[Federal Register Volume 85, Number 192 (Friday, October 2, 2020)]
[Notices]
[Pages 62342-62348]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-21785]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90034; File No. SR-NSCC-2020-804]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Amendment No. 2 and Notice of No 
Objection to Advance Notice, as Modified by Amendment Nos. 1 and 2, To 
Introduce the Margin Liquidity Adjustment Charge and Include a Bid-Ask 
Risk Charge in the VaR Charge

September 28, 2020.
    On July 30, 2020, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2020-804 pursuant to Section 
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, entitled Payment, Clearing and Settlement 
Supervision Act of 2010 (``Clearing Supervision Act''),\1\ and Rule 
19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934 
(``Exchange Act'') \3\ to add two new charges to NSCC's margin 
methodology. On August 13, 2020, NSCC filed Amendment No. 1 to the 
advance notice, to make clarifications and corrections to the advance 
notice.\4\ The advance notice, as modified by Amendment No. 1, was 
published for public comment in the Federal Register on September 4, 
2020,\5\ and the Commission has received no comments regarding the 
changes proposed in the advance notice as modified by Amendment No. 1. 
On September 10, 2020, the Commission received one comment letter on 
NSCC's related Proposed Rule Change.\6\ To the extent that the comment 
letter on the Proposed Rule Change is relevant to the Advance Notice, 
it is discussed below.\7\ On August 27, 2020, NSCC filed Amendment No. 
2 to the advance notice to provide additional data for the Commission 
to consider in analyzing the advance notice.\8\ The advance notice, as 
modified by Amendment Nos. 1 and 2, is hereinafter referred to as the 
``Advance Notice.'' The Commission is publishing this notice to solicit 
comments on Amendment No. 2 from interested persons and, for the 
reasons discussed below, is hereby providing notice of no objection to 
the Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ Amendment No. 1 made clarifications and corrections to the 
description of the advance notice and Exhibits 3 and 5 of the 
filing.
    \5\ Securities Exchange Act Release No. 89719 (September 1, 
2020), 85 FR 55332 (September 4, 2020) (File No. SR-NSCC-2020-804) 
(``Notice of Filing''). On July 30, 2020, NSCC also filed a related 
proposed rule change (SR-NSCC-2020-016) with the Commission pursuant 
to Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder. 
On August 13, 2020, NSCC filed Amendment No. 1 to the proposed rule 
change to make similar clarifications and corrections to the 
proposed rule change. See 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4 
respectively. The proposed rule change, as amended by Amendment No. 
1, was published in the Federal Register on August 20, 2020. 
Securities Exchange Act Release No. 89558 (August 14, 2020), 85 FR 
51521 (August 20, 2020). On August 27, 2020, NSCC filed Amendment 
No. 2 to the proposed rule change to provide similar additional data 
for the Commission's consideration. The proposed rule change, as 
amended by Amendment Nos. 1 and 2, is hereinafter referred to as the 
``Proposed Rule Change.'' In the Proposed Rule Change, NSCC seeks 
approval of proposed changes to its rules necessary to implement the 
Advance Notice. The comment period for the related Proposed Rule 
Change filing closed on September 10, 2020, and the Commission 
received no comments.
    \6\ See letter from Cass Sanford, Associated General Counsel, 
OTC Markets Group (September 10, 2020) (``OTC Letter''), available 
at https://www.sec.gov/comments/sr-nscc-2020-016/srnscc2020016-7757533-223234.pdf.
    \7\ As the proposals contained in the Advance Notice were also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the Proposed Rule Change or the Advance Notice.
    \8\ In Amendment No. 2, NSCC updated Exhibit 3 to the advance 
notice to include impact analysis data with respect to the proposals 
in the advance notice. NSCC filed Exhibit 3 as a confidential 
exhibit to the advance notice pursuant to 17 CFR 240.24b-2.
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I. The Advance Notice

    First, the proposals in the Advance Notice would revise NSCC's 
Rules and Procedures (``Rules'') \9\ to introduce the Margin Liquidity 
Adjustment Charge (``MLA Charge'') as an additional margin component. 
Second, the proposals in the Advance Notice would revise the Rules to 
add a bid-ask spread risk charge (``Bid-Ask Spread Charge'') to NSCC's 
margin calculations.
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    \9\ Capitalized terms not defined herein are defined in the 
Rules, available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
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A. Background

