[Federal Register Volume 78, Number 89 (Wednesday, May 8, 2013)]
[Notices]
[Pages 26832-26836]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-10847]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69495; File No. SR-FICC-2013-04]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change to the Government Securities 
Division Rules and the Mortgage-Backed Securities Division Clearing 
Rules in Connection With the Implementation of the Foreign Account Tax 
Compliance Act (FATCA)

May 2, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that on April 22, 2013, the Fixed Income Clearing Corporation 
(``FICC'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II 
and III below, which Items have been substantially prepared by FICC. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The proposed rule changes consist of modifications to the Rulebook 
of the Government Securities Division (``GSD'') and the Clearing Rules 
of the Mortgage-Backed Securities Division (``MBSD'') (collectively, 
the ``Rules'') of FICC in connection with implementation of sections 
1471 through 1474 of the Internal Revenue Code of 1986, as amended, 
that were enacted as part of the Foreign Account Tax Compliance Act, 
and the Treasury Regulations or other official interpretations 
thereunder (collectively ``FATCA'').

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, FICC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FICC has prepared summaries, set forth in sections A, B 
and C below, of the most significant aspects of such statements.\3\
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    \3\ The Commission has modified the text of the summaries 
prepared by the clearing agency.

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[[Page 26833]]

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

Background
    FATCA was enacted on March 18, 2010, as part of the Hiring 
Incentives to Restore Employment Act, and became effective, subject to 
transition rules, on January 1, 2013. The U.S. Treasury Department 
finalized and issued various implementing regulations (``FATCA 
Regulations'') on January 17, 2013. FATCA's intent is to curb tax 
evasion by U.S. citizens and residents through their use of offshore 
bank accounts. FATCA generally requires foreign financial institutions 
(``FFIs'') \4\ to become ``participating FFIs'' by entering into 
agreements with the Internal Revenue Service (``IRS''). Under these 
agreements, FFIs are required to report to the IRS information on U.S. 
persons and entities that have (directly or indirectly) accounts with 
these FFIs. If an FFI does not enter into such an agreement with the 
IRS, FATCA will impose a 30% withholding tax on U.S.-source interest, 
dividends and other periodic amounts paid to such ``nonparticipating 
FFI'' (``Income Withholding''), as well as on the payment of gross 
proceeds arising from the sale, maturity or redemption of securities or 
any instrument yielding U.S.-source interest and dividends (``Gross 
Proceeds Withholding,'' and, together with Income Withholding, ``FATCA 
Withholding''). The 30% FATCA Withholding taxes will apply to payments 
made to a nonparticipating FFI acting in any capacity, including 
payments made to a nonparticipating FFI that is not the beneficial 
owner of the amount paid and acting only as a custodian or other 
intermediary with respect to such payment. To the extent that U.S.-
source interest, dividend, and other periodic amount or gross proceeds 
payments are due to a nonparticipating FFI in any capacity, a U.S. 
payor, such as FICC, transmitting such payments to the nonparticipating 
FFI will be liable to the IRS for any amounts of FATCA Withholding that 
the U.S. payor should, but does not, withhold and remit to the IRS. For 
the reasons described below, FICC is not in a position to accept this 
liability and, by making the proposed rule changes set forth herein, is 
implementing preventive measures to protect itself against such 
liability.
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    \4\ Non-U.S. financial institutions are referred to as ``foreign 
financial institutions'' or ``FFIs'' in the FATCA Regulations.
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    In addition, under FATCA, a U.S. payor, such as FICC, could be 
required to deduct Income Withholding with regard to a participating 
FFI if either: (x) the participating FFI makes a statutory election to 
shift its withholding responsibility under FATCA to the U.S. payor; or 
(y) the U.S. payor is required to ignore the actual recipient and treat 
the payment as if made instead to certain owners, principals, 
customers, account holders or financial counterparties of the 
participating FFI. FICC is not in a position to accept this burden 
shift and, by making the proposed rule changes set forth herein, is 
implementing preventive measures to protect itself against such a 
burden.
    As an alternative to FFIs entering into individual agreements with 
