[Federal Register Volume 70, Number 55 (Wednesday, March 23, 2005)]
[Notices]
[Pages 14736-14738]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1257]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51385; File No. SR-FICC-2004-14]


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

March 16, 2005.
    On July 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\ On July 15, July 30, August 20, and 
November 10, 2004, FICC filed amendments 1, 2, 3, and 4 respectively. 
On January 3, 2005, FICC filed amendment 5 and withdrew amendments 1, 
2, 3, and 4. Notice of the proposal was published in the Federal 
Register on January 18, 2005.\2\ The Commission received three comment 
letters.\3\ 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. 51018 (Jan. 11, 2005), 
70 FR 2911.
    \3\ Letters from Kevin M. Brandt, Director, III Global Ltd., III 
Finance Ltd., and III Relative Value/Macro Hub Fund Ltd. (Oct. 25, 
2004) and Lawrence R. Uhlick, Executive Director and General 
Counsel, Institute of International Bankers (Oct. 26, 2004, and Feb. 
9, 2005). See also Memorandum to File re: Meeting with Institute of 
International Bankers (Mar. 15, 2005).
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I. Description

    Under the rule change, FICC will amend the rules of its Government 
Securities Division (``GSD'') and Mortgage-Backed Securities Division 
(``MBSD'') regarding membership requirements for non-U.S. applicants 
and members.

A. Annual Audited Financial Statements

    Prior to the rule change, GSD required non-U.S. members and 
applicants to submit financial statements prepared in accordance with 
U.S. generally accepted accounting principles (``U.S. GAAP'') 
``whenever necessary and feasible.'' MBSD required non-U.S. members and 
applicants to submit financial statements prepared in accordance with 
U.S. GAAP. Both divisions review such financial statements as part of 
their credit risk management program.
    FICC is amending these requirements uniformly across both divisions 
to enable non-U.S. members and applicants to submit financial 
statements that are prepared according to any other generally accepted 
accounting methodology (``non-U.S. GAAP''). Specifically, FICC will 
increase the existing minimum financial requirements of each applicant 
and member based on the type of non-U.S. GAAP that was used to prepare 
the audited financial statement in the following manner:
    1. For applicants and members whose financial statements are 
prepared in accordance with International Financial Reporting Standards 
(``IFRS''), the Companies Act of 1985 (``U.K. GAAP''), or Canadian 
GAAP, the minimum financial requirements will be one and one-half times 
the applicable requirements.
    2. For applicants and members whole financial statements are 
prepared in accordance with a European Union country GAAP (``EU GAAP'') 
other than U.K. GAAP, the minimum financial requirements will be five 
times the applicable requirements.
    3. For applicants and members whose financial statements are 
prepared in accordance with any other type of GAAP, the minimum 
financial requirements will be seven times the applicable requirements.
    For example, under GSD's rules, the minimum financial requirement 
for a bank netting member is equity capital of US$100 million. This 
will continue to be the requirement for all such members (both U.S. and 
non-U.S. members) whose financial statements are prepared in accordance 
with U.S. GAAP. However, if such a member's financial statements were 
prepared in accordance with IFRS, U.K. GAAP, or Canadian GAAP, the 
member's minimum financial requirement would be US$150 million. If such 
a member's financial statements were prepared in accordance with an EU 
country GAAP other than U.K. GAAP, the member's minimum financial 
requirement would be US$500 million. If a member's financial statements 
were prepared in accordance with any other type of GAAP, the member's 
minimum financial requirement would be US$700 million.

[[Page 14737]]

    In order to apply this change to non-U.S. applicants and members, 
FICC will delete the terms ``Excess Liquid Capital'' and ``Excess Net 
Capital'' in GSD Rule 3, Section 6, and instead will use the term 
``applicable minimum regulatory capital,'' which is defined in GSD Rule 
3, Section 2 as ``regulatory capital as defined by the applicant's home 
country regulator.'' MBSD Article III, Rule 1, Section 2(d) will state 
that the references to the terms ``net capital'' or ``liquid capital'' 
in, ``shall be deemed to refer to regulatory capital in cases where the 
U.S. regulatory capital terms are not applicable to a non-domestic 
entity.''
    FICC will retain the requirement that annual audited financial 
statements submitted by members and applicants be certified without 
qualification. The rule change makes clear that annual audited 
financial statements must be prepared in accordance with generally 
accepted accounting principles. In addition, all information submitted 
to FICC will have to be in English or will have to be a fair and 
accurate English translation if the information is translated into 
English.
    The proposed rule changes will be applied to current members and 
applicants.

