[Federal Register Volume 76, Number 43 (Friday, March 4, 2011)]
[Notices]
[Pages 12144-12155]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-4836]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63986; File No. SR-FICC-2010-09]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change To Introduce Cross-
Margining of Certain Positions Cleared at the Fixed Income Clearing 
Corporation and Certain Positions Cleared at New York Portfolio 
Clearing, LLC

February 28, 2011.

I. Introduction

    On November 12, 2010, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2010-09 pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'').\1\ 
Notice of the proposed rule change was published in the Federal 
Register on November 30, 2010.\2\ The Commission initially received 
thirteen comments to the proposed rule change.\3\ FICC, as well as one 
of the commenters, submitted letters responding to the comments.\4\ For 
the reasons discussed below, the Commission is granting approval of the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 63361 (November 23, 
2010), 75 FR 74110 (November 30, 2010) (FICC-2010-09). In its filing 
with the Commission, FICC included statements concerning the purpose 
of and basis for the proposed rule change. The text of these 
statements are incorporated into the discussion of the proposed rule 
change in Section II below.
    \3\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Douglas Engmann, President, Engmann 
Options, Inc. (December 6, 2010); Letter from Ronald Filler, 
Professor of Law and Director of the Center on Financial Services 
Law, New York Law School (December 8, 2010); Letter from John C. 
Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from John Willian, 
Managing Director, Goldman Sachs (December 17, 2010); Letter from 
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS 
Securities, LLC (December 20, 2010); Letter from Donald J. Wilson, 
Jr., DRW Trading Group (December 21, 2010); Letter from John A. 
McCarthy, General Counsel, GETCO (December 21, 2010); Letter from 
Gary DeWaal, Senior Managing Director and Group General Counsel, 
Newedge USA, LLC (December 21, 2010); Letter from Adam C. Cooper, 
Senior Managing Director and Chief Legal Officer, Citadel, LLC 
(December 21, 2010); Letter from William H. Navin, Executive Vice 
President and General Counsel, The Options Clearing Corporation 
(December 21, 2010); and Letter from Joan C. Conley, Senior Vice 
President & Corporate Secretary, NASDAQ OMX (December 21, 2010).
    \4\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011); Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011); and Letter from Alex 
Kogan, Vice President and Deputy General Counsel, NASDAQ OMX 
(January 10, 2011).
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II. Description

    The proposed rule change allows FICC to offer cross-margining of 
certain positions cleared at its Government Securities Division 
(``GSD'') and certain positions cleared at New York Portfolio Clearing, 
LLC (``NYPC'').\5\ GSD members will be able to combine their positions 
at GSD with their positions at NYPC, or those positions of certain 
permitted affiliates cleared at NYPC, within a single margin portfolio 
(``Margin Portfolio''). The proposed rule change also makes certain 
other related changes to GSD's rules.
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    \5\ NYPC is jointly owned by NYSE Euronext and The Depository 
Trust & Clearing Corporation (``DTCC''). DTCC is the parent company 
of FICC. On January 31, 2011, the Commodity Futures Trading 
Commission (``CFTC'') approved NYPC's registration as a derivatives 
clearing organization (``DCO'') pursuant to Section 5b of the 
Commodity Exchange Act and Part 39 of the Regulations of the CFTC.
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A. Cross-Margining With NYPC

    Under the proposed rule, a member of FICC that is also an NYPC 
clearing member (``Joint Clearing Member'') could in accordance with 
the provisions of the GSD and NYPC Rules, elect to participate in the 
cross-margining arrangement. FICC's rules permit a GSD netting member 
that is a member (or that has an affiliate that is a member) of one or 
more Futures Clearing Organizations (``FCO''),\6\ such as NYPC, to 
become a cross-margining participant in a cross-margining arrangement 
between FICC and one or more FCOs with the consent of FICC and each 
such FCO. A netting member shall become a cross-margining participant 
upon acceptance of FICC and each applicable FCO of an agreement 
executed by such cross-margining participant in the form specified in 
the applicable cross-margining agreement.\7\
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    \6\ ``FCO'' is defined in GSD Rule 1 as a clearing organization 
for a board of trade designated as a contract market under Section 5 
of the Commodity Exchange Act that has entered into a Cross-
Margining Agreement with FICC.
    \7\ See GSD Rule 43, Cross-Margining Arrangements, Section 2. 
The cross-margining agreement between FICC and NYPC as well as the 
cross-margining participant agreements for joint and permitted 
affiliates are attached to FICC's filing of proposed rule change SR-
FICC-2010-09.
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    Participating in the cross-margining arrangement would permit a 
Joint Clearing Member to have its margin requirement calculated taking 
into account both its positions at FICC and NYPC, which should provide 
a clearer picture of its risk exposure and generally facilitate better 
risk assessment by FICC. Specifically, each Joint Clearing Member would 
have its margin requirement with respect to Eligible Positions (i.e., 
positions in certain securities netted by FICC or certain futures 
contracts cleared by an FCO) \8\ in its proprietary account at

[[Page 12145]]

NYPC and its margin requirement with respect to Eligible Positions at 
FICC calculated as a single portfolio, which would factor in the net 
risk of such Eligible Positions at both clearing organizations. In 
addition, an affiliate of a member of FICC that is also a clearing 
member of NYPC (``Permitted Margin Affiliate'') \9\ could similarly 
elect to participate in the cross-margining arrangement and have its 
margin requirement with respect to Eligible Positions in its 
proprietary account at NYPC calculated as a single portfolio with the 
Eligible Positions of the FICC member.
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    \8\ The term ``Eligible Position'' is currently defined in GSD's 
rules as a position in certain Eligible Netting Securities netted by 
FICC, or certain Government securities futures contracts or interest 
rate futures contracts cleared by a FCO as identified in a Cross-
Margining Agreement as eligible for cross-margining treatment.
    ``Eligible Netting Security'' is defined in GSD Rule 1 as an 
Eligible Security that FICC has designed as eligible for netting.
     ``Eligible Security'' is defined generally in GSD Rule 1 as a 
security issued or guaranteed by the United States, a U.S. 
government agency or instrumentality, a U.S. government-sponsored 
corporation, or any other security approved by FICC's board of 
directors from time to time, or one or more categories of such 
securities as represented by a generic CUSIP number, that FICC has 
listed on the Eligible Securities master file maintained by it 
pursuant to GSD Rule 30.
    \9\ The term ``Permitted Margin Affiliate'' is being added to 
GSD Rule 1 and is defined as an affiliate of a Member that is (i) 
also a member of GSD, and/or (ii) a member of an FCO with which FICC 
has entered into a Cross-Margining Agreement that provides for 
margining of positions between FICC and the FCO as if such positions 
were in a single portfolio and that directly or indirectly controls 
such particular member, or that is directly or indirectly controlled 
by or under common control with such particular member. Ownership of 
more than 50% of the common stock of the relevant entity (or 
equivalent equity interests in the case of a form of entity that 
does not issue common stock) will be conclusive evidence of prima 
facie control of such entity for purposes of this definition.
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    The proposed rule allows (i) Joint Clearing Members and (ii) 
members of FICC and their Permitted Margin Affiliates to have their 
margin requirements for positions at FICC and NYPC determined as a 
single portfolio, with FICC and NYPC each having a security interest in 
such members' and Permitted Margin Affiliates' margin deposits and 
other collateral to secure their obligations to FICC and NYPC.
    The following types of FICC members will not be eligible to 
participate in the cross-margining arrangement (``NYPC Arrangement''), 
in order to allow FICC to maintain segregation of certain business or 
member types that are treated differently for purposes of loss 
allocation: (i) GSD Sponsored Members,\10\ (ii) Inter-Dealer Broker 
Netting Members,\11\ and (iii) Dealer Netting Members \12\ with respect 
to their segregated brokered accounts. In addition, in order for a Bank 
Netting Member \13\ to combine its accounts into a Margin Portfolio 
with any other accounts, it will have to demonstrate to the 
satisfaction of FICC and NYPC that doing so will comply with the 
regulatory requirements applicable to the Bank Netting Member (e.g., by 
providing an opinion of counsel or otherwise outlining compliance with 
relevant statutory provisions).\14\
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    \10\ A ``Sponsored Member'' of GSD is any person that has been 
approved by FICC to be sponsored into membership by a ``Sponsoring 
Member'' pursuant to GSD Rule 3A. A ``Sponsoring Member'' is a 
member of GSD's comparison and netting system whose application to 
become a sponsoring member has been approved by the FICC's board of 
directors pursuant to GSD Rule 3A. See GSD Rule 1, Definitions.
    \11\ The definition of ``Inter-Dealer Broker Netting Member,'' 
as revised by the proposed rule change, is an inter-dealer broker 
admitted to membership in GSD's netting system. See GSD Rule 2A, 
Initial Membership Requirements.
    \12\ The definition of a ``Dealer Netting Member,'' as revised 
by the proposed rule change, is a registered government securities 
dealer admitted to membership in GSD's netting system. See GSD Rule 
2A, Initial Membership Requirements.
    \13\ Under GSD Rule 2A, a person shall be eligible to apply to 
become a ``Bank Netting Member'' of GSD if it is a bank or trust 
company chartered as such under the laws of the United States, or a 
State thereof, or is a bank or trust company established or 
chartered under the laws of a non-U.S. jurisdiction, and 
participates in FICC through its U.S. branch or agency. A bank or 
trust company that is admitted to membership in GSD's netting 
system, the netting system, pursuant to these Rules, and whose 
membership in the netting system has not been terminated, shall be a 
Bank Netting Member. See GSD Rule 2A, Initial Membership 
Requirements, Section 2.
    \14\ See GSD Rule 4, Clearing Fund and Loss Allocation, Section 
1a as proposed to be amended by the proposed rule change.
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    In order to distinguish the NYPC Arrangement from an existing 
cross-margining arrangement between the Chicago Mercantile Exchange 
(``CME'') and FICC (``CME Arrangement''), the proposed rule amends the 
definition of ``Cross-Margining Agreement'' in the GSD rules to mean an 
agreement entered into between FICC and one or more FCOs pursuant to 
which a Cross-Margining Participant,\15\ in accordance with the 
provisions of the GSD Rules and otherwise at the discretion of FICC, 
could elect to have its Required Fund Deposit \16\ with respect to 
Eligible Positions at FICC, and its (or its Permitted Margin 
Affiliates' Required Fund Deposit, if applicable) margin requirements 
with respect to Eligible Positions at such FCO(s), calculated either 
(i) by taking into consideration the net risk of such Eligible 
Positions at each of the clearing organizations or (ii) as if such 
positions were in a single portfolio. The CME Arrangement falls into 
clause (i) of the definition, whereas the NYPC Arrangement will fall 
into clause (ii). Conforming changes will be made to GSD Rule 1, 
Definitions, relating to cross-margining. GSD Rule 43, Cross-Margining 
Arrangements, also will be amended to add provisions regarding single-
portfolio margining (i.e., the proposed NYPC Arrangement). To implement 
this proposal, FICC and NYPC will enter into a cross-margining 
agreement (``NYPC Agreement''). The NYPC Agreement was filed with the 
Commission as part of proposed rule change SR-FICC-2010-09 and will be 
appended to the GSD Rules and made a part thereof.
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    \15\ The term ``Cross-Margining Participant'' is defined in GSD 
Rule 1 as a Netting Member that is authorized by FICC to participate 
in the Cross-Margining Arrangement between FICC and one or more FCOs 
pursuant to a Cross-Margining Agreement. GSD Rule 1 defines the term 
``Cross-Margining Arrangement'' as the arrangement established 
between FICC and one or more FCOs pursuant to Cross-Margining 
Agreements and GSD Rule 43.
    \16\ The definition of ``Required Fund Deposit,'' as revised by 
the proposed rule change, is the amount that a Netting Member is 
required by a GSD rule to contribute to GSD's clearing fund. See GSD 
Rule 1, Definitions.
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    Pursuant to the NYPC Agreement, and consistent with previous 
approvals of cross-margining arrangements involving DCOs,\17\ cross-
margining with certain NYPC positions will be limited to positions 
carried in proprietary accounts of clearing members of NYPC. Customers 
of NYPC clearing members will not be permitted to participate in the 
NYPC Arrangement, as their participation would require the resolution 
of additional issues associated with fund segregation and operations. 
Neither FICC nor NYPC rules require their members to participate in the 
NYPC Arrangement, and any such participation by FICC and NYPC members 
will be voluntary. Joint Clearing Members and members of FICC and their 
Permitted Margin Affiliates will be required to execute the requisite 
cross-margining participant agreements.\18\
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    \17\ See, e.g., Securities Exchange Act Release No. 44301 (May 
11, 2001), 66 FR 28207 (approving a proposed rule change 
establishing cross-margining between FICC and CME) and Securities 
Exchange Act Release No. 27296 (September 26, 1989), 54 FR 41195 
(approving a proposed rule change establishing cross-margining 
between The Options Clearing Corporation and the CME).
    \18\ The NYPC Agreement and the cross-margining participant 
agreements for Joint Members and Permitted Affiliates were filed 
with the Commission as part of the proposed rule change.
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    FICC will be responsible for performing the margin calculations in 
its capacity as the Administrator under the terms of the NYPC 
Agreement. Specifically, FICC will determine the combined FICC clearing 
fund and NYPC original margin requirement for each participant.\19\ 
FICC will calculate those requirements using a Value-at-Risk (``VaR'') 
methodology, with a 99-percent confidence level and a 3-day liquidation 
period for cash positions and a 1-day liquidation period for futures 
positions. In addition, each cross-margining participant's ``one-pot'' 
margin requirement will be subject to a daily