the IRS, the U.S. Treasury Department provided another means of 
complying with FATCA for FFIs which are resident in Non-U.S. 
jurisdictions that enter into intergovernmental agreements (``IGA'') 
with the United States.\5\ Generally, such a jurisdiction (``FATCA 
Partner'') would pass laws to eliminate the conflicts of law issues 
that would otherwise make it difficult for FFIs in its jurisdiction to 
collect the information required under FATCA and transfer this 
information, directly or indirectly, to the United States. An FFI 
resident in a FATCA Partner jurisdiction would either transmit FATCA 
reporting to its local competent tax authority, which in turn would 
transmit the information to the IRS, or the FFI would be authorized/
required by FATCA Partner law to enter into an FFI agreement and 
transmit FATCA reporting directly to the IRS. Under both IGA models, 
payments to such FFIs would not be subject to FATCA Withholding so long 
as the FFI complies with the FATCA Partner's laws mandated in the IGA.
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    \5\ As of the date of this proposed rule change filing, the 
United Kingdom, Mexico, Ireland, Switzerland, Spain, Norway Denmark, 
Italy and Germany have signed or initialed an IGA with the United 
States. The U.S. Treasury Department has announced that it is 
engaged in negotiations with more than 50 countries and 
jurisdictions regarding entering into an IGA.
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    Under the FATCA Regulations, (A) beginning January 1, 2014, FICC 
will be required to do Income Withholding on any payments made to any 
nonparticipating FFI approved for membership by FICC as of such date or 
thereafter, (B) beginning July 1, 2014, FICC will be required to do 
Income Withholding on any payments made to any nonparticipating FFI 
approved for membership by FICC prior to January 1, 2014 and (C) 
beginning January 1, 2017, FICC will be required to do Gross Proceeds 
Withholding on all nonparticipating FFIs, regardless when any such 
FFI's membership was approved.
Preparing for Implementation of FATCA
    In preparation for FATCA's implementation, FFIs are being asked to 
identify their expected FATCA status as a condition of continuing to do 
business. Customary legal agreements in the financial services industry 
already contain provisions allocating the risk of any FATCA Withholding 
tax that will need to be collected, and requiring that, upon FATCA's 
effectiveness, foreign counterparties must certify (and periodically 
recertify) their FATCA status using the relevant tax forms that the IRS 
has announced it will provide.\6\ Advance disclosure by an FFI client 
or counterparty would permit a withholding agent to readily determine 
whether it must, under FATCA, withhold on payments it makes to the FFI. 
If an FFI fails to provide appropriate compliance documentation to a 
withholding agent, such FFI would be presumed to be a nonparticipating 
FFI and the withholding agent will be obligated to withhold on certain 
payments.
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    \6\ For example, credit agreements now routinely require foreign 
lenders to agree to provide certifications of their FATCA status 
under approved IRS forms to U.S. borrowers, and subscription 
agreements for alternative investment funds that are anticipated to 
earn U.S.-source income are routinely requiring similar covenants.
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    As it applies to FICC specifically, FATCA will require FICC to 
deduct FATCA Withholding on payments to certain members arising from 
certain transactions processed by FICC on behalf of such members.\7\ 
Because FATCA treats any entity holding financial assets for the 
account of others as a ``financial institution,'' FICC believes that 
almost all of its members which are treated as non-U.S. entities for 
federal income tax purposes, including those members that are U.S. 
branches of non-U.S. entities, will likely be FFIs under FATCA 
(collectively, ``FFI Members'').\8\ As such, FICC will be liable to the 
IRS for any failures to withhold correctly under FATCA on payments made 
to its FFI Members.
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    \7\ FFI Members resident in IGA countries, that are compliant 
with the terms of applicable IGAs, should not be subject to FATCA 
Withholding.
    \8\ Currently, only a small percentage of the Corporation's 
members are treated as non-U.S. entities for federal income tax 
purposes.
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    In light of this, FICC has evaluated its existing systems and 
services to determine whether and how it may comply with its FATCA 
obligations. As a result of this evaluation, FICC has determined that 
its existing systems currently cannot process the new FATCA Withholding 
obligations with regard to the securities transactions processed by it, 
as no similar withholding obligation of this

