[Federal Register Volume 85, Number 221 (Monday, November 16, 2020)]
[Notices]
[Pages 73099-73109]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-25202]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90367; File No. SR-NSCC-2020-802]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection to Advance Notice To Enhance 
National Securities Clearing Corporation's Haircut-Based Volatility 
Charge Applicable to Illiquid Securities and UITs and Make Certain 
Other Changes to Procedure XV

November 6, 2020.

I. Introduction

    On March 16, 2020, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2020-802 (``Advance Notice'') 
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 enhance the calculation of certain 
components of the Clearing Fund formula.\4\ The Advance Notice was 
published for comment in the Federal Register on April 15, 2020.\5\ The 
Commission received comments on the proposal.\6\ On May 15, 2020, the 
Commission requested further information for consideration of the 
Advance Notices, pursuant to Section 806(e)(1)(D) of the Clearing 
Supervision Act (``RFI''),\7\ which tolled the Commission's period of 
review of the Advance Notices until 60 days from the date the 
information required by the Commission was received by the 
Commission.\8\ On September 9, 2020, the Commission received responses 
to the RFI from NSCC.\9\ This publication serves as 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\ NSCC also filed related proposed rule change with the 
Commission pursuant to Section 19(b)(1) of the Act and Rule 19b-4 
thereunder, seeking approval of proposed changes to their rules 
necessary to implement the Advance Notices (``Proposed Rule 
Change''). 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, respectively. 
The Proposed Rule Change was published in the Federal Register on 
March 21, 2020. Securities Exchange Act Release No. 88474 (March 25, 
2020), 85 FR 17910 (March 31, 2020) (SR-NSCC-2020-003). On May 15, 
2020, the Commission designated a longer period within which to 
approve, disapprove, or institute proceedings to determine whether 
to approve or disapprove the Proposed Rule Change. Securities 
Exchange Act Release No. 88885 (May 15, 2020), 85 FR 31007 (May 21, 
2020) (SR-NSCC-2020-003). On June 24, 2020, the Commission issued an 
order instituting proceedings to determine whether to approve or 
disapprove the Proposed Rule Changes. Securities Exchange Act 
Release No. 89145 (June 24, 2020), 85 FR 39244 (June 30, 2020) (SR-
NSCC-2020-003). On September 22, 2020, the Commission designated a 
longer period for Commission action on the proceedings to determine 
whether to approve or disapprove the Proposed Rule Change. 
Securities Exchange Act Release No. 89949 (September 22, 2020), 85 
FR 60854 (September 28, 2020) (SR-NSCC-2020-003).
    \5\ Securities Exchange Act Release No. 88615 (April 9, 2020), 
85 FR 21037 (April 15, 2020) (SR-NSCC-2020-802) (``Notice of 
Filing'').
    \6\ Comments are available at https://www.sec.gov/comments/sr-nscc-2020-003/srnscc2020003-7108527-215929.pdf. All but one of the 
comments were submitted with respect to the Proposed Rule Change. 
Supra note 4. Because the proposals contained in the Advance Notice 
and the Proposed Rule Change are the same, all public comments 
received on the proposal were considered regardless of whether the 
comments were submitted with respect to the Advance Notice or the 
Proposed Rule Change.
    \7\ 12 U.S.C. 5465(e)(1)(D).
    \8\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); see Memorandum 
from the Office of Clearance and Settlement Supervision, Division of 
Trading and Markets, titled ``Commission's Request for Additional 
Information,'' available at https://www.sec.gov/rules/sro/nscc-an/2020/34-88615-request-for-info.pdf.
    \9\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); see Memorandum 
from the Office of Clearance and Settlement Supervision, Division of 
Trading and Markets, titled ``Response to the Commission's Request 
for Additional Information,'' available at https://www.sec.gov/rules/sro.shtml.
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II. The Advance Notice

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 unit investment trust transactions in 
the U.S. markets. A key tool that NSCC uses to manage its credit 
exposure to its Members is collecting an appropriate Required Fund 
Deposit (i.e., margin) from each Member.\10\ A Member's Required Fund 
Deposit is designed to mitigate potential losses to NSCC associated 
with liquidation of the Member's portfolio in the event of a Member 
default.\11\ 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, be insufficient to satisfy NSCC's losses.\12\
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    \10\ 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. See Rule 4 (Clearing 
Fund) and Procedure XV (Clearing Fund Formula and Other Matters) of 
the Rules.
    \11\ Under NSCC's Rules, a default would generally be referred 
to as a ``cease to act'' and could encompass a number of 
circumstances, such as a member's failure to make a Required Fund 
Deposit in a timely fashion. See Rule 46 (Restrictions on Access to 
Services), supra note 10.
    \12\ See Rule 46 (Restrictions on Access to Services), supra 
note 10.
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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, as identified within NSCC's Rules.\13\ Generally, 
the largest component of Members' Required Fund Deposits is the 
volatility component. The volatility component is designed to reflect 
the amount of money that could be lost on a portfolio over a given 
period within a 99% confidence level. This component represents the 
amount assumed necessary to absorb losses while liquidating the 
portfolio.
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    \13\ See Procedure XV, supra note 10.
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    NSCC's methodology for calculating the volatility component of a 
Member's Required Fund Deposit depends on the type of security and 
whether the security has sufficient pricing or trading history for NSCC 
to perform statistical analysis. Generally, for most securities (e.g., 
equity securities), NSCC calculates the volatility component using, 
among other things, a parametric Value at Risk (``VaR'') model, which 
results in a ``VaR Charge.'' \14\ However, the VaR model generally 
relies on predictability, and this model may be less reliable for 
measuring market risk of securities that exhibit illiquid 
characteristics. More specifically, the VaR model relies on assumptions 
that are based on historical observations of security prices. 
Securities that exhibit illiquid characteristics, which generally have 
low trading volumes or are not traded frequently may not present 
sufficient instances of price observations to allow

[[Page 73100]]

the VaR model to provide a precise measure of market risk for such 
securities. Accordingly, for securities that do not have sufficient 
pricing or trading history to perform statistical analysis, NSCC 
applies a haircut to calculate the volatility component, in lieu of the 
VaR-based calculation.
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    \14\ Specifically, NSCC calculates the VaR Charge as the 
greatest of (1) the larger of two separate calculations that utilize 
the 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 can 
be present in 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 component 
calculations. See Sections I.(A)(1)(a)(i) and I.(A)(2)(a)(i) of 
Procedure XV, supra note 10.
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B. Current Practice for Determining Volatility Component for Illiquid 
Securities and UITs

