[Federal Register Volume 64, Number 165 (Thursday, August 26, 1999)]
[Notices]
[Pages 46737-46741]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-22118]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41766; File No. SR-GSCC-98-04]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Approving a Proposed Rule Change Relating to the 
Establishment of a Cross-Margining Program

August 19, 1999.
    On November 16, 1998, the Government Securities Clearing 
Corporation (``GSCC'') filed with the Securities and Exchange 
Commission (``Commission'') a proposed rule change (File No. SR-GSCC-
98-02) pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``ACT'').\1\ Notice of the proposal was published in the Federal 
Register on February 10, 1999.\2\ The Commission received five comment 
letters from four commenters.\3\ For the reasons discussed below, the 
Commission is approving the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 41019 (February 3, 
1999), 64 FR 6727.
    \3\ Letters from Dennis A. Dutterer, President and Chief 
Executive Officer, Board of Trade Clearing Corporation (March 3, 
1999 and May 18, 1999); Sal Ricca, President, GSCC (April 19, 1999); 
George F. Haase, Jr., President, New York Clearing Corporation 
(April 23, 1999); and Scott C. Rankin, Vice President and Assistant 
General Counsel, The Bond Market Association (July 23, 1999).
    \4\ The Commission also notes that the Commodity Futures Trading 
Commission (``CFTC'') has approved New York Clearing Corporation's 
proposal to enter into a cross-margining arrangement with GSCC. 
Letter from David Van Wagner, Acting Associate Director, Division of 
Trading and Markets, CFTC to George F. Haase, Jr., President, New 
York Clearing Corporation.
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I. Description

    Under the rule change, GSCC will establish a cross-margining 
program with futures clearing organizations (``FCOs'').\5\ GSCC will 
begin cross-margining with the New York Clearing Corporation (``NYCC'') 
\6\ and intends to set up cross-margining arrangements with other 
FCOs.\7\
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    \5\ Under the rule change, the term FCO is defined in GSCC's 
Rules as a clearing organization for a board of trade designated as 
a contract market under Section 5 of the Commodity Exchange Act that 
has entered into a cross-margining agreement with GSCC. This will 
include NYCC and any other futures clearing organization with which 
GSCC establishes a cross-margining arrangement.
    \6\ Until January 15, 1999, NYCC was known as the Commodity 
Clearing Corporation.
    \7\ Each FCO that participates in cross-margining with GSCC will 
have a separate cross-margining agreement with GSCC. According to 
GSCC, each of these agreements will have essentially similar terms, 
and no preference will be given by GSCC to one FCO or its members 
over another. GSCC will file proposed rule changes for all proposed 
cross-margining arrangements with other FCOs, setting forth any 
difference in a proposed new cross-margining arrangement from the 
cross-margining arrangements with NYCC and any other approved cross-
margining arrangements.
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A. General Description of the Cross-Margining Program

    Under the rule change, cross-margining will be available to any 
GSCC member that is a member of or that has an affiliate \8\ that is a 
member of an FCO that has entered into a cross-margining agreement with 
GSCC. Any such member (or pair of affiliated members) may elect to have 
its margin requirements at both clearing organizations calculated based 
upon the net risk of its cash and forward positions at GSCC and its 
offsetting positions in related futures contracts carried at the FCO. 
Cross-margining is intended to lower the cross-margining participant's 
(or pair of affiliated members') overall margin requirement.
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    \8\ The term affiliate will be defined in each cross-margining 
agreement between GSCC and an FCO. Under the form agreement between 
GSCC and NYCC that GSCC included with its filing, ``affiliate'' 
means a clearing member of one clearing organization that (1) 
directly or indirectly controls, (2) is directly or indirectly 
controlled by, or (3) is under common control with a clearing member 
of another clearing organization. Ownership of 10% or more of the 
common stock of an entity is deemed control of the entity under the 
definition.
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    GSCC and each FCO will determine which of their members are 
eligible to participate in the cross-margining program. In order to be 
a GSCC cross-margining participant, a member must either (a) also be a 
member of an FCO or (b) have an affiliate that is a member of an 
FCO.\9\ In addition, the GSCC member (and its affiliate, if applicable) 
must sign an agreement under which it agrees to be bound by the cross-
margining agreement and which allows GSCC or an FCO to apply the 
member's (or its affiliate's) margin collateral to satisfy any 
obligation of GSCC to an FCO (or vice versa) that results from the 
default of the member (or its affiliate).
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    \9\ The GSCC cross-margining arrangement will be applicable on 
the futures side only to positions in a proprietary account of a 
cross-margining participant (or its affiliate) at an FCO. The 
arrangement will not apply to positions in a customer account at an 
FCO that would be subject to segregation requirements under the 
Commodity Exchange Act.
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    Margining based on the net risk of correlated positions will be 
carried out through an arrangement under which GSCC and the FCO agree 
to share the proceeds from correlated positions and supporting 
collateral. Under this arrangement, each clearing organization will 
hold and manage its own collateral.
    GSCC will offset each cross-margining participant's residual margin 
amount at GSCC against the offsetting residual margin amounts of the 
participant (or its

