[Federal Register Volume 79, Number 205 (Thursday, October 23, 2014)]
[Notices]
[Pages 63458-63461]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-25202]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73388; File No. SR-FICC-2014-801]


Self-Regulatory Organizations; The Fixed Income Clearing 
Corporation; Notice of No Objection to Advance Notice Filing, as 
Amended by Amendment No. 1, Concerning the Government Security 
Division's Inclusion of GCF Repo[supreg] Positions in Its Intraday 
Participant Clearing Fund Requirement Calculation, and Its Hourly 
Internal Surveillance Cycles

October 17, 2014.
    On January 10, 2014, The Fixed Income Clearing Corporation 
(``FICC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-FICC-2014-801 (``Advance Notice'') 
pursuant to Section 806(e)(1)(A) of the Payment, Clearing, and 
Settlement Supervision Act of 2010 (``Payment, Clearing and Settlement 
Supervision Act'' or ``Title VIII'') \1\ and Rule 19b-4(n)(1)(i) of the 
Securities Exchange Act of 1934 (``Act'').\2\ The Advance Notice was 
published for comment in the Federal Register on February 10, 2014.\3\ 
On March 10, 2014, the Commission staff sent FICC a letter, pursuant to 
Section 806(e)(1)(D) \4\ and Commission authorization, requesting 
additional information regarding this advance notice.\5\ FICC filed an 
amendment to the Advance Notice on August 11, 2014, which was published

[[Page 63459]]

for comment in the Federal Register on September, 26, 2014.\6\ The 
Commission received no comments on the Advance Notice. This publication 
serves as a notice of no objection to the changes proposed in the 
Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1)(A). The Financial Stability Oversight 
Council designated FICC a systemically important financial market 
utility on July 18, 2012. See Financial Stability Oversight Council 
2012 Annual Report, Appendix A, http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. Therefore, FICC is 
required to comply with Title VIII of the Payment, Clearing and 
Settlement Supervision Act.
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ Securities Exchange Act Release No. 71469 (Feb. 4, 2014), 79 
FR 7722 (Feb. 10, 2014) (SR-FICC-2014-801).
    \4\ 12 U.S.C. 5465(e)(1)(D).
    \5\ The Commission received a response to this request for 
additional information August 19, 2014, at which time a 60 day 
review period for the Advance Notice began pursuant to Section 
806(e)(1)(G). 12 U.S.C. 5465(e)(1)(G).
    \6\ Securities Exchange Act Release No. 73187 (September 23), 79 
FR 58007 (September 26, 2014) (SR-FICC-2014-801).
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I. Description of the Advance Notice

    The Advance Notice concerns a proposal by FICC's Government 
Securities Division (``GSD'') to include GCF Repo[supreg] \7\ positions 
in its intraday (i.e., noon) participant Clearing Fund requirement 
calculation (``CFR''), and its hourly internal surveillance cycles. 
FICC intends for this enhancement to align GSD's risk management 
calculations and monitoring with the changes that have been implemented 
to the tri-party infrastructure by the Tri-Party Repo Infrastructure 
Reform Task Force (``Task Force'') \8\ specifically, with respect to 
locking up of GCF Repo[supreg] collateral until 3:30 p.m. (ET) rather 
than 7:30 a.m. (ET). The Advance Notice also provides FICC the ability 
to account for an altered intraday risk profile of members as a result 
of a member's substitution of cash for securities that were used as 
collateral for a GCF Repo[supreg] position the prior day (``Cash 
Substitution'') or a clearing bank unwind of the cash lending side of 
the transaction for an inter-bank GCF Repo[supreg] transaction at 7:30 
a.m. (ET) (``Early Unwind'') by implementing an Early Unwind Intraday 
Charge (``EUIC'') where appropriate.
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    \7\ The GCF Repo[supreg] service enables dealers to trade 
general collateral repos, based on rate, term, and underlying 
product, throughout the day without requiring intra-day, trade-for-
trade settlement on a Deliver-versus-Payment (``DVP'') basis. The 
service fosters a highly liquid market for securities financing.
    \8\ The Task Force was formed in September 2009 under the 
auspices of the Payments Risk Committee, a private-sector body 
sponsored by the Federal Reserve Bank of New York. The Task Force's 
goal is to enhance the repo market's ability to navigate stressed 
market conditions by implementing changes that help better safeguard 
the market. FICC has worked in close collaboration with the Task 
Force on its reform initiatives.
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(i) Historical Background

