[Federal Register Volume 61, Number 173 (Thursday, September 5, 1996)]
[Notices]
[Pages 46887-46888]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-22580]



[[Page 46887]]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37616; File Nos. SR-MBSCC-96-02; SR-GSCC-96-03, and SR-
ISCC-96-04]


Self-Regulatory Organizations; MBS Clearing Corporation, 
Government Securities Clearing Corporation, and International 
Securities Clearing Corporation; Order Approving Proposed Rule Changes 
Seeking Authority to Enter Into Limited Cross-Guarantee Agreements

August 28, 1996.
    On April 11, 1996, May 10, 1996, and May 16, 1996, the MBS Clearing 
Corporation (``MBSCC''), the Government Securities Clearing Corporation 
(``GSCC''), and the International Securities Clearing Corporation 
(``ISCC'') (collectively referred to as the ``clearing corporations''), 
respectively, filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule changes (File Nos. SR-MBSCC-96-02, 
SR-GSCC-96-03, and SR-ISCC-96-04) pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'').\1\ On May 13, 1996, GSCC 
filed an amendment to the proposed rule change to a change the specific 
rule numbers used in the proposed rule change.\2\ On July 2, 1996 and 
on July 8, 1996, ISCC and GSCC, respectively, filed amendments to their 
proposed rule changes to make certain technical corrections.\3\ Notice 
of the proposed rule changes was published in the Federal Register on 
July 15, 1996.\4\ The Commission received no comments. For the reasons 
discussed below, the Commission is approving the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ Letter from Karen Walraven, Vice President and Associate 
Counsel, GSCC, to Jerry Carpenter, Assistant Director, Division of 
Market Regulation (``Division''), Commission (May 13, 1996).
    \3\ Letter from Julie Beyers, ISCC, to Peter Geraghty, Special 
Counsel, Division, Commission (July 1, 1996) and letter from Karen 
Walraven, Vice President and Associate Counsel, GSCC, to Peter 
Geraghty, Special Counsel, Division, Commission (July 2, 1996).
    \4\ Securities Exchange Act Release No. 37413 (July 9, 1996), 61 
FR 1199.
---------------------------------------------------------------------------

I. Description of the Proposals

    The purpose of the proposed rule change is to modify the clearing 
corporations' rules to enable them to enter into limited cross-
guarantee agreements with other clearing agencies. Generally, limited 
cross-guarantee agreements contain a guarantee from one clearing agency 
to another clearing agency that can be invoked in the event of a 
default of a common member. The guarantee provides that resources of a 
defaulting common member remaining after the defaulting common member's 
obligations to the guaranteeing clearing agency have been satisfied 
will be used to satisfy the obligations of the defaulting common member 
that remain unsatisfied at the other clearing agency. The guarantee is 
limited to the amount of a defaulting common member's resources 
remaining at the guaranteeing clearing agency.
    Generally, limited cross-guarantee agreements should be beneficial 
to the clearing corporations because amounts available under limited 
cross-guarantee agreements may be applied to unpaid obligations of the 
defaulting participant. With regard to GSCC, these amounts may reduce 
possible pro rata allocations against original counterparties of the 
defaulting participant. Similarly, these amounts available to ISCC may 
reduce the possibility of pro rata charges against its clearing fund. 
Furthermore, even though MBSCC does not mutualize risk, these amounts 
may reduce allocations against and losses of the original contrasides 
of a defaulting participant.
    The benefits generally accruing to the clearing corporations from a 
limited cross-guarantee agreement are illustrated by the following 
example:

    Dealer A, a common participant of Clearing Agency X and Clearing 
Agency Y, declares bankruptcy. Upon insolvency, Dealer A owes 
Clearing Agency Y $10 million and Clearing Agency X owes A $7 
million. In the absence of an interclearing agency limited cross-
guarantee agreement, Clearing Agency X would be obligated to pay $7 
million to Dealer A's bankruptcy estate and Clearing Agency Y would 
have a claim for $10 million against Dealer A's bankruptcy estate as 
a general creditor with no assurance as to the extent of recovery. 
However, an effective cross-guarantee arrangement would obligate 
Clearing Agency X to pay Clearing Agency Y an amount equal to Dealer 
A's $7 million receivable from Clearing Agency X thereby reducing 
Clearing Agency Y's net exposure from to $10 million to $3 million. 
This approach would enable Clearing Agency Y to secure earlier 
payment and would allow Clearing Agency X to fulfill its obligations 
without making an actual payment to Dealer A's bankruptcy estate.

