[Federal Register Volume 85, Number 64 (Thursday, April 2, 2020)]
[Notices]
[Pages 18615-18617]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-06849]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88494; File No. SR-NSCC-2020-002]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Order Approving a Proposed Rule Change To Enhance the 
Calculation of the Family-Issued Securities Charge

March 27, 2020.
    On January 28, 2020, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ 
proposed rule change SR-NSCC-2020-002 to enhance the calculation of the 
Family-Issued Securities Charge.\3\ The proposed rule change was 
published for comment in the Federal Register on February 18, 2020,\4\ 
and the Commission received no comment letters regarding the changes 
proposed in the proposed rule change.\5\ For the reasons discussed 
below, the Commission is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NSCC also filed the proposals contained in the proposed rule 
change as advance notice SR-NSCC-2020-801 with the Commission 
pursuant to Section 806(e)(1) of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act entitled the Payment, Clearing, and 
Settlement Supervision Act of 2010, 12 U.S.C. 5465(e)(1), and Rule 
19b-4(n)(1)(i) of the Act, 17 CFR 240.19b-4(n)(1)(i). Notice of 
Filing of the Advance Notice was published for comment in the 
Federal Register on February 27, 2020. Securities Exchange Act 
Release No. 88267 (February 24, 2020), 85 FR 11437 (February 27, 
2020) (File No. SR-NSCC-2020-801).
    \4\ Securities Exchange Act Release No. 88163 (February 11, 
2020), 85 FR 8964 (February 18, 2020) (``Notice of Filing'').
    \5\ As the proposals contained in the proposed rule change were 
also filed as an advance notice, all public comments received on the 
proposals are considered regardless of whether the comments are 
submitted on the proposed rule change or the advance notice.
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I. Description of the Proposed Rule Change

    The proposed rule change would revise NSCC's Rules and Procedures 
(``Rules'') \6\ to amend the calculation of NSCC's existing margin 
charge applied to long positions in Family-Issued Securities to address 
certain risk presented by these positions.
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    \6\ Capitalized terms not defined herein are defined in NSCC's 
Rules and Procedures (``Rules''), available at http://www.dtcc.com/
~/media/Files/Downloads/legal/rules/nscc_rules.pdf.
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A. Background

