[Federal Register Volume 81, Number 247 (Friday, December 23, 2016)]
[Notices]
[Pages 94448-94454]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-30935]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79592; File No. SR-NSCC-2016-803]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection to Advance Notice Filing To 
Accelerate Its Trade Guaranty, Add New Clearing Fund Components, 
Enhance Its Intraday Risk Management, Provide for Loss Allocation of 
``Off-the-Market Transactions,'' and Make Other Changes

December 19, 2016.
    National Securities Clearing Corporation (``NSCC'') filed on 
October 25, 2016 with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2016-803 (``Advance Notice'') 
pursuant to Section

[[Page 94449]]

806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of 
2010 (``Payment, Clearing and Settlement Supervision Act'') \1\ and 
Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934 
(``Exchange Act''). The Advance Notice was published for comment in the 
Federal Register on November 30, 2016.\3\ The Commission did not 
receive any comments on the Advance Notice. This publication serves as 
notice of no objection to the Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1). The Financial Stability Oversight 
Council designated NSCC 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, NSCC is 
required to comply with the Payment, Clearing and Settlement 
Supervision Act and file advance notices with the Commission. See 12 
U.S.C. 5465(e).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ Securities Exchange Act Release No. 79391 (November 23, 
2016), 81 FR 86348 (November 30, 2016) (SR-NSCC-2016-803) 
(``Notice''). NSCC also filed a related proposed rule change with 
the Commission pursuant to Section 19(b)(1) of the Exchange Act and 
Rule 19b-4 thereunder, seeking approval of changes to its rules 
necessary to implement the Advance Notice. 15 U.S.C. 78s(b)(1) and 
17 CFR 240.19b-4, respectively. The proposed rule change was 
published in the Federal Register on November 10, 2016. Securities 
Exchange Act Release No. 79245 (November 4, 2016), 81 FR 
79071(November 10, 2016) (SR-NSCC-2016-005). The Commission did not 
receive any comments on that proposal.
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I. Description of the Advance Notice

    The Advance Notice, as described by NSCC, is a proposal to modify 
NSCC's Rules & Procedures (``Rules'') \4\ to: (i) Accelerate NSCC's 
trade guaranty from midnight of one day after trade date (``T+1'') to 
the point of trade comparison and validation for bilateral submissions 
or to the point of trade validation for locked-in submissions; (ii) add 
three new components to NSCC's Clearing Fund formula, in the form of a 
a Margin Requirement Differential (``MRD''), a Coverage Component, and 
an Intraday Backtesting Charge); (iii) enhance NSCC's current intraday 
mark-to-market margin process; (iv) introduce a new loss allocation 
provision for any trades that fall within the proposed definition of 
``Off-the-Market Transactions;'' and (v) make other related and 
technical changes, such as eliminating the current Specified Activity 
charge \5\ from the Clearing Fund formula, no longer permitting NSCC to 
delay processing and reporting for certain index receipt transactions, 
clarifying the calculation of the Excess Capital Premium charge,\6\ and 
removing certain references to ID Net Subscribers.\7\ These proposed 
modifications are described in detail below.
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    \4\ Available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
    \5\ The Specified Activity charge is a current component of the 
Clearing Fund formula that mitigates the risk of NSCC's trade 
guaranty attaching prior to NSCC collecting margin on the 
transactions, where there is a shortened settlement cycle for the 
transaction. Notice, supra note 3.
    \6\ The Excess Capital Premium is a charge imposed on a Member 
when the Member's Required Deposit exceeds its excess net capital, 
as described in Procedure XV of the Rules. Notice, supra note 3.
    \7\ The ID Net service allows subscribers to the service to net 
all eligible affirmed institutional transactions at the Depository 
Trust Company against their CNS transactions at NSCC. See Securities 
Exchange Act Release No. 57901 (June 2, 2008), 73 FR 32373 (June 6, 
2008) (SR-NSCC-2007-14). NSCC's ID Net service is defined further in 
Rule 65. Rules, supra note 4.
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(A) Accelerated Trade Guaranty