    Prior to the changes implemented by the Task Force, the underlying 
collateral pertaining to the GCF Repo[supreg] positions was locked up 
each afternoon (approximately 4:30 p.m. (ET)) and unwound at the 
beginning of the next business day (approximately 7:30 a.m. (ET)). 
Thus, the GCF Repo[supreg] positions were included in the end of day 
(``EOD'') CFR calculations but not included in FICC's noon intraday CFR 
calculations. Because the GCF Repo[supreg] positions were not included 
in FICC's noon intraday CFR calculation, the noon calculation could 
result in an under-margined condition relative to the same EOD \9\ CFR. 
Thus, FICC imposed a ``higher-of'' standard on GCF Repo[supreg] 
participants, whereby their noon intraday CFR was the higher of the 
actual noon intraday CFR calculation or its prior EOD CFR 
calculation.\10\
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    \9\ As used herein ``prior EOD'' refers to the end of day cycle 
immediately preceding the current noon intraday cycle and ``same 
EOD'' refers to the cycle immediately subsequent to the current noon 
intraday cycle.
    \10\ For example, in the extreme case where a participant's 
portfolio was comprised entirely of GCF Repo[supreg] positions, at 
each EOD margining cycle FICC could calculate a substantial margin 
requirement which had to be met by 9:30 a.m. (ET) the next morning. 
But at each intraday margining cycle, FICC would calculate a 
negligible margin requirement (because GCF Repo[supreg] positions 
were not included at intraday). This would allow the participant to 
withdraw substantially all its margin collateral before the same 
EOD. In this case, if the participant defaulted overnight, FICC 
would hold almost no margin collateral from the participant while 
having the exposure of liquidating losses on a substantial GCF 
Repo[supreg] portfolio. To prevent this potential under-margin 
condition, FICC imposed the ``higher of'' standard.
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    With the advent of the Task Force's reform, which resulted in 
moving the unwind from 7:30 a.m. (ET) to 3:30 p.m. (ET), details on the 
underlying collateral pertaining to GCF Repo[supreg] positions are now 
received from the clearing banks on an hourly basis and can be 
incorporated into the noon intraday CFR calculation. Substitutions of 
underlying collateral are now permitted between 8:30 a.m. (ET) and 3:30 
p.m. (ET).\11\
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    \11\ A key aspect of the GCF Repo[supreg] service is to give the 
repo side (cash borrower) the ability to retrieve its securities 
during the business day and deliver those securities to meet a 
delivery obligation. As a result, GCF Repo[supreg] was unwound in 
the morning. With the Tri-Party Reform's change in the unwind from 
7:30 a.m. (ET) to 3:30 p.m. (ET), participants now have access to 
their securities during the day via collateral substitutions.
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(ii) Proposed Change

    Because GCF Repo[supreg] collateral remains locked-up until 3:30 
p.m. (ET), FICC proposed incorporating the underlying collateral 
pertaining to GCF Repo[supreg] positions in its noon intraday 
participant CFR calculation, and its hourly internal surveillance 
cycles.\12\ This enhancement is intended to align FICC's risk 
management calculations and monitoring with the changes that have been 
implemented to the tri-party infrastructure by the Task Force.
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    \12\ In the ordinary course of business, the ``higher of'' 
standard will not apply. However, this standard will remain 
available in the event that one or both clearing banks do not 
provide intraday underlying collateral pertaining to the GCF 
Repo[supreg] position data because such clearing bank, as 
applicable, is unable to provide the data.
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    In certain instances, Cash Substitutions, for repo and reverse repo 
positions and the Early Unwind of interbank allocations for reverse 
repo positions, could result in higher cash balances in the underlying 
collateral pertaining to GCF Repo[supreg] positions at noon intraday 
than the same EOD, and could present a potential under-margin condition 
because cash collateral is not margined but the cash likely will be 
replaced by securities in the next GCF Repo[supreg] allocation of 
collateral. The under-margin condition will exist overnight because the 
VaR on the GCF Repo[supreg] collateral in the same EOD cycle will not 
be calculated until after Fedwire is closed, thus precluding members 
from satisfying margin deficits until the morning of the next business 
day.
    As a result, FICC amended its proposal \13\ to include the EUIC to 
account for the altered intraday risk profile created by Cash 
Substitutions and Early Unwinds.\14\ In order to determine whether an 
EUIC should be applied, FICC will take the following steps:
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    \13\ See Securities Exchange Act Release No. 73187 (September 
23), 79 FR 58007 (September 26, 2014) (SR-FICC-2014-801).
    \14\ If a member is assessed an EUIC that is deemed unnecessary, 
FICC management will have the discretion to waive such charge.
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    1. At noon, FICC will compare the prior EOD VaR component of the 
CFR calculation with the current day's noon intraday VaR component of 
the CFR calculation.
    2. If the current day's noon intraday VaR calculation is equal to 
or higher than the prior EOD's VaR calculation then GSD will not apply 
an EUIC. If however, the current day's noon calculation is lower, then 
FICC will proceed to the step 3 below.
    3. FICC will review the GCF Repo[supreg] participant's DVP and GCF 
Repo[supreg] portfolio to determine whether the reduction in the noon 
calculation may be attributable to the GCF Repo[supreg] participant's 
intraday cash substitutions or early unwind of interbank allocations. 
If so, then FICC will apply the EUIC.
    4. At the participant level, the EUIC \15\ will be the lesser of 
(i) the net VaR decrease that may be deemed to be attributable to 
either Cash Substitutions