    NSCC provides clearing, settlement, risk management, central 
counterparty services, and a guarantee of completion for virtually all 
broker-to-broker trades involving equity securities, corporate and 
municipal debt securities, and certain other securities. NSCC manages 
its credit exposure to its Members by determining an appropriate 
Required Fund Deposit for each Member, which serves as each Member's 
margin.\7\ The aggregate of all NSCC Members' Required Fund Deposits 
(together with certain other deposits required under the Rules) 
constitutes NSCC's Clearing Fund, which NSCC would access should a 
Member default and that Member's Required Fund Deposit, upon 
liquidation, is insufficient to satisfy NSCC's losses.
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    \7\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters) of the Rules, supra note 6.
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    Each Member's Required Fund Deposit consists of a number of 
applicable components, each of which is calculated to address specific 
risks faced by NSCC.\8\ NSCC states that it regularly assesses the 
market, liquidity, and other risks that its margining methodologies are 
designed to mitigate to evaluate whether margin levels are commensurate 
with the particular risk attributes of each relevant product, 
portfolio, and market.\9\ Such risks include risks introduced by its 
counterparties or Members. In particular, NSCC seeks to identify and 
mitigate its exposures to specific wrong-way risk (``SWWR''), which is 
the risk that an exposure to a counterparty is highly likely to 
increase when the creditworthiness of that counterparty deteriorates. 
Such risk would arise when NSCC acts as central counterparty to a 
Member with unsettled long positions in securities that were issued by 
that Member or an affiliate of that Member (``Family-Issued 
Securities''). If that Member defaults, NSCC would seek to cover its 
losses by closing out the unsettled Family-Issued Securities long 
positions. However, because the Member default would also likely lead 
to a drop in the creditworthiness of the Member and, therefore, the 
value of the Family-Issued Securities, NSCC would likely not be able to 
completely cover its losses in closing out those positions.
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    \8\ Id.
    \9\ See Notice of Filing supra note 4, at 85 FR 8965.
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    In order to address this particular form of SWWR, NSCC imposes a 
charge on all Members with unsettled long positions in their own 
Family-Issued Securities, called the FIS Charge, which is calculated by 
multiplying the value of the net unsettled long positions in Family-
Issued Securities by a certain percentage (``Haircut Rate''). 
Currently, the Haircut Rate applied in the FIS Charge calculation is 
based on a Member's rating category on NSCC's Credit Risk Rating Matrix 
(``CRRM''), which ranges from 1 to 7. NSCC utilizes the CRRM to 
evaluate its credit risk exposure to each Member; a higher CRRM rating 
represents a higher credit risk (i.e., a greater risk of defaulting on 
settlement obligations) and may cause a Member to be subject to 
enhanced surveillance or additional margin requirements.\10\
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    \10\ See Rule 1 and Section 4 of Rule 2B of the Rules, supra 
note 6. See also Securities Exchange Act Release Nos. 80734 (May 19, 
2017), 82 FR 24177 (May 25, 2017) (SR-DTC-2017-002, SR-FICC-2017-
006, SR-NSCC-2017-002); and 80731 (May 19, 2017), 82 FR 24174 (May 
25, 2017) (SR-DTC-2017-801, SR-FICC-2017-804, SR-NSCC-2017-801).
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    Currently, the applicable Haircut Rate for the FIS Charge depends 
on a Member's rating on the CRRM.

[[Page 18616]]

Specifically, for Members that are rated 6 or 7 on the CRRM, the 
applicable Haircut Rate for net unsettled long positions in Family-
Issued Securities shall be (1) at least 80 percent for fixed income 
securities, and (2) 100 percent for equity securities. For Members that 
are rated 1 through 5 on the CRRM, the applicable Haircut Rate shall be 
(1) at least 40 percent for fixed income securities, and (2) at least 
50 percent for equity securities.\11\
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    \11\ See Procedure XV (Clearing Fund Formula and Other Matters) 
of the Rules, supra note 6.
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B. Proposed Changes to FIS Charge

    In the proposed rule change, NSCC is proposing to revise the 
calculation of the FIS Charge to use the same Haircut Rate for all 
Members regardless of their CRRM rating category. Under the proposal, 
net unsettled long positions in (1) fixed income securities that are 
Family-Issued Securities are charged a Haircut Rate of no less than 80 
percent, and (2) equity securities that are Family-Issued Securities 
are charged a Haircut Rate of 100 percent.
    NSCC states that it may still be exposed to SWWR despite applying 
different Haircut Rates based on a Member's rating on the CRRM, and it 
can better mitigate its exposure to this risk by calculating the FIS 
Charge without considering Members' CRRM rating categories.\12\ 
According to NSCC, while the current methodology appropriately assumes 
that Members with a higher rating category on the CRRM present a 
heightened credit risk to NSCC or have demonstrated higher risk related 
to their ability to meet settlement, this methodology does not account 
for the risk that a Member may default due to unanticipated causes 
(referred to as a ``jump-to-default'' scenario) not captured by the 
CRRM.\13\ This is because the CRRM relies on historical data as a 
predictor of future risks,\14\ whereas jump-to-default scenarios are 
triggered by unanticipated causes that could not be predicted based on 
historical trends or data (e.g., instances of fraud or other bad 
actions by a Member's management). Therefore, NSCC represents that the 
proposed change is designed to cover SWWR arising from potential jump-
to-default scenarios by applying the higher applicable Haircut Rate in 
calculating the FIS Charge for all Members.\15\
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    \12\ See Notice of Filing supra note 4, at 85 FR 8965.
    \13\ See id.
    \14\ See Notice of Filing supra note 4, at 85 FR 8965-66.
    \15\ See Notice of Filing supra note 4, at 85 FR 8966.
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    The practical outcome of this proposed change is that for all 
Family-Issued Securities, NSCC would apply a haircut equivalent to the 
current Haircut Rate for Members that are rated 6 or 7 on the CRRM 
regardless of whether a Member is rated at a 6 or 7. To implement this 
proposal, NSCC would amend Sections I.(A)(1)(a)(iv) and I.(A)(2)(a)(iv) 
of Procedure XV of the Rules.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \16\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and rules and regulations thereunder applicable 
to such organization. After carefully considering the proposed rule 
change, the Commission finds that the proposed rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to NSCC. In particular, the 
Commission finds that the proposed rule change is consistent with 
Section 17A(b)(3)(F) \17\ of the Act and Rules 17Ad-22(e)(4)(i) and 
(e)(6)(i) and (v) thereunder.\18\
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    \16\ 15 U.S.C. 78s(b)(2)(C).
    \17\ 15 U.S.C. 78q-1(b)(3)(F).
    \18\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i) and (v).
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A. Consistency With Section 17A(b)(3)(F)

