[Federal Register Volume 69, Number 24 (Thursday, February 5, 2004)]
[Notices]
[Pages 5624-5625]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-2456]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49158; File No. SR-FICC-2003-03]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change To Amend the Criteria Used To 
Place Members on Surveillance Status

January 30, 2004.

I. Introduction

    On March 20, 2003, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') and 
on June 3 and 18, 2003, amended the proposed rule change SR-FICC-2003-
03 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 October 30, 2003.\2\ No comment letters were received. 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. 48689 (October 24, 
2003), 68 FR 61844.
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II. Description

    Under the current rules of both the Government Securities Division 
(``GSD'') and the Mortgage-Backed Securities Division (``MBSD'') of 
FICC, management has the ability to place a member in a surveillance 
status class depending on whether the member satisfies one or more of 
the enumerated financial and operational criteria in the specific 
class. Once placed on surveillance status, FICC closely monitors the 
member's condition. The current criteria for placing members on 
surveillance status are broadly written and capture many FICC members 
that pose minimal financial or operational risk to FICC. This creates 
administrative burdens for FICC staff, who must more closely monitor 
these members that pose minimal risk, that is not necessary to protect 
FICC.
    To remedy this problem, FICC has developed new criteria for placing 
members on surveillance. Specifically, all domestic broker-dealers and 
banks \3\ that are GSD netting members and/or MBSD clearing members 
will be assigned a rating that is generated by entering financial data 
of the member into a matrix (``Matrix'') developed by credit risk 
staff.\4\ Those members with a ``weak'' rating (deemed to pose a 
relatively higher degree of risk to FICC) will be placed on an internal 
``watch list'' and will be monitored more closely by credit risk 
staff.\5\ The consequences of being put on the ``watch list'' will be 
the same as is currently the case with surveillance status in the GSD's 
rules and will include possibly requiring the member on ``watch list'' 
status to submit additional financial reports and data and/or make 
additional clearing or participants fund deposits.\6\
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    \3\ The following categories of GSD members will receive 
ratings: Category 1 and 2 Dealer Netting Members, Category 1 and 2 
Inter-Dealer Broker Netting Members, and Bank Netting Members. At 
MBSD, Comparison and Clearing System Participants that are either 
banks or broker-dealers will be rated. Domestic broker-dealers and 
domestic banks are the only member types to which the Matrix will be 
applicable because (i) they represent the majority of the members of 
FICC and (ii) their financial reports contain information that lends 
them to the Matrix approach.
    \4\ FICC's approach to the analysis of members is based on a 
thorough quantitative analysis. A broker-dealer member's rating on 
the Matrix will be based on factors including size (i.e., total 
excess net capital), capital, leverage, liquidity, and 
profitability. Banks will be reviewed based on size, capital, asset 
quality, earnings, and liquidity.
    \5\ Members will also be evaluated based on their compliance 
with certain ``parameter breaks'' which will be determined based on 
applicable monthly and/or quarterly exception reports generated by 
credit risk staff. A member may be placed on the ``watch list'' for 
parameter breaks in areas such as excess net capital, excess liquid 
capital, aggregate indebtedness, leverage ratio, or other financial 
requirements.
    \6\ The MBSD's rules do not currently provide for surveillance 
status, but the MBSD has the right under certain circumstances to 
require additional financial reports and increased participants fund 
contribution.
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    All other categories of netting and clearing members, including 
non-U.S. netting members and comparison-only members, will not be 
included in the Matrix process because these members possess 
characteristics that prevent use of the Matrix to effectively evaluate 
their risk to FICC. However, these members will be monitored by credit 
risk staff using financial criteria deemed relevant by FICC.\7\ Based 
on this

[[Page 5625]]

monitoring, such Members may also be placed on the ``watch list'' if 
they experience a financial change that presents risk to FICC. Some 
examples include failure to meet minimum financial requirements or 
experiencing a significant decrease in equity (for GSD members) or net 
asset value (for MBSD members). Members placed on the ``watch list'' in 
this way will also be monitored more closely by credit risk staff.
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    \7\ Credit risk staff will monitor these members by reviewing 
similar criteria as the criteria used for members included in the 
Matrix. FICC will file a proposed rule change should it decide to 
use a more applicable Matrix process to evaluate these members.
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    The GSD will continue, in accordance with its current procedures, 
to place GSD netting members on the ``watch list'' for failure to 
comply with operational standards and requirements.\8\ MBSD expects to 
implement a similar provision, as outlined in these rule changes, soon.
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    \8\ The GSD currently monitors the comparison rates of members. 
Currently, low comparison rates can result in a member being placed 
on Class 1 surveillance status. Under the rule change, low 
comparison rates may result in a GSD member being placed on the 
``watch list.'' Both the GSD and the MBSD may monitor for other 
operational factors in the future such as failing to timely submit 
trade data on a frequent basis.
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III. Discussion

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to facilitate the safeguarding of 
securities and funds which are in its custody or control or for which 
it is responsible.\9\ The Commission finds that FICC's proposed rule 
change is consistent with this requirement because it will improve 
FICC's member surveillance process which will better enable FICC to 
safeguard the securities and funds which are in its custody or control 
or for which it is responsible.
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    \9\ 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 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-FICC-2003-03) be and hereby 
is approved.
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    \10\ 17 CFR 200.30-3(a)(12).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-2456 Filed 2-4-04; 8:45 am]
BILLING CODE 8010-01-P