[Federal Register Volume 62, Number 95 (Friday, May 16, 1997)]
[Notices]
[Pages 27089-27091]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12893]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38601; File No. SR-GSCC-97-01]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Notice of Filing of Proposed Rule Change Regarding Off-
The-Market Transactions
May 9, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ notice is hereby given that on March 11, 1997, the
Government 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 by GSCC. 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).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The proposed rule change consists of modifications to GSCC's rules
to allow the mitigation of risk arising from the netting and guaranteed
settlement of off-the-market transactions.
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.\2\
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\2\ The Commission has modified the text of these summaries.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
GSCC's fulfillment of its basic mission, which is to ensure that
the overall settlement process for the Government securities industry
never fails, has been based on the belief that it is best to be as
inclusive as possible with regard to the transactions entered into by
its members. This makes it less likely that the failure of an industry
participant will have a chain reaction effect and lead to the failure
of other participants and the settlement process in general.
Because of this philosophy, GSCC has avoided to the extent possible
establishing barriers to the inclusion of members' trades in the
netting process. Thus, absent the potential for a member to fail to
fulfill its settlement obligations to GSCC and have GSCC cease to act
for it, GSCC's rules do not provide for limitations on a member's
ability to submit trading activity based on its financial status or its
level of overall
[[Page 27090]]
activity. Rather, GSCC's approach has been to let its margining
processes be the natural limit on a member's level of trading.
This approach works well because the clearing fund and forward
margining processes are both dynamic ones. They are not set or capped
at a specific level but are recalculated and collected daily and thus,
increase or decrease daily based on (1) the level of members' overall
historical and current day's net activity with respect to clearing fund
and (2) the net profitability of members' overall net activity with
respect to forward margin.
This inclusive approach to netting eligibility has led GSCC to
allow trades into its net that have a price that differs significantly
from the prevailing market price for the underlying security (``off-
the-market transactions''). The large majority of the off-the-market
transactions that enter the net are not independent trades per se but
rather reflect exercise of options into which the parties previously
entered. GSCC continuously monitors its receipt of data on off-the-
market transactions. For monitoring purposes, GSCC considers trades
that are greater than $1 million in value and that traded at a price
that is more than one percentage point away from GSCC's system price as
off-the-market trades.
The submission by netting members to GSCC of data on an off-the-
market transaction is of particular concern if done on the day before
the scheduled settlement date of the transaction or if the data is
submitted earlier than on the day before scheduled settlement date but
is not compared until that date because it presents GSCC with exposure
that it has not had the opportunity to appropriately assess and margin.
As noted above, most of the off-the-market transactions submitted to
GSCC are options exercises, and ordinarily, an option is settled on the
business day after the day on which it is exercised.
As a partial solution to this problem, GSCC intends in the future
to provide a comprehensive set of comparison, netting, settlement, and
risk management services for options on Government securities. As a
more immediate measure, GSCC is seeking authority to take the following
two-pronged approach to the problem of off-the-market transactions.
1. Continue to allow off-the-market trades into the net thus
keeping them eligible for netting, novation, and guaranteed settlement
but change the loss allocation process so as to allocate all of any
loss resulting from the liquidation of the off-the-market transaction
to the remaining counterparty.
This approach recognizes that allowing off-the market transactions
into the net has the potential to inappropriately increase the loss
that GSCC would incur should a member that has engaged in such
transactions fail and have its net settlement positions liquidated.
Members not involved in the off-the-market transaction should not have
to share in the loss allocation that results from its liquidation.
To avoid this, GSCC is seeking the authority to amend its rules to
allocate the loss arising from an off-the-market transaction done
either with a netting member that subsequently is determined to be
insolvent or with an executing firm that the insolvent member acts for
as a submitting member directly and entirely to the insolvent member's
counterparty.
2. Not pass through to the credit side the mark-to-market amount
associated with an off-the-market transaction until and unless it is
paid to GSCC by the debit side.
The revision to the loss allocation process addresses the inequity
of how that process applies to a failed member that has engaged in off-
the-market transactions. However, it would expose GSCC to the risk that
the failed member's counterparty also defaults on its settlement
obligations to GSCC after that member has received the benefit of the
off-the-market transaction through the funds-settlement process. If
that happens, then the allocation of loss still effectively reverts
back to the other members that were not involved in the off-the-market
transaction.
Thus, as a complement to the first proposed, GSCC is seeking the
ability to ensure that the mark-to-market exposure on the off-the-
market transaction not be inappropriately passed through to a failed
member's counterparty. GSCC would do this by amending its rules and its
operational procedures to provide that if the mark-to-market amount
associated with an off-the-market transaction is not paid to GSCC by
the debit side on the morning of the business day following the
submission of the trade (i.e., the debit side fails before it has
satisfied its funds settlement obligation), the market amount will not
be paid by GSCC to the credit side. In other words, GSCC will not pass
through the profit on an off-the-market transaction until and unless it
has received that profit amount.
GSCC is proposing as the definition of an off-the-market
transaction any of the following:
(1) An options exercise.
(2) A single transaction that is:
(i) greater than $1 million in par value and
(ii) either one percentage point higher than the highest price or
one percentage point lower than the lowest price for the underlying
security on the day of the submission of data on the transaction to
GSCC (with such prices being obtained by GSCC from a third-party source
such as Bloomberg Financial Services selected by GSCC for this
purpose).
(3) A pattern of transactions submitted by two members that if
looked at as a single transaction would constitute an off-the-market
transaction.
The proposed rule changes are consistent with the requirements of
Section 17A of the Act \3\ and the rules and regulations thereunder
because it would ensure that the mark-to-market exposure on the off-
the-market transaction not be inappropriately passed through to a
failed member's counterparty and that the liquidation of an off-the-
market transaction not lead to a significant loss by GSCC.
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\3\ 15 U.S.C. 78q-1.
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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
Written comments relating to the proposed rule change have not yet
been solicited or received. Members will be notified of the rule change
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 organizations consents,
the Commission will:
(A) by order approve rule proposed such change or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
[[Page 27091]]
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 this submission, all subsequent amendments, all written
statements with respects 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
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Room in Washington, D.C.
Copies of such filing will also be available for inspection and copying
at the principal office of GSCC. All submissions should refer to the
File No. SR-GSCC-97-01 and should be submitted by June 6, 1997.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-12893 Filed 5-15-97; 8:45 am]
BILLING CODE 8010-01-M