[[Page 12146]]

back test, and a supplemental risk-related charge referred to as a 
coverage component that will be applied to the participant in the event 
that the back test reflects insufficient coverage. The ``one-pot'' 
margin requirement for each participant would then be allocated between 
FICC and NYPC in proportion to the clearing organizations' respective 
``stand-alone'' margin requirements--in other words, an amount 
reflecting the ratio of what each clearing organization would have 
required from that participant if it was not participating in the 
cross-margining program (``Constituent Margin Ratio''). The NYPC 
Agreement provides that either FICC or NYPC can, at any time, require 
additional margin to be deposited by a Cross-Margining Participant 
above what is calculated under the NYPC Agreement based upon the 
financial condition of the participant, unusual market conditions, or 
other special circumstances (e.g., in the event of regulatory or 
criminal proceedings). The standards that FICC proposes to use for 
these purposes are the standards currently contained in the GSD rules, 
so that notwithstanding the calculation of a Cross-Margin Participant's 
clearing fund requirement pursuant to the NYPC Agreement, FICC will 
retain its rights under the GSD rules to charge additional clearing 
fund contributions under the circumstances specified in the GSD rules. 
For example, the GSD rules provide that if a Dealer Netting Member 
falls below its minimum financial requirement, it shall be required to 
make additional clearing fund contributions equal to the greater of (i) 
$1 million or (ii) 25 percent of its Required Fund Deposit.
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    \19\ Original margin is the NYPC equivalent of the FICC clearing 
fund.
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    FICC will utilize the same VaR methodology for calculating margin 
for futures and cash positions. Under this method, the prior 250 days 
of historical information for futures positions and the prior 252 days 
of historical information for cash positions, including prices, spreads 
and market variables such as Treasury zero-coupon yields and London 
Interbank Offered Rate curves, are used to simulate the market 
environments in the forthcoming 1 day for futures positions and the 
forthcoming 3 days for cash positions. Projected portfolio profits and 
losses are calculated assuming these simulated environments will 
actually be realized. These simulations will be used to calculate VaR. 
Historical simulation is a continuation of the FICC margin methodology.
    With respect to the confidence level, FICC currently utilizes 
extreme value theory \20\ to determine the 99th percentile of loss 
distribution. Upon implementation of the NYPC Arrangement, FICC will 
utilize a front-weighting mechanism to determine the 99th percentile of 
loss distribution. This front-weighting mechanism will place more 
emphasis on more recent observations. Additionally, FICC's VaR 
methodology will be enhanced to accommodate more securities; as a 
result, certain CUSIPs, which are now considered to be ``non-
priceable'' (because, for example, of a lack of historical information 
regarding the security) and subject to a ``haircut'' requirement (i.e., 
fixed percentage charge) where offsets are not permitted, will be 
treated as ``priceable'' and therefore included in the core VaR 
calculation.
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    \20\ Extreme value theory is used to analyze outcomes beyond the 
99 percent confidence interval used for VaR and provides an 
assessment of the size of these events.
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    Based on preliminary analyses, FICC expects that the FICC VaR 
component of the clearing fund requirement may be reduced by as much as 
approximately 20 percent for common FICC-NYPC members as a result of 
the NYPC Arrangement. In order to help ensure that this reduction in 
clearing fund is appropriately correlated to more precise assessment of 
exposures associated with considering offsetting positions and will not 
result in increased risks to the clearing agency, FICC has performed 
back testing analysis to verify that there will be sufficient coverage 
after the FICC-NYPC cross-margining reductions are applied.
    In the event of the insolvency or default of a member that 
participates in the NYPC Arrangement, the positions in such 
participant's ``one-pot'' portfolio, including, where applicable, the 
positions of its Permitted Margin Affiliate at NYPC, will be liquidated 
by FICC and NYPC as a single portfolio and the liquidation proceeds 
will be applied to the defaulting participant's obligations to FICC and 
NYPC in accordance with the provisions of the NYPC Agreement.
    The NYPC Agreement provides for the sharing of losses by FICC and 
NYPC in the event that the ``one-pot'' portfolio margin deposits of a 
defaulting participant are not sufficient to cover the losses resulting 
from the liquidation of that participant's trades and positions. This 
loss-sharing arrangement can be summarized as follows:
     If either clearing organization had a net loss (``worse-
off party''), and the other had a net gain (``better-off party'') that 
is equal to or exceeds the worse-off party's net loss, then the better-
off party pays the worse-off party the amount of the latter's net loss. 
In this scenario, one clearing organization's gain will extinguish the 
entire loss of the other clearing organization.
     If either clearing organization had a net loss (``worse-
off party'') and the other clearing organization had a net gain 
(``better-off party'') that is less than or equal to the worse-off 
party's net loss, then the better-off party will pay the worse-off 
party an amount equal to the net gain. Thereafter, if such payment did 
not extinguish the net loss of the worse-off party, the better-off 
party will pay the worse-off party an amount equal to the lesser of: 
(i) The amount necessary to ensure that the net loss of each clearing 
organization is in proportion to the Constituent Margin Ratio or (ii) 
the better-off party's ``Maximum Transfer Payment'' less the better-off 
party's net gain. The ``Maximum Transfer Payment'' will be defined with 
respect to each clearing organization to mean an amount equal to the 
product of (i) the sum of the aggregate margin reductions of the 
clearing organizations and (ii) the other clearing organization's 
Constituent Margin Ratio--in other words, the amount by which the other 
clearing organization reduced its margin requirements in reliance on 
the cross-margining arrangement. In this scenario, one clearing 
organization's gain does not completely extinguish the entire loss of 
the other clearing organization, and the better-off party will be 
required to make an additional payment to the worse-off party. This 
potential additional payment will be capped as described in this 
paragraph.
     If either clearing organization had a net loss, and the 
other had the same net loss, a smaller net loss, or no net loss, then:
    [cir] In the event that the net losses of the clearing 
organizations were in proportion to the Constituent Margin Ratio, no 
payment will be made.
    [cir] In the event that the net losses of the clearing 
organizations were not in proportion to the Constituent Margin Ratio, 
then the clearing organization that had a net loss which was less than 
its proportionate share of the total net losses incurred by the 
clearing organizations (``better-off party'') will pay the other 
clearing organization (``worse-off party'') an amount equal to the 
lesser of: (i) The better-off party's Maximum Transfer Payment or (ii) 
the amount necessary to ensure that the clearing organizations' 
respective net losses were allocated between them in proportion to the 
Constituent Margin Ratio.

