[Federal Register Volume 69, Number 210 (Monday, November 1, 2004)]
[Notices]
[Pages 63421-63424]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2962]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50594; File No. SR-FICC-2004-16]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change Relating to Establishment of a 
Cross-Margining Agreement With the Clearing Corporation

October 26, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on August 12, 2004, 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 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

    The Government Securities Division of FICC (``GSD'') is seeking to 
establish a cross-margining arrangement with The Clearing Corporation 
(``TCC'').

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. Background
    The Government Securities Division of FICC is proposing to enter 
into a new cross-margining agreement with TCC. FICC had a cross-
margining arrangement in place with the Board of Trade Clearing 
Corporation (``BOTCC''), TCC's predecessor, through which certain 
Chicago Board of Trade (``CBOT'') products were cross-margined with 
certain FICC products.\3\ The BOTCC arrangement was terminated on 
January 2, 2004, the date on which BOTCC ceased being the clearing 
organization for the CBOT products that were the subject of the 
arrangement.\4\ On January 2, 2004, the Chicago Mercantile Exchange 
(``CME'') became the clearing organization for the CBOT products, which 
are now included in the cross-margining arrangement that FICC recently 
has with the CME.\5\
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    \3\ Securities Exchange Act Release No. 45335 (January 25, 
2002), 67 FR 4768 [File No. SR-GSCC-2001-03].
    \4\ Securities Exchange Act Release No. 49142 (January 28, 
2004), 69 FR 5623 [File No. SR-FICC-2004-02].
    \5\ Securities Exchange Act Release No. 49003 (December 29, 
2003), 69 FR 712 [File No. SR-FICC-2003-10].
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    TCC recently became the clearing organization for EurexUS and has 
approached FICC regarding cross-margining certain U.S. Treasury and 
Agency futures and options on futures products traded on the EurexUS 
futures exchange and cleared by TCC with certain FICC products.\6\
    FICC is proposing to enter into a new cross-margining agreement 
with TCC

[[Page 63422]]