    Two types of securities for which NSCC uses a haircut to calculate 
the volatility component are securities that NSCC deems to be 
``Illiquid Securities'' and UITs. NSCC's Rules currently define an 
Illiquid Security as a security that is (i) not traded on or subject to 
the rules of a national securities exchange registered under the 
Exchange Act, or (ii) an OTC Bulletin Board \15\ or OTC Link issue.\16\ 
Based on its interpretation of that definition, NSCC considers 
securities that are not listed on the national securities exchanges, 
i.e., those exchanges which are covered by certain third party data/
pricing vendors, to be Illiquid Securities.\17\ UITs are redeemable 
securities, or units, issued by investment companies that offer fixed 
security portfolios for a defined period of time.
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    \15\ The OTC Bulletin Board is an inter-dealer quotation system 
that is used by subscribing members of the Financial Industry 
Regulatory Authority (``FINRA'') to reflect market making interest 
in eligible securities (as defined in FINRA's Rules). See http://www.finra.org/industry/otcbb/otc-bulletin-board-otcbb.
    \16\ OTC Link is an electronic inter-dealer quotation system 
that displays quotes from broker-dealers for many over-the-counter 
securities. See https://www.otcmarkets.com.
    \17\ NSCC represents that it utilizes multiple third-party 
vendors to price its eligible securities. NSCC believes that 
national securities exchanges covered by these third party vendors 
tend to list securities that exhibit liquid characteristics such as 
having more available public information, larger trading volumes and 
higher capitalization. See Notice of Filing, supra note 5, 85 FR at 
21040. The exchanges that have established listing services that the 
vendors cover for this purpose are: New York Stock Exchange LLC, 
NYSE American LLC, NYSE Arca, Inc., The Nasdaq Stock Market and Cboe 
BZX Exchange, Inc. NSCC represents that Members' Clearing Fund 
Summary reports, available through the DTCC Risk Portal, identify 
securities within their portfolio by the ticker symbol and indicate 
whether those securities are considered Illiquid Securities for 
purposes of the calculation of the Illiquid Charge. See id.
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    Under NSCC's current rules, Illiquid Securities and UITs are 
subject to haircut-based charges to calculate the volatility component 
of a Member's Required Fund Deposit based upon two distinct but related 
rationales. Specifically, Illiquid Securities are considered 
``securities that are less amenable to statistical analysis, such as 
OTC Bulletin Board or Pink Sheet issues or issues trading below a 
designated dollar threshold (e.g., five dollars),'' and UITs are 
considered ``securities that are amenable to generally accepted 
statistical analysis only in a complex manner.'' \18\ Based on these 
determinations, NSCC considers Illiquid Securities and UITs as 
categories of securities that tend to exhibit illiquid characteristics, 
such as low trading volumes or infrequent trading.\19\ NSCC therefore 
calculates the volatility component for these two categories of 
securities by multiplying the absolute value of a given position by a 
percentage that is (1) not less than 10% for securities that are less 
amenable to statistical analysis, including Illiquid Securities,\20\ 
and (2) not less than 2% for securities that are amenable to generally 
accepted statistical analysis only in a complex manner, including UITs.
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    \18\ A security that is less amenable to statistical analysis 
generally lacks pricing or trading history upon which to perform 
statistical analysis. A security that is amenable to generally 
accepted statistical analysis only in a complex manner generally may 
have pricing or trading history, but further calculations upon the 
pricing or trading history would be required to perform statistical 
analysis.
    \19\ Because the VaR model generally relies on predictability, 
this model may be less reliable for measuring market risk of 
securities that exhibit illiquid characteristics.
    \20\ NSCC currently calculates the volatility charge for IPOs, 
which have fewer than 31 business days of trading history over the 
past 153 business days, by applying a haircut of 15% and all other 
Illiquid Securities by applying a haircut of 20%. See Notice of 
Filing, supra note 5, 85 FR at 21042.
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    In addition to using the haircut-based volatility charge for 
Illiquid Securities, NSCC currently can also apply an additional charge 
(an ``Illiquid Charge'') for certain positions in Illiquid Securities 
that exceed volume thresholds set forth in the Rules.\21\ NSCC 
represents that the Illiquid Charge was designed to address a situation 
where the defaulting Member may have a relatively large position in an 
Illiquid Security, which would increase the risk that NSCC might face 
losses when liquidating the Member's position in these securities due 
to the securities' lack of marketability and other characteristics.\22\
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    \21\ Specifically, the Illiquid Charge applies to Illiquid 
Positions as defined under NSCC's Rules. The Rules specify the 
applicable thresholds that result in an Illiquid Position 
determination. For example, where a Member's net buy position in an 
Illiquid Security exceeds a threshold no greater than 100 million 
shares, that position may become subject to the Illiquid Charge. 
However, NSCC's rules also provide for certain offsets and credit 
risk considerations that will be considered when determining whether 
a position in an Illiquid Security should be considered an Illiquid 
Position and, thus, subject to the additional Illiquid Charge. See 
Rule 1 and Sections I.(A)(1)(h) and I.(A)(2)(f) of Procedure XV, 
supra note 10.
    \22\ See Notice of Filing, supra note 5, 85 FR at 21038. See 
also Securities Exchange Act Release No. 80597 (May 4, 2017), 82 FR 
21863 (May 10, 2017) (SR-NSCC-2017-001) (order approving proposed 
rule change to describe the illiquid charge that may be imposed on 
Members).
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    NSCC states that it regularly assesses its market and credit risks, 
as such risks are related to its margin methodologies, to evaluate 
whether margin levels are commensurate with the particular risk 
attributes of each relevant product, portfolio, and market.\23\ Based 
on such assessments, NSCC seeks to refine its current approach to risk 
managing Member positions in Illiquid Securities and UITs. More 
specifically, NSCC proposes to (1) revise the definition of Illiquid 
Security, (2) adopt specific exclusions from the VaR model, and 
corresponding haircut-based methods for determining volatility 
components for positions in Illiquid Securities and UITs, (3) eliminate 
the existing Illiquid Charge, and (4) make certain conforming changes 
regarding municipal and corporate bonds and Family-Issued 
Securities.\24\
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    \23\ See Notice of Filing, supra note 5, 85 FR at 21039.
    \24\ The term ``Family-Issued Security'' means a security that 
was issued by a Member or an affiliate of that Member. See Rule 1, 
supra note 10.
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C. Proposed Revision to the Definition of Illiquid Security

    Under the Advance Notice, NSCC proposes a new definition of 
Illiquid Security that would consist of three particular categories of 
securities. As noted further below, application of the new definition 
of Illiquid Security would capture a broader set of securities than the 
current definition.
(i) Securities Not Listed on a Specified Securities Exchange
    The first category of the new definition of Illiquid Securities 
would include any security that is not listed on a ``specified 
securities exchange.'' For purposes of this definition, NSCC's Rules 
would define a ``specified securities exchange'' as a national 
securities exchange that has established listing services and is 
covered by industry pricing and data vendors.\25\ NSCC would make the 
determination of whether a security falls in this category on a daily 
basis. NSCC represents that this new definition would reflect the 
process that it currently employs to determine whether a security is 
not traded on or subject to the rules of a national securities exchange 
registered under the Securities Exchange Act of 1934, as amended.\26\
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    \25\ NSCC has stated that the exchanges that would initially be 
specified securities exchanges are those listed in note 17. See 
supra note 17.
    \26\ See Notice of Filing, supra note 5, 85 FR at 21040. Based 
on historic performances, NSCC believes the national securities 
exchanges that the vendors cover are appropriate for determining if 
a security exhibits characteristics of liquidity because such 
exchanges tend to list securities that exhibit liquid 
characteristics such as having more available public information, 
larger trading volumes, and higher capitalization. See id.

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[[Page 73101]]

(ii) Micro-Capitalization Securities and ADRs Subject to an Illiquidity 
Ratio
    The second category of the new definition of Illiquid Securities 
would apply to certain securities that are listed on a specified 
securities exchange. Specifically, the types of securities that would 
potentially be considered as Illiquid Securities under this second 
category either (i) have a market capitalization that is considered by 
NSCC to be a micro-capitalization (``micro-capitalization'' or ``micro-
cap'') as of the last business day of the prior month, or (ii) are 
American depositary receipts (``ADRs'').\27\ To determine whether these 
securities qualify as Illiquid Securities, NSCC would apply, on a 
monthly basis, an illiquidity ratio test to these two sets of 
securities.
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    \27\ ADRs are securities that represent shares of non-U.S. 
companies that are held by a U.S. depository bank outside of the 
United States. Each ADR represents one or more shares of foreign 
stock or a fraction of a share.
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1. Micro-Capitalization Definition
    Initially, NSCC would define ``micro-capitalization'' as market 
capitalization of less than $300 million. Changes to this threshold 
amount of $300 million would not be subject to any particular period of 
review, but would occur when NSCC determines changes may be 
appropriate.\28\ NSCC believes that using market capitalization to 
consider whether a security is illiquid, in conjunction with the 
illiquidity ratio test, is appropriate because securities with a market 
capitalization below a certain threshold tend to exhibit illiquid 
characteristics such as limited trading volumes and a lack of public 
information.\29\
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    \28\ Any changes to the micro-cap threshold would be subject to 
NSCC's model risk management governance procedures as set forth in 
the Clearing Agency Model Risk Management Framework (``Model Risk 
Management Framework''). See Notice of Filing, supra note 5, 85 FR 
at 21040. See Securities Exchange Act Release No. 81485 (August 25, 
2017), 82 FR 41433 (August 31, 2017) (File No. SR-NSCC-2017-008) 
(describes the adoption of the Model Risk Management Framework of 
NSCC which sets forth the model risk management practices of NSCC) 
and Securities Exchange Act Release No. 84458 (October 19, 2018), 83 
FR 53925 (October 25, 2018) (File No. SR-NSCC-2018-009) (amends the 
Model Risk Management Framework). NSCC would notify Members of any 
changes to the micro-capitalization threshold by Important Notice.
    \29\ See Notice of Filing, supra note 5, 85 FR at 21040.
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2. ADRs
    With respect to ADRs, NSCC believes that subjecting these 
securities to the illiquidity ratio test to determine whether a 
particular ADR is an Illiquid Security is appropriate because the 
market capitalization of an ADR may be difficult to calculate. This is 
because of challenges associated with the day-to-day fluctuation of the 
conversion rate of an ADR into the relevant local security, which in 
turn makes it difficult to price the ADR.\30\ Without knowing the 
market capitalization of the ADR, it is therefore difficult to 
determine whether an ADR represents a non-micro-cap issuer.
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    \30\ See id.
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3. Application of the Illiquidity Ratio and the Illiquidity Ratio Test 
to Micro-Cap Securities and ADRs
    The proposal would define the illiquidity ratio for a security as 
the ratio of the security's daily price return divided by the average 
daily trading amount \31\ of such security over the prior 20 business 
days. In addition, if NSCC is unable to retrieve data to calculate the 
illiquidity ratio for a security on any day, NSCC would use a default 
value for that day for the security (i.e., the security would be 
treated as illiquid for that day).
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    \31\ The daily trading amount equals the daily trading volume 
multiplied by the end-of-day price. See id.
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    In order to classify a micro-cap security or ADR as ``illiquid,'' 
NSCC then takes the illiquidity ratio calculated for these securities 
and applies an illiquidity ratio test. The test functions as follows: 
NSCC determines whether the security's median illiquidity ratio of the 
prior six months exceeds a threshold that is set to the 99th percentile 
of the illiquidity ratio of all non-micro-cap common stock using the 
prior six months of data. Where such a threshold is exceeded, NSCC will 
designate the relevant security as an Illiquid Security. NSCC performs 
this exercise, and thereby determines the set of micro-cap securities 
and ADRs to be considered Illiquid Securities, on a monthly basis.
    The illiquidity ratio test is designed to measure the level of a 
security's price movement relative to its level of trading activity. 
For example, given the same dollar amount of trading activity, a larger 
price movement typically indicates less liquidity. Conversely, for 
price movement of a given magnitude, a smaller dollar amount of trading 
activity would indicate less liquidity.
    Securities that are exchange-traded products (``ETPs'') with market 
capitalization of less than $300 million could be classified as 
illiquid upon application of the illiquidity test. However, ETPs and 
ADRs would be excluded when calculating the illiquidity ratio 
threshold. ETPs are excluded because the underlying common stocks that 
make up the ETPs are already included in the calculation. ADRs are 
excluded because it is difficult to determine whether an ADR represents 
a non-micro-cap issuer. An ADR's market capitalization may be difficult 
to calculate due to the fact that, as noted above, each ADR often 
converts to a different number of shares of a local security. The 
threshold used in the illiquidity ratio test will be determined by NSCC 
on a monthly basis using the prior six months of data.
(iii) Securities With Limited Trading History
    The third category of the new definition of Illiquid Security would 
include securities that are listed on a specified securities exchange 
and, as determined by NSCC on a monthly basis, have fewer than 31 
business days of trading history over the past 153 business days on 
such exchange. NSCC represents that it has historically used such time 
period to identify initial public offerings (``IPOs'') which tend to 
exhibit illiquid characteristics due to their limited trading history, 
thereby making it an appropriate time period to use for the purposes of 
determining a security's liquidity, and IPOs would likely constitute 
most of the securities that would fall into this category.\32\
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    \32\ See Notice of Filing, supra note 5, 85 FR at 21042.
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D. Proposed Haircut-Based Volatility Charge Specifically Applicable to 
Illiquid Securities and UITs

