[Federal Register Volume 67, Number 21 (Thursday, January 31, 2002)]
[Notices]
[Pages 4768-4770]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-2371]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45335; File No. SR-GSCC-2001-03]


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

January 25, 2002.

I. Introduction

    On April 4, 2001, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-GSCC-2001-03 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 
September 11, 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. 44766 (September 5, 
2001), 66 FR 47251.
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II. Description \3\

    On August 19, 1999, the Commission approved GSCC's proposed rule 
filing to establish a cross-margining program with other clearing 
organizations and to begin its program with the New York Clearing 
Corporation (``NYCC'').\4\ More recently, the Commission approved 
GSCC's proposed rule filing to establish a similar cross-margining 
program with the Chicago Mercantile Exchange (``CME'').\5\ GSCC is now 
establishing a similar cross-margining arrangement with the Board of 
Trade Clearing Corporation.\6\
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    \3\ The description of GSCC's cross-margining program is drawn 
largely from representations made by GSCC.
    \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 programs with other clearing organizations were made in 
the NYCC cross-margining rule filing.
    \5\ Securities Exchange Act Release No. 44301 (May 11, 2001), 66 
FR 28207 (May 22, 2001) [File No. SR-GSCC-00-13]. In addition to 
approving GSCC's cross-margining program with the CME, the order 
granted approval to change GSCC Rule 22, Section 4, to clarify that 
before GSCC credits an insolvent member for any profit realized on 
the liquidation of the member's final net settlement positions, GSCC 
will fulfill its obligations with respect to that member under 
cross-margining agreements.
    \6\ BOTCC is a Delaware corporation that acts as the clearing 
organization for certain futures contracts and options on futures 
contracts that are traded on the Chicago Board of Trade and that are 
regulated by the Commodity Futures Trading Commission.
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    This development is significant because the Chicago Board of Trade, 
for which BOTCC clears, is by far the largest Treasury futures exchange 
market, and certain of its products, such as the 10-Year Note futures 
contract, which will be cross-margined with GSCC products, continue to 
experience growth in volume. Thus, establishing the cross-margining 
program between GSCC and BOTCC has the potential to provide significant 
collateral savings to the industry in general and to GSCC's and BOTCC's 
common members in particular. From each clearing organization's 
perspective, the cross-margining program will provide important risk 
management benefits. These benefits include such things as providing 
the clearing organizations with more information concerning members' 
intermarket positions to enable the clearing organizations to make more 
accurate decisions regarding the true risk of the positions to the 
clearing organizations and encouraging coordinated liquidation 
processes for a joint participant, or a participant and its affiliate, 
in the event of an insolvency.\7\
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    \7\ The GSCC-BOTCC cross-margining 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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A. GSCC's Cross-Margining Program

    GSCC believes that the most efficient and appropriate approach for 
establishing cross-margining programs 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 program with GSCC, such as NYCC, CME, and now BOTCC, 
(hereinafter ``Participating CO'') enters into a separate cross-
margining agreement between itself and GSCC. Each of the agreements 
will have similar terms and no preference will be given by GSCC to one 
Participating CO over another.
    Cross-margining is available to any GSCC netting member (with the 
exception of inter-dealer broker netting

[[Page 4769]]

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 of its 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) will sign an agreement under which it (or 
they) agree 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 by 
comparing the participant's positions and the related margin 
requirements at GSCC as against those at each Participating CO. GSCC 
offsets each cross-margining participant's residual margin amount at 
GSCC against the offsetting residual margin amounts of the participant 
(or its affiliate) at each Participating CO.\8\ If, within a given pair 
of offset classes, the margin that GSCC has available for a participant 
is greater than the combined margin submitted by the Participating COs, 
GSCC will allocate a portion of its margin equal to the combined margin 
at the Participating COs. If, within a given pair of offset classes, 
the combined margin submitted by the Participating COs is greater than 
the margin that GSCC has available for that participant, GSCC will 
first allocate its margin to the Participating CO with the most highly 
correlated position. If, within a given pair of offset classes, 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.\9\ 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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    \8\ The residual margin amount is the long margin amount or the 
short margin amount in each offset class that is available for 
cross-margining after all internal offsets are conducted within and 
between offset classes at a particular clearing organization.
    \9\ GSCC and each Participating CO unilaterally have the right 
not to reduce a participant'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 based on the loss sharing formula contained in the 
Cross-Margining Agreement. Each Participating CO will provide the same 
guaranty to GSCC. The amount of the guarantee is the lowest of: (1) The 
cross-margin loss of the worse off party; (2) the higher of the cross-
margin reduction or the cross-margin gain of the better off party; (3) 
the amount required to equalize the parties' cross-margin results; or 
(4) the amount by which the cross-margining reduction exceeds the 
better off party's cross-margin loss if both parties have cross-margin 
losses.

