).
    \45\Letter from Richard R. Lindsey, Division Director, 
Commission, to John G. Macfarlane III, Chairman of the Board, GSCC, 
and David Johnson, Chairman of the Board, BOTCC (December 12, 1995). 
The Commission believes it is appropriate for CCOS to begin limited 
operations prior to the implementation of such arrangements because 
these arrangements, while important to coordinating GSCC's and 
CCOS's systems, are not necessary for CCOS to commence operations.
    The Commission will monitor closely efforts in this regard and 
expects prompt action to implement linkages and cross-margin systems 
that are acceptable to the common membership so that appropriate 
linkages are in place when warranted. If it does not appear after six 
months that the parties are able to agree to establish appropriate 
linkage and cross-margining facilities, the Commission will consider 
whether to mandate the development of linkage and cross-margining 
facilities. If necessary, the Commission will use its authority under 
the Act to direct that the responsible parties act in their best 
interests to establish ``linked or coordinated facilities for clearance 
and settlement of transactions in securities * * * [and] contracts of 
sale for future delivery * * *.''46

    \46\15 U.S.C. Secs. 78q-1 (a)(2)(A)(ii) and (d)(1) (1988).
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    Approval of the application also should help foster innovation in 
clearance and settlement of government securities. The CCOS proposal 
will provide central clearing facilities for dollar rolls, which 
represent a type of repurchase agreement transaction. CCOS's proposal 
was one of the first formal responses to the recommendations of the 
1992 Joint Report on the Government Securities Market,47 and the 
Commission believes that the CCOS proposal may well have encouraged 
others, including GSCC, to develop similar or wider services.
    \47\Joint Report on the Government Securities Market, issued by 
the Department of Treasury, the Securities and Exchange Commission 
and the Board of Governors of the Federal Reserve System (January 
1992) at 31 (recommending that an efficient processing system for 
government securities repo activity be developed).
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B. Section 17A of the Act
1. Grant of Exemption
    Section 17A(b)(1) of the Act authorizes the Commission to exempt 
applicants from some or all of the clearing agency requirements of 
Section 17A if the Commission 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.48 While the 

[[Page 65081]]
Commission has never exercised its authority to exempt an applicant 
entirely from the requirements of Section 17A, it has granted newly 
registered clearing agencies narrowly drawn, temporary exemptions from 
specific statutory requirements imposed by Section 17A in a manner that 
achieves those statutory goals.49

    \48\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).
    \49\E.g., in the Commission's order approving GSCC's temporary 
registration as a clearing agency, the Commission temporarily 
exempted GSCC from compliance with the statutory standards of 
Sections 17A(b)(3)(B) and 17A(b)(4)(B) of the Act regarding a 
clearing agency's rules designating classes of participants and the 
standards used by the clearing agency to determine participation. 
The Commission also exempted GSCC from Section 17A(b)(3)(C) 
regarding fair representation of clearing agency participants in the 
selection of its directors. Securities Exchange Act Release No. 
25740 (May 24, 1988), 53 FR 19839.
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    The market break in October 1987 and the markets' 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.50 In light of the 
foregoing, the Commission believes it is appropriate for applicants 
requesting exemption from clearing agency registration to meet 
standards substantially similar to those required of registrants in 
order to assure that the fundamental goals of Section 17A (i.e., safe 
and sound clearance and settlement) will be achieved.

    \50\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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    Because the Commission believes that CBB and CCOS will promote 
innovation in the trading and clearing of government securities and 
will further the integration of the futures and government securities 
markets, it is approving CCOS's application for exemption in order that 
CCOS may begin limited operations without meeting the entire panoply of 
clearing agency registration requirements.51 Although, as 
described below, CCOS is being held to substantially the same standards 
as other registered clearing agencies, certain areas of CCOS's 
operation require further development before CCOS can be considered for 
registration under Section 17A of the Act. The Commission believes that 
granting CCOS an exemption from registration subject to the regulatory 
requirements and Commission oversight on CCOS during the exemptive 
period should allow CCOS to further develop its system for clearing and 
settling government securities in a safe and sound manner before its 
seeks full registration as a clearing agency. In granting CCOS an 
exemption from clearing agency registration, the Commission believes 
that such an exemption is consistent with the requirements of Section 
17A and that the framework of the exemption is such that the Commission 
retains adequate regulatory power and oversight to ensure that CCOS's 
services do not pose a threat to the stability of the government 
securities markets.

    \51\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. 
[Market Reform Act of 1990, Sec. 5, amending Sec. 17A(a)(2) of the 
Securities Exchange Act of 1934, 15 U.S.C. 78q-1 (1990)].
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    The Commission is imposing significant limits on CCOS as set forth 
below.52 Should CCOS determine that a change in its operations or 
procedures is necessary, CCOS will be required pursuant to this 
exemptive order to amend its CA-1 and request that the Commission 
modify the exemptive order. The Commission's oversight of CCOS, in 
conjunction with the CFTC's oversight responsibilities of BOTCC, should 
help nurture the establishment of safety mechanisms, such as cross-
margining, that further the goals of competition and integration in the 
government securities and futures markets. Furthermore, as competition 
leads to innovation and progress, the Commission believes CCOS's entry 
into the clearance and settlement of government securities should be a 
positive step towards the continued development of the world's largest 
government securities market.

