[Federal Register Volume 72, Number 25 (Wednesday, February 7, 2007)]
[Notices]
[Pages 5774-5775]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-1948]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55217; File No. SR-FICC-2006-16]


Self-Regulatory Organizations; The Fixed Income Clearing 
Corporation; Order Approving Proposed Rule Change To Replace the 
Government Securities Division Clearing Fund Calculation Methodology 
With a Yield-Driven Value-at-Risk Methodology

January 31, 2007.

I. Introduction

    On October 4, 2006, the Fixed Income Clearing Corporation 
(``FICC'') filed with the Securities and Exchange Commission 
(``Commission'') and on November 14, 2006, amended proposed rule change 
SR-FICC-2006-16 pursuant to Section 19(b)(1) of the Securities Exchange 
Act of 1934 (``Act'').\1\ Notice of the proposal was published in the 
Federal Register on December 27, 2006.\2\ The Commission received no 
comment letters in response to the proposed rule change. 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. 54964 (December 19, 
2006), 71 FR 77835 (SR-FICC-2006-16).
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II. Description

    FICC seeks to replace the Government Securities Division (``GSD'') 
margin calculation methodology with a value-at-risk (``VaR'') 
methodology.
    Netting members of FICC's GSD are required to maintain clearing 
fund deposits. Each member's required clearing fund deposit is 
calculated daily to ensure that enough funds are available to cover the 
risks associated with that member's activities. The purposes served by 
the clearing fund are to: (i) Have on deposit at FICC funds from each 
member sufficient to satisfy any losses that may be incurred by FICC or 
its members resulting from the default by a member and the resultant 
close out of that member's settlement positions and (ii) ensure that 
FICC has sufficient liquidity at all times to meet its payment and 
delivery obligations.
    FICC proposes to replace the current clearing fund methodology used 
at GSD, which uses haircuts and offsets, with a yield-driven VaR 
methodology that is expected to better reflect market volatility and 
more thoroughly distinguish the levels of risk presented by individual 
securities. VaR is defined to be the maximum amount of money that may 
be lost on a portfolio over a given period of time within a given level 
of confidence. With respect to the GSD, FICC will use a 99 percent 
three-day VaR.\3\
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    \3\ Category 2 Dealers and Category 2 Futures Commission 
Merchants will be subject to higher confidence levels than other 
Netting Members.
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    The changes to the components that comprise the current clearing 
fund methodology compared to the proposed VaR methodology in relation 
to the risks addressed by the components are summarized below.
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    \4\ Under the current GSD rules, Category 1 Inter-Dealer Brokers 
are subject to a flat $5 million clearing fund requirement. This 
proposed rule change does not alter that requirement.
    \5\ FICC will have the discretion to not apply the interest rate 
model to classes of securities whose volatility is less amenable to 
statistical analysis, which is usually due to a lack of pricing 
history. In lieu of such a calculation, the required charge with 
respect to such positions will be determined based on a historic 
index volatility model.
    \6\ FICC is adopting a new definition for ``Term Repo 
Transaction'' to clarify the types of transactions covered by this 
component. As proposed, Term Repo Transaction will mean, on any 
particular Business Day, a Repo Transaction for which settlement of 
the Close Leg ``is scheduled to occur two or more Business Days 
after the scheduled settlement of the Start Leg.'' In addition, the 
existing definition for ``Term GCF Repo Transaction'' is being 
revised to conform to the language for ``Term Repo Transaction'' as 
the new definition provides greater clarity as to transactions 
covered.