    NSCC provides central counterparty (``CCP'') services, including 
clearing, settlement, risk management, and a guarantee of completion 
for virtually all broker-to-broker trades involving equity securities, 
corporate and municipal debt securities, and certain other securities. 
In its role as a CCP, a key tool that NSCC uses to manage its credit 
exposure to its members by determining and collecting an appropriate 
Required Fund Deposit (i.e., margin) for each member.\10\ The aggregate 
of all members' Required Fund Deposits (together with certain other 
deposits required under the Rules) constitutes NSCC's Clearing Fund, 
which NSCC would access should a defaulted member's own Required Fund 
Deposit be insufficient to satisfy losses to NSCC caused by the 
liquidation of that member's portfolio.\11\
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    \10\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters) of the Rules (``Procedure XV''), supra 
note 8.
    \11\ See id.
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    Each member's Required Fund Deposit consists of a number of 
applicable components, which are calculated to address specific risks 
that the member's portfolio presents to NSCC.\12\ Generally, the 
largest component of a member's Required Fund Deposit is the volatility 
charge, which is intended to capture the risks related to the movement 
of market prices associated with the securities in a member's 
portfolio.\13\ NSCC's methodology for calculating the

[[Page 62343]]

volatility charge of the Required Fund Deposit depends on the type of 
security. For most securities, (e.g., equity securities), NSCC 
calculates the volatility charge as the greater of (1) the larger of 
two separate calculations that utilize a parametric Value at Risk 
(``VaR'') model, (2) a gap risk measure calculation based on the 
largest non-index position in a portfolio that exceeds a concentration 
threshold, which addresses concentration risk that the largest non-
index position can present within a member's portfolio, and (3) a 
portfolio margin floor calculation based on the market values of the 
long and short positions in the portfolio, which addresses risks that 
might not be adequately addressed with the other volatility charge 
calculations.\14\ For certain other securities (e.g., corporate and 
municipal bonds), NSCC's Rules apply a haircut-based volatility charge 
that is calculated by multiplying the absolute value of the positions 
by a percentage.\15\ The volatility charge is designed to calculate the 
potential losses on a portfolio over a three-day period of risk assumed 
necessary to liquidate the portfolio, within a 99 percent confidence 
level.\16\
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    \12\ See id.
    \13\ See id.
    \14\ See id.; see also Securities Exchange Act Release No. 82780 
(February 26, 2018), 83 FR 9035 (March 2, 2018) (File No. SR-NSCC-
2017-808); Securities Exchange Act Release No. 82781 (February 26, 
2018), 83 FR 9042 (March 2, 2018) (File No. SR-NSCC-2017-020).
    \15\ See id.
    \16\ See Notice of Filing, supra note 5 at 55332, 34.
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    NSCC states that it regularly assesses market and liquidity risks 
as such risks relate to its margin methodology to evaluate whether 
margin levels are commensurate with the particular risk attributes of 
each relevant product, portfolio, and market.\17\ NSCC states that the 
proposed MLA Charge and Bid-Ask Spread Charge are necessary for NSCC to 
effectively account for risks associated with certain types and 
attributes of member portfolios.\18\
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    \17\ See Notice of Filing, supra note 5 at 55333.
    \18\ See id.
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B. Margin Liquidity Adjustment Charge

