[Federal Register Volume 70, Number 122 (Monday, June 27, 2005)]
[Notices]
[Pages 36981-36982]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-3324]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51896; File No. SR-FICC-2004-22]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving a Proposed Rule Change Establishing a Sponsored 
Membership Program

June 21, 2005.
    On November 12, 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\ and on February 28, 
2005, and May 6, 2005, amended the proposed rule change.\2\ Notice of 
the proposal was published in the Federal Register on May 12, 2005.\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\ The May 6, 2005, amendment to the proposed rule change 
clarified that sponsored members must ``immediately'' notify the 
sponsoring member (instead of ``promptly'' notify FICC as would have 
been required by the original filing) and that sponsoring members 
must promptly notify FICC if the sponsored member is no longer in 
compliance with the membership requirements. Because this change is 
technical in nature, republication of the notice was not required.
    \3\ Securities Exchange Act Release No. 51659 (May 5, 2005); 70 
FR 25129.
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I. Description

    The rule change creates a new Rule 3A of FICC's Government 
Securities Division's (``GSD'') rules that will establish new 
membership categories and requirements for sponsoring members and 
sponsored members whereby certain existing netting members will be 
permitted to sponsor certain buy-side entities into membership. The 
rule change will also make conforming changes to FICC's 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.\4\ In order to be eligible 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 are 
both the initial and the continuing minimum financial requirements for 
sponsoring members. All applications for sponsoring membership will be 
decided on by FICC's Membership and Risk Management Committee.\5\
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    \4\ FICC will submit a proposed rule change should it decide to 
expand the types of entities that may be sponsoring members.
    \5\ 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.\6\ 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 each sponsoring 
member to represent in writing that each entity it wishes to sponsor 
meets these requirements. Thereafter, sponsoring members will have to 
make these representations to FICC on an on-going basis. Sponsored 
members will have to immediately notify their sponsoring member anytime 
it is no longer in compliance with the membership requirements. GSD 
management will decide on entities applying to become sponsored 
members.\7\
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    \6\ FICC will submit a proposed rule change should it decide to 
expand the types of entities that may be sponsored members.
    \7\ Rule 3A, Sections 2(d) and 3.
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    Since a sponsoring member will act as the processing agent for its 
sponsored members, FICC will interact solely with the sponsoring member 
for operational purposes. The sponsoring member will have to establish 
an omnibus account for all of its sponsored members' activity. The 
omnibus account will be in addition to the sponsoring member's regular 
netting account. FICC will permit, but not require, the sponsoring 
member to submit sponsored member activity on a locked-in basis. \8\
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    \8\ Rule 3A, Sections 5 and 6.
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    FICC will 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 will be netted as 
if it were the activity of one netting member. As a result, the omnibus 
account will have only one net settlement obligation per CUSIP on a 
daily basis.\9\ The same will be true with respect to funds-only 
settlement for the omnibus account.\10\
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    \9\ Rule 3A, Sections 7 and 8.
    \10\ Rule 3A, Section 9.
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    The required clearing fund deposit of each sponsored member whose 
trading activity is submitted to the omnibus account will be calculated 
in the same manner as is done for the trading activity of a netting 
member in its regular netting account except that FICC will compute the 
required clearing fund deposit for each sponsored member on a 
standalone basis. FICC then will add each sponsored member's calculated 
requirement to two additional figures that will be calculated at the 
omnibus account level (i.e., the portion of the clearing fund 
calculation for adjusted funds-only settlement amounts for and fail net 
settlement positions) to come to a total clearing fund requirement for 
the omnibus account. For risk management purposes, FICC will 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.\11\
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    \11\ Rule 3A, Section 10.
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    FICC understands 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.\12\ Under the GSD clearing 
fund formula, this would cause a sponsoring member to pay clearing fund 
of an additional 4 percent of its overall transactional volume with its 
sponsored members,

[[Page 36982]]

which may potentially amount to hundreds of millions of dollars of 
additional clearing fund obligations.\13\ FICC believes that this 
potential adverse impact on a sponsoring member is unnecessary because 
these additional funds payments are pass-through amounts between 
sponsored members and their sponsoring members do not represent risk to 
FICC or its members. Therefore, FICC will 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 will 
reserve the right to not adjust the funds-only settlement component 
when, in its discretion, the circumstances warrant such action (for 
example, under extraordinary market conditions).
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    \12\ This means that when a custody client wishes to engage in a 
reverse repo transaction (for example, the custodian client is 
lending $100), it will generally require collateral of 102 percent 
of the value of the money loaned (in this example, $102 worth of 
U.S. Treasury securities).
    \13\ The following example will illustrate why this occurs under 
FICC's GSD's 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. 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, the sponsored member will pay $102 in funds. This 
requires FICC to make an adjustment for funds-only settlement 
purposes by debiting the sponsored member $2 and crediting the 
sponsoring member $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 will be principally liable for satisfying its 
securities and funds-only settlement obligations. For operational and 
administrative purposes, FICC will interact with the sponsoring member 
as agent for the sponsored members for day-to-day satisfaction of these 
obligations.\14\
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    \14\ Rule 3A, Sections 8 and 9.
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    While the sponsored members will be principally liable for their 
settlement obligations, the sponsoring member will 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 will be able to invoke the guaranty 
provided by the sponsoring member.\15\
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    \15\ Definition of ``Sponsoring Member Guaranty'' and Rule 3A, 
Section 2.
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    Sponsored members will 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 will not be responsible for or considered in the 
calculation of the loss allocation obligations. Such obligations will 
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 will 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.\16\
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    \16\ Rule 3A, Section 12.
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II. 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.\17\ The 
proposed rule change is consistent with the requirements of Section 17A 
of the Act and the rules and regulations thereunder because the 
sponsoring and sponsored membership categories and related rules have 
been crafted in a manner that, while providing for sponsored members, 
adequately takes into account any associated risks.
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    \17\ 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 \18\ and the 
rules and regulations thereunder.
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    \18\ 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-2004-22) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-3324 Filed 6-24-05; 8:45 am]
BILLING CODE 8010-01-P