[[Page 46738]]

affiliate) at each FCO pro rata based upon the residual margin amount 
available at each.\10\ GSCC and each FCO may then reduce the amount of 
collateral that they collect to reflect the offsets between the cross-
margining participant's positions at GSCC and its (or its affiliate's) 
futures positions at an FCO. If more than one FCO is cross-margining 
with GSCC for a cross-margining participant, the participant's long or 
short position in government securities at GSCC will be apportioned pro 
rata among its offsetting short or long positions (if any) at each 
FCO.\11\
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    \10\ All possible offsets among positions carried by a cross-
margining participant within a single clearing organization will be 
carried out before any offsets are carried out between GSCC and the 
FCO.
    \11\ For example, if a cross-margining participant has a $9 
million residual short margin amount at GSCC and residual long 
margin amounts in the same product of $8 million at FCO 1 and $4 
million at FCO 2, GSCC will use two-thirds of the $9 million margin 
amount ($6 million) for offset against the participant's FCO 1 
activity and one-third of the $9 million margin amount ($3 million) 
for offset against FCO 2 activity.
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    Each clearing organization will guarantee the cross-margining 
participant's (or its affiliate's) performance to the other clearing 
organization up to a specified maximum amount. Each clearing 
organization's guaranty will be backed by the positions and margin 
deposits of its cross-margining participant. The amount of the guaranty 
will ordinarily be equal to the amount of the offsetting residual 
margin used to reduce the cross-margining participant's margin 
requirement.
    GSCC will issue a guaranty to each FCO with respect to a cross-
margining participant (or its affiliate) in an amount based on the pro 
rata allocation among the FCOs of the participant's residual margin 
amounts. In the event of a default and liquidation of a cross-margining 
participant, the loss sharing arrangements as between GSCC and each FCO 
will be based on the same pro rata shares. Loss sharing between 
clearing organizations will be subject to a cap.