    NSCC's current margin methodology does not account for the risk of 
a potential increase in market impact costs that NSCC could incur when 
liquidating a defaulted member's portfolio that contains a 
concentration of large positions, as compared to the overall market, in 
a particular security or group of securities sharing a similar risk 
profile.\19\ In a member default, liquidating such large positions 
within a potentially compressed timeframe \20\ (i.e., in a fire sale) 
could have an impact on the underlying market, resulting in price moves 
that increases NSCC's risk of incurring additional liquidation costs. 
Therefore, NSCC designed the MLA Charge to address this specific 
risk.\21\
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    \19\ See id.
    \20\ NSCC's risk models assume the liquidation occurs over a 
period of three business days. See Notice of Filing, supra note 5 at 
55333-34.
    \21\ See Notice of Filing, supra note 5 at 55333.
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    The MLA Charge would be based on comparing the market value of 
member portfolio positions in specified asset groups \22\ to the 
available trading volume of those asset groups. If the market value of 
a member's positions in a certain asset group is large in comparison to 
the available trading volume of that asset group,\23\ then it is more 
likely that NSCC would have to manage reduced marketability and 
increased liquidation costs for those positions during a member default 
scenario. Specifically, NSCC's margin methodology assumes for each 
asset group that a certain share of the market can be liquidated 
without price impact.\24\ Aggregate positions in an asset group which 
exceed this share are generally considered as large and would therefore 
incur application of the MLA Charge to anticipate and address those 
increased costs.
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    \22\ The specified asset groups would include (1) equities 
(excluding equities defined as Illiquid Securities pursuant to the 
Rules), (2) Illiquid Securities, (3) unit investment trusts, or 
UITs, (4) municipal bonds (including municipal bond exchange-traded 
products, or ``ETPs''), and (5) corporate bonds (including corporate 
bond ETPs). NSCC would then further segment the equities asset group 
into the following subgroups: (i) Micro-capitalization equities, 
(ii) small capitalization equities, (iii) medium capitalization 
equities, (iv) large capitalization equities, (v) treasury ETPs, and 
(vi) all other ETPs. See id.
    \23\ NSCC states that it would determine average daily trading 
volume by reviewing data that is made publicly available by the 
Securities Industry and Financial Markets Association (``SIFMA''), 
at https://www.sifma.org/resources/archive/research/statistics. See 
id.
    \24\ NSCC would establish the particular share for each asset 
group or subgroup based on empirical research which includes the 
simulation of asset liquidation over different time horizons. See 
Notice of Filing, supra note 5 at 55333-34.
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    For each position in a market capitalization subgroup of the 
equities asset group, NSCC would calculate the market impact cost by 
multiplying four components: (1) An impact cost coefficient that is a 
multiple of the one-day market volatility of that subgroup and is 
designed to measure impact costs, (2) the gross market value of the 
position in that subgroup, (3) the square root of the gross market 
value of the position in that subgroup in the portfolio divided by an 
assumed percentage of the average daily trading volume of that 
subgroup, and (4) a measurement of the relative weight of the position 
in that subgroup of the portfolio. With respect to the fourth 
component, NSCC states that this measurement would include aggregating 
the weight of each CUSIP in that position relative to the weight of 
that CUSIP in the subgroup, such that a portfolio with fewer positions 
in a subgroup would have a higher measure of concentration for that 
subgroup.\25\
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    \25\ NSCC would calculate the relative weight by dividing the 
absolute market value of a single CUSIP in the member's portfolio by 
the total absolute market value of that portfolio. See Notice of 
Filing, supra note 5 at 55334.
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    For each position in the municipal bond, corporate bond, Illiquid 
Securities and UIT asset groups, and for positions in the treasury ETP 
and other ETP subgroups of the equities asset group, NSCC would 
calculate the market impact cost by multiplying three components: (1) 
An impact cost coefficient that is a multiple of the one-day market 
volatility of that asset group or subgroup, (2) the gross market value 
of the position in that asset group or subgroup, and (3) the square 
root of the gross market value of the position in that asset group or 
subgroup in the portfolio divided by an assumed percentage of the 
average daily trading volume of that subgroup.\26\
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    \26\ See supra note 22.
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    For each asset group or subgroup, NSCC would compare the calculated 
market impact cost to a portion of the volatility charge that is 
allocated to positions in that asset group or subgroup.\27\ If the 
ratio of the calculated market impact cost to the applicable one-day 
volatility charge is greater than a threshold, NSCC would apply an MLA 
Charge to that asset group or subgroup.\28\ If the ratio of these two

[[Page 62344]]

amounts is equal to or less than this threshold, NSCC would not apply 
an MLA Charge to that asset group or subgroup. The threshold would be 
based on an estimate of the market impact cost that is incorporated 
into the calculation of the applicable one-day volatility charge, such 
that NSCC would only apply an MLA Charge when the calculated market 
impact cost exceeds this threshold.
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    \27\ For purposes of this calculation, NSCC would use a portion 
of the applicable volatility charge that is based on a one-day 
assumed period of risk and calculated by applying a simple square-
root of time scaling, referred to in this advance notice as ``one-
day volatility charge.'' See Notice of Filing, supra note 5 at 
55334. Any changes that NSCC deems appropriate to this assumed 
period of risk would be subject to NSCC's model risk management 
governance procedures set forth in the Clearing Agency Model Risk 
Management Framework (``Model Risk Management Framework''). See 
Securities Exchange Act Release Nos. 81485 (August 25, 2017), 82 FR 
41433 (August 31, 2017) (File No. SR-NSCC-2017-008); 84458 (October 
19, 2018), 83 FR 53925 (October 25, 2018) (File No. SR-NSCC-2018-
009); 88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-
NSCC-2020-008).
    \28\ NSCC would set the initial threshold at 0.4, because 
approximately 40 percent of the one-day volatility charge currently 
addresses market impact costs. NSCC would review this threshold from 
time to time and any changes that NSCC deems appropriate would be 
subject to NSCC's model risk management governance procedures set 
forth in the Model Risk Management Framework. See id.
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    When applicable, an MLA Charge for each asset group or subgroup 
would be calculated as a proportion of the product of (1) the amount by 
which the ratio of the calculated market impact cost to the applicable 
one-day volatility charge exceeds the threshold, and (2) the one-day 
volatility charge allocated to that asset group or subgroup.
    For each portfolio, NSCC would total the MLA Charges for positions 
in each of the subgroups of the equities asset group to determine an 
MLA Charge for the positions in the equities asset group. NSCC would 
then total the MLA Charge for positions in the equities asset group 
together with each of the MLA Charges for positions in the other asset 
groups to determine a total MLA Charge for a member.
    In certain circumstances, NSCC may be able to partially mitigate 
the risks that the MLA Charge is designed to address by extending the 
time period for liquidating a defaulted member's portfolio beyond the 
three day period. Accordingly, the Advance Notice also describes a 
method that NSCC would use to reduce a member's total MLA Charge when 
the volatility charge component of the member's margin increases beyond 
a specified point. Specifically, NSCC would reduce the member's MLA 
Charge where the market impact cost of a particular portfolio, 
calculated as part of determining the MLA Charge, would be large 
relative to the one-day volatility charge for that portfolio (i.e., a 
portion of the three-day assumed margin period of risk). When the ratio 
of calculated market impact cost to the one-day volatility charge is 
lower, NSCC would not adjust the MLA Charge. However, as the ratio gets 
higher, NSCC would reduce the MLA Charge. NSCC designed this reduction 
mechanism to avoid assessing unnecessarily large MLA Charges.\29\
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    \29\ See Notice of Filing, supra note 5 at 55334.
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    On a daily basis, NSCC would calculate the final MLA Charge for 
each member (if applicable), to be included as a component of each 
member's Required Fund Deposit.
    Finally, NSCC would amend the Rules to add the MLA Charge to the 
list of Clearing Fund components that are excluded from the calculation 
of the Excess Capital Premium charge.\30\ The Excess Capital Premium is 
imposed on a member when the member's Required Fund Deposit exceeds its 
excess net capital. NSCC states that including the MLA Charge in the 
calculation of the Excess Capital Premium could lead to more frequent 
and unnecessary Excess Capital Premium charges, which is not the 
intended purpose of the Excess Capital Premium charge and could place 
an unnecessary burden on members.\31\
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    \30\ See Section I.(B)(2) of Procedure XV, supra note 8.
    \31\ See Notice of Filing, supra note 5 at 55335.
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C. Bid-Ask Spread Charge

