[Federal Register Volume 61, Number 149 (Thursday, August 1, 1996)]
[Notices]
[Pages 40274-40276]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19569]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37482; File No. SR-GSCC-96-04]
July 25, 1996.
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Order Granting Approval of a Proposed Rule Change Relating
to Interdealer Broker Netting Members Participating in Repurchase
Transactions Settlement Services
On May 10, 1996, the Government Securities Clearing Corporation
(``GSCC'') filed with the Securities and Exchange Commission
(``Commission'') a proposed rule change (File No. SR-GSCC-96-04) under
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\
to allow interdealer broker (``IDB'') netting members to become
eligible for GSCC's netting service for repurchase and reverse
repurchase transactions involving government securities as the
underlying instrument (``repos''). On May 13, 1996, GSCC amended the
filing.\2\ Notice of the proposal was published in the Federal Register
on May 28, 1996.\3\ The Commission received six comment letters \4\
with GSCC responding to one of the comment letters.\5\ For the reasons
discussed below, the Commission is approving the proposed rule change.
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\1\ 15 U.S.C. Sec. 78(b)(1) (1988).
\2\ Letter from Jeffrey F. Ingber, General Counsel and
Secretary, GSCC, to Christine Sibille, Division of Market Regulation
(``Division''), Commission (May 13, 1996).
\3\ Securities Exchange Act Release No. 37230 (May 20, 1996), 61
FR 26550.
\4\ Letters from Edwin F. Payne, Chief Executive Officer,
Liberty Brokerage Investment Corp. (``Liberty''), to Jonathan G.
Katz, Secretary, Commission (May 16, 1996); David C. Bushnell,
Managing Director, Salomon Brothers, Inc. (``Salomon''), to Jonathan
G. Katz, Secretary, Commission (May 16, 1996); Roger J. Cohen, Chief
Operating Officer, Garvin GuyButler (``Garvin'') to Jonathan G.
Katz, Secretary, Commission (May 17, 1996); William S. Molloy,
Managing Director, Morgan Stanley & Co. (``Morgan Stanley''), to
Jonathan G. Katz, Secretary, Commission (May 20, 1996); Raymond
McLaughlin, Managing Director, Patriot Securities, Inc.
(``Patriot''), to Jonathan G. Katz, Secretary, Commission (May 17,
1996); and Stephen K. Lynner, President, Delta Clearing Corp.
(``Delta''), to Jonathan G. Katz, Secretary, Commission (June 18,
1996).
\5\ Letter from Jeffrey F. Ingber, General Counsel and
Secretary, GSCC, to Jerry W. Carpenter, Assistant Director,
Division, Commission (June 25, 1996).
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I. Description
GSCC previously introduced a comparison service for repo
transactions \6\ and a netting service for the non-same-day-settling
aspects of next-day and term repos.\7\ As initially implemented, IDB
netting members were not eligible for participation in the repo netting
service.\8\ This proposal allows IDB netting members to participate in
GSCC's repo netting service.
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\6\ Securities Exchange Act Release No. 35557 (March 31, 1995),
60 FR 17598 [File No. SR-GSCC-94-10] (Order approving proposed rule
change relating to implementing a comparison service for repos).
\7\ Securities Exchange Act Release No. 36491 (November 17,
1995), 60 FR 61577 [File No. SR-GSCC-95-02] (order approving a
proposed rule change relating to netting services for the non-same-
day-settling aspects of next-day and term repos).
\8\ GSCC's long-range plans for its repo services entail the
full and complete automation of all aspects of start and close leg
processing, including the intraday settlement of repo start legs.
IDB netting members were not made eligible for GSCC's repo netting
services because brokering in the repo market generally was done on
a give-up basis (i.e., the brokers give up the names of each
counterparty to the other and drop out of the transaction). GSCC
initially intended to address IDB participation in the repo netting
system when implementing a netting and settlement service for same-
day-settling start legs. Because GSCC will not be able to implement
such a service until the last quarter of this year at the earliest,
GSCC filed this proposed rule change in order to expedite the entry
of IDB netting members in the repo netting system.
