[Federal Register Volume 86, Number 127 (Wednesday, July 7, 2021)]
[Notices]
[Pages 35854-35864]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-14390]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-92303; File No. SR-FICC-2020-017]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving a Proposed Rule Change To Modify the Calculation of the 
MBSD VaR Floor To Incorporate a Minimum Margin Amount

June 30, 2021.
    On November 20, 2020, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2020-017 (``Proposed Rule Change'') 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder.\2\ The Proposed Rule Change 
was published for comment in the Federal Register on December 10, 
2020.\3\ On December 30, 2020, pursuant

[[Page 35855]]

to Section 19(b)(2) of the Act,\4\ 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.\5\ 
On February 16, 2021, the Commission instituted proceedings to 
determine whether to approve or disapprove the Proposed Rule Change.\6\ 
On June 11, 2021, pursuant to Section 19(b)(2) of the Act,\7\ the 
Commission extended the period for the conclusion of proceedings to 
determine whether to approve or disapprove the Proposed Rule Change.\8\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 90568 (December 4, 
2020), 85 FR 79541 (December 10, 2020) (SR-FICC-2020-017) 
(``Notice''). FICC also filed the proposal contained in the Proposed 
Rule Change as advance notice SR-FICC-2020-804 (``Advance Notice'') 
with the Commission pursuant to Section 806(e)(1) of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 (``Clearing 
Supervision Act''). 12 U.S.C. 5465(e)(1); 17 CFR 240.19b-4(n)(1)(i). 
Notice of filing of the Advance Notice was published for comment in 
the Federal Register on January 6, 2021. Securities Exchange Act 
Release No. 90834 (December 31, 2020), 86 FR 584 (January 6, 2021) 
(File No. SR-FICC-2020-804) (``Notice of Filing''). Upon publication 
of the Notice of Filing, the Commission extended the review period 
of the Advance Notice for an additional 60 days because the 
Commission determined that the Advance Notice raised novel and 
complex issues. On March 12, 2021, the Commission issued a request 
for information regarding the Advance Notice. See Commission's 
Request for Additional Information, available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804-8490035-229981.pdf. On April 16, 2021, FICC submitted its response thereto. 
See Response to Commission's Request for Additional Information, 
available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804-8685526-235624.pdf; Letter from James Nygard, Director 
and Assistant General Counsel, FICC (April 16, 2021), available at 
https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804-8679555-235605.pdf. The proposal contained in the Proposed Rule Change and 
the Advance Notice shall not take effect until all regulatory 
actions required with respect to the proposal are completed.
    \4\ 15 U.S.C. 78s(b)(2).
    \5\ Securities Exchange Act Release No. 90794 (December 23, 
2020), 85 FR 86591 (December 30, 2020) (SR-FICC-2020-017).
    \6\ Securities Exchange Act Release No. 91092 (February 9, 
2021), 86 FR 9560 (February 16, 2021) (SR-FICC-2020-017).
    \7\ 15 U.S.C. 78s(b)(2)(B)(ii)(II).
    \8\ Securities Exchange Act Release No. 92117 (June 7, 2021), 86 
FR 31354 (June 11, 2021) (SR-FICC-2020-017).
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    The Commission received comment letters on the Proposed Rule 
Change.\9\ In addition, the Commission received a letter from FICC 
responding to the public comments.\10\ For the reasons discussed below, 
the Commission is approving the Proposed Rule Change.
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    \9\ Comments on the Proposed Rule Change are available at 
https://www.sec.gov/comments/sr-ficc-2020-017/srficc2020017.htm. 
Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804.htm. Because the proposals 
contained in the Advance Notice and the Proposed Rule Change are the 
same, all 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.
    \10\ See Letter from Timothy J. Cuddihy, Managing Director of 
Depository Trust & Clearing Corporation Financial Risk Management, 
(March 5, 2021) (``FICC Letter'').
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I. Description of the Proposed Rule Change

A. Background

    FICC, through MBSD, serves as a central counterparty (``CCP'') and 
provider of clearance and settlement services for the mortgage-backed 
securities (``MBS'') markets. A key tool that FICC uses to manage its 
respective credit exposures to its members is the daily collection of 
margin from each member. The aggregated amount of all members' margin 
constitutes the Clearing Fund, which FICC would access should a 
defaulted member's own margin be insufficient to satisfy losses to FICC 
caused by the liquidation of that member's portfolio.
    Each member's margin consists of a number of applicable components, 
including a value-at-risk (``VaR'') charge (``VaR Charge'') designed to 
capture the potential market price risk associated with the securities 
in a member's portfolio. The VaR Charge is typically the largest 
component of a member's margin requirement. The VaR Charge is designed 
to provide an estimate of FICC's projected liquidation losses with 
respect to a defaulted member's portfolio at a 99 percent confidence 
level.
    To determine each member's daily VaR Charge, FICC generally uses a 
model-based calculation designed to quantify the risks related to the 
volatility of market prices associated with the securities in a 
member's portfolio.\11\ As an alternative to this calculation, FICC 
also uses a haircut-based calculation to determine the ``VaR Floor,'' 
which replaces the model-based calculation to become a member's VaR 
Charge in the event that the VaR Floor is greater than the amount 
determined by the model-based calculation.\12\ Thus, the VaR Floor 
currently operates as a minimum VaR Charge.
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    \11\ The model-based calculation, often referred to as the 
sensitivity VaR model, relies on historical risk factor time series 
data and security-level risk sensitivity data. Specifically, for 
TBAs, the model-based calculation incorporates the following risk 
factors: (1) Key rate, which measures the sensitivity of a price 
change to changes in interest rates; (2) convexity, which measures 
the degree of curvature in the price/yield relationship of key 
interest rates; (3) spread, which is the yield spread added to a 
benchmark yield curve to discount a TBA's cash flows to match its 
market price; (4) volatility, which reflects the implied volatility 
observed from the swaption market to estimate fluctuations in 
interest rates; (5) mortgage basis, which captures the basis risk 
between the prevailing mortgage rate and a blended Treasury rate; 
and (6) time risk factor, which accounts for the time value change 
(or carry adjustment) over an assumed liquidation period. See 
Securities Exchange Act Release No. 79491 (December 7, 2016), 81 FR 
90001, 90003-04 (December 13, 2016) (File No. SR-FICC-2016-007).
    \12\ FICC uses the VaR Floor to mitigate the risk that the 
model-based calculation does not result in margin amounts that 
accurately reflect FICC's applicable credit exposure, which may 
occur in certain member portfolios containing long and short 
positions in different asset classes that share a high degree of 
historical price correlation.
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    During the period of extreme market volatility in March and April 
2020, FICC's current model-based calculation and the VaR Floor haircut-
based calculation generated VaR Charge amounts that were not sufficient 
to mitigate FICC's credit exposure to its members' portfolios at a 99 
percent confidence level. Specifically, during the period of extreme 
market volatility, FICC observed that its margin collections yielded 
backtesting deficiencies beyond FICC's risk tolerance.\13\ FICC states 
that these deficiencies arose from a particular aspect of its margin 
methodology with respect to MBS (particularly, higher coupon TBAs 
\14\), i.e., that current prices may reflect higher mortgage prepayment 
risk than FICC's margin methodology currently takes into account during 
periods of extreme market volatility. In the Proposed Rule Change, FICC 
proposes to revise the margin methodology in its Rules \15\ and its 
quantitative risk model \16\ to better address the risks posed by 
member portfolios holding TBAs during such volatile market conditions.
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    \13\ Backtesting is an ex-post comparison of actual outcomes 
(i.e., the actual margin collected) with expected outcomes derived 
from the use of margin models. See 17 CFR 240.17Ad-22(a)(1). FICC 
conducts daily backtesting to determine the adequacy of its margin 
assessments. MBSD's monthly backtesting coverage ratio with respect 
to margin amounts was 86.6 percent in March 2020 and 94.2 percent in 
April 2020. See Notice, supra note 3 at 79543.
    \14\ The vast majority of agency MBS trading occurs in a forward 
market, on a ``to-be-announced'' or ``TBA'' basis. In a TBA trade, 
the seller agrees on a sale price, but does not specify which 
particular securities will be delivered to the buyer on settlement 
day. Instead, only a few basic characteristics of the securities are 
agreed upon, such as the MBS program, maturity, coupon rate, and the 
face value of the bonds to be delivered.
    \15\ The MBSD Clearing Rules are available at https://www.dtcc.com/legal/rules-and-procedures.aspx.
    \16\ As part of the Proposed Rule Change, FICC filed Exhibit 
5B--Proposed Changes to the Methodology and Model Operations 
Document MBSD Quantitative Risk Model (``QRM Methodology''). 
Pursuant to 17 CFR 240.24b-2, FICC requested confidential treatment 
of Exhibit 5B.
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B. Minimum Margin Amount