[[Page 63460]]

and/or Early Unwinds of interbank allocations or (ii) the prior EOD VaR 
minus the noon intraday VaR.\16\
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    \15\ The EUIC will be included in the noon intraday participant 
CFR, but not the same EOD CFR. This is because the risk associated 
with cash lockups exists at intraday, that is, at any time before at 
EOD. At EOD in the normal course of business, GCF Repo[supreg] 
positions consist of 100% eligible non-cash securities. GCF 
Repo[supreg] is used for overnight financing of securities 
inventory. Absent extraordinary circumstances, participants do not 
use cash to collateralized overnight cash loans. Cash Substitutions 
occur at intraday as participants substitute in cash to withdraw 
securities they need for intraday deliveries.
    \16\ In the event that cash substitutions or early unwind of 
interbank allocations impacts the CFR, the prior end of day CFR is 
used as a proxy for the same end of day CFR for the portion of the 
portfolio that is impacted by such cash substitutions or early 
unwind of interbank allocations. The EUIC is designed to prevent the 
impact of cash substitutions and early unwind of interbank 
allocations from unduly reducing noon intraday CFR relative to the 
prior EOD CFR calculation, thus the EUIC will not increase the noon 
intraday CFR above the prior EOD CFR calculation. (But the noon 
intraday CFR calculation exclusive of EUIC could be higher than the 
prior EOD CFR calculation.)
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The EUIC for Cash Substitutions will apply to both the repo side (cash 
borrower) and the reverse repo side (cash lender) of the transaction 
and the EUIC for the Early Unwinds of interbank allocations will apply 
to the reverse repo side only. The EUIC applies to the reverse repo 
side because although that side does not initiate the Cash Substitution 
or the Early Unwind of interbank allocations, these events change the 
reverse repo participants' risk profile and as a result, their noon 
intraday CFR could be unduly reduced. The EUIC for the Early Unwind of 
interbank allocations will only apply to the reverse repo side (cash 
lender) since it is only the reverse side whose lockup is unwound 
early. The securities subject to the Early unwind are not returned to 
the repo side (cash borrower) in connection with the early unwind of 
interbank allocations. The Early Unwind of interbank allocations is 
performed on the reverse repo side to ensure that the underlying 
collateral is available to the repo side at its settlement bank. Cash 
is returned to the reverse repo side and thus unwound early. There is 
no automatic unwind (return of securities) to the repo side. If the 
repo side needs its securities before the 3:30 p.m. (ET) scheduled 
unwind, it may perform a securities-for-securities substitution or a 
cash-for-securities substitution (in which case it may be subject to 
the EUIC).