[[Page 26834]]

magnitude has ever been imposed upon it to date, and FICC has therefore 
not built its systems to support such an obligation.
    Further, the vast majority of the transactions that are processed 
at FICC are processed through its netting and settlement systems at its 
GSD and MBSD divisions (the ``Systems''). At GSD, the netting and 
settlement system service provides centralized, automated clearance and 
guaranteed settlement of eligible U.S. Treasury bills, notes, bonds, 
strips and book-entry non-mortgage-backed agency securities. Through 
netting, the GSD establishes a single net long or short position for 
each participant's daily trading activity in a given security. The 
participant's net position is the difference between all long and all 
short positions in a given security.
    At MBSD, the mortgage-backed securities trades entering the MBSD 
clearing and settlement systems are settled using either the Settlement 
Balance Order system (SBO) or the Trade-for-Trade system (TFTD). The 
SBO settlement system is MBSD's trade netting system, which nets by 
automatically pairing off settlement obligations with like terms, such 
as MBS product, coupon rate, maturity and settlement date, on a 
multilateral basis, i.e., regardless of contra party identity, 
resulting in the fewest possible number of receive/deliver obligations. 
Through the Trade-for-Trade settlement system, members are given the 
opportunity to settle individual trades on a gross basis, as originally 
executed, following matching and comparison of each trade. Further 
netting is accomplished through MBSD's CCP Pool Netting service (``Pool 
Netting''). Members submit pool details (``Pool Instructs'') into the 
Pool Netting system for bilateral matching versus their counterparties' 
submissions. As many of the matched Pool Instructs as possible are then 
netted by the Pool Netting system. For pools that meet all the 
criteria, FICC steps in as the central counter-party to settle the net 
pool obligations with its members.
    FICC believes that each division's net settlement functionality 
could make FATCA Withholding virtually impossible, or, at the very 
least, would create onerous efficiency and liquidity issues for both 
FICC and its membership. Undertaking FATCA Withholding, given FICC's 
settlement functionality, could require FICC in certain circumstances 
to resort to a draw on FICC's clearing fund for GSD or MBSD, as 
applicable (``Clearing Fund'') in order to fund FATCA Withholding taxes 
with regard to nonparticipating FFI Members in non-FATCA Partner 
jurisdictions whenever the net credit owed to such FFI Member is less 
than the 30% FATCA tax. For example, if a nonparticipating FFI (in a 
non-FATCA Partner jurisdiction) is owed a $100M payment from the sale 
of U.S. securities, but such nonparticipating FFI is in a net debit 
position at the end of that day because of FICC's net settlement 
functionality, there would be no payment to this FFI Member from which 
FICC can withhold. In this example, FICC would likely need to fund the 
$30M FATCA Withholding tax until such time as the FFI Member can 
reimburse FICC and, as FICC has no funds for this purpose, it would 
likely require a draw on the Clearing Fund.\9\ FICC would need to 
consider an increase in the amount of cash required to be deposited 
into the Clearing Fund, either by FFI Members or perhaps all of its 
members, which would reduce such member's liquidity and could have 
significant systemic effects. The amount of the FATCA Withholding taxes 
would be removed from market liquidity, which could lead to increased 
risk of member failure and increased financial instability.
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    \9\ We note that the FATCA Regulations provide that ``clearing 
organizations'', which settle money on a net basis, may withhold on 
a similar net basis for FATCA purposes. However, it is unclear 
whether certain amounts being netted at the Corporation would 
