[Federal Register Volume 85, Number 39 (Thursday, February 27, 2020)]
[Notices]
[Pages 11413-11419]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-03996]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88266; File No. SR-FICC-2020-801]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Advance Notice To Amend the Mortgage-Backed 
Securities Division Stress Testing Methodology

February 24, 2020.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 (``Clearing 
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities 
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on 
January 21, 2020, Fixed Income Clearing Corporation (``FICC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
advance notice SR-FICC-2020-801 (``Advance Notice'') as described in 
Items I, II and III below, which Items have been prepared by the 
clearing agency. The Commission is publishing this notice to solicit 
comments on the Advance Notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This Advance Notice consists of modifications to the Mortgage-
Backed Securities Division's (``MBSD'') stress testing methodology.\3\ 
FICC is proposing to (1) use vendor-supplied historical risk factor \4\ 
time series data (``Historical Data'') in MBSD's stress testing 
methodology's historical stress scenario selection (``Scenario 
Selection'') process, (2) change the look-back period for identifying 
historical stress scenarios for the Scenario Selection process, (3) use 
vendor-supplied security-level risk sensitivity data \5\ (``Security-
Level Data'') and Historical Data in the stress testing methodology's 
calculation of stress profits and losses (``P&L'') for Clearing 
Members' portfolios,\6\ and (4) use a back-up calculation in the event 
the vendor fails to provide the Security-Level Data and Historical Data 
(such failure, a ``Vendor Data Disruption''), as described in greater 
detail below.\7\ The proposed changes would not require modifications 
to the MBSD Rules.
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    \3\ Capitalized terms used herein and not otherwise defined 
shall have the meaning assigned to such terms in the FICC MBSD 
Clearing Rules (the ``MBSD Rules''), available at www.dtcc.com/legal/rules-and-procedures.aspx.
    \4\ Generally, the term ``risk factor'' (or ``risk driver'') 
means an attribute, characteristic, variable or other concrete 
determinant that influences the risk profile of a system, entity, or 
financial asset. Risk factors may be causes of risk or merely 
correlated with risk.
    \5\ The term ``sensitivity'' means the percentage value change 
of a security given each risk factor change.
    \6\ The proposed change to use Security-Level Data would be 
applicable to MBSD's stress testing methodology for historical and 
hypothetical scenarios. The proposed change to use Historical Data 
would be applicable only for historical scenarios. FICC currently 
receives the Security-Level Data and Historical Data from a vendor. 
FICC currently utilizes this Security-Level Data and Historical Data 
in MBSD's value-at-risk (``VaR'') model, which calculates the VaR 
Charge component in each Clearing Member's margin (referred to in 
the MBSD Rules as Required Fund Deposit). See MBSD Rule 1, 
Definitions--VaR Charge, supra note 3. FICC is proposing to use this 
same data set in MBSD's Scenario Selection process, and stress P&L 
calculation of each Clearing Member's portfolio.
    \7\ FICC would receive the following data from the vendor:
     Interest rate (including 11 tenors) measures the 
sensitivity of a price change to changes in interest rates;
     convexity measures the degree of curvature in the 
price/yield relationship of key interest rates (convexity would not 
be utilized in the scenarios selection process; it would only be 
utilized in the stress P&L calculation);
     mortgage option adjusted spread is the yield spread 
that is added to a benchmark yield curve to discount a TBA's cash 
flows to match its market price, which takes into account a credit 
premium and the option-like feature of mortgage-backed-securities 
due to prepayment;
     interest rate volatility reflects the implied 
volatility observed from the swaption market to estimate 
fluctuations in interest rates; and
     mortgage basis captures the basis risk between the 
prevailing mortgage rate and a blended U.S. Treasury rate, which 
impacts borrowers' refinance incentives and the model prepayment 
assumptions.
    The Historical Data would include (1) interest rate, (2) 
mortgage option adjusted spread, (3) interest rate volatility, and 
(4) mortgage basis.
    The Security Level Data would include (1) sensitivity to 
interest rates, (2) convexity, (3) sensitivity to mortgage option 
adjusted spread, (4) sensitivity to interest rate volatility, and 
(5) sensitivity to mortgage basis.
    FICC does not believe that its current engagement of the vendor 
would present a conflict of interest because the vendor is not an 
existing Clearing Member nor are any of the vendor's affiliates 
existing Clearing Members. To the extent that the vendor or any of 
its affiliates applies to become a Clearing Member, FICC will 
negotiate an appropriate information barrier with the applicant in 
an effort to prevent a conflict of interest from arising. An 
affiliate of the vendor currently provides an existing service to 
FICC; however, this arrangement does not present a conflict of 
interest because the existing agreement between FICC and the vendor, 
and the existing agreement between FICC and the vendor's affiliate, 
each contains provisions that limit the sharing of confidential 
information.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

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

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants, or Others

    FICC has not received or solicited any written comments relating to 
this proposal. FICC will notify the Commission of any written comments 
received by FICC.