    The bid-ask spread refers to the difference between the observed 
market price that a buyer is willing to pay for a security and the 
observed market price at which a seller is willing to sell that 
security. NSCC faces the risk of potential bid-ask spread transaction 
costs when liquidating the securities in a defaulted member's 
portfolio. However, NSCC's current margin methodology does not account 
for this risk of potential bid-ask spread transaction costs to NSCC in 
connection with liquidating a defaulted member's portfolio. Therefore, 
NSCC designed the Bid-Ask Spread Charge to address this deficiency in 
its current margin methodologies.
    The Bid-Ask Spread Charge would be haircut-based and tailored to 
different groups of assets that share similar bid-ask spread 
characteristics. NSCC would assign each asset group a specified bid-ask 
spread haircut rate (measured in basis points (``bps'')) that would be 
applied to the gross market value of the portfolio's positions in that 
particular asset group. NSCC would calculate the product of the gross 
market value of the portfolio's positions in a particular asset group 
and the applicable basis point charge to obtain the bid-ask spread risk 
charge for these positions. NSCC would total the applicable bid-ask 
spread risk charges for each asset class in a member's portfolio to 
calculate the member's final Bid-Ask Spread Charge.
    NSCC determined the proposed initial haircut rates on an analysis 
of bid-ask spread transaction costs using (1) the results of NSCC's 
annual member default simulation and (2) market data sourced from a 
third-party data vendor. NSCC's proposed initial haircut rates are 
listed in the table below:

------------------------------------------------------------------------
                                                                Haircut
                         Asset group                             (bps)
------------------------------------------------------------------------
Large and medium capitalization equities.....................        5.0
Small capitalization equities................................       12.3
Micro-capitalization equities................................       23.1
ETPs.........................................................        1.5
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    NSCC proposes to review the haircut rates annually.\32\ Based on 
analyses of recent years' simulation exercises, NSCC does not 
anticipate that these haircut rates would change significantly year 
over year.\33\ NSCC may also adjust the haircut rates following its 
annual model validation review, to the extent the results of that 
review indicate the current haircut rates are not adequate to address 
the risk presented by transaction costs from a bid-ask spread.\34\
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    \32\ See id.
    \33\ See id.
    \34\ All proposed changes to the haircuts would be subject to 
NSCC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See supra note 26.
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II. 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-NSCC-2020-804 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NSCC-2020-804. 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

[[Page 62345]]

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 such filings will also be available 
for inspection and copying at the principal office of NSCC and NSCC's 
website at https://www.dtcc.com/legal.
    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-NSCC-2020-804 and should be 
submitted on or before October 19, 2020.

