[Federal Register Volume 69, Number 183 (Wednesday, September 22, 2004)]
[Notices]
[Pages 56810-56811]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2296]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50389; File No. SR-FICC-2003-06]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to the 
Assessment of Funds-Only Settlement Obligations

September 15, 2004.

I. Introduction

    On July 11, 2003, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2003-06 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 23, 2004.\2\ 
No comment letters were received. For the reasons discussed below, the 
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. 49242 (February 12, 
2004), 69 FR 8251.
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II. Description

    The proposed rule change for the most part eliminates the complex 
manual adjustments currently made by FICC's Operations Department with 
regard to the forward margin debit obligations and credit entitlements 
of repo broker members of the Government Securities Division (``GSD'') 
of FICC.\3\ When GSD initially implemented its blind-brokered 
repurchase agreement (``repo'') service, it operated a system whereby 
the majority of members submitted trade data in a single batch file at 
the end of each day. The batch file submission process made it 
virtually impossible for repo brokers, that expect to net out of their 
position as middlemen in brokered repos, to timely determine the 
existence of trades on which they had positions, contact the 
appropriate counterparties, and correct trade details. As a result, any 
erroneous submissions on the part of a dealer counterparty resulted in 
a forward margin assessment to the repo broker. Realizing that a repo 
broker should always be flat from a net-settlement position 
perspective, FICC granted repo brokers relief from the forward 
margining process by providing a look through to the dealer 
counterparties for purposes of assessing forward margin obligations.\4\ 
However, the look through involves a manual adjustment process that 
requires complex calculations inconsistent with FICC's overall 
management policy.\5\
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    \3\ Forward margin is a component of a netting member's daily 
funds-only settlement obligation. Forward margin is a mark-to-market 
payment on forward-settling positions. It is passed through in the 
form of cash from the debit side to the credit side. The amounts are 
reversed on the following day with interest collected from the 
credit side and paid through to the debit side.
    \4\ FICC, in a prior rule filing, amended its rules to allow 
management to look through brokered repo transactions in order that 
repo brokers were not left with debit or credit obligations caused 
by erroneous submissions on behalf of the dealers. Securities 
Exchange Act Release No. 38603 (May 9, 1997), 62 FR 27088 (May 16, 
1997) (File No. SR-GSCC-96-12). In accordance with FICC's risk 
strategy at the time, the risk management process worked most 
effectively if a repo broker was netted out of its positions as a 
middleman. However, with the advent of real time trade matching and 
the ready ability of brokers to rectify dealer submission errors, 
GSD believes that risk management initiatives are better served by 
using the parameters outlined in this filing.
    \5\ On each business day, the Operations Division routinely 
adjusts the overall funds-only settlement obligation of a repo 
broker that has a forward margin debit or credit. If the repo broker 
has an overall credit forward margin, GSD will reduce its aggregate 
funds-only credit obligation or increase its aggregate funds-only 
debit entitlement by an amount equal to the forward margin credit. 
Conversely, if the repo broker is in an overall debit forward margin 
position, GSD will reduce its aggregate funds-only debit obligation 
or increase its funds-only credit entitlement by an amount equal to 
the debit; however, it then will apply that amount to the uncompared 
dealer (the dealer who failed to submit or submitted erroneously).
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    FICC has determined that it will no longer provide a look through 
to relieve repo brokers from forward margin obligations. Subsequent to 
the events of September 11, 2001, FICC decided to eliminate all 
operations functions that require complex manual adjustment or input as 
a way to reduce risk in all operations processes. In addition, almost 
all repo broker activity is now submitted to FICC on an interactive, 
real-time basis that allows brokers to readily rectify any outstanding 
data submission errors during the day. For these reasons, FICC is 
proposing to modify the forward margin adjustment process to require 
the repo brokers to satisfy their forward margin obligations including 
both paying forward margin debits and receiving forward margin credits.
    Going forward, FICC will apply the following parameters with 
respect to the forward margin obligations of repo brokers. Debits and 
credits up to a predetermined dollar amount cap will be automatically 
collected or paid as applicable by the repo brokers as is the case for 
all other netting members.\6\ Debits and credits in excess of the cap 
will be subject to hybrid processing, whereby the dollar amount up to 
the cap will always be collected or paid in its entirety by the broker, 
amounts over the cap (``excess debits'' or ``excess credits'') will be 
financed by GSD at the discretion of FICC.
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    \6\ The FICC Membership and Risk Management Committee will 
determine, based on historical data and risk considerations, what 
the debit and credit cap will be for forward margin debits and 
credits. The Committee has approved an initial cap of $2 million.
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    The following is an example of hybrid processing for a broker with 
an excess debit. First, the Operations Department will request that the 
affected repo broker pay the excess debit to FICC. In the event that 
the repo broker is unable to pay the excess debit, the Operations 
Department, in consultation with the Credit Risk Department, will 
determine whether it is appropriate for FICC to finance the excess 
debit. If FICC finances the excess debit, the broker will be charged a 
financing fee, representing the interest amount that FICC will be 
charged by the clearing bank, and the member will be subject to an 
administrative fee.\7\ GSD will collect the calculated interest amount 
from the repo broker on the subsequent business day. GSD will also 
reserve the right in certain situations to assess the forward margin 
amounts in excess of the dollar amount cap by looking through to the 
dealer, as is done by the current manual process.\8\ All extensions of 
financing by

[[Page 56811]]

FICC will be secured by the clearing fund deposit of the repo broker.
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    \7\ This fee will be designed to cover FICC's cost of arranging 
financing and will be filed before implementation.
    \8\ FICC will continue to look through to the dealer 
counterparty for purposes of assessing forward margin obligations in 
cases of a systemic outage where any non-submission by one 
counterparty versus a repo broker exceeds $1 billion.
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    In applying the hybrid processing to excess credits, the Operations 
Department in consultation with the Credit Risk Department will 
determine whether it is appropriate to pass through the excess credit 
to the repo broker. To the extent that GSD does not pass through to the 
broker all or a portion of its calculated excess credit, GSD will 
calculate an interest amount tied to the rate of interest earned by GSD 
on its overnight cash investment on such unpaid excess credit and will 
pay this interest amount to the repo broker on the subsequent business 
day. The proposed rule change will require some manual adjustments when 
the hybrid approach is used, but these instances will occur 
infrequently and will not rise to the complexity of the current 
process.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to promote the prompt and 
accurate clearance and settlement of securities transactions.\9\ FICC's 
look-through rule was established to eliminate the forward margin 
debits and credits of repo broker members of GSD when their dealer 
counterparties failed to timely submit trade data or submitted 
incorrect data. The transition to real time trade submission from end 
of day batch trade submission has significantly reduced the likelihood 
that repo brokers will be assessed forward margin and in FICC's view 
has rendered the look-through rule and its attendant manual adjustments 
unnecessary. Under the proposed rule change, forward margin will be 
collected from repo brokers or financed by GSD, but FICC will retain 
the right to look-through to the dealer counterparties when necessary. 
Accordingly, by significantly reducing the amount of manual processing 
with regard to forward margin debit obligations and credit entitlements 
without affecting FICC's ability to collect forward margin, the 
proposed rule change should help FICC to devote more resources to 
promoting the prompt and accurate clearance and settlement of 
securities transactions.
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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 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-FICC-2003-06) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
 [FR Doc. E4-2296 Filed 9-21-04; 8:45 am]
BILLING CODE 8010-01-P