[Federal Register Volume 82, Number 144 (Friday, July 28, 2017)]
[Notices]
[Pages 35245-35248]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-15905]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81192; File Nos. SR-DTC-2017-005; SR-FICC-2017-009; SR-
NSCC-2017-006]


Self-Regulatory Organizations; The Depository Trust Company; 
Fixed Income Clearing Corporation; National Securities Clearing 
Corporation; Notice of Filing Amendment No. 1 and Order Instituting 
Proceedings to Determine Whether to Approve or Disapprove Proposed Rule 
Changes to Adopt the Clearing Agency Stress Testing Framework (Market 
Risk)

July 24, 2017.

I. Introduction

    On April 7, 2017, The Depository Trust Company (``DTC''), Fixed 
Income Clearing Corporation (``FICC''), and National Securities 
Clearing Corporation (``NSCC,'' each a ``Clearing Agency,'' and 
collectively, the ``Clearing Agencies''), filed with the Securities and 
Exchange Commission (``Commission'') proposed rule changes SR-DTC-2017-
005, SR-FICC-2017-009, and SR-NSCC-2017-006, respectively, pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder.\2\ The proposed rule changes were published 
for comment in the Federal Register on April 25, 2017.\3\ The 
Commission did not receive any comment letters on the proposed rule 
changes. On June 7, 2017, the Commission designated a longer period for 
Commission Action on the proposed rule changes.\4\ On July 19, 2017, 
the Clearing Agencies each filed Amendment No. 1 to their respective 
proposed rule changes (hereinafter, ``Proposed Rule Change''). 
Amendments No. 1 would clarify how the Clearing Agencies would use 
scenarios to estimate the profits and losses (``P&L'') of a member 
closeout. This order institutes proceedings under Section 19(b)(2)(B) 
of the Act \5\ to determine whether to approve or disapprove the 
Proposed Rule Changes.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 80485 (April 19, 
2017), 82 FR 19131 (April 25, 2017) (SR-DTC-2017-005; SR-FICC-2017-
009; SR-NSCC-2017-006) (``Notice'').
    \4\ See Securities Exchange Act Release No. 80876 (June 7, 
2017), 82 FR 27091 (June 13, 2017) (SR-DTC-2017-005; SR-FICC-2017-
009; SR-NSCC-2017-006).
    \5\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposed Rule Changes

    The Proposed Rule Changes would adopt the Clearing Agency Stress

[[Page 35246]]

Testing Framework (Market Risk) (``Framework''), which would set the 
Clearing Agencies' procedures for identifying, measuring, monitoring, 
and managing their credit exposures to members. Although the Framework 
would be a rule of each Clearing Agency, the Proposed Rule Changes do 
not require any changes to the Rules, By-Laws and Organizational 
Certificate of DTC (``DTC Rules''), the Rulebook of GSD (``GSD 
Rules''), the Clearing Rules of MBSD (``MBSD Rules''), or the Rules & 
Procedures of NSCC (``NSCC Rules''), as the Framework would be a 
standalone document.\6\
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    \6\ Available at http://www.dtcc.com/en/legal/rules-and-procedures. FICC is comprised of two divisions: The Government 
Securities Division (``GSD'') and the Mortgage-Backed Securities 
Division (``MBSD''). Each division serves as a central counterparty, 
becoming the buyer and seller to each of their respective members' 
securities transactions and guarantying settlement of those 
transactions, even if a member defaults. GSD provides, among other 
things, clearance and settlement for trades in U.S. Government debt 
issues. MBSD provides, among other things, clearance and settlement 
for trades in mortgage-backed securities. GSD and MBSD maintain 
separate sets of rules, margin models, and clearing funds. Notice at 
19131.
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    In general, the Framework would describe the stress-testing 
practices adopted by the Clearing Agencies. The Clearing Agencies 
designed their stress testing to ensure the sufficiency of each 
Clearing Agency's total prefunded-financial resources.\7\ The Framework 
would describe (i) the sources of each Clearing Agency's total 
prefunded-financial resources; (ii) the Clearing Agencies' stress-
testing methodologies; (iii) the Clearing Agencies' stress-testing 
governance and execution processes; and (iv) the Clearing Agencies' 
model-validation practices.\8\
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    \7\ Notice, 82 at 19132.
    \8\ Id.
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A. Sources of Prefunded-Financial Resources

