[Federal Register Volume 62, Number 146 (Wednesday, July 30, 1997)]
[Notices]
[Pages 40877-40879]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-20052]
[[Page 40877]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38871; File No. SR-GSCC-97-03]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Notice of Filing of a Proposed Rule Change Relating to
Eligibility of Forward-Starting Repos for Netting and Guaranteed
Settlement Prior to Their Scheduled Start Date
July 24, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on May 8, 1997, the
Government Securities Clearing Corporation (``GSCC'') filed with the
Securities and Exchange Commission (``Commission'') and on June 13,
1997, amended the proposed rule change (File No. SR-GSCC-97-03) as
described in Items I, II, and III below, which items have been prepared
primarily 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 Purpose of the proposed rule change is to make transactions in
forward-starting repurchase agreements (``repos'') eligible for netting
and guaranteed settlement before they reach their scheduled start date.
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 the summaries
prepared by GSCC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
Presently, forward-starting repos are not eligible for netting and
guaranteed settlement until they reach their scheduled settlement
date.\3\ GSCC proposes amendments to several of its rules to make these
transactions eligible for these services before they reach their
scheduled start date.
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\3\ Forward-starting repo transactions are repo transactions
which have start legs settling one or more business days in the
future.
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1. Background
Since November 1995, GSCC has provided netting services for repo
transactions. Each business day, all eligible repo transactions are
netted with regular cash activity and Treasury auction purchases in the
same CUSIP to establish a single net position in the security for each
netting member participating in the repo netting process. For netting
purposes, the settlements associated with repo close legs and reverse
start legs are treated as long positions. The settlements associated
with repo start legs and reverse close legs are treated as short
positions. The difference between a participant's total short activity
and its total long activity within a CUSIP is the participant's net
position in the CUSIP.
After GSCC nets repo transactions, it interposes itself between the
submitting participants for transaction settlement purposes as it does
for cash transactions. In doing so, GSCC assumes contra party
responsibility and guarantees settlement of all repos that enter its
netting system. GSCC's guarantee for netted repose includes
guaranteeing the return of repo collateral to repo participants, the
return of principal (i.e., repo start amount) to reverse participants,
and the payment of repo interest to the full term of the repo to
reverse participants.
Because forward-starting repos currently are not eligible for
netting or guaranteed settlement until they reach their scheduled start
date, they are not subject to clearing fund or forward margin
requirements until that time. This results in two problems. One is a
general management concern for GSCC arising from the possibility that a
netting member that has entered into a forward-starting repo will
become insolvent on the morning of the scheduled start date for the
repo, after GSCC has netted, novated, and guaranteed the settlement of
the repo but before the member has satisfied its funds-only settlement
obligation (i.e., clearing fund or forward margin requirements) with
GSCC for that day. If this occurs, GSCC may have an uncovered interest
rate exposure that has built up over a period of time and consequently
is of a significant size.\4\ The other concern is that members that
enter into forward-starting repos do not have the benefit of GSCC's
netting and guaranteed settlement services for those transactions until
the start of the transaction.
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\4\ If a member defaults after GSCC has guaranteed the trade,
GSCC will be responsible to the counterparty for the difference
between the contract repo rate and the current repo rate.
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2. Comparison of Forward-Starting Repos
The principal impediment to making forward-starting repos eligible
for netting and guaranteed settlement immediately after their execution
is an inability to compare certain types of forward-starting repos.
Forward-starting repos may be said to be of two types: (1) ``Specific
collateral'' for which the underlying CUSIP is known from the date of
execution of the repo and (2) ``general collateral'' for which the
specific security and par amount that will be transferred from the repo
participant to the reverse participant on the start date are not known
at the time of execution. Because the underlying CUSIP is not known,
general collateral repo transactions cannot be compared under GSCC's
current matching requirements for data submissions.
To rectify this problem, GSCC will allow repo participants
submitting to GSCC data on general collateral repo transactions to use
one of the seventeen generic CUSIP numbers established by the CUSIP
service bureau for identifying collateral. These CUSIP numbers identify
the type of Government security (e.g., bill, bond, or note) and
indicate the remaining length to maturity for the issue. In addition,
the par amount of the underlying collateral will not be required to
match. This will allow GSCC to make general collateral forward-starting
repos eligible for netting upon their submission to GSCC.