    \52\The limits are described in Section III., Part D., 
Conditions.
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2. Registration Standards
    Before granting registration to a clearing agency, Section 17A of 
the Act requires that the Commission make a number of determinations 
with respect to the clearing agency's organization, capacity, and 
rules. Paragraphs (A) through (F) of Section 17A(b)(3) set forth 
general criteria which a clearing agency must satisfy in order to be 
registered. Congress reserved to the Commission the task of making 
specific determinations as to whether an applicant's organization, 
capacity, and rules satisfy the general criteria. In Securities 
Exchange Act Release No. 16900, the Division set forth its views and 
positions concerning satisfaction of the general criteria (``Standards 
Release'').53

    \53\Securities Exchange Act Release Nos. 16900 (June 17, 1980), 
45 FR 41920 (announcement of standards for the registration of 
clearing agencies) 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).
    Refer also to 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 self-regulatory 
organizations.
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    These statutory standards are designed to assure the safety and 
soundness of the clearance and settlement system. As previously stated, 
the Commission, in granting CCOS's exemption is requiring CCOS to meet 
in substantial form these same statutory standards and is satisfied 
that CCOS's operation will not be a threat to the safety or soundness 
of the national market system. Furthermore, the Commission will 
continue to monitor CCOS's operations to assure its soundness in the 
clearance and settlement of government securities.
a. Safeguarding of Securities and Funds
    Sections 17A(b)(3) (A) and (F) of the Act require a clearing agency 
be organized and its rules designed to facilitate the prompt and 
accurate clearance and settlement of securities transactions for which 
it is responsible and to safeguard securities and funds in its custody 
or control or for which it is responsible.54 The Commission 
believes that CCOS meets these standards. Among other things, CCOS will 
maintain appropriate audit and internal controls55 and will make 
available 

[[Page 65082]]
reports to participants concerning its internal accounting 
controls.56 In addition, CCOS has developed several procedures to 
safeguard securities and funds; prevent loss or destruction of 
securities, funds, or data; and to recover from losses that do 
occur.57
    \54\15 U.S.C. 78q-1(b)(3) (A) and (F) (1988).
    In addition to BOTCC's responsibilities as facilities manager, 
CCOS must assure itself that BOTCC complies with all of the 
safeguards, as appropriate, set forth in the section of the 
Standards Release regarding the safeguarding of securities and funds 
and prompt and accurate clearance and settlement of securities 
transactions; and that these operations will be subject to 
examination by CCOS's independent public accountant, the Commission 
and the appropriate regulatory agency to the same extent as in the 
case of a clearing agency which carries out its own processing. 
Standards Release, supra note 53.
    \55\Clearing agencies should have an audit committee which 
selects or makes recommendations to the Board of Directors of the 
clearing agency regarding the selection of the clearing agency's 
public accountant. CCOS Rule 213 requires the establishment of an 
audit committee consisting of at least three nonmanagement directors 
of CCOS. The committee will, among other things, make 
recommendations to the Board of Directors regarding the selection of 
CCOS's independent public accountants.
    CCOS proposes to employ outside independent auditors rather than 
establish an internal audit department for CCOS. The outside 
independent auditors will perform those duties typically performed 
by an internal audit department and will report to the audit 
committee, and conduct audit reviews as requested by the audit 
committee, but not less than once per fiscal year. The Commission 
believes that CCOS's method of establishing an audit committee and 
its use of outside independent auditors meets the requirements of 
the Act. Although the Standards Release recommends the use of an 
internal audit department, the Commission has on previous occasions 
found the use of outside auditors acceptable and falling within the 
requirements of the Act. See Securities Exchange Act Release No. 
27611 (January 12, 1990), 55 FR 1890 (order granting Delta 
Government Options Corp. temporary registration as a clearing 
agency).
    \56\The Standards Release noted that the objectives of internal 
accounting control are presumed to be a fundamental aspect of 
management's responsibilities. CCOS proposes to direct its 
independent public accountants to prepare an annual report on CCOS's 
system of internal accounting controls, and present the report to 
the CCOS Board of Directors. CCOS's proposal to use independent 
public accountants to produce an annual report on its system of 
internal accounting controls meets the requirements of the Act with 
regard to the security and accuracy requirements under Section 
17A(b)(3) (A) and (F) because it aids in assessing the safety and 
integrity of the clearing agency operations and promotes confidence 
and increased participation in the national clearance and settlement 
system.
    \57\CCOS proposes three levels of safeguards to prevent or 
minimize interruption of service as a result of hardware, systems 
software, or applications software failures. The first level 
addresses procedural practices within CCOS to control migration of 
changes in application systems to the production environment and the 
implementation of new systems. The second and third levels address 
interruptions in service due to equipment and systems software 
failures at different levels of severity, i.e. short and long term 
interruptions.
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i. Organization and Processing Capacity
    A clearing agency should be organized in a manner that effectively 
establishes operational and audit controls while fostering director 
independence.58 As in the example set forth in the Standards 
Release, CCOS meets these standards by keeping its Board of Directors 
informed of its operations and the impact that new or expanded services 
or volume increases would have on its processing capacity. CCOS also 
will keep its Board of Directors informed by reporting on periodic risk 
assessments of CCOS's operations, automated data processing systems, 
and facilities and by supervising the establishment, maintenance and 
updating of safeguards.59 The Commission is satisfied that CCOS's 
organizational and processing capacity meets the requirements of the 
Act, explained in the Standards Release, by providing a necessary flow 
of information to its Board of Directors which will allow it to oversee 
management's performance and to assure the operational capability and 
integrity of CCOS.
    \58\Standards Release, supra note 53.
    \59\For a detailed description of the Commission's policy on 
self-regulatory organization systems reviews, refer to Securities 
Exchange Act Release No. 29185 (May 9, 1991), 56 FR 22490 [File No. 
S7-12-91] (release setting forth the Commission's second automation 
review policy statement [``ARP II'']).
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ii. Financial Reports
    Participants that have made clearing fund contributions or have 
money or securities in a clearing agency's system should receive 
timely, audited annual financial statements. CCOS meets the 
requirements regarding financial reports, and the distribution of 
financial statements will enable CCOS's Board of Directors and 
participants to remain apprised of the clearing agency's financial 
condition and the adequacy and accuracy of its records.60 By 
making the financial statements available, CCOS is assisting the 
Commission and other appropriate regulatory agencies in the discharge 
of their regulatory responsibilities by facilitating access to 
important information that is necessary in evaluating the safety and 
soundness of clearing agencies.
    \60\CCOS Rule 214 states that within 60 days after the end of 
each of the Corporation's fiscal years, CCOS shall deliver to each 
participant unconsolidated audited financial statements for the 
fiscal year then ended covered by a report prepared by CCOS's 
independent public accountants. CCOS Rule 214 also states that upon 
request by any participant, CCOS shall deliver unconsolidated, 
unaudited quarterly financial statements.
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b. Fair Representation
    Section 17A(b)(3)(C) of the Act requires that the rules of a 
clearing agency provide for fair representation of the clearing 
agency's shareholders or members and participants in the selection of 
the clearing agency's directors and administration of the clearing 
agency's affairs. This section contemplates that users of a clearing 
agency have a significant voice in the direction of the affairs of the 
clearing agency.
    CCOS is a privately owned for profit corporation run for the 
benefit of its sole shareholder, BOTCC. Therefore, the Board of 
Directors of CCOS will be selected from members of the Board of 
Governors of BOTCC, and the officers of CCOS will be elected by the 
Board of Directors. While CCOS participants will have the opportunity 
to provide input to the CCOS Board through the CCOS Participant's 
Advisory Committee, this committee is only advisory in nature and its 
advice or recommendations is not binding on CCOS.61