(B) Advance Notice Filed Pursuant to Section 806(e) of the Clearing 
Supervision Act

I. Nature of the Proposed Change

A. Background

    Stress testing is an essential component of FICC's risk management. 
FICC uses stress testing to help ensure that it is collecting adequate 
prefunded financial resources \8\ to cover MBSD's potential losses 
resulting from the default of a Clearing Member and such Clearing 
Member's affiliated family (that are also Clearing Members) 
(``Affiliated Family'') under multiple extreme but plausible market 
stress conditions (sometimes referred to as ``stress scenarios'').\9\ 
As set forth in the Framework, the development of FICC's

[[Page 11414]]

stress testing methodology is comprised of three key components.\10\
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    \8\ MBSD's prefunded financial resources consist of Required 
Fund Deposits collected from Clearing Members in the form of cash 
and/or Eligible Clearing Fund Securities, with any such Eligible 
Clearing Fund Securities being subject to a haircut. See MBSD Rules 
1 and 4, supra note 3.
    \9\ Consistent with the Clearing Agency Stress Testing Framework 
(Market Risk) (``Framework''), FICC aggregates each Clearing 
Member's stress deficiency within such Clearing Member's applicable 
Affiliated Family because FICC assumes that all Affiliated Families 
will simultaneously default, and the gains and losses of different 
legal entities within an Affiliated Family would not offset each 
other. The Framework is described in rule filing SR-FICC-2017-009. 
See Securities Exchange Act Release No. 82368 (December 19, 2017), 
82 FR 61082 (December 26, 2017) (``Framework Approval Order'').
    \10\ Id. at 61083.
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    The first component is the risk identification process. FICC 
identifies the principal credit/market risk drivers that are 
representative and specific to each Clearing Member's portfolio to 
determine potential risk exposure. FICC accomplishes this by analyzing 
the securities in each Clearing Member's portfolio to identify the 
principal market price risk factor drivers and capture the risk 
sensitivity of such portfolios under stressed market conditions.
    The second component is the scenario development process, which is 
designed to construct comprehensive and relevant sets of extreme but 
plausible historical and hypothetical stress scenarios. In order to 
select historical stress scenarios, MBSD's stress testing model selects 
dates from the past that represent stressed market conditions based on 
the largest historical changes of the selected risk factors. In order 
to select hypothetical stress scenarios, MBSD considers potential 
future events and their perceived impact to portfolio market risk 
factors.
    The third component is the risk measurement and aggregation 
process. This process involves calculating risk metrics for each 
Clearing Member's portfolio. The stress testing methodology calculates 
stress P&L under each stress scenario and determines the loss amount 
exceeding a Clearing Member's Required Fund Deposit for each scenario. 
This calculation is referred to as the ``Clearing Member Level Stress 
Deficiencies.'' In addition, the stress testing methodology calculates 
the ratio of an Affiliated Family's deficiency \11\ over the total 
value of the MBSD Clearing Fund excluding the sum value of the 
applicable Affiliated Family's Required Fund Deposits. This calculation 
is referred to as the ``Cover 1 Ratio.'' \12\
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    \11\ An ``Affiliated Family deficiency'' is the aggregate of all 
Clearing Members' stress deficiencies within the applicable 
Affiliated Family.
    \12\ See Framework Approval Order, 82 FR at 61083.
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B. Proposed Change to MBSD's Stress Testing Methodology