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Pursuant to this rule change, IDB netting members and their non-IDB
netting member customers (i.e., dealers) will submit data on brokered
repos to GSCC in the same manner as they do for cash transactions. GSCC
will compare, net, and settle repo start legs which are submitted prior
to the start date (i.e., non-same-day-settling start legs) and all repo
close legs for next-day and term repos pursuant to GSCC's existing
procedures for the netting and settling of repos. GSCC Rule 18, Special
Provisions for Repo Transactions, will also apply to brokered repos.\9\
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\9\ Rule 18 establishes eligibility requests for participation
in the repo netting process, establishes the timing for novation of
repo transactions, and sets forth netting members' obligations to
submit repo transactions to GSCC, another registered clearing
agency, or a clearing agency that has been exempted from
registration as a clearing agency.
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Because GSCC currently does not clear same-day-settling start legs,
the parties to brokered repos will assume the responsibility for the
intraday settlement of such start legs outside of GSCC. As a result,
IDBs will be assuming principal liability for these transactions.
Through its novation, GSCC will be the legal counterparty for all
eligible netted close legs and start legs submitted prior to the
settlement date and will guarantee settlement as of the delivery to
participants of netting output information on the day following the
trade date (``T+1''). Therefore, an IDB's exposure is limited to its
principal liability in the event that GSCC ceases to act for its
customer pursuant to GSCC Rule 19 or 20 during the period between the
execution of the trade and the effectiveness of GSCC's guarantee. If a
dealer fails in its settlement obligations to the IDB but is still a
GSCC member, GSCC will accept the repo transaction and treat the start
leg as a forward settling start leg to be settled through GSCC.
Only IDBs that have and agree to maintain a level of excess net
capital or excess liquid capital, as applicable, of at least $10
million are eligible to submit data on repo transactions to GSCC.\10\
Furthermore, IDBs may only submit to GSCC repo transactions that have
been executed between two dealers that have been designated as eligible
to participate in GSCC's repo netting services.\11\ As a result, the
IDB's position will always net out at GSCC.
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\10\ The Commission recently approved File No. SR-GSCC-96-02,
which requires all IDBs, regardless of whether they participate in
the repo netting service, to have and to maintain a minimum level of
excess liquid/net capital of at least $10 million. Securities
Exchange Act Release No. 37343 (June 20, 1996), 61 FR 33564 (order
approving a proposed rule change modifying the minimum financial
criteria for Category 1 IDB netting membership).
\11\ The definitions for Category 1 and Category 2 IDBs have
been amended to account for repo transactions with non-GSCC members
which will not be submitted to GSCC. Specifically, Category 1 IDBs
are not limited to acting exclusively as brokers on behalf of GSCC
netting members and/or grandfathered nonmembers with respect to repo
transactions. Similarly, Category 2 IDBs are not limited to acting
exclusively as brokers or conducting at least ninety percent of
their business with GSCC netting members and/or grandfathered
nonmembers with respect to repo transactions. IDB netting members
will not need to report data on repos pursuant to Section 3 of Rule
15, and the continuance standards of Rule 3, Section 5 (g) and (i)
will not take into account repo transactions.
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IDBs are subject to the following operational requirements: (1)
Upon being informed by either GSCC or another netting member of an
error in or problem with the data on an eligible repo transaction that
it has submitted to GSCC, an IDB netting member must act promptly and
in good faith to correct the error; (2) each IDB repo netting member
will be assigned a second GSCC participant number, and all repos must
be processed using that number;\12\ and (3) each IDB repo netting
member will be required to establish a separate account with a separate
Fedwire address at a clearing bank that will be used exclusively for
the intraday settlement outside of GSCC of same-day-settling start
legs. (I.e., the dealer member on the repo side of the start leg will
deliver securities to this separate Fedwire account, and the IDB will
redeliver the securities to the contraparty from this account.) Each
IDB repo netting member must authorize its clearing bank to allow GSCC
to review this clearing account. GSCC will review this account to
facilitate the correction of errors and
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problems. For example, if a same-day-settling start leg fails to
settle, GSCC will be aware that the deliver and receive obligations
must be carried into GSCC for settlement. GSCC will not have or will
not assume any responsibility for the settlement of a same-day-settling
start leg other than same-day-settling legs that are converted into
forward settling start legs.
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\12\ The second account will make it easier for GSCC to monitor
an IDB's repo activity.
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II. Comment Letters
The Commission received five letters from commenters in favor of
GSCC's proposed rule change.\13\ The three IDB commenters believe that
being excluded from the repo netting process puts them at a
disadvantage as market participants.\14\ Three commenters believe that
the proposal will increase liquidity in the repo market.\15\ Three
commenters believe that allowing IDBs to participate in repo netting
will bring enhanced risk protection and a more efficient settlement
process to a broader scope of repo transactions.\16\
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\13\ Supra note 3. Of the five commenters in favor of the
proposal, three are IDBs (Liberty, Garvin, and Patriot) and two are
broker-dealers (Salomon and Morgan Stanley).