    \61\As provided in CCOS Rule 501, the Participant's Advisory 
Committee will be comprised of three to ten participants who may 
advise CCOS on matters pertaining to the operation of CCOS. The 
purpose of the Participant's Advisory Committee is to provide 
representation to participants on matters which are of concern to 
them. In addition, participants will have prior notice of changes to 
rules that may affect their rights, obligations, or clearing 
requirements. CCOS will accept comments from participants with 
respect to any such changes; however, the Participant's Advisory 
Committee serves only in an advisory capacity and any advice or 
recommendation of the Committee is not binding on CCOS.
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    The Commission believes that neither the method in which CCOS's 
directors are selected nor the method for participant input meets the 
requirements of fair representation under Section 17A(b)(3)(C) of the 
Act but that the request for an exemption is appropriate in this 
context, as it was in the context of Delta Government Options Corp. 
CCOS expects that if its clearing volumes grow, it will file with the 
Commission for full registration as a clearing agency. At that time, 
the Commission will reevaluate whether CCOS's methods for assuring 
participants representation in the selection of its Board of Directors 
and in the administration of its affairs is consistent with the Act. If 
in its reevaluation the Commission believes that because of changed 
circumstances an exemption that does not comport with the fair 
representation requirement is no longer justified, the Commission will 
modify the conditions or terminate CCOS's clearing agency 
exemption.62
    \62\Because CCOS is being granted full exemption from 
registration as a clearing agency, a specific exemption is not being 
issued with regard to fair representation. Rather, the exemption 
from these requirements is included within the grant of a complete 
exemption from registration as a clearing agency.
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c. Financial Risk Management
    Commenters expressed concern about the financial resources 
available to CCOS in the event of liquidity problems. Because CCOS will 
rely on BOTCC for certain liquidity resources and because BOTCC's 
capital and credit lines are committed to its futures business, 
commenters expressed concern that a shortfall could occur if a member 
common to BOTCC and CCOS were to fail. In response, BOTCC has agreed to 
dedicate specific credit and financial resources to CCOS, and CCOS and 
BOTCC have established a framework for allocating losses between the 
two entities. As a condition to its exemption, CCOS has agreed to 
evaluate 

[[Page 65083]]
its capital and liquidity resources periodically, and BOTCC has agreed 
to supplement, in consultation with the Commission and the CFTC, CCOS's 
liquid resources as necessary to meet prudential standards.
    In addition to its financial resources, CCOS has facilities to 
identify its potential financial exposure from its participants and to 
collect margin deposits or other collateral adequate to address that 
exposure. As discussed above, CCOS in conjunction with BOTCC will 
calculate margin requirements and collect margin deposits from its 
participants for open positions. CCOS will obtain information from its 
participants regarding their financial condition and will have the 
authority to collect additional margin or collateral if it deems it 
appropriate. CCOS and BOTCC also will cooperate in sharing risk 
management information, to the extent possible, with securities and 
futures clearing organizations where CCOS and BOTCC members also are 
members.
    The Commission believes that entering into additional information 
sharing agreements is an area in which CCOS should explore in order to 
help ensure the safety and soundness of the clearance and settlement 
system and to promote financial risk management. The Commission 
recommends that CCOS become a part of the information sharing system 
established between all of the commodities clearing houses.63 In 
addition, the Commission encourages CCOS to pursue obtaining membership 
in the Securities Clearing Group (``SCG'').64 The Commission 
believes that CCOS's membership in both of these information sharing 
systems should permit CCOS and other clearing organizations to be more 
aware of common member risks and to implement effective crisis 
management procedures if needed.