    As further described below, FICC is proposing to use Security-Level 
Data and Historical Data in MBSD's stress testing methodology. 
Specifically, FICC is proposing to (1) use Historical Data in the 
Scenario Selection process, (2) change the look-back period used for 
identifying historical stress scenarios for the Scenario Selection 
process, (3) use Security-Level Data and Historical Data in the 
methodology's calculation of stress P&L for Clearing Members' 
portfolios,\13\ and (4) use a back-up calculation in the event of a 
Vendor Data Disruption.
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    \13\ In connection with this proposal, FICC is not proposing any 
changes to the hypothetical Scenario Selection process other than to 
use the vendor's data. The hypothetical scenarios are currently 
represented by five interest rate tenors (i.e., 1-year, 2-year, 5-
year, 10-year, and 30-year tenors), one mortgage option adjusted 
spread, and one interest rate volatility point. The hypothetical 
scenarios are reflected as shocks to the referenced risk factors. 
This process would not change, however, in order to calculate the 
stress P&L in the proposed model, FICC would map the referenced risk 
factors to the set of risk factors in the proposed model.
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(1) Proposed Change To Use Historical Data in the Scenario Selection 
Process
    FICC uses two risk factors as inputs to the MBSD stress testing 
model for the historical Scenario Selection process. The risk factors 
are (1) interest rate and (2) mortgage option adjusted spread. The 
interest rate risk factor consists of swap rates \14\ with tenors \15\ 
of 2 years, 5 years, 10 years, and 30 years. The mortgage option 
adjusted spread risk factor is constructed as the difference between 
the agency mortgage-backed TBA securities' current coupon rate and the 
average swap rate, in each case, for Fannie Mae (``FNMA'') 30-year 
mortgages and Ginnie Mae (``GNMA'') 30-year mortgages. MBSD's scenario 
selection algorithm uses a technique referred to as principal component 
analysis \16\ to convert correlated risk factors into uncorrelated risk 
drivers that account for the joint co-movements \17\ of the multiple 
risk factors during the 10-year look-back period.
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    \14\ Generally, the term ``swap rate'' means the fixed interest 
rate that the receiver demands in exchange for the uncertainty of 
having to pay the short-term floating rate over time.
    \15\ Generally, the term ``tenor'' means the amount of time left 
for the repayment of a loan or until a financial contract expires.
    \16\ Principal component analysis is a standard statistical 
technique that is applied to a set of observations of potentially 
correlated variables. It is used to identify a set of linearly 
uncorrelated variables, which are referred to as principal 
components.
    \17\ Generally, the term ``joint co-movement'' means the 
movement of two variables at the same time.
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    FICC is proposing to continue to utilize the interest rate risk 
factor and the mortgage option adjusted spread risk factor as inputs to 
MBSD's stress testing model, however, both risk factors would be 
sourced from a vendor. FICC is also proposing to include two new risk 
factors in the methodology--interest rate volatility and mortgage 
basis. The proposed change would result in an expansion of the number 
of tenors for the existing interest rate risk factor and an expansion 
of the number of individual factors to the existing mortgage option 
adjusted spread risk factor. As a result of this change, the proposed 
interest rate risk factor would include 11 tenors and the proposed 
mortgage option adjusted spread risk factor would include up to 
approximately 32 individual factors,\18\ which would differentiate 
between various agency mortgage programs, underlying collateral 
maturities, and the level of moneyness.\19\
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    \18\ As described in the paragraph above, the current stress 
testing methodology uses four tenors for the interest rate risk 
factor and two individual factors for the mortgage option adjusted 
spread risk factor.
    \19\ The changes of spread are parameterized according to the 
difference between the underlying weighted average coupon (``WAC'') 
and the current prevailing mortgage rate. This difference is also 
referred to as the ``moneyness.'' A TBA security with a WAC that is 
10 basis points higher than the prevailing mortgage rate is said to 
be 10 basis points in the money. Fifteen moneyness points are used 
to parameterize the FNMA 30-year mortgage.
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    FICC is proposing to use the Historical Data (as described above) 
because this data is more comprehensive, granular,\20\ and transparent. 
The Historical Data is more comprehensive and granular because (1) it 
would reflect a total of four risk factors (i.e., interest rate, 
interest rate volatility, mortgage option adjusted spread and mortgage 
basis), (2) the proposed interest rate risk factor would include 11 
tenors and (3) the proposed mortgage option adjusted spread risk factor 
would include up to approximately 32 individual factors. As a result of 
this change, FICC believes that the proposed Historical Data would 
better explain the market price changes of TBA transactions cleared by 
MBSD \21\ and FICC would be able to identify stress risk exposures 
under broader and more varied market conditions. The Historical Data 
would also provide MBSD with an enhanced capability to design more 
transparent scenarios. Because Clearing Members typically use risk 
factor analysis for their own risk

[[Page 11415]]