III. Discussion and Commission Findings

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, the stated purpose of the Clearing 
Supervision Act is instructive: To mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for SIFMUs and 
strengthening the liquidity of SIFMUs.\35\
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    \35\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe regulations containing risk management 
standards for the payment, clearing, and settlement activities of 
designated clearing entities engaged in designated activities for which 
the Commission is the supervisory agency.\36\ Section 805(b) of the 
Clearing Supervision Act provides the following objectives and 
principles for the Commission's risk management standards prescribed 
under Section 805(a):\37\
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    \36\ 12 U.S.C. 5464(a)(2).
    \37\ 12 U.S.C. 5464(b).
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     to promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among others areas.\38\
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    \38\ 12 U.S.C. 5464(c).
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    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange Act (the ``Clearing Agency Rules'').\39\ The Clearing Agency 
Rules require, among other things, each covered clearing agency to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for its operations and risk management practices on an 
ongoing basis.\40\ As such, it is appropriate for the Commission to 
review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act. As 
discussed below, the Commission believes the proposal in the Advance 
Notice is consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act,\41\ and in the Clearing 
Agency Rules, in particular Rules 17Ad-22(e)(4) and (e)(6).\42\
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    \39\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11). 
See also Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards''). NSCC is a ``covered clearing agency'' as 
defined in Rule 17Ad-22(a)(5).
    \40\ 17 CFR 240.17Ad-22.
    \41\ 12 U.S.C. 5464(b).
    \42\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the Advance Notice is consistent with 
the stated objectives and principles of Section 805(b) of the Clearing 
Supervision Act. \43\
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    \43\ One of the issues raised by the OTC Letter is directed at 
the Proposed Rule Change, will be addressed in that context. 
Specifically, OTC Markets Group argues that the proposal imposes an 
undue burden on competition, stating that the proposal would impose 
additional margin requirements for firms processing transactions in 
smaller and less liquid securities and disproportionately impact 
member firms with lower operating margins or higher costs of 
capital. That issue is relevant to the Commission's evaluation of 
the related Proposed Rule Change, which is conducted under the 
Exchange Act, but not to the Commission's evaluation of the Advance 
Notice, which, as discussed below in Section III.B, is conducted 
under the Clearing Supervision Act and generally considers whether 
the proposal will mitigate systemic risk and promote financial 
stability. Accordingly, concerns regarding burden on competition are 
not discussed herein but will be addressed in the Commission's 
review of the related Proposed Rule Change, as applicable, under the 
Exchange Act.
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    The Commission believes that adopting NSCC's proposed MLA Charge 
and Bid-Ask Spread Charge would be consistent with the promotion of 
robust risk management at NSCC. As described above in Section I.A and 
B, NSCC's current margin methodology does not account for the potential 
increase in market impact costs that NSCC could incur when liquidating 
a defaulted member's portfolio where the portfolio contains a 
concentration of large positions in a particular security or group of 
securities sharing a similar risk profile. Additionally, as described 
above in Section I.C, NSCC's margin methodology does not account for 
the risk of potential bid-ask spread transaction costs when liquidating 
the securities in a defaulted member's portfolio. NSCC proposes to 
address these respective risks by adding the MLA Charge and Bid-Ask 
Spread Charge to its margin methodology.\44\
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    \44\ The Commission notes that the other clearing agencies it 
regulates have charges to account for these types of risks in their 
margin methodologies, and that addressing these types of risks has 
received a great deal of industry focus in recent years.
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    Specifically, the MLA Charge should better enable NSCC to manage 
the risk of incurring costs associated with the decreased marketability 
of a defaulted member's portfolio where the portfolio contains a large 
position in securities sharing similar risk profiles, resulting in 
potentially higher liquidation costs. To avoid excessive MLA Charges, 
NSCC has identified circumstances that would warrant reducing a 
member's MLA Charge when NSCC could otherwise partially mitigate the 
relevant risks by extending the time period for liquidating a defaulted 
member's portfolio beyond the three day period. The Commission views 
this targeted reduction in the MLA Charge as a feature of the proposal 
that demonstrates a robust approach towards managing the relevant risks 
through appropriate (i.e., not simply ``larger'') margin requirements. 
Additionally, since NSCC's current margin methodology does not account 
for bid-ask spread transaction costs when liquidating a defaulted 
member's portfolio, the Bid-Ask Spread Charge should enable NSCC to 
manage such risks. Accordingly, the Commission believes that adopting 
the proposed MLA Charge and Bid-Ask Spread Charge would allow for 
measurement and targeted mitigation of risks and costs not captured 
elsewhere in NSCC's current margin methodology, and would therefore 
provide for more comprehensive management of risks in a member default 
scenario, consistent with the promotion of robust risk management.
    The commenter argues that NSCC's Advance Notice fails to provide 
sufficient information to evaluate the necessity and impact of the 
proposal. Specifically, the commenter argues that the proposal provides 
no explanation as to why the current Clearing Fund

[[Page 62346]]