In conjunction with this, GSCC will impose upon the parties to a
general collateral forward-starting repo the obligation to inform GSCC
when the specific CUSIPs and associated par values that will be used
for settlement purposes are determined. The notification must be made
to GSCC no later than by the close of business on the business day
prior to the date on which the repo is scheduled to start.
The notification must be made in the same manner as that in which
members inform GSCC of their intention to substitute collateral.\5\
First, they must submit an ``intent to substitute'' notification
providing specific collateral details to GSCC using an on-line function
(i.e., a screen input facility)
[[Page 40878]]
provided by GSCC. GSCC will then modify existing trade data in its
system by canceling the ``old'' generic CUSIP data and by creating
replacement data based on the specific CUSIP.
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\5\ See Section 4 for a description of substitution of
collateral.
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If one of the members that has submitted the data on the repo is a
broker, GSCC will accept the ``intent to substitute'' notification
solely from the broker without the need for a matching notification
from the dealer counterparty. If neither of the members that submitted
the data on the repo are brokers, GSCC will accept the ``intent to
substitute'' notification from the member in the short or delivering
position without the need for a matching notification from the dealer
counterparty; however, GSCC will attempt to verify manually with the
other member the accuracy of the details of the notification.
3. Forward Margin and Clearing Fund Requirements
A second impediment to making forward-starting repos eligible for
netting was an internal system constraint that has been resolved. GSCC
now has developed the system's capability to calculate and collect
clearing fund and forward margin on forward-starting repos from the
time of their submission to GSCC.
Until a forward-starting repo actually starts, the forward margin
and clearing fund requirements apply to it will differ from those
applied at all other repos. With regard to forward margin, because a
forward-starting repo that has not yet started presents only interest
rate exposure and not exposure to movements in the value of the
underlying collateral, only an interest rate mark-to-market will be
applied.\6\ This interest rate mark component will be calculated by
multiplying the principal value of the repo first by a factor equal to
the absolute difference between the system and contract repo rates and
then by a fraction where the numerator is the number of calendar days
from the scheduled start date of the repo until the scheduled close
date for the repo and the denominator is 360. The interest rate mark
will differ from the financing mark applied to repos that have already
started in that, because the exposure presented to GSCC is a pure rate
risk exposure, it can be a debit to either the short side or the long
side.\7\
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\6\ As a part of the morning funds-only settlement process, GSCC
collects and passes through a daily basis a mark-to-market amount
(``forward margin'') equivalent to its ongoing exposure on each
forward net settlement position. This payment requirement reflects
the daily mark-to-market obligation associated with a member's
ongoing forward net settlement position in each security with a
distinct CUSIP from the time of comparison and novation of the
trades that underlie such position. Thus, for repos, the market
value is subtracted from the repo's contract value (i.e., the amount
of money that was exchanged for the collateral), and a debit or
credit collateral mark is established depending upon the result of
the calculation and whether or not the participant is on the reverse
or repo side of the transaction.
The forward margin calculation for repos differs from that for
cash market trades in that there is additional financing mark
component. The financing mark component reflects the fact that, if
GSCC replaced the reverse side or the repo by buying securities and
putting them out on repo, a financing cost would be incurred. The
financing mark is debited to the reverse side and credited to the
repo side.
\7\ For repos for which the underlying collateral has already
been exchanged, each day GSCC guarantees to the reverse repo party
the interest payment on the principal amount. However, until the
repos begins, GSCC only guarantees the difference between the agreed
upon repo rate and the rate the party could receive in the open
market.
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With regard to clearing fund, again because there is no exposure to
movements in the value of the underlying collateral for a forward-
starting repo that has not yet started, only the funds adjustment
component of clearing fund would be affected until the scheduled start
date.\8\ Therefore, the clearing fund requirement for a forward-
starting repo during its forward-starting period will be computed by
taking the average of the twenty largest funds-only settlement amounts
occurring in the most recent seventy-five business days. Only the
interest rate mark, described above, would be included in these funds-
only settlement amounts for any forward-starting repos entered into by
the member.
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\8\ There are three components to the regular clearing fund
deposit requirement, with the sum of the three being a members
overall requirement:
(A) Funds Adjustment (FAD) Component: This is based on each
member's average funds-only settlement amount. The relevant variable
in this calculation is the size of the settlement amount; it does
not matter whether the funds are to be collected from the member or
paid to the member.
