[Federal Register Volume 68, Number 225 (Friday, November 21, 2003)]
[Notices]
[Pages 65753-65756]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-29085]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48796; File No. SR-FICC-2003-10]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Amend the Fixed Income 
Clearing Corporation's Cross-Margining Agreements With the Chicago 
Mercantile Exchange, BrokerTec Clearing Company, and the Board of Trade 
Clearing Corporation and To Eliminate the Cross-Margining Agreement 
With the New York Clearing Corporation

November 17, 2003.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on October 6, 2003, the Fixed 
Income Clearing Corporation (``FICC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change described 
in Items I, II, and III below, which items have been prepared primarily 
by FICC. The Commission is publishing this notice to

[[Page 65754]]

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

    FICC is seeking to amend its cross-margining agreements with the 
Chicago Mercantile Exchange (``CME''), BrokerTec Clearing Company 
(``BCC''), and the Board of Trade Clearing Corporation (``BOTCC'') and 
to eliminate its cross-margining agreement with the New York Clearing 
Corporation (``NYCC'').

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FICC 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. FICC 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 FICC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. New Cross-Margining Agreement With CME
    Through its Government Securities Division (``GSD''), FICC has a 
cross-margining arrangement with CME.\3\ FICC is proposing to terminate 
its existing cross-margining agreement with CME and to enter into a new 
cross-margining agreement with the CME (``New FICC-CME Agreement'') to 
reflect the fact that, as of January 2, 2004, the CME will begin 
clearing certain Treasury and Agency futures contracts and options on 
futures contracts that are traded on the Chicago Board of Trade 
(``CBOT'') and are currently cleared by BOTCC. Under the New FICC-CME 
Agreement, the FICC products that will be eligible for cross-margining 
will be Treasury securities that fall into the GSD's offset classes A 
through G and GCF Repo Treasury securities with equivalent remaining 
maturities and non-mortgage-backed Agency securities that fall into the 
GSD's offset classes e and f and GCF Repo non-mortgage-backed Agency 
securities with equivalent remaining maturities. The CME products that 
will be eligible for cross-margining will be of two types: (i) the 
products currently eligible under the existing arrangement between FICC 
and CME which are Eurodollar futures contracts with ranges in maturity 
from 3 months to 10 years and options on such future contracts cleared 
by CME and (ii) the CBOT products which are Two-Year Treasury Note 
Futures contracts and options thereon, Five-Year Treasury Note Futures 
contracts and options thereon, Ten-Year Treasury Note Futures contracts 
and options thereon, Thirty-Year Treasury Bond Futures contracts and 
options thereon, Five-Year Agency Note Futures contracts and options 
thereon, and Ten-Year Agency Note Futures contracts and options thereon 
to be cleared by CME.
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    \3\ Securities Exchange Act Release No. 44301 (May 11, 2001), 66 
FR 28207 (May 22, 2001) [File No. SR-GSCC-00-13].
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    No significant changes are being proposed to the existing FICC-CME 
cross-margining arrangement other than the addition of the CBOT 
products and certain FICC products as discussed in more detail below. 
The key aspects of the cross-margining arrangement, most notably, the 
calculation of the cross-margining reduction and the loss sharing 
provisions in the event of a participant default are not being amended.
2. Key Proposed Changes to the Existing Cross-Margining Agreement 
Between FICC and CME
    The addition of the CBOT products has necessitated new definitions 
for ``CBOT Eligible Products,'' ``CME Eligible Products,'' and ``FICC 
Eligible Products,'' as well as Offset Class tables for these products 
in Appendix B of the agreement.
    Appendix B of the FICC-CME Agreement is also being amended to 
include FICC's GCF Repo Treasury and non-mortgage-backed Agency 
products in the cross-margining arrangement.\4\ By the effective date 
of the New FICC-CME Agreement, FICC will be margining its GCF Repo 
Treasury and non-mortgage-backed Agency products based upon the 
specific underlying collateral, as opposed to the current system of 
margining these products based upon the longest maturity of eligible 
underlying collateral.\5\ Therefore, these GCF Repo products can now be 
included in the cross-margining arrangement because they will no longer 
be margined at a generic rate but rather at a specific rate based on 
the actual underlying Treasury and Agency collateral.
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    \4\ This amendment is also being proposed with respect to the 
GCF Repo Treasury products and the BCC cross-margining arrangement 
as discussed below.
    \5\ Because of a previous inability to obtain timely data on the 
actual instruments posted in support of GCF Repo positions, the GSD 
has calculated affected members' Clearing Fund requirements based 
upon the assumption that collateral providers have assigned to each 
generic CUSIP the most volatile (i.e., the longest maturity) 
collateral eligible. The GSD has been in the process of developing 
improvements to the current margining methodology. By the effective 
date of the proposed rule change, the GSD will be able to identify 
the specific CUSIP posted in calculating a member's Clearing Fund 
requirement related to its Treasury and Agency GCF Repo activity.
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    As is the case with the current agreement between FICC and CME, the 
parties provide in the New FICC-CME Agreement that they will agree from 
time to time in a separate writing on the disallowance factors that 
will be used in the cross-margining arrangement. The disallowance 
factors that will be used upon implementation of the new arrangement 
are the ones set forth as examples in Appendix B to the New FICC-CME 
Agreement. The disallowance factors between FICC eligible products and 
CME eligible products (i.e., Eurodollar products) have not changed. A 
new disallowance factor table has been added for cross-margining of 
FICC eligible Treasury and Agency products with CBOT Treasury and 
Agency eligible products.\6\
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    \6\ FICC has computed and tested disallowance factors that will 
be applicable to each potential pair of positions being offset.
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    Appendix C of the current agreement which sets forth the 
methodology for converting CME eligible products into Treasury cash 
equivalents for purposes of ultimately calculating the cross-margining 
reduction has been made into Appendix C1 and a new Appendix C2 has been 
added which contains the methodology for converting the CBOT eligible 
products into Treasury cash equivalents. This is identical to the 
methodology contained in the BOTCC and BCC cross-margining agreements.
    The existing agreement between FICC and CME provides for a 
``Maximization Payment'' which is a cross-guaranty provision that sets 
forth a mechanism for a clearing organization with a remaining surplus 
after all guaranty payments in relation to cross-margining have been 
made (``Aggregate Net Surplus'') to distribute funds to one or more 
cross-margining partners with remaining losses. The New FICC-CME 
Agreement will make it clear that: (i) The Maximization Payment is also 
a guaranty payment (albeit outside of cross-margining, arising out of 
the ``Maximization Payment Guaranty'') and (ii) the defaulting member 
would have a reimbursement obligation with respect to such payment 
(``Maximization