------------------------------------------------------------------------
                                                    Proposed methodology
    Existing methodology         Risk addressed              \4\
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Receive/Deliver component     Fluctuation in        Interest rate or
 using margin factors.         security prices.      index-driven model,
                                                     as appropriate.\5\
Repo Volatility component...  Fluctuation in repo   Repo index-driven
                               interest rates.       model.\6\
Funds Adjustment Deposit      Uncertainty of        Margin Requirement
 component (based on the       whether a member      Differential
 average size of the           will satisfy its      (``MRD'') (a
 member's 20 highest funds-    funds-only            portion of which is
 only settlement amounts       settlement            based on the
 over the most recent 75       obligation.           historical size of
 business days).                                     a member's funds-
                                                     only settlement
                                                     obligation).
Average Post Offset Margin    Uncertainty of        MRD (a portion of
 Amount component (based on    whether a member      which is based on
 the 20 highest margin         will satisfy its      the historical
 amounts derived from all      next clearing fund    variability of a
 outstanding net settlement    call.                 member's clearing
 positions over the most                             fund requirement).
 recent 75 business days).
Not specifically covered....  Intraday risk and     Coverage Component
                               additional exposure   (if necessary,
                               due to portfolio      applies additional
                               variation and         minimum charge to
                               potential loss in     bring coverage to
                               unlikely situations   the applicable
                               beyond the model's    confidence level).
                               effective range.
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[[Page 5775]]

    In addition, FICC will be able to include in a member's clearing 
fund requirement a ``special charge'' based on such factors as FICC 
determines to be appropriate from time to time. Such factors may 
include, but are not limited to, such things as price fluctuation, 
volatility, or lack of liquidity.
    The proposed VaR methodology will necessitate a change to FICC's 
risk management consequences of the late allocation of repo 
substitution collateral. Because offset classes and margin rates will 
no longer be present in the revised GSD rules, FICC will base the 
margining for such a generic CUSIP on the same calculation as that used 
for securities whose volatility is less amenable to statistical 
analysis.\7\
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    \7\ Securities Exchange Act Release No. 53534 (March 21, 2006), 
71 FR 15781 (March 29, 2006) (File No. SR-FICC-2005-18). This rule 
change created a generic CUSIP offset and applicable margin rate for 
determining clearing fund consequences for such late allocations.
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    The VaR methodology will not include calculations that are 
incorporated in the GSD's current cross-margining programs with The 
Clearing Corporation (``TCC'') and with the Chicago Mercantile Exchange 
(``CME''). In order to provide for continuity of cross-margining 
following the implementation of the VaR methodology and because certain 
key calculations required for cross-margining are unique to cross-
margining, FICC will continue to perform the applicable cross-margining 
calculations outside of the VaR model. FICC will then adjust the cross-
margining clearing fund calculation using a scaling ratio of the VaR 
clearing fund calculation to the cross-margining clearing fund 
calculation so that the clearing fund amount available for cross-
margining is appropriately aligned with the VaR model. The proposed 
changes described herein will necessitate amendments to FICC's cross-
margining agreements with TCC and with CME as follows:
    1. The definition of FICC's ``Margin Rate'' in each of the 
agreements will be amended to reflect that the margin rate will no 
longer be based on margin factors published in the current rules (as 
these will no longer be applied under the VaR methodology). Instead, 
they will be determined based on a percentage that will be determined 
using the same parameters and data (e.g., confidence level and historic 
indices) as those used to generate margin factors in the current rules.
    2. Section 5(a) of each cross-margining agreement will be amended 
to state that FICC's residual margin amount will be calculated as 
specified in the agreement and will be adjusted, if necessary, to 
correct for differences between the methodology of calculating the 
residual margin amount as described in the agreement and the VaR 
methodology. This change will be necessary to account for the deletion 
of relevant margin factors and disallowance schedules (which, like the 
margin factors, are incorporated into the agreements by reference) from 
GSD rules and to adjust for the possibility that the new VaR 
methodology could generate a charge that would otherwise allow for a 
cross-margining reduction that is greater than the margin requirement.

III. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to assure the safeguarding of 
securities and funds in FICC's custody or control or for which it is 
responsible.\8\ Because FICC's proposed rule change implements a VaR 
methodology that should better reflect market volatility and should 
more thoroughly distinguish the levels of risk presented by individual 
securities, FICC should be able to more accurately calculate the risk 
presented by each of its member's activity and to collect clearing fund 
to protect against that risk. As a result, FICC should be in a better 
position to assure the safeguarding of securities and funds in its 
custody or control or for which it is responsible.
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    \8\ 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. In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition and capital 
formation.\9\
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    \9\ 15 U.S.C. 78c(f).
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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-2006-16) be and hereby 
is approved.
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    \10\ 17 CFR 200.30-3(a)(12).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-1948 Filed 2-6-07; 8:45 am]
BILLING CODE 8010-01-P