[Federal Register Volume 61, Number 88 (Monday, May 6, 1996)]
[Notices]
[Pages 20304-20306]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11230]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37152; File No. SR-PTC-96-02]


Self-Regulatory Organizations; Participants Trust Company; Notice 
of Filing and Order Granting Accelerated Approval of Proposed Rule 
Change Establishing on a Permanent Basis the Margin and Pricing 
Methodology for Collateralized Mortgage Obligations

April 30, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on March 8, 1996, the 
Participants Trust Company (``PTC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change (File No. 
SR-PTC-96-02) as described in Items I and II below, which Items have 
been prepared primarily by PTC. The Commission is publishing this 
notice and order to solicit comments from interested persons and to 
grant accelerated approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1) (1988).

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[[Page 20305]]

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change establishes on a permanent basis the 
margin and pricing methodology utilized by PTC for collateralized 
mortgage obligations (``CMOs'') that are eligible for deposit or that 
may become eligible for deposit at PTC.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, PTC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. Summaries of the most significant aspects of such 
statements are set forth in sections A, B, and C below.\2\
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    \2\ The Commission has modified the text of the summaries 
prepared by PTC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

    The purpose of the proposed rule change is to establish a permanent 
methodology to formulate the percentage (i.e., margin) to be deducted 
from the market value of CMOs that are eligible for deposit or that may 
become eligible for deposit at PTC.\3\ The proposed margin and pricing 
methodology is substantially the same as the current margin and pricing 
methodology except for one variation that is proposed as a result of 
PTC's research and analysis of additional data compiled in the period 
since the temporary approval was granted.
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    \3\ PTC's current CMO margin and pricing methodology was 
approved by the Commission on a temporary basis through April 30, 
1996, in order to allow PTC to make technical enhancements that 
enabled PTC to use and compare data from two pricing vendors and 
also enabled PTC to further evaluate the results of the CMO pricing 
and margin methodology as enhanced. Securities Exchange Act Release 
No. 35641 (April 24, 1995), 60 FR 21228 [File No. SR-PTC-95-03] 
(order approving proposed rule change on an accelerated basis).
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Margin under PTC's Rules
    Under PTC's rules, a certain percentage (''applicable percentage'') 
of the market value of securities is included in the computation of 
participants' Net Free Equity.\4\ Net Free Equity represents PTC's 
calculation of the amount of excess equity available in a participant's 
account which PTC may borrow against or liquidate in the event a 
participant's debit balance is not satisfied at the end of the day. Net 
Free Equity of zero or greater is required to be maintained by 
participants in each of its agency, pledge, or proprietary accounts in 
order for transactions to be processed.\5\
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    \4\ As set forth in PTC Rules, Article II, Rule 9, Net Free 
Equity is calculated as the sum of (a) the cash balance in the 
account; (b) the market value of securities in the account less the 
applicable percentage; (c) the value of the optional deposits to the 
Participants Fund which are allocated to that account (optional 
deposits to the Participants Fund are deposits that exceed the 
minimum deposit required pursuant to PTC's rules and procedures); 
and (d) 20% of the mandatory deposits to the Participants Fund for 
the master account (mandatory deposits to the Participants Fund are 
minimum deposits required to be deposited into such fund pursuant to 
PTC's rules and procedures) minus (e) ``reserve on gain.'' Reserve 
on gain means (1) the contract value credited to the cash balance of 
a delivering participant or limited purpose participant over the 
market value of securities credited to the transfer account 
associated with the account of the receiving participant or (2) the 
market value of securities credited to the transfer account 
associated with the account of a receiving participant over the 
contract value credited to the cash balance of the delivering 
participant or limited purpose participant.
    \5\ PTC Rules, Article II, Rule 13, ``Transfers of Securities.''
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    By including only a portion of the market value of securities in 
Net Free Equity, PTC attempts to limit the risk caused by fluctuations 
in the market value of these securities. For example, for Government 
National Mortgage Association (``GNMA'') single-class securities other 
than construction, project, and mobile home securities, margin is set 
at five percent, which is a rate that exceeds these securities' largest 
historic consecutive two-day downward price movement. GNMA 
construction, project, and mobile home securities have a higher margin 
to reflect their reduced liquidity.\6\
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    \6\ Securities Exchange Act Release No. 33840 (March 31, 1994), 
59 FR 16672 [File No. PTC-93-04] (order approving proposed rule 
change).
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CMO Margins
    CMOs that are currently eligible for deposit at PTC are GNMA 
REMICs, Department of Veterans Affairs (``VA'') REMICs, and certain 
Federal Home Loan Mortgage Corporation (``FHLMC'') and Federal National 
Mortgage Association (``FNMA'') REMICs. Unlike GNMA single-class 
securities, CMOs are multiple-class mortgage cash flow securities which 
redirect the cash flow from an underlying standard mortgage-backed 
security, such as a GNMA security, and which allow the CMO issuer to 
create classes or tranches with many different interest rates, average 
lives, prepayment sensitivities, and final maturities.
    To establish margins for CMOs, PTC uses a model which takes into 
account the unique characteristics of each tranche to predict its 
potential price movement. The parameters of the model include the 
current price of the security, the prepayment assumptions, and the 
corresponding Treasury yield curve. PTC subjects each CMO tranche to a 
stress test to determine its response to yield changes in order to 
assign each tranche an appropriate margin.
    Currently, margins are based on a fifty basis point upward movement 
in the yield of the underlying Treasury securities for CMO tranches 
that exhibit positive effective duration (i.e., tranches which rise in 
value with falling interest rates) or a fifty basis point downward 
movement in the yield of the underlying Treasury security for CMO 
tranches that exhibit negative effective duration (i.e., tranches which 
decline in value with falling interest rates). CMO tranches that are 
not modeled by PTC's pricing vendors are margined at one hundred 
percent, and the minimum margin for any CMO tranche is five percent.
    All margins are reevaluated at least quarterly. In addition, 
margins are reevaluated any time there is a shift of one hundred basis 
points or more on any point of the Treasury yield curve for the 
applicable CMOs and for any CMOs that experience a one-day price 
decrease in excess of fifty percent of the assigned margin.
Proposed New Margin Methodology
    Because PTC anticipates that additional issues of FHLMC and FNMA 
CMOs may become eligible for deposit at PTC, it has extended its 
analysis of historical shifts in Treasury yield decreases. As a result 
of this analysis, PTC proposes to increase the basis points used for 
margin calculation for CMOs that exhibit negative effective duration 
from fifty basis points to one hundred basis points.\7\ Therefore, PTC 
has requested permanent approval of its methodology to establish 
margins for CMOs based upon the maximum percentage decrease resulting 
from a fifty basis point upward movement in the yield of the underlying 
Treasury security for CMO tranches that exhibit positive effective 
duration or a one hundred basis point downward movement in the yield of 
the underlying Treasury security for CMO tranches that exhibit negative 
effective duration.
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    \7\ One hundred basis points corresponds to the largest actual 
decrease in Treasury yields over the most current ten year period. 
The largest actual decrease in Treasury yields over the most current 
ten year period occurred when the two-year Treasury yield declined 
99.5 basis points between the days before and after the stock market 
break on October 19, 1987 (comparing Friday, October 16, 1987, with 
Tuesday, October 20, 1987).