    FICC proposes to introduce a new minimum margin amount into its 
margin methodology. Under the proposal, FICC would revise the existing 
definition of the VaR Floor, which acts as the minimum margin 
requirement, to mean the greater of (1) the current haircut-based 
calculation, as described above, and (2) the proposed minimum margin 
amount, which would use a dynamic haircut method based on observed TBA 
price moves. Application of the minimum margin amount would increase 
FICC's margin collection during periods of extreme market volatility, 
particularly when TBA price changes would otherwise significantly 
exceed those projected by either the model-based calculation or the 
current VaR Floor calculation.
    Specifically, the minimum margin amount would serve as a minimum 
VaR Charge for net unsettled positions, calculated using the historical 
market price changes of certain benchmark TBA securities.\17\ FICC 
proposes to calculate

[[Page 35856]]

the minimum margin amount per member portfolio.\18\ The proposal would 
allow offsetting between short and long positions within TBA securities 
programs since the TBAs aggregated in each program exhibit similar risk 
profiles and can be netted together to calculate the minimum margin 
amount to cover the observed market price changes for each portfolio.
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    \17\ FICC would consider the MBSD portfolio as consisting of 
four programs: Federal National Mortgage Association (``Fannie 
Mae'') and Federal Home Loan Mortgage Corporation (``Freddie Mac'') 
conventional 30-year mortgage-backed securities (``CONV30''), 
Government National Mortgage Association (``Ginnie Mae'') 30-year 
mortgage-backed securities (``GNMA30''), Fannie Mae and Freddie Mac 
conventional 15-year mortgage-backed securities (``CONV15''), and 
Ginnie Mae 15-year mortgage-backed securities (``GNMA15''). Each 
program would, in turn, have a default benchmark TBA security.
     FICC would map 10-year and 20-year TBAs to the corresponding 
15-year TBA security benchmark. As of August 31, 2020, 20-year TBAs 
account for less than 0.5%, and 10-year TBAs account for less than 
0.1%, of the positions in MBSD clearing portfolios. FICC states that 
these TBAs were not selected as separate TBA security benchmarks due 
to the limited trading volumes in the market. See Notice, supra note 
3 at 79543.
    \18\ The specific calculation would involve the following: FICC 
would first calculate risk factors using historical market prices of 
the benchmark TBA securities. FICC would then calculate each 
member's portfolio exposure on a net position across all products 
and for each securitization program (i.e., CONV30, GNMA30, CONV15 
and GNMA15). Finally, FICC would multiply a ``base risk factor'' by 
the absolute value of the member's net position across all products, 
plus the sum of each risk factor spread to the base risk factor 
multiplied by the absolute value of its corresponding position, to 
determine the minimum margin amount.
    To determine the base risk factor, FICC would calculate an 
``outright risk factor'' for GNMA30 and CONV30, which constitute the 
majority of the TBA market and of positions in MBSD portfolios. For 
each member's portfolio, FICC would assign the base risk factor 
based on whether GNMA30 or CONV30 constitutes the larger absolute 
net market value in the portfolio. If GNMA30 constitutes the larger 
absolute net market value in the portfolio, the base risk factor 
would be equal to the outright risk factor for GNMA30. If CONV30 
constitutes the larger absolute net market value in the portfolio, 
the base risk factor would be equal to the outright risk factor for 
CONV30.
    For a detailed example of the minimum margin amount calculation, 
see Notice, supra note 3 at 79544.
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    The proposal would allow a lookback period for those historical 
market price moves and parameters of between one and three years, and 
FICC would set the initial lookback period for the minimum margin 
amount at two years.\19\ FICC states that the minimum margin amount 
would improve the responsiveness of its margin methodology during 
periods of market volatility because it would have a shorter lookback 
period than the model-based calculation, which reflects a ten-year 
lookback period.\20\
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    \19\ FICC would be permitted to adjust the lookback period 
within the range in accordance with FICC's model risk management 
practices and governance procedures set forth in the Clearing Agency 
Model Risk Management Framework. See Securities Exchange Act Release 
No. 81485 (August 25, 2017), 82 FR 41433 (August 31, 2017) (SR-DTC-
2017-008; SR-FICC-2017-014; SR-NSCC-2017-008); Securities Exchange 
Act Release No. 84458 (October 19, 2018), 83 FR 53925 (October 25, 
2018) (SR-DTC-2018-009; SR-FICC-2018-010; SR-NSCC-2018-009); 
Securities Exchange Act Release No. 88911 (May 20, 2020), 85 FR 
31828 (May 27, 2020) (SR-DTC-2020-008; SR-FICC-2020-004; SR-NSCC-
2020-008).
    \20\ Notice, supra note 3 at 79543-44.
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II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \21\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and rules and regulations thereunder applicable 
to such organization. After carefully considering the Proposed Rule 
Change, the Commission finds that the Proposed Rule Change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to FICC. In particular, the 
Commission finds that the Proposed Rule Change is consistent with 
Sections 17A(b)(3)(F) \22\ and (b)(3)(I) \23\ of the Act and Rules 
17Ad-22(e)(4)(i), (e)(6)(i), and (e)(23)(ii) thereunder.\24\
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    \21\ 15 U.S.C. 78s(b)(2)(C).
    \22\ 15 U.S.C. 78q-1(b)(3)(F).
    \23\ 15 U.S.C. 78q-1(b)(3)(I).
    \24\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i), and (e)(23)(ii).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act \25\ requires that the rules of a 
clearing agency, such as FICC, be designed to, among other things, (i) 
promote the prompt and accurate clearance and settlement of securities 
transactions, (ii) assure the safeguarding of securities and funds 
which are in the custody or control of the clearing agency or for which 
it is responsible, and (iii) protect investors and the public interest.
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    \25\ 15 U.S.C. 78q-1(b)(3)(F).
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    As described above in Section I.B., FICC proposes to introduce the 
minimum margin amount into its margin methodology to help ensure that 
FICC collects sufficient margin to manage its potential loss exposure 
during periods of extreme market volatility, particularly when TBA 
price changes would otherwise significantly exceed those projected by 
the current model-based calculation and the current VaR Floor 
calculation (i.e., during periods of extreme market volatility, similar 
to that which occurred in March and April 2020). The minimum margin 
amount calculation would use a dynamic haircut method based on observed 
TBA price moves.\26\ FICC states that the minimum margin amount would 
improve the responsiveness of its margin methodology during periods of 
market volatility because it would have a shorter lookback period (two 
years, initially) than the model-based calculation (ten years).\27\
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    \26\ See supra note 17.
    \27\ Notice, supra note 3 at 79543-44. VaR calculations 
typically rely on historical data over a specified lookback period 
to estimate the probability distribution of potential market prices. 
The length of the lookback period is designed to reflect the market 
movements over the lookback period, and calculate margin levels 
accordingly. A VaR calculation that utilizes a relatively short 
lookback period would therefore respond with a sharper increase to a 
period of market volatility than a VaR calculation that utilizes a 
longer lookback period. Similarly, a VaR calculation that utilizes a 
short lookback period would respond with a sharper decrease once the 
period of market volatility recedes beyond lookback period. As a 
result, while a longer lookback period typically produces more 
stable VaR estimates over time, a shorter lookback period is 
typically more responsive to recent market events. See, e.g., 
Securities Exchange Act Release No. 80341 (March 30, 2017), 82 FR 
16644 (April 5, 2017) (SR-FICC-2017-801).
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    As described above in Section I.A., FICC provided backtesting data 
to demonstrate that during the period of extreme market volatility in 
March and April 2020, FICC's current model-based calculation and VaR 
Floor haircut generated VaR Charge amounts that were not sufficient to 
mitigate FICC's credit exposure to its members' portfolios at a 99 
percent confidence level.
    FICC designed the minimum margin amount calculation to better 
address the risks posed by member portfolios holding TBAs during such 
periods of extreme market volatility. As described in the Notice, FICC 
has provided data demonstrating that if the minimum margin amount had 
been in place, overall margin backtesting coverage (based on 12-month 
trailing backtesting) would have increased from approximately 99.3% to 
99.6% through January 31, 2020 and approximately 97.3% to 98.5% through 
June 30, 2020.\28\ The Commission has reviewed FICC's data and analysis 
(including detailed information regarding the impact of the proposed 
change on the portfolio of each FICC member over various time periods), 
and agrees that its results indicate that the proposed minimum margin 
amount would generate margin levels that should better enable FICC to 
cover the credit exposure arising from its members' portfolios. 
Moreover, the Commission believes that adding the minimum margin amount 
to FICC's margin methodology should allow FICC to collect margin that 
better reflects the risks and particular attributes of its members' 
portfolios during periods of extreme market