[[Page 12147]]

     If FICC had a net gain after making a payment as described 
above, FICC will pay to NYPC the amount of any deficiency in the 
defaulting member's customer segregated funds accounts or, if 
applicable, such defaulting member's Permitted Margin Affiliate held at 
NYPC up to the amount of FICC's net gain.
     If FICC received a payment under the Netting Contract and 
Limited Cross-Guaranty (``Cross-Guaranty Agreement'') \21\ to which it 
is a party (i.e., because FICC had a net loss), and NYPC had a net 
loss, FICC will share the cross-guaranty payment with NYPC pro rata, 
where such pro rata share is determined by comparing the ratio of 
NYPC's net loss to the sum of FICC's and NYPC's net losses. This 
allocation is appropriate because the ``one-pot'' combines FICC and 
NYPC proprietary positions into a unified portfolio that will be 
margined and liquidated as a single unit. FICC will no longer need to 
share the cross-guaranty payments with NYPC once NYPC becomes a party 
to the Cross-Guaranty Agreement.
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    \21\ FICC's predecessors, the Government Securities Clearing 
Corporation (``GSCC'') and the MBS Clearing Corporation (``MBSCC''), 
filed rule filings in 2001 to enter into the Cross-Guaranty 
Agreement with The Depository Trust Company, National Securities 
Clearing Corporation, Emerging Markets Clearing Corporation, and The 
Options Clearing Corporation. Securities Exchange Act Release No. 
45868 (May 2, 2002), 67 FR 31394. Under the agreement, if the assets 
of a defaulting member at one clearing agency exceed its liabilities 
to that clearing agency, those excess assets may be made available 
to satisfy the liabilities of that defaulting common member to 
another clearing agency.
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    The GSD rules will further provide that FICC will offset its 
liquidation results in the event of a close out of the positions of a 
Cross-Margining Participant in the NYPC Agreement first with NYPC 
because the liquidation will essentially be of a single Margin 
Portfolio and then will present its results for purposes of the 
multilateral Cross-Guaranty Agreement.

B. Access to NYPC Arrangement

    FICC has represented that the NYPC Arrangement has been structured 
in a way that access to, and the benefits of, the ``one-pot'' are 
provided to other futures exchanges and DCOs on fair and reasonable 
terms as described below. The proposed ``one-pot'' cross-margining 
method is expected to allow members to post margin that should more 
accurately reflect the net risk of their aggregate positions across 
asset classes, thereby releasing excess capital into the economy for 
more efficient use. By linking positions in fixed income securities 
held at FICC with interest rate products traded on NYSE Liffe U.S. and 
other designated contract markets (``DCMs''), the NYPC Arrangement has 
the potential to create a substantial pool of highly correlated assets 
that are capable of being cross-margined. This pool will deepen as more 
DCOs and DCMs join NYPC, creating the potential for even greater margin 
and risk offsets.
    The proposed ``one-pot'' is required to be accessed by other 
futures exchanges and DCOs via NYPC.\22\ FICC stated that this is done 
to ensure the uniformity and consistency of risk methodologies and risk 
management, to simplify and standardize operational requirements for 
new participants and to maximize the effectiveness of the one-pot 
arrangement.
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    \22\ Section 16 of the NYPC Agreement provides that FICC 
covenants and agrees that, during the term of the NYPC Agreement: 
(i) NYPC-cleared contracts shall have priority for margin offset 
purposes over any other cross-margining agreement; (ii) FICC will 
not enter into any other cross-margining agreement if such agreement 
would adversely affect the priority of NYPC and FICC under the NYPC 
Agreement with respect to available assets; and (iii) FICC will not, 
without the prior written consent of NYPC, amend the CME Agreement, 
if such further amendment would adversely affect NYPC's right to 
cross-margin positions in eligible products prior to any cross-
margining of CME positions with FICC-cleared contracts or adversely 
affect the priority of NYPC and FICC under the NYPC Agreement with 
respect to available assets.
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    FICC stated that NYPC will initially clear certain contracts 
transacted on NYSE Liffe U.S. and that NYPC will clear for additional 
DCMs that seek to clear through NYPC as soon as it is feasible for NYPC 
do so. Such additional DCMs will be treated in the same way as NYSE 
Liffe US, i.e., they must: (i) Be eligible under the rules of NYPC, 
(ii) contribute to NYPC's guaranty fund, (iii) demonstrate that they 
have the operational and technical ability to clear through NYPC, and 
(iv) enter into a clearing services agreement with NYPC.
    Moreover, NYPC has also committed to admit other DCOs as limited 
purpose participants as soon as it is feasible, thereby allowing such 
DCOs to participate in the one-pot margining arrangement with FICC 
through their limited purpose membership in NYPC.\23\ Such DCOs will be 
required to satisfy pre-defined, objective criteria set forth in NYPC's 
rules.\24\ In particular, such DCOs must: (i) Submit trades subject to 
the limited purpose participant agreement between NYPC and each DCO 
that would otherwise be cleared by the DCO to NYPC, with NYPC acting as 
central counterparty and DCO with respect to such trades,\25\ (ii) be 
eligible under the rules of NYPC and agree to be bound by the NYPC 
rules,\26\ (iii) contribute to NYPC's guaranty fund,\27\ (iv) provide 
clearing services to unaffiliated markets on a ``horizontal'' basis 
(i.e., not limit their provision of clearing services on a vertical 
basis to a single market or limited number of markets),\28\ and (v) 
agree to participate using the uniform risk methodology and risk 
management policies, systems and procedures that have been adopted by 
FICC and NYPC for implementation and administration of the NYPC 
Arrangement.\29\ Reasonable clearing fees will be allocated between 
NYPC and the limited purpose participant DCO as may be agreed by NYPC 
and the DCO, taking into account factors such as the cost of services 
(including capital expenditures incurred by NYPC), technology that may 
be contributed by the limited purpose participant, the volume of 
transactions, and such other factors as may be relevant.
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    \23\ See NYPC Agreement, Section 14.
    \24\ NYPC's rules can be viewed as part of NYPC's DCO 
registration application on the CFTC's Web site (http:/
/.www.cftc.gov), as well as on NYPC's Web site (http://www.nypclear.com).
    \25\ See NYPC Rule 801(b)(1).
    \26\ See NYPC Rule 801(b)(2).
    \27\ The NYPC Agreement provides that except as otherwise 
provided in a limited purpose participant agreement, a limited 
purpose participant shall make a contribution to the NYPC Guaranty 
Fund in form and substance similar to and in an amount that is no 
less than the amount of the NYSE Guaranty, which will initially 
consist of a $50,000,000 guaranty secured by $25,000,000 in cash 
during the first year of NYPC's operations. FICC and NYPC have 
subsequently clarified and affirmatively represented that the 
limited purpose participant agreements will be individually 
negotiated and that ``the Guaranty Fund contribution that will be 
required by NYPC from any Limited Purpose Participant will be 
determined by risk-based factors without regard to whether such 
contribution amount is more or less than the amount contributed to 
the NYPC Guaranty Fund by NYSE Euronext.'' See Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011). See also Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
    \28\ See NYPC Rule 801(c)(1)(i).
    \29\ See NYPC Rule 801(c)(1)(ii).
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    FICC and NYPC anticipate that the limited purpose participant 
agreement will encompass the foregoing requirements for limited purpose 
membership contained in NYPC's rules. Because each DCO could present 
different operational issues, terms beyond the basic rules provisions 
will be discussed on a case-by-case basis and reflected in the 
respective limited purpose participant agreement accordingly. FICC and 
NYPC envision that a possible structure for DCO limited purpose 
participation could be an omnibus account, with the DCO limited purpose 
participant essentially acting as

[[Page 12148]]

a processing agent for its clearing members vis-a-vis NYPC with respect 
to the submission of eligible positions of the DCO's clearing members 
to NYPC for purposes of inclusion in the one-pot arrangement with FICC. 
In order for their eligible positions to be included in the ``one-
pot,'' clearing members of the DCO limited purpose participant would be 
required to authorize the DCO to submit their positions to NYPC. Under 
such a structure, the DCO would be responsible for fulfilling all 
margin and guaranty fund requirements associated with the activity in 
the omnibus account.
    With respect to both the clearance of trades for unaffiliated DCMs 
and the admission of DCOs as limited purpose participants, FICC has 
indicated that NYPC has committed that it will complete the process to 
allow one or more DCMs or DCOs to be admitted and integrated into the 
``one-pot'' cross-margining arrangement as soon as feasible, but no 
later than 24 months from the start of operations. FICC has represented 
that this provision is necessary to the effective implementation of the 
one-pot cross-margining methodology and that this window of time is 
required to allow for refinement and enhancement of certain systems 
after operations commence, to allow time for the possible simultaneous 
integration with multiple major clearing members so that fair market 
access is assured, and to allow time for the completion of the material 
operational challenge of connecting and integrating NYPC with the 
separate technologies of other DCMs and/or DCOs. However, during this 
interim period, NYPC may engage, and FICC has represented in its filing 
to the Commission that NYPC is engaging, in discussions with other DCMs 
and DCOs. FICC has also represented in its filing that NYPC anticipates 
that it will be able to complete the integration of additional DCMs 
and/or DCOs in advance of this two-year period.

