[Federal Register Volume 66, Number 15 (Tuesday, January 23, 2001)]
[Notices]
[Pages 7522-7525]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-1907]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43849; File No. SR-GSCC-00-13]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Notice of Filing of Proposed Rule Change Relating to 
Establishment of a Cross-Margining Agreement With the Chicago 
Mercantile Exchange and a Clarification of the Government Securities 
Clearing Corporation's Cross-Margining Rules

January 17, 2001.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on October 13, 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 
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

    GSCC is seeking to establish a cross-margining arrangement with the

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Chicago Mercantile Exchange (``CME'').\2\ In addition, GSCC is 
proposing to revise GSCC Rule 22, Section 4, to clarify that GSCC will 
fulfill its obligations under any cross-margining agreement before 
crediting an insolvent member for any profit realized on the 
liquidation of the member's final net settlement positions.
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    \2\ CME is a Delaware corporation whose clearing division acts 
as the clearing organization for certain futures and options on 
futures contracts that are traded on the CME. The Commodity Futures 
Trading Commission (``CFTC''), pursuant to the Commodity Exchange 
Act, as amended (``CEA''), has designated the CME as a contract 
market for such contracts.
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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.\3\
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    \3\ 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

    On August 19, 1999, the Commission approved GSCC's proposed rule 
change to establish a cross-margining program with other clearing 
organizations and to begin its program with the New York Clearing 
Corporation (``NYCC'').\4\ GSCC is now seeking to establish a cross-
margining arrangement with the CME similar to the one GSCC already has 
in place with NYCC. The proposal will implement GSCC's ``hub-and-
spoke'' method of cross-margining, which was introduced in the rule 
filing establishing the GSCC-NYCC cross-margining arrangement and which 
applies when more than one clearing organization is involved in cross-
margining with GSCC.
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    \4\ Securities Exchange Act Release No. 41766 (August 19, 1999), 
64 FR 46737 (August 26, 1999) [File No. SR-GSCC-98-04]. The 
requisite rule changes necessary for GSCC to engage in cross-
margining were made in the NYCC cross-margining rule filing. GSCC is 
proposing one additional rule change in this rule filing in order to 
further clarify that GSCC will fulfill its obligations under any 
cross-margining agreement before crediting an insolvent member for 
any profit realized on the liquidation of the member's final net 
settlement positions.
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(i) GSCC's Cross-Margining Program
    GSCC believes that the most efficient and appropriate approach for 
establishing cross-margining links for fixed-income and other interest 
rate products is to do so on a multilateral basis with GSCC as the 
``hub.'' Each clearing organization that participates in a cross-
margining arrangement with GSCC (hereinafter a ``Participating CO'') 
will enter into a separate cross-margining agreement between itself and 
GSCC, as in the case of NYCC and now CME. Each of the agreements will 
have similar terms,\5\ and no preference will be given by GSCC to one 
Participating CO over another.
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    \5\ It is anticipated that in the interest of conformity NYCC 
and GSCC will execute a new cross-margining agreement that is 
substantially the same as the draft agreement with the CME. the 
draft agreement is attached as Exhibit B to GSCC's rule filing.
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    Cross-margining is available to any GSCC netting member (with the 
exception of inter-dealer broker netting members) that is, or that has 
an affiliate that is, a member of a Participating CO. 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 repo positions at GSCC and offsetting and 
correlated positions in related contracts carried at the Participating 
CO. Cross-margining is intended to lower the cross-margining 
participant's (or pair of affiliated members') overall margin 
requirement. The GSCC member (and its affiliate, if applicable) signs 
an agreement under which it (or they) agrees to be bound by the cross-
margining agreement between GSCC and the Participating CO and which 
allows GSCC or the Participating CO to apply the member's (or its 
affiliate's) margin collateral to satisfy any obligation of GSCC to the 
Participating CO (or vice versa) that results from a default of the 
member (or its affiliate).
    Margining based on the net combined risk of correlated positions is 
based on an arrangement under which GSCC and each Participating CO 
agree to accept the correlated positions in lieu of supporting 
collateral. Under this arrangement, each clearing organization holds 
and manages its own positions and collateral and independently 
determines the amount of margin that it will make available for cross-
margining (referred to as the ``residual margin amount'').
    GSCC computes the amount by which the cross-margining participant's 
margin requirement can be reduced at each clearing organization (i.e., 
the ``cross margin reduction'') by comparing the participant's 
positions and the related margin requirements at GSCC against those at 
each Participating CO.\6\ GSCC offsets each cross-margining 
participant's residual margin amount (based on related positions) at 
GSCC against the offsetting residual margin amounts of the participant 
(or its affiliate) at each Participating CO. If the residual margin 
that GSCC has available for a participant is greater than the combined 
residual margin submitted by the Participating COs, GSCC will allocate 
a portion of its residual margin equal to the combined residual margin 
at the Participating COs. If the combined residual margin submitted by 
the Participating COs is greater than the residual margin that GSCC has 
available for that participant, GSCC will first allocate its residual 
margin to the Participating CO with the most highly correlated 
position.\71\ if the positions are equally correlated, GSCC will 
allocate pro rata based upon the residual margin amount available at 
each Participating CO. GSCC and each Participating CO 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) positions at the Participating CO.\8\ In the event of 
the default and liquidation of a cross-margining participant, the loss 
sharing between GSCC and each of the Participating COs will be based 
upon the foregoing allocations and the cross-margin reduction.
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    \6\ NYCC uses GSCC's margin rates to determine margin reduction. 
CME, which utilizes its own rates, and GSCC compare margin reduction 
rates and use the lower of the two in determining margin reduction.
    \7\ GSCC has computed and tested disallowance factors that will 
be applicable to each potential pair of positions being offset.
    \8\ GSCC and each Participating CO unilaterally have the right 
to not reduce a participant's's margin requirement by the cross-
margin reduction or to reduce it by less than the cross-margin 
reduction. However, the clearing organizations may not reduce a 
participant's margin requirement by more than the cross-margin 
reduction.
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    GSCC will guarantee the cross-margining participant's (or its 
affiliate's) performance to each Participating CO up to a specified 
maximum amount which relates back to the cross-margin reduction. Each 
Participating CO will provide the same guaranty up to the same 
specified maximum amount to GSCC. The guaranty represents a contractual 
commitment that each clearing organization has to the other. There will 
always be a cap on the amount that one clearing organization is 
required to pay another clearing organization.