B. Information Specific to the Current Agreement Between GSCC and BOTCC

    1. Participation in the cross-margining program: Any netting member 
of GSCC other than an inter-dealer broker will be eligible to 
participate.\10\ Any clearing member of BOTCC will be eligible to 
participate.
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    \10\ Because inter-dealer brokers should not and generally do 
not have positions at GSCC at the end of the day, they should have 
no margin requirement to be reduced.
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    2. Products subject to cross-margining: The products that will be 
eligible for the GSCC-BOTCC cross-margining arrangement are the 
Treasury securities with certain remaining maturities that fall into 
GSCC's Offset Classes C, E, F, and G as defined in GSCC's Rules that 
are cleared by GSCC and the 2-Year Note, 5-Year Note, 10-Year Note, and 
U.S. Treasury Bond futures contracts and options on these futures 
contracts that are cleared by BOTCC.\11\ All eligible positions 
maintained by a cross-margining participant in its account at GSCC and 
in its (or its affiliate's) proprietary account at BOTCC will be 
eligible for cross-margining.\12\ Initially, as a conservative measure, 
residual margin amounts will be applied only within the same offset 
class (e.g., the 2-Year Note against the 2-Year Note future). An 
appropriate disallowance factor\13\ based on correlation studies and a 
minimum margin factor\14\ will be applied.\15\
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    \11\ Non-mortgage backed agency securities will be added at a 
later date. GCF Repo products will not be included in the 
arrangement. GSCC will notify the Commission when additional 
securities and futures are added to the cross-margining program.
    \12\ The GSCC-BOTCC cross-margining arrangement will be 
applicable on the futures side only to positions in a proprietary 
account of a cross-margining participant at BOTCC. The arrangement 
will not apply to positions in a customer account at BOTCC that 
would be subject to segregation requirements under the Commodity 
Exchange Act. This is also the case with respect to the arrangements 
with NYCC and the CME.
    \13\ The disallowance factor is the haircut reflective of the 
correlation analysis done by GSCC for each offset class.
    \14\ The minimum margin factor is the contractually agreed upon 
cap on the amount of the margin reduction that the clearing 
organizations will allow. (In some of the documents submitted by 
GSCC, the minimum margin factor is referred to as the minimum 
disallowance factor.) Initially, the GSCC-BOTCC cross-margining 
program will employ a 50% minimum margin factor. Should GSCC decide 
to change the minimum factor, it will submit a proposed rule filing 
under Section 19(b) of the Act.
    \15\ GSCC will review the cross-margining parameters on a yearly 
basis unless market events dictate the need for more frequent 
reviews. Letter from Jeffrey F. Ingber, Managing Director, General 
Counsel, and Secretary, GSCC (November 6, 2001).
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    3. Margin Rates: GSCC and BOTCC currently use different margin 
rates to establish margin requirements for their respective products. 
Margin reductions in the GSCC-BOTCC 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 the 
Participating COs.
    4. Daily Procedures: On each business day, it is expected that 
BOTCC will inform GSCC of the residual margin amounts it is making 
available for cross-margining by approximately 11 p.m. New York time. 
GSCC will inform BOTCC by approximately 1 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.

C. Benefits of Cross-Margining

    GSCC believes that its cross-margining program enhances the safety

[[Page 4770]]

and soundness of the settlement process for the Government securities 
marketplace by: (1) Providing clearing organizations with more 
information 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 break 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 the 
Commodity Futures Trading Commission facilitate cross-margining 
programs among clearing organizations. This resulted in the first 
cross-margining arrangement between clearing organizations which was 
approved in 1988.\16\
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    \16\ Securities Exchange Act Release No. 26153 (October 3, 
1988), 53 FR 39567 (October 7, 1988) [File No. SR-OCC-86-17] (order 
approving cross-margining program between OCC and The Intermarket 
Clearing Corporation).
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III. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. In section 17A(a)(2)(A)(ii) of the Act, Congress directs 
the Commission having due regard for, among other things, the public 
interest, the protection of investors, the safeguarding of securities 
and funds, to use its authority under the Act to facilitate the 
establishment of linked or coordinated facilities for clearance and 
settlement of transactions in securities, securities options, contracts 
of sale for future delivery and options thereon, and commodity 
options.\17\ Section 17A(b)(3)(F) of the Act requires that the rules of 
a clearing agency be designed to assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency 
for which it is responsible.\18\ The Commission finds that the approval 
of GSCC's proposed rule change is consistent with these Sections.
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    \17\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
    \18\ 15 U.S.C. 78q-1(b)(3)(F).
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    First, the Commission's approval of GSCC's proposed rule change to 
establish a cross-margining arrangement with BOTCC and to extend its 
hub and spoke approach to cross-margining to include BOTCC along with 
CME and NYCC is in line with the Congressional directive to the 
Commission to facilitate linked and coordinated facilities for the 
clearance and settlement of securities and futures.\19\ Second, 
approval of GSCC's proposal should result in increased and better 
information sharing between GSCC and Participating COs regarding the 
portfolios and financial conditions of participating joint and 
affiliated members. As a result, GSCC and participating COs will be in 
a better position to monitor and assess the potential risks of 
participating joint or affiliated members and will be in a better 
position to handle the potential losses presented by the insolvency of 
any joint or affiliated member. Therefore, GSCC's proposal should help 
GSCC better safeguard the securities and funds in its possession or 
control or for which it is responsible. While cross-margining should 
provide benefits and efficiencies to common participants in GSCC and 
BOTCC, GSCC has determined to adopt a conservative approach in 
introducing its cross-margining program with BOTCC. We believe that 
that is a prudent approach consistent with maintaining the safety and 
soundness of the national system for prompt and accurate clearance and 
settlement of transactions in securities.
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    \19\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular 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-2001-03) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-2371 Filed 1-30-02; 8:45 am]
BILLING CODE 8010-01-P