    Pursuant to Addendum K of the Rules, NSCC currently guarantees the 
completion of trades that are cleared and settled through NSCC's 
Continuous Net Settlement, or ``CNS'' system \8\ (``CNS trades''), and 
through its Balance Order Accounting Operation \9\ (``Balance Order 
trades'') that have reached the later of midnight of T+1 or midnight of 
the day they are reported to NSCC members (``Members'').\10\ NSCC 
proposes to shorten the time at which its trade guaranty applies to 
trades by amending its Rules to guarantee the completion of CNS trades 
and Balance Order trades upon comparison and validation for bilateral 
submissions to NSCC or upon validation for locked-in submissions to 
NSCC.\11\
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    \8\ CNS and its operation are described in Rule 11 and Procedure 
VII. Rules, supra note 4.
    \9\ The Balance Order Accounting Operation is described in Rule 
5 and Procedure V. Rules, supra note 4. NSCC does not become a 
counterparty to Balance Order trades, but it does provide a trade 
guaranty to the receive and deliver parties that remains effective 
through close of business on the originally scheduled settlement 
date.
    \10\ Today, shortened process trades, such as same-day and next-
day settling trades, are already guaranteed upon comparison or trade 
recording processing.
    \11\ Validation refers to the process whereby NSCC validates a 
locked-in trade, or compares and validates a bilateral trade, to 
confirm such trade has sufficient and correct information for 
clearance and settlement processing. For purposes of this 
description in the proposed rule change, the process of comparing 
and validating bilateral submissions and the process for validating 
locked-in submissions are collectively referred to as ``trade 
validation.'' Notice, supra note 3.
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    NSCC has previously shortened the time at which its trade guaranty 
applied to trades in response to processing developments, risk 
management considerations, and to follow industry settlement 
cycles.\12\ According to NSCC, the accelerated trade guaranty and 
related changes it now proposes would benefit the industry by 
mitigating counterparty risk and enhancing counterparties' ability to 
assess that risk by having NSCC become the central counterparty 
(``CCP'') to CNS trades and by applying the trade guaranty to Balance 
Order trades at an earlier point in the settlement cycle. The transfer 
of counterparty credit risk from Members to NSCC at an earlier point in 
the settlement cycle would facilitate a shortened holding period of 
bilateral credit risk for Members by transferring the obligation onto 
NSCC.
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    \12\ See Securities Exchange Act Release Nos. 44648 (August 2, 
2001), 66 FR 42245 (August 10, 2001) (SR-NSCC-2001-11); 35442 (March 
3, 1995), 60 FR 13197 (March 10, 1995) (SR-NSCC-95-02); 35807 (June 
5, 1995), 60 FR 31177 (June 13, 1995) (SR-NSCC-95-03); and 27192 
(August 29, 1989), 54 FR 37010 (approving SR-NSCC-87-04, SR-MCC-87-
03, and SR-SCCP-87-03 until December 31, 1990).
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    To implement this proposed change, NSCC would amend Addendum K of 
the Rules \13\ to provide that CNS trades and Balance Order trades 
would be guaranteed by NSCC at the time of trade validation.\14\ NSCC 
also proposes to clarify in Addendum K \15\ that the guaranty of 
obligations arising out of the exercise or assignment of options that 
are settled at NSCC is not governed by Addendum K \16\ but by a 
separate arrangement between NSCC and The Options Clearing Corporation, 
as referred to in Procedure III of the Rules.\17\
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    \13\ Supra note 4.
    \14\ The proposed accelerated trade guaranty would not apply to 
items not currently guaranteed today.
    \15\ Supra note 4.
    \16\ Id.
    \17\ Id.
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(B) Proposed Enhancements to NSCC's Clearing Fund Formula

    In conjunction with the proposed accelerated trade guaranty, NSCC 
would enhance its Clearing Fund formula to address the risks posed by 
the expanded trade guaranty. Specifically, NSCC proposes to amend 
Procedure XV (Clearing Fund Formula and Other Matters) of the Rules 
\18\ to include three new components: the MRD, the Coverage Component, 
and the Intraday Backtesting Charge.
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    \18\ Id.
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1. Margin Requirement Differential
    The MRD component is designed by NSCC to help mitigate the risks 
posed to NSCC by day-over-day fluctuations in a Member's portfolio. It 
would do this by forecasting future changes in a Member's portfolio 
based on a historical look-back at each Member's portfolio over a given 
time period. A Member's portfolio may fluctuate significantly from one 
trading day to the next as the Member executes trades throughout the

[[Page 94450]]