[[Page 35857]]

volatility. For these reasons, the Commission believes that 
implementing the minimum margin amount should help ensure that, in the 
event of a member default, FICC's operation of its critical clearance 
and settlement services would not be disrupted because of insufficient 
financial resources. Accordingly, the Commission finds that the minimum 
margin amount should help FICC to continue providing prompt and 
accurate clearance and settlement of securities transactions in the 
event of a member default, consistent with Section 17A(b)(3)(F) of the 
Act.
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    \28\ See Notice, supra note 3 at 79545.
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    Moreover, as described above in Section I.A., FICC would access the 
mutualized Clearing Fund should a defaulted member's own margin be 
insufficient to satisfy losses to FICC caused by the liquidation of 
that member's portfolio. The minimum margin amount should help ensure 
that FICC has collected sufficient margin from members, thereby 
limiting non-defaulting members' exposure to mutualized losses. The 
Commission believes that by helping to limit the exposure of FICC's 
non-defaulting members to mutualized losses, the minimum margin amount 
should help FICC assure the safeguarding of securities and funds which 
are in its custody or control, consistent with Section 17A(b)(3)(F) of 
the Act.
    The Commission believes that the Proposed Rule Change should also 
help protect investors and the public interest by mitigating some of 
the risks presented by FICC as a CCP. Because a defaulting member could 
place stresses on FICC with respect to FICC's ability to meet its 
clearance and settlement obligations upon which the broader financial 
system relies, it is important for FICC to maintain a robust margin 
methodology to limit FICC's credit risk exposure in the event of a 
member default. As described above in Section I.B., the proposed 
minimum margin amount likely would function as the VaR Charge during 
periods of extreme market volatility, particularly when TBA price 
changes could otherwise significantly exceed those projected by the 
model-based calculation and the current VaR Floor calculation. When 
applicable, the minimum margin amount would increase FICC's margin 
collection during periods of extreme market volatility. The minimum 
margin amount should help improve FICC's ability to collect sufficient 
margin amounts commensurate with the risks associated with its members' 
portfolios during periods of extreme market volatility. By enabling 
FICC to collect margin that more accurately reflects the risk 
characteristics of mortgage-backed securities and market conditions, 
FICC would be in a better position to absorb and contain the spread of 
any losses that might arise from a member default. Therefore, the 
minimum margin amount should reduce the possibility that FICC would 
need to utilize resources from non-defaulting members due to a member 
default, which could cause liquidity stress to non-defaulting members 
and inhibit their ability to facilitate securities transactions. 
Accordingly, because the minimum margin amount should help mitigate 
some of the risks presented by FICC as a CCP, the Commission believes 
that the proposal is designed to protect investors and the public 
interest, consistent with Section 17A(b)(3)(F) of the Act.
    Several commenters suggest that FICC's implementation of the 
minimum margin amount would not be in the public interest because it 
would burden markets in times of stress and force members to maintain 
additional reserve funding capacity.\29\ More specifically, commenters 
suggest that due to potentially increased margin requirements, small- 
and mid-sized broker-dealers will be forced to scale back their 
offerings of risk management tools and services to smaller originators, 
who will then turn to larger institutions for these tools and services. 
They suggest that this would result in a more concentrated market, or 
that smaller originators would not be able to obtain these tools and 
services, putting the smaller originators in a position in which they 
could not implement their desired risk management approaches or fully 
serve their customer bases.\30\
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    \29\ See Letter from James Tabacchi, Chairman, Independent 
Dealer and Trade Association, Mike Fratantoni, Chief Economist/
Senior Vice President, Mortgage Bankers Association (January 26, 
2021) (``IDTA/MBA Letter I'') at 2-3, 5; Letter from Christopher 
Killian, Managing Director, Securities Industry and Financial 
Markets Association (January 29, 2021) (``SIFMA Letter I'') at 2, 4; 
Letter from Christopher Killian, Managing Director, Securities 
Industry and Financial Markets Association (February 23, 2021) 
(``SIFMA Letter II'') at 2; Letter from Christopher A. Iacovella, 
Chief Executive Officer, American Securities Association (January 
28, 2021) (``ASA Letter'') at 1-2. The Commission further addresses 
these comments below in Sections II.C. and II.D. to the extent the 
comments raise issues related to Rules (e)(4)(i) and (e)(6)(i) under 
the Exchange Act. 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
    \30\ See id.
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    In response, FICC states that the Proposed Rule Change is not 
intended to advantage or disadvantage capital formation in any 
particular market segment.\31\ Instead, FICC states that the Proposed 
Rule Change focuses entirely on managing the clearance and settlement 
risk associated with TBAs.\32\
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    \31\ See FICC Letter at 4.
    \32\ See id.
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    The Commission acknowledges that the minimum margin amount could 
increase the margin required from some members, which may, in turn, 
cause such members to incur additional costs to access the liquidity 
needed to meet elevated margin requirements. Despite these potential 
impacts, the Commission believes that FICC has provided sufficient 
justification for the proposal. Specifically, FICC's backtesting data 
demonstrates that its current methodology did not generate enough 
margin during March and April 2020, and the proposed minimum margin 
amount would generate margin levels that should better enable FICC to 
cover the credit exposure arising from its members' portfolios.
    The Commission also acknowledges the possibility that, as a result 
of the Proposed Rule Change, some members might pass along some of the 
costs related to margin requirements such that these costs ultimately 
are borne, to some degree, by their clients. However, a non-defaulting 
member's exposure to mutualized losses resulting from a member default, 
and any consequent disruptions to clearance and settlement absent the 
Proposed Rule Change, might also increase costs to a member's clients 
and potentially adversely impact market participation, liquidity, and 
access to capital. The Proposed Rule Change, by helping to reduce 
counterparty default risk, would allow the corresponding portion of 
transaction costs to be allocated to more productive uses by members 
and their clients who otherwise would bear those costs.\33\ Moreover, 
as discussed above, by helping to limit the exposure of non-defaulting 
members to mutualized losses, the Proposed Rule Change should help FICC 
assure the safeguarding of securities and funds of its members that are 
in FICC's custody or control, consistent with Section 17A(b)(3)(F).
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    \33\ See Securities Exchange Act Release No. 78961 (September 
28, 2016), 81 FR 70786, 70866-67 (October 13, 2016) (S7-03-14) 
(``CCA Standards Adopting Release'').
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    While the Commission acknowledges that the proposal could result in 
certain FICC members raising the price of liquidity provision (or 
reducing the amount of liquidity provision) to their mortgage 
originator clients to account for increased margin requirements, a 
number of factors could mitigate such effects on market liquidity. 
First, to the extent that the minimum margin amount might raise margin 
requirements differently across MBS (e.g., higher coupon TBAs might 
generate higher margin requirements