    The benefits specifically accruing to MBSCC from a limited cross-
guarantee agreement are illustrated by the following example:

    A sells to B who sells to C. A also sells to X who sells to Y; 
and A also sells to Q. B and X net out, leaving obligations of A 
owing to C, Y, and Q. A becomes insolvent. Under MBSCC's rules, if 
A's participants fund contribution is not adequate to cover the 
aggregate of C's and Y's losses, then B, X, and Q as original 
contrasides would be responsible for covering such losses. However, 
before allocating C's and Y's aggregate loss to B, X, and Q, MBSCC 
may obtain resources under a limited cross-guarantee agreement to 
reduce, if not eliminate, the amount of such allocations. If those 
resources are sufficient to satisfy C's and Y's losses, any 
remaining funds would also be available for the satisfaction of Q's 
losses.

    The limited cross-guarantee agreements are designed to preserve 
substantial flexibility to the counterparty clearing corporation. The 
agreements will provide a list of all the limited cross-guarantee 
agreements to which the clearing agencies are a party, including the 
counterparties to those agreements. The agreements will set forth the 
clearing agency's priority structure with respect to the order in which 
it will make guarantee payments to its counterparty clearing agencies 
(if more than one exist) in the event of a defaulting common 
participant. GSCC intends to prioritize its counterparty clearing 
agencies in the following manner: (1) pro rata to those counterparty 
clearing agencies with a transactional nexus to GSCC; (2) the National 
Securities Clearing Corporation; and (3) pro rata to all other 
counterparty clearing agencies.\5\
---------------------------------------------------------------------------

    \5\ At this time, MBSCC and ISCC have not determined the 
priority structures of their limited cross-guarantee agreements.
---------------------------------------------------------------------------

    An additional source of flexibility in a limited cross-guarantee 
agreement is the length of time within which a demand for payment must 
be made. This period is negotiated and agreed to by the counterparty 
clearing agencies. GSCC believes that an appropriated time period for 
this purpose is six months.\6\ During this six month period, the 
limited cross-guarantee agreement would permit recalculations of each 
clearing agency's available resources and losses.
---------------------------------------------------------------------------

    \6\ At this time, MBSCC and ISCC have not determined a specific 
recovery period for their limited cross-guarantee agreements.
---------------------------------------------------------------------------

    Accordingly, GSCC's proposed rule change modifies GSCC's rules to 
establish GSCC to enter into one or more limited cross-guarantee 
agreements. Proposed GSCC Rule 41 governing limited cross-guarantee 
agreements provides that a participant is obligated to GSCC for any 
guarantee payment that GSCC is required to make to a clearing agency 
pursuant to the terms of any limited cross-guarantee agreement. GSCC's 
Rule 41 and the proposed modifications to Rule 4, Section 8 provide 
that amounts received by GSCC under any limited cross-guarantee 
agreement will be applied to the common participant's unpaid 
obligations to GSCC and will reduce assessments against original 
counterparties of the defaulting

[[Page 46888]]

participant. The proposed rule change also modifies GSCC's Rule 1 to 
add definitions of the terms ``common member,'' ``cross-guarantee 
obligation,'' ``cross-guarantee party,'' ``defaulting common member,'' 
``defaulting member,'' and ``limited cross-guarantee agreement.'' GSCC 
also is proposing to amend Rule 4, Section 6 to clarify that 
liabilities of GSCC include limited cross-guarantee payments made to a 
counterparty clearing agency pursuant to a limited cross-guarantee 
agreement.\7\
---------------------------------------------------------------------------

    \7\ The definitions of the terms described above as well as the 
specific changes to GSCC's rules and procedures are attached as 
Exhibit A to GSCC's proposed rule change which is available through 
GSCC or through the Commission's public reference room.
---------------------------------------------------------------------------

