Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Granting Approval of a Proposed Rule Change To Introduce Cross-Margining of Certain Positions Cleared at the Fixed Income Clearing Corporation and Certain Positions Cleared at New York Portfolio Clearing, LLC, 12144-12155 [2011-4836]

Download as PDF 12144 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices Filing Dates: The applications were filed on December 9, 2010, and amended on February 11, 2011. Applicants’ Address: 9920 Corporate Campus Drive, Suite 1000, Louisville, Kentucky 40223. For the Commission, by the Division of Investment Management, pursuant to delegated authority. Elizabeth M. Murphy, Secretary. [FR Doc. 2011–4861 Filed 3–3–11; 8:45 am] BILLING CODE 8011–01–P II. Description SECURITIES AND EXCHANGE COMMISSION The proposed rule change allows FICC to offer cross-margining of certain positions cleared at its Government Securities Division (‘‘GSD’’) and certain positions cleared at New York Portfolio Clearing, LLC (‘‘NYPC’’).5 GSD members [File No. 500–1] Advanced Optics Electronics, Inc.; Order of Suspension of Trading March 2, 2011. It appears to the Securities and Exchange Commission that there is a lack of current and accurate information concerning the securities of Advanced Optics Electronics, Inc. because it has not filed any periodic reports since the period ended March 31, 2007. The Commission is of the opinion that the public interest and the protection of investors require a suspension of trading in Advanced Optics Electronics, Inc. Therefore, it is ordered, pursuant to Section 12(k) of the Securities Exchange Act of 1934, that trading in the securities of the above-listed company is suspended for the period from 9:30 a.m. EST on March 2, 2011, through 11:59 p.m. EDT on March 15, 2011. By the Commission. Jill M. Peterson, Assistant Secretary. [FR Doc. 2011–5038 Filed 3–2–11; 4:15 pm] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION jlentini on DSKJ8SOYB1PROD with NOTICES [Release No. 34–63986; File No. SR–FICC– 2010–09] Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Granting Approval of a Proposed Rule Change To Introduce Cross-Margining of Certain Positions Cleared at the Fixed Income Clearing Corporation and Certain Positions Cleared at New York Portfolio Clearing, LLC February 28, 2011. I. Introduction On November 12, 2010, Fixed Income Clearing Corporation (‘‘FICC’’) filed with the Securities and Exchange VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 Commission (‘‘Commission’’) proposed rule change SR–FICC–2010–09 pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’ or ‘‘Act’’).1 Notice of the proposed rule change was published in the Federal Register on November 30, 2010.2 The Commission initially received thirteen comments to the proposed rule change.3 FICC, as well as one of the commenters, submitted letters responding to the comments.4 For the reasons discussed below, the Commission is granting approval of the proposed rule change. 1 15 U.S.C. 78s(b)(1). Exchange Act Release No. 63361 (November 23, 2010), 75 FR 74110 (November 30, 2010) (FICC–2010–09). In its filing with the Commission, FICC included statements concerning the purpose of and basis for the proposed rule change. The text of these statements are incorporated into the discussion of the proposed rule change in Section II below. 3 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010); Letter from Douglas Engmann, President, Engmann Options, Inc. (December 6, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); Letter from John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of ELX Futures, LP (December 15, 2010); Letter from John Willian, Managing Director, Goldman Sachs (December 17, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010); Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010); Letter from Gary DeWaal, Senior Managing Director and Group General Counsel, Newedge USA, LLC (December 21, 2010); Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from William H. Navin, Executive Vice President and General Counsel, The Options Clearing Corporation (December 21, 2010); and Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010). 4 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011); Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011); Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011); and Letter from Alex Kogan, Vice President and Deputy General Counsel, NASDAQ OMX (January 10, 2011). 