and financial reporting, such Members would have comparable data and 
analysis to stress test their portfolios. Thus, Clearing Members would 
be able to simulate their stressed portfolios to a closer degree than 
under the existing stress testing methodology.
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    \20\ The term ``granular'' in the risk context means detailed 
and diversified.
    \21\ Specified Pool Trades and Stipulated Trades are mapped to 
the corresponding TBAs. FICC's guarantee of Option Contracts on TBAs 
is limited to the intrinsic value of the option positions meaning 
that, when the underlying price of the TBA position is above the 
call price, the Option Contract is considered in-the-money and 
FICC's guarantee reflects this portion of the Option Contract's 
positive value at the time of a Clearing Member's insolvency. The 
value change of an Option Contract's position is simulated as the 
change in its intrinsic value. No changes are being proposed to 
MBSD's treatment of Specified Pool Trades, Stipulated Trades and 
Option Contracts pursuant to this proposal.
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(2) Proposed Change to the Look-Back Period Used for the Identification 
of Historical Stress Scenarios in the Scenario Selection Process
    MBSD's current set of historical stress scenarios is comprised of 
scenarios that reflect the most severe market price movements which 
have been observed during past periods of extreme market conditions. To 
identify specific dates for these market movements, MBSD's stress 
testing model analyzes the historical risk factor time series data over 
a 10-year look-back period. Specifically, MBSD's stress testing model 
currently selects 50 historical scenarios based on actual historical 
time periods observed over a 10-year look-back period.\22\ On a 
quarterly basis, MBSD eliminates all historical data that fall outside 
the scope of the 10-year look-back period.
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    \22\ In addition to these 50 historical scenarios, FICC 
supplements the historical scenario set by including additional 
events that have occurred outside of the 10-year look-back period 
and have been identified as important periods of historical stress 
because such events have had a significant impact on the financial 
market. These dates include May 29, 1994 (when the Federal Reserve 
significantly raised rates), October 5, 1998 (when the Long-Term 
Capital Management crisis occurred), and September 11, 2001 (when 
the terrorist attacks occurred).
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    FICC is proposing to change the current 10-year look-back period to 
a look-back period that starts on a fixed date of May 29, 2002 and 
continues to expand forward--meaning that no portion of the timeframe 
within the proposed look-back period would be eliminated from the 
stress testing model; instead the entire timeframe within the look-back 
period would continue to expand forward.\23\
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    \23\ FICC would continue to include events that have occurred 
prior to the proposed fixed date of May 29, 2002. These events 
include the events referred to in footnote 22 above.
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    FICC selected May 29, 2002 as the fixed starting point based on its 
assessment of the accuracy and consistency of the Historical Data 
provided by the vendor. FICC is proposing this change because it 
believes that the expanded look-back period would better capture the 
potential market price changes of TBA securities, preserve historical 
dates that would otherwise be eliminated under the current 10-year 
look-back period, and provide the stress testing model with a larger 
set of scenarios for the historical Scenario Selection process.\24\
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    \24\ Pursuant to the proposed change, the look-back period would 
include at least 16 years of historical data.
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(3) Proposed Change To Use Security-Level Data and Historical Data in 
the Stress Testing Model's Stress P&L Calculation
    Currently, in order to determine the potential loss to a Clearing 
Member's portfolio under a given stress scenario, MBSD's stress testing 
methodology applies a profit-and-loss calculation that multiplies a set 
of risk factors' stress movements by its corresponding risk 
sensitivities. Currently this methodology utilizes two interest rate 
risk factors (i.e., 2-year swap rates and 10-year swap rates) and the 
FNMA 30-year current coupon mortgage option adjusted spread. The risk 
sensitivities are estimated using an empirical regression with a two-
month look-back period.\25\ FICC believes that the current 
methodology's use of a smaller set of risk factors and the relatively 
short two-month look-back period is a limitation that contributes to an 
inability to explain the results of the sensitivities estimation.
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    \25\ Empirical regression is a statistical measure that 
determines the coefficient range used in the stress P&L calculation.
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    FICC is proposing to leverage the Security-Level Data and 
Historical Data in the methodology's calculation of stress P&L. 
Specifically, FICC is proposing to replace the current empirical 
regression-based profit-and-loss calculation with a financial profit-
and-loss calculation. The proposed financial profit-and-loss 
calculation would use the Security-Level Data and Historical Data. The 
Security-Level Data is generated using the vendor's suite of security 
valuation models that includes an agency mortgage prepayment model and 
interest rate term structure model.\26\ FICC believes that the vendor's 
approach generates more stable and robust Security-Level Data and 
addresses the limitations of the current empirical regression 
algorithm.\27\ Because the proposed change would include Security-Level 
Data, FICC believes the proposed Security-Level Data would improve the 
stress testing model's stress P&L calculation, and the calculated 
results would be closer to actual price changes for TBA securities 
during larger market moves which are typical of stress testing 
scenarios.
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    \26\ A prepayment model captures cash flow uncertainty as a 
result of unscheduled payments of principal (prepayments). An 
interest rate term structure model describes the relationship 
between interest rates of different maturities.
    \27\ As described above, these limitations include the limited 
number of risk factors and the two-month look-back period.
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(4) Proposed Change To Use a Back-Up Calculation in the Event of a 
Vendor Data Disruption
    As described above, FICC would utilize the vendor's data for MBSD's 
stress testing methodology. Prior to MBSD's use of this data in its VaR 
model, FICC reviewed a description of the vendor's calculation 
methodology and the manner in which the market data is used to 
calibrate the vendor's models. At that time, The Depository Trust & 
Clearing Corporation's (``DTCC'') Quantitative Risk Management, Vendor 
Risk Management, and Information Technology teams conducted due 
diligence of the vendor in order to evaluate its control framework for 
managing key risks.\28\ FICC's due diligence included an assessment of 
the vendor's technology risk, business continuity, regulatory 
compliance, and privacy controls. Because of FICC's due diligence and 
its use of the vendor data in connection with the calculation of MBSD's 
margin model, FICC understands and remains comfortable with the 
vendor's controls. In addition, DTCC's Data Integrity department 
manages the data that FICC receives including, but not limited to, 
market data and analytical data provided by vendors.\29\ As a result, 
FICC feels comfortable with leveraging the Security-Level Data and 
Historical Data for purposes of MBSD's stress testing methodology.
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    \28\ DTCC is FICC's parent company. DTCC operates on a shared 
services model with respect to FICC. Most corporate functions are 
established and managed on an enterprise-wide basis pursuant to 
intercompany agreements under which DTCC generally provides a 
relevant service to FICC.
    \29\ DTCC's Data Integrity department oversees data integrity on 
behalf of DTCC's Counterparty Credit, Market, and Liquidity Risk 
Management groups as well as Securities Valuation, Model Validation 
and Control, and Quantitative Risk Management (collectively, 
Financial Risk Management (``FRM'')), and the Systemic Risk Office. 
The Data Integrity department's mission is to align with FRM and 
ensure that the highest data quality is managed for the purpose of 
lowering risk and improving efficiency within FRM. The Data 
Integrity department's prime directive consists of the following: 
(1) Ensuring a data governance framework is established and adhered 
to within FRM; (2) ensuring sufficient integrity of key data sources 
through active rules-based data monitoring; (3) ensuring sufficient 
alerting is in place to inform necessary parties when data anomalies 
occur; (4) liaising with subject matter experts to resolve data 
anomalies in an efficient and effective manner; and (5) ensuring 
that critical FRM data is catalogued and defined in the enterprise 
data dictionary.
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    In connection with FICC's proposal to use the Security-Level Data 
and Historical Data in its stress testing methodology for the 
historical and hypothetical scenarios, FICC is also