C. Other GSD Proposed Rule Changes

    The proposed rule filing allows FICC to permit margining of 
positions held in accounts of an affiliate of a member within GSD, akin 
to the inter-affiliate margining in the CME Arrangement and the 
proposed NYPC Arrangement. Thus, as in those arrangements, if a GSD 
member defaults, its GSD clearing fund deposits, cash settlement 
amounts and other available collateral will be available to FICC to 
cover the member's default, as will the GSD clearing fund deposits and 
available collateral of any Permitted Margin Affiliate with which it 
cross-margins.
1. Loss Allocation
    Under the current loss allocation methodology in GSD Rule 4, 
Clearing Fund and Loss Allocation, GSD allocates losses first to the 
most recent counterparties of a defaulting member. The proposed changes 
to GSD Rule 4 will delete this step in the loss allocation methodology 
in order to achieve a more even distribution of losses among GSD 
members without a focus on recent counterparties.
    Under the proposed rule change any loss allocation will be made 
first against the retained earnings of FICC attributable to GSD in an 
amount up to 25 percent of FICC's retained earnings or such higher 
amount as may be approved by the Board of Directors of FICC.
    If a loss still remains, GSD will divide the loss between the FICC 
Tier 1 Netting Members and the FICC Tier 2 Netting Members. The terms 
``Tier 1 Netting Member'' and ``Tier 2 Netting Member'' have been 
introduced in the GSD Rules to reflect two different categories of 
membership, which have been designated as such by FICC for loss 
allocation purposes. Currently, only investment companies registered 
under the Investment Company Act of 1940, as amended, (which companies 
are subject to regulatory requirements restricting their ability to 
mutualize losses) will qualify as Tier 2 Netting Members. Tier 2 
Netting Members will only be subject to loss to the extent they traded 
with the defaulting members and will not be responsible for mutualizing 
losses with participants with which they do not trade, in order to 
account for regulatory requirements applicable to such registered 
investment companies.
    Tier 1 Netting Members will be allocated the loss applicable to 
them first by assessing the Clearing Fund deposit of each such member 
in the amount of up to $50,000, equally. If a loss remains, Tier 1 
Netting Members will be assessed ratably in accordance with the 
respective amounts of their Required Fund Deposits based on the average 
daily amount of the member's Required Fund Deposit over the prior 
twelve months. Consistent with the current GSD rules, GSD members that 
are acting as inter-dealer brokers will be limited to a loss allocation 
of $5 million with respect to their inter-dealer broker activity.
2. Margin Calculation--Intraday Margin Calls
    GSD proposes to calculate Clearing Fund requirements twice per day. 
GSD will retain its regular calculation and call as set out in the GSD 
rules. An additional daily intra-day calculation and call (``Intraday 
Supplemental Clearing Fund Deposit'') are being added to GSD's 
rules.\30\ The intra-day call will be subject to a threshold that will 
be identified in FICC's risk management procedures.\31\ In addition, 
GSD will process a mark-to-market pass-through twice per day, instead 
of the current practice of once daily. The second collection and pass-
through of mark-to-market amounts will include a limited set of 
components to be defined in FICC's risk management procedures. All 
mark-to-market debits will be collected in full. FICC will pay out 
mark-to-market credits only after any intra-day clearing fund deficit 
is met.
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    \30\ See GSD Rule 4, Clearing Fund and Loss Allocation, Section 
2a as proposed to be amended by the proposed rule change.
    \31\ Id. FICC shall establish procedures for collection of an 
amount calculated in respect of a Member's Intraday Supplemental 
Fund Deposit, including parameters regarding threshold amounts that 
require payment, and the form and time by which payment is required 
to be made to FICC.
---------------------------------------------------------------------------

    Since GSD will be recalculating and margining a GSD member's 
exposure intra-day, the margin calculation methodology set forth in GSD 
Rule 4, Clearing Fund and Loss Allocation, will be revised to eliminate 
the ``Margin Requirement Differential'' component of the FICC clearing 
fund calculation. In addition, GSD Rule 4 will be revised to provide 
that in the case of a Margin Portfolio that contains accounts of a 
Permitted Margin Affiliate, FICC will apply the highest VaR confidence 
level applicable to the GSD member or the Permitted Margin Affiliate, 
in the event that multiple confidence levels are used to determine 
margin. Application of a higher VaR confidence level will result in a 
higher margin rate. Consistent with current GSD rules, a minimum 
Required Fund Deposit of $5 million will apply to a member that 
maintains broker accounts.
3. Consolidated Funds-Only Settlement
    The funds-only settlement process at GSD currently requires a 
member to appoint a settling bank that will settle the member's net 
debit or net credit amount due to or from GSD by way of the National 
Settlement Service of the Board of Governors of the Federal Reserve 
System (``NSS''). Any funds-only settling bank that will settle for a 
member that is also an NYPC member or that will settle for a member and 
a Permitted Margin Affiliate that is an NYPC member will have its net-
net credit or debit balances at each clearing corporation, other than 
balances with respect to futures positions of a ``customer'' as such 
term is defined in

[[Page 12149]]

CFTC Regulation 1.3(k), aggregated and netted for operational 
convenience and will pay or be paid such netted amount. The proposed 
rule change makes clear that, notwithstanding the consolidated 
settlement, the member will remain obligated to GSD for the full amount 
of its funds-only settlement amount.
4. Submission of Locked-In Trades from NYPC
    The current GSD rules allow for submission of ``locked-in trades'' 
(i.e., trades that are deemed compared when the data on the trade is 
received from a single source) \32\ submitted by a locked-in trade 
source on behalf of a GSD member. Currently, designated locked-in trade 
sources are Federal Reserve Banks on behalf of the Treasury Department, 
Freddie Mac, and GCF-Authorized Inter-Dealer Brokers for GCF Repo 
transactions. Under the proposed rule change, GSD Rule 6C, Locked-In 
Comparison, will be amended to include NYPC as an additional locked-in 
trade source. This is necessary because there will be futures 
transactions cleared by NYPC that will proceed to physical delivery. 
NYPC will submit the trade data as a locked-in trade source for 
processing through FICC, identifying the GSD member that had authorized 
FICC to accept the locked-in trade from NYPC. Once these transactions 
are submitted to FICC, they will no longer be futures, but rather will 
be in the form of buys or sells eligible for processing by GSD. As will 
be the case with other locked-in trade submissions accepted by FICC, 
the GSD member designated in the trade information must have executed 
appropriate documentation evidencing to FICC its authorization of NYPC.
---------------------------------------------------------------------------

    \32\ The term ``Locked-In Trade'' means a trade involving 
Eligible Securities that is deemed a compared trade once the data on 
such trade is received from a single, designated source and meets 
the requirements for submission of data on a locked-in trade 
pursuant to GSD's rules, without the necessity of matching the data 
regarding the trade with data provided by each member that is or is 
acting on behalf of an original counterparty to the trade. The data 
regarding a locked-in trade are provided to FICC by a locked-in 
trade source that has been authorized by a member that is a party to 
the trade to provide such data to FICC.
---------------------------------------------------------------------------

5. Deletion of the Category 1/Category 2 Distinction
    The proposed rule change will delete the legacy characterization of 
certain types of members as either ``Category 1'' or ``Category 2,'' a 
distinction that currently applies to ``Dealer Netting Members,'' 
``Futures Commission Merchant Netting Members'' and ``Inter-Dealer 
Broker Netting Members'' at GSD. Historically, the two categories were 
used to margin lower capitalized members (i.e., Category 2) at a higher 
rate. Following FICC's adoption of the VaR methodology for GSD in 
2006,\33\ FICC has determined that the distinction between Category 1 
and Category 2 members is no longer necessary. Rather than margin 
netting members at higher rates solely due to a single static 
capitalization threshold, FICC is able, by use of the VaR margin 
methodology, to margin netting members at a higher rate by applying a 
higher confidence level against any netting member, which, regardless 
of size, FICC has determined poses a higher risk.
---------------------------------------------------------------------------

    \33\ Securities Exchange Act Release No. 55217 (January 31, 
2007), 72 FR 5774.
---------------------------------------------------------------------------

    With the deletion of the Category 1/Category 2 distinction, Section 
1 of GSD Rule 13, Funds-Only Settlement, is proposed to be changed to 
provide that all netting members could receive forward mark adjustment 
payments, subject to FICC's general discretion to withhold credits that 
would be otherwise due to a distressed netting member.
6. Amendment of CME Agreement
    The proposed NYPC Arrangement will necessitate an amendment to the 
CME Agreement to clarify that the NYPC Arrangement will take priority 
over the CME Arrangement when determining residual FICC positions that 
will be available for cross-margining with the CME. As a result, only 
those FICC positions that are not able to be cross-margined with NYPC 
positions under the NYPC Arrangement will generally be considered for 
cross-margining with the CME. In addition, when calculating and 
presenting liquidation results under the CME Agreement, the amendment 
will provide that FICC's liquidation results will include FICC's 
liquidation results in combination with NYPC's liquidation results 
because the NYPC Agreement will provide for a right of first offset 
between FICC and NYPC. The CME Agreement showing the proposed changes 
was filed as an attachment to the proposed rule change as part of 
Exhibit 5.

D. Summary of Other Proposed Changes to Rule Text

    In GSD Rule 1, Definitions, the following definitions are proposed 
to be added, revised or deleted:
    The terms ``Broker Account'' and ``Dealer Account'' will be added 
to the text of the GSD Rules. A ``Broker Account'' is an account that 
is maintained by an inter-dealer broker netting member, or a segregated 
broker account of a netting member that is not an inter-dealer broker 
netting member. An account that is not a Broker Account is referred to 
as a Dealer Account.
    ``Coverage Charge'' will be revised to refer to the additional 
charge with respect to the member's Required Fund Deposit (rather than 
its VaR Charge) which brings the member's coverage to a targeted 
confidence level.
    ``Current Net Settlement Positions'' will be corrected to clarify 
its current intent, that it is calculated with respect to a certain 
business day and not necessarily on that day, since it may be 
calculated after market close on the day prior to its application 
(i.e., before or after midnight between the close of business one day 
and the open of business on the next day).
    ``Excess Capital Differential'' will be corrected to refer to the 
amount by which a member's VaR Charge exceeds its excess capital, 
instead of by reference to the amount by which its required clearing 
fund deposit exceeds its excess capital.
    ``Excess Capital Premium Calculation Amount'' will be deleted 
because, with the introduction of VaR methodology, the calculation is 
no longer applicable. The terms ``Excess Capital Differential'' and 
``Excess Capital Ratio'' will be amended to delete archaic references 
to ``Excess Capital Premium Calculation Amount'' and to refer instead 
to the comparison of a member's capital calculation to its VaR Charge. 
In addition, the text of Section 14 of GSD Rule 3 will be amended to 
provide that the ``Excess Capital Premium'' charge applies to any type 
of entity that is a GSD netting member rather than limiting its 
applicability to only the specified types formerly identified in the 
text.
    ``Excess Capital Ratio'' will be amended to mean the quotient 
resulting from dividing the amount of a member's VaR Charge by its 
excess net capital.
    ``GSD Margin Group'' will be added to refer to the GSD accounts 
within a Margin Portfolio.
    ``Margin Portfolio'' will be added to refer to the positions 
designated by the member as grouped for cross-margining, subject to the 
rules set forth in GSD Rule 4. ``Dealer Accounts'' and ``Broker 
Accounts'' cannot be combined in a common Margin Portfolio. A 
``Sponsoring Member Omnibus Account'' cannot be combined with any other 
accounts.
    ``Unadjusted GSD Margin Portfolio Amount'' will be added to define 
the amount calculated by GSD with regard to a Margin Portfolio, before 
application of premiums, maximums or minimums.