5 NYPC is jointly owned by NYSE Euronext and The Depository Trust & Clearing Corporation (‘‘DTCC’’). DTCC is the parent company of FICC. On January 31, 2011, the Commodity Futures Trading Commission (‘‘CFTC’’) approved NYPC’s registration as a derivatives clearing organization (‘‘DCO’’) 2 Securities PO 00000 Frm 00132 Fmt 4703 Sfmt 4703 will be able to combine their positions at GSD with their positions at NYPC, or those positions of certain permitted affiliates cleared at NYPC, within a single margin portfolio (‘‘Margin Portfolio’’). The proposed rule change also makes certain other related changes to GSD’s rules. A. Cross-Margining With NYPC Under the proposed rule, a member of FICC that is also an NYPC clearing member (‘‘Joint Clearing Member’’) could in accordance with the provisions of the GSD and NYPC Rules, elect to participate in the cross-margining arrangement. FICC’s rules permit a GSD netting member that is a member (or that has an affiliate that is a member) of one or more Futures Clearing Organizations (‘‘FCO’’),6 such as NYPC, to become a cross-margining participant in a cross-margining arrangement between FICC and one or more FCOs with the consent of FICC and each such FCO. A netting member shall become a cross-margining participant upon acceptance of FICC and each applicable FCO of an agreement executed by such cross-margining participant in the form specified in the applicable crossmargining agreement.7 Participating in the cross-margining arrangement would permit a Joint Clearing Member to have its margin requirement calculated taking into account both its positions at FICC and NYPC, which should provide a clearer picture of its risk exposure and generally facilitate better risk assessment by FICC. Specifically, each Joint Clearing Member would have its margin requirement with respect to Eligible Positions (i.e., positions in certain securities netted by FICC or certain futures contracts cleared by an FCO) 8 in its proprietary account at pursuant to Section 5b of the Commodity Exchange Act and Part 39 of the Regulations of the CFTC. 6 ‘‘FCO’’ is defined in GSD Rule 1 as a clearing organization for a board of trade designated as a contract market under Section 5 of the Commodity Exchange Act that has entered into a CrossMargining Agreement with FICC. 7 See GSD Rule 43, Cross-Margining Arrangements, Section 2. The cross-margining agreement between FICC and NYPC as well as the cross-margining participant agreements for joint and permitted affiliates are attached to FICC’s filing of proposed rule change SR–FICC–2010–09. 8 The term ‘‘Eligible Position’’ is currently defined in GSD’s rules as a position in certain Eligible Netting Securities netted by FICC, or certain Government securities futures contracts or interest rate futures contracts cleared by a FCO as identified in a Cross-Margining Agreement as eligible for cross-margining treatment. ‘‘Eligible Netting Security’’ is defined in GSD Rule 1 as an Eligible Security that FICC has designed as eligible for netting. ‘‘Eligible Security’’ is defined generally in GSD Rule 1 as a security issued or guaranteed by the E:\FR\FM\04MRN1.SGM 04MRN1 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices jlentini on DSKJ8SOYB1PROD with NOTICES NYPC and its margin requirement with respect to Eligible Positions at FICC calculated as a single portfolio, which would factor in the net risk of such Eligible Positions at both clearing organizations. In addition, an affiliate of a member of FICC that is also a clearing member of NYPC (‘‘Permitted Margin Affiliate’’) 9 could similarly elect to participate in the cross-margining arrangement and have its margin requirement with respect to Eligible Positions in its proprietary account at NYPC calculated as a single portfolio with the Eligible Positions of the FICC member. The proposed rule allows (i) Joint Clearing Members and (ii) members of FICC and their Permitted Margin Affiliates to have their margin requirements for positions at FICC and NYPC determined as a single portfolio, with FICC and NYPC each having a security interest in such members’ and Permitted Margin Affiliates’ margin deposits and other collateral to secure their obligations to FICC and NYPC. The following types of FICC members will not be eligible to participate in the cross-margining arrangement (‘‘NYPC Arrangement’’), in order to allow FICC to maintain segregation of certain business or member types that are treated differently for purposes of loss allocation: (i) GSD Sponsored Members,10 (ii) Inter-Dealer Broker Netting Members,11 and (iii) Dealer United States, a U.S. government agency or instrumentality, a U.S. government-sponsored corporation, or any other security approved by FICC’s board of directors from time to time, or one or more categories of such securities as represented by a generic CUSIP number, that FICC has listed on the Eligible Securities master file maintained by it pursuant to GSD Rule 30. 