qualify for the special FATCA netting rule. Even if the end of day 
net settlement amount would qualify as the correct amount to do 
FATCA Withholding on, the liquidity risks described herein are still 
present. This is because the sheer volume of the Corporation's net 
daily payments among the Corporation and members means that 
withholding FATCA tax from such net settlement payments, in any 
material proportion, would likely reduce liquidity and thus increase 
financial instability.
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    For the reasons explained above and the following additional 
reasons, FICC is proposing amendments to its Rules (detailed below) to 
implement preventive measures that would generally require all of 
FICC's (i) existing members that are treated as Non-U.S. entities for 
federal income tax purposes and (ii) any applicants applying to become 
members that are treated as Non-U.S. entities for federal income tax 
purposes to be participating FFIs:
     Undertaking FATCA Withholding by FICC (even if possible) 
would make it economically unfeasible for affected FFI Members to 
engage in transactions involving U.S. securities. It would likely also 
quickly cause a significant negative impact on such FFI Members' 
liquidity because such withholding taxes would be imposed on the very 
large sums that FICC pays to such FFI Members. Furthermore, members 
would be burdened with extra costs and the negative impact on liquidity 
caused by the likely need to substantially increase the amount of cash 
required to be deposited into the Clearing Fund.
     The cost of implementing a FATCA Withholding system for a 
small number of nonparticipating FFI Members would be substantial and 
disproportionate to the related benefit. Under the Model I IGA form and 
its executed versions with various FATCA Partners, FICC would not be 
required to withhold with regard to FFI residents in such FATCA Partner 
jurisdictions. Accordingly, FICC's withholding obligations under FATCA 
would effectively be limited to nonparticipating FFI Members in non-
FATCA Partner jurisdictions. Since the cost of developing and 
maintaining a complex FATCA Withholding system would be passed on to 
FICC's members at large, it may burden members that otherwise comply 
with, or are not subject to, FATCA Withholding.
     As briefly noted above, if the proposed rule changes were 
not to take effect, in order to avoid counterparty credit risk, FICC 
would likely require each of the nonparticipating FFI Members in non-
FATCA Partner jurisdictions to make initial or additional cash deposits 
to the Clearing Fund as collateral for the approximate potential FATCA 
tax liability of such nonparticipating FFI Member or otherwise adjust 
required deposits to the Clearing Fund. The amount of such deposits, 
which could amount to billions of dollars, would be removed from market 
liquidity.
     From the nonparticipating FFI Member's perspective, having 
30% of its payments withheld and sent to the IRS would have a severe 
negative impact on such nonparticipating FFI Member's financial status. 
In many cases, the gross receipts would be for client accounts, and the 
nonparticipating FFI Member would need to make such accounts whole. 
Without receipt of full payment for its dispositions, the 
nonparticipating FFI Member would not have sufficient assets to fund 
its client accounts.
     The proposed rule changes set forth herein should not 
create business issues or be onerous to FICC's membership because 
requiring FFIs to certify (and to periodically recertify) their FATCA 
status, and imposing the costs of non-compliance on them, are becoming 
standard market practice in the United States, separate and apart from 
membership in FICC.
Proposed Rule Changes
    Managing the risks inherent in executing securities transactions is 
a key component of FICC's business. The globalization of financial 
markets, the

