[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

[[Page 40276]]

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