day. Currently, daily fluctuations in a Member's portfolio resulting 
from such trades do not pose any additional or different risk to NSCC 
because those trades are not guaranteed by NSCC until a margin in the 
form of a Required Deposit \19\ reflecting such trades is collected by 
NSCC. However, under the accelerated trade guaranty proposal, NSCC's 
trade guaranty would attach to current-day trades immediately upon 
trade validation, before Required Deposits reflecting these trades have 
been collected (which NSCC refers to herein as the ``coverage 
gap'').\20\ The MRD would increase Members' Required Deposits by an 
amount calculated to cover forecasted fluctuations in Members' 
portfolios, based upon historical activity.
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    \19\ NSCC collects Required Deposits from all Members as margin 
to protect NSCC against losses in the event of a Member's default. 
The objective of the Required Deposit is to mitigate potential 
losses to NSCC associated with liquidation of the Member's portfolio 
if NSCC ceases to act for a Member (i.e., a ``default''). NSCC 
determines Members' Required Deposit amounts using a risk-based 
margin methodology that is intended to capture market price risk. 
The methodology uses historical market moves to project or forecast 
the potential gains or losses on the liquidation of a defaulting 
Member's portfolio, assuming that a portfolio would take three days 
to liquidate or hedge in normal market conditions. The projected 
liquidation gains or losses are used to determine the Member's 
Required Deposit, which is calculated to cover projected liquidation 
losses to be at or above a 99 percent confidence level (``Coverage 
Target''). Notice, supra note 3.
    \20\ The coverage gap is the period between the time that NSCC 
would guarantee a trade and the time that NSCC would collect 
additional margin to cover such trade.
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    The MRD would be calculated and charged on a daily basis, as a part 
of each Member's Required Deposit, and consists of two components: 
``MRD VaR'' and ``MRD MTM.'' MRD VaR would look at historical day-over-
day positive changes in the start of day (``SOD'') volatility component 
of a Member's Required Deposit \21\ (the volatility component is 
referred to as the ``Volatility Charge'') over a 100-day look-back 
period and would be calculated to equal the exponentially weighted 
moving average (``EWMA'') of such changes to the Member's Volatility 
Charge during the look-back period. MRD MTM would look at historical 
day-over-day increases to the SOD mark-to-market component of a 
Member's Required Deposit \22\ over a 100-day look-back period and 
would be calculated to equal the EWMA of such changes to the Member's 
SOD mark-to-market component during the look-back period. The MRD would 
be calculated to equal the sum of MRD VaR and MRD MTM times a 
multiplier calibrated based on backtesting results. NSCC has determined 
that a 100-day look-back period would provide a sufficient time series 
to reflect current market conditions.
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    \21\ The Volatility Charge component of the Clearing Fund 
formula for CNS trades and Balance Order trades is described in 
Procedure XV, Sections I.(A)(1)(a) and I.(A)(2)(a), respectively.
    \22\ The SOD mark-to-market component of the Clearing Fund 
formula for CNS trades consists of Regular Mark-to-Market and ID Net 
Mark-to-Market, which are described in Procedure XV, Sections 
I(A)(1)(b) and I(A)(1)(c), respectively. The SOD mark-to-market 
component of the Clearing Fund formula for Balance Order trades is 
described in Procedure XV, Section I(A)(2)(b).
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    By addressing the day-over-day changes to each Member's SOD 
Volatility Charge and SOD mark-to-market component, NSCC states that 
the MRD would help mitigate the risks posed to NSCC by un-margined day-
over-day fluctuations to a Member's portfolio resulting from intraday 
trading activity that would be guaranteed during the coverage gap.
2. Coverage Component
    The Coverage Component is designed by NSCC to mitigate the risks 
associated with a Member's Required Deposit being insufficient to cover 
projected liquidation losses to the Coverage Target by adjusting a 
Member's Required Deposit towards the Coverage Target. NSCC would face 
increased exposure to a Member's un-margined portfolio as a result of 
the proposed accelerated trade guaranty and would have an increased 
need to have each Member's Required Deposit meet the Coverage Target. 
The Coverage Component would supplement the MRD by preemptively 
increasing a Member's Required Deposit by an amount calculated to 
forecast potential deficiencies in the margin coverage of a Member's 
guaranteed portfolio. The preemptive nature of the Coverage Component 
differentiates it from NSCC's current Backtesting Charge \23\ (to be 
renamed as the ``Regular Backtesting Charge'' pursuant to this 
proposal, as described below) and the Intraday Backtesting Charge, both 
of which are backwards looking increases to the Member's Required 
Deposit to above the Coverage Target.
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    \23\ Rules, Procedure XV, Section I(B)(3), supra note 4.
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    The Coverage Component would be calculated and charged on a daily 
basis as a part of each Member's Required Deposit. To calculate the 
Coverage Component, NSCC would compare the simulated liquidation profit 
and loss of a Member's portfolio, using the actual positions in the 
Member's portfolio and the actual historical returns on the security 
positions in the portfolio, against the sum of each of the following 
components of the Clearing Fund formula: Volatility Charge, the MRD, 
Illiquid Charge, and Market Maker Domination Charge (collectively, 
``Market Risk Components''). The results of that calculation would 
determine if there were any deficiencies between the amounts collected 
by these components and the simulated profit and loss of the Member's 
portfolio that would have been realized had it been liquidated during a 
100-day look-back period. NSCC would then determine a daily ``peak 
deficiency'' amount for each Member equal to the maximum deficiency 
over a rolling 10 business day period for the preceding 100 days. The 
Coverage Component would be calculated to equal the EWMA of the peak 
deficiencies over the 100-day look-back period.
3. Intraday Backtesting Charge
    NSCC currently employs daily backtesting to determine the adequacy 
of each Member's Required Deposit. NSCC compares the Required Deposit 
\24\ for each Member with the simulated liquidation profit and loss 
using the actual positions in the Member's portfolio and the actual 
historical returns on the security positions in the portfolio. NSCC 
investigates the cause of any backtesting deficiencies. As a part of 
this investigation, NSCC pays particular attention to Members with 
backtesting deficiencies that bring the results for that Member below 
the Coverage Target to determine if there is an identifiable cause of 
repeat backtesting deficiencies. NSCC also evaluates whether multiple 
Members experience backtesting deficiencies for the same underlying 
reason. Upon implementation of the accelerated trade guaranty, NSCC 
would employ a similar backtesting process on an intraday basis to 
determine the adequacy of each Member's Required Deposit. However, 
instead of backtesting a Member's Required Deposit against the Member's 
SOD portfolio, NSCC would use portfolios from two intraday time 
slices.\25\
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    \24\ For backtesting comparisons, NSCC uses the Required Deposit 
amount without regard to the actual collateral posted by the Member.
    \25\ Intraday time slices are subject to change based upon 
market conditions and would include the positions from SOD plus any 
additional positions up to that time.
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    NSCC's objective with the Intraday Backtesting Charge is to 
increase Required Deposits for Members that are likely to experience 
intraday backtesting deficiencies on the basis described above by an 
amount sufficient to maintain such Member's intraday backtesting 
coverage above the Coverage