(i) Haircut-Based Volatility Charge Applicable to Illiquid Securities
    As proposed in the Advance Notice, NSCC would expressly exclude 
Illiquid Securities when calculating the volatility component of a 
Required Fund Deposit using the VaR model and instead would apply a 
haircut-based volatility charge specifically to Illiquid Securities. To 
determine the appropriate volatility charge, NSCC would group Illiquid 
Securities by price level.\33\ NSCC generally would calculate one 
haircut-based volatility charge for short and long positions together. 
However, with respect to an Illiquid Security that is a sub-penny 
security, NSCC would calculate the haircut-based volatility

[[Page 73102]]

charge for short positions and long positions separately.\34\
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    \33\ The price level groupings would be subject to NSCC's model 
risk management governance procedures set forth in the Model Risk 
Management Framework. See Notice of Filing, supra note 5, 85 FR at 
21043; see also Model Risk Management Framework, supra note 28.
    \34\ NSCC states that the different treatment for Illiquid 
Securities that are sub-penny securities is appropriate because 
short positions in sub-penny securities have unlimited upside market 
price risk, as the price of a security may increase and could 
potentially subject NSCC to losses under its trade guaranty. NSCC 
further states the proposal would allow NSCC to calculate a haircut-
based volatility charge that accounts for this risk of such price 
movements. Further, NSCC states that sub-penny securities are 
typically issued by companies with low market capitalization, and 
may be susceptible to market manipulation, enforcement actions, or 
private litigation. See Notice of Filing, supra note 5, at 85 FR at 
21043; Letter from Timothy J. Cuddihy, Managing Director, DTCC 
Financial Risk Management (September 3, 2020) (``NSCC Letter'') at 
10.
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    The haircut percentage applicable to each group of Illiquid 
Securities would be determined at least annually. The applicable 
percentage, and the decision of how often the applicable percentage is 
determined, would be subject to NSCC's model risk management governance 
procedures set forth in the Model Risk Management Framework.\35\ NSCC 
states that a number of important considerations consistent with the 
model risk management practices adopted by NSCC could prompt more 
frequent haircut review, such as material deterioration of a Member's 
backtesting performance, market events, market structure changes, and 
model validation findings.\36\
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    \35\ See Notice of Filing, supra note 5, 85 FR at 21042; see 
also Model Risk Management Framework, supra note 28.
    \36\ See id.
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    The haircut percentage would be the highest of the following 
percentages: (1) 10%, (2) a percent benchmarked to be sufficient to 
cover the 99.5th percentile of the historical 3-day returns of each 
group of Illiquid Securities in each Member's portfolio, and (3) a 
percent benchmarked to be sufficient to cover the 99th percentile of 
the historical 3-day returns of each group of Illiquid Securities in 
each Member's portfolio after incorporating a fixed transaction cost 
equal to one-half of the estimated bid-ask spread.\37\ The look-back 
period for purposes of calibrating the applicable percentage would be 
no less than five years and would initially be five years to be 
consistent with the historical data set used in model development. The 
look-back period may be adjusted by NSCC as necessary consistent with 
the model risk management practices adopted by NSCC to respond to, for 
example, market events that impact liquidity in the market and Member 
backtesting deficiencies.\38\
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    \37\ If NSCC needs to liquidate a defaulting Member's portfolio, 
it may incur a transaction cost which represents bid-ask spreads. 
Bid-ask spreads account for the difference between the observed 
market price that a buyer is willing to pay for a security and the 
observed market price for which a seller is willing to sell that 
security.
    \38\ Adjustments to the look-back period would be subject to 
NSCC's model risk governance procedures set forth in the Model Risk 
Management Framework. See Notice of Filing, supra note 5, 85 FR at 
21042-43; see also Model Risk Management Framework, supra note 28.
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(ii) Haircut-Based Volatility Charge Applicable to UITs
    Similar to its proposed approach to risk managing Illiquid 
Securities, NSCC would exclude UITs from calculating the volatility 
component of the Required Fund Deposit using the VaR model, and instead 
would assign a percentage to be used in the calculation of a haircut-
based volatility charge. UITs are less suited to application of the VaR 
model because they generally have a limited trading history, which does 
not provide the type of pricing data that allows for application of the 
VaR model. NSCC would review the percentage used in this calculation at 
least annually.
    The haircut percentage applicable to UITs would be the highest of 
(1) 2%, and (2) the 99.5th percentile of the historical 3-day returns 
for the group of UITs within each Member's portfolio using a look-back 
period of no less than 5 years. The applicable percentage, and the 
decision of how often the applicable percentage is determined, would be 
subject to NSCC's model risk management governance procedures set forth 
in the Model Risk Management Framework.\39\
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    \39\ See Notice of Filing, supra note 5, 85 FR at 21043; see 
also Model Risk Management Framework, supra note 28.
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(iii) Revisions to Description of Securities Not Amenable to Generally 
Accepted Statistical Analysis or Amenable to Statistical Analysis Only 
in a Complex Manner
    NSCC proposes to revise the existing language in its Rules relating 
to securities that are either less amenable to statistical analysis or 
amenable to statistical analysis only in a complex manner.\40\ Because 
Illiquid Securities and UITs would each have specific haircut-based 
volatility charges pursuant to the Advance Notice, these sections would 
no longer apply to Illiquid Securities or UITs. Furthermore, NSCC 
represents that the proposed definition of Illiquid Security would 
effectively encompass all securities that are currently considered as 
securities that are less amenable to statistical analysis.\41\ However, 
NSCC believes that it should preserve this category of securities 
within its Rules because NSCC may find it necessary to calculate margin 
charges for certain securities that do not constitute Illiquid 
Securities or UITs and instead would continue to fall under this 
category.
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    \40\ NSCC represents that it also would remove the phrase ``such 
as OTC Bulletin Board or Pink Sheet issues or issues trading below a 
designated dollar threshold (e.g., five dollars)'' from the existing 
language relating to securities that are less amenable to 
statistical analysis. While this language was intended as an example 
of these types of securities, NSCC now believes that the example 
inadequately describes all of the securities that are less amenable 
to statistical analysis and may be misleading. See Notice of Filing, 
supra note 5, 85 FR at 21043.
    \41\ See Notice of Filing, supra note 5, 85 FR at 21043.
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    Further, NSCC represents that certain fixed income securities, such 
as preferred stocks,\42\ would continue to fall into the category of 
securities that are amenable to statistical analysis only in a complex 
manner. Thus, these types of securities would still be subject to a 
haircut-based charge. The application of a haircut percentage to any 
new security, using these categories, would be subject to NSCC's model 
risk management governance procedures set forth in the Model Risk 
Management Framework.\43\
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    \42\ See Notice of Filing, supra note 5, 85 FR at 21044.
    \43\ See id.; see also Model Risk Management Framework, supra 
note 28.
---------------------------------------------------------------------------