[[Page 65755]]

Reimbursement Obligation''). This means that should a clearing 
organization become obligated to pay the Maximization Payment, it may 
rely on the defaulting member's collateral to do so.\7\
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    \7\ The new guaranty provisions with respect to the Maximization 
Payment Guaranty will be identical to the ones in the current cross-
margining agreement between FICC and BCC. In order to protect the 
clearing organizations in the event that a court determines that any 
amount of a Maximization Reimbursement Obligation may not be 
recovered by the clearing organization that made a Maximization 
Payment pursuant to a Maximization Payment Guaranty, a provision has 
been added (Section 8C(c)) to the New FICC-CME Agreement to provide 
that the payee clearing organization will be expected to return that 
amount. This protective provision is also in the BCC cross-margining 
agreement.
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    A provision has been added to the New FICC-CME Agreement to take 
into account that a regulator or other entity having supervisory 
authority over FICC or CME may for safety and soundness purposes direct 
the clearing organization not to liquidate a defaulting member or to 
partially liquidate such member. In order to prevent the affected 
clearing organization from being penalized under the agreement for 
failing to liquidate or partially liquidating the member in this type 
of situation, the last two paragraphs of section 7(d) of the New FICC-
CME Agreement will provide that the affected clearing organization 
would be deemed to have a cross-margin gain equal to the base amount of 
the guaranty (i.e., cross-margining reduction) or a pro rated amount of 
the base amount of the guaranty in a partial liquidation scenario.
    A sentence has been added to section 7(h) making clear that the 
clearing organizations have security interests in the ``Aggregate Net 
Surplus,'' a large component of which would be the collateral and 
proceeds of positions of a defaulting member, as security for any 
reimbursement obligation including any maximization reimbursement 
obligation that may arise on the part of a defaulting member.
    Language has been added to the cross-margining participant 
agreements in Appendices D and E in order to further protect the 
clearing organizations by making clear that the clearing organizations 
have a security interest in the Aggregate Net Surplus and that a 
participant will have a reimbursement obligation in the event that a 
clearing organization becomes obligated to make a maximization payment. 
Participants in the current arrangement between FICC and CME and those 
in the arrangement between FICC and BOTCC to the extent they are not 
the same are being asked to reexecute the revised participant 
agreements in order to make them subject to the provisions of the New 
FICC-CME Agreement.\8\
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    \8\ Cross-margining is available to any FICC GSD 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. 
The FICC member (and its affiliate, if applicable) sign an agreement 
under which it (or they) agree to be bound by the cross-margining 
agreement between FICC and the Participating CO and which allows 
FICC or the Participating CO to apply the member's (or its 
affiliate's) margin collateral to satisfy any obligation of FICC to 
the Participating CO (or vice versa) that results from a default of 
the member (or its affiliate). Ownership of 50 percent or more of 
the common stock of an entity indicates control of the entity for 
purposes of the definition of ``affiliate.''
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3. Key Proposed Changes to FICC's Cross-Margining of CBOT Products
    Because FICC is currently cross-margining its products with certain 
CBOT products pursuant to its agreement with BOTCC and because these 
CBOT products will be cross-margined pursuant to the proposed New FICC-
CME Agreement if the proposed rule change is approved by the 
Commission, it is important to note the key differences between the 
