[Federal Register Volume 61, Number 206 (Wednesday, October 23, 1996)]
[Notices]
[Pages 55059-55060]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-27092]


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

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37828; File No. SR-GSCC-96-05]


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

October 16, 1996.
    On May 28, 1996, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-GSCC-96-05) 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ to expand the types of securities that are eligible to be 
used as clearing fund collateral and to redefine the concept of current 
trading activity for loss allocation purposes. GSCC amended the filing 
on July 25, 1996.\2\ Notice of the proposal was published in the 
Federal Register on August 19, 1996.\3\ No comment letters were 
received regarding the proposed rule change. 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 W. Carpenter, Assistant Director, Division 
of Market Regulation, Commission (July 22, 1996).
    \3\ Securities Exchange Act Release No. 37548 (August 9, 1996), 
61 FR 42925.
---------------------------------------------------------------------------

I. Description

A. Clearing Fund Collateral

    GSCC Rule 4 requires that each netting member make and 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 
under Rule 4, Section 4, 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.\4\ Conversely, GSCC currently 
processes a broad range of securities (``eligible netting securities'') 
through its netting system. The proposed rule change expands the types 
of securities that will be acceptable forms of clearing fund collateral 
\5\ to include all securities that are eligible for processing in 
GSCC's netting system.
---------------------------------------------------------------------------

    \4\ Currently, only treasury bills and coupon bearing treasury 
notes and bonds are eligible as clearing fund collateral. 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.
---------------------------------------------------------------------------

    Pursuant to GSCC's Rules, eligible netting securities are 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. Such securities must be Fed 
Wire eligible. Specific examples of eligible netting securities issued 
by U.S. government agencies include fixed-rate discount notes with one 
year maturity issued by the Tennessee Valley Authority, fixed-rate 
stripped interest payment or stripped principal securities sold at a 
discount by the Resolution Funding Corporation, and fixed-rate notes 
issued by the International Finance Corporation.
    GSCC limits liquidity and price volatility risks by applying an 
appropriate haircut percentage to each type of security accepted as 
clearing fund collateral. Pursuant to GSCC Rules, the haircuts for 
eligible netting securities other than eligible treasury securities are 
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

[[Page 55060]]

relevant security by GSCC's liquidity bank. Furthermore, GSCC retains 
the right to refuse to accept particular types of collateral for 
liquidity or other reasons upon action by its Board of Directors. 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.
---------------------------------------------------------------------------

    \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, and 
securities with a remaining maturity of ten years or greater are 
subject to a five percent haircut. Eligible treasury securities with 
a remaining maturity of up to one year receive no haircut. GSCC does 
not propose to change these existing haircut provisions at this 
time.
    With respect to agency securities and zero coupon and stripped 
treasury securities, GSCC will apply the above haircuts unless 
GSCC's liquidity bank applies higher or more conservative haircut 
percentages. At this time, GSCC's haircuts are consistent with the 
haircut percentages applied by its liquidity bank. Letter from Karen 
Walraven, Vice President and Associate Counsel, GSCC to Peggy Blake, 
Attorney, Division of Market Regulation, Commission (August 8, 
1996).
---------------------------------------------------------------------------

B. 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 arose in 
connection with brokered transactions. Brokered transactions are 
categorized as either brokered transactions involving only GSCC members 
or brokered transactions involving a nonmember on one side of the 
trade. After the brokered and non-brokered proportions are determined, 
the remaining loss is allocated among participants based largely upon 
their trading activity with the defaulting member netted and novated on 
the day of default.\7\
---------------------------------------------------------------------------

    \7\ To the extent a remaining loss is determined to arise in 
connection with non-brokered transactions (i.e., 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 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 defaulting member 
netted and novated on the day of default. 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. GSCC has filed a proposal to amend certain aspects of 
the loss allocation provisions related to the percentage of the loss 
allocated to interdealer brokers. Securities Exchange Act Release 
No. 37565 (August 14, 1996), 61 FR 43103.
---------------------------------------------------------------------------

    GSCC Rule 4, Section 8(a)(v) defines ``trading activity with the 
defaulting member netted and novated on the day of default'' as trading 
activity with a defaulting member submitted by a netting member that 
was compared, entered GSCC's net system, 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 was less than the dollar value amount of the 
defaulting member's securities liquidated pursuant to GSCC's close out 
procedure, the term had encompassed trading activity going back as many 
days as was necessary to reach a level of activity that was equal to or 
greater than the dollar value amount of such liquidated securities. The 
proposed rule change modified 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.\8\
---------------------------------------------------------------------------

    \8\ 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).
---------------------------------------------------------------------------

II. Discussion

    The Commission finds that the proposed rule change is consistent 
with the Act, and specifically with Section 17A(b)(3)(F).\9\ Section 
17A(b)(3)(F) requires the rules of a clearing agency be designed 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 that the expansion of GSCC's 
acceptable clearing fund collateral will help to assure the 
safeguarding of securities because it should provide GSCC's members 
with more flexibility in meeting their clearing fund obligations with 
risk levels that should not be significantly higher than those present 
under the current clearing fund collateral definition. GSCC is limiting 
the potential for liquidity and price volatility risks in this regard 
by applying haircut percentages to each type of security accepted as 
clearing fund collateral. GSCC also will retain the right to refuse to 
accept particular types of collateral for liquidity or other reasons.
---------------------------------------------------------------------------

    \9\ 15 U.S.C Sec. 78q-1(b)(3)(F) (1988).
---------------------------------------------------------------------------

    The Commission believes that GSCC's modifications to its loss 
allocation procedures also will help to assure the safeguarding of 
securities or funds in its control or for which it is responsible. 
Expanding the amount of trading that will be encompassed for loss 
allocation purposes should spread out the loss among a greater number 
of participants and thus decrease the likelihood that any one 
participant will be disproportionately affected. As a result, GSCC 
should be in a better position to collect such funds should the need 
ever arise. Because the rule change also results in participants having 
potential liability for trades entered into with a failing participant 
over a greater time period, it should encourage participants to assess 
the creditworthiness of their counterparties more carefully. As a 
result, the level of risk of the trades submitted to GSCC should be 
reduced, and GSCC's ability to safeguard securities and funds should be 
enhanced.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with Section 17A of the Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-GSCC-96-05) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
---------------------------------------------------------------------------

    \10\ 17 CFR 200.30-3(a)(12) (1996).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-27092 Filed 10-22-96; 8:45 am]
BILLING CODE 8010-01-M