[[Page 94451]]

Target. Members that maintain consistent end of day positions but have 
a high level of intraday trading activity pose risk to NSCC if they 
were to default intraday.
    Because the intraday trading activity and size of the intraday 
backtesting deficiencies vary among impacted Members, NSCC would assess 
an Intraday Backtesting Charge that is specific to each impacted 
Member. To do so, NSCC would examine each impacted Member's historical 
intraday backtesting deficiencies observed over the prior 12-month 
period to identify the five largest intraday backtesting deficiencies 
that have occurred during that time. The presumptive Intraday 
Backtesting Charge amount would equal that Member's fifth largest 
historical intraday backtesting deficiency, subject to adjustment as 
further described below. NSCC believes that applying an additional 
margin charge equal to the fifth largest historical intraday 
backtesting deficiency to a Member's Required Deposit would have 
brought the Member's historically observed intraday backtesting 
coverage above the Coverage Target.\26\
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    \26\ Intraday backtesting would include 500 observations per 
year (twice per day over 250 observation days). Each occurrence of a 
backtesting deficiency would reduce a Member's overall backtesting 
coverage by 0.2 percent (1 exception/500 observations). Accordingly, 
an Intraday Backtesting Charge equal to the fifth largest 
backtesting deficiency would have brought backtesting coverage up to 
99.2 percent.
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    Although the fifth largest historical backtesting deficiency for a 
Member would be used as the Intraday Backtesting Charge in most cases, 
NSCC would retain discretion to adjust the charge amount based on other 
circumstances that might be relevant for assessing whether an impacted 
Member is likely to experience future backtesting deficiencies and the 
estimated size of such deficiencies. According to NSCC, examples of 
relevant circumstances that could be considered by NSCC in calculating 
the final, applicable Intraday Backtesting Charge amount include 
material differences among the Member's five largest intraday 
backtesting deficiencies observed over the prior 12-month period, 
variability in the net settlement activity after the collection of the 
Member's Required Deposit, and observed market price volatility in 
excess of the Member's historical Volatility Charge. Based on NSCC's 
assessment of the impact of these circumstances on the likelihood, and 
estimated size, of future intraday backtesting deficiencies for a 
Member, NSCC could, in its discretion, adjust the Intraday Backtesting 
Charge for such Member in an amount that NSCC determines to be more 
appropriate for maintaining such Member's intraday backtesting results 
above the Coverage Target.
    In order to differentiate the Backtesting Charge assessed on the 
start of the day portfolio from the Backtesting Charge assessed on an 
intraday basis, NSCC would amend the Rules by adding a defined term 
``Regular Backtesting Charge'' to Procedure XV, Section I.(B)(3).\27\
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    \27\ Supra note 4.
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    If NSCC determines that an Intraday Backtesting Charge should apply 
to a Member who was not assessed an Intraday Backtesting Charge during 
the immediately preceding month or that the Intraday Backtesting Charge 
applied to a Member during the previous month should be increased, NSCC 
would notify the Member on or around the 25th calendar day of the month 
prior to the assessment of the Intraday Backtesting Charge or prior to 
the increase to the Intraday Backtesting Charge, as applicable, if not 
earlier.
    NSCC would impose the Intraday Backtesting Charge as an additional 
charge applied to each impacted Member's Required Deposit on a daily 
basis for a one-month period and would review each applied Intraday 
Backtesting Charge each month. However, the Intraday Backtesting Charge 
would only be applicable to those Members whose overall 12-month 
trailing intraday backtesting coverage falls below the Coverage Target. 
If an impacted Member's trailing 12-month intraday backtesting coverage 
exceeds the Coverage Target (without taking into account historically 
imposed Intraday Backtesting Charges), the Intraday Backtesting Charge 
would be removed.

