[Federal Register Volume 66, Number 8 (Thursday, January 11, 2001)]
[Notices]
[Pages 2466-2468]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-898]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43794; File No. SR-GSCC-00-10]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Notice of Filing of Proposed Rule Change Relating to the 
Submission of Repo Collateral Substitutions

January 3, 2001.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on September 11, 2000, the 
Government Securities Clearing Corporation (``GSCC'') filed with the 
Securities and Exchange Commission (``Commission'') the proposed rule 
change and on November 20, 2000, amended 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 parties.
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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 amends GSCC's rules relating to repo 
collateral substitutions processes and the fees associated with such 
substitutions.

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 section A, B, 
and C below, of the most significant aspects of these 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

    Support of repo collateral substitutions has been an integral part 
of GSCC's array of services for blind-brokered repo markets since its 
introduction in 1996. Over the past two years, however, GSCC members 
have at times engaged in certain practices in connection with the repo 
collateral substitution process that present risk to GSCC and its 
members by placing an inordinate level of stress on the operational 
infrastructures of GSCC and its inter-dealer broker members, and by 
causing undue fail-financing expenses for other members. GSCC desires 
to prohibit these practices and to impose an additional risk management 
measure on the repo substitution process.
1. Late Notifications
    Over the past two years, there have been an increasing number of 
occasions where GSCC experienced dramatic increases in the number of 
substitutions requests.\3\ In addition, many members have not followed 
The Bond Market Association's (``TBMA'') published deadlines for 
substitution requests applicable to dealers and brokers which has 
resulted in GSCC receiving the substitution requests late in the 
day.\4\ Specifically, some dealers are not complying with the 
substitution deadlines and some brokers, in turn, are not able to 
submit the requisite notifications to GSCC in a timely manner. The 
combination of the increased volume and the late submissions has, on 
certain occasions, placed an inordinate amount of stress on both GSCC's 
and the brokers' infrastructures. In addition, because ``new'' 
collateral is often delivered at or too near the close of the 
securities Fedwire to be redelivered by GSCC, GSCC is forced in many 
instances to obtain overnight financing, the cost of which is passed on 
to the netting members.\5\
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    \3\ These spikes in substitution requests occur most often at 
month-end and quarter-end.
    \4\ Update 98-3 of the TBMA's Repo Trading Practices Guidelines 
(August 1996) (hereinafter ``TBMA's Guidelines'') states:
    Unless the parties to a trade otherwise agree, in all trades 
executed through brokers, dealers should notify the brokers of any 
substitution of collateral no later than 9:55 a.m. (New York Time). 
In turn the broker should notify the counterparty dealer of the 
substitution by 10:00 a.m. (New York time). Substitution 
notifications received after the relevant deadline will be 
accommodated on a ``best efforts'' basis. Additionally, dealers 
should provide brokers with the description of the substituted 
collateral by 11:00 a.m. (New York time). (Emphasis in original.)
    \5\ GSCC's Rule 12 provides that the costs or expenses incurred 
by GSCC in obtaining financing under such circumstances are 
generally allocated pro rata among all netting members based upon 
usage of GSCC's services. Rule 12 also provide that if the GSCC 
Board determines that a netting member has on a frequent basis and 
without good cause caused GSCC to incur financing costs, the member 
can become obligated to pay for or reimburse GSCC for the entire 
amount of the financing costs.
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    GSCC has requested a number of times over the past two years that 
industry participants voluntarily comply with TBMA deadlines for

[[Page 2467]]