B. Summary of the Operation of the Cross-Margining Program

    Data Exchange: GSCC and each FCO will exchange daily position and 
margin data for each cross-margining participant (or pair of affiliated 
members) with respect to each product eligible for cross-margining.
    Collateral Management: Margin collateral will be collected, 
maintained, valued, and returned separately by GSCC and each FCO 
according to its own rules and procedures. GSCC will not maintain 
cross-margining accounts for a cross-margining participant separate 
from the cross-margining participant's regular account at GSCC, and 
there will be no separate collateral pool at GSCC for cross-margining 
activity.
    Unified Margin Calculation: GSCC will agree with each of the FCOs 
on the particular products cleared by each that are sufficiently price 
correlated to be eligible for cross-margining treatment (e.g., cash 
positions in two-year Treasury notes and futures on two-year Treasury 
notes). Such products will be referred to as ``eligible products'' and 
a cross-margining participant's long or short positions in eligible 
products will be called ``eligible positions.'' GSCC and FCO will agree 
upon a common margin formula including the percentage of principal 
amount to be used as the base margin calculation on each long or short 
position in each eligible product, any disallowance factors to be 
applied when offsetting long and short margin amounts in different 
eligible products, and the minimum charges for offsetting 
positions.\12\
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    \12\ According to GSCC, an appropriate conversion method will be 
agreed upon to equate the size of futures and cash positions for 
offset purposes.
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    Coordinated Mark to Market Process: GSCC and each FCO will 
coordinate their daily mark to market and variation margin processes. 
If a cross-margining participant does not pay its debit mark or make a 
required clearing fund or margin deposit to one clearing organization 
on a particular business day, the other will be so informed and will 
not pay out to that participant (or its affiliate) any credit mark or 
clearing fund or margin withdrawal relating to cross-margined 
positions.
    Daily Calculation of Cross-Margining Reduction and Cross-
Guaranties: On each business day, GSCC will complete its own internal 
margining process for buy-sell, repo, and Treasury auction transactions 
for each cross-margining participant (including to the extent permitted 
in GSCC's rules the setting off or netting of GCF repo transactions 
with other activity).\13\ Each FCO will perform an equivalent internal 
process for each of its cross-margining members by offsetting long 
margin amounts against short margin amounts for futures and options on 
futures contracts that are eligible products to the extent specified in 
the FCO's rules.\14\
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    \13\ For a description of GSCC's GCF Repo service, refer to 
Securities Exchange Act Release No. 40623 (October 30, 1998), 63 FR 
59831 [File No. SR-GSCC-98-02] (order approving proposed rule 
change).
    \14\ For example, on each business day, GSCC and NYCC each will 
calculate for each cross-margining participant an initial margin 
requirement with respect to eligible positions. This calculation 
will be done independently based upon an agreed upon method without 
the other clearing corporation's review. However, GSCC and NYCC will 
review generally each other's margining process on a periodic basis, 
and each will have the obligation to inform the other of any 
material changes to its margining process.
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    After completing the internal margining process, each clearing 
organization may have ``residual'' long or short margin amounts for a 
member in various eligible products. The residual long or short margin 
amount is the amount of long or short margin (i.e., margin with respect 
to a long position or a short position) that has not been ``used up'' 
in the internal offsetting process.\15\
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    \15\ A margin amount may be ``used up'' whether or not there has 
been a full offset against it. For example, assume that a GSCC 
member has a $1 million gross margin requirement on a short position 
in the 10-year note (offset class F) that is offset against a $1 
million gross margin requirement on a long position in the long bond 
(offset class G). Because there is a 20% disallowance on offsets 
between classes F and G, the member has a $200,000 margin 
requirement after the offset. However, both $1 million margin 
amounts have now been entirely used up, and nothing is available for 
further offset either within GSCC or for cross-margining with an 
FCO.
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    Each FCO will inform GSCC how much residual long or short margin 
amount in each eligible product that the FCO intends to make available 
for cross-margining offsets on that day for each cross-margining 
participant. GSCC then will determine the amount of the long or short 
residual margin offered by each FCO that GSCC can offset against the 
participant's short or long residual margin amounts at GSCC for 
purposes of determining the cross-margining reduction.\16\ GSCC will 
inform each FCO of the cross-margining reduction as between GSCC and 
that FCO for each cross-margining participant. The cross-margining 
reduction is the amount by which GSCC and the FCO may each 
appropriately reduce its cross-margining participant's margin 
requirement to reflect the cross-margining offset.\17\
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    \16\ The cross-margining reduction is determined by the residual 
margin amounts made available by an FCO and ``used'' by GSCC in 
determining the amount of the cross-guaranties. It does not depend 
upon the amount, if any, by which either GSCC or an FCO actually 
reduces a cross-margining participant's margin requirement. In other 
words, after an offer by an FCO of $1 million in residual margin and 
acceptance by GSCC of that amount for offset, the cross-margining 
reduction would be $1 million, and the base amount of the cross-
guaranties would be fixed at that amount. However, either clearing 
organization might nevertheless decide to reduce the cross-margining 
participant's clearing fund or margin requirement by less than $1 
million or not at all. In any event, the cross-margining reduction 
under the cross-margining agreement would still be $1 million. The 
clearing organization would simply have made a determination to hold 
more collateral without affecting the amount of the guaranty it 
receives from the other clearing organization.
    \17\ If a cross-margining participant has eligible positions at 
more than one participating FCO, the participant's total margin 
reduction at GSCC will be the sum of the cross-margining reductions 
between GSCC and each FCO.

