[Federal Register Volume 70, Number 91 (Thursday, May 12, 2005)]
[Notices]
[Pages 25129-25131]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-2352]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51659; File No. SR-FICC-2004-22]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating To Establishing a 
Sponsored Membership Program

May 5, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

[[Page 25130]]

(``Act''),\1\ notice is hereby given that on November 12, 2004, the 
Fixed Income Clearing Corporation (``FICC'') filed a proposed rule 
change with the Securities and Exchange Commission (``Commission'') and 
on February 28, 2005, amended the proposed rule change as 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 persons.
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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 proposed rule change would establish a sponsoring member-
sponsored member relationship in FICC's rules whereby certain existing 
netting members would be permitted to sponsor certain buy-side entities 
into membership.

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 such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In an effort to have buy-side entities, such as registered 
investment companies, become members of FICC's Government Securities 
Division (``GSD''), FICC is proposing to add a new Rule 3A to GSD's 
rules that would govern the rights and obligations of sponsoring 
members and sponsored members and to make conforming changes to 
existing rules to accommodate the introduction of these new membership 
categories.
    GSD will initially permit only bank netting members to apply to 
become sponsoring members.\2\ In order to be eligible to apply to 
become a sponsoring member, a bank netting member will have to meet 
more stringent minimum financial requirements than those required for 
GSD netting membership. Specifically, the sponsoring member will have 
to have a level of equity capital of at least $5 billion and will have 
to satisfy the ratios established by the Federal Deposit Insurance 
Corporation for being ``well-capitalized.'' If the sponsoring member 
has a bank holding company that is registered under the Bank Holding 
Company Act of 1956, then the bank holding company will also have to be 
``well-capitalized'' under the relevant regulations of the Board of 
Governors of the Federal Reserve System. These financial criteria will 
also be the sponsoring member's continuing minimum financial 
requirements that it will have to be maintained on an on-going basis. 
Applications for sponsoring membership will be considered by FICC's 
Membership and Risk Management Committee.\3\
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    \2\ FICC understands that submission of a rule filing will be 
necessary in order to expand the types of entities that may be 
sponsoring members.
    \3\ Proposed Rule 3A, Section 2.
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    To become a sponsored member, GSD will permit only entities that 
are (i) registered investment companies under the Investment Company 
Act of 1940 and (ii) qualified institutional buyers under Rule 144A of 
the Securities Act of 1933.\4\ In addition, an entity will only be able 
to become a sponsored member if there is a sponsoring member willing to 
sponsor the entity into membership. FICC will require a sponsoring 
member to represent in writing that each entity it wishes to make its 
sponsored member meets these requirements. Thereafter, sponsoring 
members will have to make these representations on an on-going basis as 
well. GSD management will approve entities to become sponsored 
members.\5\
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    \4\ FICC understands that submission of a rule filing will be 
necessary in order to expand the types of entities that may be 
sponsored members.
    \5\ Proposed Rule 3A, Sections 2(d) and 3.
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    The risk management of this arrangement would occur primarily at 
the sponsoring member level. FICC believes that this obviates the need 
for it to conduct financial reviews and on-going financial surveillance 
of sponsored members as it performs for netting members and as it will 
perform for sponsoring members.
    Since a sponsoring member would act as the processing agent for its 
sponsored members, FICC would interact solely with the sponsoring 
member for operational purposes. The sponsoring member would have to 
establish an omnibus account for all of its sponsored members' 
activity. The omnibus account would be in addition to the sponsoring 
member's regular netting account. FICC would permit the sponsoring 
member to submit sponsored member activity on a locked-in basis if it 
chooses to do so.\6\
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    \6\ Proposed Rule 3A, Sections 5 and 6.
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    FICC would provide its settlement guaranty to each sponsored member 
with respect to its respective net settlement positions (i.e., for 
clearing fund calculation, each sponsored member's trading activity is 
treated separately). For operational and securities clearance purposes, 
however, all of the activity in the omnibus account would be netted as 
if it were the activity of one netting member. Therefore, the omnibus 
account would have only one net settlement obligation per CUSIP on a 
daily basis as an operational matter.\7\ The same would be true with 
respect to funds-only settlement.\8\
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    \7\ Proposed Rule 3A, Sections 7 and 8.
    \8\ Proposed Rule 3A, Section 9.
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    The margin requirement of each sponsored member whose activity is 
submitted to the omnibus account would be calculated in the same manner 
as is done for a netting member except that FICC would compute the 
required clearing fund deposit for each sponsored member on a 
standalone basis. FICC then would add those figures to two additional 
figures that would be calculated at the omnibus account level (for 
adjusted funds-only settlement amounts and fail net settlement 
positions) to come to a total clearing fund requirement for the omnibus 
account. For risk management purposes, FICC would not net the resulting 
clearing fund calculations of each sponsored member within the omnibus 
account with those of other sponsored members in the omnibus 
account.\9\
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    \9\ Proposed Rule 3A, Section 10.
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    FICC has learned that the custodial banks that are likely to be 
interested in becoming sponsoring members generally collateralize their 
custody clients (i.e., the potential sponsored members) at 102 percent 
for U.S. Treasury repurchase agreements.\10\ Under the current GSD 
clearing fund formula, this would cause a sponsoring member to pay an 
additional 4 percent of its overall transactional volume with sponsored 
members in the form of clearing fund margin, which may potentially 
amount to hundreds of millions of dollars of additional clearing fund 
obligations.\11\ FICC believes that