[[Page 11416]]

proposing a back-up calculation (as described in the paragraph below) 
that it would utilize in the event the vendor fails to provide the 
data. If the vendor fails to provide any data or a significant portion 
of the data in accordance with the timeframes agreed to by FICC and the 
vendor, FICC would use the most recently available data on the first 
day that such disruption occurs. Subject to discussions with the 
vendor, if a Managing Director, who oversees Market Risk Management, 
determines that the vendor would resume providing data within five (5) 
business days, such Managing Director would determine whether the daily 
stress testing calculation should continue to be calculated by using 
the most recently available data or whether the back-up calculation (as 
described below) should be invoked, subject to the approval of DTCC's 
Group Chief Risk Officer or his/her designee.\30\ Subject to 
discussions with the vendor, if a Managing Director, who oversees 
Market Risk Management, determines that the data disruption would 
extend beyond five (5) business days, the back-up calculation would be 
applied, subsequent to the approval of DTCC's Management Risk 
Committee, followed by notification to the Board Risk Committee.
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    \30\ For the avoidance of doubt, after taking into consideration 
the vendor's condition and, to the extent applicable, market 
conditions, FICC may treat the interruption as an extended data 
interruption sooner.
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    The proposed back-up calculation would be as follows: MBSD would 
(1) calculate each Clearing Member's portfolio net exposures in four 
securitization programs,\31\ (2) calculate the stress return for each 
securitization program as the three-day price return for each 
securitization program index for each scenario date, and (3) calculate 
each Clearing Member's stress P&L as the sum of the products of the net 
exposure of each securitization program and the stress return value for 
each securitization program. FICC would use publicly available indices 
(e.g., the Bloomberg FNMA 30-year index, Bloomberg GNMA 30-year index, 
Bloomberg FNMA 15-year index and Bloomberg GNMA 15-year index) as the 
data source for the stress return calculations.\32\
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    \31\ The securitization programs are as follows: (1) FNMA and 
Freddie Mac (``FHLMC'') conventional 30-year mortgage-backed 
securities, (2) GNMA 30-year mortgage-backed securities, (3) FNMA 
and FHLMC conventional 15-year mortgage-backed securities, and (4) 
GNMA 15-year mortgage-backed securities.
    \32\ The proposed calculation is similar to MBSD's calculation 
of the Margin Proxy, which is the back-up calculation that MBSD will 
use to calculate the VaR Charge in the event of a vendor data 
disruption. See MBSD Rule 1, Definitions--Margin Proxy, supra note 
3.
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C. Delayed Implementation of the Proposal

    This proposal would become operative within 45 business days after 
the date of the Commission's notice of no objection to this advance 
notice filing. FICC would announce the operative date in an important 
notice issued to Clearing Members.\33\
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    \33\ MBSD's important notices are available at http://www.dtcc.com/legal/important-notices?subsidiary=FICC+-+MBS&pgs=1.
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II. Anticipated Effect on and Management of Risks

    FICC believes that the proposed change to MBSD's stress testing 
methodology, which consists of proposals to (1) use Historical Data in 
the Scenario Selection process, (2) change the 10-year look-back period 
used for the identification of historical stress scenarios in the 
Scenario Selection process, (3) use Security-Level Data and Historical 
Data in the stress testing methodology's calculation of stress P&L for 
Clearing Members' portfolios, and (4) use a back-up calculation in the 
event of a Vendor Data Disruption, would affect MBSD's management of 
risk because the changes would help to ensure that MBSD's stress 
testing methodology more effectively measures whether it is collecting 
adequate prefunded financial resources to cover its potential losses 
resulting from the default of a Clearing Member and its Affiliated 
Family under multiple extreme but plausible market stress conditions.