    \63\Since 1980, the Chicago Mercantile Exchange (``CME'') and 
BOTCC have been sharing original margin and pay/collect information. 
In 1987, an information sharing agreement was executed between all 
U.S. commodity clearing houses. The Options Clearing Corporation 
(``OCC'') became a party to this information sharing agreement in 
1993. Letter from Dennis Dutterer, Executive Vice President and 
General Counsel/Secretary, BOTCC, to Margaret R. Blake, Attorney, 
Division of Market Regulation, Commission (May 5, 1995). Pursuant to 
the information sharing agreement, each commodity clearing house and 
the OCC send its margin requirements and daily cash flow information 
to BOTCC every night. The following morning, BOTCC sends the 
information back to the clearing houses so they can compare the 
margin account excesses, deficits, and cash flows.
    \64\The SCG was established in 1989 as a result of developments 
surrounding the October 1987 Market Break and subsequent studies on 
the causes of the Market Break. The stated purpose of the SCG is to 
increase cooperation and coordination among securities clearing 
entities and to facilitate the sharing of certain clearance and 
settlement information regarding surveillance and member risk 
monitoring. While SCG membership is limited to registered clearing 
agencies, the Commission encourages SCG to review its membership 
standards and consider whether certain clearing agencies with 
conditional registration exemptions should be eligible for 
membership.
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    The Commission believes that CCOS's rules and procedures are 
adequately designed to protect CCOS and its participants against 
financial losses associated with its services. CCOS's financial risk 
management initiatives, including its initial capitalization, its twice 
daily margin collection,65 and its committed credit facility, are 
aimed at preventing financial loss by participants and CCOS.66 As 
a result, the Commission believes that CCOS's rules and procedures and 
the methods by which CCOS proposes to safeguard the financial security 
of its clearing facilities adequately satisfies the requirements of the 
Act.
    \65\Supra note 28. The Commission believes that the method by 
which CCOS converts government securities to futures equivalents in 
its margin calculations is a prudent risk management measure.
    \66\As discussed above, CCOS will begin operations with an 
initial capitalization of $2 million and BOTCC's commitment to 
provide additional capital as necessary to cover CCOS's continuing 
costs of operations. CCOS will calculate margin requirements at 
least twice daily and will collect margin deficiencies from 
participants on T and on T+1 while retaining the authority to 
collect additional margin at any time. CCOS will establish a 
committed credit facility guaranteed by BOTCC. The credit facility 
initially will be $5 million and will be increased in increments of 
$5 million for each $1 billion increase in CCOS's daily average net 
settlements over a 90 day period.
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d. Participation standards
    Section 17A(b)(3)(B) of the Act enumerates certain categories of 
persons that a clearing agency's rules must authorize as potentially 
eligible for access to clearing agency membership and services. Section 
17A(b)(4)(B) of the Act contemplates that a registered clearing agency 
have financial responsibility, operational capability, experience, and 
competency standards that are used to accept, deny, or condition 
participation of any participant or any category of participants 
enumerated in Section 17A(b)(3)(B). The Commission believes that an 
exempt clearing agency should impose the same standards. In addition, 
the Act recognizes that a clearing agency may discriminate among 
persons in the admission to or the use of the clearing agency if such 
discrimination is based on standards of financial responsibility, 
operational capability, experience and competence.
    CCOS Rule 301 requires each member to maintain personnel and 
facilities adequate to ensure the expeditious and orderly transaction 
of business with CCOS or other participants. In addition, CCOS Rule 302 
requires participants in CCOS to meet initial and continuing financial 
and operational standards as determined by the CCOS Board of Directors 
and administered by CCOS management.67 Participation in CCOS will 
be open to members of BOTCC and members of the CBOT that are affiliated 
with members of BOTCC.68 The Board of Directors also may approve 
access by other clearing agencies that are regulated by the Commission 
or are excepted from regulation by the Commission.69

    \67\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.
    \68\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.
    BOTCC's minimum financial requirements for BOTCC corporate 
futures commission merchants (``FCM'') include the greater of a 
specified amount of capital or a percentage of funds required to be 
segregated and secured pursuant to the Commodities Exchange Act, 7 
U.S.C. Secs. 1, et seq. (1988), combined with non-customer margin 
requirements for proprietary trading. Once admitted, a clearing 
member may operate below the initial minimum, but must maintain a 
specific minimum amount of capital with no formal action taken 
(Level I). When the clearing member's initial minimum falls below 
the Level I minimum, but remains above the Level II minimum, the 
clearing member is subject to detailed financial analysis with a 
written report provided to senior management recommending no action 
or a change in status to Level III. At Level III the clearing member 
must maintain a minimum amount of capital and is immediately subject 
to 125% of normal margin requirements and provision of pro forma 
weekly capital computations for one month. If the capital ratios do 
not meet Level I standards by the next month, the clearing member 
will be moved to Level IV status. The Risk Management Committee is 
notified when the firm is subject to Level III requirements. When 
the clearing member falls below the Level III minimum they will be 
immediately subject to 150% of normal margin requirements. A formal 
report will be prepared for the Risk Management Committee outlining 
the problem with a recommendation for appropriate action which may 
include a further increase in margin requirements, restrictions on 
business activities or suspension or termination of clearing 
privileges. Letter from Dennis A. Dutterer, General Counsel, BOTCC, 
to Margaret R. Blake, Attorney, Division of Market Regulation, 
Commission (May 1, 1995).
    \69\Clearing agencies that are granted access to CCOS's services 
are not considered participants of CCOS for the purposes of CCOS's 
Rules except to the extent determined by the Board of Directors. 
Following Commission approval of its application and upon receipt of 
a bona fide request for access, CCOS will prepare and submit to the 
Commission for review, rules providing broader access to CCOS 
services for persons other than those currently envisioned by the 
CCOS Rules, consistent with the requirements of Section 17A of the 
Act. 