    MBSCC's proposed rule change will add new Rule 4 to Article III of 
MBSCC's rules. The new rule will enable MBSCC to enter into one or more 
limited cross-guarantee agreements. The new rule provides that a former 
participant\8\ is obligated to MBSCC for any guarantee payment MBSCC is 
required to make to a clearing agency pursuant to the terms of any 
limited cross-guarantee agreement. The new rule also provides that 
amounts received by MBSCC under any limited cross-guarantee agreement 
will be applied to unpaid obligations of the former participant to 
MBSCC and to reduce assessments against and losses of original 
contraside participants. A technical modification will be made to 
renumber current Rule 4 of Article III as Rule 5. MBSCC's proposed rule 
change also modifies Rule 1 of Article I of MBSCC's rules to add 
definitions of the terms ``limited cross-guarantee agreement,'' 
``cross-guarantee obligation,'' and ``cross-guarantee party.'' MBSCC's 
proposed rule change also modifies Chapter VI of MBSCC's procedures 
relating to application of the participants fund to reflect that 
amounts received by MBSCC under any limited cross-guarantee agreement 
will be applied to unpaid obligations of a former participant of MBSCC 
and to reduce assessments against and losses of original contraside 
participants.\9\
---------------------------------------------------------------------------

    \8\ Under Section 10 of Rule 3 of Article III of MBSCC's rules, 
the term ``former participant'' is defined as a participant for whom 
MBSCC has ceased to act pursuant to Sections 1 and 2 of Rule 3 of 
Article III.
    \9\ The definitions of the terms described above as well as the 
specific changes to MBSCC's rules and procedures are attached as 
Exhibit A to MBSCC's proposed rule change which is available through 
MBSCC or through the Commission's public reference room.
---------------------------------------------------------------------------

    ISCC's proposed rule change will add new Rule 13 to ISCC's rules. 
The new rule provides that an ISCC member is obligated to ISCC for any 
guarantee payment ISCC is required to make to a clearing agency 
pursuant to the terms of any limited cross-guarantee agreement. ISCC's 
proposed rule change also modifies ISCC's rules to indicate that 
amounts available to satisfy aggregate losses will include amounts 
available under limited cross-guarantee agreements. ISCC's proposal 
also modifies ISCC's Rule 1 to add definitions of the terms ``limited 
cross-guaranty agreement,'' ``cross-guaranty obligation,'' and ``cross-
guaranty party.''\10\
---------------------------------------------------------------------------

    \10\ The definitions of the terms described above as well as the 
specific changes to ISCC's rules and procedures are attached as 
Exhibit A to ISCC's proposed rule change which is available through 
ISCC or through the Commission's public reference room.
---------------------------------------------------------------------------

II. Discussion

    Section 17A(b)(3)(F) of the Act\11\ 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 and to foster cooperation and coordination with 
persons engaged in the clearance and settlement of securities 
transactions. The Commission believes the proposals are consistent with 
each clearing corporation's obligation to assure the safeguarding of 
securities and funds in the custody or control of the clearing agency 
or for which it is responsible because cross-guarantee agreements among 
clearing agencies are a method of reducing clearing agencies' risk of 
loss due to a common member's default. Furthermore, the Commission has 
encouraged the use of cross-guarantee agreements and other similar 
arrangements among clearing agencies.\12\ Consequently, cross-guarantee 
agreements should assist clearing agencies in assuring the safeguarding 
of securities and funds in their custody or control.
---------------------------------------------------------------------------

    \11\ 15 U.S.C. Sec. 78q-1(b)(3)(F) (1988).
    \12\ E.g., Securities Exchange Act Release Nos. 36431 (October 
27, 1995), 60 FR 55749 [File No. SR-GSCC-95-03] and 36597 (December 
15, 1995), 60 FR 66570 [File No. SR-MBSCC-95-05] (orders approving 
proposed rule changes authorizing the release of clearing data 
relating to participants).
---------------------------------------------------------------------------

    The Commission also believes the proposals are consistent with each 
clearing corporation's obligation to foster cooperation and 
coordination with persons engaged in the clearance and settlement of 
securities transactions. The Commission believes that by entering into 
such cross-guarantee agreements, clearing corporations can mitigate the 
systemic risks posed to an individual clearing corporation and to the 
national clearance and settlement system as a result of a defaulting 
common member.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposals are consistent with the requirements of the Act, and in 
particular with Section 17A(b)(3)(F) of the Act and the rules and 
regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule changes (File Nos. SR-MBSCC-96-02, SR-GSCC-96-
03, and SR-ISCC-96-04) be, and hereby are, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\13\
---------------------------------------------------------------------------

    \13\ 17 CFR 200.30-3 (a)(12) (1995).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-22580 Filed 9-4-96; 8:45 am]
BILLING CODE 8010-01-M