[[Page 12150]]

It includes the VaR Charge and the coverage charge for GSD. In the case 
of a Cross-Margining Participant of GSD, the Unadjusted GSD Margin 
Portfolio Amount also will include the cross-margining reduction, if 
any.
    The terms ``Category 2 Gross Margin Amount,'' ``Margin Adjustment 
Amount,'' ``Repo Volatility Factor,'' and ``Revised Gross Margin 
Amount'' will be deleted from GSD Rule 1 since they are no longer used 
elsewhere in the GSD Rules. The Schedule of Repo Volatility Factors 
will be deleted because it is no longer applicable.
    In Section 2 of GSD Rule 3, Ongoing Membership Requirements, the 
requirement that GCF counterparties submit information relating to the 
composition of their NFE-related accounts,\34\ will be amended to 
require the submission of such information periodically, rather than on 
a quarterly basis. GSD currently requires this information every other 
month and by this change, FICC could institute periodic reporting on a 
schedule that is appropriate at such time, in response to current 
conditions. This has the potential to help tailor the frequency of 
reporting based on market conditions and thereby facilitate the risk 
management of the clearing agency.
---------------------------------------------------------------------------

    \34\ The term ``NFE-Related Account'' means each securities 
account and deposit account maintained by a GCF Clearing Agent Bank 
for an Interbank Pledging Member in which the GCF Clearing Agent 
Bank has, pursuant to agreement with the Interbank Pledging Member 
or by operation of law, a security interest or right of setoff 
securing or supporting the payment of obligations of such Interbank 
Pledging Member to the Bank, including each such account to which 
such Interbank Pledging Member's Prorated Interbank Cash Amount is 
debited. See GSD Rule 1, Definitions.
---------------------------------------------------------------------------

    In Section 9 of GSD Rule 4, Clearing Fund and Loss Allocation, 
concerning the return of excess deposits and payments, FICC's 
discretion to withhold the return of excess clearing fund to a member 
that has an outstanding payment obligation to FICC will be changed from 
being based on FICC's determination that the member's anticipated 
transactions or obligations over the next 90 calendar days may be 
reasonably expected to be materially different than those of the 90 
prior calendar days, under the current rule, to being based on FICC's 
determination that the member's anticipated transactions or obligations 
in the near future may be reasonably expected to be materially 
different than those in the recent past. In addition, technical and 
clarifying changes are proposed to be made to the rules and cross-
references to rule sections contained throughout. The rules have been 
reviewed by FICC and proposed to be corrected as needed to reflect the 
correct rule section references as originally intended.

III. Comments

    The Commission received thirteen comments to the proposed rule 
change and four response letters responding to comments.\35\ Nine 
commenters supported the proposed rule.\36\ Of this group, seven 
commenters generally stated that the cross-margining proposal benefits 
competition by permitting ``open access'' to cross-margining.\37\ In 
addition, six commenters argued that the proposed rule change permits 
risk minimization \38\ and promotes transparency.\39\
---------------------------------------------------------------------------

    \35\ See supra notes 3 and 4.
    \36\ Letter from Adam C. Cooper, Senior Managing Director and 
Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from 
Gary DeWaal, Senior Managing Director and Group General Counsel, 
Newedge USA, LLC (December 21, 2010); Letter from John A. McCarthy, 
General Counsel, GETCO (December 21, 2010); Letter from Donald J. 
Wilson, Jr., DRW Trading Group (December 21, 2010); Letter from 
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS 
Securities, LLC (December 20, 2010); Letter from John Willian, 
Managing Director, Goldman Sachs (December 17, 2010); Letter from 
Ronald Filler, Professor of Law and Director of the Center on 
Financial Services Law, New York Law School (December 8, 2010); 
Letter from Douglas Engmann, President, Engmann Options, Inc. 
(December 6, 2010); and Letter from Jack DiMaio, Managing Director, 
Morgan Stanley (December 2, 2010).
    \37\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Ronald Filler, Professor of Law and 
Director of the Center on Financial Services Law, New York Law 
School (December 8, 2010); Letter from John Willian, Managing 
Director, Goldman Sachs (December 17, 2010); Letter from James B. 
Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, 
LLC (December 20, 2010); Letter from Adam C. Cooper, Senior Managing 
Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); 
Letter from Gary DeWaal, Senior Managing Director and Group General 
Counsel, Newedge USA, LLC (December 21, 2010); and Letter from John 
A. McCarthy, General Counsel, GETCO (December 21, 2010).
    \38\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Douglas Engmann, President, Engmann 
Options, Inc. (December 6, 2010); Letter from Ronald Filler, 
Professor of Law and Director of the Center on Financial Services 
Law, New York Law School (December 8, 2010); Letter from John A. 
McCarthy, General Counsel, GETCO (December 21, 2010); Letter from 
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS 
Securities, LLC (December 20, 2010); and Letter from Donald J. 
Wilson, Jr., DRW Trading Group (December 21, 2010).
    \39\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Ronald Filler, Professor of Law and 
Director of the Center on Financial Services Law, New York Law 
School (December 8, 2010); Letter from James B. Fuqua and David 
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 
2010); Letter from Adam C. Cooper, Senior Managing Director and 
Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from 
John A. McCarthy, General Counsel, GETCO (December 21, 2010); and 
Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 
2010).
---------------------------------------------------------------------------

    Three commenters opposed the proposed rule, absent changes to 
mitigate what they identified as anti-competitive features.\40\ One 
commenter recommended further study of the rule and its risk 
methodology, but agreed with the commenters opposing the proposed rule 
change on the grounds that the rule should permit only non-exclusive 
arrangements that promote competition.\41\ The commenters against the 
proposed rule change generally stated that the cross-margining scheme 
is anti-competitive and raises risk management issues. These commenters 
raised concerns or provided comments related to the following major 
aspects of the cross-margining proposal: (1) The effect on competition; 
(2) risk management; and (3) the effect on efficiency and costs. FICC 
responded to these comments in three comment letters that it 
submitted.\42\
---------------------------------------------------------------------------

    \40\ Letter from William H. Navin, Executive Vice President and 
General Counsel, The Options Clearing Corporation (December 21, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); and Letter from John C. Hiatt, 
Chief Administrative Officer, Ronin Capital (December 10, 2010).
    \41\ Letter from Joan C. Conley, Senior Vice President & 
Corporate Secretary, NASDAQ OMX (December 21, 2010).
    \42\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011); Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
---------------------------------------------------------------------------

A. Effect on Competition

    Many of the commenters' concerns with respect to competition 
stemmed from FICC having an exclusive agreement to enter into a direct 
arrangement for ``one-pot'' cross-margining with NYPC.\43\ NYPC is 
jointly owned by NYSE Euronext and DTCC. DTCC is the parent company of 
FICC. NYSE Liffe is the global derivatives business of the NYSE 
Euronext. These affiliations combined with the exclusive nature of the 
direct arrangement raised concerns for these commenters.
---------------------------------------------------------------------------

    \43\ Letter from William H. Navin, Executive Vice President and 
General Counsel, The Options Clearing Corporation (December 21, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt, 
Chief Administrative Officer, Ronin Capital (December 10, 2010); and 
Letter from Joan C. Conley, Senior Vice President & Corporate 
Secretary, NASDAQ OMX (December 21, 2010).
---------------------------------------------------------------------------

    With regard to allowing other parties direct access to cross-
margining, FICC argued that it is neither operationally feasible nor 
prudent to establish a framework of multiple, competing ``one-

[[Page 12151]]

pots'' with multiple, competing DCOs under this arrangement.\44\ Among 
other things, such an arrangement would result in FICC clearing members 
that are members of multiple DCOs cross-margining their futures 
positions against different segments of their portfolios at FICC, 
rather than having the risk of their positions being measured 
comprehensively.\45\ FICC stated that it believes that the attendant 
risk of delays and errors in processing would substantially increase 
systemic risk as clearing members continuously moved positions at FICC 
from one cross-margin pot to another in order to maximize their margin 
savings.\46\ For example, there is the potential that operational 
issues of managing such movements across multiple systems would create 
risks in the settlement process by adding complexities associated with 
linking and monitoring the use of multiple one cross-margin pot 
arrangements. Furthermore, FICC stated that the existence of multiple 
``one-pots'' would likely greatly complicate the liquidation of a 
cross-margining participant that was in default at FICC and NYPC, 
thereby increasing systemic risk.\47\
---------------------------------------------------------------------------

    \44\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011).
    \45\ Id.
    \46\ Id.
    \47\ Id.
---------------------------------------------------------------------------

    Commenters recognized that other DCOs (i.e., DCOs other than NYPC) 
will have the ability to obtain indirect access to the cross-margining 
arrangement by entering into a Limited Purpose Participant (``LPP'') 
agreement and becoming an LPP of NYPC. Commenters raised concerns about 
the potential for this type of indirect access, citing concerns about 
the requirements to agree to be bound by the rules of NYPC, agree to an 
allocation of clearing fees, and contribute to the NYPC guaranty fund 
in an amount equal to the contribution made by NYSE Euronext.\48\
---------------------------------------------------------------------------

    \48\ Letter from William H. Navin, Executive Vice President and 
General Counsel, The Options Clearing Corporation (December 21, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt, 
Chief Administrative Officer, Ronin Capital (December 10, 2010); and 
Letter from Joan C. Conley, Senior Vice President & Corporate 
Secretary, NASDAQ OMX (December 21, 2010).
---------------------------------------------------------------------------