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[[Page 46739]]

    As a result, the maximum cross-margining reduction that a cross-
margining participant will receive will be determined by the amount of 
residual margin taken by GSCC. For example, if an FCO offers $1 million 
in residual short margin for a particular member in 2-year note futures 
and if GSCC sets all of that amount off against a $2 million cash 
position in the 2-year note, then the cross-margining reduction amount 
will be $1,000,000 for GSCC and $1,000,000 for the FCO.
    Under the anticipated terms of the cross-margining agreements 
between GSCC and each participating FCO, GSCC will be deemed to have 
extended its guaranty of a cross-margining participant's (or its 
affiliate's) obligation to each FCO in a base amount equal to the 
cross-margining reduction for that participant. Similarly, each 
participating FCO will be deemed to have extended its guaranty of the 
cross-margining participant's (or its affiliate's) obligation to GSCC 
in the same base amount. For example, if GSCC has a residual short 
margin amount for a cross-margining participant of $10 million in a 
product which is offset against an FCO's residual long margin amount of 
$4 million, then the base amount of the cross-guaranties is $4 million, 
and GSCC can reduce the participant's margin requirement for that 
product to $6 million because the FCO will have guaranteed $4 
million.\18\
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    \18\ As noted above, GSCC and each FCO will retain the right to 
reduce a cross-margining participant's clearing fund or margin 
requirement by less than the amount of the cross-margining reduction 
or not to reduce it at all.
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    Each clearing organization will represent to the other that it will 
margin a cross-margining participant's positions such that the amount 
of margin is adequate to cover the cross-margining participant's 
obligations to that clearing organization including the obligation to 
reimburse any payment under the guaranty. In addition, on any day that 
is a business day for an FCO and not for GSCC or vice versa, the gross-
guaranties as they existed on the immediately preceding business day 
will remain in effect. It shall be the responsibility of the clearing 
organization that is open for business on such day to adjust its margin 
requirements with respect to cross-margining participants to cover such 
cross-margining participants' obligations.\19\
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    \19\ The cross-margining participant's margin or clearing fund 
deposit will remain fixed at the clearing organization that is 
closed, and the closed clearing organization must therefore continue 
to rely on the guaranty based on the previous day's cross-margining 
reduction. However, the clearing organization that is open 
ordinarily will be able to assess and collect additional margin or 
clearing fund deposits if needed to reflect updated positions in the 
participant's account on its own books as well as the fixed guaranty 
obligation that is still outstanding to the other clearing 
organization.
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    Default of a Cross-Margining Participant: Liquidation and Loss-
Sharing: If a cross-margining participant becomes insolvent and its 
eligible positions are liquidated by GSCC and the FCO(s), GSCC and each 
FCO will calculate its ``net loss'' or ``net surplus'' from the 
liquidation.\20\ GSCC and each FCO will use their best efforts to 
coordinate the liquidation of eligible positions so that offsetting or 
hedged positions can be closed out simultaneously. GSCC and each FCO 
may unilaterally elect not to terminate or suspend and liquidate the 
eligible positions of its cross-margining participant. However, a 
clearing organization that does so will remain liable to the other on 
this guaranty. In addition, a clearing organization that elects not to 
liquidate the eligible positions of a defaulting participant will be 
deemed to have no net loss and no net surplus.