(``Proposed FICC-TCC Agreement'') to cover the EurexUS traded products 
cleared by TCC. Under the Proposed FICC-TCC 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, 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 TCC products that will be 
eligible for cross-margining will be the EurexUS 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, cleared or to be cleared by TCC.\7\
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    \6\ The products traded on the EurexUS futures exchange and 
cleared by TCC are substantially similar to the CBOT products 
originally cleared by BOTCC.
    \7\ TCC is not currently clearing the Agency futures products. 
However, because it expects to clear Agency futures products in the 
future, FICC has included these products in the proposed rule change 
and the draft agreement. These Agency products are also covered by 
the current cross-margining agreement between FICC and the CME.
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2. FICC's Cross-Margining Program in General
    In general, cross-margining allows members to optimize their 
capital usage by permitting their clearing organizations to view their 
positions across clearing organizations as a combined portfolio and to 
reduce margin requirements accordingly.\8\ Margining based on the net 
combined risk of correlated positions is based on the cross margining 
arrangement under which FICC and each Participating CO agree to accept 
the correlated positions in lieu of supporting collateral.\9\ All 
eligible positions maintained by a cross-margining participant in its 
account at FICC and in its (or its affiliate's) proprietary account at 
a Participating CO are eligible for cross-margining.\10\
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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 
clearing organization (``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.''
    \9\ FICC employs the ``hub-and-spoke'' method of cross-
margining, which means that FICC cross-margins on a multilateral 
basis (i.e., with more than one Participating CO) with FICC as the 
``hub.'' Each Participating CO enters into a separate cross-
margining agreement between itself and FICC. No preference is given 
by FICC to one Participating CO over another.
    \10\ Upon implementation of the new arrangement between FICC and 
TCC, the arrangement will not apply to positions in a customer 
account at TCC that would be subject to the segregation requirements 
of the Commodity Exchange Act. This is also the case under the 
cross-margining arrangement that FICC has in place with the CME.
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    Under the arrangement, FICC and each Participating CO holds and 
manages its own positions and collateral and independently determines 
the amount of margin that it will make available for cross-margining, 
which is referred to as the ``residual margin amount.'' FICC computes 
the amount by which the cross-margining participant's margin 
requirement can be reduced at each clearing organization (i.e., the 
``cross-margining reduction'') by comparing the participant's positions 
and the related margin requirements at FICC against those at each 
Participating CO.\11\ FICC offsets each cross-margining participant's 
residual margin amount at FICC against the offsetting residual margin 
amounts of the participant (or its affiliate) at each Participating CO.
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    \11\ FICC and the Participating COs currently use different 
margin rates to establish margin requirements for their respective 
products. Margin reductions in the cross-margining arrangement are 
always computed based on the lower of the applicable margin rates. 
This methodology results in a potentially lesser benefit to the 
participant but ensures a more conservative result (i.e., more 
collateral held at the clearing organization) for the Participating 
CO and FICC.
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    If the margin that FICC has available for a participant is greater 
than the combined margin submitted by the Participating COs, FICC will 
allocate a portion of its margin equal to the combined margin at the 
Participating COs. If the combined margin submitted by the 
Participating COs is greater than the margin that FICC has available 
for that participant, FICC will first allocate its margin to the 
Participating CO with the most highly correlated position. If the 
positions are equally correlated, FICC will allocate pro rata based 
upon the residual margin amount available at each Participating CO. 
FICC and each Participating CO may then reduce the amount of collateral 
that they collect to reflect the offsets between the cross-margining 
participant's positions at FICC and its (or its affiliate's) positions 
at the Participating CO.\12\
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    \12\ FICC and each Participating CO unilaterally have the right 
not to reduce a participant's margin requirement by the cross-
margining reduction or to reduce it by less than the cross-margining 
reduction. However, the clearing organizations may not reduce a 
participant's margin requirement by more than the cross-margining 
reduction.
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    FICC and each Participating CO will guarantee the cross-margining 
participant's (or its affiliate's) performance to each other up to a 
specified maximum amount that relates back to the cross-margining 
reduction and the results of liquidating the member's positions and 
ultimately its collateral. The guaranty represents a contractual 
commitment that each clearing organization has to the other.
    A default by a cross-margining participant will trigger the loss 
sharing provisions of the cross-margining agreement. The loss-sharing 
provisions determine the guaranty payments, if any, that will flow 
between the clearing organizations if the default of the participant 
results in a loss. It should be noted that a declaration of default of 
a cross-margining participant by one of the clearing organizations in 
and of itself will provide grounds for the other clearing organization 
to declare the participant (or its affiliate) in default as well. If 
the guaranty is triggered, the cross-margining participant becomes 
obligated to reimburse the guarantor clearing organization for the 
amount of the guaranty payment (called the ``Reimbursement 
Obligation'').
    The cross-margining agreement also provides for the sharing of 
remaining resources beyond the cross-margining arrangement through a 
``cross-guaranty'' provision. This provision reflects the view that 
excess collateral of a defaulting member should remain with the 
clearing organizations, if needed, to cover their losses. Specifically, 
if after guaranty payments, if any, one of the clearing organizations 
has a remaining surplus, and the other has a remaining loss, the 
agreement provides a mechanism for the distribution of that surplus to 
the clearing organization that still has a remaining loss.
3. Key Proposed Changes to the Former Agreement Between FICC and TCC
    (a) The minimum margin factor under the former FICC-BOTCC cross-
margining agreement was 50 percent. FICC and TCC have agreed to a 
minimum margin factor of 25 percent. This is the same minimum margin 
factor used in the current cross-margining arrangement with the 
CME.\13\
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    \13\ The minimum margin factor is the contractually agreed upon 
cap on the amount of the margin reduction that the clearing 
organizations will allow. Should FICC decide to change the minimum 
margin factor, it will submit a proposed rule filing under Section 
19(b) of the Act.
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    (b) The Proposed FICC-TCC Agreement provides for inter-offset class 
cross-margining whereas the former

[[Page 63423]]