B. Material Regulatory Filings

    As part of its credit risk management, FICC requires applicants and 
members to submit interim financial data. In the case of U.S. bank and 
broker-dealer members, GSD and MBSD are able to obtain this financial 
information through regulatory reports. Non-U.S. MBSD members are 
required to submit unaudited monthly financial statements to MBSD. Non-
U.S. GSD netting members are required to submit certain quarterly 
financial information to GSD. In addition, the GSD rules currently 
require non-U.S. members and applicants to also submit all ``material 
regulatory filings'' that the entity makes with its primary regulator 
in its home jurisdiction. However, FICC cannot specifically identify 
all such material regulatory filings for non-U.S. members and 
applicants with confidence.
    Under the rule change, which will be adopted uniformly across both 
FICC divisions, FICC will require non-U.S. members (other than those 
organized or established in the U.K. and regulated by the Financial 
Services Authority (``FSA'')) to provide specific monthly or quarterly 
financial data, as applicable, directly to FICC. FICC will provide the 
non-U.S. members with a form requesting specific financial data related 
to capital, assets, liabilities, revenue, pertinent ratios, and various 
capital requirements, as applicable. Each non-U.S. member will be 
required to complete the form, have it signed by the entity's chief 
financial officer, chief executive officer, or similar high-ranking 
official, and return it to FICC by a prescribed deadline.
    Broker-dealers and banks that are organized or established in the 
U.K. and regulated by the FSA will be required to submit certain 
regulatory monthly or quarterly reports, as applicable, that are filed 
with the FSA.\4\ Because FICC will be able to obtain the necessary 
financial data from these reports, these U.K. firms will not be 
required to complete and submit FICC's financial reporting form as are 
other non-U.S. members. FICC's rules will provide that failure to 
submit the financial form or the U.K. regulatory reports, as 
applicable, to FICC within the timeframes established by FICC will 
subject a member to the same consequences, including a fine, as is 
currently provided for in FICC's rules for late submission of required 
financial documents.
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    \4\ Although FICC currently has no U.K. members, FICC is 
familiar with the regulatory reports filed by banks and broker-
dealers that are organized or established in the U.K. and regulated 
by the FSA.
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    FICC recognizes that certain regulatory filings provide warnings of 
possible concerns regarding a member's compliance with regulatory 
standards and its financial status. For example, under FICC's current 
rules, GSD's and MBSD's U.S. broker-dealer members are required to 
submit to FICC SEC Rule 17a-11 reports. GSD's netting members, MBSD's 
U.S. non-broker-dealer members, and all non-U.S. members must submit to 
FICC, concurrently with their submission to their relevant regulator, 
copies of regulatory notifications required to be made when a member's 
capital levels or other financial requirements fall below prescribed 
levels.\5\
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    \5\ Securities Exchange Act Release Nos. 49947 (June 30, 2004), 
69 FR 41316 (July 8, 2004) [File No. SR-FICC-2003-01] and 49156 
(Jan. 30, 2004), 69 FR 5881 (Feb. 6, 2004) [File No. SR-MBSCC-2001-
06].
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    The rule change expands this by requiring members to submit to FICC 
any regulatory notifications required to be made when it does not 
comply with its financial reporting and responsibility standards set by 
its home country regulator and when it becomes subject to a 
disciplinary action by its home country regulator. In addition, the 
rule change makes the late submission of any such filing subject to a 
fine and other related consequences that have been recently approved by 
or are pending with the Commission.\6\ This rule change requires that 
such filings be submitted to FICC in English or be in a fair and 
accurate English translation if they have been translated into English.
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    \6\ Securities Exchange Act. Release Nos. 50659 (Nov. 15, 2004), 
69 FR 67767 (Nov. 19, 2004) [File No. SR-FICC-2004-11] and 51146 
(Feb. 7, 2005), 70 FR 7984 (Feb. 16, 2005) [File No. SR-FICC-2004-
13].
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    Finally, the rule change requires MBSD non-U.S. regulated 
applicants to certify that they are in compliance with the financial 
reporting and responsibility standards of their home country. This 
requirement was recently added to GSD's rules.\7\
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    \7\ Securities Exchange Act Release No. 50617 (Nov. 1, 2004), 69 
FR 64796 (Nov. 8, 2004) [File No. SR-FICC-2004-01].
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C. Legal Risk