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    \20\ Under the form agreement between GSCC and NYCC that GSCC 
included with its filing, net surplus and net loss are calculated as 
follows:
    In the event that (i) the sum of ``available margin'' and any 
proceeds of eligible positions realized by such clearing 
organization (including securities deliverable to and amounts 
receivable with respect to securities deliverable by such cross-
margining participant in settlement of eligible positions) and any 
mark to market payments or other settlement amounts due from such 
clearing organization with respect to eligible positions exceeds 
(ii) the sum of the mark to market payments or other settlement 
amounts owed to such clearing organization with respect to or as a 
result of the closeout of eligible positions (including securities 
deliverable by or amounts payable with respect to securities 
deliverable to such cross-margining participant with respect to 
eligible positions) plus any interest expense, fees, commissions, or 
other costs reasonably incurred in such closeout or otherwise 
arising from such eligible positions, then the amount of such excess 
shall be deemed to be the net surplus. In the event that the sum 
referred to in clause (i) of the preceding sentences is less than 
the amount referred to in clause (ii), the difference shall be the 
net loss.
    ``Available margin'' is defined as the amount of clearing fund 
deposits, margin, or other collateral remaining after satisfaction 
of all obligations of the cross-margining participant to the 
clearing organization other than obligations arising from eligible 
positions.
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    In the event a cross-margining participant is liquidated, if either 
GSCC or an FCO has a net loss and the other has a smaller net loss, no 
net loss, or a net surplus, then the one with the larger net loss 
(``worse-off party'') is entitled to receive a payment from the other 
(``better-off party'') that equalizes its losses. The amount of this 
equalizing payment will be capped at the least of: (1) The ``maximum 
guaranty amount'' of the better-off party; (2) if the better-off party 
has a net loss, an amount that together with its net loss equals its 
total cross-margining reduction; or (3) the worse-off party's net loss.
    Generally, the guaranty arising from the cross-margining reduction 
will be a cap on the amount of loss that either GSCC or an FCO can 
incur as the result of a default by a participating member (or its 
affiliate) to the other. The ``maximum guaranty amount'' of GSCC or the 
FCO will exceed the amount of the cross-margining reduction only to the 
extent that the better-off party has funds of the participant remaining 
(i.e., a ``net surplus'') after satisfying all other obligations of the 
participant to the better-off party.\21\
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    \21\ Where a cross-margining participant had eligible positions 
at more than one FCO, GSCC's net loss or net surplus for purposes of 
the cross-margining agreement between GSCC and any one FCO will be a 
portion of GSCC's aggregate net loss or net surplus from all 
eligible positions and available margin at GSCC that is equal to the 
portion of the residual margin at GSCC that was offset against the 
residual margin at that FCO. For example, assume that FCO 1 and FCO 
2 each offer GSCC $2 million in residual short margin based on a 
$200 million short position in futures on the 10-year note. If GSCC 
has only $2 million in residual long margin, it would ``take'' $1 
million residual from each FCO for offset purposes. If GSCC incurs a 
$10 million loss in liquidating the $200 million futures position, 
GSCC's ``net loss'' for purposes of its agreement with FCO 1 would 
ordinarily be half of that or $5 million. However, the cross-
margining agreements will also contain provisions permitting further 
contribution by FCO 1 if FCO 1's net surplus exceeds $5 million and 
FCO 2 contributes less than $5 million.
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C. Information Specific to the Current Form Agreement Between GSCC and 
NYCC

