[Federal Register Volume 61, Number 161 (Monday, August 19, 1996)]
[Notices]
[Pages 42925-42927]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-21054]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37548; File No. SR-GSCC-96-05]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Notice of Filing of Proposed Rule Change Relating to 
Clearing Fund Collateral and Loss Allocation Provisions

August 9, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on May 28, 1996, the 
Government

[[Page 42926]]

Securities Clearing Corporation (``GSCC'') filed with the Securities 
and Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which items have been prepared 
primarily by GSCC. GSCC amended this filing on July 25, 1996.\2\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ Letter from Karen Walraven, Vice President and Associate 
Counsel, GSCC, to Jerry W. Carpenter, Assistant Director, Division 
of Market Regulation, Commission (July 22, 1996).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    GSCC proposes to modify its rules and related information to expand 
the types of securities that are deemed eligible for clearing fund 
collateral and to redefine the concept of current trading activity for 
loss allocation purposes.

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

    In its filing with the Commission, GSCC 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. GSCC has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.\3\
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    \3\ The Commission has modified the text of the summaries 
prepared by GSCC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

1. Clearing Fund Collateral
    GSCC proposes to expand the types of securities that are deemed 
eligible for clearing fund collateral to include all eligible netting 
securities. The purpose of the clearing fund is (i) to have on deposit 
from each netting member assets sufficient to satisfy any losses that 
might be incurred by GSCC or its members as the result of default by a 
member and the resultant close out of that member's settlement 
positions; (ii) to maintain a total asset amount sufficient to satisfy 
potential losses to GSCC and its members resulting from the failure of 
more than one member; and (iii) to ensure that GSCC has sufficient 
liquidity at all times to meet its payment and delivery obligations.
    GSCC Rule 4 requires each netting member to make and to maintain a 
deposit to the clearing fund, and Section 4 thereof prescribes the form 
that a netting member's clearing fund deposit must take. Currently, 
there are three types of eligible clearing fund collateral: cash, 
eligible Treasury securities, and eligible letters of credit. An 
eligible Treasury security is defined as an unmatured, marketable debt 
security in book-entry form that is a direct obligation of the U.S. 
government. In practice, GSCC accepts only treasury bills, notes, and 
bonds as collateral.\4\ Conversely, GSCC currently processes a broad 
range of securities (i.e., eligible netting securities) through the 
netting system. GSCC proposes to expand the types of securities that 
will be deemed acceptable forms of clearing fund collateral \5\ to 
include all securities that are eligible for the netting system (e.g., 
any non-mortgage-backed security, including zero-coupon securities, 
issued or guaranteed by the U.S., a U.S. government agency or 
instrumentality, or a U.S. government-sponsored corporation). GSCC 
believes that the risks associated with this broader range of 
government securities are minimal and can be managed in an appropriate 
fashion, as discussed below.
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    \4\ Currently, only coupon bearing Treasury notes and bonds are 
eligible as clearing fund collateral. See Securities Exchange Act 
Release No. 33237 (December 1, 1993), 58 FR 63414.
    \5\ At this time no change is proposed with respect to the cash 
and letters of credit eligible for clearing fund deposits.
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    GSCC believes that an expansion of acceptable clearing fund 
collateral will benefit its members by providing them with more 
flexibility in meeting their clearing fund obligations and that the 
expansion will enable GSCC to maximize the liquidity of the clearing 
fund at risk levels that are not significantly higher than those 
present under the current definition. The securities in the eligible 
netting security category are eligible for settlement on a book-entry 
basis over the Fedwire, are liquid, and are not subject to a high 
degree of price volatility. Nonetheless, GSCC intends to limit 
liquidity and price volatility risks by applying an appropriate haircut 
percentage to each type of security accepted as clearing fund 
collateral. The haircut will be at least equal to the haircut GSCC 
takes on eligible Treasury securities,\6\ and in no event will the 
haircut be lower than that applied to the relevant security by GSCC's 
liquidity bank.
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    \6\ Section 4 of GSCC Rule 4 provides that eligible Treasury 
securities with a remaining maturity of greater than one year and 
less than ten years are subject to a three percent haircut while 
securities with a remaining maturity of ten years or greater are 
subject to a five percent haircut. GSCC does not propose to change 
these existing haircut provisions at this time.
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    Furthermore, pursuant to action by its Board of Directors, under 
the proposed rule change GSCC will retain the right to refuse to accept 
particular types of collateral for liquidity or other reasons. Such 
refusal could arise under a variety of circumstances such as GSCC's 
liquidity bank's reluctance to accept a certain type of security as 
collateral for an extension of credit.
2. Loss Allocation
    Rule 20, Section 4(c) of GSCC's rules provides that upon a member's 
default GSCC will close out the positions of the defaulting member. If 
the close out of all the defaulting member's positions results in GSCC 
incurring a loss, that loss will be allocated pursuant to GSCC Rule 4.
    Under Section 8 of Rule 4, GSCC looks first to the defaulting 
member's clearing fund collateral. If the defaulting member's 
collateral does not fully cover GSCC's loss, GSCC determines the 
proportion of the remaining loss that arose in connection with non-
brokered (i.e., direct) transactions and the proportion that rose in 
connection with brokered transactions. Brokered transactions are 
categorized as either brokered transactions involving only members or 
brokered transactions involving a nonmember on one side of the trade.
    To the extent a remaining loss is determined to arise in connection 
with direct transactions, the loss is allocated pro rata among netting 
members other than interdealer brokers based on the dollar value of the 
trading activity of each such netting member with the defaulting member 
netted and novated on the day of default. If the loss is determined to 
arise in connection with member brokered transactions, GSCC allocates 
ten percent of the loss to the interdealer broker netting members on an 
equal basis regardless of the level of trading activity of each such 
broker with the defaulting member. The remainder of the loss is divided 
pro rata among all other netting members based upon the dollar value of 
each netting member's trading activity through interdealer brokers with 
the defaulting member netted and novated on the day of default. If the 
loss is determined to arise in connection with nonmember brokered 
transactions, GSCC allocates ten percent of the loss to the interdealer 
broker netting members on an equal basis regardless of the level of 
trading activity of each such broker with the defaulting member. The 
remainder of the loss is allocated pro rata among the