\14\ These commenters state that eligibility will allow them to
shift to blind brokering of repos, as opposed to brokering on a
give-up basis, which they believe is a preferable form of trading.
\15\ Salomon, Garvin, and Morgan.
\16\ Salomon, Morgan, and Liberty.
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One commenter opposed the proposed rule change.\17\ This commenter
believes that allowing IDBs to assume the role of principal in repo
transactions introduces an element of credit and performance risk to
the repo marketplace. The commenter is concerned that IDBs, which are
traditionally agents, do not have the requisite experience to act as
repo counterparties. The commenter also is concerned that IDBs could
have exposure over several days resulting from a dealer's failure to
meet its settlement obligations.
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\17\ Delta Clearing Corp., supra note 3.
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GSCC responded to this commenter stating that there will be no
significant risks with the participation of IDBs in repo netting
because GSCC will accept only data on repo transactions that have been
executed between dealer netting members eligible to participate in
GSCC's repo netting service.\18\ Thus, absent error, GSCC believes that
IDBs should net out in every case. Furthermore, GSCC noted that in
addition to certain financial requirements, GSCC will impose
significant operational requirements on participating IDBs to ensure
that if data submission errors do occur, they will be corrected
promptly.\19\ GSCC also stated that there is no possibility of multiday
exposure by a participating dealer member to an IDB because if a dealer
counterparty on the short side fails on trade date to deliver
securities to its IDB counterparty in settlement of the start leg but
is still a GSCC member, the start leg will be treated as a forward
settling start leg that will be guaranteed and settled by GSCC.
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\18\ Supra note 5.
\19\ As indicated above, these operational requirements include
the requirement that an IDB act promptly and in good faith to
correct any error in or problem with the data on an eligible repo
transaction that it has submitted to GSCC; the assignment of a
second GSCC participant number for processing of all repos; and the
requirement that each IDB repo netting member establish a separate
account with a separate Fedwire address at a clearing bank to be
used exclusively for the intraday settlement outside of GSCC of
same-day-settling start legs.
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III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder and particularly with the requirements of Section
17A(b)(3)(F).\20\ Section 17A(b)(3)(F) requires that the rules of a
clearing agency be designed to promote the prompt and accurate
clearance and settlement of securities transactions and to assure the
safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible. The
Commission believes GSCC's rule change meets these goals because the
introduction of IDBs to the repo netting system continues the process
whereby GSCC provides the benefits of centralized automated settlement
to a broader segment of government securities transactions.
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\20\ 15 U.S.C. Sec. 78q-1(b)(3)(F) (1988).
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The one adverse commenter expressed concern over the credit and
performance risks of IDBs as counterparties in repo transactions. The
Commission believes that GSCC has in place risk management procedures
that adequately address these concerns. For example, GSCC imposes
minimum excess net capital or minimum excess liquid capital
requirements on IDBs, as applicable, for eligibility in submitting data
on repo transactions to GSCC for netting. By only accepting data on
repo transactions that have been executed between two dealers that have
been designated as eligible to participate in GSCC's repo netting
services, GSCC reduces the risks associated with IDBs by assuring that
the IDBs' positions at GSCC will generally net out. Furthermore, unless
GSCC ceases to act for a dealer participant prior to the effectiveness
of GSCC's guarantee of the close leg on T+1, IDBs' liability is limited
to one day's exposure.
The Commission believes that GSCC's operational requirements will
minimize potential risks of allowing IDBs to participate in the repo
netting service. The Commission also believes that the benefits of the
proposed rule change, including more efficient settlement, outweigh any
possible risks of allowing IDBs to participate in the repo netting
system and promote the prompt and accurate clearance and settlement of
securities transactions. Furthermore, the risk management and
operational procedures imposed by GSCC on IDB netting members
participating in the repo netting service should help to assure the
safeguarding of securities and funds in the custody or control of GSCC
or for which it is responsible.
IV. Conclusion
The Commission finds that GSCC's proposal is consistent with the
requirements of the Act and particularly with Section 17A and the rules
and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-GSCC-96-04) be and hereby is
approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\21\
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\21\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-19569 Filed 7-31-96; 8:45 am]
BILLING CODE 8010-01-M