[[Page 35858]]

than other MBS), market participants, including mortgage originators, 
could respond by trading more of the securities for which the minimum 
margin amount would not increase margin or would increase margin less 
than higher coupon TBAs. Alternatively, mortgage originators could 
hedge the interest rate risk of their mortgage pipelines by trading in 
other hedging instruments such as Treasury futures and mortgage option 
contracts.\34\
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    \34\ See Vickery, James I., and Joshua Wright. ``TBA trading and 
liquidity in the agency MBS market.'' Economic Policy Review 19, no. 
1 (2013).
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    Moreover, the Commission does not believe that the impact of the 
Proposed Rule Change would be that mortgage originators would raise 
mortgage rates in response to increased costs for liquidity. The 
ability of mortgage originators to raise mortgage rates depends in part 
on competition at the local loan market level, which could incentivize 
mortgage originators to avoid raising mortgage rates in spite of 
absorbing the costs associated with the minimum margin amount. Because 
competition between mortgage originators varies across local loan 
markets,\35\ their ability to raise mortgage rates likely also varies 
across markets. Mortgage originators in more competitive markets likely 
would have less ability to raise mortgage rates to pass on costs that 
may be associated with the Proposed Rule Change than mortgage 
originators in less competitive markets.\36\ Thus, it is unclear 
whether this proposal will have any effect on mortgage rates.
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    \35\ See Scharfstein, David, and Adi Sunderam. ``Market power in 
mortgage lending and the transmission of monetary policy.'' 
Unpublished working paper, Harvard University 2 (2016) (showing that 
county-level competition among mortgage originators, as measured by 
the market share of the top four mortgage originators concentration, 
varies across different counties in the U.S.).
    \36\ See id. at 3.
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    Further, the introduction of cost-saving technologies may lower 
mortgage origination costs and facilitate the entry of new mortgage 
originators operating on lower-cost business models.\37\ The entry of 
these new mortgage originators could limit the pricing power of 
incumbent mortgage originators in a given loan market. Finally, the 
Federal Reserve's continued commitment to purchasing agency MBS \38\ 
could continue to exert downward pressure on mortgage rates and 
mitigate an increase in mortgage rates, if any, by mortgage originators 
in response to Proposed Rule Change. FICC also provided confidential 
analysis as part of the Proposed Rule Change indicating that there does 
not appear to be a clear linkage between FICC margin amounts and 
community lenders' mortgage activity.
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    \37\ See Buchak, Greg, Gregor Matvos, Tomasz Piskorski, and Amit 
Seru. ``Fintech, regulatory arbitrage, and the rise of shadow 
banks.'' Journal of Financial Economics 130, no. 3 (2018): 453-483.
    \38\ In response to the COVID-19 outbreak, the Federal Open 
Market Committee (``FOMC'') announced that the Federal Reserve would 
purchase at least $200 billion of agency mortgage-backed securities 
over the coming months. While the Federal Reserve tapered purchases 
between April and May 2020, it restarted purchases in June 2020. 
(See https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm). On December 12, 2020, the FOMC directed the 
Federal Reserve Bank of New York to continue to purchase $40 billion 
of agency mortgage-backed securities per month. (See https://www.newyorkfed.org/markets/opolicy/operating_policy_201216).
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    Finally, the Commission believes that the impact of the minimum 
margin amount would be entirely determined by a member's portfolio 
composition and trading activity rather than the member's size or type. 
The Proposed Rule Change would calculate the VaR Charge based on the 
risks presented by positions in the member's portfolio. To the extent a 
member's VaR Charge would increase under the Proposed Rule Change, that 
increase would be based on the securities held by the member and FICC's 
requirement to collect margin to appropriately address the associated 
risk.
    Accordingly, notwithstanding the potential impact that the Proposed 
Rule Change might indirectly have on small mortgage originators, the 
Commission believes that such potential impacts are justified by the 
potential benefits to members and the resulting overall improved risk 
management at FICC described above (i.e., the prompt and accurate 
clearance and settlement of securities transactions and the 
safeguarding of securities and funds based on the collection of margin 
commensurate with the risks presented by TBAs), to render the Proposed 
Rule Change consistent with the investor protection and public interest 
provisions of Section 17A(b)(3)(F) of the Act.
    For the reasons discussed above, the Commission believes that the 
Proposed Rule Change is consistent with the requirements of Section 
17A(b)(3)(F) of the Act.\39\
---------------------------------------------------------------------------

    \39\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

B. Consistency With Section 17A(b)(3)(I) of the Act

    Section 17A(b)(3)(I) of the Act requires that the rules of a 
clearing agency do not impose any burden on competition not necessary 
or appropriate in furtherance of the Act.\40\ This provision does not 
require the Commission to find that a proposed rule change represents 
the least anticompetitive means of achieving the goal. Rather, it 
requires the Commission to balance the competitive considerations 
against other relevant policy goals of the Act.\41\
---------------------------------------------------------------------------

    \40\ 15 U.S.C. 78q-1(b)(3)(I).
    \41\ See Bradford National Clearing Corp., 590 F.2d 1085, 1105 
(D.C. Cir. 1978).
---------------------------------------------------------------------------

    The Commission received comments regarding the impacts the Proposed 
Rule Change might have on competition. One commenter argues that FICC 
has not explained how the additional margin collected pursuant to the 
minimum margin amount would be equitably distributed amongst members to 
avoid an unnecessary burden on competition.\42\ Several commenters 
argued that the proposal would disproportionately affect small- and 
mid-sized broker-dealer members rather than larger bank-affiliated 
broker-dealer members.\43\ One commenter states that FICC's impact 
study demonstrates that smaller members would bear a greater burden 
than larger members if the minimum margin amount were to be 
adopted.\44\ One commenter argues that larger members should bear more 
of the minimum margin amount burden because their business models 
likely include subsidiaries that confer an unfair advantage by enabling 
them to net their exposures.\45\
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    \42\ See Letter from James Tabacchi, Chairman, Independent 
Dealer and Trade Association, Mike Fratantoni, Chief Economist/
Senior Vice President, Mortgage Bankers Association (February 23, 
2021) (``IDTA/MBA Letter II'') at 3.
    \43\ See IDTA/MBA Letter I at 2-4, 6; IDTA/MBA Letter II at 2-3; 
ASA Letter at 1-2; SIFMA Letter I at 4.
    \44\ See IDTA/MBA Letter II at 2-3. Specifically, the commenter 
cites FICC's statement that during the impact study period, the 
largest dollar increase for any member would have been $333 million, 
or 37% increase in the VaR Charge. The commenter assumes that the 
member with the largest dollar increase is one of FICC's largest 
clearing members. The commenter also cites FICC's statement that the 
largest percentage increase in VaR Charge for any member would have 
been 146%, or $22 million. The commenter assumes that the member 
with the largest percentage increase is a smaller member. Thus, the 
commenter concludes that the minimum margin amount would affect 
smaller members more dramatically than larger members. Additionally, 
the commenter cites FICC's statement that the top 10 members based 
on size of the VaR Charges would have contributed 69.3% of the 
aggregate VaR Charges had the minimum margin amount been in place; 
whereas those 10 members only would be responsible for 54% of the 
additional margin collected pursuant to the minimum margin amount. 
Therefore, the commenter concludes that FICC's largest members would 
contribute disproportionately less than FICC's smaller members 
pursuant to the minimum margin amount.
    \45\ See Letter from James Tabacchi, Chairman, Independent 
Dealer and Trade Association (February 23, 2021) (``IDTA Letter'') 
at 2. The commenter also speculates that the business models of 
larger members that enable them to net their exposures likely 
increases concentration risk at those members, which the minimum 
margin amount does not address.

