[Federal Register Volume 70, Number 11 (Tuesday, January 18, 2005)]
[Notices]
[Pages 2914-2915]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-161]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51021; File No. SR-FICC-2004-09]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving a Proposed Rule Change Relating to Changes to 
Membership Requirements

January 11, 2005.
    On April 14, 2004, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission''), a 
proposed rule change pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ (File No. SR-FICC-2004-09) and on 
November 16, 2004, and January 3, 2005,\2\ amended the proposed rule 
change. Notice of the proposal was published in the Federal Register on 
November 30, 2004.\3\ 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\ Although the proposed rule change was amended after it was 
noticed for comment in the Federal Register, republication of the 
notice is not necessary because the post-notice amendment made only 
a technical change to the proposed rule change.
    \3\ Securities Exchange Act Release No. 50718 (Nov. 22, 2004), 
69 FR 69653.
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I. Description

    FICC's Government Securities Division (``GSD'') and Mortgage Backed 
Securities Division (``MBSD'') rules will be changed in the following 
areas:

A. Annual Audited Financial Statements

    Prior to this rule change, GSD's rules required U.S. applicants for 
GSD membership to submit annual audited financial statements for the 
preceding year and non-U.S. applicants to submit annual audited 
financial statements for the preceding three years. MBSD's rules used 
to require U.S. and non-U.S. membership applicants to submit annual 
audited financial statements for the preceding year.
    Under the rule change, FICC will amend both divisions' rules to 
require GSD netting applicants and MBSD clearing applicants to submit 
two years of annual audited financial statements. However, if an 
applicant or member has not been in business for two years (i.e., a 
newly-formed applicant or member \4\), FICC will permit such applicant 
or member to submit annual audited financial statements for a lesser 
period and/or annual audited financial statements of a predecessor firm 
in the case of an applicant or member formed by a corporate 
transaction. If audited financial statements cannot be obtained, newly-
formed applicants will be permitted to submit unaudited pro forma 
financial statements. If FICC accepts pro forma or consolidated 
financial statements, the following shall apply:

    \4\ A newly formed applicant includes a company with no business 
history or a company formed as a result of a corporate transaction 
such as a merger.

    1. If an applicant is newly formed and does not have annual audited 
financial statements, the applicant shall be required to submit pro 
forma financial statements and, if it has filed any regulatory reports, 
such regulatory reports.\5\ FICC will verify the applicant's capital 
base by reviewing evidence from a third party as to the applicant's 
capital at the time of application.\6\
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    \5\ Unregulated and non-U.S. entities will be required to 
produce specific information that FICC needs in order to develop a 
risk profile to evaluate creditworthiness. This information will be 
requested in a form provided to the firms by FICC and signed by a 
senior officer of the firm. This form, which was the subject of a 
proposed rule filing, SR-FICC-2004-14, replaced the requirement for 
the submission of regulatory reports by non-U.S. entities. 
Securities Exchange Act Release No. 51018 (Jan. 11, 2005).
    \6\ For example, FICC may request a bank statement to verify 
that cash has been deposited, thereby verifying that the applicant 
meets FICC's minimum capital requirement.
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    2. If an applicant is newly formed as a result of a merger (or 
similar corporate transaction), the applicant shall be required to 
submit pro forma financial statements, the most recent annual audited 
financial statement of its predecessor firm if such statement is 
available, and if it has filed regulatory reports, such regulatory 
reports.
    3. If the applicant does not have its own audited financial 
statements but is consolidated in its parent's audited financial 
statements and it has filed its own regulatory reports, the applicant 
shall be required to submit such regulatory reports in addition to the 
consolidated financial statements.

    FICC believes the proposed rule change permitting less than two 
years of annual audited financial statements or unaudited pro forma 
financial statements is necessary and appropriate in order to 
accommodate entities that are newly-formed and those that are 
created as a result of a merger of existing entities or other 
similar corporate transaction. First, firms that are newly-formed do 
not have audited financials and in some instances can only provide 
pro forma financial statements. Second, the GSD's rules already 
contemplate the admission of entities with little or no business 
history, which often are of equal or even greater credit quality 
than more established entities. For example, GSD's rules provide 
that a netting applicant must have an established,