    The Framework would outline the prefunded-financial resources and 
related stress-testing methodologies of the Clearing Agencies. The 
Framework would begin by describing the applicable regulatory 
requirements, with respect to credit risk management, of each Clearing 
Agency and how the Clearing Agencies address those requirements.\9\ The 
Framework would address these requirements by describing how the 
Clearing Agencies maintain what each deems to be sufficient prefunded-
financial resources to cover fully their credit exposures to each of 
their respective members with a high degree of confidence.\10\ The 
Framework would also describe how the Clearing Agencies maintain 
additional prefunded-financial resources that, at a minimum, would 
enable them to cover a wide range of foreseeable stress scenarios that 
include, but are not limited to, the default of the affiliated family 
of members (``Affiliated Family'') that would potentially cause the 
largest aggregate credit exposure to the Clearing Agency in extreme but 
plausible market conditions (``Cover One Requirement'').\11\ Because 
the credit risks and prefunded-financial resources of each Clearing 
Agency differ, the Framework would describe the prefunded-financial 
resources and related stress-testing methodologies of the Clearing 
Agencies separately.\12\
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    \9\ Id.
    \10\ Id.
    \11\ See 17 CFR 240.17Ad-22(e)(4)(iii).
    \12\ Notice, 82 at 19132.
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    With respect to FICC and NSCC, the Framework would describe that 
such prefunded-financial resources are their respective clearing funds, 
containing deposits from their members of both cash and eligible 
securities.\13\ The Framework would describe that such deposits are 
calculated for each individual member pursuant to the GSD Rules, MBSD 
Rules, or NSCC Rules, as applicable, and each member's deposits would 
be referred to in the Framework as its ``Required Deposit.'' \14\
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    \13\ Id. Any eligible security is subject to a haircut. GSD Rule 
4 (Clearing Fund and Loss Allocation), MBSD Rule 4 (Clearing Fund 
and Loss Allocation), and NSCC Rule 4 (Clearing Fund), supra note 4.
    \14\ Id.
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    With respect to DTC, the Framework would describe that its 
prefunded financial resources are cash deposits to its ``Participants 
Fund.'' \15\ The Framework would also describe that DTC may use its 
risk management control, the ``Collateral Monitor,'' to monitor and 
assure that the settlement obligations of each member are fully 
collateralized.\16\
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    \15\ Id. DTC Rule 4 (Participants Fund and Participants 
Investment). Supra note 4.
    \16\ Notice, 82 at 19132. ``Collateral Monitor'' is defined in 
DTC Rule 1, Section 1 (Definitions), and its calculation is further 
provided for in the DTC Settlement Service Guide of the DTC Rules. 
Supra note 4.
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B. Stress-Testing Methodology

    The Framework would describe the stress-testing methodologies that 
the Clearing Agencies use to test the sufficiency of their total 
prefunded-financial resources against Cover One Requirements. The 
Framework would state that the stress testing would be designed to 
identify potential weaknesses in the methodologies used to calculate 
members' Required Deposits and to determine collateral haircuts.\17\
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    \17\ Id.
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    The Framework would describe in detail the three key components of 
the development of stress-testing methodologies:
    1. Risk Identification. The Clearing Agencies would identify the 
principal credit-risk drivers that are representative and specific to 
each Clearing Agency's clearing and/or collateral portfolio under 
stressed market conditions.\18\
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    \18\ Id.
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    2. Scenario Development. The Clearing Agencies would construct 
comprehensive and relevant sets of extreme but plausible historical and 
hypothetical stress scenarios for the identified risk drivers.\19\ The 
Framework would describe how the Clearing Agencies would develop and 
select both historical and hypothetical scenarios that reflect stressed 
market conditions.\20\ Historical scenarios would be based on stressed 
market conditions that occurred on specific dates in the past.\21\ 
Contrastingly, hypothetical stress scenarios would be theoretical 
market conditions.\22\
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    \19\ Id.
    \20\ Id.
    \21\ Notice, 82 at 19133.
    \22\ Id.
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    3. Risk Measurement and Aggregation. The Clearing Agencies would 
calculate the risk metrics of each Clearing Agency's actual portfolio 
to estimate the P&L of a close out over a suitable stressed period of 
risk, deficiencies, and coverage ratios.\23\ The Framework would 
describe how the Clearing Agencies would develop P&L estimation 
methodologies, and how they would calculate risk metrics that are 
applicable to such methodologies under the chosen stress-testing 
scenarios.\24\ The Clearing Agencies could use a number of P&L 
methodologies for stress-testing purposes, including risk sensitivity, 
index mapping, and actual or approximate historical shock 
approaches.\25\
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    \23\ Id.
    \24\ Id.
    \25\ Id.
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    The Framework would further describe the stress-testing methodology 
by stating that the Clearing Agencies would calculate member stress 
deficiencies,\26\ Affiliated Family