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[[Page 35859]]

    In response, FICC states that the Notice addressed concerns that 
the Proposed Rule Change would impose a burden on competition.\46\ 
Specifically, the Notice acknowledged that based on FICC's impact 
studies, the minimum margin amount would have increased members' VaR 
Charges by an average of approximately 42% during the impact study 
period, and that the Proposed Rule Change could impose a burden on 
competition.\47\ Additionally, the Notice stated that members may be 
affected disproportionately by the minimum margin amount because 
members with higher percentages of higher coupon TBAs in their 
portfolios were more likely to be impacted.\48\
---------------------------------------------------------------------------

    \46\ See FICC Letter at 3; Notice, supra note 3 at 79547-48.
    \47\ See id.
    \48\ See id.
---------------------------------------------------------------------------

    Regarding comments that the minimum margin amount would 
disproportionately affect smaller members, FICC acknowledges that the 
minimum margin amount could increase margin requirements as a result of 
extreme market volatility, and that it may also result in higher margin 
costs overall for members whose business is concentrated in higher 
coupon TBAs, relative to other members with more diversified 
portfolios.\49\ However, FICC states that the methodology for computing 
the minimum margin amount does not take into consideration the member's 
size or overall mix of business.\50\ Any effect the proposal would have 
on a particular member's margin requirement is solely a function of the 
default risk posed to FICC by the member's activity at FICC--firm size 
or business model is not pertinent to the assessment of that risk.\51\ 
Accordingly, FICC believes that the Proposed Rule Change does not 
discriminate against members or affect them differently on either of 
those bases.\52\
---------------------------------------------------------------------------

    \49\ See FICC Letter at 3; Notice, supra note 3 at 79545, 47.
    \50\ See FICC Letter at 4.
    \51\ See id.
    \52\ See id.
---------------------------------------------------------------------------

    The Commission acknowledges that the Proposed Rule Change could 
entail increased margin charges. In considering the costs and benefits 
of the requirements of Rule 17Ad-22(e)(6), the Commission expressly 
acknowledged that ``since risk-based initial margin requirements may 
cause market participants to internalize some of the costs borne by the 
CCP as a result of large or risky positions, confirming that margin 
models are well-specified and correctly calibrated with respect to 
economic conditions will help ensure that the margin requirements 
continue to align the incentives of a CCP's members with the goal of 
financial stability.'' \53\ Nevertheless, in response to the comments 
that the Proposed Rule Change would disproportionately affect small- 
and mid-sized broker-dealer members or those broker-dealer members that 
are not affiliated with large banks, the Commission believes that the 
impact of the minimum margin amount would be entirely determined by a 
member's portfolio composition and trading activity rather than the 
member's size or type. The Proposed Rule Change would calculate the VaR 
Charge based on the risks presented by positions in the member's 
portfolio. To the extent a member's VaR Charge would increase under the 
Proposed Rule Change, that increase would be based on the securities 
held by the member and FICC's requirement to collect margin to 
appropriately address the associated risk.
---------------------------------------------------------------------------

    \53\ See CCA Standards Adopting Release, supra note 33, 81 FR at 
70870. In addition, when considering the benefits, costs, and 
effects on competition, efficiency, and capital formation, the 
Commission recognized that a covered clearing agency, such as FICC, 
might pass incremental costs associated with compliance on to its 
members, and that such members may seek to terminate their 
membership with that CCA. See id., 81 FR at 70865. Moreover, when 
considering similar comments related to a proposed rule change 
designed to address a covered clearing agency's liquidity risk, the 
Commission concluded that the imposition of additional costs did not 
render the proposal inconsistent with the Act. See Securities 
Exchange Act Release No. 82090 (November 15, 2017), 82 FR 55427, 
55438 n. 209 (November 21, 2017) (SR-FICC-2017-002).
---------------------------------------------------------------------------

    In addition, as noted above, the Commission acknowledges that the 
impact of a higher margin requirement may present higher costs on some 
members relative to others due to a number of factors, such as access 
to liquidity resources, cost of capital, business model, and applicable 
regulatory requirements. These higher relative burdens may weaken 
certain members' competitive positions relative to other members.\54\ 
However, the Commission believes that such burden on competition 
stemming from a higher impact on some members than on others is 
necessary and appropriate in furtherance of the Act. FICC is required 
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, considers and produces margin levels commensurate with the 
risks and particular attributes of each relevant product, portfolio, 
and market.\55\ FICC's members include a large and diverse population 
of entities with a range of ownership structures.\56\ By participating 
in FICC, each member is subject to the same margin requirements, which 
are designed to satisfy FICC's regulatory obligation to manage the 
risks presented by its members. As discussed in more detail in Section 
II.D. below, the Proposed Rule Change is designed to ensure that FICC 
collects margin that is commensurate with the risks presented by each 
member's portfolio resulting from periods of extreme market volatility.
---------------------------------------------------------------------------

    \54\ These potential burdens are not fixed, and affected members 
may choose to restructure their liquidity sources, costs of capital, 
or business model, thereby moderating the potential impact of the 
Proposed Rule Change.
    \55\ See 17 CFR 240.17Ad-22(e)(6)(i).
    \56\ See FICC MBSD Membership Directory, available at https://www.dtcc.com/client-center/ficc-mbs-directories.
---------------------------------------------------------------------------

    Furthermore, FICC has provided data demonstrating that if the 
minimum margin amount had been in place, overall margin backtesting 
coverage (based on 12-month trailing backtesting) would have increased 
from approximately 99.3% to 99.6% through January 31, 2020 and 
approximately 97.3% to 98.5% through June 30, 2020.\57\ As noted above, 
the Commission has reviewed FICC's backtesting data and agrees that it 
indicates that had the minimum margin amount been in place during the 
study period, it would have generated margin levels that better reflect 
the risks and particular attributes of the member portfolios and help 
FICC achieve backtesting coverage closer to FICC's targeted confidence 
level. In turn, the Commission believes that the Proposed Rule Change 
would improve FICC's ability to maintain sufficient financial resources 
to cover its credit exposures to each member in full with a high degree 
of confidence. By helping FICC to better manage its credit exposure, 
the Proposed Rule Change would improve FICC's ability to mitigate the 
potential losses to FICC and its members associated with liquidating a 
member's portfolio in the event of a member default, in furtherance of 
FICC's obligations under Section 17A(b)(3)(F) of the Act.
---------------------------------------------------------------------------

    \57\ See Notice, supra note 3 at 79545.
---------------------------------------------------------------------------

    Therefore, for the reasons stated above, the Commission believes 
that the Proposed Rule Change is consistent with the requirements of 
Section 17A(b)(3)(I) of the Act \58\ because any competitive burden 
imposed by the Proposed Rule Change is necessary and appropriate in 
furtherance of the Act.
---------------------------------------------------------------------------

    \58\ 15 U.S.C. 78q-1(b)(3)(I).

---------------------------------------------------------------------------

[[Page 35860]]

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

    Rule 17Ad-22(e)(4)(i) under the Act requires that FICC 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.\59\
---------------------------------------------------------------------------

    \59\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    Several commenters question whether FICC has adequately 
demonstrated that the proposed minimum margin amount is consistent with 
Rule 17Ad-22(e)(4)(i) under the Exchange Act, arguing that there are 
more effective methods that FICC could use to mitigate the relevant 
risks. Three commenters argue that the model-based calculation is well-
suited to address FICC's credit risk in volatile market conditions, and 
instead of adding the minimum margin amount to its margin methodology, 
FICC should enhance this calculation to address periods of extreme 
market volatility such as occurred in March and April 2020.\60\
---------------------------------------------------------------------------

    \60\ See IDTA/MBA Letter I at 4-5; ASA Letter at 1; SIFMA Letter 
I at 2-3; Letter from Christopher Killian, Managing Director, 
Securities Industry and Financial Markets Association (February 23, 
2021) (``SIFMA Letter II'') at 1-2.
---------------------------------------------------------------------------

    In response to these comments, FICC explains that enhancing the 
model-based calculation would not be an effective approach towards 
mitigating the risk resulting from periods of extreme market 
volatility. Although the model-based calculation takes into account 
risk factors typical to TBAs, the extreme market volatility of March 
and April 2020 was caused by other factors (e.g., changes in the 
Federal Reserve purchase program) affecting TBA factors, yet such 
factors are not accounted for in the model-based calculation.\61\ To 
further demonstrate why the minimum margin amount is necessary, FICC 
relies upon the results of recent backtesting analyses demonstrating 
that its existing VaR Charge calculations did not respond effectively 
to the March and April 2020 levels of market volatility and economic 
uncertainty such that FICC's margin collections during that period did 
not meet its 99 percent confidence level.\62\
---------------------------------------------------------------------------