[[Page 65084]]

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    The Commission believes that temporarily exempting CCOS from 
Sections 17A(b)(3)(B) and 17A(b)(4)(B) of the Act is appropriate. CCOS 
rules do not meet the requirements of Section 17A(b)(3)(B) of the Act 
with regard to participants because CCOS rules do not provide for 
membership by all of the enumerated categories of persons. In addition, 
CCOS rules do not specify applicant and member financial standards as 
contemplated in Section 17A(b)(4)(B) of the Act.70 Financial and 
operational membership standards depend on factors that CCOS will 
develop based on the scope of CCOS's operations. CCOS's Board of 
Directors will review these factors from time to time and establish 
membership standards based on its findings. Presently, however, the 
participant standards have not been determined as required by the Act, 
and an exemption from participation requirements is appropriate.

    \70\CCOS Rule 302 and Rule 309 anticipate the determination of 
participant financial standards by the Board of Directors. At this 
time, however, the standards remain undefined.
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C. Comments and the Commission's Responses

1. Fragmentation of the Clearance and Settlement of Government 
Securities
    Some commenters believe that approval of CCOS's exemption 
application will result in fragmentation of the clearance and 
settlement of government securities and will preclude one account 
settlement. These commenters believe allowing CCOS to settle government 
securities trades in a manner not effectively integrated with the 
existing registered clearing corporation process would be deleterious 
to the systemic risk management currently provided by GSCC by causing 
lowered overall netting capability, incomplete management of the risk 
exposure presented by individual firms, and impairment of crisis 
management. The commenters argue that government securities 
transactions will operate in the safest and most efficient manner if 
participants have all of their government securities trades netted, 
margined, and settled through one central facility (``one account 
settlement'').71

    \71\One-account settlement enables a market participant to 
settle all of its trades through one clearing agency regardless of 
the location of the other parties to the trades and regardless of 
the markets in which the trades were executed.
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    Although commenters fear fragmentation in the clearance and 
settlement of government securities, the clearance and settlement of 
government securities transactions already is subject to diverse 
clearing arrangements. While GSCC is the only registered clearing 
agency providing clearance and settlement services in the government 
securities market, it is not the sole government securities clearing 
facility. Banks currently clear and settle substantial amounts of 
government securities transfers among themselves through the Federal 
Reserve System's book-entry wire system without any involvement by 
GSCC. Furthermore, BOTCC provides clearance and settlement services for 
futures and options on government securities including the physical 
delivery of government securities to satisfy futures delivery 
obligations.
    Section 17A(a)(2) of the Act directs the Commission, having due 
regard for the maintenance of fair competition among clearing agencies, 
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.72 Moreover, the requirement in Section 
17A(b)(3)(B)(ii) that clearing agencies admit other clearing agencies 
as participants appears to indicate that Congress, and the Commission 
which worked with Congress in developing the 1975 Amendments,73 
contemplated a national system for the clearance and settlement of 
securities transactions in which there could be multiple clearing 
agencies serving a securities market.

    \72\Standards Release, supra note 53.
    \73\Securities Acts Amendments of 1975, Pub. L. No. 94-29 
Sec. 17A(a), 89 Stat. 97.
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    Where more than one clearing agency for a market exists, the 
Commission believes that the linking of these clearing agencies, such 
as the envisioned linkage of CCOS, BOTCC, and GSCC, promotes 
competition and innovation while still allowing for one-account 
settlement. The Commission believes that one-account settlement can be 
achieved in a multiple-clearing agency environment through the use of 
interclearing agency links and interfaces.74

    \74\In the Commission release addressing conditions for the 
National Securities Clearing Corporation's (``NSCC'') approval as a 
clearing agency, the Commission stated that ``even though a broker-
dealer would be able to achieve one account processing through any 
one of the clearing corporation components of the National System, a 
broker-dealer would be able to use more than one clearing 
corporation if the broker-dealer chose to do so.'' Later in that 
same release the Commission stated, ``The development and expansion 
of interfaces during the past year, particularly the establishment 
of regional interfaces for the processing of over-the-counter 
transactions, has made one-account processing almost universally 
available.'' Securities Exchange Act Release No. 12954 (November 3, 
1976), 41 FR 49722.
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    The approach to one-account processing for the clearance and 
settlement of government securities transactions advocated by GSCC, 
where one clearing agency compares, nets, and settles all trades in 
government securities, is not the approach taken by the Commission when 
establishing the National System for clearance and settlement. The 
Commission believes that rather than mandate centralized clearance and 
settlement in the government securities market, it should encourage the 
coordination of any competing systems through economically efficient 
linkages that ultimately will foster both competition and investor 
confidence. For these reasons, the Commission, as a part of its 
granting CCOS an exemption from clearing agency registration, is urging 
CCOS, BOTCC, and GSCC to develop settlement interface and cross-
margining programs.75

