[Federal Register Volume 67, Number 35 (Thursday, February 21, 2002)]
[Notices]
[Pages 8048-8050]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-4170]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45438; File No. SR-GSCC-2002-01]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Notice of Filing of Proposed Rule Change to Establish a 
Cross-Margining Program With BrokerTec Clearing Company, L.L.C.

February 13, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on January 18, 2002, 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 program with 
BrokerTec Clearing Company, L.L.C. (``BCC'').

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 sections (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

    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''). The GSCC-NYCC cross-margining program was 
implemented on February 25, 2000.\3\ GSCC subsequently submitted a rule 
filing to the Commission to establish a similar cross-margining program 
with the Chicago Mercantile Exchange (``CME''). That program was 
approved on May 11, 2001.\4\ On January 25, 2002, the Commission 
approved a cross-margining program between GSCC and the Board of Trade 
Clearing Corporation (``BOTCC'').\5\ GSCC is now seeking to establish a 
similar cross-margining program with BCC.
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    \3\ 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.
    \4\ 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.
    \5\ Securities Exchange Act Release No. 45335 (January 25, 
2002), 67 FR 4768 (January 31, 2001) [File No. SR-GSCC-2001-03].
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    BCC is the affiliated clearing organization for futures 
transactions

[[Page 8049]]

executed on BrokerTec Futures Exchange, L.L.C. (``BTEX''). On June 18, 
2001, the Commodities Futures Trading Commission approved the 
application of BTEX for contract market designation and approved 
registration of BCC as a derivatives clearing organization. BCC 
currently clears futures contracts on U.S. Treasury securities traded 
on BTEX.\6\ It is expected that, in the future, BTEX intends to offer 
trading in other U.S. fixed-income futures contracts and options on 
futures contracts traded on BTEX. BCC will provide clearing services 
for these products.
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    \6\ Currently, BTEX offers trading in futures contracts on the 
5-year Note, 10-year Note, and 30-year Bond.
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A. 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 program with GSCC (``Participating CO'') enters into a 
separate cross-margining agreement between itself and GSCC, as in the 
case of NYCC, CME, BOTCC, and now proposed for BCC. Each of the 
agreements do and will continue to have similar terms, and no 
preference will be given by GSCC to one Participating CO over another. 
Under GSCC's arrangement, cross-margining occurs between GSCC and each 
Participating CO and not between Participating COs.
    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 its offsetting and 
correlated positions in certain futures contracts carried at the 
Participating CO. Cross-margining is intended to lower the cross-
margining member's (or pair of affiliated members'') overall margin 
requirement, as inter-market hedges are taken into consideration in the 
margining process. The GSCC member (and its affiliate, if applicable) 
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 the Participating CO to GSCC that results from a 
default of the member (or its affiliate).
    Margining based on the combined net risk of correlated positions is 
based on an arrangement under which GSCC and each Participating CO 
agree to accept the offsetting 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 collect from 
its member and that it will make available for cross-margining. This 
available margin is referred to as the ``residual margin amount.'' \7\
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    \7\ 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.
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    GSCC computes the amount by which the cross-margining member's 
margin requirement can be reduced at each clearing organization by 
comparing the member's positions and the related margin requirements at 
GSCC against those submitted to GSCC by each Participating CO. This 
reduction amount is referred to as the ``cross margin reduction.'' GSCC 
offsets each cross-margining member's residual margin amount (based on 
related positions) at GSCC against the offsetting residual margin 
amounts of the member (or its affiliate) at each Participating CO. 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 member, 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 
submitted by 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 member's positions at GSCC and its 
(or its affiliate's) positions at the Participating CO(s).\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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    \8\ GSCC and each Participating CO unilaterally have the right 
not to reduce a member'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 member'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 BCC
    1. Participation in the cross-margining program: Any netting member 
of GSCC other than an inter-dealer broker will be eligible to 
participate.\9\ Any clearing member of BCC will be eligible to 
participate.\10\
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    \9\ 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.
    \10\ The GSCC-BCC cross-margining agreement requires ownership 
of 50 percent or more of the common stock of an entity to be deemed 
``control'' of that entity for purposes of the definition of 
``affiliate.''
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    2. Products subject to cross-margining: The products that will be 
eligible for the GSCC-BCC cross-margining program are the Treasury and 
non-mortgage-backed Agency securities of certain remaining maturities 
that fall into GSCC's Offset Classes A through G and a through g as 
defined in the cross-margining agreement that are cleared by GSCC and 
the 2-year Note, 5-year Note, 10-year Note, and the 30-year Bond 
futures contracts cleared by BCC.\11\ In addition, it is anticipated 
that the GSCC products specified above will be cross-margined with the 
5-year and 10-year Agency futures and options on futures when these 
products are traded on the BTEX and cleared by BCC.\12\ All eligible 
positions maintained by a cross-margining member in its account at GSCC 
and in its (or its affiliate's) proprietary account at BCC will be

[[Page 8050]]

eligible for cross-margining.\13\ An appropriate disallowance factor 
\14\ based on correlation studies and a minimum margin factor \15\ will 
be applied.\16\
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    \11\ GCF Repo products will not be included in the program.
    \12\ GSCC will notify the Commission when additional securities 
are added to the cross-margining program.
    \13\ The GSCC-BCC cross-margining program will be applicable, on 
the futures side, only to positions in a proprietary account of a 
cross-margining member (or its affiliate) at BCC. Positions in a 
customer account at BCC that would be subject to segregation 
requirements under the Commodity Exchange Act will not be included 
in the program. This is also the case with respect to the 
arrangements with NYCC, CME, and BOTCC.
    \14\ The disallowance factor is the haircut reflective of the 
correlation analysis done by GSCC for each offset class.
    \15\ 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-BCC cross-margining 
program will employ a 25% minimum margin factor. Should GSCC decide 
to change the minimum margin factor, it will submit a proposed rule 
filing under Section 19(b) of the Act.
    \16\ GSCC will review the cross-margining parameters on a yearly 
basis unless market events dictate the need for more frequent 
reviews.
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    3. Margin Rates: Margin reductions in the GSCC-BCC cross-margining 
program will always be computed based on the lower of GSCC's and BCC's 
margin rates. This methodology results in potentially less benefits to 
the members 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 BCC 
will inform GSCC of the residual margin amounts it is making available 
for cross-margining by approximately 10:30 p.m. New York time. GSCC 
will inform BCC by approximately 12:30 a.m. New York time of how much 
of these residual margin amounts it will use (i.e., the cross-margining 
reduction). The actual reductions which may be no greater than the 
cross-margining reduction, will be reflected in the daily clearing fund 
calculation.
C. 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 member, or a member 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 CFTC 
facilitate cross-margining programs among clearing organizations. This 
resulted in the first cross-margining arrangement between clearing 
organizations which was approved in 1988.\17\
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    \17\ 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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    GSCC believes that the proposed rule change is consistent with the 
requirements of Section 17A of the Act \18\ 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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    \18\ 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 any 
impact or impose any 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) 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-2002-01 and should 
be submitted by March 8, 2002.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-4170 Filed 2-20-02; 8:45 am]
BILLING CODE 8010-01-P