    FICC responded to these comments.\49\ Specifically, FICC stated 
that, while DCOs that are LPPs clearing through NYPC would need to 
abide by NYPC's rules, NYPC's intention is that there would be separate 
requirements (including with respect to margin deposits and guaranty 
fund contributions applied) to the LPP, on the one hand, and the LPP's 
members, on the other, unless: (i) NYPC and the LPP separately agree to 
allocate those amounts to the LPP and its members, or (ii) a clearing 
member of NYPC is also a clearing member of an LPP.\50\ FICC and NYPC 
also represented that the NYPC rules would apply to a LPP but not to 
the members of the LPP, unless such members are otherwise clearing 
members of NYPC.\51\ In addition, FICC noted that NYPC Rule 801 is 
designed to permit maximum flexibility in structuring the admission of 
LPPs, as it is contemplated that any such admission would be subject to 
substantial negotiation between NYPC and the prospective LPP regarding 
the operational mechanics of margin deposits and related subjects.\52\
---------------------------------------------------------------------------

    \49\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011) and Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation; Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
    \50\ Id.
    \51\ Letter from Michael Bodson, Executive Managing Director, 
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive 
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
    \52\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011) and Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011).
---------------------------------------------------------------------------

    In addition, FICC has represented to the Commission that the fees 
NYPC charges LPPs will be determined on a case-by-case basis based on 
the services provided to recoup operational and other costs that NYPC 
incurs in integrating the new LPP.\53\ Moreover, FICC and NYPC 
clarified and affirmatively represented that the limited purpose 
participant agreements will be individually negotiated and that ``the 
Guaranty Fund contribution that will be required by NYPC from any 
Limited Purpose Participant will be determined by risk-based factors 
without regard to whether such contribution amount is more or less than 
the amount contributed to the NYPC Guaranty Fund by NYSE 
Euronext''.\54\
---------------------------------------------------------------------------

    \53\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011); Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
    \54\ Letter from Michael Bodson, Executive Managing Director, 
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive 
Officer, New York Portfolio Clearing, LLC (February 7, 2011) and 
Letter from Michael Bodson, Executive Managing Director, Fixed 
Income Clearing Corporation and Walt Lukken, Chief Executive 
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
---------------------------------------------------------------------------

    Three commenters also noted that under the proposed structure, it 
may take up to two years before other DCMs are permitted to clear at 
NYPC or before other DCOs might be given indirect access in order to 
participate in the NYPC Arrangement, which may cause commercial 
impairment.\55\ Two other commenters, however, argued that the delay is 
not unduly burdensome on competition,\56\ with one in particular 
explaining that ``[a]ny new arrangement needs the requisite time to 
ensure that it satisfies all of the underlying concerns and issues that 
may occur with any new concept''.\57\ FICC responded, saying that the 
transition period is necessary to complete implementation, systems 
integration, and testing, among other things, and that it and NYPC have 
pledged to open the arrangement to other participants as soon as 
operationally feasible.\58\ FICC also stated that attempting to 
integrate a pre-existing clearinghouse directly into the ``one-pot'' 
cross-margining arrangement would by necessity be even more difficult 
and likely more costly than the integration between FICC and NYPC, 
which was created in order to cross-margin positions with FICC.\59\ In

[[Page 12152]]

addition, FICC has previously stated that NYPC has committed that it 
will complete the process to allow one or more DCMs or DCOs to be 
admitted and integrated into the ``one-pot'' cross-margining 
arrangement as soon as feasible, but no later than 24 months from the 
start of operations.
---------------------------------------------------------------------------

    \55\ Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from William H. Navin, 
Executive Vice President and General Counsel, The Options Clearing 
Corporation (December 21, 2010); and Letter from Joan C. Conley, 
Senior Vice President & Corporate Secretary, NASDAQ OMX (December 
21, 2010).
    \56\ Letter from Gary DeWaal, Senior Managing Director and Group 
General Counsel, Newedge USA, LLC (December 21, 2010) and Letter 
from Ronald Filler, Professor of Law and Director of the Center on 
Financial Services Law, New York Law School (December 8, 2010).
    \57\ Letter from Ronald Filler, Professor of Law and Director of 
the Center on Financial Services Law, New York Law School (December 
8, 2010).
    \58\ FICC represented that ``[f]ollowing the announcement of 
NYPC, FICC, the NYPC management team and senior management of NYSE 
Euronext have repeatedly reached out to [The Options Clearing 
Corporation], as well as other DCOs and DCMs, to initiate the 
process of integrating such other organizations into the `single 
pot'. While those efforts have not yet been productive, FICC and 
NYPC remain committed to expanding the `single pot' to include other 
DCOs and DCMs.'' Letter from Douglas Landy, Allen & Overy on behalf 
of the Fixed Income Clearing Corporation (January 4, 2011). See also 
supra Section II.B., at 16.
    \59\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011); and Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011).
---------------------------------------------------------------------------

    The nine commenters in favor of the proposed rule change generally 
argued that the rule change will increase competition in trade 
execution and clearing which, in turn, will encourage innovation, 
efficiency, and improved choices.\60\ Furthermore, FICC also indicated 
that its proposal promotes competition. Specifically, FICC stated that 
``[u]nlike the traditional `vertical' relationship between futures 
exchanges and their affiliated * * * DCOs * * *, NYPC has been uniquely 
structured * * * to allow unaffiliated DCOs and * * * DCMs * * * `open 
access' to the benefits of the `single pot' cross-margining arrangement 
as soon as operationally feasible, subject to only certain object, 
reasonable and non-discriminatory criteria''.\61\ FICC also stated that 
the current market for clearing U.S. dollar-denominated interest rates 
is dominated by one entity and that its approach has the potential to 
introduce competition in this market.\62\
---------------------------------------------------------------------------

    \60\ See, e.g., Letter from John Willian, Managing Director, 
Goldman Sachs (December 17, 2010); Letter from Ronald Filler, 
Professor of Law and Director of the Center on Financial Services 
Law, New York Law School (December 8, 2010); and Letter from Adam C. 
Cooper, Senior Managing Director and Chief Legal Officer, Citadel, 
LLC (December 21, 2010).
    \61\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011).
    \62\ Id.
---------------------------------------------------------------------------

B. Risk Management

    Five commenters believed that the proposal would increase the 
transparency of risks across asset classes and allow regulators to 
better monitor and assess risk.\63\ These commenters supported the 
proposed rule's use of the Value at Risk (VaR) methodology, because it 
is well understood, has been extensively tested, and relies on 
historical information to simulate the market.\64\ Moreover, two 
commenters noted that ``one-pot'' margining decreases the risk for 
market participants because it allows for the offset of risk between 
U.S. Treasury futures and U.S. Treasury cash bonds.\65\ Additionally, 
two commenters believed that the proposal allows for a greater portion 
of financial instruments to be centrally cleared, which, among other 
things, reduces overall risk.\66\
---------------------------------------------------------------------------

    \63\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from John A. McCarthy, General Counsel, 
GETCO (December 21, 2010); Letter from James B. Fuqua and David 
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 
2010); Letter from Ronald Filler, Professor of Law and Director of 
the Center on Financial Services Law, New York Law School (December 
8, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group 
(December 21, 2010).
    \64\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from John A. McCarthy, General Counsel, 
GETCO (December 21, 2010); Letter from James B. Fuqua and David 
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 
2010); Letter from Ronald Filler, Professor of Law and Director of 
the Center on Financial Services Law, New York Law School (December 
8, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group 
(December 21, 2010).
    \65\ Letter from Donald J. Wilson, Jr., DRW Trading Group 
(December 21, 2010) and Letter from John A. McCarthy, General 
Counsel, GETCO (December 21, 2010).
    \66\ Letter from Adam C. Cooper, Senior Managing Director and 
Chief Legal Officer, Citadel, LLC (December 21, 2010) and Letter 
from John A. McCarthy, General Counsel, GETCO (December 21, 2010).
---------------------------------------------------------------------------

    Two commenters, however, raised concerns about risk management, 
stating that because cross-margining allows for greater leverage than 
standard margining, in particular during periods of market stress and 
extreme volatility, the proposed rule may increase systemic risk.\67\ 
FICC responded by stating that ``the NYPC-FICC margin model does not 
necessarily increase leverage and may, in fact, reduce leverage in 
highly risky portfolios with limited hedges.''\68\ FICC further 
explained that, ``[a]t the same time, the NYPC-FICC model can offer 
margin reductions for hedged portfolios because it more accurately 
estimates true economic risk by taking into account the benefits of 
highly correlated, offsetting positions in a single portfolio.''\69\
---------------------------------------------------------------------------

    \67\ Letter from Joan C. Conley, Senior Vice President & 
Corporate Secretary, NASDAQ OMX (December 21, 2010) and Letter from 
John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 
10, 2010).
    \68\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011).
    \69\ Id.
---------------------------------------------------------------------------

    One commenter suggested that the VaR method for calculating margin 
requirements should be tested further.\70\ This commenter also 
suggested that the scenario-based Standard Portfolio Analysis of Risk 
(``SPAN'') method be considered and tested in comparison to VaR. FICC's 
response noted that the proposed VaR methodology is based on a common 
method of historical simulation and that it has conducted risk-related 
testing, including sensitivity tests, back testing of the model's 
validity, and stress tests of the sufficiency of the guaranty fund.\71\
---------------------------------------------------------------------------

    \70\ Letter from Joan C. Conley, Senior Vice President & 
Corporate Secretary, NASDAQ OMX (December 21, 2010).
    \71\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011).
---------------------------------------------------------------------------

    One commenter requested that documentation of previous 
consideration of the risk aspects of the proposal be made public.\72\ 
In response, FICC provided a discussion and analysis of its VaR 
methodology compared to SPAN.\73\ FICC explained that because it needs 
to measure the risk of combined portfolios for futures and cash 
positions, it believes that a historical VaR-based margin model 
provides a more accurate estimate of portfolio risk than SPAN.\74\ FICC 
noted, however, that because it is standard practice for the futures 
industry to use SPAN to calculate and monitor margin requirements, it 
will make available SPAN formatted calculations of its VaR-based 
customer risk parameters to clearing members and their customers. FICC 
also noted that in initially listing NYPC-clearing contracts, NYSE 
Liffe U.S. will use, among other factors, SPAN-formatted input 
parameters to establish minimum customer initial margin requirements 
for each NYPC-cleared interest rate contract and intra- and inter-
commodity spreads.\75\
---------------------------------------------------------------------------

