[Federal Register Volume 68, Number 113 (Thursday, June 12, 2003)]
[Notices]
[Pages 35244-35246]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-14831]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47998; File No. SR-GSCC-00-12]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Granting Approval of a Proposed Rule Change Relating 
to Insolvency and Clearing Fund Requirements

June 6, 2003.

I. Introduction

    On October 5, 2000, Government Securities Clearing Corporation 
(``GSCC'') \1\ filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change File No. SR-GSCC-00-12 pursuant 
to section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') 
\2\ and on December 14, 2000, amended the proposed rule change. Notice 
of the proposal was published in the Federal Register on June 17, 
2002.\3\ No comment letters were received. For the reasons discussed 
below, the Commission is approving the proposed rule change.
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    \1\ On January 1, 2003, MBS Clearing Corporation was merged into 
GSCC under New York law and GSCC was renamed the Fixed Income 
Clearing Corporation. Securities Exchange Act Release No. 47015 
(December 17, 2002), 67 FR 78531 (December 24, 2002) (File Nos. SR-
GSCC-2002-10 and MBSCC-2002-01).
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ Securities Exchange Act Release No. 46053 (June 10, 2002), 
67 FR 41285.
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II. Description

    On January 30, 1996, the Commission issued an order approving 
GSCC's

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proposed rule change permitting foreign entities to become members of 
GSCC's netting system.\4\ The rule change established application and 
continuing membership requirements for foreign entities, including the 
delivery to GSCC of an opinion of foreign counsel addressing the 
particular jurisdictional concerns raised by the admission of a foreign 
entity to netting system membership.\5\
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    \4\ Securities Exchange Act Release No. 36788 (January 10, 
1996), 61 FR 4500 (February 6, 1996) (File No. SR-GSCC-95-05).
    \5\ GSCC also requires each prospective foreign member to 
provide a legal opinion on insolvency discussing applicable U.S. 
Federal and State laws.
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    Having gained experience from reviewing the legal opinions 
regarding foreign law that were provided in connection with the 
applications of the foreign banks that GSCC has admitted to its netting 
system to date, GSCC has determined to clarify its insolvency rule, 
rule 22, in the manner described in subsection (i) below so that the 
insolvency rule more appropriately references the types of insolvency 
proceedings to which a foreign member might become subject. GSCC will 
also make conforming language changes to GSCC's rules dealing with 
applications for membership standards as they apply to foreign members.
    Some of the legal opinions referred to in the previous paragraph 
have indicated that GSCC would be exposed to ``legal risk'' as a result 
of the application of the particular jurisdiction's law to a foreign 
member's insolvency or bankruptcy. The legal risk can take the form of 
prohibiting or delaying GSCC from: Accessing some or all of the 
clearing fund deposit of the member; performing its netting, close-out, 
or liquidation of transactions; or setting off obligations as set forth 
in its clearing fund rule (rule 4), its ceasing to act rule (rule 21), 
or its insolvency rule (rule 22) or taking any other action 
contemplated by these rules. GSCC is amending its rules to better 
protect itself and its members from these types of legal risk in the 
circumstances where GSCC reasonably determines based upon factors such 
as outside legal advice or discussions with a relevant regulator that 
such legal risk exists. The proposed rule changes are described more 
fully in subsection (ii) below.
    GSCC's experience in connection with the admission of U.S. branches 
of foreign banks has also indicated that certain issues that are 
described in these opinions could affect GSCC's rights in the event of 
the insolvency or bankruptcy of a domestic member. GSCC believes, given 
the importance of its being able to exercise its rights as set forth in 
its clearing fund rule, its ceasing to act rule, and its insolvency 
rule that the proposed rule changes discussed below in subsection (ii) 
should also apply to domestic members that present GSCC with legal 
risk. GSCC would reasonably determine that such legal risk exists based 
upon factors such as outside legal advice or discussions with a 
relevant regulator.
    GSCC is also adding language to its clearing fund rule clarifying 
its right to rehypothecate the cash deposits of its clearing fund.