[[Page 25131]]

this potential adverse impact on a sponsoring member is unnecessary 
because these additional funds payments are pass-through amounts and do 
not represent risk to FICC or its members. Therefore, FICC proposes to 
amend the clearing fund rule to adjust for this funds-only settlement 
component when calculating the clearing fund requirements for the 
sponsored members, the omnibus account, and the sponsoring member's 
regular netting account. FICC would reserve the right to not adjust the 
funds-only settlement component under extraordinary circumstances.
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    \10\ This means that when a custody client wishes to engage in a 
reverse repo transaction by lending money (for example, $100), it 
will generally require collateral in excess of the money loaned (for 
example, $102).
    \11\ An example will illustrate why this occurs under the 
clearing fund formula. Assume that the start leg of the repo 
transaction between the sponsoring member and the sponsored member 
calls for the sponsored member to lend $100 and receive $102 in 
securities. During the next day, the close leg of the repo 
transaction to which FICC has become counterparty will call for the 
sponsored member to send the collateral back to FICC, and FICC, 
which settles at market value, will pay $102 in funds. This requires 
an adjustment to occur for funds-only settlement purposes: FICC will 
debit the sponsored member $2 and will, in turn, credit the 
sponsoring member's regular netting account $2. These funds-only 
settlement amount payments are referred to as ``transaction 
adjustment payments'' in the GSD's rules. Because one component of 
the clearing fund requires inclusion of the absolute value of the 
funds-only settlement amounts (i.e., regardless of whether they are 
debits or credits), the transaction adjustment payments will 
artificially inflate the clearing fund requirements related to both 
the sponsored member omnibus account and the sponsoring member's 
regular netting account.
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    Each sponsored member would be principally liable for satisfying 
its securities and funds-only settlement obligations. For operational 
and administrative purposes, FICC would interact with the sponsoring 
member as agent for the sponsored members for day-to-day satisfaction 
of these obligations.\12\
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    \12\ Proposed Rule 3A, Sections 8 and 9.
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    While the sponsored members would be principally liable for their 
settlement obligations, the sponsoring member would be required to 
provide a guaranty to FICC with respect to such obligations. This means 
that in the event one or more sponsored members do not satisfy their 
settlement obligations, FICC would be able to invoke the guaranty 
provided by the sponsoring member.\13\
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    \13\ Proposed definition of ``Sponsoring Member Guaranty'' and 
proposed Rule 3A, Section 2.
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    Sponsored members would not be liable for any loss allocation 
obligations. To the extent that a ``remaining loss'' (as defined in the 
GSD's rules) arises in connection with ``direct transactions'' (as 
defined in the GSD's rules) between the sponsoring member and its 
sponsored members (i.e., the sponsoring member is the insolvent party), 
the sponsored members would not be responsible for or considered in the 
calculation of the loss allocation obligations. Such obligations would 
be the obligation of the other netting members that had direct 
transactions with the sponsoring member in its capacity as a netting 
member. To the extent there is an allocation other than for direct 
transactions between the sponsoring member and its sponsored members, 
the sponsored members would be counted as if they were obligated to pay 
the loss allocation amounts but it will be the sponsoring member's 
obligation to pay such amounts.\14\
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    \14\ Proposed Rule 3A, Section12.
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    FICC believes that the proposed rule change is consistent with the 
requirements of the Act and the rules thereunder because it would 
enable more entities to take advantage of FICC's services thereby 
promoting the prompt and accurate clearance and settlement of 
securities transactions.

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.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    FICC has not solicited or received written comments relating to the 
proposed rule change. FICC will notify the Commission of any written 
comments it receives.

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-2004-22 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-2004-22. 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://ficc.com/gov/gov. docs.jsp?NS-query=. 
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-2004-22 
and should be submitted on or before June 2, 2005.

    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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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-2352 Filed 5-11-05; 8:45 am]
BILLING CODE 8010-01-P