E. Proposed Elimination of the Illiquid Charge

    NSCC proposes to eliminate the existing Illiquid Charge (and the 
corresponding definition of Illiquid Position), which may be imposed as 
an additional charge in the volatility component that is applied to 
Illiquid Securities as securities that are less amenable to statistical 
analysis. NSCC represents that because the current haircut-based 
volatility charge that is applied to Illiquid Securities uses fixed 
percentages for all such securities (15% for IPOs and 20% for the rest 
of Illiquid Securities), the Illiquid Charge was added to cover some of 
the risks that the current volatility charge did not cover. NSCC also 
represents that the proposal would address the risks presented by 
positions in Illiquid Securities more adequately than the Illiquid 
Charge, and that therefore the Illiquid Charge would no longer be 
needed.\44\
---------------------------------------------------------------------------

    \44\ See Notice of Filing, supra note 5, 85 FR at 21044.
---------------------------------------------------------------------------

F. Proposed Conforming Changes

    NSCC proposes to make two conforming changes to harmonize the Rules 
in light of the proposed amendments discussed above. First, the current 
Rules state that securities less amenable to statistical analysis or 
amenable to statistical analysis only in

[[Page 73103]]

a complex manner ``other than municipal and corporate bonds'' shall be 
excluded from the VaR Charge.\45\ NSCC believes that this drafting is 
unclear regarding whether municipal and corporate bonds are excluded 
from this section of the Rules. Moreover, the reference to municipal 
and corporate bonds is not necessary in this portion of the Rules 
because a different subsection of the Rules \46\ provides separately 
for haircut-based volatility charges for municipal and corporate bonds. 
The proposal would therefore remove this reference to municipal and 
corporate bonds from this section of the Rules.
---------------------------------------------------------------------------

    \45\ Sections I.(A)(1)(a)(ii) and I.(A)(2)(a)(ii) of Procedure 
XV, supra note 10.
    \46\ Section I.(A)(1)(a)(iii) of Procedure XV, supra note 10.
---------------------------------------------------------------------------

    Second, the Rules currently provide that Family-Issued Securities 
are excluded from calculation of the volatility component using the VaR 
model because the specific haircut-based volatility charge for such 
securities is provided in a separate subsection. However, the separate 
subsection only refers to ``long Net Unsettled Positions in Family-
Issued Securities.'' \47\ Based on the current drafting of the Rules, 
NSCC believes that it is unclear how positions in Family-Issued 
Securities would be treated.\48\ In practice, NSCC states that 
currently, short positions in Family-Issued Securities whose volatility 
is less amenable to statistical analysis are subject to the haircut set 
forth in Sections I.(A)(1)(a)(ii) and I.(A)(2)(a)(ii) of Procedure XV, 
and those short positions in Family-Issued Securities that meet 
particular volume thresholds are subject to the Illiquid Charge.\49\ 
NSCC proposes to revise the Rules to expressly reference its current 
practice that long positions in Family-Issued Securities would be 
excluded from the VaR Charge but subject to the haircut-based 
volatility charge exclusively applicable to such securities in a 
separate provision of the Rules. In addition, determination of the 
appropriate margin for short positions in Family-Issued Securities 
would continue to be covered by the haircut-based volatility charge in 
Sections I.(A)(1)(a)(ii) and I.(A)(2)(A)(ii) as securities that are 
less amenable to statistical analysis.
---------------------------------------------------------------------------

    \47\ Id. In addition, the current Rules exclude ``family issued 
security'' from the current definition of Illiquid Security, which 
is subject to Illiquid Charge, providing that the term is provided 
in Procedure XV, although Procedure XV does not provide such 
definition.
    \48\ See Notice of Filing, supra note 5, 85 FR at 21041.
    \49\ See Notice of Filing, supra note 5, 85 FR at 21042 and 
21044 n. 52.
---------------------------------------------------------------------------

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.\50\
---------------------------------------------------------------------------

    \50\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------

    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.\51\ 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): \52\
---------------------------------------------------------------------------

    \51\ 12 U.S.C. 5464(a)(2).
    \52\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

     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.\53\
---------------------------------------------------------------------------

    \53\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------

    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'').\54\ 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.\55\ 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,\56\ and in the Clearing 
Agency Rules, in particular Rule 17Ad-22(e)(4)(i), (e)(6)(i), and 
(e)(23)(ii).\57\
---------------------------------------------------------------------------

    \54\ 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) (``Standards for 
Covered Clearing Agencies''). NSCC is a ``covered clearing agency'' 
as defined in Rule 17Ad-22(a)(5).
    \55\ Id.
    \56\ 12 U.S.C. 5464(b).
    \57\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i), and (e)(23)(ii).
---------------------------------------------------------------------------

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.\58\ Specifically, the Commission believes that the 
changes proposed in the Advance Notice are consistent with promoting 
robust risk management, promoting safety and soundness, reducing 
systemic risks, and supporting the broader financial system.\59\
---------------------------------------------------------------------------

    \58\ 12 U.S.C. 5464(b).
    \59\ Several of the issues raised by the commenters are directed 
at the Proposed Rule Change and will be addressed in that context. 
These comments generally relate to the proposal's impact on 
competition, its consistency with the Exchange Act, and its effect 
on capital formation. See Letter from Christopher R. Doubek, CEO, 
Alpine Securities Corporation (April 21, 2020) (``Alpine Letter'') 
at 3; Letter from John Busacca, Founder, The Securities Industry 
Professional Association (April 23, 2020) (``SIPA Letter'') at 5-6; 
Letter from Charles F. Lek, Lek Securities Corporation (April 30, 
2020) (``Lek Letter'') at 1; Letter from Kimberly Unger, The 
Security Traders Association of New York, Inc. (June 30, 2020) 
(``STANY Letter'') at 1 (commenting on impact on competition). See 
Letter from James C. Snow, Chief Compliance Officer, Wilson-Davis & 
Co., Inc. (July 29, 2020) (``Wilson II Letter'') at 2-7; Letter from 
Daniel Zinn, General Counsel and Cass Sanford, Associate General 
Counsel, OTC Markets Group Inc. (June 26, 2020) (``OTC I Letter'') 
at 4-5 (commenting on the application of Section 17A(b)(3)(F) of the 
Exchange Act). See Alpine Letter at 3; Wilson II Letter at 2-7; 
STANY Letter at 1 (commenting on capital formation). The 
Commission's evaluation of the Advance Notice is conducted under the 
Clearing Supervision Act and, as noted above, generally considers 
whether the proposal will mitigate systemic risk and promote 
financial stability.
---------------------------------------------------------------------------

    The Commission believes that the proposal is consistent with 
promoting robust risk management. First, as described in Section II.C 
above, NSCC proposes to revise the definition of ``Illiquid 
Securities'' to broaden the scope of securities that will be considered 
as Illiquid Securities for assessing margin requirements, including by 
providing specific objective criteria that would lead to a security 
being considered an ``Illiquid Security.'' Revising the definition of 
Illiquid Securities to specifically include a broader set of these 
types of

[[Page 73104]]

securities within the definition of Illiquid Securities would allow 
NSCC to apply a haircut to determine the volatility component for such 
securities, thereby avoiding reliance on assumptions employed by the 
VaR model. As described above in Section II.A., the method that NSCC 
currently uses to calculate the volatility component of the margin for 
most securities (i.e., the VaR model) yields a less accurate measure of 
market risk for securities with illiquid characteristics because the 
VaR model is a model-based calculation, which generally relies on 
predictability. More specifically, the VaR model relies on assumptions 
that are based on historical observations of security prices. 
Securities that exhibit illiquid characteristics, which generally have 
low trading volumes or are not traded frequently, may not provide 
sufficient price observations for the VaR model to provide an 
appropriate measure of market risk.
    In addition, as described in Section II.D above, NSCC proposes to 
specifically exclude Illiquid Securities and UITs from application of 
the VaR model and change the haircut-based volatility component of the 
Clearing Fund formula that is applicable to positions in Illiquid 
Securities and UITs. Currently, in order to calculate the volatility 
component, fixed percentages are applied to two general categories of 
securities that encompass Illiquid Securities and UITs, i.e., (1) 
securities that are less amenable to statistical analysis, and (2) 
securities that are amenable to generally accepted statistical analysis 
only in a complex manner. The proposal would apply a specific 
percentage developed for Illiquid Securities and UITs. Moreover, for 
Illiquid Securities, instead of using the current fixed haircut 
percentages, the proposal would group such securities by price level 
and apply a different haircut percentage based on the specific price 
group. Illiquid Securities that are sub-penny securities would be 
separately grouped by long or short position to more accurately reflect 
different levels of risk presented by long and short positions of such 
securities (i.e., a higher level of risk is associated with the short 
positions in sub-penny securities). By allowing for the application of 
a haircut more precisely tailored to Illiquid Securities (grouped by 
price level and as long or short positions) and UITs, this change 
should result in margin amounts that are more commensurate with the 
risk attributes of these types of securities, thereby limiting NSCC's 
credit exposure to Members holding positions in such securities in a 
more precise manner.\60\ Also, the proposal's provision that NSCC 
regularly assess appropriate haircut percentages to cover its credit 
risks would require NSCC to take account of changing circumstances and 
allow NSCC to respond more effectively to such changing circumstances.
---------------------------------------------------------------------------