(i) Changes to Insolvency Rule

    GSCC's insolvency rule contains a section that lists the various 
types of events or proceedings that would permit GSCC to treat a member 
as insolvent. The rule was written utilizing terms common in United 
States insolvency or bankruptcy proceedings. GSCC is amending its 
insolvency rule to add language so that the rule more appropriately 
references the types of insolvency proceedings to which a foreign 
member might become subject.
    GSCC's foreign membership agreements have already been expanded to 
incorporate the insolvency triggering events that GSCC is now making 
part of its rules. The changes will bring the rules into conformity 
with the foreign membership agreements and specifically give GSCC the 
right pursuant to its rules to declare a foreign member to be insolvent 
under the requisite circumstances.\6\
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    \6\ In addition, the proposed rule change makes conforming 
language changes to GSCC's rule 2 (Members) and rule 3 (Financial 
Responsibility and Operational Capability Standards) as they apply 
to foreign members.
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(ii) Clearing Fund Requirements

    One of GSCC's most important risk management tools is its clearing 
fund, which is comprised of cash, certain netting-eligible securities, 
and eligible letters of credit. The purposes served by the clearing 
fund are: (1) To have on deposit from each netting member assets 
sufficient to satisfy any losses that may be incurred by GSCC as the 
result of the default by the member and the resultant close-out of that 
member's settlement positions; (2) to maintain a total asset amount 
sufficient to satisfy potential losses to GSCC and its members 
resulting from the failure of more than one member (and the failure of 
such members' counterparties to pay their pro rata allocation of loss); 
and (3) to ensure that GSCC has sufficient liquidity at all times to 
meet its payment and delivery obligations.
    A member's clearing fund deposit, to serve its intended purpose, 
should be immediately accessible by GSCC in the event of the member's 
bankruptcy or insolvency. However, the application of certain domestic 
or foreign laws could delay or prevent GSCC from accessing the portion 
of the member's clearing fund deposit that is in the form of cash and 
securities. The portion of the member's clearing fund deposit that is 
in the form of letters of credit (``LCs'') is generally not subject to 
the same risk because LCs are typically not considered to be part of 
the bankrupt/insolvent entity's estate.
    The rules with respect to the calculation of a member's clearing 
fund deposit do not currently address this legal risk. In order to 
better protect itself and its members, GSCC is amending its rules to 
require a domestic or foreign member that in management's reasonable 
view (which may be based upon factors such as outside legal advice or 
discussions with a relevant regulator) presents heightened legal risk 
to GSCC to deposit additional collateral over what would normally be 
required under GSCC's clearing fund rule and/or to post some additional 
portion of its clearing fund deposit requirement in the form of an 
LC.\7\
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    \7\ GSCC's clearing fund rule requires that LCs constitute no 
more than 70 percent of a member's clearing fund deposit. GSCC is 
amending its rule so that it may ask for a higher percentage in the 
form of an LC if circumstances warrant.
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(iii) Clarification of Rehypothecation Right With Respect to Cash 
Deposits

    GSCC's clearing fund rule contains a provision that permits GSCC to 
rehypothecate, transfer, or assign its clearing fund collateral in the 
event that GSCC needs to secure a loan or to satisfy an obligation 
incurred by it incident to its clearance and settlement business. GSCC 
is clarifying the provision with respect to the portions of the 
clearing funds that may be rehypothecated, transferred, or assigned by 
GSCC. The provision refers to the securities and the LCs that members 
pledge or deposit to the clearing fund as well as to the ``deposits or 
other instruments in which the cash deposits'' are invested. GSCC 
believes that this language could be read to not actually refer to the 
cash deposits themselves. Therefore, GSCC believes that it is prudent 
to specifically add a reference in the rule to ``cash deposits'' in 
order to eliminate any doubt as to GSCC's ability to use the cash 
portion of the clearing fund in the manner set forth in the clearing 
fund rule.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the

[[Page 35246]]

rules and regulations thereunder and particularly with the requirements 
of section 17A(b)(3)(F) of the Act, which requires that the rules of a 
clearing agency be designed to safeguard securities and funds in its 
custody or control or for which it is responsible.\8\ The Commission 
finds that by having the ability to require an additional clearing fund 
deposit or deposits in the form of letters of credit in circumstances 
as described above, the proposed rule change will help to ensure that 
GSCC has adequate clearing fund assets available to it in the event 
that it must liquidate the collateral of an insolvent participant. 
Additionally, the change to GSCC's insolvency rule to include 
references to certain insolvency proceedings against foreign members 
will better equip GSCC to handle the financial difficulties of foreign 
members and should help GSCC to assure the safeguarding of securities 
and funds in the its custody or control or for which it is responsible. 
Therefore, the proposed rule change is consistent with GSCC 
safeguarding obligations under section 17A(b)(3)(F).
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    \8\ 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-00-12) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-14831 Filed 6-11-03; 8:45 am]
BILLING CODE 8010-01-P