    FICC members that are incorporated outside of the U.S. present FICC 
with increased legal risk in the event they become insolvent.\8\ 
Notwithstanding the protections for clearing agencies contained in the 
U.S. federal laws \9\ and the New York Banking Law (which is applicable 
to GSD foreign netting members with New York state-licensed branches 
and agencies), there is a risk that a U.S. court could determine not to 
apply New York law to the adjudication of FICC's rights against an 
insolvent non-U.S. member.\10\ In such event, the foregoing protections 
may not be available to FICC.
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    \8\ At this time, GSD will continue to only permit non-U.S. 
banks operating out of U.S. branches or agencies to be Foreign 
Netting Members.
    \9\ E.g., the Federal Deposit Insurance Corporation Improvement 
Act of 1991 and the U.S. Bankruptcy Code.
    \10\ This particular matter is currently being adjudicated in a 
case that will be argued before the Second Circuit. The case 
involves a Serbian governmental agency that has brought a U.S. 
Bankruptcy Code Section 304 proceeding seeking to have the 
disposition of the assets of certain Yugoslavian banks with New York 
state-licensed agencies be considered under home country law. See 
Agency for Deposit Ins., Rehab., Bankr. & Liquidation of Banks v. 
Superintendent of Banks, Case No. 03-CV-9320 (JSR), Case No. 03-CV-
9321 (JSR), 2004 U.S. Dist. LEXIS 10848 (S.D.N.Y. June 2004).
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    In order to mitigate this risk, FICC has required and will continue 
to require non-U.S. GSD netting and MBSD clearing applicants to submit 
non-U.S. legal opinions drafted by outside counsel from the 
jurisdiction in which the member is incorporated and/or primarily 
conducts its business. As is its current practice, FICC will continue 
to make a case-by-case determination, based on its analysis of the 
legal opinion, of the legal risks presented by the home country laws of 
such applicants. In doing so, FICC will now retain U.S. outside counsel 
to review the legal opinions and to advise FICC of any risks presented. 
The rule change makes clear that, based on its review of the legal 
opinion, FICC will determine

[[Page 14738]]

what, if any, protective measures it will impose to mitigate any legal 
risks. Protective action may, for example, take the form of requiring 
the member to post additional collateral and/or requiring a member to 
post a certain percentage of its collateral requirement in a certain 
form (such as letters of credit).
    In order to protect FICC against any adverse changes in home 
country law that may have arisen since the members submitted their 
legal opinions as a part of the membership/application process and in 
order to determine whether any positive developments in home country 
law would support eliminating or relaxing any collateral premiums that 
may have been imposed on any members,\11\ FICC will require all of its 
current non-U.S. members (except those members whose opinions have been 
issued within the past 18 months) to submit a current legal opinion 
from outside non-U.S. counsel addressing the non-U.S. legal issues or 
to provide a letter on their outside counsel's letterhead stating that 
no material changes have occurred in home country law since the date of 
the original legal opinions. FICC will require its current members to 
submit these updated legal opinions (or letters) within three months of 
the approval of this filing by the Commission. FICC will then review 
with the assistance of its outside counsel all such revised legal 
opinions and those original legal opinions that counsel indicates 
remain current and will determine whether protective measures need to 
be taken or whether the current increased collateral requirements 
should continue, be relaxed, or be eliminated.
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    \11\ GSD currently has three non-U.S. netting members that are 
subject to increased clearing fund requirements due to past 
determinations of heightened legal risk presented by the insolvency 
laws of their home jurisdictions. These members are currently 
posting 100 percent of their clearing fund requirement in the form 
of one or more letters of credit and an additional 30 percent in the 
form of cash or securities.
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    The rule change will also require all non-U.S. members to provide 
an annual update of their non-U.S. legal opinion or to provide a letter 
from their outside counsel stating that no material issues have arisen 
since the issuance of the opinion or the last update. FICC may impose 
such additional requirements on non-U.S. members as described above 
based on review of such updated legal opinions.