    \72\ Letter from Alex Kogan, Vice President and Deputy General 
Counsel, NASDAQ OMX (January 10, 2011).
    \73\ Letter from Michael Bodson, Executive Managing Director, 
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive 
Officer, New York Portfolio Clearing, LLC (February 7, 2011). The 
public record contains information regarding testing that went to 
the subject of risk management. The Commission also received from 
FICC proprietary, highly confidential information, including 
information about individual portfolios. This non-public 
information, in addition to the public information submitted in 
support of the rule proposal, supported the Commission's conclusion 
that the proposal is consistent with the Act, but was not included 
in the public record because of its sensitivity.
    \74\ Id.
    \75\ Letter from Alex Kogan, Vice President and Deputy General 
Counsel, NASDAQ OMX (January 10, 2011).
---------------------------------------------------------------------------

C. Effect on Efficiency and Costs

    Four commenters stated that the proposal promotes the reduction of 
risk that will lead to margin and capital efficiencies and lower 
costs.\76\ One

[[Page 12153]]

commenter believed that ``one-pot'' margining would increase cash flow 
and margin efficiencies for certain clearing members.\77\ Two 
commenters also stated that the ``one-pot'' approach will reduce 
delivery costs because it offers direct delivery of expiring futures 
contracts into cash bonds held at FICC, which will minimize fails and 
squeezes and improve price convergence and stress on the settlement 
system.\78\ Additionally, two commenters that were opposed to the 
cross-margining agreement as proposed also expressed their general 
support for ``one-pot'' cross-margining on the ground that it reduces 
risk while facilitating more efficient uses of capital markets.\79\
---------------------------------------------------------------------------

    \76\ Letter from Gary DeWaal, Senior Managing Director and Group 
General Counsel, Newedge USA, LLC (December 21, 2010); Letter from 
Adam C. Cooper, Senior Managing Director and Chief Legal Officer, 
Citadel, LLC (December 21, 2010); Letter from Ronald Filler, 
Professor of Law and Director of the Center on Financial Services 
Law, New York Law School (December 8, 2010); and Letter from James 
B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, 
LLC (December 20, 2010).
    \77\ Letter from John Willian, Managing Director, Goldman Sachs 
(December 17, 2010).
    \78\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010) and Letter from Donald J. Wilson, Jr., DRW 
Trading Group (December 21, 2010).
    \79\ Letter from John C. Hiatt, Chief Administrative Officer, 
Ronin Capital (December 10, 2010) and Letter from William H. Navin, 
Executive Vice President and General Counsel, The Options Clearing 
Corporation (December 21, 2010).
---------------------------------------------------------------------------

    According to FICC's response, the proposed rule streamlines the 
delivery process for U.S. Treasury futures, which will improve 
operational efficiency and decrease systemic settlement risk.\80\ FICC 
also stated that the proposal should increase liquidity by providing 
market participants with an alternate venue for trading U.S. dollar-
denominated interest rate futures contracts.\81\
---------------------------------------------------------------------------

    \80\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011).
    \81\ Id.
---------------------------------------------------------------------------

IV. Discussion

    The Commission has carefully considered the proposed rule change 
and the comments thereto and the Commission finds that the proposed 
rule change is consistent with the requirements of the Act and the 
rules and regulations thereunder, including Sections 17A(a)(2)(A)(ii) 
\82\ and 17A(b)(3)(A), (F) and (I) of the Act.\83\
---------------------------------------------------------------------------

    \82\ 15 U.S.C. 78q-1(b)(2)(A)(ii). This provision directs the 
Commission to use its authority to facilitate the establishment of 
coordinated facilities for clearance and settlement of transactions 
in securities and contracts of sale for future delivery.
    \83\ 15 U.S.C. 78q-1(b)(3)(A), (F) and I. In approving the 
proposed rule change, the Commission considered the proposal's 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
---------------------------------------------------------------------------

    The proposed rule change provides for modifications to certain risk 
management related processes and definitions under GSD's rules, 
including changes to the loss allocation methodology, intraday 
margining, categories of membership, and related definitional changes. 
The Commission believes that these changes to GSD's rules are 
consistent with Sections 17A(b)(3)(A) and (F) of the Act because they 
should help facilitate and promote the prompt and accurate clearance 
and settlement of securities transactions, and help assure the 
safeguarding of securities and funds under FICC's control or for which 
it is responsible. In particular, the Commission believes that these 
changes to GSD's rules, by virtue of strengthening FICC's risk 
management and related operations, should result in a more timely, 
accurate, and efficient system of settlement.
    In addition, the proposed rule change would provide for a cross-
margining arrangement between certain positions in GSD and NYPC. The 
Commission's staff has closely evaluated the proposed cross-margining 
arrangement including the risk management, competition and efficiency 
issues raised by the proposed rule change (as discussed below) against 
the requirements of the Act, including Sections 17A(b)(3)(F) and (I) of 
the Act. Based on our staff's analysis, and taking into consideration 
the matters discussed throughout, including the representations 
discussed below, the Commission finds the proposed rule change is 
consistent with the Act.

A. Risk Management

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and assure the 
safeguarding of securities and funds in the custody or control of the 
clearing agency or for which it is responsible.\84\ The Commission has 
historically supported and approved cross-margining at clearing 
agencies and has previously recognized the potential benefits of cross-
margining systems, which include freeing capital through reduced margin 
requirements, reducing clearing costs by integrating clearing 
functions, reducing clearing organization risk by centralizing asset 
management and harmonizing liquidation procedures.\85\ The Commission 
has encouraged cross-margining arrangements as a way to promote more 
efficient risk management across product classes.\86\ Cross-margining 
arrangements may be consistent with Section 17A(b)(3)(F) in that they 
may strengthen the safeguarding of assets through effective risk 
controls that more broadly take into account offsetting positions of 
participants in both the cash and futures markets, and promote prompt 
and accurate clearance and settlement of securities through increased 
efficiencies.
---------------------------------------------------------------------------

    \84\ 15 U.S.C. 78q-1(b)(3)(F).
    \85\ See, e.g., Securities Exchange Act Release No. 27296 
(September 26, 1989), 54 FR 41195 (approving proposed rule changes 
establishing cross-margining between The Options Clearing 
Corporation and the Chicago Mercantile Exchange) and Securities 
Exchange Act Release No. 26153 (October 3, 1988), 53 FR 39561 
(approving proposed rule changes concerning cross-margining between 
The Options Clearing Corporation and the Intermarket Clearing 
Corporation). Previously, the Interim Report of the President's 
Working Group on Financial Markets (May 1988) recommended that the 
SEC and CFTC facilitate cross-margining programs among clearing 
organizations. In addition, the Bachmann Task Force, which was 
formed by the Commission in response to the 1987 Market Break, 
presented its findings to the Commission in May 1992 that included, 
among other things, a recommendation that cross-margining programs 
among clearing agencies be implemented or expanded. See Securities 
Exchange Act Release No. 31904 (February 23, 1993), 58 FR 11806 
(March 1, 1993).
    \86\ See Securities and Exchange Act Release No. 44301, 66 FR 
28297 (May 11, 2001) (order approving a ``two-pot'' cross-margining 
proposal between FICC's predecessor and CME). In addition, the 
Interim Report of the President's Working Group on Financial Markets 
(May 1988) also recommended that the SEC and CFTC facilitate cross-
margining programs among clearing organizations.
---------------------------------------------------------------------------

    As set forth in the proposal, FICC will perform margin calculations 
using VaR methodology with a 99 percent confidence level and 3-day 
liquidation for cash positions and 1-day liquidation for futures, using 
historical information for the prior year (250 trading days for futures 
and 252 for cash positions) and the margin calculations will employ a 
front weighted mechanism that places a greater emphasis on more recent 
observations. FICC will also conduct daily back testing and assess an 
additional coverage component charged to participants if the back tests 
show insufficient coverage. In the event of unusual market conditions, 
FICC or NYPC could at any time require additional margin provided such 
requirements are consistent with the standards in Section 17A of the 
Exchange Act. The Commission believes these actions assist in the 
promotion under the proposed cross-margining arrangement of prompt and 
accurate clearance and settlement of securities transactions and help 
assure the safeguarding of securities and funds consistent with the 
requirements under Section 17A(b)(3)(F) of the Act because they would 
facilitate appropriate risk management by FICC by providing flexibility 
and promoting ongoing monitoring of risk.\87\
---------------------------------------------------------------------------

    \87\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    The proposal also contains provisions for managing risk in the 
event of a

[[Page 12154]]

member default. The NYPC Agreement provides for the sharing of losses 
by FICC and NYPC in the event that the ``one-pot'' portfolio margin 
deposits of a defaulting participant are not sufficient to cover the 
losses resulting from the liquidation of that participant's trades and 
positions. In the event of a member default, the proposal requires that 
FICC and NYPC would liquidate posted margin as a single portfolio, 
which will allow them to preserve the value of the assets posted as 
collateral. In addition, FICC and NYPC are providing financial 
guarantees to each other in the event the available collateral is 
insufficient. These features of the proposed rule change would help to 
ensure that FICC is able to meet its settlement obligations in the 
event of default. As a result, the Commission believes that the 
proposal would promote the prompt and accurate clearance and settlement 
of securities transactions and assure the safeguarding of securities 
and funds in a manner consistent with Section 17A(b)(3)(F) of the 
Act.\88\
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    The Commission has previously noted that cross-margining systems 
entail certain risks.\89\ For instance, even in normal market 
conditions, products that have been highly correlated in the past may 
diverge and may diverge even more so in extreme market conditions. Such 
a breakdown in correlation might lead to inadequate clearing margins or 
losses upon a liquidation. To address these concerns, as noted in the 
description of the proposed rule change and in FICC's response letters, 
FICC has performed testing of the VaR margining model. This included 
sensitivity tests of the model to changing market conditions, back 
tests of sample portfolios to check model validity, stress tests of 
sample portfolios to test the sufficiency of the NYPC guaranty fund, 
and back tests to verify the sufficiency of coverage after the FICC-
NYPC cross-margining reductions are applied.
---------------------------------------------------------------------------

    \89\ Securities Exchange Act Release No. 26153 (October 3, 
1988), 53 FR 39561.
---------------------------------------------------------------------------

    The Commission takes commenters' concerns about risk management 
seriously. As discussed below, to provide the Commission with enhanced 
ability to monitor FICC's risk management, FICC has represented and 
undertaken to make continuing risk analysis reports, discussed below, 
to the Commission. This ongoing reporting should also help FICC conduct 
its own monitoring of the NYPC Arrangement. In addition, FICC is 
subject to the Commission's ongoing examination program, which examines 
registered clearing agencies with respect to their risk management 
systems and other aspects of their operations. The Commission believes 
FICC's prior analysis, as discussed above, as well as FICC's commitment 
to provide additional reports on a periodic basis will promote the 
prompt and accurate clearance and settlement of securities transactions 
and help assure the safeguarding of securities and funds in a manner 
consistent with Section 17A(b)(3)(F) of the Act.