BOTCC arrangement was limited to intra-offset class cross-margining. 
The new agreement is consistent with the approach in the existing 
arrangement between FICC and the CME.
    (c) Appendix B of the FICC-TCC Agreement will include more FICC 
products than did the former BOTCC arrangement. The former BOTCC 
agreement covered FICC offset classes C, E, F, G and f, and offset 
classes E, F, and f were defined more narrowly for purposes of the 
arrangement than they were defined in the GSD's rules. The Proposed 
FICC-TCC Agreement includes the GSD's offset classes A through G and 
GCF Repo Treasury securities with equivalent remaining maturities, 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. These offset classes are as broad 
as they are defined in the GSD's rules.
    (d) Appendix B of the FICC-TCC Agreement will also include FICC's 
GCF Repo Treasury and non-mortgage-backed Agency products. FICC is now 
able to margin its GCF Repo Treasury and non-mortgage-backed Agency 
products based upon the specific underlying collateral as opposed to 
the former system of margining these products based upon the longest 
maturity of eligible underlying collateral.\14\ Therefore, these GCF 
Repo products can now be included in the cross-margining arrangement 
because they are being margined at a specific rate based on the actual 
underlying Treasury and Agency collateral. These products are also 
included in the current cross-margining agreement between FICC and the 
CME.
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    \14\ Because of a previous inability to obtain timely data on 
the actual instruments posted in support of GCF Repo positions, up 
until recently the GSD 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 recently developed 
improvements to its margining methodology and is now able to 
identify the specific CUSIP posted.
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    (e) The Proposed FICC-TCC Agreement provides that the parties will 
agree from time to time in a separate writing on the disallowance 
factors that will be used in the arrangement. Prior to the 
implementation date of the proposed FICC-TCC cross-margining program, 
the disallowance factors will be tested and agreed to by FICC and TCC 
in writing.
    (f) The current agreement between FICC and CME provides that in 
order to determine the gain or loss from the liquidation (resulting 
from a default) of the positions that were cross-margined, only the 
proceeds from the side of the market that was offset pursuant to the 
agreement at the last margin cycle are considered. This approach will 
be extended to the Proposed FICC-TCC Agreement products to provide 
consistency in the liquidation methods.
    (g) The former FICC-BOTCC agreement provided for a ``Maximization 
Payment'' whereby a clearing organization with a remaining surplus 
after all guaranty payments in relation to cross-margining were made 
(``Aggregate Net Surplus'') to distribute funds to one or more cross-
margining partners with remaining losses. The Proposed FICC-TCC 
Agreement makes clear that: (i) the Maximization Payment is also a 
guaranty payment (albeit outside of cross-margining) and (ii) the 
defaulting member would have a reimbursement obligation with respect to 
such payment (``Maximization Reimbursement Obligation''). Should a 
clearing organization become obligated to pay the Maximization Payment, 
it may rely on the defaulting member's collateral to do so.\15\
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    \15\ The new guaranty provisions with respect to the 
Maximization Payment Guaranty are identical to the ones in the 
current cross-margining agreement between FICC and CME. 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, provision has been added to the Proposed FICC-TCC 
Agreement providing that the payee clearing organization will be 
expected to return that amount. This protective provision is also in 
the FICC-CME cross-margining agreement.
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    (h) A provision has been added to take into account that a 
regulator or other entity having supervisory authority over FICC or TCC 
may 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 Proposed FICC-TCC Agreement provides 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.
    (i) The proposed FICC-TCC Agreement makes 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 
arises on the part of a defaulting member.
    (j) The proposed FICC-TCC cross-margining participant agreement has 
language 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. Members 
that wish to participate in the proposed FICC-TCC cross-margining 
arrangement will be required to execute the participant agreement to 
make them subject to the provisions of the Proposed FICC-TCC Agreement.
(4) Amendment 1 to the FICC-CME Cross-margining Agreement
    FICC is proposing to amend Appendix A of the cross-margining 
agreement with the CME to add a reference to the Proposed FICC-TCC 
Agreement. In Appendix A, the parties set forth the other cross-
margining or similar arrangements that they have in place and indicate 
whether such agreements take priority over the present agreement. As 
stated above, no preference is given by FICC to one Participating CO 
over another.
    FICC believes that the proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to FICC and particularly with the requirements of Section 
17A(b)(3)(F) \16\ of the Act, which requires that the rules of a 
clearing agency be designed to provide for the safeguarding of 
securities and funds which are in its possession or control or for 
which it is responsible. By continuing its cross-margin program to 
include products cleared by TCC, FICC will provide its members with the 
benefits of cross-margining, including greater liquidity and more 
efficient use of collateral, in a manner that is consistent with FICC's 
overall risk management process.
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    \16\ 15 U.S.C. 78q-1(b)(3)(F).
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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.

[[Page 63424]]

(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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml) or
     Send an e-mail to [email protected]. Please include 
File Number SR-FICC-2004-16 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-FICC-2004-16. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml!). 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 on FICC's Web site at http://www.ficc.com. All comments received 
will be posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-FICC-2004-16 and should be submitted on 
or before November 16, 2004.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E4-2962 Filed 10-29-04; 8:45 am]
BILLING CODE 8010-01-P