9 The term ‘‘Permitted Margin Affiliate’’ is being added to GSD Rule 1 and is defined as an affiliate of a Member that is (i) also a member of GSD, and/ or (ii) a member of an FCO with which FICC has entered into a Cross-Margining Agreement that provides for margining of positions between FICC and the FCO as if such positions were in a single portfolio and that directly or indirectly controls such particular member, or that is directly or indirectly controlled by or under common control with such particular member. Ownership of more than 50% of the common stock of the relevant entity (or equivalent equity interests in the case of a form of entity that does not issue common stock) will be conclusive evidence of prima facie control of such entity for purposes of this definition. 10 A ‘‘Sponsored Member’’ of GSD is any person that has been approved by FICC to be sponsored into membership by a ‘‘Sponsoring Member’’ pursuant to GSD Rule 3A. A ‘‘Sponsoring Member’’ is a member of GSD’s comparison and netting system whose application to become a sponsoring member has been approved by the FICC’s board of directors pursuant to GSD Rule 3A. See GSD Rule 1, Definitions. 11 The definition of ‘‘Inter-Dealer Broker Netting Member,’’ as revised by the proposed rule change, is an inter-dealer broker admitted to membership in GSD’s netting system. See GSD Rule 2A, Initial Membership Requirements. VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 Netting Members 12 with respect to their segregated brokered accounts. In addition, in order for a Bank Netting Member 13 to combine its accounts into a Margin Portfolio with any other accounts, it will have to demonstrate to the satisfaction of FICC and NYPC that doing so will comply with the regulatory requirements applicable to the Bank Netting Member (e.g., by providing an opinion of counsel or otherwise outlining compliance with relevant statutory provisions).14 In order to distinguish the NYPC Arrangement from an existing crossmargining arrangement between the Chicago Mercantile Exchange (‘‘CME’’) and FICC (‘‘CME Arrangement’’), the proposed rule amends the definition of ‘‘Cross-Margining Agreement’’ in the GSD rules to mean an agreement entered into between FICC and one or more FCOs pursuant to which a CrossMargining Participant,15 in accordance with the provisions of the GSD Rules and otherwise at the discretion of FICC, could elect to have its Required Fund Deposit 16 with respect to Eligible Positions at FICC, and its (or its Permitted Margin Affiliates’ Required Fund Deposit, if applicable) margin requirements with respect to Eligible Positions at such FCO(s), calculated either (i) by taking into consideration the net risk of such Eligible Positions at each of the clearing organizations or (ii) as if such positions were in a single portfolio. The CME Arrangement falls 12 The definition of a ‘‘Dealer Netting Member,’’ as revised by the proposed rule change, is a registered government securities dealer admitted to membership in GSD’s netting system. See GSD Rule 2A, Initial Membership Requirements. 13 Under GSD Rule 2A, a person shall be eligible to apply to become a ‘‘Bank Netting Member’’ of GSD if it is a bank or trust company chartered as such under the laws of the United States, or a State thereof, or is a bank or trust company established or chartered under the laws of a non-U.S. jurisdiction, and participates in FICC through its U.S. branch or agency. A bank or trust company that is admitted to membership in GSD’s netting system, the netting system, pursuant to these Rules, and whose membership in the netting system has not been terminated, shall be a Bank Netting Member. See GSD Rule 2A, Initial Membership Requirements, Section 2. 14 See GSD Rule 4, Clearing Fund and Loss Allocation, Section 1a as proposed to be amended by the proposed rule change. 15 The term ‘‘Cross-Margining Participant’’ is defined in GSD Rule 1 as a Netting Member that is authorized by FICC to participate in the CrossMargining Arrangement between FICC and one or more FCOs pursuant to a Cross-Margining Agreement. GSD Rule 1 defines the term ‘‘CrossMargining Arrangement’’ as the arrangement established between FICC and one or more FCOs pursuant to Cross-Margining Agreements and GSD Rule 43. 