B. Competition

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency are not designed to permit unfair discrimination in the 
admission of participants or among participants in the use of the 
clearing agency.\90\ Section 17A(b)(3)(I) of the Act requires that the 
rules of the clearing agency do not impose any burden on competition 
not necessary and appropriate in furtherance of the purposes of the 
Exchange Act.\91\
---------------------------------------------------------------------------

    \90\ 15 U.S.C. 78q-1(b)(3)(F).
    \91\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    The Commission has carefully considered the comments and the 
responses submitted to the Commission. With respect to commenters' 
concerns regarding the exclusive nature of the agreement to enter into 
a direct arrangement for ``one-pot'' cross-margining with NYPC, the 
Commission believes that FICC has raised valid concerns regarding the 
potential for greater risk arising from connections to multiple DCOs. 
The Commission believes that the NYPC Arrangement, and FICC's 
representations in its responses, discussed above, regarding how 
indirect access would operate in practice, would provide increased 
potential for indirect access to the cross-margining arrangement by 
entering into a LPP agreement and becoming an LPP of NYPC.
    The Commission believes that the proposed FICC indirect access 
arrangement would provide a viable option for those seeking to access 
the ``one-pot'' cross-margining arrangement because it would be open to 
all DCOs and DCMs and would contain membership criteria that are 
commensurate with risks associated with accessing the ``one-pot'' 
cross-margining arrangement. Accordingly, the Commission believes the 
proposed cross-margining arrangement is not designed to permit unfair 
discrimination in the admission of participants or among participants 
in the use of the clearing agency consistent with Section 
17A(b)(3)(F).\92\
---------------------------------------------------------------------------

    \92\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    The Commission acknowledges that the admission and integration of 
other DCMs or DCOs will not be immediate. However, the Commission 
believes that, in light of existing technological limitations, FICC has 
raised valid concerns regarding the operational feasibility of 
providing multiple links for direct access to the cross-margining 
arrangement at this time. These potential operational risks associated 
with managing such an arrangement, such as maintaining appropriate 
account of the positions of participants and calculating appropriate 
margin, must be weighed against the desire for greater direct access 
immediately.
    The Commission notes that FICC has previously indicated that NYPC 
has committed that it will complete the process to allow one or more 
DCMs or DCOs to be admitted and integrated into the ``one-pot'' cross-
margining arrangement as soon as feasible, but no later than 24 months 
from the start of NYPC's operations. FICC has stated that the 
transition period is necessary to complete implementation, systems 
integration, and testing, among other things, and that it would open 
the arrangement to other participants as soon as operationally 
feasible.\93\ The Commission believes that the operational issues, 
including those cited by FICC, would need to be resolved prior to 
admitting a DCM or DCO as an LPP. The Commission believes that this 
aspect of the proposal would not impose any burden on competition not 
necessary and appropriate in furtherance of the purposes of the 
Exchange Act consistent with Section 17A(b)(3)(I) of the Act.
---------------------------------------------------------------------------

    \93\ FICC represented that following the announcement of NYPC, 
FICC, the NYPC management team and senior management of NYSE 
Euronext have been in discussions with other DCOs and DCMs to 
initiate the process of integrating such other organizations into 
the ``one-pot.'' While those efforts have not yet been productive, 
FICC and NYPC remain committed to expanding the ``one-pot'' to 
include other DCOs and DCMs. Letter from Douglas Landy, Allen & 
Overy on behalf of the Fixed Income Clearing Corporation (January 4, 
2011).
---------------------------------------------------------------------------

    Moreover, the Commission notes that FICC has stated that the 
proposal would provide market participants with an alternate venue for 
trading U.S. dollar-denominated interest rate futures contracts, 
thereby potentially helping to increase competition in this market. The 
Commission believes that these pro-competitive features of the proposal 
are consistent with the Act.
    The Commission takes seriously commenters' concerns regarding 
competition. As discussed below, FICC has represented and undertaken to 
provide the Commission with

[[Page 12155]]

information about the LLP agreements concerning the proposed cross-
margining arrangements.
    The Commission believes FICC's commitment to provide ongoing 
information with respect LLP agreements would help to evaluate its 
efforts to facilitate indirect access and would thereby help to ensure 
that the proposal would not impose any burden on competition not 
necessary and appropriate in furtherance of the purposes of the 
Exchange Act, consistent with Section 17A(b)(3)(I) of the Act.\94\ The 
Commission anticipates that this information will be primarily used for 
the limited purpose of identifying any instances in which there is 
potential non-compliance with the terms of this order or the 
representations made by FICC.
---------------------------------------------------------------------------

    \94\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    The Commission has considered the concerns presented by commenters 
and has determined that the benefits of the proposal outweigh any anti-
competitive effects of the proposal. The Commission believes that the 
proposal would not impose any burden on competition not necessary and 
appropriate in furtherance of the purposes of the Exchange Act 
consistent with Section 17A(b)(3)(I) of the Act.\95\
---------------------------------------------------------------------------

    \95\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

C. Effect on Efficiency and Costs

    As previously discussed, both FICC and those commenting on the 
proposed rule change expect that the cross-margining proposal will 
reduce costs, including delivery costs, and increase cash flows through 
margin efficiencies. The Commission believes that the NYPC Arrangement 
has the potential to increase efficiencies by allowing clearing 
agencies to streamline the delivery process, employ common and 
coordinated risk management and margin methodologies, and lower costs 
for market participants.
    A ``two-pot'' arrangement allows for offsets and lowered margin 
based on correlations in a members' cleared positions at different 
clearinghouses; however, there is not a unified arrangement for risk 
management or loss allocations.\96\ The ``two-pot'' cross-margining 
arrangements approved by the Commission in the past, including one 
between FICC and CME, have allowed clearinghouses to allow credit 
against the margin requirement for offsetting positions cleared at 
another clearinghouse, but each clearinghouse maintained and managed 
separate pools of collateral. The ``one-pot'' arrangement would offer 
greater margin reductions than a ``two-pot'' arrangement.
---------------------------------------------------------------------------

    \96\ See Securities and Exchange Act Release No. 44301, 66 FR 
28297 (May 11, 2001) (approving a ``two-pot'' cross-margining 
proposal between FICC's predecessor and CME).
---------------------------------------------------------------------------

    As result of these benefits in facilitating a more accurate and 
cost-effective system for settlement, the Commission believes that the 
proposal would promote the prompt and accurate clearance and settlement 
of securities transactions and help assure the safeguarding of 
securities and funds in a manner consistent with Section 17A(b)(3)(F) 
of the Act.\97\
---------------------------------------------------------------------------

    \97\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

D. Additional Reporting

    As noted above, FICC has represented that it will provide certain 
information and reports to the Commission on an ongoing basis in order 
to facilitate ongoing monitoring of the cross-margining arrangement and 
thereby help ensure compliance with the standards in Section 17A of the 
Act.\98\ In particular, with respect to information pertaining to risk 
matters, the Commission believes that these reports would assist the 
Commission in its efforts to monitor risk management practices under 
the cross-margining arrangement by providing information to help 
confirm that the actual performance of the models and systems are 
consistent with those anticipated during tests prior to launch. 
Specifically, FICC has agreed to provide the following information upon 
the proposed rule change becoming effective:
---------------------------------------------------------------------------

    \98\ Letter from Michael Bodson, Executive Managing Director, 
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive 
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
---------------------------------------------------------------------------

     For the first 250 trading days upon the proposed rule 
change becoming effective, FICC will provide the Commission staff with 
quarterly reports that itemize divergences between CME prices and NYSE 
Liffe prices for ``look-alike contracts.'' \99\
---------------------------------------------------------------------------

    \99\ ``Look-alike contracts'' refers to contracts that have 
similar economic features but are traded separately on CME and NYSE 
Liffe.
---------------------------------------------------------------------------

     Semi-annually, FICC will provide the Commission staff with 
reports summarizing the sensitivity of the model used for the NYPC 
Agreement and the collected margin to the model's assumptions and 
established parameters.
     Quarterly, FICC will provide the Commission staff with 
detailed portfolio analyses of members participating in the NYPC 
Arrangement.
     Monthly, FICC will provide the Commission staff with 
reports summarizing the details of: (1) Any instances in which the 
account of a member participating in the NYPC Agreement experienced a 
loss that exceeded its margin requirement and the magnitude of such 
loss; (2) FICC's analysis of the sufficiency of NYPC's guaranty fund in 
conjunction with NYPC; and (3) FICC's analysis of daily correlations 
between the futures and cash products that are subject to the NYPC 
Arrangement.
     FICC will provide the Commission staff with DTCC's 
periodic default simulations that factor in members' participation in 
the NYPC Agreement.
     For 24 months upon the proposed rule change becoming 
effective, FICC will provide the Commission staff with information on a 
quarterly basis regarding potential LPPs, including progress on 
negotiations and discussions of agreements or potential agreements with 
potential LPPs.
     FICC will provide the Commission all agreements entered 
into between NYPC and any LPPs, as well as all amendments to such 
agreements, including, but not limited to, those regarding changes in 
the fee arrangements.

V. 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 \100\ and the rules and 
regulations thereunder.
---------------------------------------------------------------------------

    \100\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-FICC-2010-09) be, and hereby 
is, approved.

Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-4836 Filed 3-3-11; 8:45 am]
BILLING CODE 8011-01-P