    \60\ In addition, the proposal would eliminate the existing 
Illiquid Charge, which would be replaced by the haircut-based 
charges on Illiquid Securities as described in Section II.E. Because 
the proposal would address the risks presented by positions in 
Illiquid Securities more adequately than the Illiquid Charge, the 
Illiquid Charge would no longer be needed.
---------------------------------------------------------------------------

    NSCC's backtesting results and Member impact studies indicate that 
Illiquid Securities, particularly low-priced Illiquid Securities, are 
more likely to have reduced backtesting coverage, which indicates that 
NSCC does not collect sufficient margin to cover additional risk 
present in those securities.\61\ Specifically, the Commission has 
considered NSCC's analyses and understands that the proposal's revised 
definition of Illiquid Securities and the corresponding new haircut 
methodology for determining the margin for Illiquid Securities would 
improve its backtesting coverage from 96.2% to 99.5% for the asset 
group that exhibited the lowest average backtesting coverage 
percentages (i.e., short positions in sub-penny securities and 
securities priced between one cent and one dollar), consistent with the 
high degree of confidence required by the Commission's rules for 
coverage of exposures to participants.\62\ The Commission believes that 
this improved backtesting coverage demonstrates that NSCC's proposal 
would result in margin levels that better reflect the risks and 
particular attributes of the Member's portfolio.
---------------------------------------------------------------------------

    \61\ Backtesting refers to an ex-post comparison of actual 
outcomes, i.e., the actual margin collected, with expected outcomes 
derived from the use of margin models.
    \62\ NSCC also provided additional information regarding the 
improvements in backtesting coverage for other asset groups in 
confidential exhibits.
---------------------------------------------------------------------------

    Accordingly, the Commission believes that these proposed changes 
for determining what constitutes an Illiquid Security and the adoption 
of a specific haircut methodology for Illiquid Securities and UITs 
would be consistent with promoting robust risk management because the 
proposed methodology would enable NSCC to more precisely manage the 
relevant risks than the current methodology.
    The Commission also believes that the proposal is consistent with 
the promotion of safety and soundness at NSCC. As summarized above, the 
proposed changes are designed to allow NSCC to collect sufficient 
margin amounts that are more precisely tailored to the nature of the 
risks presented by positions in securities with illiquid 
characteristics. By doing so, the proposed methodology would help 
provide NSCC with a more precisely determined level of resources to 
limit its exposure in the event of a Member default. Such an increase 
in NSCC's available financial resources would decrease the likelihood 
that losses arising out of a member default would exceed NSCC's 
prefunded resources and threaten the safety and soundness of NSCC's 
ongoing operations. Accordingly, the Commission believes that the 
proposal would be consistent with promoting safety and soundness at 
NSCC.\63\
---------------------------------------------------------------------------

    \63\ The Commission believes that NSCC's proposal to make 
certain clarifying changes regarding the applicability of particular 
sections to municipal and corporate bonds and Family-Issued 
Securities is also consistent with promoting safety and soundness at 
NSCC because these changes would eliminate potential uncertainty 
within NSCC's Rules. Such changes should result in clear and 
coherent Rules, which should help enhance the ability of NSCC and 
its Members to more effectively plan for and manage their risks.
---------------------------------------------------------------------------

    Finally, the Commission believes that the proposal is consistent 
with reducing systemic risk and supporting 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 caused by the 
liquidation of that Member's portfolio. With the proposed changes, NSCC 
seeks to collect margin at levels that better reflect the risks 
presented by positions in securities that exhibit illiquid 
characteristics. By collecting margin that more accurately reflects the 
risk characteristics of such securities, NSCC would be in a better 
position to absorb losses in connection with a Member default, and 
could thereby reduce the possibility that NSCC would need to mutualize 
among the non-defaulting Members losses arising out of a Member 
default. 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. The 
Commission believes, therefore, that the proposal would be consistent 
with reducing 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.

[[Page 73105]]

B. Consistency With Rule 17Ad-22(e)(4)(i)

    Rule 17Ad-22(e)(4)(i) under the Exchange Act requires 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, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence.\64\
---------------------------------------------------------------------------

    \64\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    Several commenters question whether NSCC has adequately 
demonstrated that its proposal is consistent with Rule 17Ad-22(e)(4)(i) 
under the Exchange Act by showing the insufficiency of NSCC's current 
margin methodology and whether the increase in margin is necessary.\65\ 
Two commenters state that NSCC has not demonstrated that its current 
margin requirements are insufficient to cover credit risks to its 
Members.\66\
---------------------------------------------------------------------------

    \65\ See Lek Letter at 1; STANY Letter at 1; OTC I Letter at 2.
    \66\ See STANY Letter at 1; OTC I Letter at 2.
---------------------------------------------------------------------------

    In response, NSCC states that the proposal is designed to provide a 
more accurate measure of the risks associated with Illiquid Securities 
and to cover in full the risks presented by Members to NSCC.\67\ To 
demonstrate why the proposed revision to its methodology for assessing 
margin on Illiquid Securities is necessary to address the risk 
presented by such securities, NSCC relies upon the results of recent 
backtesting analyses. Specifically, NSCC examines the backtesting 
coverage for a historical time period under both the current and 
proposed margin methodologies. Based on this analysis, NSCC represents 
that the proposal would help NSCC to address the risk presented by 
Illiquid Securities and that it would improve the lowest average 
backtesting coverage with respect to Illiquid Securities from 96.2% to 
99.5% for the asset group that exhibited the lowest average backtesting 
coverage percentages (i.e., short positions in sub-penny securities and 
securities priced between one cent and one dollar).\68\ NSCC further 
states that its backtesting results and Member impact studies indicate 
that Illiquid Securities, particularly low-priced Illiquid Securities, 
are more likely to present additional risk.\69\
---------------------------------------------------------------------------

    \67\ See NSCC Letter at 6.
    \68\ Id. at 5; 17 CFR 240.17Ad-22(e)(4)(i). NSCC also notes that 
this improvement in coverage level would allow it to meet the high 
degree of confidence referenced in Rule 17Ad-22(e)(4)(i). Id. As 
stated above, the volatility component of the margin collected by 
NSCC is designed to reflect the amount of money that could be lost 
on a portfolio over a given period within a 99% confidence level, 
and NSCC has established a 99% target backtesting confidence level. 
See, e.g., Procedure XV, Section I.B(3), supra note 10.
    \69\ See NSCC Letter at 5.
---------------------------------------------------------------------------

    NSCC notes that the proposed changes to its methodology produce a 
more accurate haircut calculation by factoring in price levels, 
resulting in margin levels that better reflect the risks and particular 
attributes of Member portfolios.\70\ NSCC represents that the enhanced 
methodology for identifying Illiquid Securities and the calculation of 
the haircut-based volatility component applicable to these securities 
and UITs improve the risk-based methodology, which in turn, better 
manage its credit exposures to Members.\71\
---------------------------------------------------------------------------

    \70\ See NSCC Letter at 5-6.
    \71\ See NSCC Letter at 6.
---------------------------------------------------------------------------

    The Commission believes that the proposal is consistent with Rule 
17Ad-22(e)(4)(i) under the Exchange Act.\72\ Specifically, the proposal 
to revise the definition of Illiquid Securities would help NSCC to 
better identify securities that may present credit exposures unique to 
such securities for purposes of applying an appropriate margin charge. 
Additionally, the proposal would provide additional criteria that use 
more objective factors to determine what constitutes an Illiquid 
Security. These factors consider a security's listing status, trading 
history, and market capitalization, and would result in a more accurate 
classification of securities with illiquid characteristics being 
considered as Illiquid Securities. In addition, the proposal to base 
the calculation of the haircut-based volatility charge applied to 
positions in Illiquid Securities and UITs on those securities' price 
level and risk profile would enable NSCC to collect and maintain 
sufficient resources to cover its credit exposures to each participant 
whose portfolio contains positions in Illiquid Securities and/or UITs 
with a high degree of confidence. The Commission has reviewed and 
analyzed NSCC's analysis of the improvements in its backtesting 
coverage, which demonstrate that the proposal would result in better 
backtesting coverage and, therefore, less credit exposure to its 
Members. Finally, the proposal requires NSCC to review and determine 
the haircut percentages at least annually. Accordingly, the Commission 
believes that the proposal would enable NSCC to better manage its 
credit risks by allowing it to respond regularly and more effectively 
to any material deterioration of backtesting performances, market 
events, market structure changes, or model validation findings.
---------------------------------------------------------------------------