[[Page 26835]]

trading of more complex instruments and the application of new 
technology all make risk management more critical and challenging. 
FICC's ``risk tolerances'' (i.e., the levels of risk FICC is prepared 
to confront, under a range of possible scenarios, in carrying out its 
business functions) are determined by the Board of Directors, in 
consultation with the Group Chief Risk Officer. FICC uses a combination 
of risk management tools, including strict criteria for membership, to 
mitigate the risks inherent in its business.
    In line with its risk management focus, FICC has determined that 
compliance with FATCA, such that FICC shall not be responsible for 
FATCA Withholding, should be a general membership requirement (A) for 
all applicants seeking membership at GSD or MBSD, as applicable, that 
are treated as non-U.S. entities for federal income tax purposes, and 
(B) for all existing FFI Members.\10\ In connection therewith, FICC 
proposes to amend its Rules as follows:
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    \10\ FICC may grant a waiver under certain circumstances, 
provided, however, that FICC will not grant a waiver if it causes 
FICC to be obligated to withhold under FATCA on gross proceeds from 
the sale or other disposition of any property.
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     Amend GSD Rule 1 and MBSD Rule 1 to add ``FATCA'', ``FATCA 
Certification'', ``FATCA Compliance Date''\11\, ``FATCA Compliant'' and 
``FFI Member'', as defined terms;
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    \11\ Although Income Withholding with regard to FFI Members 
approved for membership by the Corporation prior to January 1, 2014 
is first required under FATCA beginning July1, 2014, the proposed 
amendments to the GSD Rules and MBSD Rules would require such 
existing FFI Members to be FATCA compliant approximately 60 days 
prior to July 1, 2014 in order for the Corporation to comply with 
its disciplinary and notice processes as set forth in its Rules.
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     Amend GSD Rule 2A, Section 2(a)(v) and MBSD Rule 2A, 
Section 1 to (1) require foreign members to certify to FICC that they 
are FATCA Compliant and (2) add FATCA Compliance as a qualification 
requirement for any applicant that will be an FFI Member;
     Amend GSD Rule 2A Section 5 and MBSD Rule 2A Section 3 to 
add that each applicant must complete and deliver a FATCA Certification 
to FICC as part of its membership application unless FICC has waived 
this requirement with regard to membership type;
     Amend GSD Rule 2A Section 6 and MBSD Rule 2A Section 4 to 
add FATCA Compliance as a qualification requirement for any applicant 
that will be an FFI Member;
     Amend GSD Rule 3, Section 7 and MBSD Rule 3, Section 6 to 
specify that failure to be FATCA Compliant creates a duty upon an FFI 
Member (both new and existing) to inform FICC;
     Amend GSD Rule 3, Section 9 and MBSD Rule 3, Section 8 to 
require that all FFI Members (both new and existing), in general: (i) 
Agree not to conduct any transaction or activity through FICC if such 
FFI Member is not FATCA Compliant, (ii) certify and, as required under 
the timelines set forth under FATCA, periodically recertify, to FICC 
that they are FATCA Compliant; and (iii) indemnify FICC for any losses 
sustained by FICC resulting from such FFI Member's failure to be FATCA 
Compliant.
     FICC believes the proposed rule changes are consistent 
with the requirements of the Exchange Act. In particular, the proposed 
rule changes are consistent with Section 17A(b)(3)(F) of the Exchange 
Act\12\ because they promote the prompt and accurate clearing and 
settlement of securities transactions by eliminating an uncertainty in 
payment settlement that would arise if FICC were subject to FATCA 
Withholding obligations under FATCA. The proposed rule changes are also 
consistent with Section 17A(b)(3)(D) of the Exchange Act\13\ because 
they provide for the equitable allocation of reasonable dues, fees, and 
other charges among FICC's members. Specifically, the proposed rule 
changes allow FICC to comply with FATCA Regulations without developing 
and maintaining a complex FATCA Withholding system, the cost of which, 
as discussed above, would be would be passed on to FICC's members at 
large for the benefit of a small number of nonparticipating FFI 
Members.
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    \12\ 12 U.S.C. 78q-1(b)(3)(F).
    \13\ 12 U.S.C. 78q-1(b)(3)(D).
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(B) Clearing Agency's Statement on Burden on Competition

    FICC does not believe that the proposed rule change will have any 
negative impact, or impose any burden, on competition.

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received from Members, Participants, or Others

    Written comments relating to the proposed rule changes have not yet 
been solicited or received. FICC will notify the Commission of any 
written comments received by FICC.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Exchange Act. Comments may be submitted 
by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form
    (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-FICC-2013-04 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-FICC-2013-04. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available 
for inspection and copying at the principal office of FICC and on 
FICC's Web site (http://www.dtcc.com/legal/rule--filings/

[[Page 26836]]

ficc/2013.php). All comments received will be posted without change; 
the Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
FICC-2013-04 and should be submitted on or before May 29, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-10847 Filed 5-7-13; 8:45 am]
BILLING CODE 8011-01-P