[Federal Register Volume 66, Number 133 (Wednesday, July 11, 2001)]
[Notices]
[Pages 36352-36353]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-17268]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44495; File No. SR-GSCC-00-02]


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

June 29, 2001.
    On April 17, 2000, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-GSCC-00-02) 
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 January 9, 2001.\2\ No comment letters were received. For 
the reasons discussed below, the Commission is approving the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 43791 (January 2, 2001), 
66 FR 1709.
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I. Description

    A GSCC's 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 with the sum of the three being a member's 
overall requirement. The three components are (1) the funds adjustment 
(FAD) component,\3\ (2) the repo volatility component,\4\ and (3) the 
receive/deliver settlement component.\5\ GSCC computes four receive/
deliver settlement amounts each day. The four results are compared 
daily, and the largest amount is used in determining a member's 
clearing fund requirement. The four receive/deliver settlement 
computations are as follows: (1) Post-offset margin amount (POMA); \6\ 
(2) average POMA; \7\ (3) adjusted

[[Page 36353]]

POMA; \8\ and (4) liquidation amount. The liquidation computation, 
which is the subject of this rule filing, 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 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.
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    \3\ The funds adjustment 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.
    \4\ The repo volatility 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 market 
rates might change over the remaining course of the repo.
    \5\ The receive/deliver settlement 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. By multiplying security settlement values by their 
corresponding margin factors, GSCC estimates 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 similarity in time remaining 
to maturity.
    \6\ The POMA 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.
    \7\ The average POMA computation is based on the member's twenty 
highest POMA amounts occurring in the most recent 75 business days.
    \8\ The adjusted POMA 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.
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    The proposed rule change lowers 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 this more 
appropriately balances the level of margin it collects against the 
liquidity needs of its members.
    GSCC believes that 25 percent was overly conservative for several 
reasons. First, GSCC's experience has demonstrated that its POMA and 
average POMA calculations provide adequate protection against potential 
settlement risks. 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. Also, 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 methodologies for identifying and computings its risks 
provide it with a high level of protection on an 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 
itself and in turn its clearing corporation from the risk of its 
failure. However, GSCC believes that the current 25 percent requirement 
effectively disregards the protection afforded to GSCC by a member that 
engages in trading activity on a fully hedged basis.

II. Discussion

    Section 17A(b)(3)(F)\9\ of the Act requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds that are in its custody or control or for which it is 
responsible. Because the Commission believes that even with the 
liquidation component of the clearing fund formula reduced from 25 
percent to 10 percent, GSCC's clearing fund formula will give GSCC 
sufficient resources to protect it in a situation where a member is 
insolvent and fails to settle with GSCC. As such, the Commission 
believes GSCC's proposal is consistent with its obligation to assure 
the safeguarding of securities and funds that are in its custody or 
control or for which it is responsible.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F).
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III. 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(b)(3)(F) 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-00-02) be and hereby is 
approved.

    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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-17268 Filed 7-10-01; 8:45 am]
BILLING CODE 8010-01-M