[[Page 42927]]

Category 2 interdealer broker netting members that were parties to such 
nonmember brokered transactions based upon the dollar value of each 
such broker member's trading activity with the derfaulting member 
netted and novated on the day of default.\7\
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    \7\ Category 1 interdealer brokers act exclusively as brokers 
and trade only with netting members and with certain grandfathered 
nonmember firms. Category 2 interdealer brokers are permitted to 
have up to ten percent of their business with nonnetting members 
other than grandfathered nonmembers.
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    An important principle in the loss allocation process is the 
definition of ``trading activity with the defaulting member netted and 
novated on the day of default.'' \8\ GSCC's rules define this as 
trading activity with a defaulting member submitted by a netting member 
that was compared, entered the net, and was novated on the business day 
on which the failure of the defaulting member to fulfill its 
obligations to GSCC occurred. However, if the aggregate level of such 
trading activity is less than the dollar value amount of the defaulting 
member's securities liquidated pursuant to GSCC's close out procedure, 
the term will encompass trading activity going back as many days as is 
necessary to reach a level of activity that is equal to or greater than 
the dollar value amount of such liquidated securities.
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    \8\ GSCC Rule 4, Section 8(a)(v).
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    GSCC proposes to modify its loss allocation procedures by 
redefining the concept of ``trading activity with the defaulting member 
netted and novated on the day of default'' to capture a level of 
trading activity that is at least five times the dollar value amount of 
the securities of the defaulting member that are liquidated. The five-
fold multiple is based on the approximate netting factor of eighty 
percent. Historically, the aggregate transactions processed through 
GSCC's netting system net down to approximately twenty percent of the 
aggregate transactional volume (i.e., for approximately every five 
transactions that enter the netting process, only one needs to be 
settled through the movement of securities and cash).
    GSCC's current approach to loss allocation focuses on the date on 
which a transaction is netted and novated by GSCC and this will 
continue to be the case. However, with the advent of netting of 
repurchase agreements (``repos'') and the resultant increase in the 
number of relatively longterm transactions introduced into the netting 
process, GSCC has reevaluated its loss allocation process with a view 
toward better taking into account the duration of netted transactions.
    The proposed approach does not take into account the duration of 
the trade (i.e., t he time between trade date and settlement date). 
Rather, GSCC seeks a balance between assessing transactions based 
purely on when they were entered into versus taking into account their 
duration by expanding the amount of trading that will be encompassed 
for loss allocation purposes. GSCC believes this will have the effect 
of establishing a greater incentive for members to assess the 
creditworthiness of counterparties.
    GSCC believes the proposed rule change is consistent with its 
obligations under Section 17A of the Act \9\ because by broadening the 
range of securities acceptable as clearing fund collateral and by 
modifying the loss allocation procedures to encompass more trades, GSCC 
will facilitate member transactions and will cause members to assess 
the creditworthiness of their counterparties based on duration of 
transactions. This should promote the prompt and accurate clearance and 
settlement of securities transactions.
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    \9\ 15 U.S.C. 78q-1 (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    GSCC does not believe that the proposed rule change will have an 
impact or impose a burden on competition.

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

    Comments on the proposed rule change have not yet been solicited or 
received. Members will be notified of the rule filing, and comments 
will be solicited by an important notice. GSCC will notify the 
Commission of any written comments received by GSCC.

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

    Within thirty-five days of the date of publication of this notice 
in the Federal Register or within such longer period (i) as the 
Commission may designate up to ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (A) By order approve such proposed rule change or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

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. Sec. 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 GSCC. All 
submissions should refer to File No. SR-GSCC-96-05 and should be 
submitted by September 9, 1996.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-21054 Filed 8-16-96; 8:45 am]
BILLING CODE 8010-01-M