[[Page 35247]]

deficiencies,\27\ and Cover One Ratios daily.\28\
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    \26\ The Framework would define ``member stress deficiency'' for 
each scenario as, with respect to FICC and NSCC, the stress loss 
exceeding the applicable member's Required Deposits. The Framework 
would define ``member stress deficiency'' for each scenario at DTC 
as the shortfall of a member's Collateral Monitor. Id.
    \27\ The Framework would define ``Affiliated Family deficiency'' 
as the aggregate of all member stress deficiencies within the 
applicable Affiliated Family. Id.
    \28\ The Framework would define ``Cover One Ratio'' as the ratio 
of Affiliated Family deficiency over the total value of the relevant 
Clearing Agency's clearing fund (or, for DTC, the Participants 
Fund), excluding the value of the applicable Affiliated Family's 
Required Deposits. Id.
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    The Framework would further state that FICC and NSCC would consider 
non-Cover-One Ratio coverages, such as comparing member stress 
deficiencies against such member's known financial resources (e.g., 
equity capital base), to keep abreast of potential financial 
vulnerabilities facing such member.\29\ Additionally, the Framework 
would state that DTC would also test the adequacy of its collateral 
haircuts by measuring ``Haircut Deficiency'' as the amount of stress 
losses exceeding the haircut applied to collateral securities.\30\
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    \29\ Id.
    \30\ Id.
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    Moreover, the Framework would state that the Clearing Agencies 
measure both specific and generic wrong way risk for each Clearing 
Agency's members and Affiliated Families.\31\ To measure specific wrong 
way risk, for each given Member and its Affiliated Family and each 
given scenario, the securities issued by the Affiliated Family would be 
subject to shocks that reflect the default of a Member's Affiliated 
Family. To measure general wrong way risk, the Framework would apply 
historical scenarios during the 2008 financial crisis to securities 
issued by the Affiliated Family as well as securities issued by the 
non-Affiliated Family.
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    \31\ Id.
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    The Framework would also describe the reverse stress-testing 
analyses that are performed by FICC and NSCC on at least a semi-annual 
basis.\32\ These analyses provide FICC and NSCC, as central 
counterparties, another means for testing the sufficiency of the 
Clearing Agencies' respective prefunded financial resources.\33\ In 
conducting reverse stress-testing, FICC and NSCC would utilize 
scenarios of multiple defaults, extreme market shocks, or shocks for 
other risk factors, which would cause those Clearing Agencies, as 
applicable, to exhaust all of their respective prefunded financial 
resources.\34\
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    \32\ Id.
    \33\ Id.
    \34\ Id.
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C. Stress-Testing Governance and Execution Process

    The Framework would describe the Clearing Agencies' stress-testing 
governance and execution processes. Stress testing would be conducted 
daily for each of the Clearing Agencies, and stress-testing risk 
metrics also would be generated each day.\35\ The Cover One Ratios and 
member stress deficiencies would be monitored against pre-established 
thresholds.\36\ Breaches of these pre-established thresholds would 
initially be subject to more detailed studies to identify any potential 
impact to the applicable Clearing Agencies' Cover One Requirement.\37\ 
The Framework would describe that, to the extent such studies indicate 
a potential impact to a Clearing Agency's Cover One Requirement, the 
threshold breach would be escalated internally and analyzed to 
determine if (i) there is a need to adjust the stress-testing 
methodology, or (ii) the threshold breach indicates an issue with a 
particular member.\38\ Based on these analyses, the Clearing Agencies 
would determine the appropriate course of action.\39\
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    \35\ Id.
    \36\ According to the Clearing Agencies, risk-threshold levels 
are chosen to assist each Clearing Agency in achieving a high degree 
of confidence that its Cover One Requirement is met daily. Id.
    \37\ Id.
    \38\ Id.
    \39\ Id.
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D. Model Validation

    The Framework would describe the process the Clearing Agencies 
would use to validate their stress-testing procedures. The Clearing 
Agencies would conduct comprehensive analyses of daily stress-testing 
results, the existing scenario sets (including any changes to such 
scenarios for the period since the last review), and the performance of 
the stress-testing methodologies along with key underlying parameters 
and assumptions.\40\ These analyses would be performed at least monthly 
and would be conducted to assess whether each Clearing Agency's stress-
testing components appropriately determine the sufficiency of the 
Clearing Agency's prefunded-financial resources.\41\ The Framework 
would state that such analyses may occur more frequently than monthly 
if, for example, (i) the products cleared or markets served by a 
Clearing Agency display high volatility or become less liquid, or (ii) 
the size or concentration of positions held by the applicable Clearing 
Agency's members increases significantly.\42\
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    \40\ Id.
    \41\ Id.
    \42\ Id.
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    The Framework would state that the results of these analyses are 
reviewed monthly by the DTCC Enterprise Stress Testing Council.\43\ The 
Framework would also state that daily stress-testing results are 
summarized and reported monthly to the DTCC Risk Management 
Committee.\44\ Finally, the Framework would state that stress-testing 
methodologies and related models are subject to independent model 
validation on at least an annual basis.\45\
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    \43\ Id.
    \44\ Id.
    \45\ Id.
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E. Notice of Filing of Amendment No. 1