    Section 17A(b)(3)(F) of the Act requires, in part, that the rules 
of a clearing agency, such as NSCC, be designed to promote the prompt 
and accurate clearance and settlement of securities transactions, and 
to assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible.\19\
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    \19\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that the proposal is consistent with the 
promotion of prompt and accurate clearance and settlement of securities 
transactions. As described above, NSCC faces SWWR when it acts as 
central counterparty to a Member with long positions in Family-Issued 
Securities. Although NSCC's current margin methodology addresses SWWR 
through imposition of the FIS Charge, it does not address SWWR 
associated with a jump-to-default scenario. The proposal would address 
SWWR associated with a jump-to-default scenario by using the higher 
applicable Haircut Rate for all Members concerning their net unsettled 
long positions in Family-Issued Securities, regardless of the Members' 
CRRM rating category. As such, the proposal would address a risk not 
captured currently under NSCC's margin methodology and provide for more 
comprehensive risk management of NSCC's risks. Further, applying the 
higher applicable Haircut Rate in calculating the FIS Charge for all 
Members would result in the collection of additional margin, which 
should, in turn, better enable NSCC to manage the potential losses 
arising out of a Member default and continue operations of its critical 
clearance and settlement services in default scenarios. Accordingly, 
the Commission finds that NSCC's proposal should help NSCC to continue 
providing prompt and accurate clearance and settlement of securities 
transactions in the event of a Member default.
    The Commission also believes that the proposal is consistent with 
assuring the safeguarding of securities and funds which are in the 
custody or control of NSCC for which it is responsible. As described 
above, the proposal would allow NSCC to collect additional margin to 
collateralize exposures to SWWR associated with jump-to-default 
scenario that NSCC may face when liquidating Family-Issued Securities 
positions that are depreciating in value in response to a Member's 
default. By expanding the higher haircut rates to all Members, the 
proposal would assist NSCC in collecting margin and maintaining the 
Clearing Fund that more precisely reflects NSCC's overall risk exposure 
to its Members. By better limiting NSCC's exposure to Members, the 
proposal is designed to help ensure that NSCC has collected sufficient 
margin from Members with long positions in Family-Issued Securities, so 
that non-defaulting Members would not be exposed to mutualized losses 
as a result of a default of a Member with long positions in Family-
Issued Securities. By helping to limit non-defaulting Members' exposure 
to mutualized losses, the proposal is designed to help assure the 
safeguarding of securities and funds which are in NSCC's custody or 
control. For the reasons stated above, the Commission believes that the 
Proposed Rule Change is consistent with the requirements of Section 
17A(b)(3)(F) of the Act.\20\
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    \20\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(4)(i)