    \72\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    In response to comments that NSCC has not demonstrated that current 
margin requirements are insufficient to cover credit risks to its 
Members, the Commission disagrees. In considering these comments, the 
Commission thoroughly reviewed and considered (i) the Advance Notice, 
including the supporting exhibits that provided confidential 
information on the performance of the proposed revision to the 
definition of an Illiquid Security and the use of a revised haircut-
based methodology applicable to both Illiquid Securities and UITs, 
three rounds of impact analysis, and backtesting coverage results; (ii) 
the comments received; and (iii) the Commission's own understanding of 
the performance of the current margin methodology, with which the 
Commission has experience from its general supervision of NSCC, 
compared to the proposed margin methodology. Based on its review of 
these materials, the Commission believes that the proposal would, in 
fact, better enable NSCC to cover its credit exposure to Members and 
meet the applicable Commission regulatory requirements. Specifically, 
the Commission has considered the results of NSCC's backtesting 
coverage analyses, which indicate that the current margin methodology 
results in backtesting coverage that does not meet NSCC's targeted 
confidence level. The analyses also indicate that the proposal would 
result in improved backtesting coverage that meets NSCC's targeted 
coverage level. Therefore, the Commission believes that the proposal 
would provide NSCC with a more precise margin calculation designed to 
meet the applicable regulatory requirements for margin coverage.
    Therefore, for the reasons discussed above, the Commission believes 
that the changes proposed in the Advance Notice are reasonably designed 
to enable NSCC to effectively identify, measure, monitor, and manage 
its credit exposure to Members, consistent with Rule 17Ad-
22(e)(4)(i).\73\
---------------------------------------------------------------------------

    \73\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(6)(i)

    Rule 17Ad-22(e)(6)(i) under the Exchange 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

[[Page 73106]]

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.\74\
---------------------------------------------------------------------------

    \74\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    Several commenters suggest that the proposal does not reflect the 
actual risk attributes of the securities to which it would apply.\75\ 
For example, two commenters state that treating as Illiquid Securities 
all securities that are not listed on a ``specified securities 
exchange,'' which would be defined as a national securities exchange 
that has established listing services and is covered by industry 
pricing and data vendors, is not tailored to accurately capture 
securities that present the defined liquidation and marketability 
risks, noting that many large international companies' securities are 
traded in the OTC marketplace.\76\ One commenter states that the 
proposal is unwarranted because the existing margin has always been 
enough to cover a defaulting Member's losses, and accordingly, the 
current margin should be enough to cover the risks presented by 
Members' portfolios.\77\ One commenter states that NSCC has not 
justified a $300 million market capitalization requirement for all 
exchange-listed stocks, and that this threshold does not consider the 
actual risks facing NSCC.\78\ Another commenter states that ETPs and 
ADRs, which are products typically offered by large banks and 
brokerages, are excluded from the definition of an Illiquid Security, 
and that such exclusion shows a bias against small Members.\79\ In 
addition, one commenter states that the proposal bears no relationship 
to a Member's actual credit rating.\80\
---------------------------------------------------------------------------

    \75\ See Alpine Letter; OTC I Letter; STANY Letter; and Letter 
from Daniel Zinn, General Counsel and Cass Sanford, Associate 
General Counsel, OTC Markets Group Inc. (July 21, 2020) (``OTC II 
Letter'').
    \76\ See OTC II Letter at 5; STANY Letter at 3.
    \77\ See Lek Letter at 1. Lek also states that net capital 
should be considered solely as additional insurance for agency 
firms, and that NSCC should include the margin that Lek collects 
from its customers when computing Lek's capital. Id. However, this 
issue is beyond the scope of this proposal and is not addressed 
herein.
    \78\ See STANY Letter at 3.
    \79\ See SIPA Letter.
    \80\ See Alpine Letter at 4.
---------------------------------------------------------------------------

    In response to comments regarding treating as Illiquid Securities 
all securities that are not listed on a national securities exchange 
that has established listing services and is covered by industry 
pricing and data vendors, NSCC states that securities that trade on a 
national securities exchange tend to trade with greater frequency in 
higher volumes than other venues, and national securities exchanges are 
subject to price and volume reporting regimes that assure greater 
accuracy of price and volume information.\81\ NSCC further states that 
securities that are not listed on a national securities exchange may 
trade without being registered with the Commission and have less 
reliable price and volume information.\82\
---------------------------------------------------------------------------

    \81\ See NSCC Letter at 8.
    \82\ See NSCC Letter at 8-9.
---------------------------------------------------------------------------

    In addition, NSCC explains that it included the second element of 
the proposed definition's criteria, ``covered by industry pricing and 
data vendors,'' to ensure that NSCC is able to access and utilize 
quality third party pricing data to derive returns in order to 
calculate the appropriate margin.\83\ NSCC further explains that the 
commercial availability of reliable information from independent, third 
party sources is critical to ensuring that NSCC can rely on end of day 
and intraday pricing in order to accurately manage risk positions 
consistent with its Rules.\84\ Accordingly, NSCC believes that the use 
of ``specified securities exchange'' as defined in the proposal is an 
appropriate basis for determining whether a security is an Illiquid 
Security.\85\
---------------------------------------------------------------------------

    \83\ See id.
    \84\ See id.
    \85\ See id.
---------------------------------------------------------------------------

    Regarding the comments that many large international companies' 
securities are traded in the OTC marketplace, NSCC acknowledges that 
the proposed definition of Illiquid Securities would cover the 
securities of some large, well-capitalized issuers not listed on a 
specified securities exchange.\86\ However, NSCC states that the 
proposal is designed to appropriately address risk in part by grouping 
Illiquid Securities by price level, and sub-penny securities by long or 
short position.\87\ Accordingly, not all Illiquid Securities would be 
given the same haircut or have the same margin requirements or result 
in a higher deposit than would be required under the current Rules.\88\
---------------------------------------------------------------------------

    \86\ See id.
    \87\ See id.
    \88\ See id.
---------------------------------------------------------------------------

    The Commission understands that, as described above, the proposal 
as a whole is designed to enable NSCC to more effectively address the 
risks presented by Members' positions in securities with illiquid 
characteristics, including Illiquid Securities and UITs. As such, NSCC 
seeks to produce margin levels that are more commensurate with the 
particular risk attributes of these securities, including the risk of 
increased transaction and market costs to NSCC to liquidate or hedge 
due to lack of liquidity or marketability of such positions. The 
Commission believes that the proposal would improve NSCC's ability to 
consider, and produce margin levels commensurate with, the risks and 
particular attributes of Illiquid Securities and UITs.
    First, by expanding and refining the definition of Illiquid 
Securities, the Commission believes that NSCC should be able to better 
identify those securities that may exhibit illiquid characteristics. 
Specifically, the proposal would ensure that three separate categories 
of securities are included in the definition of an Illiquid Security, 
and all three categories are calibrated to take into account specific 
and objective factors that are indicative of a security's liquidity. 
For example, the second category of the proposed definition of an 
Illiquid Security would apply an illiquidity ratio to micro-cap 
securities and ADRs to get a more precise measure of their liquidity. 
Moreover, consistent with NSCC's current practice for determining the 
margin for securities in an initial public offering, the third category 
of the proposed definition would consider the frequency of a security's 
trading, to take into account that infrequent trading reduces the 
amount of price and volume information available to measure market 
risk.
    In addition, the Commission believes that the proposed changes to 
the haircut-based volatility charges to base the calculation on the 
price level and risk profile of the applicable security would help NSCC 
to more effectively measure the risks that are particular to Illiquid 
Securities and UITs. Based on its analysis of the backtesting and 
impact analyses and its understanding of the proposed definition of an 
Illiquid Security, the Commission believes that the differentiated 
haircut percentages are reasonably designed to cover NSCC's exposures 
to Members more appropriately than the current fixed percentage 
approach because NSCC designed the variable haircut percentages to 
reflect specific risks presented by Illiquid Securities by price level 
and by UITs. The Commission also believes that it is reasonable to 
separate long and short positions of sub-penny securities in order to 
reflect the different risk levels presented by such positions.
    Taken together, the Commission believes that the proposal should 
permit NSCC to calculate a haircut-based volatility charge that is more