A. Proposed Change To Use Historical Data in the Scenarios Selection 
Process

    FICC's proposal to utilize Historical Data in MBSD's historical 
stress scenario selection process would affect FICC's management of 
risk because the change would incorporate a broader range of risk 
factors to better understand a Clearing Member's exposure to these risk 
factors. As described above, the proposed change would enable MBSD to 
leverage vendor expertise in supplying the risk data attributes that 
would then be incorporated into MBSD's stress testing model. The data 
would expand the number of tenors for the existing interest rate risk 
factor and expand the number of individual factors to the existing 
mortgage option adjusted spread risk factor. The proposed interest rate 
risk factor would include 11 tenors and the proposed mortgage option 
adjusted spread risk factor would include up to approximately 32 
individual factors.\34\ In addition, FICC would include two new risk 
factors in the methodology--interest rate volatility and mortgage 
basis. FICC believes that the proposed change would provide more 
comprehensive, granular and transparent risk representations that 
enable sensitivity analysis on key model parameters and assumptions.
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    \34\ The proposed interest rate risk factor would include 11 
tenors between 3 months and 30 years, and the proposed mortgage 
option adjusted spread risk factor would include factors related to 
relative value, spread between 15-year and 30-year products, and 
spread between GNMA and FNMA.
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B. Proposed Change to the 10-Year Look-Back Period Used for the 
Identification of Historical Stress Scenarios in the Scenario Selection 
Process

    FICC's proposal to change the current 10-year look-back period to a 
look-back period that starts on a fixed date of May 29, 2002 and 
continues to expand forward would affect FICC's management of risk 
because the change (which includes at least 16 years of historical 
data) would give MBSD the ability to assess a broader spectrum of 
historical stressed market events that would be used in the stress 
testing methodology to design a comprehensive set of historical stress 
scenarios.

C. Proposed Change To Use Security-Level Data and Historical Data in 
the Stress Testing Model's Stress P&L Calculation

    FICC's proposal to use Security-Level Data and Historical Data in 
the stress testing methodology's calculation of stress P&L would affect 
FICC's management of risk because leveraging the vendor-supplied data 
would improve the estimation of the stress P&L calculation by giving 
FICC the ability to attribute the stress loss under a given stress 
scenario to specific risk factor changes. As described above, FICC 
would replace the current empirical regression based profit-and-loss 
calculation with a financial profit-and-loss calculation that uses 
Security-Level Data and Historical Data, which are not included in the 
current algorithm.\35\ Thus, FICC believes the proposed change would 
improve the stress testing model's stress P&L calculation because the 
calculated results would be closer to actual price changes for TBA 
securities during larger market moves which are typical of stress 
testing scenarios.
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    \35\ As described above, the empirical regression algorithm 
incorporates fewer risk factors and a shorter look-back period.
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    In an effort to assess the impact of the proposed change, FICC 
compared the results of the current stress testing

[[Page 11417]]

methodology with the proposed stress testing methodology for the period 
of February 1, 2018 through January 1, 2019 with respect to the 
historical stress scenarios. The average of the maximum daily 
historical Cover 1 Ratio for this period is 20.3% for the proposed 
stress testing methodology compared to 19.2% for the current stress 
testing methodology (meaning that the proposed methodology would be 
approximately 1.1% higher (on average) than the current methodology).

D. Proposed Change To Use a Back-Up Calculation in the Event of a 
Vendor Data Disruption

    FICC's proposal to use a back-up calculation would affect FICC's 
management of risk because it would help to ensure that FICC continues 
to test the adequacy of MBSD's prefunded financial resources in the 
event of a Vendor Data Disruption. As described above, FICC would 
manage the risks associated with a potential data disruption by using 
the most recently available data (before the disruption) on the first 
day that a data disruption occurs. If the vendor fails to provide any 
data or a significant portion of the data in accordance with the 
timeframes agreed to by FICC and the vendor, FICC would use the most 
recently available data on the first day that such disruption occurs. 
Subject to discussions with the vendor, if a Managing Director, who 
oversees Market Risk Management, determines that the vendor would 
resume providing data within five (5) business days, such Managing 
Director would determine whether the daily stress testing calculation 
should continue to be calculated by using the most recently available 
data or whether the back-up calculation should be invoked, subject to 
the approval of DTCC's Group Chief Risk Officer or his/her designee. 
Subject to discussions with the vendor, if a Managing Director, who 
oversees Market Risk Management, determines that the data disruption 
would extend beyond five (5) business days, the back-up calculation 
would be applied, subject to the approval of DTCC's Management Risk 
Committee, followed by notification to the Board Risk Committee.