formula is inadequate or how the proposed methodology would limit 
NSCC's exposure in the event of a member default. The Commission 
disagrees. As described in the Notice and noted above, NSCC's current 
margin methodology does not account for the risk of a potential 
increase in market impact costs that NSCC could incur when liquidating 
a defaulted member's portfolio that contains a concentration of large 
positions, as compared to the overall market and account for this risk 
of potential bid-ask spread transaction costs in connection with 
liquidating a defaulted member's portfolio. As a result, NSCC's Advance 
Notice is designed to address these specific risks, that are currently 
unaddressed, and thus limit NSCC's exposure.
    Furthermore, when considering the issues raised in the Advance 
Notice, the Commission thoroughly considered (1) NSCC's Advance Notice, 
including the supporting exhibits that provided, among other things, 
confidential impact analyses regarding the proposals in NSCC's Advance 
Notice; \45\ (2) the OTC Letter; and (3) the Commission's own 
understanding of NSCC's margin methodology, with which the Commission 
has experience from its general supervision of NSCC. Based on its 
review of these materials, the Commission believes that, as set forth 
in the Notice of Filing, NSCC has done exactly what the commenter 
seeks, in that the proposal explains why the current methodology is 
inadequate (i.e., it does not address these particular risks), and how 
the proposed methodology would address this issue (i.e., by including 
add-on charges calibrated to address these particular risks).\46\ Thus, 
notwithstanding the comments raised in the OTC Letter, the Commission 
believes that adopting the proposed MLA Charge and Bid-Ask Spread 
Charge would be consistent with the promotion of robust risk management 
at NSCC.
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    \45\ Specifically, the confidential Exhibit 3 submitted by NSCC 
includes, among other things, (1) impact studies for various time 
periods detailing the average and maximum MLA and Bid-Ask Charges 
for each member, by both percentage and amount, (2) a detailed 
methodology describing the calculation of the MLA and Bid-Ask 
Charges, and (3) information regarding how NSCC determined the 
appropriate methodology.
    \46\ Moreover, to the extent that the commenter argues that 
additional detail or information is necessary to enable the public 
to evaluate the proposal, the Commission disagrees. With respect to 
the MLA Charge, the Notice of Filing explains that concentrated 
positions would lead to application of the MLA Charge and provides 
sufficient information as to the components that would be used to 
make the determination of concentration to allow a Member to 
consider whether the MLA Charge would apply. With respect to the 
Bid-Ask Spread Charge, the Notice of Filing identifies the 
particular haircuts that would apply to all securities.
---------------------------------------------------------------------------

    Further, the Commission believes that adopting NSCC's proposed MLA 
Charge and Bid-Ask Spread Charge would be consistent with promoting 
safety and soundness at NSCC. NSCC designed the MLA Charge and Bid-Ask 
Spread Charge to ensure that NSCC collects margin amounts sufficient to 
manage NSCC's risk of incurring costs associated with liquidating 
defaulted member portfolios. The proposed MLA Charge and Bid-Ask Spread 
Charge would generally provide NSCC with additional resources to manage 
potential losses arising out of a member default. Such an increase in 
available financial resources would decrease the likelihood that losses 
arising out of a member default would exceed NSCC's resources and 
threaten the safety and soundness of NSCC's ongoing operations. 
Accordingly, the Commission believes that adding the proposed MLA 
Charge and Bid-Ask Spread Charge to NSCC's margin methodology would be 
consistent with promoting safety and soundness at NSCC.
    Finally, the Commission believes that adopting NSCC's proposed MLA 
Charge and Bid-Ask Spread Charge would be consistent with reducing 
systemic risks and supporting the stability of the broader financial 
system. As discussed above, in a member default scenario, NSCC would 
access its Clearing Fund should the defaulted member's own Required 
Fund Deposit be insufficient to satisfy losses to NSCC caused by the 
liquidation of that member's portfolio. NSCC proposes to add the MLA 
Charge and Bid-Ask Spread Charge to its margin methodology to better 
manage the potential costs of liquidating a defaulted member's 
portfolio. NSCC proposes to collect additional margin to cover such 
costs. This, in turn, could reduce the possibility that NSCC would need 
to mutualize among the non-defaulting members a loss arising out of the 
close-out process. Reducing the potential for loss mutualization could, 
in turn, reduce the potential knock-on effects to non-defaulting 
members, their customers, and the broader market arising out of a 
member default. Further, the Commission notes that, to the extent that 
the MLA Charge results in any reduction in members' large positions in 
securities with similar risk profiles, it could reduce the potential 
risk of adverse market impacts that can arise from liquidating those 
large positions. However, the Commission also notes that the proposal 
to reduce the MLA Charge when NSCC could otherwise partially mitigate 
the relevant risks would help ensure that NSCC would not impose the MLA 
Charge without an appropriate risk management basis. Accordingly, the 
Commission believes that NSCC's adoption of the proposed MLA Charge and 
Bid-Ask Spread Charge would be consistent with the reduction of 
systemic risk and supporting the stability of the broader financial 
system.
    For the reasons stated above, the Commission believes the changes 
proposed in the Advance Notice are consistent with Section 805(b) of 
the Clearing Supervision Act.\47\
---------------------------------------------------------------------------

    \47\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(4)(i)

    Rule 17Ad-22(e)(4)(i) requires that NSCC 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, including by maintaining sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence.\48\
---------------------------------------------------------------------------

