[Federal Register Volume 67, Number 178 (Friday, September 13, 2002)]
[Notices]
[Pages 58090-58092]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-23356]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46472; File No. SR-GSCC-2001-10]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Granting Approval of a Proposed Rule Change 
Establishing a Loss Allocation Cap for Dealers Acting as Brokers on 
Substantially All of Their Repurchase Agreement Trades

September 6, 2002.

I. Introduction

    On August 16, 2001, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-GSCC-2001-10) 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ On August 31, 2001, GSCC amended the proposed rule 
change. Notice of the proposed rule change was published in the Federal 
Register on March 27, 2002.\2\ No comment letters were received. For 
the reasons discussed below, the

[[Page 58091]]

Commission is granting approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 45605 (March 20, 2002), 
67 FR 14753.
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II. Description

    GSCC is amending its current loss allocation rule concerning non-
inter-dealer broker (``dealer'') members who act as brokers in certain 
of their repurchase agreement (repo) transactions. Under the amended 
rule, repo transaction accounts of these dealers will be subject to the 
same $5 million per event absolute loss allocation cap currently 
applicable to inter-dealer brokers (``IDBs'') instead of an unlimited 
loss allocation liability. The rule change is designed to afford 
appropriate relief for these dealers while not unfairly burdening other 
members.

A. Loss Allocation Procedure Without Benefit of Current Rule Change

    If upon liquidating a defaulting member's positions GSCC incurs a 
loss due to the failure of the defaulting member to fulfill its 
obligations to GSCC, GSCC looks to the collateral deposited by that 
defaulting member to satisfy the loss. If the defaulting member's 
collateral is insufficient to cover the loss, the defaulting member's 
most ``recent'' trading partners will be looked to, on a pro rata 
basis, in order to satisfy the ``remaining loss.''
    Before the loss can be allocated to the defaulting member's most 
``recent'' trading partners, GSCC must first determine the proportion 
of the loss that arose in connection with member-brokered transactions 
and non-member brokered transactions and the proportion that arose in 
connection with direct transactions.
    To the extent the remaining loss is determined by GSCC to arise in 
connection with member brokered transactions, GSCC's rules provide that 
fifty percent of the loss will be allocated to netting members that are 
category 1 IDBs or category 2 IDBs pro rata based upon the dollar value 
of each such IDB netting member's trading activity with the defaulting 
member compared, netted, and novated on the day of default. The 
remaining fifty percent of the loss will be allocated to the dealer 
netting members pro rata based upon the dollar value of the trading 
activity through IDBs of each such dealer netting member's trading 
activity with the defaulting member compared, netted, and novated on 
the day of default. For purposes of an allocation of loss determined to 
arise in connection with member brokered transactions, an IDB netting 
member will not be subject to an allocation of loss for any single 
loss-allocation event in an amount greater than $5 million. A dealer 
netting member will not be subject to an allocation of loss for any 
single loss-allocation event in an amount greater than the lesser of $5 
million or five percent of the overall loss amount allocated to dealer 
netting members. To the extent that this cap is applicable, any excess 
amounts not collected from individual netting members, whether an IDB 
or a dealer, will be reallocated pro rata to the netting membership in 
general based on average daily clearing fund deposit requirement over 
the twelve-month period prior to the insolvency. However, even with the 
reallocation, an IDB netting member would not be subject to an 
aggregate loss allocation for any single loss allocation event in an 
amount greater than $5 million.
    To the extent a remaining loss is determined by GSCC to arise in 
connection with non-member brokered transactions, it is allocated among 
the recent category 2 IDB netting members that were parties to such 
non-member brokered transactions pro rata based upon the dollar value 
of each such category 2 IDB netting member's trading activity with the 
defaulting member compared, netted, and novated on the day of default. 
For purposes of an allocation of loss determined to arise in connection 
with non-member brokered transactions, there is no loss-allocation cap.
    To the extent a remaining loss is determined to arise in connection 
with direct transactions, it is allocated among the recent counterparty 
netting members pro rata based on the dollar value of the trading 
activity of each such netting member's trading activity with the 
defaulting member compared, netted, and novated during the recent 
trading period. For purposes of an allocation of loss determined to 
arise in connection with direct transactions, there is no loss-
allocation cap.
    Under the current loss allocation procedure, dealer netting members 
acting as brokers on all or substantially all of their repo 
transactions do not enjoy the $5 million per event absolute loss 
allocation cap applicable to IDBs. Consequently, these dealers are 
likely to be disproportionately assessed for allocation loss in the 
current environment.

B. Changes to Loss Allocation Procedure Under the Rule Change

    The rule change addresses the manner in which the loss allocation 
procedure described above will apply to dealers that act as brokers in 
their repo transactions. Specifically, the rule change establishes an 
account-based loss allocation process whereby the segregated repo 
accounts of these dealers are treated in the same way as IDB accounts.
    In order to accomplish this, GSCC added two new definitions to its 
rules, ``non-IDB repo broker'' and ``segregated repo account.'' A non-
IDB repo broker with respect to activity in its segregated repo account 
is a dealer netting member that GSCC has determined operates in the 
same manner as a broker and participates in GSCC's repo netting service 
pursuant to the same requirements imposed under GSCC's rules on IDB 
netting members that participate in that service. These requirements 
include keeping their brokered repo activity (with a GSCC netting 
member on each side of each trade) in a separate account called the 
segregated repo account.
    Since GSCC's loss allocation procedures with respect to remaining 
losses distinguish between brokered transactions and direct 
transactions and since it is with respect to non-IDB repo brokers' 
brokered transactions that GSCC is giving relief, the rule change 
amends: (i) The definition of ``brokered transaction'' to include 
transactions in which a non-IDB repo broker with regard to activity in 
its segregated repo account is a party; (ii) the loss allocation rule 
applicable to brokered transactions to include references to non-IDB 
repo brokers and the activity in their segregated repo accounts; and 
(iii) the loss allocation rule to provide non-IDB repo brokers with 
regard to activity in their segregated repo accounts with a cap on 
their total loss allocation obligation of $5 million as is currently 
applied to IDB netting members.
    All of the other activity processed by non-IDB repo brokers outside 
of their segregated repo broker accounts will continue to be subject to 
the loss allocation rules applicable to dealer netting members.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency not be designed to permit unfair discrimination among 
participants in the use of the clearing agency.\3\ The rule change 
provides that dealer participants of GSCC that act as brokers in their 
repo transactions will be subject to the same $5 million per event 
absolute loss allocation cap that is applicable to IDBs instead of to 
an unlimited loss allocation liability. The rule change should provide 
for a more equitable loss allocation process among GSCC's participants 
and, therefore, should remove any unfair discrimination in the

[[Page 58092]]

area of loss allocation among GSCC dealers and brokers where their 
securities businesses are similar. Therefore, the Commission finds that 
the rule change is consistent with Section 17A of the Act and the rules 
and regulations thereunder.
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    \3\ 15 U.S.C. 78q-1(b)(3)(F).
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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 with the requirements of Section 17A of the Act and the 
rules and regulations thereunder applicable.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-GSCC-2001-10) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\4\
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    \4\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-23356 Filed 9-12-02; 8:45 am]
BILLING CODE 8010-01-P