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(ii) Information Specific to the Current Agreement between GSCC and CME
    (a) Participation in the cross-margining program: Any netting 
member of GSCC other than an inter-dealer broker will be eligible to 
participate. Any clearing member of CME will be eligible to 
participate.\9\
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    \9\ The draft GSCC-CME agreement requires ownership of 50 
percent or more of the common stock of an entity to indicate control 
of the entity for purposes of the definition of ``affiliate.''
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    (b) Products subject to cross-margining: The products that will be 
eligible for the GSCC-CME cross-margining arrangement are the Treasury 
securities that fall into GSCC's Offset Classes A through G as defined 
in GSCC's Rules that are cleared by GSCC and Eurodollar futures 
contracts with ranges in maturity from 3 months to 10 years and options 
on such futures contracts cleared by CME.\10\ GSCC offset classes will 
be offset against CME offset classes based on correlation studies, and 
the appropriate disallowance factors will be applied. All eligible 
positions maintained by a cross-margining participant in its account at 
GSCC and in its (or its affiliate's) proprietary account at CME will be 
eligible for cross-margining.\11\
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    \10\ The NYCC products eligible for cross-margining under the 
GSCC-NYCC cross-margining arrangement are Treasury futures.
    \11\ At least initially, the GSCC-CME 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 the CME. The arrangement will not apply to positions 
in a customer account at CME that would be subject to segregation 
requirements under the CEA. This is also the case with respect to 
the arrangement with NYCC.
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    (c) Margin Rates: GSCC and CME currently use different margin rates 
to establish margin requirements for their respective products. Margin 
reductions in the GSCC-CME cross-margining arrangement will always be 
computed based on the lower of the applicable margin rates. This 
methodology results in a potentially lesser benefit to the participant 
but ensures a more conservative result (i.e., more collateral held at 
the clearing organization) for both GSCC and CME.
    (d) Daily Procedures: On each business day, it is expected that the 
CME will inform GSCC of the residual amounts it is making available for 
cross-margining by approximately 10 p.m. New York time. GSCC will 
inform CME by approximately 12 a.m. New York time how much of these 
residual margin amounts it will use. Reductions as computed will be 
reflected in the daily clearing fund calculation.
(iii) Benefits of Cross-Margining
    GSCC believes that its cross-margining program enhances the safety 
and soundness of the settlement process for the Government securities 
marketplace by: (1) Providing clearing organizations with more data 
concerning members intermarket positions (which is especially valuable 
during stressed market conditions) to enable them to make more accurate 
decisions regarding the true risk of such positions to the clearing 
organizations; (2) allowing for enhanced sharing of collateral 
resources; and (3) encouraging coordinated liquidation processes for a 
joint participant, or a participant and its affiliate, in the event of 
an insolvency. GSCC further believes that cross-margining benefits 
participating clearing members by providing members with the 
opportunity to more efficiently use their collateral. More important 
from a regulatory perspective, however, is that cross-margining 
programs have long been recognized as enhancing the safety and 
soundness of the clearing system itself. Studies of the October, 1987 
market crash gave support to the concept of cross-margining. For 
example, The Report of the President's Task Force on Market Mechanisms 
(January 1988) noted that the absence of a cross-margining system for 
futures and securities options markets contributed to payment strains 
in October 1987. The Interim Report of the President's Working Group on 
Financial Markets (May 1988) also recommended that the SEC and CFTC 
facilitate cross-margining programs among clearing organizations. As a 
result, the first cross-margining arrangement between clearing 
organizations was implemented in 1988.\12\
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    \12\ Securities Exchange Act Release No. 26153 (October 3, 
1988), 53 FR 39567 (October 7, 1988) [File No. SR-OCC-86-17].
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    GSCC believes that the proposed rule change is consistent with the 
requirements of section 17A of the Act\13\ and the rules and 
regulations thereunder applicable to GSCC because it will provide 
members with significant benefits, such as greater liquidity and more 
efficient use of collateral in a prudent manner and will enhance GSCC's 
overall risk management process.
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    \13\ 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 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 the principal office of GSCC.
    All submissions should refer to File No. SR-GSCC-00-13 and should 
be submitted by February 13, 2001.


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    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 01-1907 Filed 1-22-01; 8:45 am]
BILLING CODE 8010-01-M