cross-margining of the CBOT products under the existing arrangement 
with BOTCC and under the proposed new arrangement with the CME.
    The minimum margin factor under FICC's cross-margining arrangement 
with BOTCC is 50 percent. FICC and CME have agreed to a minimum margin 
factor of 25 percent to apply to the cross-margining of CBOT products 
versus FICC products. This is the same minimum margin factor as is used 
in the current cross-margining arrangement with the CME with respect to 
the eligible Eurodollar products and is the same minimum margin factor 
used in the arrangement with BCC.
    The New FICC-CME Agreement provides for inter-offset class cross-
margining whereas the BOTCC arrangement is limited to intra-offset 
class cross-margining. The new agreement is consistent with the 
approach in the existing arrangements between FICC and both CME and 
BCC.
    The current agreement between FICC and CME provides that in order 
to determine the gain or loss from the liquidation of the positions 
that were cross-margined resulting from a default of a member, only the 
proceeds from the side of the market that was offset pursuant to the 
agreement at the last margin cycle are considered. In the New FICC-CME 
Agreement, this approach will be extended to the CBOT products in order 
to provide consistency in the liquidation methods.
4. Amendments 1, 2, and 3 to the FICC-BCC cross-margining agreement
    FICC is proposing to amend its cross-margining agreement with BCC 
\9\ with Amendment 3 to the agreement. Amendment 3 will (i) add FICC's 
GCF Repo Treasury and non-mortgage-backed Agency products to the 
arrangement, (ii) add FICC's non-mortgage-backed Agency offset classes 
e and f, and (iii) amend the contingency procedures between the 
clearing organizations (contained in Appendix I of the agreement) to 
provide that FICC will not wait past 12 a.m. Eastern time for the BCC 
cross-margining file in order to run its cross-margining system. With 
respect to (ii), FICC has determined that even though BCC does not 
currently clear non-mortgage-backed Agency futures, the parties can 
still cross-margin FICC's Agency products against BCC's Treasury 
products given that the agreement provides for inter-offset class 
cross-margining using the appropriate correlation factors. With respect 
to (iii), the operational procedures provide that FICC will wait until 
3 a.m. Eastern time for the BCC file which is the same cut-off time for 
all of its other cross-margining partners. However, FICC has determined 
that the 3 a.m. Eastern time cut-off, which is significantly later than 
the GSD's normal cross-margining processing time, should only be used 
for extreme situations where not including a particular file would be 
disruptive to members. Currently, this would not be anticipated to be 
the case for a BCC file because of BCC's files relatively low 
historical impact.\10\ Therefore, FICC has determined that it would be 
more prudent from a risk management perspective to adopt a cut-off time 
of 12 a.m. Eastern time for receipt of BCC files.
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    \9\ Securities Exchange Act Release No. 45656 (March 27, 2002), 
67 FR 15646 (April 2, 2002) [File No. SR-GSCC-2002-01].
    \10\ The operational and contingency procedures contained in the 
FICC-BCC agreement provide that in the event FICC does not receive 
BCC's file by the cut-off time, FICC will calculate the applicable 
cross-margining reductions assuming that BCC submitted a file with 
no positions available for cross-margining which may result in 
margin calls for the affected participants by both FICC and BCC. 
These margin calls would not be disruptive to members because the 
cross-margining reductions in the program with the BCC are not 
anticipated to be large amounts.
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    As part of this proposed rule change filing, FICC would like to 
include Amendments 1 and 2 that were previously made with respect to 
its existing cross-margining agreement with BCC. The purpose of 
Amendment 1 was to update the list of products being cross-margined. 
The purposes of Amendment 2 were to remove