    \75\Supra note 45.
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2. Illusory Regulatory Oversight
    As stated above, BOTCC will be the sole shareholder and will act as 
the facilities manager for the CCOS operations. Because of the 
relationship between CCOS and BOTCC, some commenters expressed concern 
that the Commission would be unable to oversee appropriately the 
operations of CCOS. Furthermore, these commenters stated that the 
Commission's regulatory authority over CCOS would be illusory because 
CCOS would be controlled and operated by BOTCC. These commenters stated 
that CCOS is merely a shell for BOTCC and that approval of CCOS's 
application will allow BOTCC to provide clearance and settlement 
services for government securities. Finally, several commenters noted 
their concern with and objection to CCOS performing the services of a 
registered clearing agency without the federal oversight imposed upon 
all other registered clearing agencies. These commenters argued that 
for the safety and soundness of the national clearance and settlement 
system, CCOS should be subject to the same standards and requirements 
as all other registered clearing agencies.
    Under the proposal, CCOS will share office space and staff with 
BOTCC, and BOTCC will perform all margin calculations and collection 
and payment 

[[Page 65085]]
functions for CCOS. Sharing office space and staff among clearing 
agencies and contracting out certain clearing agency functions is not 
unusual.76

    \76\In 1988, GSCC began operations with a facilities management 
agreement with NSCC whereby NSCC provides GSCC with the necessary 
administrative and technical services. GSCC continues to share staff 
and office space with its affiliates, NSCC and International 
Securities Clearing Corporation. In fact, NSCC and GSCC do not 
operate their own clearance and settlement systems; instead, they 
contract that function out to the Securities Industry Automation 
Corporation.
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    The standards established for registration of a clearing agency 
that hires a facility manager to perform data or other processing 
functions requires the clearing agency to maintain appropriate 
procedures to insure the prompt and accurate clearance and settlement 
of securities transactions.77 The clearing agency also should 
assure itself that the facilities manager complies with all of the 
appropriate safeguards set forth in the Standards Release. The 
Standards Release also requires any such clearing agency to assure 
itself that its facility manager will cooperate fully with clearing 
agency auditors, Commission examiners, independent public accountants, 
and any other appropriate regulatory agency to the same extent as a 
clearing agency which conducts its own processing functions.

    \77\Standards Release, supra note 53.
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    The Commission's experience with facilities management arrangements 
is that the Commission can carry out its clearing agency oversight 
responsibilities through its jurisdiction over the clearing agencies. 
Facilities managers cannot, for example, unilaterally make systems 
changes that would alter the rules of the clearing agency or the rights 
and obligations of clearing agency participants without having those 
changes filed by the clearing agency with the Commission.78 To the 
extent that the Commission needs access to a facilities manager's 
premises or personnel, the Commission expects and has found clearing 
agencies and their facilities managers to be cooperative with 
Commission staff.79

    \78\As discussed below, because CCOS will operate under an 
exemption from registration as a clearing agency, it will not file 
rule changes under the Section 19(b) process. Rather, CCOS will have 
to file amendments to its Form CA-1 exemption application and 
request modification of its exemptive order to change its rules or 
procedures.
    \79\The Commission generally has not required that facilities 
management contracts specifically grant the Commission unlimited 
access to a facilities manager's premises. If in the future the 
Commission perceives a need for express authority for such access, 
it will revisit the issue at that time.
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    Regarding commenters' concerns about the need for uniform federal 
oversight, in granting its application for exemption the Commission is 
requiring CCOS to meet basically the same standards as those registered 
clearing agencies must meet, and believes that CCOS has set forth a 
plan to enable it to meet those standards.80 CCOS recognizes that 
it must comply with the regulatory standards governing the operations 
of clearing agencies in a manner consistent with its operational 
structure and with the specific services it will offer. CCOS has 
represented that it intends to comply fully with all relevant 
regulatory requirements applicable to other clearing agencies.81

    \80\Id.
    \81\Letters from John C. Hiatt, President and Chief Executive 
Officer, BOTCC, to Jonathan G. Katz, Secretary, Commission (May 23 
and June 22, 1994).
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3. Fair Competition
    Some commenters believe that the approval of CCOS's application 
will not promote fair competition among clearing agencies as 
contemplated by Section 17A of the Act because CCOS will have exclusive 
access to cross-margining with BOTCC with respect to government 
securities. The Commission recognizes that to promote competition among 
clearing agencies, the benefits of CCOS's operations (e.g., greater 
access to the government securities market by persons other than 
primary dealers, the development of improved systems capabilities and 
new services, and perhaps lower prices to participants) must not 
``impose any burden on competition not necessary or appropriate in 
furtherance of the purposes'' of the federal securities laws.82

    \82\15 U.S.C. 78q-1(b)(3)(I) (1988).
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    Since approval of the first cross-margining program in 1988,\83\ 
the Commission repeatedly has found that cross-margining programs are 
consistent with clearing agency responsibilities under Section 17A of 
the Act. As the Commission has previously noted, cross-margining 
programs, among other things, tend to enhance clearing member and 
systemic liquidity both in times of normal trading and in times of 
stress.\84\ Under routine trading, clearing members that participate in 
cross-margining programs have lower margin requirements which help 
clearing members manage their cash flows by increasing available cash 
to be used for other purposes. In times of market stress and high 
volatility, lower margin requirements could prove crucial in 
maintaining the liquidity of clearing members and thus could enhance 
liquidity in the market as a whole. By enhancing market liquidity, 
cross-margining arrangements remove impediments to and help perfect the 
mechanism of a national system for the prompt and accurate clearance 
and settlement of securities transactions.\85\

