[Federal Register Volume 66, Number 6 (Tuesday, January 9, 2001)]
[Notices]
[Pages 1709-1710]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-539]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43791; File No. SR-GSCC-00-02]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Notice of Filing of a Proposed Rule Change Relating to the 
Enhancement of Risk Management Processes

January 2, 2001.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on April 17, 2000, 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 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 proposed rule change will enhance one of the components of 
GSCC's clearing fund formula by reducing the liquidation amount from 25 
percent to 10 percent.

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 propose 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 parts of these statements.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    As part of its ongoing review of its risk management process, GSCC 
is seeking authority to enhance one of the components of its clearing 
fund formula. Specifically, GSCC is proposing to lower the liquidation 
amount from 25 percent to 10 percent. GSCC believes that this would 
more appropriately balance the level of margin it collects against the 
liquidity needs of its members.
Background
    A netting member's clearing fund requirement is based on a formula 
designed to take into account the three basic risks posed to GSCC by 
netting members. These risks include: (1) That a member might not pay a 
funds only settlement amount due to GSCC; (2) that a member may fail to 
settle a long-term repo; and (3) that a member might not deliver or 
take delivery of securities that comprise a net settlement position.
    As a result, there are three components to each member's clearing 
fund deposit requirement, as described below, with the sum of the three 
being a member's overall requirement:
Funds Adjustment (FAD) Component
    This component 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.
Repo Volatility Component
    This component reflects the interest rate exposure incurred by GSCC 
in guaranteeing the contractual rate of interest on a repo transaction. 
The repo volatility factor essentially represents an estimate of the 
amount that repo.
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 in historical daily price volatility. By multiplying 
security settlement values by their corresponding margin factors, GSCC 
estimate the amount of loss to which it is potentially exposed from 
price changes.
    Margin amounts on receive (long) and deliver (short) positions are 
allowed to offset each other. The extent to which an offset is allowed 
is determined by product and the degree of similarly in time remaining 
to maturity.
    GSCC computes four receive/deliver settlement amounts each day. The 
four results are compared daily, and the largest amount is applied to 
the clearing fund requirement. The four receive/deliver computations 
are as follows:
    (1) Post-Offset Margin Amount (POMA): This computation offsets 
gains against losses in liquidating a member's positions that are 
anticipated based on historical experience. The POMA essentially is the 
total margin on the current day's positions and forward net settlement 
positions taking into account allowable offset percentages.
    (2) Average POMA: This computation is based on the member's twenty 
highest POMA amounts occurring in the most recent 75 business days.
    (3) Adjusted POMA: This computation is the same as the POMA with 
the exception that it excludes all trades that are scheduled to settle 
on the current day. This is done based on the assumption that those 
trades will in fact settle on the current day and that calculating POMA 
in this manner will more accurately reflect GSCC's settlement exposure 
during the current day.
    (4) Liquidation Amount: This computation is a floor amount designed 
to ensure that if the margin offsets ordinarily allowed in calculating 
the receive/deliver settlement component do not reflect actual market 
conditions during a liquidation period, GSCC nonetheless will have a 
sufficient level of collateral protection. In other words, this minimum 
requirement, which is 25 percent of the total margin on all net long 
and short positions without offsets, protects against the risk that 
during a liquidation period the yield curve will be aberrational. In 
such a situation, collection of a minimum amount of margin based on 
gross calculation should ensure that GSCC will have sufficient 
collateral to cover liquidation losses.
Proposed Change
    GSCC proposes to lower the percentage calculated on the net long 
and net short positions in the liquidation amount calculation from 25 
percent to 10 percent. GSCC believes that 25 percent is overly 
conservative for the reasons set forth below.
    First, the current received/deliver settlement component 
calculation is overly conservative. GSCC's experience has demonstrated 
that its POMA and average POMA calculations provide adequate protection 
against potential settlement risks. The POMA, by itself, is

[[Page 1710]]

a conservative calculation that is a function of: (1) Margin factors 
that are designed to cover one day market movements as least 95 percent 
of the time but that typically exceed this confidence level and (2) a 
cautious disallowance scheme providing only limited credits (benefits) 
for hedging across offset classes (for example, GSCC does not allow 
offsets of zeros against non-zeros).
    Furthermore, by calculating an average POMA (based on a member's 
twenty highest POMA amounts occurring in the most recent 75 business 
days), GSCC ensures that it calculates a historically sufficient 
receive/deliver settlement component for a member even when current 
activity results in a relatively low requirement.
    Finally, periodic studies conducted by GSCC assessing the risks 
presented to it from the potential default by a member on its 
obligations to GSCC have concluded that GSCC's methodogies for 
identifying and computing its risks provide it with a high level of 
protection on a individual and aggregate basis.
    Second, the liquidation amount ignores and negates much of the 
protection afforded by a hedging strategy. The more a member engages in 
a hedging strategy with respect to its trading, the more it protects 
its clearing corporation from the risk of its failure. However, GSCC 
believes that the current 25 percent minimum margin call effectively 
disregards the protection afforded to GSCC by a member that engages in 
trading activity on a fully hedged basis. In addition, it penalizes the 
member by forcing it to post excessive collateral with GSCC.
    In sum, the liquidation amount calculation is necessary because it 
recognizes the fact that an aberrational yield curve may exist at the 
time of a liquidation. However, GSCC believes that the use of 25 
percent is overly conservative and ties up excessive amounts of 
collateral of netting members. Thus, GSCC believes that the percentage 
in liquidation amount calculation should be lowered to 10 percent.
    GSCC believes that the proposed rule change will revise GSCC's risk 
management processes in a prudent manner that is consistent with 
minimizing collateral and operational burdens on and maximizing the 
liquidity of GSCC netting members. Thus, GSCC believes that the 
proposed rule change is consistent with Section 17A of the Act because 
the proposed rule change will facilitate the prompt and accurate 
clearance and settlement of securities transactions and will in general 
protect investors and the public interest.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    GSCC does not believe that the proposed rule will have an impact on 
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

    Comments on the proposed rule change have not yet been solicited. 
Members will be notified of the rule filing and comments will be 
solicited by an Important Notice. GSCC will notify the Commission of an 
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, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street NW., Washington, DC 20549-0609. 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. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room in Washington, DC. Copies of such filing will 
also be available for inspection and copying at the principal office of 
GSCC. All submissions should refer to File No. SR-GSCC-00-02 and should 
be submitted by January 30, 2001.

    For the Commission by the Divisioin of Market Regulation 
pursuant to delegated authority.\3\
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    \3\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-539 Filed 1-8-01; 8:45 am]
BILLING CODE 8010-01-M