[Federal Register Volume 61, Number 236 (Friday, December 6, 1996)]
[Notices]
[Pages 64779-64780]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-31086]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37995; File No. SR-GSCC-96-07]


Self-Regulatory Organization's; Government Securities Clearing 
Corporation; Order Approving Proposed Rule Change Modifying the Rights 
and Responsibilities of Interdealer Broker Netting Members

November 27, 1996.
    On July 2, 1996, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-GSCC-96-07) 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ to modify the rights and responsibilities of interdealer 
broker (``IDB'') netting members. GSCC amended the filing on July 23, 
1996.\2\ Notice of the proposed rule change, as amended, was published 
in the Federal Register on August 20, 1996.\3\ On August 16, 1996, and 
on August 21, 1996, GSCC filed amendments No. 2 and No. 3 to the 
filing.\4\ Because the amendments were substantive in nature, notice of 
the proposed amendments was published in the Federal Register on 
September 12, 1996.\5\ No comment letters were received regarding the 
proposed rule change or proposed amendments. For the reasons discussed 
below, the Commission is approving the proposed rule change, as 
amended.
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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 (``Division''), Commission (July 18, 1996).
    \3\ Securities Exchange Act Release No. 37565 (August 14, 1996), 
61 FR 43103.
    \4\ Letter from Karen Walraven, Vice President and Associate 
Counsel, GSCC, to Jerry W. Carpenter, Division, Commission (August 
12, 1996, and August 15, 1996).
    \5\ Securities Exchange Act Release No. 37658 (September 6, 
1996), 61 FR 48190.
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I. Description

    This rule change modifies GSCC's loss allocation and clearing fund 
requirements for IDBs.\6\ The percentage allocated collectively to IDBs 
from losses arising from member brokered transactions is raised to 
fifty percent with a dollar cap on each IDB's potential liability, as 
discussed below. Each IDB's individual share of the collective broker 
allocation will be allocated pro rata based on the dollar value of its 
trading activity with the defaulting member. By implementing this 
change, the IDB will no longer be subject to an allocation of a portion 
of a loss arising from the default of a firm with which the IDB never 
traded. Because only Category 2 IDBs may enter into brokered 
transactions with nonmembers,\7\ the entire loss from such a 
transaction will be allocated among Category 2 IDBs pro rata based on 
the level of their trading activity with the defaulting member.
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    \6\ Unless otherwise indicated, the term IDB refers to both 
Category 1 and Category 2 IDBs. Under current rules, Category 1 IDBs 
act exclusively as brokers, trade exclusively with GSCC netting 
members and certain grandfathered nonmember firms, and must maintain 
$10 million in net or liquid capital. Category 2 IDBs may transact 
up to 10% of their trading volume with nonmembers and must maintain 
$25 million in net worth and $10 million in excess net or liquid 
capital.
    \7\ A nonmember brokered transaction is a brokered transaction 
where either the buyside or sellside counterparty to the IDB is a 
nonmember.
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    Currently, the loss amount allocated to each IDB is capped at $1.6 
million per calendar year for losses attributable to brokered 
transactions with members. The proposed rule change raises the maximum 
amount of loss that can be allocated to each IDB to $5 million per loss 
allocation event as opposed to a calendar year maximum.\8\
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    \8\ As noted above, Category 2 IDBs are subject to an unlimited 
loss allocation, based on trading volume, for losses related to 
brokered transactions with nonmembers.
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    GSCC is raising the clearing fund requirement for Category 1 IDBs 
from a fixed $1.6 million to a fixed $5 million and raising the minimum 
clearing fund requirement for Category 2 IDBs from $1.6 million to $5 
million. Under the proposed rule change, at least thirty percent of a 
Category 1 IDB's clearing fund deposit must consist of cash or eligible 
netting securities, and no more than seventy percent of the clearing 
fund deposit may be met by pledging eligible letters of credit. 
Category 2 IDBs will be subject to the same clearing fund deposit 
composition requirement as other non-Category 1 IDB netting members, 
which is ten percent of the required fund deposit ($500,000) must be in 
cash, and no more than seventy percent of the total may consist of 
eligible letters of credit.
    Category 1 IDBs are now subject to all of the surveillance 
requirements of Section 3 of GSCC Rule 4, including GSCC's authority to 
increase the amount of clearing fund deposit for any IDB on 
surveillance status. Category 1 IDBs are now required to participate in 
the daily funds-only settlement process. In addition, the proposed rule 
change eliminates the exception in Section 3 of GSCC Rule 11 that 
permitted IDBs to exclude trades from GSCC's netting system if the 
inclusion of such trade would have resulted in the IDB having a net 
settlement position other than zero. GSCC Rule 11, Section 3 will 
continue to permit netting members to exclude repo transactions from 
the

[[Page 64780]]

netting system in accordance with GSCC Rule 18.

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.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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    By changing the loss allocation procedures for IDBs, GSCC is 
increasing the percentage allocated among IDBs from losses arising from 
brokered transactions. IDBs will share on a collective basis equally 
with the dealers any loss allocation arising from brokered transactions 
and in proportion to the amount of trading the IDB conducted with the 
defaulting member. The Commission believes that the new loss allocation 
procedures should give IDBs a greater incentive to assess the 
creditworthiness of their counterparties, which should reduce the risk 
to GSCC of the trades submitted from IDBs. The Commission believes that 
by reducing the number of trades with financially suspect participants 
that are submitted to GSCC, the proposed rule change should enhance 
GSCC's ability to safeguard securities and funds. Furthermore, by 
placing a dollar cap on each IDB's share of a loss, the IDBs will 
continue to be protected from unusually large loss allocations.
    The Commission believes that increasing the clearing fund 
requirement for IDBs should provide GSCC with more readily accessible 
funds if needed to cover a member's default. Moreover, the Commission 
believes that by requiring IDBs to fulfill a larger portion of their 
clearing fund deposit with cash and eligible netting securities, GSCC 
will increase the liquidity of its clearing fund thereby further 
enabling GSCC to assure the safeguarding of securities and funds in its 
control or for which it is responsible.

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-96-07) be and hereby is 
approved.

    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) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-31086 Filed 12-5-96; 8:45 am]
BILLING CODE 8010-01-M