[Federal Register Volume 70, Number 50 (Wednesday, March 16, 2005)]
[Notices]
[Pages 12919-12920]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1155]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51355; File No. SR-FICC-2004-08]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change To Provide Interpretive Guidance 
to Members Regarding the Criteria Used To Place Members on Surveillance 
Status

March 10, 2005.

I. Introduction

    On March 29, 2004, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') and 
on February 28, 2005,\1\ and March 3, 2005, amended \2\ proposed rule 
change SR-FICC-2004-08 pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'').\3\ Notice of the proposal was published 
in the Federal Register on November 23, 2004.\4\ No comment letters 
were received. For the reasons discussed below, the Commission is 
approving the proposed rule change.
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    \1\ The February 28, 2005, amendment was withdrawn by FICC on 
March 3, 2005.
    \2\ In the March 3, 2005, amendment, FICC elaborated on how it 
applies and monitors the matrix. The amendment did not modify the 
substance of the proposed rule change and therefore did not require 
republication of notice.
    \3\ 15 U.S.C. 78s(b)(1).
    \4\ Securities Exchange Act Release No. 50671 (November 16, 
2004), 69 FR 68200.
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II. Description

    FICC is seeking to provide interpretive guidance to members 
pertaining to the member surveillance rules of the Government 
Securities Division (``GSD'') and the Mortgage-Backed Securities 
Division (``MBSD'') of FICC.

1. Background

    Prior to the Commission's approval of SR-FICC-2003-03,\5\ the GSD 
had the ability to place a member in a surveillance status class 
depending on whether the member satisfied one or more of the enumerated 
financial and operational criteria. Upon approval of SR-FICC-2003-03, 
FICC implemented new criteria for placing members on surveillance. 
Specifically, all domestic broker-dealers and banks that are GSD 
netting members and/or MBSD clearing members are now assigned a rating 
that is generated by entering financial data of the member into a risk 
assessment matrix (``Matrix''). The Matrix is used by FICC and its 
affiliated clearing agency, National Securities Clearing Corporation. 
Specifically, in order to run the Matrix, credit risk staff uses the 
financial data of each applicable FICC member and the financial data of 
each applicable member of NSCC. In this way, each applicable member of 
GSD, MBSD, and NSCC is rated against other applicable members of FICC 
and NSCC. Members who receive a low rating are placed on an internal 
``watch list'' and are monitored more closely. All members that are not 
domestic banks or broker-dealers are not included in the Matrix process 
but are monitored by FICC's credit risk staff using financial criteria 
deemed relevant by FICC.
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    \5\ Securities Exchange Act Release No. 49158 (January 30, 
2004), 69 FR 5624 (February 5, 2004).
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    FICC will continually evaluate the methodology and its 
effectiveness and make such changes as it deems prudent and practicable 
within such time frame as is determined to be appropriate by FICC. FICC 
will update the Commission staff on its evaluations of the Matrix 
pursuant to a schedule developed by FICC, NSCC, and Commission staff.

2. Clarification of Rules Provisions

    In describing the process by which credit risk staff will implement 
the Matrix process and review members, FICC included in SR-FICC-2003-03 
explanatory footnotes 2 and 3. FICC at this time wishes to clarify its 
procedures with regard to application of the Matrix.
    Credit risk staff approaches its analysis of members pursuant to 
the new procedures in the following manner. First, as mentioned above, 
domestic broker-dealers and domestic banks are run through the Matrix 
and assigned a rating. Low-rated members are placed on the watch list. 
At this point, credit risk staff may downgrade a particular member's 
score based on various qualitative factors. For example, one 
qualitative factor might be that the member in question received a 
qualified audit opinion on its annual audit. In order to protect FICC 
and its other members, it is important that credit risk staff maintain 
the discretion to downgrade a member's rating on the Matrix and thus 
subject the member to closer monitoring. All rated members, including 
those on the watch list, are

[[Page 12920]]

monitored monthly or quarterly, depending upon the member's financial 
filing frequency, against basic minimum financial requirements and 
other parameters.
    All broker-dealer members included on the watch list are monitored 
more closely. This means that they are also monitored for various 
parameter breaks which may include but are not limited to such things 
as a defined decline in excess net capital over a one month or three 
month period, a defined period loss, a defined aggregate indebtedness/
net capital ratio, a defined net capital/aggregate debit items ratio, 
and a defined net capital/regulatory net capital ratio. All bank 
members included on the watch list are also monitored more closely for 
watch list parameter breaks which may include but are not limited to 
such things as a defined quarter loss, a defined decline in equity, a 
defined tier one leverage ratio, a defined tier one risk-based capital 
ratio, and a defined total risk-based capital ratio. FICC wishes to 
make clear that monitoring for the above more stringent parameter 
breaks is only applicable to those members placed on the watch list.
    In addition, FICC would like to address footnote 5 of Amendment I 
to rule filing SR-FICC-2003-03. That footnote stated that credit risk 
staff would monitor those members not included in the Matrix process 
(this includes members that are not domestic banks and broker dealers) 
using the same criteria as those used for members included on the 
Matrix. FICC wishes to make clear that credit risk staff will not be 
using the same criteria to monitor these members but will use similar 
criteria. As stated in the narrative of SR-FICC-2003-03, these criteria 
may include but are not limited to such things as failure to meet 
minimum financial requirements, experiencing a significant decrease in 
equity or net asset value, or a significant loss. This class of members 
may be placed on the watch list based on credit risk staff's analysis 
of this information.

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.\6\ The Commission finds that FICC's proposed rule 
change is consistent with this requirement because it improves FICC's 
member surveillance process which should 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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    \6\ 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-2004-08) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-1155 Filed 3-15-05; 8:45 am]
BILLING CODE 8010-01-P