    \61\ See FICC Letter at 2-3.
    \62\ See FICC Letter at 3.
---------------------------------------------------------------------------

    The Commission believes that the proposed minimum margin amount is 
consistent with Rule 17Ad-22(e)(4)(i) under the Exchange Act.\63\ As 
described above, FICC's current VaR Charge calculations resulted in 
margin amounts that were not sufficient to mitigate FICC's credit 
exposure to its members' portfolios at FICC's targeted confidence level 
during periods of extreme market volatility, particularly when TBA 
price changes significantly exceeded those implied by the VaR model 
risk factors. The Commission believes that adding the minimum margin 
amount calculation to its margin methodology should better enable FICC 
to collect margin amounts that are sufficient to mitigate FICC's credit 
exposure to its members' portfolios.
---------------------------------------------------------------------------

    \63\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    In reaching this conclusion, the Commission thoroughly reviewed and 
analyzed the (1) Proposed Rule Change, including the supporting 
exhibits that provided confidential information on the calculation of 
the proposed minimum margin amount, impact analyses (including detailed 
information regarding the impact of the proposed change on the 
portfolio of each FICC member over various time periods), and 
backtesting coverage results, (2) comments received, and (3) 
Commission's own understanding of the performance of the current margin 
methodology, with which the Commission has experience from its general 
supervision of FICC, compared to the proposed margin methodology.\64\ 
Specifically, as discussed above, the Commission has considered the 
results of FICC's backtesting coverage analyses, which indicate that 
the current margin methodology results in backtesting coverage that 
does not meet FICC's targeted confidence level. FICC's backtesting data 
shows that if the minimum margin amount had been in place, overall 
margin backtesting coverage (based on 12-month trailing backtesting) 
would have increased from approximately 99.3% to 99.6% through January 
31, 2020 and approximately 97.3% to 98.5% through June 30, 2020.\65\ 
The analyses also indicate that the minimum margin amount would result 
in improved backtesting coverage towards meeting FICC's targeted 
coverage level. Therefore, the Commission believes that the proposal 
would provide FICC with a more precise margin calculation, thereby 
enabling FICC to manage its credit exposures to members by maintaining 
sufficient financial resources to cover such exposures fully with a 
high degree of confidence.
---------------------------------------------------------------------------

    \64\ In addition, because the proposals contained in the Advance 
Notice and the Proposed Rule Change are the same, all information 
submitted by FICC was considered regardless of whether the 
information was submitted with respect to the Advance Notice or the 
Proposed Rule Change. See supra note 9.
    \65\ See Notice, supra note 3 at 79545.
---------------------------------------------------------------------------

    In response to the comments regarding enhancing the model-based 
calculation instead of adding the minimum margin amount, the Commission 
believes that FICC's model-based calculation takes into account risk 
factors that are typical TBA attributes, whereas the extreme market 
volatility of March and April 2020 was caused by other external factors 
that are less subject to modeling. Thus, the commenters' preferred 
approach is not a viable alternative that would allow for consideration 
of such factors.
    Accordingly, for the reasons discussed above, the Commission 
believes that the changes proposed in the Proposed Rule Change are 
reasonably designed to enable FICC to effectively identify, measure, 
monitor, and manage its credit exposure to members, consistent with 
Rule 17Ad-22(e)(4)(i).\66\
---------------------------------------------------------------------------

    \66\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

D. Consistency With Rules 17Ad-22(e)(6)(i) and (iii)

    Rules 17Ad-22(e)(6)(i) and (iii) under the Act require that FICC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market, and calculates margin sufficient to cover its potential 
future exposure to participants.\67\
---------------------------------------------------------------------------

    \67\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
---------------------------------------------------------------------------

    One commenter suggests that the minimum margin amount would be 
inefficient and ineffective at collecting margin amounts commensurate 
with the risks presented by the securities in member portfolios.\68\ 
Several commenters argue that the proposed minimum margin amount 
calculation would produce sudden and persistent spikes in margin 
requirements.\69\ One commenter argues that the minimum margin amount 
would effectively replace FICC's existing model-based calculation with 
one likely to produce procyclical results by increasing margin 
requirements at times of increased market volatility.\70\ One commenter 
suggests the March-April 2020 market volatility was so unique that FICC 
need

[[Page 35861]]

not adjust its margin methodology to account for a future similar 
event.\71\
---------------------------------------------------------------------------

    \68\ See id.
    \69\ See IDTA/MBA Letter I at 5; ASA Letter at 2; SIFMA Letter I 
at 3-4.
    \70\ See IDTA/MBA Letter I at 5.
    \71\ See SIFMA Letter I at 3.
---------------------------------------------------------------------------

    In addition, one commenter argues that the proposed minimum margin 
amount is inconsistent with Rule 17Ad-22(e)(6)(i) because the minimum 
margin amount calculation is not reasonably designed to mitigate future 
risk due to its reliance on historical price movements that will not 
generate margin requirements that equate to future protections against 
market volatility.\72\ Two commenters argue that the proposed minimum 
margin amount calculation is not reasonably designed to mitigate future 
risks because the calculation relies on historical price movements, 
which will not necessarily generate margin amounts that will protect 
against future periods of market volatility.\73\ One commenter argues 
that the minimum margin amount is not necessary despite the March and 
April 2020 backtesting deficiencies because there were no failures or 
other events that caused systemic issues.\74\
---------------------------------------------------------------------------

    \72\ See IDTA/MBA Letter I at 4.
    \73\ See IDTA/MBA Letter I at 5; SIFMA Letter I at 2.
    \74\ See SIFMA Letter I at 2.
---------------------------------------------------------------------------

    Several commenters speculate that since the minimum margin amount 
is typically larger than the model-based calculation, the minimum 
margin amount will likely become the predominant calculation for 
determining a member's VaR Charge.\75\ One commenter argues that 
instead of the minimum margin amount, FICC should consider adding 
concentration charges to its margin methodology to address the relevant 
risks.\76\
---------------------------------------------------------------------------

    \75\ See IDTA/MBA Letter I at 4-5; ASA Letter at 1; SIFMA Letter 
I at 2-3.
    \76\ See IDTA/MBA Letter I at 5.
---------------------------------------------------------------------------

    In response, FICC states that any increased margin requirements 
resulting from the proposed minimum margin amount during periods of 
extreme market volatility would appropriately reflect the relevant 
risks presented to FICC by member portfolios holding large TBA 
positions.\77\ FICC also states that the minimum margin amount's 
reliance on observed price volatility with a shorter lookback period 
will provide margin that responds quicker during market volatility to 
limit FICC's exposures.\78\ FICC also notes that the margin increases 
that the minimum margin amount would have imposed following the March-
April 2020 market volatility would not have persisted at such high 
levels indefinitely.\79\
---------------------------------------------------------------------------

    \77\ See FICC Letter at 5-6.
    \78\ See id.
    \79\ See id.
---------------------------------------------------------------------------

    In addition, regarding whether the minimum margin amount will 
likely become the predominant calculation for determining a member's 
VaR Charge, FICC states that as the period of extreme market volatility 
stabilized and the model-based calculation recalibrated to current 
market conditions, the average daily VaR Charge increase decreased from 
$2.2 billion (i.e., 42%) to $838 million (i.e., 7%) during the fourth 
quarter of 2020.\80\ Regarding concentration charges, FICC states that 
concentration charges and the minimum margin amount address separate 
and distinct types of risk.\81\ Whereas the minimum margin amount is 
designed to cover the risk of market price volatility, concentration 
charges (e.g., FICC's recently approved Margin Liquidity Adjustment 
Charge \82\) are designed to mitigate the risk to FICC of incurring 
additional market impact cost from liquidating a directionally 
concentrated portfolio.\83\
---------------------------------------------------------------------------