[[Page 73107]]

appropriately designed to address the risks presented by the positions 
in Illiquid Securities and UITs.
    In response to the comment questioning whether the proposal is 
necessary because ``the existing margin has always been enough to 
cover'' \89\ a defaulting Member's losses, the Commission does not 
agree that the fact that margin has historically been sufficient to 
cover a defaulting Member's losses obviates the need for the changes 
proposed in the Advance Notice. As an initial matter, credit exposures 
are not measured only by those events that have actually happened, but 
also include events that could potentially occur in the future. For 
this reason, a risk-based margin system is required to cover potential 
future exposure to participants.\90\ Potential future exposure is, in 
turn, defined as the maximum exposure estimated to occur at a future 
point in time with an established single-tailed confidence level of at 
least 99% with respect to the estimated distribution of future 
exposure.\91\ Thus, to be consistent with its regulatory requirements, 
NSCC must consider potential future exposure, which includes, among 
other things, losses associated with the liquidation of a defaulted 
member's portfolio. As demonstrated by the backtesting analysis 
discussed above, under its current margin methodology, NSCC is not 
achieving its 99% targeted confidence level for asset groups that are 
Illiquid Securities. Based on its review of the Advance Notice, in 
conjunction with the Commission's supervisory observations, the 
Commission believes that the proposed changes would better enable NSCC 
to collect margin commensurate with the different levels of risk that 
Members pose to NSCC as a result of their particular trading activity 
in Illiquid Securities and UITs. Further, the Commission believes the 
amount of margin NSCC would collect under the proposed changes would 
help NSCC better manage its credit exposures to its Members and those 
exposures arising from its payment, clearing, and settlement processes.
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    \89\ See Lek Letter at 1.
    \90\ 17 CFR 240.17Ad-22(e)(6)(iii) (requiring a covered clearing 
agency to 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, calculates margin sufficient to cover its 
potential future exposure to participants in the interval between 
the last margin collection and the close out of positions following 
a participant default).
    \91\ 17 CFR 240.17Ad-22(a)(13).
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    In response to the comment asserting that a $300 million market 
capitalization requirement for all exchange-listed stocks is not 
justifiable, the Commission disagrees with this interpretation of the 
proposal. Not all securities that fall under the market capitalization 
threshold under the proposal would be deemed to be Illiquid Securities 
or require a higher margin compared to the current Rules. As set forth 
in the proposal, the determination of whether a micro-cap security is 
an Illiquid Security does not rely solely on capitalization. By 
contrast, under the proposal, the initial determination of whether a 
security is a micro-cap security would employ a $300 million 
threshold,\92\ and a micro-cap security would then be subject to the 
illiquidity ratio test described in Section II.C(ii)3 above to take 
into account the security's liquidity and determine whether it is an 
Illiquid Security. Therefore, depending on the liquidity of the issuer, 
there could be instances where a security with less than $300 million 
in market capitalization would not constitute an Illiquid Security.
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    \92\ NSCC represents that the initial threshold is set at $300 
million because it is based on prevailing thresholds for market 
capitalization categories in the industry. See NSCC Letter at 9; 
Notice of Filing, supra note 5, 85 FR at 21040 n. 24 (citing, as an 
example of the prevailing views, https://www.sec.gov/reportspubs/investor-publications/investorpubs/microcapstockhtm.html).
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    In response to the comments stating that treating all securities 
that are not listed on a specified exchange as Illiquid Securities is 
not tailored to accurately capture securities that present the defined 
liquidation and marketability risks, the Commission disagrees. This 
proposal does not change the current treatment of securities that are 
not listed on a specified securities exchange, because the current 
Rules define Illiquid Securities to include securities that are not 
traded on a national securities exchange. Further, the Commission 
believes that this distinction is appropriate. Securities that are 
quoted on the OTC market differ from those listed on national 
securities exchanges.\93\ In particular, the average OTC security 
issuer is smaller, and their securities trade less, on average, than 
securities traded on a national securities exchange.\94\ Moreover, 
issuers of quoted OTC securities tend to have a lower market 
capitalization than those with securities listed on a national 
securities exchange,\95\ and many quoted OTC securities are 
illiquid.\96\ Quoted OTC securities are characterized by significantly 
lower dollar trading volumes than listed stocks, even for securities of 
similar size as measured by market capitalization.\97\
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    \93\ Publication or Submission of Quotations Without Specified 
Information, Final Rule; Exchange Act Release No. 89891, at 218 
(September 16, 2020), available at https://www.sec.gov/rules/final/2020/33-10842.pdf.
    \94\ See id.
    \95\ See id.
    \96\ See id. at 220.
    \97\ See id. at 218-19.
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    In response to the comment that ETPs and ADRs are exempt from the 
definition of Illiquid Securities, the Commission disagrees. The 
Proposed Rule Change would not exclude all ETPs and ADRs by category 
from the definition of Illiquid Securities. Instead, the proposal would 
only exclude ETPs and ADRs when calculating the illiquidity ratio 
threshold for purposes of the second test under the definition of an 
Illiquid Security (i.e., the median of the illiquidity ratio threshold 
based on non-micro-cap common stocks). An ETP or an ADR could be 
determined to be an Illiquid Security, and NSCC would apply a haircut 
to ETPs and ADRs in the same manner as other Illiquid Securities.
    Finally, in response to the comment that the proposal bears no 
relationship to a Member's actual credit rating, the Commission 
disagrees that such a relationship is necessary in order to design an 
accurate and appropriate margin methodology for the securities that a 
Member holds. Neither the proposal, nor NSCC's margin methodology more 
broadly, is designed to calculate the volatility component based on a 
Member's credit rating but rather on the risks presented by each 
security. Therefore, the Member's credit rating is not relevant to the 
determination of the appropriate volatility component of the margin for 
a particular security.\98\
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    \98\ The Alpine Letter also questions whether the Credit Risk 
Rating Matrix (``CRRM'') will continue to be used in the margin 
calculation for Illiquid Securities. See Alpine Letter at 3. NSCC 
responds that the calculation of the appropriate haircuts for 
Illiquid Securities, including calculation of the appropriate volume 
thresholds, does not consider the Member's CRRM rating. The CRRM 
rating currently is used in determining the Illiquid Position 
subject to NSCC's Illiquid Charge, which will be eliminated upon 
implementation of the proposal. See NSCC Letter at 7-8. Going 
forward, the CRRM would continue to be used in general credit risk 
monitoring of members, but would not be used for the determination 
of the volatility component of the margin for a particular security. 
See Securities Exchange Act Release No. 80734 (May 19, 2017), 82 FR 
24177 (May 25, 2017) (order approving proposed rule changes to 
enhance the CRRM).
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    Accordingly, the Commission believes the proposal is consistent 
with Rule 17Ad-22(e)(6)(i) under the Exchange Act because it is 
designed to assist NSCC in maintaining a risk-based

[[Page 73108]]

margin system that considers, and produces margin levels commensurate 
with, the risks and particular attributes of portfolios that exhibit 
illiquid risk attributes.\99\
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    \99\ 17 CFR 240.17Ad-22(e)(6)(i).
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D. Consistency With Rule 17Ad-22(e)(23)(ii)

    Rule 17Ad-22(e)(23)(ii) under the Exchange Act requires each 
covered clearing agency to establish, implement, maintain, and enforce 
written policies and procedures reasonably designed to provide 
sufficient information to enable participants to identify and evaluate 
the risks, fees, and other material costs they incur by participating 
in the covered clearing agency.\100\
---------------------------------------------------------------------------

    \100\ 17 CFR 240.17Ad-22(e)(23)(ii).
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    The majority of commenters express concerns regarding the method 
for determining the proposed volatility component for Illiquid 
Securities being confidential. Several commenters express concern that 
the proposal does not explain how the haircut-based volatility charge 
will be calculated and that the proposal does not allow Members to 
review the proposed margin equations, models, and calculations.\101\ 
Other commenters state that the proposal does not allow Members to 
predict the financial consequences and operating impacts of their 
activities, and the impact on their liquidity needs.\102\
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    \101\ See Alpine Letter at 2; SIPA Letter at 4-5; OTC I Letter 
at 2-3; OTC II Letter at 3-4; Wilson II Letter at 7. Wilson II also 
asserts that NSCC has failed to meet the requirements of Rule 17Ad-
22(e)(23)(iii) for failing to quantify the current inadequate market 
capitalization, median illiquidity ratios, and how those factors 
would be improved under the proposal. However, Rule 17Ad-
22(e)(23)(iii) requires each covered clearing agency to establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to publicly disclose relevant basic data on 
transaction volume and values. This rule does not require a covered 
clearing agency to disclose the specific information that the 
commenter seeks because the information described by the commenter 
is not the basic data on transaction volumes and values required by 
the rule. Moreover, NSCC publicly provides data on transaction 
volumes and values in its quantitative disclosures, which are 
available at https://www.dtcc.com/legal/policy-and-compliance.
    \102\ See Letter from James C. Snow, President/CCO, Wilson-Davis 
& Co., Inc. (May 1, 2020) (``Wilson I Letter'') at 2-3; STANY Letter 
at 2.
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    In response, NSCC states that the language of the proposal is 
reasonably transparent and clear enough to enable Members to determine 
the Member's Required Fund Deposit.\103\ NSCC states that the proposed 
parameters are definitive and non-discretionary to enable application 
on an algorithmic basis.\104\ For example, a security that is an ADR or 
has a micro-capitalization of less than $300 million would be subject 
to the illiquidity ratio test, which would be provided in the Rules, to 
determine whether it is an Illiquid Security. In addition, NSCC states 
that, because haircuts would be applied according to the price level of 
the Illiquid Securities, Members should be able to more easily 
determine the applied margin impact per the current market price of the 
security.\105\
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    \103\ See NSCC Letter at 6.
    \104\ See id.
    \105\ See id.
---------------------------------------------------------------------------