D. Additional Changes

    The rule change will delete all references to certifications by the 
chief executive officer, chief financial officer, or other that 
accompany financial statements, financial data, or regulatory reports. 
These certifications do not appear to be standard documentation, and 
FICC historically has not received such certifications. If a need to 
request a certification with respect to a particular member or 
applicant arises, FICC will have the authority to request it pursuant 
to the general authority that it has in both division's rules to seek 
additional information.
    In addition, in a previous rule change, FICC amended its rules with 
the intention of giving FICC the option to request that financial 
figures be submitted in U.S. dollar equivalents.\12\ This rule change 
deletes this option from FICC's rules as FICC performs these 
calculations itself, intends to continue doing so, and believes that 
the pending language has the potential for confusion.
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    \12\ Supra note 8, SR-FICC-2004-01.
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    Finally, the rule change will amend the number of recent routine 
regulatory reports that a U.S. GSD netting applicant or MBSD clearing 
applicant is required to submit to FICC to the number of such reports 
that the entity has filed during the preceding 12 months or a lesser 
period if the applicant has been in business or has been registered or 
licensed for a lesser period. For example, a GSD U.S. broker-dealer 
applicant that is a monthly FOCUS filer would need to submit copies of 
all of its FOCUS reports filed during the preceding 12 months. With 
respect to 17a-11 reports, where the current rules do not specify the 
necessary time period, the proposed rule change requires U.S. broker-
dealer applicants to submit all 17a-11 reports filed during the 
preceding 24 months.

II. Comments

    The Institute of International Bankers (``IIB'') submitted two 
comment letters. While the first letter objected to the increased 
financial requirements for entities submitting financial statements 
prepared using non-U.S. GAAP, its primarily focus was on its objections 
to standard clearing fund premiums for all non-U.S. members. After FICC 
amended the proposal to remove the standard clearing fund premiums for 
non-U.S. members, the IIB wrote in support of the proposed rule change, 
particularly with respect to the provisions that address how FICC will 
manage the legal risk arising from the participation in FICC by 
branches of international banks that operate in the United States.
    The III Global Ltd., III Finance Ltd., and III Relative Value/Macro 
Hub Fund Ltd. investment companies submitted a comment letter also 
objecting to standard clearing fund premiums for non-U.S. members. 
However, as with the IIB's first letter, this letter also addressed a 
version of the proposed rule change that the Commission had not yet 
published for comment and that FICC substantively modified.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing be designed to assure the safeguarding of 
securities and funds which are in its custody or control.\13\ The 
proposed rule change should enhance FICC's surveillance and assessment 
of applicants' and members' financial and legal condition. In addition, 
the proposed rule change will harmonize both of FICC's division's 
application and membership requirements and will make clear to all 
applicants and members of the breadth of financial and legal 
information that FICC will require and review in order to develop an 
accurate risk profile to evaluate an applicant's or member's financial 
condition. Accordingly, the proposed rule should appropriately enhance 
FICC's ability to mitigate financial risk to itself and to its members 
and therefore should help FICC to assure the safeguarding of securities 
and funds that are in its custody or control or for which it is 
responsible.
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    \13\ 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 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act \14\ and the 
rules and regulations thereunder.
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    \14\ 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-2004-14) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-1257 Filed 3-22-05; 8:45 am]
BILLING CODE 8010-01-P