    \80\ See FICC Letter at 5.
    \81\ See FICC Letter at 7-8.
    \82\ See Securities Exchange Act Release No. 90182 (October 14, 
2020), 85 FR 66630 (October 20, 2020) (SR-FICC-2020-009).
    \83\ See FICC Letter at 7-8.
---------------------------------------------------------------------------

    The Commission believes that the proposal is consistent with Rule 
17Ad-22(e)(6)(i). Implementing the proposed minimum margin amount would 
result in margin requirements that reflect the risks such holdings 
present to FICC better than FICC's current margin methodology. In 
reaching this conclusion and considering the comments above, the 
Commission thoroughly reviewed and analyzed the (1) Proposed Rule 
Change, including the supporting exhibits that provided confidential 
information on the calculation of the proposed minimum margin amount, 
impact analyses, and backtesting coverage results, (2) comments 
received, and (3) Commission's own understanding of the performance of 
the current margin methodology, with which the Commission has 
experience from its general supervision of FICC, compared to the 
proposed margin methodology. Based on its review and analysis of these 
materials, including the effect that the minimum margin amount would 
have on FICC's backtesting coverage, the Commission believes that the 
proposed minimum margin amount is designed to consider, and collect 
margin commensurate with, the market risk presented by member 
portfolios holding TBA positions, specifically during periods of market 
volatility such as what occurred in March and April 2020. For the same 
reasons, the Commission disagrees with the comments suggesting that the 
minimum margin amount calculation is not designed to effectively and 
efficiently collect margin sufficient to mitigate the risks presented 
by the securities.
    In response to comments regarding the sudden and persistent 
increases in margin that could arise from the minimum margin amount, 
the Commission acknowledges that, for some member portfolios in certain 
market conditions, application of the minimum margin amount calculation 
would result in an increase in the member's margin requirement based on 
the potential exposures arising from the TBA positions. The Commission 
notes that, by design, the minimum margin amount should respond more 
quickly to heightened market volatility because of its use of 
historical price data over a relatively short lookback period, as 
opposed to the model-based calculation which relies on risk factors and 
uses a longer lookback period.
    The Commission also observes, however, based on its review and 
analysis of FICC's confidential data and analyses, that the increase in 
margin requirements generated by the minimum margin amount--as compared 
to the other calculations--would generally only apply during periods of 
high market volatility and for a time period thereafter.\84\ The 
frequency with which the minimum margin amount would constitute a 
majority of members' margin requirements decreases as markets become 
less volatile, and therefore, is not expected to persist 
indefinitely.\85\ The Commission believes that including the minimum 
margin amount as a potential method of determining a member's margin 
requirement is appropriate, in light of the potential exposures that 
could arise in a time of heightened market volatility and the need for 
FICC to cover those exposures. Therefore, the Commission believes that 
the proposal would provide FICC with a margin calculation better 
designed to enable FICC to cover its credit exposures to its members by 
enhancing FICC's risk-based margin system to produce margin levels 
commensurate with, the risks and particular attributes of TBAs.
---------------------------------------------------------------------------

    \84\ FICC provided this data as part of its response to the 
Commission's Request for Additional Information in connection with 
the Advance Notice. Pursuant to 17 CFR 240.24b-2, FICC requested 
confidential treatment of its RFI response. See also FICC Letter at 
5.
    \85\ See FICC Letter at 5.
---------------------------------------------------------------------------

    In response to the comments regarding the potential procyclical 
nature of the minimum margin amount calculation and whether it is

[[Page 35862]]

appropriate for the margin methodology to take into account such 
extreme market events, the Commission notes that as a general matter, 
margin floors generally operate to reduce procyclicality by preventing 
margin levels from falling too low. Moreover, despite the commenters' 
procyclicality concerns, the Commission understands that the purpose of 
the minimum margin amount calculation is to ensure that FICC collects 
sufficient margin in times of heightened market volatility, which means 
that FICC would, by design, collect additional margin at such times if 
the minimum margin amount applies. The Commission believes that, 
because heightened market volatility may lead to increased credit 
exposure for FICC, it is reasonable for FICC's margin methodology to 
collect additional margin at such times and to be responsive to market 
activity of this nature.
    In response to the comment that the proposed minimum margin amount 
is not necessary because the March and April 2020 market volatility did 
not cause the failure of FICC members or otherwise cause broader 
systemic problems, the Commission disagrees. Similar to the 
Commission's analysis above, the relevant standard is not merely for 
FICC to maintain sufficient financial resources to avoid failures or 
systemic issues, but for FICC to cover its credit exposures to members 
with a risk-based margin system that produces margin levels 
commensurate with, the risks and particular attributes of each relevant 
product, portfolio, and market.\86\ During periods of extreme market 
volatility, FICC has demonstrated that adding the minimum margin amount 
to its margin methodology better enables FICC to manage its credit 
exposures to members by producing margin charges commensurate with the 
applicable risks. The Commission has reviewed and analyzed FICC's 
backtesting data, and agrees that the data demonstrate that the minimum 
margin amount would result in better backtesting coverage and, 
therefore, less credit exposure of FICC to its members. Accordingly, 
the Commission believes that the proposed minimum margin amount would 
enable FICC to better manage its credit risks resulting from periods of 
extreme market volatility.
---------------------------------------------------------------------------

    \86\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    In response to the comments regarding the minimum margin amount 
calculation's reliance on historical price movements, the Commission 
does not agree that Rule 17Ad-22(e)(6)(i) precludes FICC from 
implementing a margin methodology that relies, at least in part, on 
historical price movements or that FICC's margin methodology must 
generate margin requirements that ``equate to future protections 
against market volatility.'' FICC's credit exposures are reasonably 
measured both by events that have actually happened as well as events 
that could potentially occur in the future. For this reason, a risk-
based margin system is necessary for FICC to cover its potential future 
exposure to members.\87\ 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 
percent with respect to the estimated distribution of future 
exposure.\88\ Thus, to be consistent with its regulatory requirements, 
FICC must consider potential future exposure, which includes, among 
other things, losses associated with the liquidation of a defaulted 
member's portfolio.
---------------------------------------------------------------------------

    \87\ See 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).
    \88\ 17 CFR 240.17Ad-22(a)(13).
---------------------------------------------------------------------------

    In response to the comments regarding enhancing the model-based 
calculation instead of adding the minimum margin amount, the Commission 
believes that, as FICC stated in its response, the inputs to FICC's 
model-based calculation include risk factors that are typical TBA 
attributes, whereas the extreme market volatility of March and April 
2020, which affected the TBA markets, was caused by other external 
factors that are less subject to modeling. Accordingly, the Commission 
believes that FICC would more effectively cover its exposure during 
such periods by including the minimum margin amount as an alternative 
margin component based on the price volatility in each member's 
portfolio using observable TBA benchmark prices, using a relatively 
short lookback period.\89\
---------------------------------------------------------------------------

    \89\ See FICC Letter at 3.
---------------------------------------------------------------------------

    In response to the comments regarding whether the minimum margin 
amount will likely become the predominant calculation for determining a 
member's VaR Charge, the Commission disagrees. For example, the average 
daily VaR Charge increase from February 3, 2020 through June 30, 2020 
would have been approximately $2.2 billion or 42%, but as the model-
based calculation took into account the current market conditions, the 
average daily increase during Q4 of 2020 would have been approximately 
$838 million or 7%.\90\
---------------------------------------------------------------------------

    \90\ See FICC Letter at 5. The Commission's conclusion is also 
based upon information that FICC submitted confidentially regarding 
member-level impact of the proposal from February through December 
2020.
---------------------------------------------------------------------------

    Finally, in response to the comments regarding concentration 
charges, the Commission notes that there is a distinction between 
concentration charges and the VaR Charge in that they are generally 
designed to mitigate different risks. Whereas the VaR Charge is 
designed to cover the risk of market price volatility, concentration 
charges are typically designed to mitigate the risk of incurring 
additional market impact cost from liquidating a directionally 
concentrated portfolio.\91\
---------------------------------------------------------------------------