    \83\Securities Exchange Act Release No. 26153 (October 3, 1988), 
53 FR 39567 (approving nonproprietary cross-margining program 
between OCC and ICC).
    \84\E.g., Securities Exchange Act Release Nos. 30413 (February 
26, 1992), 57 FR 7830 (order approving OCC/Kansas City Board of 
Trade Clearing Corporation cross-margining program for proprietary 
positions); 29991 (November 26, 1991), 56 FR 61458 (order approving 
expansion of OCC/CME cross-margining program to include positions 
held for market professionals); 29888 (October 31, 1991), 56 FR 
56680 (order approving OCC/BOTCC cross-margining program for 
proprietary positions); 27296 (September 26, 1989), 54 FR 41195 
(order approving OCC/CME cross-margining program for proprietary 
positions).
    \85\Shortly after the 1987 market break, then Treasury Secretary 
Nicholas F. Brady referred to the clearance and settlement system as 
the weakest link in the nation's financial system and noted that 
improvements to the clearance and settlement system, such as those 
provided by cross-margining arrangements, would ``help ensure that a 
securities market failure does not become a credit market failure.'' 
The Market Reform Act of 1989: Joint Hearings on S. 648 before the 
Subcomm. on Securities and the Senate Comm. on Banking, Housing and 
Urban Affairs, 101st Cong., 1st Sess. 225 (Oct. 26, 1989) (statement 
of Nicholas F. Brady, Secretary of the Treasury).
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    Because CCOS and BOTCC have proposed a cross-margining plan between 
themselves, the Commission has encouraged CCOS, BOTCC, and GSCC to 
create and implement a cross-margin arrangement so that fair 
competition in the clearing of government securities will exist. The 
Commission believes that competition among clearing agencies should not 
be based on margin levels but should be based on technology, services, 
or product types offered by the competing clearing agencies. Therefore, 
the Commission views the implementation of a cross-margining 
arrangement among CCOS, BOTCC, and GSCC as vital to the satisfaction of 
the statutory goals of Section 17A of the Act. Towards this end, CCOS, 
BOTCC, and GSCC have entered into negotiations regarding cross-
margining and linkage agreements. However, because such an agreement 
has not yet been finalized, the Commission believes it is appropriate 
to allow CCOS to begin operations with certain limits in place prior to 
the implementation of cross-margining and linkage agreements.\86\

    \86\Supra note 45.
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D. Conditions

    This Order exempts CCOS from registration as a clearing agency 
under Section 17A of the Act subject to certain conditions which the 
Commission believes are appropriate for an entity operating under an 
exemptive framework. As explained in detail below, these conditions 
include:


[[Page 65086]]

    1. Establishment of acceptable linkage and cross-margining 
agreements between CCOS, BOTCC, and GSCC;
    2. The Commission's access to CCOS and related BOTCC facilities 
and records in order to inspect CCOS's operations and to insure 
CCOS's compliance with the federal securities laws and this Order;
    3. The requirement that all proposed material changes to CCOS's 
rules, operations, and systems be submitted as proposed amendments 
to its Form CA-1;
    4. The requirement that CCOS notify the Commission of 
participant defaults;
    5. The establishment of sound automation review programs 
including system change notification procedures and system outage 
notification procedures; and
    6. Until the establishment of acceptable linkage and cross-
margining agreements between CCOS, BOTCC, and GSCC, the requirement 
that CCOS limit its activity to no more than $3 billion net daily 
settlement for government securities and $12 billion for dollar 
rolls.
1. Linkage and Cross-Margining
    Throughout this Order, the Commission has emphasized the importance 
of linkage and cross-margining agreements between CCOS, BOTCC, and 
GSCC. While the Commission recognizes that such agreements will entail 
substantial negotiations among the parties, the Commission also 
recognizes the importance of allowing CCOS to begin operations without 
further delay.\87\ Therefore, the Commission is approving CCOS's 
application for exemption and will allow CCOS to commence operating 
with a volume cap of $3 billion net daily settlement for government 
securities and $12 billion for dollar rolls.\88\ During CCOS's initial 
period of operation, the Commission anticipates that CCOS, BOTCC, and 
GSCC will finalize linkage and cross-margining agreements pursuant to 
the Commission's recommendations at which time CCOS will be permitted 
to proceed to its exemptive limits of $6 billion and $24 billion.\89\ 
Either upon CCOS's request or by its own initiative, the Commission may 
review whether the current volume limitations should be modified or 
removed. Such review may be conducted even if the linkage and cross-
margining agreements among CCOS, BOTCC, and GSCC have not been 
finalized.