    NSCC also represents that it maintains the NSCC Risk Management 
Reporting application on the Participant Browser Service (``PBS'') and 
the NSCC Risk Client Portal (``Portal'') to improve transparency of 
Members' Clearing Fund requirements.\106\ NSCC states that the PBS is a 
member-accessible website portal for accessing reports and other 
disclosures. NSCC further states that the Risk Management Reporting 
application enables a Member to view and download Clearing Fund 
requirement information and component details, including issue-level 
Clearing Fund information related to start of day volatility charges 
and mark-to-market, intraday exposure, and other components.\107\ NSCC 
represents that the application enables a Member to view, for example, 
a portfolio breakdown by asset type, including the amounts attributable 
to the parametric VaR model and the amounts associated with Illiquid 
Securities.\108\ NSCC also represents that Members are able to view and 
download spreadsheets that contain market amounts for current clearing 
positions and the associated volatility charges.\109\
---------------------------------------------------------------------------

    \106\ See id.
    \107\ See id.
    \108\ See id.
    \109\ See id.
---------------------------------------------------------------------------

    In addition, NSCC represents that the Portal provides members the 
ability, for information purposes, to view and analyze certain risks 
relating to their portfolio, including calculators to assess the risk 
and clearing fund impact of certain activities and to compare their 
portfolio to historical and average values. For example, it allows 
Members to review both hourly and 15-minute intra-day snapshots to 
monitor fluctuations in the volatility and exposure in their portfolios 
to help Members to anticipate potential intra-day margin calls. The 
intervals are available through 7:00 p.m. to provide additional reports 
that may help Members to forecast next-day margin requirements.\110\
---------------------------------------------------------------------------

    \110\ See NSCC Letter at 7.
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    NSCC further represents that it maintains the NSCC Client 
Calculator on the Portal that provides functionality to Members to 
enter `what-if' position data and to recalculate their volatility 
charges to determine margin impact pre-trade.\111\ NSCC specifically 
states that this calculator allows Members to see the impact to the 
volatility charge if specific transactions are executed, or to 
anticipate the impact of an increase or decrease to a current clearing 
position.\112\ NSCC represents that the Client Calculator portfolio 
detail can be downloaded to modify a current margin portfolio, and then 
allow Members to upload the portfolio to run a margin calculation, and 
permit Members to view position level outputs in order to make informed 
risk management and execution decisions.\113\
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    \111\ See id.
    \112\ See id.
    \113\ See id.
---------------------------------------------------------------------------

    Finally, NSCC states that it conducted member outreach in 
connection with the proposal described in the Advance Notice. NSCC 
represents that, in 2019 and 2020, NSCC distributed three rounds of 
impact studies to Members impacted by the change to communicate 
revisions to the methodology and discuss specific portfolio impacts by 
reviewing charts and quantitative results.\114\ NSCC further represents 
that it has performed outreach to Members with details for this 
proposal for the past two years, which allowed Members to understand 
and ask questions about the proposal.\115\
---------------------------------------------------------------------------

    \114\ See id.
    \115\ See id.
---------------------------------------------------------------------------

    NSCC states that it has also posted an NSCC Risk Margin Component 
Guide (``Guide'') on the Portal which provides descriptions of some of 
the components used in NSCC's current risk-based methodology, including 
the volatility charges, mark-to-market charges, fail charges for CNS 
transactions, a charge for Family-Issued Securities to mitigate wrong 
way risk, a charge for Illiquid Positions, a charge to mitigate day 
over day margin differentials, a coverage component and a backtesting 
charge.\116\ NSCC represents that the Guide will be updated to reflect 
the changes in methodology set forth in the proposal.\117\
---------------------------------------------------------------------------

    \116\ See id.
    \117\ See id.
---------------------------------------------------------------------------

    The Commission believes that the proposal is consistent with Rule 
17Ad-22(e)(23)(ii) and is designed to provide sufficient information to 
enable Members to identify and evaluate the risks and other material 
costs they incur by participating in NSCC. The changes described in the 
proposal would be reflected in NSCC's Rules and therefore publicly 
available to NSCC's Members

[[Page 73109]]

and prospective members for application to their own portfolios. 
Specifically, the proposed rule text would reflect the two sets of 
changes in the proposal. First, the proposed rule text would define the 
types of securities that would constitute ``Illiquid Securities'' as 
three particular categories of securities, as described in Section 
II.C(i), (ii), and (iii). By reviewing the definitions of an Illiquid 
Security, NSCC's members should be able to understand the types of 
factors that would cause a security to be considered an Illiquid 
Security, all of which are ascertainable, such as its trading history 
(including whether it is traded on an exchange or not and, if so, on 
which exchange), its market capitalization, and the type of security 
(i.e., whether it is an ADR). The specific parameters of the 
illiquidity ratio test would also be reflected in NSCC's Rules, thereby 
enabling a Member to determine whether a security that is an ADR or has 
a micro-capitalization of less than $300 million would be an Illiquid 
Security.
    Second, the proposed rule text would provide that NSCC would apply 
a haircut to Illiquid Securities to determine the appropriate 
volatility component, with Illiquid Securities grouped by price level 
to determine the appropriate haircut to apply to a particular security. 
The proposed rule text would further specify that the haircut 
percentage would be the highest of the three percentages as provided in 
Section II.D(i), and would be determined at least annually. 
Additionally, if a Member had questions with respect to a particular 
security, it could use the various client-facing tools described above 
to determine whether a security would be considered an Illiquid 
Security. Taken together, the Division believes that the proposal, 
which would be reflected in NSCC's Rules, in conjunction with the 
various client-facing tools, provides sufficient information to Members 
to understand the operation of the haircut-based volatility charges and 
how such charges would apply to particular transactions. The Commission 
further believes that NSCC provided sufficient information to Members 
to identify and evaluate the risks and other material costs they would 
incur due to securities with illiquid characteristics under the 
proposal.
    For these reasons, the Commission disagrees with the comments 
stating that the proposal lacks details and does not explain how the 
haircut-based volatility charge will be calculated, and that the 
proposal does not allow Members to predict the impact on their 
activities. The Commission acknowledges that, as some commenters have 
noted, the proposal does not provide or specify the actual models or 
calculations that NSCC would use to determine the appropriate haircut 
or what constitutes an Illiquid Security. However, when adopting the 
CCA Standards, the Commission declined to adopt a commenter's view that 
a covered clearing agency should be required to provide, at least 
quarterly, its methodology for determining initial margin requirements 
at a level of detail adequate to enable participants to replicate the 
covered clearing agency's calculations, or, in the alternative, that 
the covered clearing agency should be required to provide a 
computational method with the ability to determine the initial margin 
associated with changes to each respective participant's portfolio or 
hypothetical portfolio, participant defaults and other relevant 
information. The Commission stated that ``[m]andating disclosure of 
this frequency and granularity would be inconsistent with the 
principles-based approach the Commission is taking in Rule 17Ad-
22(e).'' \118\ Consistent with that approach, the Commission does not 
believe that Rule 17Ad-22(e)(23)(ii) would require NSCC to disclose its 
actual margin methodology, so long as NSCC has provided sufficient 
information for its Members to understand the potential costs and risks 
associated with participating in NSCC for clearing Illiquid Securities.
---------------------------------------------------------------------------

    \118\ See Standards for Covered Clearing Agencies, supra note 
54, 81 FR at 70845.
---------------------------------------------------------------------------

    For the reasons discussed above, the Commission believes that the 
proposals in the Advance Notice would enable NSCC to establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to provide sufficient information to enable Members 
to identify and evaluate the risks, fees, and other material costs they 
incur as NSCC's Members, consistent with Rule 17Ad-22(e)(23)(ii).\119\
---------------------------------------------------------------------------

    \119\ 17 CFR 240.17Ad-22(e)(23)(ii).
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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-2020-802) and that NSCC is AUTHORIZED to 
implement the proposal as of the date of this notice or the date of an 
order by the Commission approving proposed rule change SR-NSCC-2020-
003, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-25202 Filed 11-13-20; 8:45 am]
BILLING CODE 8011-01-P