    Participation in the Cross-Margining Program: Any netting member of 
GSCC other than an interdealer broker will be eligible to participate. 
Any clearing member of NYCC will be eligible to participate.
    Positions subject to Cross-margining: The products that will 
initially be eligible for cross-margining at GSCC are its offset 
classes for the 2-year note, 5-year note, 10-year note, and 30-year 
bond and at NYCC are its 2-year note, 5-year note, 10-year note, and 
30-year bond futures products. Residual margin amounts will be applied 
only within the same ``offset class'' (e.g., the 2-year note against 
the 2-year note future). All eligible positions maintained by a cross-
margining participant in its account at GSCC and in its (or its 
affiliate's) proprietary account at NYCC will be eligible for cross-
margining.
    Unified Margin Factors: GSCC and NYCC will apply GSCC's margin 
factors to eligible positions.
    Daily Procedures: On each business day by midnight, NYCC will 
inform

[[Page 46740]]

GSCC of the residual margin amounts it is making available. GSCC will 
inform NYCC by 2:00 a.m. how much of these residual margin amounts it 
will use.

D. GSCC Rule Changes

    The rule change adds definitions relating to cross-margining to 
GSCC Rule 1. These definitions correspond generally to certain terms 
that will be defined in the cross-margining agreements.
    The rule change amends Section 2 of GSCC Rule 4 to provide that the 
required fund deposit otherwise calculated for a cross-margining 
participant may be reduced at GSCC's sole discretion in an amount not 
to exceed the sum of the cross-margining reductions calculated under 
the various cross-margining agreements. The rule change amends Sections 
5 and 6 of Rule 4 to clarify the application of those provisions in the 
context of the cross-margining arrangements. Specifically, the 
amendments provide tat GSCC may set off a cross-margining participant's 
obligation to reimburse GSCC for the payment of a guaranty against any 
asset of the participant that GSCC holds as collateral and against any 
amounts due to the participant. Section 6 of Rule 4 is also amended to 
provide that GSCC may apply a member's clearing fund deposits to 
satisfy a loss without treating the member as insolvent. The rule 
change also adds a provision to Section 2 of Rule 22 to specify that 
GSCC may but is not required to treat a cross-margining participant as 
insolvent if the member is declared to be insolvent by an FCO.
    The rule change adds new Rule 43 to GSCC's rules to set forth How a 
GSCC netting member may become a cross-margining participant and its 
obligations as a cross-margining participant. Section 3 of Rule 43 
provides that a cross-margining participant has the obligation to 
reimburse GSCC for any amount that it pays to an FCO on behalf of the 
participant (or its affiliated member) under a cross-margining 
guaranty. Rule 43 also cross-references the corresponding provisions of 
the cross-margining agreement which state that any obligations of a 
defaulting cross-margining participant to the FCO will be netted 
against any amounts held by or due to the participant as a result of 
its positions at GSCC. As a result, a defaulting participant will be 
entitled to receive from the close out of its positions and margin at 
GSCC only what remains after netting out the sum of its obligations to 
GSCC and the FCOs. Section 4 of Rule 43 provides that a cross-margining 
participant may be treated as insolvent at the discretion of GSCC if 
(1) the cross-margining participant is determined to be insolvent by an 
FCO or (2) the cross-margining participant's affiliate is deemed to be 
insolvent by an FCO and the cross-margining participant does not 
immediately upon GSCC's demand deposit with GSCC the amount of GSCC's 
cross-margining guaranty to the FCO.

II. Comment Letters

    The Commission received five comment letters from four commenters 
in response to GSCC's filing.\22\
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    \22\ Supra note 3.
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A. Letters From the Board of Trade Clearing Corporation