(B) Receive/Deliver Settlement Component: This component is
based on the size and nature of net settlement positions. The margin
collected on net settlement positions is determined by applying
margin factors that are designed to estimate security price
movements. The factors are expressed as percentages and are
determined by historical daily price volatility. Multiplying
security settlement values by their corresponding margin factors is
a proxy for the estimated amount of loss to which GSCC is
potentially exposed from price changes.
(C) Repo Volatility Component: This component reflects the
interest rate exposure incurred by GSCC in guaranteeing the payment
to the funds lender in a repo transaction of the full amount of
interest due on the transaction. The repo volatility amount, which
corresponds to the volatility of repo rates, is used to provide GSCC
with protection from the portion of that fluctuation in value that
represents interest exposure. A repo volatility factor essentially
represents an estimate of the amount that repo market rates might
change during the liquidation period for the repo transaction.
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4. Right to Substitute Collateral
Currently, repo participants are able to submit details of their
rights of substitution to GSCC. This proposal will amend GSCC's rules
to clarify that a right of substitution continues after GSCC novates
the trade. The proposal also will add Section 4 to Rule 18 to clarify
the method of substituting collateral. Should a repo participant want
to implement a substitution, either it or its broker must submit an
``intent to substitute'' notification to GSCC using GSCC's on line
collateral substitution function. The ``intent to substitute''
notification must contain information regarding the ``old'' collateral
so that GSCC may begin preparing for the substitution. Additional
details regarding the replacement collateral may be provided in the
same notification or in a subsequent notification when known.
Upon receiving the ``intent to substitute'' notification, GSCC will
prepare to process the substitution by identifying the repo and
collateral being replaced. The proposal will clarify that as it
currently does today with other substitute GSCC will not review the
appropriateness of the substitute collateral. Once all required details
have been submitted, GSCC will modify its database to reflect the
substitution. For money fill substitutions, the par amount and/or CUSIP
may change, and for par fill substitutions, the principal, CUSIP, and/
or end money may change.
All movements associated with the substitution will be made through
GSCC, and substitutions will be reported to participants as ``cancel
and correct'' transactions. The reverse dealer will deliver the ``old''
collateral to GSCC, and GSCC will redeliver that collateral to the repo
dealer. These deliveries will be done versus the ``old'' collateral
principal amount.
Conversely, the repo dealer will deliver the replacement collateral
to GSCC, and GSCC will redeliver that collateral to the reverse dealer.
For par fill substitutions, these deliveries will be done versus the
replacement or ``new'' collateral principal amount. For money fill
substitutions, the principal amount will not change so both deliveries
will be done at the same amount.
Regardless of the type of substitution, GSCC will maintain accrued
interest information throughout the life of the repo across multiple
collateral substitutions as required. GSCC also will reverse any
previous mark-to-market and clearing fund monies calculated for the
collateral being replaced. These amounts will be
[[Page 40879]]
recalculated using the security information for the replacement
collateral.
5. Substitution of Maturing Collateral
Finally, GSCC is making eligible for its netting system repos with
underlying collateral that matures on or prior to the scheduled close
date by eliminating from the list of requirements for netting-
eligibility the requirement that the maturity date of the underlying
securities be on or later than the scheduled settlement date of the
close leg. The proposal will add Section 6 to Rule 18 to require that
if a repo participant has transferred securities as underlying
collateral that mature prior to the settlement date of the close leg,
that participant must substitute equivalent securities with a later
maturity date prior to the business day before the maturity date.
The proposed rule change is consistent with the requirements of
Section 17A of the Act \9\ and the rules and regulations thereunder
because it will authorize GSCC to make forward-starting repos eligible
for netting in a prudent fashion once they are compared by GSCC. This
will allow members to enjoy the benefit of guaranteed settlement of
their forward-starting repos as soon as possible.
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\9\ 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 would 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 GSCC 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 the file number SR-GSCC-97-03 and should be
submitted by August 20, 1997.
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).
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Jonathan G. Katz,
Secretary.
[FR Doc. 97-20052 Filed 7-29-97; 8:45 am]
BILLING CODE 8610-01-M