(C) Enhanced Intraday Mark-to-Market Margining

    NSCC proposes to enhance its current intraday margining to further 
mitigate the intraday coverage gap risk that may be introduced to NSCC 
as a result of the proposed accelerated trade guaranty. As part of its 
Clearing Fund formula, NSCC currently collects a SOD mark-to-market 
margin, which is designed to mitigate the risk arising out of the value 
change between the contract/settlement value of a Member's open 
positions and the current market value. A Member's SOD mark-to-market 
margin is calculated and collected daily as part of a Member's daily 
Required Deposit based on the Member's prior end-of-day positions. The 
SOD mark-to-market component of the daily Required Deposit is 
calculated to cover a Member's exposure due to market moves and/or 
trading and settlement activity by bringing the portfolio of open 
positions up to the current market value.
    Because the SOD mark-to-market component is calculated only once 
daily using the prior end-of-day positions and prices, it does not 
cover a Member's exposure arising out of any intraday changes to 
position and market value in a Member's portfolio. For such exposure, 
the Volatility Charge already collected from each Member as part of the 
Member's daily Required Deposit is calculated to cover projected 
changes in the contract/settlement value of a Member's portfolio, which 
should be sufficient to cover intraday changes to a Member's portfolio, 
and thus NSCC's risk of loss as a result of that Member's intraday 
activities. However, in certain instances, a Member could have intraday 
mark-to-market changes that are significant enough that NSCC is exposed 
to an increased risk of loss that would not be covered by the Member's 
Volatility Charge. To monitor and account for these instances, NSCC 
measures each Member's intraday mark-to-market exposure against the 
Volatility Charge twice daily and collects an intraday mark-to-market 
amount from any Member whose intraday mark-to-market exposure meets or 
exceeds 100 percent of the Member's Volatility Charge, although NSCC 
may lower that threshold and measure exposure more often during 
volatile market conditions. NSCC believes that such Members pose an 
increased risk of loss to NSCC because the coverage provided by the 
Volatility Charge, which is designed to cover estimated losses to a 
portfolio over a specified time period, would be exhausted by an 
intraday mark-to-market exposure so large that the Member's Required 
Deposit would potentially be unable to absorb further intraday losses 
to the Member's portfolio.
    To further mitigate the risk posed to NSCC by the proposed 
accelerated trade guaranty, NSCC is proposing to enhance its collection 
of intraday mark-to-market margin by imposing the intraday mark-to-
market margin amount at a lower threshold. With this proposal, instead 
of collecting intraday mark-to-market margin if a Member's intraday 
mark-to-market exposure meets or exceeds 100 percent of the Member's 
Volatility Charge, NSCC would make an intraday margin call if a 
Member's intraday mark-to-market exposure meets or exceeds 80 percent 
of the Member's Volatility Charge (while still retaining the ability to 
reduce the threshold during volatile market conditions). This proposed 
change would serve to collect

[[Page 94452]]

more intraday margin earlier and more proactively preserve the coverage 
provided by a Member's Volatility Charge and Required Deposit.
    Finally, to ensure that Members are aware that NSCC regularly 
monitors and considers intraday mark-to-market as part of its regular 
Clearing Fund formula and understand the circumstances and criteria for 
the assessment of an intraday mark-to-market call, NSCC proposes to 
amend Procedure XV to include a comprehensive description of the 
enhanced intraday mark-to-market margin charge and the proposed new 
criteria NSCC would use to assess it.

(D) Loss Allocation Provision for Off-the-Market Transactions

    NSCC proposes to introduce a new loss allocation provision for any 
trades that fall within the proposed definition of ``Off-the-Market 
Transactions.'' This loss allocation provision would be designed to 
limit NSCC's exposure to certain trades that have a price that differs 
significantly from the prevailing market price for the underlying 
security at the time the trade is executed. It would apply in the event 
that NSCC ceases to act for a Member that engaged in Off-the-Market 
Transactions and only to the extent that NSCC incurs a net loss in the 
liquidation of such Transactions.\28\
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    \28\ A net loss on liquidation of the Off-the-Market Transaction 
means that the loss on liquidation of the Member's portfolio exceeds 
the collected Required Deposit of the Member and such loss is 
attributed to the Off-the-Market Transaction.
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    NSCC would define ``Off-the-Market Transaction'' as a single 
transaction (or a series of transactions settled within the same trade 
cycle) that is (i) greater than $1 million in gross proceeds, and (ii) 
at trade price that differs significantly (i.e., either higher or 
lower) from the most recently observed market price, at the time the 
trade was submitted to NSCC, by a percentage amount determined by NSCC 
based upon market conditions and factors that impact trading behavior 
of the underlying security, including volatility, liquidity and other 
characteristics of such security.
    In addition to defining Off-the-Market Transactions, the proposed 
change would establish the loss allocation for when they occur. 
Specifically, any net losses to NSCC resulting from the liquidation of 
a guaranteed, Off-the-Market Transaction of a defaulted Member would be 
allocated directly and entirely to the surviving counterparty to that 
transaction, or on whose behalf the Off-the-Market Transaction was 
submitted to NSCC. Losses would be allocated to counterparties in 
proportion to their specific Off-the-Market Transaction gain and would 
be allocated only to the extent of NSCC's loss; however, no allocation 
would be made if the defaulted Member has satisfied all requisite 
intraday mark-to-market margin assessed by NSCC with respect to the 
Off-the-Market Transaction.\29\
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    \29\ A Member's Off-the-Market Transaction that has been marked 
to market is, by definition, no longer an Off-the-Market Transaction 
when the mark-to-market component of the Member's Required Deposit 
is satisfied.
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    According to NSCC, this proposed change would allow NSCC to 
mitigate the risk of loss associated with guaranteeing these Off-the-
Market Transactions. NSCC has recognized that applying the accelerated 
trade guaranty to transactions whose price significantly differs from 
the most recently observed market price could inappropriately increase 
the loss that NSCC may incur if a Member that has engaged in Off-the-
Market Transactions defaults and its open, guaranteed positions are 
liquidated. Members not involved in Off-the-Market Transactions, or not 
involved in Off-the-Market Transactions that result in losses to NSCC, 
would not be included in this process. This exclusion would apply only 
to losses that are attributable to Off-the-Market Transactions and 
would not exclude Members from other obligations that may result from 
any loss or liabilities incurred by NSCC from a Member default.
    To implement this proposed change, NSCC would amend Rule 4 \30\ 
(Clearing Fund) to provide that, if a loss or liability of NSCC is 
determined by NSCC to arise in connection with the liquidation of any 
Off-the-Market Transactions, such loss or liability would be allocated 
directly to the surviving counterparty to the Off-the-Market 
Transaction that submitted the transaction to NSCC for clearing. NSCC 
also would amend Rule 1\31\ (Definitions and Descriptions) to include a 
definition of Off-the-Market Transactions.
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    \30\ Supra note 4.
    \31\ Id.
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(E) Other Related and Technical Changes