    \48\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    As described above in Section I.A and B, NSCC's current margin 
methodology does not account for the risk of a potential increase in 
market impact costs that NSCC could incur when liquidating a defaulted 
member's portfolio where the portfolio contains a large position in 
securities sharing similar risk profiles. Additionally, as described 
above, NSCC's current margin methodology does not account for the risk 
of potential bid-ask spread transaction costs when liquidating the 
securities in a defaulted member's portfolio. NSCC proposes to address 
such risks by adding the MLA Charge and Bid-Ask Spread Charge to its 
margin methodology. Adding these margin charges to NSCC's margin 
methodology should better enable NSCC to collect margin amounts 
commensurate with the risk attributes of a broader range of its 
members' portfolios than NSCC's current margin methodology. 
Specifically, the MLA Charge should better enable NSCC to manage the 
risk of increased costs to NSCC associated with the decreased 
marketability of a defaulted member's portfolio where the portfolio 
contains a large position in securities sharing similar risk profiles. 
Additionally, since NSCC's current margin methodology does not account 
for bid-ask spread transaction costs associated with liquidating a 
defaulted member's portfolio, the Bid-Ask Spread Charge

[[Page 62347]]

should enable NSCC to manage such risks and costs.
    The commenter suggests that the proposals in NSCC's Advance Notice 
are duplicative of a separate NSCC proposal regarding Illiquid 
Securities that is currently pending before the Commission.\49\ The 
commenter argues that since both proposals include provisions that 
would apply to Illiquid Securities,\50\ thereby potentially affecting 
their margin levels, both proposals appear to address the same 
concerns. Therefore, the commenter suggests that instead of approving 
NSCC's Advance Notice, the Commission should consolidate NSCC's Advance 
Notice together with the Illiquid Securities Proposal and extend the 
public comment period before the Commission makes a substantive 
determination.
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    \49\ Securities Exchange Act Release No. 88615 (April 9, 2020), 
85 FR 21037 (April 15, 2020) (SR-NSCC-2020-802) (``Illiquid 
Securities Proposal'').
    \50\ Under NSCC's Rules, Illiquid Securities may include any 
security that meets the criteria set forth in the term's definition 
and would not necessarily be limited to securities with small or 
micro market capitalizations.
---------------------------------------------------------------------------

    The Commission disagrees with the comments raised in the OTC 
Letter. NSCC's Advance Notice and the Illiquid Securities Proposal deal 
with separate and distinguishable aspects of NSCC's margin methodology, 
even if there is a group of Illiquid Securities to which both proposals 
would apply. The Illiquid Securities Proposal is designed to amend the 
method by which NSCC determines the appropriate volatility component of 
margin for a particular thinly traded security, i.e., calculate 
appropriate margin to cover potential losses on a portfolio using 
historical, mid-point securities prices. The Advance Notice is designed 
to address two specific risks that are not captured directly by 
historical mid-point security price movements and that are directed at 
additional costs that may arise during the liquidation of a Member's 
portfolio in the event of a default: (1) The potential added costs of 
liquidating large concentrated positions in a limited period of time 
and (2) bid-ask spread transactions costs.
    Specifically, the Illiquid Securities Proposal seeks to, among 
other things, more accurately identify securities that exhibit illiquid 
characteristics for margin purposes and to establish a separate 
haircut-based method for determining the margin for Illiquid 
Securities. NSCC's methodology for calculating the volatility component 
of a member's margin depends on the type of securities in the member's 
portfolio. Generally, for most securities (e.g., equity securities), 
NSCC calculates the volatility component using, among other things, a 
parametric Value at Risk (``VaR'') model, and the volatility component 
typically constitutes the largest portion of a member's required 
margin. However, securities with illiquid characteristics generally 
incur a wider degree of price variability and are less amenable to 
statistical analysis, and, as such, may merit a more conservative 
margining approach through a haircut-based method. The proposed 
haircut-based method is more conservative because it does not allow for 
inter-asset risk offsetting in the way that the VaR model does.
    Accordingly, for certain securities that are less amenable to the 
statistical analysis provided in the VaR model, including Illiquid 
Securities, NSCC currently calculates a haircut-based volatility 
component by multiplying the absolute value of a member's positions in 
such securities by a certain percentage. NSCC's pending Illiquid 
Securities Proposal would, among other things, establish a separate 
haircut-based method for determining the volatility component of the 
margin for Illiquid Securities. Thus, the Illiquid Securities Proposal 
would alter the way in which NSCC determines the appropriate margin for 
Illiquid Securities.
    In contrast, NSCC's Advance Notice is not designed to identify 
which securities exhibit illiquid characteristics, and it would not 
alter the methodology by which NSCC determines the volatility component 
of the margin for any particular securities, including Illiquid 
Securities. Instead, with respect to the MLA Charge, NSCC's Advance 
Notice relates to a new margin charge add-on that, if triggered, 
applies to all securities cleared at NSCC (i.e., not solely to Illiquid 
Securities), and the proposed add-on is distinct from the underlying 
margin otherwise collected for all securities (including Illiquid 
Securities). Rather than addressing the volatility component of margin 
and the potential losses on a portfolio, as does the Illiquid 
Securities Proposal, the proposal described in the Advance Notice is 
designed to address the discrete risks of a default liquidation 
scenario. These discrete risks include those associated with (1) 
concentrated large positions in any type of security or group of 
securities sharing a similar risk profile, and (2) bid-ask spread 
transaction costs that are currently unaccounted for in NSCC's margin 
methodology. Moreover, the MLA Charge would not automatically be 
applied based on the security or type of security that is held; 
instead, it would only apply to concentrated positions that could be 
difficult to liquidate in a limited time in the event of a default. 
Because NSCC's Advance Notice and the Illiquid Securities Proposal 
address wholly separate and distinct aspects of NSCC's margin 
methodology, the Commission disagrees with the OTC Markets Group that 
the two proposals should be consolidated or otherwise disposed of 
together.
    The Commission believes that adding the MLA Charge and Bid-Ask 
Spread Charge to NSCC's margin methodology should enable NSCC to more 
effectively identify, measure, monitor, and manage its credit exposures 
in connection with liquidating a defaulted member's portfolio that may 
give rise to (1) decreased marketability due to large positions of 
securities sharing similar risk profiles, and (2) bid-ask spread 
transaction costs. Accordingly, the Commission believes that adding the 
MLA Charge and Bid-Ask Spread Charge to NSCC's margin methodology would 
be consistent with Rule 17Ad-22(e)(4)(i) because these new margin 
charges should better enable NSCC to maintain sufficient financial 
resources to cover NSCC's credit exposure to its members fully with a 
high degree of confidence.\51\
---------------------------------------------------------------------------