III. Consistency With the Clearing Supervision Act and the Covered 
Clearing Agency Standards

    Although the Clearing Supervision 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.\36\
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    \36\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act \37\ authorizes 
the Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like FICC, and financial institutions engaged in designated activities 
for which the Commission is the supervisory agency or the appropriate 
financial regulator. Section 805(b) of the Clearing Supervision Act 
\38\ states that the objectives and principles for the risk management 
standards prescribed under Section 805(a) shall be to, among other 
things, 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 Clearing Supervision Act \39\ and 
Section 17A of the Act \40\ (the risk management standards are referred 
to as the ``Covered Clearing Agency Standards'').\41\ The Covered 
Clearing Agency Standards require registered clearing agencies to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to be consistent with the 
minimum requirements for their operations and risk management practices 
on an ongoing basis.\42\
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    \37\ See 12 U.S.C. 5464(a)(2).
    \38\ See 12 U.S.C. 5464(b).
    \39\ See 12 U.S.C. 5464(a)(2)
    \40\ See 15 U.S.C. 78q-1.
    \41\ See 17 CFR 240.17Ad-22.
    \42\ Id.
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    FICC believes that the proposed changes in this advance notice are 
consistent with the objectives and principles of the risk management 
standards as described in Section 805(b) of the Clearing Supervision 
Act and in the Covered Clearing Agency Standards. As discussed above, 
FICC is proposing several changes to MBSD's stress testing methodology. 
FICC believes the proposed changes are consistent with promoting robust 
risk management because the changes are designed to enhance MBSD's 
stress testing methodology, which is used to help ensure that MBSD 
collects adequate prefunded financial resources to cover its potential 
losses resulting from the default of a Clearing Member and its 
Affiliated Family under multiple extreme but plausible market stress 
conditions.
    First, FICC is proposing to leverage Historical Data in the 
Scenario Selection process. FICC believes the proposed change would 
promote robust risk management because the Historical Data would 
incorporate a broader range of risk factors that would be used in 
MBSD's stress testing model to better understand a Clearing Member's 
exposure to these risk factors.
    Second, FICC is proposing to change the 10-year look-back period to 
a look-back period that starts on a fixed date of May 29, 2002 and 
continues to expand forward. FICC believes the proposed change would 
promote robust risk management because the change, which includes at 
least 16 years of historical data, would capture the potential market 
price changes of TBA securities over a longer time period, preserve 
historical dates that would otherwise be eliminated under the current 
10-year look-back period and provide the stress testing model with a 
larger set of scenarios for the historical Scenario Selection process.
    Third, FICC is proposing to leverage Security-Level Data and 
Historical Data in the methodology's calculation of stress P&L. FICC 
believes the proposed change would promote robust risk management 
because it would replace the current empirical regression-based profit-
and-loss calculation with a financial profit-and-loss calculation that 
utilizes the Security-Level Data and Historical Data. The change would 
cause the stress testing model's stress P&L calculation to calculate 
amounts that are closer to actual price changes for TBA securities 
during larger market moves in an effort to test the adequacy of MBSD's 
prefunded resources.
    Fourth, FICC is proposing to use a back-up calculation in the event 
of a Vendor Data Disruption. FICC believes the proposed change would 
promote robust risk management because the change would help to ensure 
that FICC has a stress testing methodology in place that allows it to 
continue to test the adequacy of MBSD's prefunded financial resources 
in the event of a Vendor Data Disruption.
    For these reasons, FICC believes the proposed changes would help to 
promote MBSD's robust risk management, which, in turn, is consistent 
with reducing systemic risks and supporting the stability of the 
broader financial system, consistent with Section 805(b) of the 
Clearing

[[Page 11418]]

Supervision Act.\43\ FICC also believes the changes proposed in this 
advance notice are consistent with promoting safety and soundness, 
which, in turn, is consistent with reducing systemic risks and 
supporting the stability of the broader financial system, consistent 
with Section 805(b) of the Clearing Supervision Act.\44\ As described 
above, the proposed changes are designed to help ensure that FICC's 
stress testing methodology measures whether MBSD is collecting adequate 
prefunded financial resources to cover its potential losses resulting 
from the default of a Clearing Member and its Affiliated Family under 
multiple extreme but plausible market stress conditions. Because the 
proposed changes would better position FICC to limit its exposures to 
Clearing Members in the event of a Clearing Member's default, FICC 
believes the proposed changes are consistent with promoting safety and 
soundness, which, in turn, is consistent with reducing systemic risks 
and supporting the stability of the broader financial system.
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    \43\ See 12 U.S.C. 5464(b).
    \44\ Id.
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B. Consistency With Rule 17Ad-22(e)(4) Under the Act