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[[Page 20306]]

    The increase in the basis points used for CMOs that exhibit 
negative effective duration does not affect the margins of the CMOs 
currently on deposit at PTC because the CMO tranches that would decline 
in value assuming a one hundred basis point decline in the yield of the 
underlying Treasury security are interest only (``IO'') tranches or 
tranches which have IO like characteristics. These securities are not 
currently priced by PTC's pricing vendors and accordingly are assigned 
a value of zero on PTC's system.\8\ However, PTC anticipates that as 
additional issues become depository eligible at PTC and PTC's pricing 
vendors are able to provide prices for such issues, some of these 
issues may include tranches which are sensitive to a one hundred basis 
point decline.
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    \8\ Since temporary approval for the current CMO margin and 
pricing methodology was granted, PTC has completed the system 
enhancements necessary to use and compare data from two pricing 
vendors. CMO prices are established by defaulting to the lower of 
the two in the event of any discrepancy.
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    PTC believes that the proposed rule change is consistent with 
Section 17A(b)(3)(F) of the Act \9\ and the rules and regulations 
thereunder because it facilitates the prompt and accurate clearance and 
settlement of securities transactions and provides for the safeguarding 
of securities and funds in PTC's custody or control or for which PTC is 
responsible.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    PTC does not believe that the proposed rule change imposes any 
burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    PTC has discussed the proposed margin methodology with its Risk 
Management Committee, which is comprised of participant 
representatives. PTC has neither solicited nor received written 
comments from participants or other interested parties on this proposed 
rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Section 17A(b)(3)(F) of the Act \10\ requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds in the custody or control of the clearing agency or for which 
it is responsible. The Commission believes that the proposed margin and 
pricing methodology utilized by PTC for CMOs is consistent with this 
obligation.
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    \10\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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    The Commission previously approved PTC's current margin and pricing 
methodology for CMOs on a temporary basis in order to allow PTC further 
time to evaluate the methodology and to take steps to address any 
concerns which existed with respect to the methodology. During the 
temporary approval period, PTC has provided information to the 
Commission describing the steps taken by PTC to improve the margin and 
pricing methodology including finalizing arrangements with a second 
pricing vendor for daily pricing and stress test analysis. Because PTC 
believes it has made all the changes that its research and analysis 
conducted during the temporary approval period revealed needed to be 
made, PTC has decided to request permanent approval of the margin and 
pricing methodology.
    PTC's margin and pricing methodology helps ensure that in 
establishing CMO margins, PTC takes into account the unique 
characteristics of each CMO tranche. Furthermore, PTC's reliance on two 
pricing sources should provide PTC with timely and accurate price 
information. The resulting margins established for CMOs that are 
eligible for deposit or that may become eligible for deposit at PTC 
should afford PTC sufficient protection in the event it becomes 
necessary for PTC to borrow against or liquidate these assets to 
satisfy a participant's debit balance that is not satisfied at the end 
of the day. In addition, increasing the basis points used in 
calculating margins for CMOs that exhibit negative effective duration 
from fifty basis points to one hundred basis points should result in 
more conservative margins for these securities and thereby should help 
to limit PTC's risk resulting from fluctuations in the market values of 
these securities.
    PTC has requested that the Commission find good cause for approving 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice of the filing. The Commission finds such good 
cause for so approving the proposed rule change because accelerated 
approval will allow PTC to continue employing its margin and pricing 
methodology without disruption of service prior to the expiration of 
the current temporary approval on April 30, 1996. Furthermore, the 
Commission did not receive any comment letters during the comment 
period before it granted temporary approval or during the temporary 
approval period and does not expect to receive any during the present 
comment period. The staff of the Board of Governors of the Federal 
Reserve System (``Board of Governors'') has concurred with the 
Commission's granting of accelerated approval.\11\
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    \11\ Telephone conversation between John Rudolph, Board of 
Governors, and Ari Burstein, Division of Market Regulation, 
Commission (April 15, 1996).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of PTC. All 
submissions should refer to file number SR-PTC-96-02 and should be 
submitted by May 27, 1996.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-PTC-96-02) be and hereby is 
approved on an accelerated basis.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR. 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-11230 Filed 5-3-96; 8:45 am]
BILLING CODE 8010-01-M