[[Page 2915]]

profitable business history of a minimum of six months or personnel 
with sufficient operational background and experience to ensure in 
the judgment of FICC's Membership and Risk Management Committee the 
ability of the firm to conduct its business.\7\ Third, FICC believes 
that the foregoing information will provide sufficient evidence that 
the applicant meets FICC's membership standards. Upon approval for 
membership, such a firm will be required to submit interim financial 
data to FICC, which will be used to monitor adherence to FICC's 
established financial parameters. As of its fiscal year-end, the 
firm will be required to provide its annual audited financial 
statement. At that time, the applicable interim statement will be 
compared to the audited financial statement. If there are 
discrepancies, the firm will be required to supply FICC with an 
acceptable explanation.
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    \7\ FICC Rule 2, Sec.  4 and Rule 3, Sec.  2(c).
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B. Financial Statements Prepared at the Applicant or Member Level

    Prior to this rule change, the rules of both FICC divisions 
specified that all required audited financial statements be prepared at 
the applicant or member level. However, some entities do not prepare 
their own audited financial statements. Their financial status is 
included in audited consolidated financial statements of a parent 
company.\8\
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    \8\ References to a ``parent'' company can mean a direct parent, 
intermediate parent, or ultimate parent company.
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    FICC will amend both divisions' rules to permit the submission of 
audited consolidated financial statements in situations where audited 
financial statements are not prepared at the applicant or member level. 
First, many members are not required to prepare their own audited 
financial statements by their regulators and doing so would be very 
expensive. Second, FICC is comfortable in accepting audited 
consolidated financial statements because FICC is able to obtain 
information regarding an applicant's or member's financial status 
through interim financial data on the applicant or member itself. This 
interim data is on the applicant or member firm level and is obtained 
from regulatory reports filed by the applicant or member itself or 
unaudited financial reports prepared internally by the applicant or 
member. FICC staff compares data from the applicable interim statement 
to the audited financial statement or applicable audited consolidated 
financial statement. If there are discrepancies, the firm would be 
required to supply FICC with an acceptable explanation. In addition, in 
instances where the member or applicant is unregulated and regulatory 
reports are thus not available, FICC may request consolidating 
financial statements from the member firm, which will show the 
financials of the entities that were included in the audited 
consolidated financial statement.
    In addition to this change, FICC will make a technical change to 
the term ``financial statements'' in GSD Rule 2, Section 7, to update 
the current reference to ``shareholder's equity'' to ``owner's equity'' 
to encompass those entities that do not have shareholders.

C. Compliance With Certain Capital Requirements

    Before this rule change, GSD's rules stated that a comparison-only 
applicant must be in compliance with the capital requirements imposed 
by its designated examining authority, appropriate regulatory agency, 
or other examining authority or regulator, and any other self-
regulatory organizations to which it is subject by statute, regulation, 
or agreement. FICC will eliminate this requirement because comparison-
only membership does not present FICC with any credit or financial risk 
since FICC does not guarantee that service.

D. Letters of Credit

    GSD's rules used to provide that if an approved letter of credit 
issuer was a non-U.S. bank acting through a branch or agency in the 
U.S., it was required to provide FICC with a ``guarantee of 
performance'' of such branch or agency deemed sufficient by FICC. FICC 
believes that the current language needs to be clarified because it was 
never meant to require a financial guarantee. FICC believes that it is 
not appropriate to require the head office of an approved letter of 
credit issuer to provide a financial guarantee for its branch or 
agency, given that the latter is simply an ``arm'' of the head office 
itself and not a separate legal entity.
    Accordingly, FICC will change the current language to specify that 
non-U.S. banks wishing to become approved letter of credit issuers must 
have language in their opinion of counsel indicating that the head 
office is ``ultimately responsible'' for the credit obligation of the 
branch or agency. This language is already contained in the pro forma 
legal opinions that are part of the FICC letter of credit issuer 
application.

II. Discussion

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to assure the safeguarding 
of securities and funds which are in its custody or control or for 
which it is responsible.\9\ The rule change will harmonize both of 
FICC's division's application requirements and will make clear to all 
applicants and members of the breadth of financial information that 
FICC will require and review in order to develop an accurate risk 
profile to evaluate an applicant's or member's financial 
responsibility. Accordingly, the proposed rule should assist FICC 
mitigate financial risk to itself and to its members and therefore 
should help FICC to assure the safeguarding of 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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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act \10\ and the 
rules and regulations thereunder.
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    \10\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-FICC-2004-09) be, and hereby 
is, approved. 

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-161 Filed 1-14-05; 8:45 am]
BILLING CODE 8010-01-P