[Federal Register Volume 67, Number 63 (Tuesday, April 2, 2002)]
[Notices]
[Pages 15646-15649]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-7903]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45656; File No. SR-GSCC-2002-01]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Approving Proposed Rule Change Relating to 
Establishment of a Cross-Margining Program With BrokerTec Clearing 
Company, L.L.C.

March 27, 2002.

I. Introduction

    On January 18, 2002, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'')

[[Page 15647]]

proposed rule change SR-GSCC-2002-01 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 February 21, 2002.\2\ 
The Commission received two comment letters in response to the proposed 
rule change.\3\ 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. 45438 (February 13, 
2002), 67 FR 8048.
    \3\ Letters from Douglas E. Harris, General Counsel, BrokerTec 
Clearing Company, L.L.C. (``BCC'') (January 28, 2002) and Henry D. 
Mlynarski, President, BCC (March 4, 2002).
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II. Description \4\

    On August 19, 1999, the Commission approved GSCC's rule filing to 
establish a cross-margining program with other clearing organizations 
and to begin its program with the New York Clearing Corporation 
(``NYCC'').\5\ Subsequently, the Commission approved GSCC's rule filing 
to establish similar cross-margining programs with the Chicago 
Mercantile Exchange (``CME'') \6\ and with the Board of Trade Clearing 
Corporation (``BOTCC'').\7\ GSCC is now seeking to establish a similar 
cross-margining program with BCC.
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    \4\ The description of GSCC's cross-margining program is drawn 
largely from representations made by GSCC.
    \5\ 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.
    \6\ 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.
    \7\ 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 the BrokerTec 
Futures Exchange, L.L.C. (``BTEX''). On June 18, 2001, the Commodity 
Futures Trading Commission approved the application of BTEX for 
contract market designation and granted registration of BCC as a 
derivatives clearing organization. BCC clears the futures contracts on 
U.S. Treasury securities traded on BTEX.\8\
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    \8\ Currently, BTEX offers trading in futures contracts on the 
5-year Note, 10-year Note, and 30-year Bond. It is expected that, in 
the future, BTEX will 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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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 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.\9\ 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 intermarket 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).
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    \9\ 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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    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.'' \10\
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    \10\ 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).\11\ 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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    \11\ 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:

[[Page 15648]]

(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.\12\ Any clearing member of BCC will be eligible to 
participate.
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    \12\ 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-BCC cross-margining program are the Treasury and 
non-mortgage-backed Agency securities of certain remaining maturities 
that fall into GSCC's Offset Classes C, E, F, and G and e and f as 
defined in the cross-margining agreement that are cleared by GSCC and 
the 5-year Note, 10-year Note, and the 30-year Bond futures contracts 
cleared by BCC.\13\ 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.\14\ 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 eligible 
for cross-margining.\15\ An appropriate disallowance factor \16\ based 
on correlation studies and a minimum margin factor \17\ will be 
applied.\18\
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    \13\ GCF Repo products will not be included in the program.
    \14\ GSCC will notify the Commission when additional securities 
and futures are made eligible for the cross-margining program.
    \15\ 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.
    \16\ The disallowance factor is the haircut reflective of the 
correlation analysis done by GSCC for each offset class.
    \17\ 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.
    \18\ 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.\19\
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    \19\ 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. Comment Letters

    The Commission received two comment letters in response to the 
proposed rule change.\20\ Both letters from BCC were strongly in 
support of the proposed cross-margining program between GSCC and BCC. 
The January BCC comment letter stated that BCC has filed amendments to 
its rules and bylaws with the Commodity Futures Trading Commission to 
allow BCC to implement the cross-margining program with GSCC and that 
the program is similar in all major respects to GSCC's cross-margining 
programs with other U.S. futures clearing organizations that have been 
reviewed and approved by the Commission. Finally, the letter requested 
that the Commission act as quickly as possible on approval of the rule 
change.
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    \20\ Letters from Douglas E. Harris and Henry D. Mlynarski, 
supra note 3.
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    The second BCC comment letter, which reiterated the comments in the 
January BCC letter, urged the Commission to approve promptly the 
proposed rule change because it will improve collateral and risk 
management. The second letter also stated that the amendments to BCC's 
rules and bylaws to allow it to implement the cross-margining program 
became effective on January 30, 2002.

IV. 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

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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.\21\ 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.\22\ The Commission finds that the approval 
of GSCC's proposed rule change is consistent with these Sections.
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    \21\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
    \22\ 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 BCC and to extend its hub 
and spoke approach to cross-margining to include BCC along with BOTCC, 
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.\23\ 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.
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    \23\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
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V. 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-2002-01) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-7903 Filed 4-1-02; 8:45 am]
BILLING CODE 8010-01-P