    As originally proposed, the Framework stated that it would use 
scenarios to measure specific and generic wrong way risk. The Clearing 
Agencies filed Amendment No. 1 to clarify that to capture specific 
wrong way risk, for each given Member and its Affiliated Family and 
each given scenario, the securities issued by the Affiliated Family 
would be subject to shocks that reflect the default of a Member's 
Affiliated Family. To capture general wrong way risk, the Framework 
would apply historical scenarios during the 2008 financial crisis to 
securities issued by the Affiliated Family as well as securities issued 
by the non-Affiliated Family.

III. Proceedings To Determine Whether To Approve or Disapprove the 
Proposed Rule Changes and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act \46\ to determine whether the Proposed Rule 
Changes should be approved or disapproved. Institution of proceedings 
is appropriate at this time in view of the legal and policy issues 
raised by the Proposed Rule Changes. As noted above, institution of 
proceedings does not indicate that the Commission has reached any 
conclusions with respect to any of the issues involved. Rather, the 
Commission seeks and encourages interested persons to comment on the 
Proposed Rule Changes, and provide arguments to support the 
Commission's analysis as to whether to approve or disapprove the 
Proposed Rule Changes.
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    \46\ 15 U.S.C. 78s(b)(2)(B).
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    Pursuant to Section 19(b)(2)(B) of the Act,\47\ the Commission is 
providing notice of the grounds for disapproval under consideration. 
The Commission is

[[Page 35248]]

instituting proceedings to allow for additional analysis of the 
Proposed Rule Changes' consistency with the Act and the rules 
thereunder. Specifically, the Commission believes that the Proposed 
Rule Changes raise questions as to whether they are consistent with (i) 
Section 17A(b)(3)(F) of the Act,\48\ which requires, in part, that 
clearing agency rules be designed to assure the safeguarding of 
securities in the custody or control of the clearing agency and, in 
general, protect investors and the public interest, and (ii) Rule 17Ad-
22(e)(4) under the Act, which requires, in general, that each covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to, among other things, 
effectively identify, measure, monitor, and manage their credit 
exposures to participants and those arising from its payment, clearing, 
and settlement processes.\49\
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    \47\ Id.
    \48\ 15 U.S.C. 78q-1(b)(3)(F).
    \49\ 17 CFR 240.17Ad-22(e)(4).
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    As discussed above, pursuant to the Proposed Rule Changes, Clearing 
Agencies would adopt the Framework, which would procedures for 
identifying, measuring, monitoring, and managing their credit exposures 
to members. The Commission solicits comment on whether the Proposed 
Rule Changes are consistent with Section 17A(b)(3)(F) of the Act \50\ 
and Rule 17Ad-22(e)(4) under the Act.\51\
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    \50\ 15 U.S.C. 78q-1(b)(3)(F).
    \51\ 17 CFR 240.17Ad-22(e)(4).
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IV. Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to issues 
raised by the Proposed Rule Changes. In particular, the Commission 
invites the written views of interested persons concerning whether the 
Proposed Rule Changes are consistent with Sections 17A(b)(3)(F) of the 
Act and Rules 17Ad-22(e)(4) under the Act, cited above, or any other 
provision of the Act, or the rules and regulations thereunder. 
Interested persons are invited to submit written data, views, and 
arguments on or before August 14, 2017. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal on or 
before August 18, 2017. 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-2017-002 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Numbers SR-DTC-2017-005, SR-FICC-
2017-009, or SR-NSCC-2017-006. 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 Changes 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 
such filings also will be available for inspection and copying at the 
principal office of the Clearing Agencies and on DTCC's Web site 
(http://dtcc.com/legal/sec-rule-filings.aspx). 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 Numbers SR-DTC-2017-005, SR-FICC-2017-009, or SR-
NSCC-2017-006 and should be submitted on or before August 14, 2017. If 
comments are received, any rebuttal comments should be submitted on or 
before August 18, 2017.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\52\
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    \52\ 17 CFR 200.30-3(a)(57).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-15905 Filed 7-27-17; 8:45 am]
 BILLING CODE 8011-01-P