    \91\ See Securities Exchange Act Release No. 34-90182 (October 
14, 2020), 85 FR 66630 (October 20, 2020).
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    Accordingly, the Commission believes that adding the minimum margin 
amount to FICC's margin methodology would be consistent with Rules 
17Ad-22(e)(6)(i) and (iii) because this new margin calculation should 
better enable FICC to establish a risk-based margin system that 
considers and produces relevant margin levels commensurate with the 
risks associated with liquidating member portfolios in a default 
scenario, including volatility in the TBA market.\92\
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    \92\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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E. 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.\93\
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    \93\ 17 CFR 240.17Ad-22(e)(23)(ii).
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    Several commenters express concerns that the Proposed Rule Change 
does not provide sufficient information to enable FICC's members to 
identify and evaluate the minimum margin amount. Two commenters argue 
that FICC's margin calculations are opaque, which makes liquidity 
planning difficult for members.\94\ In particular, these commenters 
express concern that the minimum margin amount could trigger sudden 
margin spikes that could result in forced selling or other market 
disruptions.\95\ One commenter argues that since the Proposed Rule 
Change

[[Page 35863]]

would set a member's VaR Charge as the greater of the model-based 
calculation, current VaR Floor haircut, and the minimum margin amount, 
members would always need to be prepared to fund the minimum margin 
amount, which makes it difficult for members to identify and evaluate 
the material costs associated with their trading activities.\96\ Two 
commenters argue that the Proposed Rule Change did not discuss the 
anticipated impacts on members' cost to do business or disparate 
impacts between large and small members.\97\ One commenter argues that 
enhancing the model-based calculation would better enable members to 
understand the causes of increased margin requirements than the minimum 
margin amount.\98\ One commenter claims that at the time of its comment 
letter, FICC had not yet provided members with updated impact studies 
demonstrating that as 2020 market volatility stabilized, the minimum 
margin amount and model-based calculation became more aligned.\99\ One 
commenter claims that FICC has not explained which entities contributed 
to the March and April 2020 backtesting deficiencies, or how any 
reduced Backtesting Charges during the impact study period were 
equitably distributed among members.\100\ One commenter states that 
while the proposed lookback period for the minimum margin amount would 
be two years, the period FICC appears to have used to determine a 
deficit in the desired 99 percent coverage ratio is only one 
month.\101\ Finally, one commenter argues that the minimum margin 
amount is difficult to evaluate because FICC did not discuss whether 
the minimum margin amount would cause additional member obligations 
with respect to FICC's Capped Contingency Liquidity Facility 
(``CCLF'').\102\
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    \94\ See SIFMA Letter I at 4; ASA Letter at 2.
    \95\ See id.
    \96\ See SIFMA Letter II at 2.
    \97\ See SIFMA Letter I at 4; ASA Letter at 2.
    \98\ See SIFMA Letter I at 4.
    \99\ See IDTA/MBA Letter I at 3.
    \100\ See IDTA/MBA Letter I at 3; IDTA/MBA Letter II at 3.
    \101\ See SIFMA Letter I at 3.
    \102\ See SIFMA Letter I at 4. CCLF is a rules-based, committed 
liquidity resource designed to enable FICC to meet its cash 
settlement obligations in the event of a default of the member or 
family of affiliated members to which FICC has the largest exposure 
in extreme but plausible market conditions. See MBSD Rule 17, supra 
note 15.
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    In response to the comments, the Commission notes that FICC 
provided a detailed member-level impact analysis of the minimum margin 
amount as part of the Proposed Rule Change filing.\103\ FICC discussed 
the impact analysis in the narrative of the Proposed Rule Change in 
general terms to avoid disclosing confidential member information.\104\
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    \103\ As part of the Proposed Rule Change, FICC filed Exhibit 
3--FICC Impact Studies. Pursuant to 17 CFR 240.24b-2, FICC requested 
confidential treatment of Exhibit 3.
    \104\ See Notice, supra note 3 at 79545.
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    Additionally, FICC responds that it has provided its members with 
explanations regarding the effects of the minimum margin amount, 
including updated impact study data through the fourth quarter of 
2020.\105\ FICC further states that it provides ongoing tools and 
resources to assist its members to determine their margin requirements 
and the anticipated impact of the minimum margin amount.\106\ 
Specifically, FICC maintains the Real Time Matching Report Center, 
Clearing Fund Management System, and FICC Customer Reporting service, 
which are member-accessible websites for accessing risk reports and 
other risk disclosures.\107\ These websites enable a member to view and 
download margin requirement information and component details.\108\ The 
reporting enables a member to view, for example, a portfolio breakdown 
by CUSIP, including the amounts attributable to the model-based 
calculation.\109\ In addition, members are able to view and download 
spreadsheets that contain market amounts for current clearing 
positions, and the associated VaR Charge.\110\ FICC also maintains the 
FICC Risk Client Portal, which is a member-accessible website that 
enables members to view and analyze certain risks related to their 
portfolios, including daily customer reports and calculators to assess 
the risk and margin impact of certain activities.\111\ FICC maintains 
the FICC Client Calculator that enables members to enter ``what-if'' 
position data and recalculate their VaR Charge to determine margin 
impact before trade execution.\112\ Finally, the FICC Client Calculator 
allows members to see the impact to the VaR Charge if specific 
transactions are executed, or to anticipate the impact of an increase 
or decrease to a current clearing position.\113\
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    \105\ See FICC Letter at 6.
    \106\ See id.
    \107\ See id.
    \108\ See id.
    \109\ See id.
    \110\ See id.
    \111\ See FICC Letter at 6-7.
    \112\ See FICC Letter at 7.
    \113\ See id.
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    Regarding the comment that although the proposed lookback period 
for the minimum margin amount would be two years, the period FICC 
appears to have used to determine a deficit in the desired 99 percent 
coverage ratio is only one month, FICC states that the minimum margin 
amount lookback period is for the model calibration, whereas the 
backtesting coverage calculation is based on rolling 12 months.\114\
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    \114\ See FICC Letter 5.
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    Finally, regarding CCLF, FICC states margin requirements and CCLF 
obligations are not directly related, and each is designed to account 
for different risks.\115\ Margin requirements are designed to address 
the market risk inherent in each member's portfolio and mitigate 
potential losses to FICC associated with liquidating a member's 
portfolio in a default scenario. CCLF is a rules-based liquidity tool 
designed to ensure that MBSD has sufficient liquidity resources to 
complete settlement in the event of the failure of FICC's largest 
member (including affiliates). FICC does not believe that CCLF 
procedures or member obligations would need to be modified as a result 
of implementing the minimum margin amount.\116\
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    \115\ See FICC Letter at 7.
    \116\ See id.
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    For the foregoing reasons, the Commission disagrees with the 
comments stating that the Proposed Rule Change does not provide 
sufficient information to enable members to identify and evaluate the 
risks and other material costs they incur by participating in FICC or 
that the Proposed Rule Change does not allow members to predict the 
minimum margin amount's impact on their activities. The Commission 
acknowledges that, as some commenters have noted, the Proposed Rule 
Change does not provide or specify the actual models or calculations 
that FICC would use to determine the minimum margin amount. However, 
when adopting the CCA Standards,\117\ 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

[[Page 35864]]

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 FICC to disclose its actual 
margin methodology, so long as FICC has provided sufficient information 
for its members to understand the potential costs and risks associated 
with participating in FICC.
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    \117\ 17 CFR 240.17Ad-22(e).
    \118\ See CCA Standards Adopting Release, supra note 33, 81 FR 
at 70845.
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    For the reasons discussed above, the Commission believes that the 
Proposed Rule Change would enable FICC 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 FICC's members, consistent with Rule 17Ad-22(e)(23)(ii).\119\
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    \119\ 17 CFR 240.17Ad-22(e)(23)(ii).
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular with the requirements of Section 17A of the Act \120\ and 
the rules and regulations promulgated thereunder.
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    \120\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\121\ that proposed rule change SR-FICC-2020-017, be, and hereby is, 
approved.\122\
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    \121\ 15 U.S.C. 78s(b)(2).
    \122\ In approving the proposed rule change, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f). See also Sections II.A. and 
II.B.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\123\
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    \123\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-14390 Filed 7-6-21; 8:45 am]
BILLING CODE 8011-01-P