II. Discussion and Commission Findings

    Although the Payment, Clearing and Settlement Supervision Act does 
not specify a standard of review for an advance notice, the Commission 
believes its stated purpose is instructive.\17\ The stated purpose is 
to mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically-important financial market utilities 
(``FMU'') and strengthening the liquidity of systemically important 
FMUs.\18\
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    \17\ See 12 U.S.C. 5461(b).
    \18\ Id.
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    Section 805(a)(2) of the Payment, Clearing, and Settlement 
Supervision Act \19\ authorizes the Commission to prescribe risk 
management standards for the payment, clearing, and settlement 
activities of designated clearing entities and financial institutions 
engaged in designated activities for which it is the supervisory agency 
or the appropriate financial regulator. Section 805(b) of the Payment, 
Clearing, and Settlement Supervision Act \20\ states that the 
objectives and principles for the risk management standards prescribed 
under Section 805(a) shall be to:
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    \19\ 12 U.S.C. 5464(a)(2).
    \20\ 12 U.S.C. 5464(b).
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     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.
    The Commission has adopted risk management standards under Section 
805(a)(2) of the Payment, Clearing and Settlement Supervision Act \21\ 
(``Clearing Agency Standards'').\22\ The Clearing Agency Standards 
became effective on January 2, 2013 and require registered clearing 
agencies that perform central counterparty (``CCP'') services to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for their operations and risk management practices on an 
ongoing basis.\23\ As such, it is appropriate for the Commission to 
review advance notices against these Clearing Agency Standards and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Payment, Clearing and Settlement 
Supervision Act.\24\
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    \21\ 12 U.S.C. 5464(a)(2).
    \22\ Rule 17Ad-22, 17 CFR 240.17Ad-22. Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
    \23\ The Clearing Agency Standards are substantially similar to 
the risk management standards established by the Board of Governors 
of the Federal Reserve System (``Federal Reserve'') governing the 
operations of designated DFMUs that are not clearing entities and 
financial institutions engaged in designated activities for which 
the Commission or the Commodity Futures Trading Commission is the 
Supervisory Agency. See Financial Market Utilities, 77 FR 45907 
(August 2, 2012).
    \24\ 12 U.S.C. 5464(b).
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    Because it was based on the previous pre-reform unwinding process 
described above, FICC's intraday risk calculation does not currently 
capture the GCF Repo[supreg] positions on an intraday basis. The change 
to incorporate the underlying collateral pertaining to the GCF 
Repo[supreg] positions in its noon intraday participant CFR 
calculation, and its hourly internal surveillance cycles, should 
improve FICC's risk management by providing a more accurate and timely 
view of member positions and their corresponding exposures and may help 
ensure that FICC collects sufficient clearing fund deposits to 
safeguard itself in the event of a member default. Further, 
incorporating GCF Repo[supreg] positions into intraday participant CFR 
calculations and hourly surveillance cycles may better reflect the 
actual risk in its members' portfolios. Moreover, the inclusion of the 
EUIC may allow FICC to use more accurate position information in its 
margin calculations and mitigate the effects of Cash Substitutions and 
Early Unwinds that occur during the intraday period.
    The Commission believes that including GCF Repo[supreg] positions 
in FICC's intraday participant clearing fund calculations and hourly 
internal surveillance meets the objectives and principles for the risk 
management standards prescribed under Section 805(a). The inclusion of 
GCF[supreg] Repo positions may provide FICC with a more accurate view 
of members' intraday exposures and more accurate risk profiles. 
Additionally, the EUIC allows FICC to account for risks posed by 
intraday VaR fluctuations that are caused by Cash Substitutions and 
Early Unwinds and may allow FICC to better manage intraday risk. Thus, 
the proposal promotes robust risk management and safety and soundness 
of FICC's risk management systems, reduces systemic risk, and supports 
the stability of the broader financial system.\25\
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    \25\ 12 U.S.C. 5464(b).
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    The proposed change is also consistent with Rule 17Ad-22 \26\ of 
the Clearing Agency Standards which establishes the minimum 
requirements regarding how registered clearing agencies must maintain 
effective risk management procedures and controls. Specifically, Rule 
17Ad-22(b)(1) requires a clearing agency that performs CCP services to 
establish, implement, maintain and enforce written policies reasonably 
designed to measure its credit exposures at least daily and to limit 
exposures to potential losses from defaults by participants under 
normal market conditions so that the operations of the clearing agency 
should not be disrupt and non-defaulting participants would not be 
exposed to losses that they cannot anticipate or control.\27\ Rule

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17Ad-22(b)(2) requires FICC to establish, implement, maintain and 
enforce written policies and procedures reasonably designed to use 
margin requirements to limit its credit exposures to participants under 
normal market conditions and use risk-based models and parameters to 
set margin requirements.\28\ To these ends, the change may provide FICC 
with a more accurate measurement of daily credit exposure using a risk-
based model and is designed to address exposures that may occur from 
intraday activity. In sum, FICC's more accurate and timely calculations 
around and monitoring of GCF Repo[supreg] activity may better enable 
FICC to respond in the event that a member defaults.
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    \26\ 17 CFR 240.17Ad-22.
    \27\ 17 CFR 240.17Ad-22(b)(1).
    \28\ 17 CFR 240.17Ad-22(b)(2).
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Payment, Clearing and Settlement Supervision Act,\29\ that the 
Commission does not object to advance notice proposal (SR-FICC2014-801) 
and that FICC is authorized to implement the proposal as of the date of 
this notice or the date of an order by the Commission approving a 
proposed rule change that reflects rule changes that are consistent 
with this advance notice proposal (SR-FICC-2014-01), whichever is 
later.
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    \29\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2014-25202 Filed 10-22-14; 8:45 am]
BILLING CODE 8011-01-P