    This proposal is also designed to be consistent with Rule 17Ad-
22(e)(4) under the Act, which requires, in part, that each covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to effectively identify, 
measure, monitor, and manage its credit exposures to participants and 
those arising from its payment, clearing, and settlement processes.\45\
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    \45\ 17 CFR 240.17Ad-22(e)(4).
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    Rule 17Ad-22(e)(4)(i) under the Act requires that a covered 
clearing agency maintain sufficient financial resources to cover its 
credit exposure to each participant fully with a high degree of 
confidence.\46\ The proposed changes are consistent with Rule 17Ad-
22(e)(4)(i) because they describe how FICC has developed and carries 
out a credit risk management strategy to maintain sufficient prefunded 
financial resources to cover fully its credit exposures to each 
Clearing Member with a high degree of confidence.
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    \46\ 17 CFR 240.17Ad-22(e)(4)(i).
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    FICC believes (1) the proposal to use Historical Data in the 
historical Scenario Selection process and incorporate a broader range 
of risk factors that would be used in MBSD's stress testing model would 
enable FICC to better understand a Clearing Member's exposure to these 
risk factors, (2) the proposal to change the 10-year look-back period 
to a look-back period that starts on a fixed date of May 29, 2002 and 
continues to expand forward would better capture the potential market 
price changes of TBA securities, preserve historical dates that would 
otherwise be eliminated under the current 10-year look-back period and 
provide the stress testing model with a larger set of scenarios for the 
historical selection process, (3) the proposal to leverage Security-
Level Data and Historical Data in the stress testing methodology's 
calculation of stress P&L for Clearing Members' portfolios would 
provide for calculated amounts that are closer to actual price changes 
for TBA securities during larger market moves in an effort to test the 
adequacy of MBSD's prefunded resources, and (4) the proposal to use a 
back-up calculation would help to ensure that FICC has a methodology in 
place that allows it to continue to measure the adequacy of MBSD's 
prefunded financial resources in the event of a Vendor Data Disruption. 
FICC believes that the proposed changes would improve MBSD's stress 
testing methodology, which is used to test the sufficiency of MBSD's 
prefunded resources daily to support compliance with Rule 17Ad-
22(e)(4)(i). As such, FICC believes that, taken together, the proposed 
changes are designed to be consistent with the requirements of Rule 
17Ad-22(e)(4)(i) under the Act.\47\
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    \47\ 17 CFR 240.17Ad-22(e)(4)(i).
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    Rule 17Ad-22(e)(4)(vi)(A) under the Act requires that a covered 
clearing agency conduct stress testing of its total financial resources 
once each day using standard predetermined parameters and 
assumptions.\48\ FICC believes the proposal to (1) use Historical Data 
in the historical Scenario Selection process, (2) change the 10-year 
look-back period to a look-back period that starts on a fixed date of 
May 29, 2002 and continues to expand forward, (3) leverage Security-
Level Data and Historical Data in the stress testing methodology's 
calculation of stress P&L for Clearing Members' portfolios, and (4) use 
a back-up calculation in the event of a Vendor Data Disruption would 
reflect standard predetermined parameters and assumptions that FICC 
would use in MBSD's stress testing methodology to conduct daily stress 
testing.
---------------------------------------------------------------------------

    \48\ 17 CFR 240.17Ad-22(e)(4)(vi)(A). The Framework identifies 
the sources of MBSD's prefunded resources for purposes of meeting 
FICC's requirements under Rule 17Ad-22(e)(4)(iii).
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    FICC believes that the proposed changes would reflect its use of 
standard predetermined parameters and assumptions in FICC's daily 
stress testing of its financial resources in order to support 
compliance with Rule 17Ad-22(e)(4)(vi)(A) under the Act.\49\ As such, 
FICC believes that, taken together, the proposed changes are designed 
to be consistent with the requirements of Rule 17Ad-22(e)(4)(vi)(A) 
under the Act.\50\
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    \49\ Id.
    \50\ 17 CFR 240.17Ad-22(e)(4)(vi)(A).
---------------------------------------------------------------------------

III. Date of Effectiveness of the Advance Notice, and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date that the proposed change was filed with the Commission or (ii) the 
date that any additional information requested by the Commission is 
received. The clearing agency shall not implement the proposed change 
if the Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    The clearing agency shall post notice on its website of proposed 
changes that are implemented.

IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-FICC-2020-801 on the subject line.

Paper Comments

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


[[Page 11419]]


All submissions should refer to File Number SR-FICC-2020-801. 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 website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the Advance Notice that are filed with the 
Commission, and all written communications relating to the Advance 
Notice 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 website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of FICC and on DTCC's website 
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-FICC-2020-801 and should be submitted on 
or before March 13, 2020.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-03996 Filed 2-26-20; 8:45 am]
BILLING CODE 8011-01-P