    \51\ Id.
---------------------------------------------------------------------------

C. Consistency With Rules 17Ad-22(e)(6)(i) and (v)

    Rule 17Ad-22(e)(6)(i) requires that NSCC 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.\52\ Rule 
17Ad-22(e)(6)(v) requires that NSCC 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.\53\
---------------------------------------------------------------------------

    \52\ 17 CFR 240.17Ad-22(e)(6)(i).
    \53\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

    As described above in Section I.A and B, NSCC's current margin 
methodology does not account for the potential increase in market 
impact costs when liquidating a defaulted member's portfolio where the 
portfolio contains a large position in securities sharing

[[Page 62348]]

similar risk profiles. NSCC proposes to address this risk by adding the 
MLA Charge to its margin methodologies. To avoid excessive MLA Charges 
and ensure margin requirements are commensurate with the relevant 
risks, NSCC also contemplates reducing a member's MLA Charge when NSCC 
could otherwise partially mitigate the relevant risks by extending the 
time period for liquidating a defaulted member's portfolio beyond the 
three day period.
    Additionally, as described above in Section I.A and B, NSCC's 
current margin methodology does not account for the risk of incurring 
bid-ask spread transaction costs when liquidating the securities in a 
defaulted member's portfolio. NSCC proposes to address this risk by 
adding the Bid-Ask Spread Charge to its margin methodology. Adding the 
MLA Charge and Bid-Ask Spread Charge to NSCC's margin methodology 
should better enable NSCC to collect margin amounts commensurate with 
the risk attributes of its members' portfolios than NSCC's current 
margin methodology. Specifically, the MLA Charge should better enable 
NSCC to manage the risk of increased costs to NSCC associated with the 
decreased marketability of a defaulted member's portfolio where the 
portfolio contains a large position in securities sharing similar risk 
profiles. Moreover, the proposal to reduce the MLA Charge when NSCC 
could otherwise partially mitigate the relevant risks demonstrates how 
the proposal provides an appropriate method for measuring credit 
exposure, in that it seeks to take into account the particular 
circumstances related to a particular portfolio when determining the 
MLA Charge. Additionally, since NSCC's current margin methodology does 
not account for bid-ask spread transaction costs associated with 
liquidating a defaulted member's portfolio, the Bid-Ask Spread Charge 
should enable NSCC to manage such risks.
    Accordingly, the Commission believes that adding the MLA Charge and 
Bid-Ask Spread Charge to NSCC's margin methodology would be consistent 
with Rules 17Ad-22(e)(6)(i) and (v) because these new margin charges 
should better enable NSCC to establish a risk-based margin system that 
(1) considers and produces relevant margin levels commensurate with the 
risks associated with liquidating member portfolios in a default 
scenario, including decreased marketability of a portfolio's securities 
due to large positions in securities sharing similar risk profiles and 
bid-ask transaction costs, and (2) uses an appropriate method for 
measuring credit exposure that accounts for such risk factors and 
portfolio effects.\54\
---------------------------------------------------------------------------

    \54\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission does not object to 
Advance Notice (SR-NSCC-2020-804) and that NSCC is authorized to 
implement the proposed change as of the date of this notice or the date 
of an order by the Commission approving Proposed Rule Change SR-NSCC-
2020-016, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-21785 Filed 10-1-20; 8:45 am]
BILLING CODE 8011-01-P