[[Page 65756]]

references to the cross-margining agreement with NYCC from Appendix A 
in which the parties are required to list other outstanding cross-
margining arrangements and to update the notice provision.
5. Amendments 1 and 2 to the FICC-BOTCC Cross-Margining Agreement
    As in the case of the BCC agreement, FICC would like to include as 
part of this proposed rule change filing Amendments 1 and 2 that were 
previously made with respect to its existing cross-margining 
arrangement with BOTCC. \11\ The purposes of Amendment 1 were to update 
the list of products being cross-margined, add an appendix setting 
forth operational contingency procedures, clarify procedures to be used 
if one clearing organization discovers a calculation error, correct 
cited Bankruptcy Code language, correct language in one of the 
participant agreements, and refine the timing of the effectiveness of 
changes to the cross-margining reduction. The purpose of Amendment 2 
was to remove references to the cross-margining agreement with NYCC 
from Appendix A.
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    \11\ FICC currently has a cross-margining agreement in place 
with BOTCC through which certain CBOT products are cross-margined 
with certain FICC products. Securities Exchange Act Release No. 
45335 (January 25, 2002), 67 FR 4768 (January 31, 2001) [File No. 
SR-GSCC-2001-03]. BOTCC recently announced that it will become the 
clearing corporation for Eurex. In the next few weeks, FICC will 
determine the status of its cross-margining arrangement with BOTCC 
and will submit a proposed rule change filing addressing changes to 
the existing agreement, if necessary.
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6. Removal of NYCC Cross-Margining Agreement From the GSD's Rules
    FICC is proposing to remove its cross-margining agreement with NYCC 
\12\ from the GSD's rules. That arrangement has been dormant for some 
time and the parties have agreed that should they determine to 
reinstitute cross-margining, they will enter into a new cross-margining 
agreement that will be similar to FICC's other cross-margining 
agreements. At that time, FICC would file the appropriate proposed rule 
change with the Commission.
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    \12\ Securities Exchange Act Release No. 41766 (August 19, 
1999), 64 FR 46737 (August 26, 1999) [File No. SR-GSCC-98-04].
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    FICC believes that the proposed rule change is consistent with the 
requirements of section 17A of the Act \13\ and the rules and 
regulations thereunder applicable to FICC because it will facilitate 
the safeguarding of securities and funds which are in its custody or 
control or for which it is responsible and in general will protect 
investors and the public interest by continuing FICC's cross-margining 
program which provides members with significant benefits, such as 
greater liquidity and more efficient use of collateral in a prudent 
manner, and enhances FICC's overall risk management process.
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    \13\ 15 U.S.C. 78q-1.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    FICC 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. FICC will notify the Commission of any 
written comments received by FICC.

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. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-FICC-2003-10. This file number should be included on the 
subject line if e-mail is used. To help us process and review comments 
more efficiently, comments should be sent in hardcopy or by e-mail but 
not by both methods.
    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 FICC and at http://www.ficc.com.
    All submissions should refer to File No. SR-FICC-2003-10 and should 
be submitted by December 12, 2003.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-29085 Filed 11-20-03; 8:45 am]
BILLING CODE 8010-01-P