1. Removing the Specified Activity Charge
    Currently, NSCC collects a Specified Activity charge, which is 
designed to cover the risk posed to NSCC by transactions that settle on 
a T+2, T+1, or T timeframe.\32\ Because such transactions may be 
guaranteed by NSCC prior to the collection of margin, they pose an 
increased risk to NSCC (a similar risk that posed to NSCC by the 
proposed accelerated trade guaranty). The Specified Activity charge 
currently mitigates this risk by increasing the Required Deposit for a 
Member in relation to the number of Specified Activity trades submitted 
to NSCC by the Member over a 100-day look-back period. However, 
according to NSCC, the addition of the proposed MRD and Coverage 
Components to the Clearing Fund formula would mitigate the risks posed 
by trades guaranteed by NSCC prior to the collection of margin on those 
trades, thereby obviating the need to collect a separate Specified 
Activity charge. Accordingly, because it would be duplicative of the 
MRD and Coverage Components that are being added to the Clearing Fund 
Formula, NSCC proposes to eliminate the Specified Activity charge.
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    \32\ Examples of these trades can include next day settling 
trades, same day settling trades, cash trades, and sellers' options.
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2. Eliminating Delay in Processing and Reporting of Next Day Settling 
Index Receipts
    Next day settling index receipts may be guaranteed prior to the 
collection of margin reflecting such trades and thus carry a risk 
similar to the risk posed by Specified Activity trades described above. 
More specifically, because these trades are settled on the day after 
they are received and validated by NSCC, NSCC currently attaches its 
guaranty to them at the time of validation, prior to the collection of 
a Required Deposit that reflects such trades. Unlike the risk from 
Specified Activity trades, which is mitigated by the Specified Activity 
charge, the risk for next day settling index receipts is currently 
mitigated by permitting NSCC to delay the processing and reporting of 
these trades if a Member's Required Deposit is not paid on time. 
However, as with the risk associated with Specified Activity, under the 
proposed change, this risk would generally be mitigated by the addition 
of the MRD and Coverage Component. Therefore, NSCC proposes to amend 
Procedure II of the Rules \33\ (Trade Comparison and Recording Service) 
to remove the language that permits NSCC to delay the processing and 
reporting of next day settling index receipts until the applicable 
margin on these transactions is paid.
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    \33\ Supra note 4.

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[[Page 94453]]