    The Board of Trade Clearing Corporation (``BOTCC'') submitted two 
comment letters in response to GSCC's proposal. In its first comment 
letter, BOTCC stated its specific concerns with GSCC's proposal. 
BOTCC's second letter responded to some of the statements in GSCC's 
comment letter (which is described below). In its comment letters, 
BOTCC expressed concern with the structure of GSCC's proposed cross-
margining program and with the legal enforceability of some of the 
payment mechanisms in the program.
    BOTCC noted that GSCC's proposed cross-margining program differs 
from existing cross-margining programs in that GSCC and participating 
FCOs will each maintain their own collateral and will not pool cross-
margining positions and margin deposits on those positions in a jointly 
controlled account. BOTCC stated that the primary protection against 
loss in current cross-margining programs is the fact that participating 
clearing organizations have a joint first priority lien on and security 
interest in all positions in cross-margined accounts, all funds and 
securities deposited to satisfy margin requirements, and all proceeds 
resulting from the liquidation of the accounts.
    BOTCC stated that it believes that the structure of GSCC's proposal 
does not ensure that GSCC and the FCOs will have sufficient resources 
to satisfy losses that might result from a default of a cross-margining 
participant. BOTCC stated that GSCC's proposal does not provide for any 
limitation on the amount of guaranties that GSCC and the FCOs can 
extend to each other. In addition, BOTCC stated that under GSCC's 
proposal, margin reductions would be backed by mutual unsecured 
promises rather than by a pool of collateral controlled jointly by GSCC 
and the FCOs.
    BOTCC also expressed concern that certain provisions of GSCC's 
proposed cross-margining program might not be enforceable under the 
U.S. Bankruptcy Code against a cross-margining participant that had 
filed a bankruptcy petition. Specifically, BOTCC stated that if GSCC 
became obligated to pay an FCO in order to equalize losses resulting 
from liquidating positions of a defaulting cross-margining participant, 
it would not be permitted under the Bankruptcy Code to setoff the 
participant's obligation to reimburse that amount to GSCC against any 
assets GSCC was holding for the participant.
    Section 362(a) of the Bankruptcy Code \23\ provides for a stay 
(known as the ``automatic stay'') of all actions against a debtor that 
has filed a bankruptcy petition for claims that arose before the 
petition was filed. However, Section 362(b)(6) of the Bankruptcy Code 
\24\ provides an exception to the automatic stay which permits a 
clearing agency to setoff a mutual claim against the debtor for a 
margin payment or a settlement payment arising out of securities 
contracts against property that is held by or due from the clearing 
agency to margin or guarantee securities contracts. BOTCC stated that 
Section 362(b)(6) does not allow a clearing agency to setoff a pre-
petition debt against a post-petition claim. BOTCC believes that a 
claim against the participant for reimbursement of an amount that GSCC 
paid to an FCO would be a post-petition debt and that GSCC would not be 
permitted under Section 362(b)(6) to setoff the reimbursement 
obligation against assets of that participant that GSCC was holding 
pre-petition (e.g., surplus margin deposits). In addition, BOTCC 
believes that it is not clear that the reimbursement obligation is a 
``margin payment'' or a ``settlement payment'' as defined in the 
Bankruptcy Code \25\ because the obligation (a) is not a specific type 
of margin payment, (b) would not secure the cross-margining 
participant's already liquidated positions at GSCC, and (c) is not 
closely related to the settlement process.
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    \23\ 11 U.S.C. 362(a).
    \24\ 11 U.S.C. 362(b)(6).
    \25\ The term ``margin payment'' is defined in Sections 101, 
741, and 761 of the Bankruptcy Code, 11 U.S.C. 101, 741, and 761. 
The term ``settlement payment'' is defined in Sections 101 and 741 
of the Bankruptcy Code, 11 U.S.C. 101 and 741.
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B. Letter from GSCC

    GSCC submitted a comment letter in response to BOTCC's first 
comment letter. With respect to BOTCC's statements on the structure of 
its proposed cross-margining program,

[[Page 46741]]

GSCC stated that all cross-margining arrangements rely to some extent 
on unsecured promises between clearing agencies. GSCC noted that it and 
the FCOs can decide to reduce or eliminate the cross-margining 
reduction for a particular member or for all members. In addition, GSCC 
stated that it can increase the amount of collateral that a cross-
margining participant is required to deposit to support its obligation 
to GSCC including GSCC's guaranty obligations to the FCOs. GSCC further 
stated that it believes that the structure of its cross-margining 
program has an advantage over traditional cross-margining programs in 
that the total possible liability of GSCC to another clearing agency 
can be precisely calculated at any given point in time.
    With respect to BOTCC's statements regarding the enforceability 
under the Bankruptcy Code of a cross-margining participant's obligation 
to reimburse GSCC's payment of a guaranty to an FCO, GSCC stated that 
the reimbursement obligation would be a pre-petition claim because it 
would be a contingent contractual obligation that would arise at the 
time the cross-margining participant becomes subject to the cross-
margin agreement. In addition, GSCC stated that it believes that the 
reimbursement obligation is a margin payment or a settlement payment 
because (a) it would be made in settlement of a debt owed to GSCC and 
(b) because it would represent a reimbursement to GSCC of a payment 
made to an FCO to meet variation margin and settlement obligations. 
GSCC further stated that in the alternative the cross-margining 
agreement is a ``netting contract'' under the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (``FDICIA'') \26\ and therefore is 
not subject to automatic stay provisions of Section 362 of the 
Bankruptcy Code.\27\
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    \26\ 12 U.S.C. 4401-4407.
    \27\ In its second comment letter, BOTCC responded to GSCC's 
statements and reiterated its statements regarding the structure of 
the proposed cross-margining program and the effect of the 
Bankruptcy Code an a cross-margining participant's reimbursement 
obligation. In addition, BOTCC stated that it believes that FDICIA 
only permits the enforcement of a netting contract against a 
bankrupt party if there is an applicable exception from the 
automatic stay.
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C. Letter From NYCC