    Rule 17Ad-22(e)(4)(i) under the Act requires that each covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to

[[Page 18617]]

effectively identify, measure, monitor, and manage its credit exposures 
to participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence.\21\
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    \21\ 17 CFR 240.17Ad-22(e)(4)(i).
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    As described above, NSCC is exposed to SWWR where it acts as 
central counterparty for its Members' transactions in Family-Issued 
Securities. Applying the same higher Haircut Rate to all Members with 
net long unsettled positions in Family-Issued Securities, regardless of 
their rating on the CRRM, would help further mitigate NSCC's SWWR 
exposures, especially in a jump-to-default scenario. Thus, applying the 
same Haircut Rate in the FIS charge calculation is designed to help 
NSCC collect sufficient financial resources to help cover its credit 
exposures, with a high degree of confidence, to those Members seeking 
to clear and settle transactions in Family-Issued Securities. 
Therefore, the Commission believes the proposed change is consistent 
with Rule 17Ad-22(e)(4)(i).\22\
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    \22\ Id.
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C. Consistency With Rules 17Ad-22(e)(6)(i) and (v)

    Rule 17Ad-22(e)(6)(i) under the Act requires that each covered 
clearing agency that provides central counterparty services establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to cover its credit exposures to its participants 
by establishing a risk-based margin system that, at a minimum, 
considers, and produces margin levels commensurate with, the risks and 
particular attributes of each relevant product, portfolio, and 
market.\23\ Rule 17Ad-22(e)(6)(v) under the Act requires that each 
covered clearing agency that provides central counterparty services 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, uses an appropriate method for measuring credit exposure that 
accounts for relevant product risk factors and portfolio effects across 
products.\24\
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    \23\ 17 CFR 240.17Ad-22(e)(6)(i).
    \24\ 17 CFR 240.17Ad-22(e)(6)(v).
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    As described above, NSCC faces SWWR in jump-to-default scenarios 
where it acts as central counterparty to Member transactions in Family-
Issued Securities. This risk is present regardless of a Member's rating 
on the CRRM. However, the current methodology assumes that Members with 
a higher rating on the CRRM present a heightened credit risk to NSCC 
and applies a higher Haircut Rate to such Members. This distinction 
does not take into account the SWWR that would manifest in a jump-to-
default scenario. As such, NSCC proposes to apply the same higher 
Haircut Rate to all Members. This proposal would improve NSCC's ability 
to mitigate its exposure to SWWR in a jump-to-default scenario, thereby 
helping NSCC to maintain a risk-based margin system that considers, and 
produces margin levels commensurate with, the risks and particular 
attributes of net unsettled long positions in Family-Issued Securities. 
Therefore, the Commission believes that the proposal would be 
consistent with Rule 17Ad-22(e)(6)(i).\25\
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    \25\ 17 CFR 240.17Ad-22(e)(6)(i).
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    Additionally, because the enhanced FIS Charge would be a component 
of the margin that NSCC collects from its Members to help cover NSCC 
credit exposure to the Members, and because the charge would be based 
on different product risk factors with respect to equity and fixed-
income securities, it would be part of an appropriate method for 
measuring credit exposure that accounts for relevant product risk 
factors and portfolio effects across products, as described above. 
Therefore, the Commission believes the proposed change is consistent 
with Rule 17Ad-22(e)(6)(v).\26\
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    \26\ 17 CFR 240.17Ad-22(e)(6)(v).
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular with the requirements of Section 17A of the Act \27\ and 
the rules and regulations promulgated thereunder.
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    \27\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\28\ that proposed rule change SR-NSCC-2020-002, be, and hereby is, 
approved.\29\
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    \28\ 15 U.S.C. 78s(b)(2).
    \29\ In approving the proposed rule change, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\30\
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    \30\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-06849 Filed 4-1-20; 8:45 am]
BILLING CODE 8011-01-P