3. Clarifying That the MRD and Coverage Component Should Not Be 
Included in the Calculation of a Member's Excess Capital Premium Charge
    The Excess Capital Premium charge \34\ is designed to address 
significant, temporary increases in a Member's Required Deposit based 
upon any one day of activity. It is not designed to provide additional 
Required Deposits over an extended period of time. Currently, the 
Excess Capital Premium charge for a Member is calculated based upon the 
Member's Required Deposit and the Member's excess net capital. The 
Premium is the amount by which a Member's Required Deposit exceeds its 
excess regulatory capital multiplied by the Member's ratio of Required 
Deposit to excess regulatory capital, expressed as a percent. Because 
they would be new components of a Member's Required Deposit under the 
current proposal, the MRD and Coverage Component would necessarily be 
included in the calculation of a Member's Excess Capital Premium. 
However, the MRD and Coverage Component each utilize a historical look-
back period, which accounts for the risk of such activity well after 
the relevant trades have settled. Risks related to such trades would be 
reflected in increased amounts assessed for these components over the 
subsequent time periods. If these components are included in the 
calculation of the Excess Capital Premium, especially during periods 
following an increase in activity, the increased MRD and Coverage 
Component could lead to more frequent Excess Capital Premium charges 
over an extended period of time. According to NSCC, this is not the 
intended purpose of the Excess Capital Premium and could place an 
unnecessary burden on Members. Accordingly, NSCC proposes to exclude 
these charges from the calculation of the Excess Capital Premium.
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    \34\ As stated above, the Excess Capital Premium is a charge 
imposed on a Member when the Member's Required Deposit exceeds its 
excess net capital, as described in Procedure XV of the Rules. 
Rules, supra note 4.
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4. Removing Reference to ID Net Subscribers
    NSCC also proposes to change Procedure XV \35\ to clarify how the 
``Regular Mark-to-Market'' component of the Required Deposit for CNS 
transactions is calculated. The Mark-to-Market component of a Member's 
Required Deposit is designed to protect NSCC from risk of loss based on 
changes to the value of a Member's portfolio and therefore may result 
in a debit to a Member (i.e., NSCC would collect more Required 
Deposit), but cannot result in a credit from NSCC to a Member. 
Accordingly, if a Member's mark-to-market calculation for a CNS or 
Balance Order trade results in a credit to the Member, NSCC's policy is 
to adjust the calculation to zero, thereby avoiding a credit from NSCC 
to the Member. When NSCC implemented the ID Net service,\36\ it added a 
provision to Procedure XV \37\ that explicitly stated this policy with 
respect to CNS transactions of subscribers to the ID Net service. 
According to NSCC, this change inadvertently created an implication 
that the calculation of Regular Mark-to-Market credit for Members who 
were not ID Net Subscribers would not be set to zero. NSCC proposes to 
revise the applicable provision of Procedure XV to remove the reference 
to ID Net Subscribers.
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    \35\ Id.
    \36\ Supra note 6.
    \37\ Supra note 4.
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II. Discussion and Commission Findings

    Although the Act does not specify a standard of review for an 
advance notice, its stated purpose is instructive: 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 and strengthening the 
liquidity of systemically important financial market utilities.\38\ 
Section 805(a)(2) of the Act 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.\39\ Section 805(b) of the Act 
states that the objectives and principles for the risk management 
standards prescribed under Section 805(a) shall be to:
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    \38\ See 12 U.S.C. 5461(b).
    \39\ 12 U.S.C. 5464(a)(2).
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     Promote robust risk management;
     promote safety and soundness;
     reduce systemic risks; and
     support the stability of the broader financial system.\40\
---------------------------------------------------------------------------

    \40\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    The Commission has adopted risk management standards under Section 
805(a)(2) of the Act \41\ and Section 17A of the Exchange Act \42\ 
(``Clearing Agency Standards'').\43\ The Clearing Agency Standards 
require registered clearing agencies 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.\44\ It is therefore 
appropriate for the Commission to review proposed changes in 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 Act.\45\
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    \41\ 12 U.S.C. 5464(a)(2).
    \42\ 15 U.S.C. 78q-1.
    \43\ See 17 CFR 240.17Ad-22. Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
    \44\ Id.
    \45\ 12 U.S.C. 5464(b).
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    The Commission believes the proposal in the Advance Notice is 
consistent with the objectives and principles described in Section 
805(b) of the Act,\46\ and the Clearing Agency Standards, in 
particular, Rule 17Ad-22(b)(1) \47\ and Rule 17Ad-22(b)(2) \48\ under 
the Exchange Act, as described in detail below.
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    \46\ Id.
    \47\ 17 CFR 240.17Ad-22(b)(1).
    \48\ 17 CFR 240.17Ad-22(b)(2).
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A. Consistency With Section 805(b) of the Act

    First, the Commission believes that the changes proposed in the 
Advance Notice, as described above, are consistent with promoting 
robust risk management. NSCC's proposal to add the three new components 
to its margin methodology (i.e, the MRD, Coverage Component, and 
Intraday Backtesting Charge) would enable NSCC to collect more margin, 
thereby promoting robust risk management practices at NSCC with respect 
to the potential default of a Member. By collecting more margin, NSCC 
would be in a better position to manage the counterparty credit risk 
presented by Members, particularly the additional counterparty credit 
risk from the proposed accelerated trade guaranty. Similarly, the 
proposal to lower the threshold for collection of intraday mark-to-
margin by collecting intraday mark-to-market margin when NSCC's 
exposure to a Member meets or exceeds 80 percent of that Member's 
Volatility Charge, rather than 100 percent, would enhance NSCC's 
intraday mark-to-market margin practice by allowing NSCC to collect 
more intraday margin stemming from intraday price fluctuations more 
often. As such, the proposed threshold reduction would also promote 
robust risk management practices at NSCC. With respect to the