    \87\As noted, a joint user committee established by the Boards 
of Directors of GSCC, BOTCC, and CCOS will provide to the respective 
Boards within three months of formation of the committee a report of 
its analysis and proposed resolutions to the outstanding linkage and 
cross-margining issues. The Commission expects prompt action with 
regard to the establishment of linkage and cross-margining 
facilities, and if necessary, the Commission will use its authority 
under the Act to direct that such facilities be established. Supra 
notes 45-46 and accompanying text.
    \88\These amounts are half of the maximum daily net settlement 
amounts agreed to by CCOS and the Division, as discussed in note 35. 
The Commission believes these limits are large enough to allow CCOS 
to begin effective operations while it works with GSCC to develop 
linkage and cross-margining facilities to advance efficient 
clearance and settlement.
    \89\These are the maximum average daily net settlements agreed 
to by CCOS and the Division during the exemptive period. In 
addition, limits on CCOS's clearing capacity must be considered in 
light of the limits to be placed on CBB as a government securities 
broker. CCOS will be limited to clearing $6 billion in net daily 
cash securities and $24 billion in dollar rolls on an average basis 
over a ninety-day period. Supra note 35.
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2. Inspection
    As noted above, pursuant to this Order the Commission has the 
authority to inspect at any time the operations of CCOS in order to 
insure its compliance with its obligations to safeguard securities and 
funds and to provide prompt and accurate clearance and settlement of 
securities transactions. As facilities manager for CCOS, BOTCC's 
facilities and operations as they pertain to CCOS are also subject to 
inspection by the Commission in order that the Commission may assure 
itself that BOTCC's operations with regard to CCOS are in compliance 
with the safety and soundness requirements set forth in the Act. The 
Commission expects to coordinate any inspections of BOTCC with the 
CFTC.
3. Rule Changes
    Under Section 19(b)(1) of the Act,\90\ a registered clearing agency 
as a self-regulatory organization must file proposed rule changes with 
the Commission for approval. The Commission uses the rule filing 
process as a method to monitor and regulate the operations of clearing 
agencies. Because CCOS is not a registered clearing agency, amendments 
to its rules need not be made through use of the Section 19(b) process. 
As a condition to this Order, however, should CCOS desire to amend its 
rules, it must submit proposed amendments to its Form CA-1 for 
Commission review.\91\ The Commission believes that this method of 
notifying the Commission of proposed changes at CCOS will allow the 
Commission to conduct a thorough examination of each proposed change 
and its potential effects on CCOS and the clearance and settlement of 
government securities. Submission by CCOS of a proposed amendment to 
its Form CA-1 each time it proposes to make a change in its rules, 
operations, or systems is an appropriate method by which the Commission 
can exercise its regulatory responsibilities with regard to CCOS.

    \90\15 U.S.C. Sec. 78s(b)(1) (1988).
    \91\CCOS will be required to amend its CA-1 application for any 
proposed changes to its stated policies, practices, or 
interpretations as that phrase is defined in Rule 19b-4 (17 CFR 
240.19b-4).
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4. Notice of Defaults
    CCOS will be required to notify the Commission of any defaults by 
participants so that the Commission can monitor the situation and 
determine if all appropriate methods of recovery are being utilized. 
Failure by a participant or user could create or exacerbate systemic 
risks. Prompt notification should help facilitate cooperation and 
coordination among regulators and market participants.
5. Automation Review
    CCOS also will be required to establish a sound automation review 
program based upon the Commission's second automation review policy 
statement (``ARP II'').\92\ The automation review program should 
include appropriate planning processes (i.e., contingency planning and 
security assessment), independent reviews by CCOS of its systems, 
notification to the Commission of significant systems changes, and 
procedures for timely notification of significant system outages. The 
Commission believes the automation review program is essential for the 
safety and soundness of CCOS's operations and the national market 
system because it will require, among other things, CCOS to evaluate 
regularly its processes related to the capacity and vulnerabilities of 
its automated systems.

    \92\Securities Exchange Act Release Nos. 27445 (November 16, 
1989) [54 FR 48704] (``ARP I''), and 29185 (May 9, 1991) [56 FR 
22489], (``ARP II'').
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6. Limits on Activity
    The Commission believes that until acceptable linkage and cross-
margining plans are in place, CCOS's clearing activity should be 
limited to one half of the maximum daily net settlement amounts agreed 
to by CCOS and the Division. These limit amounts are no more than $3 
billion in net daily settlement for government securities, and $12 
billion for dollar rolls. Once the linkage and cross-margining plans 
are in place, CCOS's activity may proceed to the full amounts agreed to 
in this Order.
    The Commission reserves the right to modify by order the terms, 
scope, or conditions of CCOS's exemption from registration as a 
clearing agency, including such terms, scope, or condition that the 
Commission may issue in the future regarding amendments to CCOS's Form 
CA-1, if the Commission determines that such modification is 
appropriate for the 

[[Page 65087]]
protection of investors or in the public interest. Furthermore, the 
Commission reserves the right to suspend or revoke this exemption or to 
censure or impose limitations upon the activities, functions, and 
operations of CCOS if the Commission finds that CCOS has violated or is 
unable to comply with any of the provisions set forth in this Order or 
in its own rules or that CCOS has failed without reasonable 
justification to enforce compliance with any provision of its own rules 
by one of its participants.

IV. Conclusion

    The Commission finds that CCOS's application for exemption from 
registration as a clearing agency meets the standards and requirements 
deemed appropriate for such an exemption including those standards set 
forth under Section 17A of the Act.
    It is therefore ordered, pursuant to Section 19(a)(1) of the Act, 
that the application for exemption from registration as a clearing 
agency filed by the Clearing Corporation for Options and Securities 
(File No. 600-27) be, and hereby is, approved subject to the conditions 
listed in this Order.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-30660 Filed 12-15-95; 8:45 am]
BILLING CODE 8010-01-P '