    NYCC stated that it supports GSCC's proposal and that the GSCC 
structure allows each clearing organization to use its own systems to 
monitor risk without having to set up a different system to monitor 
cross-margined positions. In addition, NYCC stated that all cross-
margining arrangements rely on the risk systems, default protections, 
and the ability of a clearing organization to be able to fulfill its 
obligations.

D. Letter From the Bond Market Association

    The Bond Market Association (``BMA'') stated that it strongly 
supports cross-margining arrangements like the one proposed by GSCC. In 
addition, the BMA stated that it agrees with GSCC's conclusion that the 
cross-margining program will benefit cross-margining participants by 
lowering their margin requirements and thereby allowing them more 
efficient use of collateral and reduced operational costs. Moreover, 
the BMA stated that it ``is comfortable expressing its agreement with 
GSCC's analysis of the FDICIA netting provisions and the Bankruptcy 
Code as they relate to its proposed cross-margining arrangement.''

III. Discussion

    Under Section 19(b) of the Act,\28\ the Commission is directed to 
approve a proposed rule change of a clearing agency if it finds that 
the proposed rule change is consistent with the Act and the rules and 
regulations thereunder. Section 17A(b)(3)(F) of the Act\29\ requires 
that the rules of a clearing agency be designed to assure the 
safeguarding of securities and funds which are in the custody and 
control of the clearing agency or for which it is responsible. Section 
17A(a)(2)(A)(ii) of the Act\30\ directs the Commission to use its 
authority under the Act to facilitate the establishment of linked or 
coordinated facilities for the clearance and settlement of transactions 
in securities, securities options, contracts of sale for future 
delivery and options thereon, and commodity options.
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    \28\ 15 U.S.C. 78s(b).
    \29\ 15 U.S.C. 78q-1(b)(3)(F).
    \30\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
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    The comment letters that the Commission received from BOTCC raised 
questions about the structure of GSCC's proposed cross-margining 
program and about the legal enforceability of certain provisions of the 
program. GSCC stated in response that it believes that its cross-
margining program will be safe and prudent from a risk management 
perspective and that its payment mechanisms will be enforceable against 
a defaulting cross-margining participant.
    The Commission believes that GSCC's proposal should adequately 
limit GSCC's potential financial exposure to a defaulting cross-
margining participant.\31\ In particular, the Commission notes that 
GSCC may reduce or eliminate the cross-margining reduction to any 
cross-margining participant and that GSCC will be able to calculate 
precisely its potential liability to FCOs with respect to each cross-
margining participant. Furthermore, the Commission has always viewed 
properly structured cross-margining programs as a significant risk 
reduction method because they reduce the extent to which clearing 
organizations have to independently manage the risk associated with 
some but not all of the components (ie., the futures or government 
securities component) of a member's total portfolio. Therefore, the 
cross-margining program is structured so that GSCC will continue to be 
able to assure the safeguarding of securities and funds which are in 
its custody or control or for which it is responsible.
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    \31\ The Commission believes that the arguments in GSCC's 
comment letter are persuasive. However, the Commission recognizes 
that in a bankruptcy proceeding a court could reach a different 
result.
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    GSCC's proposal will also enable it to coordinate with the FCOs in 
the management of risks associated with their members' (or affiliated 
members') positions in government securities and in related futures 
contracts. The cross-margining program should also result in increased 
and better information sharing regarding the financial condition of 
participating joint and affiliated members. Therefore, GSCC's proposal 
should facilitate the establishment of linked or coordinated facilities 
for the clearance and settlement of transactions in government 
securities and in futures contracts.

IV. 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 the requirements of Section 17A 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 change (File No. SR-GSCC-98-04) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-22118 Filed 8-25-99 8:45 am]
BILLING CODE 8010-01-M