[[Page 94454]]

proposed change to introduce a new loss allocation provision for 
certain off-the-market transactions, it too would promote robust risk 
management at NSCC, as it would help protect NSCC from transactions of 
a defaulted Member that were made at prices that differed significantly 
from the prevailing market price at the time the trade is executed and 
resulted in a loss to NSCC in connection with NSCC's liquidation of the 
transaction.
    Second, the Commission believes that the changes proposed in the 
Advance Notice are consistent with promoting safety and soundness. As 
described above, NSCC proposes to accelerate its trade guaranty for CNS 
trades and Balance Order trades from midnight of T+1 to the point of 
trade validation. This earlier guaranty would promote safety and 
soundness for Members because the counterparty credit risk that Members 
currently hold until NSCC's guaranty applies at midnight of T+1 would 
shift to NSCC almost immediately upon NSCC's receipt of the trade on T. 
Because NSCC risk manages its guaranteed transactions, NSCC is able to 
better ensure that trades settle if a counterparty defaults.
    The above-described proposed changes to NSCC's margin methodology 
(i.e., the addition of the MRD, Coverage Component, and Intraday 
Backtesting Charge), along with the proposed reduction of NSCC's 
intraday mark-to-margin threshold, also would promote safety and 
soundness at NSCC because they would improve NSCC's ability to collect 
margin. Likewise, the proposed loss allocation provision for off-the-
market transactions would promote safety and soundness at NSCC by 
helping to protect NSCC from losses due to transactions of a defaulted 
Member that were made at prices significantly different from the 
prevailing market price at the time of the trade. Collectively, these 
proposed changes would enable NSCC to manage better the additional risk 
that would result from the proposed accelerated guaranty.
    Third, the Commission believes that the Advance Notice is 
consistent with reducing systemic risks and promoting the stability of 
the broader financial system. As described above, by providing a trade 
guaranty at an earlier point in the settlement cycle, counterparty 
credit risk also would transfer from Members, which are not CCPs, to 
NSCC, which is a third-party CCP that risk-manages its guaranteed 
transactions, at an earlier point in the settlement cycle. Because NSCC 
risk manages its guaranteed transactions, NSCC is able to better ensure 
that trades settle if a counterparty defaults. Thus, the proposed 
accelerated process would help reduce systemic risks and promote the 
stability of the broader financial system by mitigating Members' 
exposure to a counterparty default earlier in the settlement cycle and 
by providing an earlier assurance that transactions will settle despite 
a Member default.
    At the same time, the three proposed additions to NSCC's margin 
methodology, the proposed reduction of NSCC's intraday mark-to-margin 
threshold, and the proposed loss allocation provision for off-the-
market transactions, as described above, would also help mitigate the 
systemic risks that NSCC presents as a CCP because they would improve 
NSCC's margining abilities and help protect NSCC against potential 
losses from a Member default. Accordingly, the changes would therefore 
promote the stability of the broader financial system.

B. Consistency With Rule 17Ad-22(b)(1)

    Rule 17Ad-22(b)(1) under the Exchange Act requires a CCP, such as 
NSCC, to, among other things, ``establish, implement, maintain and 
enforce written policies and procedures reasonably designed to . . . 
limit its exposures to potential losses from defaults by its 
participants under normal market conditions . . . .'' As described 
above, because the proposed change would transfer counterparty credit 
risk to NSCC at an earlier point in the settlement cycle, NSCC proposes 
to enhance its margin methodology by adding three new margin components 
and by lowering the threshold for the intraday mark-to-market margin 
collection. It also proposes to establish a loss allocation provision 
for off-the-market transactions. These proposed changes are designed to 
limit NSCC's exposure to potential losses from the default of a Member 
by enabling NSCC to collect more margin, better manage when it collects 
margin, and protect itself from certain losses of a defaulted Member. 
Therefore, the Commission believes that the proposal would be 
consistent with Rule 17Ad-22(b)(1).

C. Consistency With Rule 17Ad-22(b)(2)

    Rule 17Ad-22(b)(2) under the Exchange Act requires a CCP, such as 
NSCC, to, among other things, ``establish, implement, maintain and 
enforce written policies and procedures reasonably designed to . . . 
[u]se margin requirements to limit its credit exposures to participants 
under normal market conditions and use risk-based models and parameters 
to set margin requirements . . . .'' Again, the proposal would add 
three new components to NSCC's margin methodology (i.e., the MRD, 
Coverage Component, and Intraday Backtesting Charge), which use risk 
based models and parameters to calculate charges, and would lower the 
threshold at which NSCC would make an intraday mark-to-market margin 
call. As such, the proposal would help NSCC better account for and 
cover its credit exposure to Members. In addition, by establishing the 
proposed margin components and the new intraday mark-to-market margin 
collection threshold, the proposal is consistent with using risk-based 
models and parameters to set margin requirements. Therefore, the 
Commission believes that the proposal would be consistent with Rule 
17Ad-22(b)(2).

III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Payment, Clearing and Settlement Supervision Act,\49\ that the 
Commission does not object to Advance Notice (SR-NSCC-2016-803) and 
that NSCC is authorized to implement the proposed change as of the date 
of this notice or the date of an order by the Commission approving the 
proposed rule change (SR-NSCC-2016-005) that reflects rule changes that 
are consistent with this Advance Notice, whichever is later.
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    \49\ 12 U.S.C. 5465(e)(1)(I).

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2016-30935 Filed 12-22-16; 8:45 am]
 BILLING CODE 8011-01-P