submitting the requisite notifications for repo collateral substitution 
requests and that GSCC receive the notifications by or shortly after 
the 11:00 a.m. TBMA deadline by which the broker should have all 
requisite substitution information. There has not been sufficient 
compliance with these requests. Therefore, GSCC believes it is 
necessary to amend its rules to impose deadlines for the submission of 
the requisite notifications to GSCC.
    Under the proposed rule change, GSCC will amend Rule 18 (``Special 
Provisions for Repo Transaction''), its Schedule of Timeframes, and its 
Fee Schedule to initially impose: (i) a deadline of noon (12 p.m.) 
after which the dealer member that initiated the substitution will be 
subject to a late fee of $500 per substitution notification and (ii) an 
absolute deadline of 12:30 p.m. after which GSCC will reject the 
substitution notification.\6\ GSCC will extend these submission 
deadlines by one hour on those days that the TBMA announces in advance 
will be extraordinary volume days. All required information must be 
included in the notification in order for it to be deemed to be 
received by the imposed deadlines. Finally, substitution notifications 
or amendments thereto will no longer be accepted verbally but instead 
will only be accepted through the use of GSCC's designated messaging 
utility that is available to all repo netting participants.
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    \6\ The 12:00 p.m. deadline is one hour after which the broker 
should have received all of the requisite substitution information 
under TBMA guidelines. In the future, GSCC may change these 
deadlines depending on market practice. GSCC will notify its members 
of any changes in these timeframes in advance by an important 
notice.
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2. Improper Use of Delivery Identification Codes
    The other inappropriate practice in which members have been 
engaging with respect to the repo collateral substitution process 
involves the manner in which some members have been identifying the 
securities being delovered to GSCC. There are two codes that can be 
used to identify a securities delivery over the Fedwire: (i) A delivery 
code and (ii) a reversal code. The delivery code indicates to the 
receiver of the securities that the securities are being delivered to 
satisfy a ``pending receive'' obligation. The reversal code indicates 
that a delivery of securities has been rejected and is being sent back 
to the initiating party. (The industry terminology for this situations 
a ``DK,'' that is the receiver of the securities ``does not know'' 
transaction.)
    There have been occasions where GSCC has received a securities 
delivery in relation to a repo collateral substitution before receiving 
the requisite substitution notification because members have been 
submitting the notifications to GSCC late in the day. Without the 
requisite notification, GSCC ``does not know'' the transaction for 
which the securities are being delivered and thus is forced to DK the 
securities. These securities eventually are redelivered to GSCC. 
However, many members have been redelivering the securities to GSCC 
using a reversal code instead of a delivery code.\7\
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    \7\ These members are, in effect, ``DK-ing'' a GSCC ``DK.''
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    When GSCC receives a repo collateral substitution notification, it 
establishes a ``pending receive'' instruction on the clearing bank's 
system. The only automated way in which that ``pending receive'' may be 
satisfied is by securities identified by a delivery code. If the 
securities are sent using a reversal code, they will not automatically 
match the obligation that they are supposed to satisfy. A securities 
delivery identified by a reversal code appears from GSCC's point of 
view to be a DK of an original delivery (sent by GSCC) causing GSCC 
staff to have to research the reason for the DK. In instances where 
this process occurs near the close of the securities Fedwire, GSCC may 
be required to obtain overnight financing, the cost of which is usually 
borne by all members.
    The proposed rules change revises Rule 12 (``Securities 
Settlement'') to make clear that the use of the reversal codes in the 
situation described above is improper and that members may not use a 
reversal code for a securities delivery obligation to GSCC unless the 
member has obtained GSCC's prior consent. Moreover, the proposed rule 
changes provide that, if GSCC is required to obtain overnight financing 
with respect to securities delivered in violation of this new rule, the 
entire amount of the financing cost will be borne by the offender. It 
should be noted that a member may continue to use a reversal code under 
circumstances where it wishes to indicate to GSCC (with GSCC as the 
initiating party of a securities delivery to the member) that it ``does 
not know'' the transaction. For example, if GSCC sends a securities 
delivery to a member in error, it is appropriate for the member to DK 
such delivery.
3. Prohibition of Substitutions Outside of GSCC
    For risk management reasons, it is important to require that repo 
collateral substitutions with respect to repos that are in GSCC's net 
be made through GSCC. GSCC marks-to-market and establishes settlement 
obligations based on the transaction information underlying a repo 
transaction as it knows it. If a repo substitution occurs outside of 
GSCC, these calculations, which are vital for risk management purposes, 
will be incorrect. Therefore, GSCC proposes to change Rule 18 to add a 
requirement that all collateral substitutions with regard to repos that 
are on GSCC's books pending settlement must be made through GSCC.
4. Definition of a ``Repo Broker''
    In order to accommodate proposed changes to Section 4 of Rule 18, 
which will permit a repo broker to submit a repo collateral 
substitution, GSCC is proposing to add the definition of repo broker to 
its definitions under Rule 1. A repo broker will be defined as an 
inter-dealer broker or a division or other separate operating unit 
within a dealer netting member that operates in the same manner as a 
broker and that participates in GSCC's repo netting service pursuant to 
the same requirements imposed under Rule 15 governing special 
provisions for certain netting members and Rule 19 governing special 
provisions for brokered repo transactions.
    GSCC believes that the proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to GSCC and in particular with section 17A(b)(3)(F) of the 
Act because it will prohibit practices that are potentially harmful to 
GSCC's risk management process and operational infrastructure, and will 
result in undue financing costs for members.

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. 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)

[[Page 2468]]

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 organization 
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 thereof 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 Section, 450 Fifth Street, NW., 
Washington, DC 20549. Copies of such filing also will be available for 
inspection and copying at GSCC's principle office. All submissions 
should refer to File No. SR-GSCC-00-10 and should be submitted by 
February 1, 2001.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-898 Filed 1-10-01; 8:45 am]
BILLING CODE 8010-01-M