16 The definition of ‘‘Required Fund Deposit,’’ as revised by the proposed rule change, is the amount that a Netting Member is required by a GSD rule to contribute to GSD’s clearing fund. See GSD Rule 1, Definitions. PO 00000 Frm 00133 Fmt 4703 Sfmt 4703 12145 into clause (i) of the definition, whereas the NYPC Arrangement will fall into clause (ii). Conforming changes will be made to GSD Rule 1, Definitions, relating to cross-margining. GSD Rule 43, Cross-Margining Arrangements, also will be amended to add provisions regarding single-portfolio margining (i.e., the proposed NYPC Arrangement). To implement this proposal, FICC and NYPC will enter into a cross-margining agreement (‘‘NYPC Agreement’’). The NYPC Agreement was filed with the Commission as part of proposed rule change SR–FICC–2010–09 and will be appended to the GSD Rules and made a part thereof. Pursuant to the NYPC Agreement, and consistent with previous approvals of cross-margining arrangements involving DCOs,17 cross-margining with certain NYPC positions will be limited to positions carried in proprietary accounts of clearing members of NYPC. Customers of NYPC clearing members will not be permitted to participate in the NYPC Arrangement, as their participation would require the resolution of additional issues associated with fund segregation and operations. Neither FICC nor NYPC rules require their members to participate in the NYPC Arrangement, and any such participation by FICC and NYPC members will be voluntary. Joint Clearing Members and members of FICC and their Permitted Margin Affiliates will be required to execute the requisite cross-margining participant agreements.18 FICC will be responsible for performing the margin calculations in its capacity as the Administrator under the terms of the NYPC Agreement. Specifically, FICC will determine the combined FICC clearing fund and NYPC original margin requirement for each participant.19 FICC will calculate those requirements using a Value-at-Risk (‘‘VaR’’) methodology, with a 99-percent confidence level and a 3-day liquidation period for cash positions and a 1-day liquidation period for futures positions. In addition, each cross-margining participant’s ‘‘one-pot’’ margin requirement will be subject to a daily 17 See, e.g., Securities Exchange Act Release No. 44301 (May 11, 2001), 66 FR 28207 (approving a proposed rule change establishing cross-margining between FICC and CME) and Securities Exchange Act Release No. 27296 (September 26, 1989), 54 FR 41195 (approving a proposed rule change establishing cross-margining between The Options Clearing Corporation and the CME). 18 The NYPC Agreement and the cross-margining participant agreements for Joint Members and Permitted Affiliates were filed with the Commission as part of the proposed rule change. 19 Original margin is the NYPC equivalent of the FICC clearing fund. E:\FR\FM\04MRN1.SGM 04MRN1 jlentini on DSKJ8SOYB1PROD with NOTICES 12146 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices back test, and a supplemental riskrelated charge referred to as a coverage component that will be applied to the participant in the event that the back test reflects insufficient coverage. The ‘‘one-pot’’ margin requirement for each participant would then be allocated between FICC and NYPC in proportion to the clearing organizations’ respective ‘‘stand-alone’’ margin requirements—in other words, an amount reflecting the ratio of what each clearing organization would have required from that participant if it was not participating in the cross-margining program (‘‘Constituent Margin Ratio’’). The NYPC Agreement provides that either FICC or NYPC can, at any time, require additional margin to be deposited by a Cross-Margining Participant above what is calculated under the NYPC Agreement based upon the financial condition of the participant, unusual market conditions, or other special circumstances (e.g., in the event of regulatory or criminal proceedings). The standards that FICC proposes to use for these purposes are the standards currently contained in the GSD rules, so that notwithstanding the calculation of a Cross-Margin Participant’s clearing fund requirement pursuant to the NYPC Agreement, FICC will retain its rights under the GSD rules to charge additional clearing fund contributions under the circumstances specified in the GSD rules. For example, the GSD rules provide that if a Dealer Netting Member falls below its minimum financial requirement, it shall be required to make additional clearing fund contributions equal to the greater of (i) $1 million or (ii) 25 percent of its Required Fund Deposit. FICC will utilize the same VaR methodology for calculating margin for futures and cash positions. Under this method, the prior 250 days of historical information for futures positions and the prior 252 days of historical information for cash positions, including prices, spreads and market variables such as Treasury zero-coupon yields and London Interbank Offered Rate curves, are used to simulate the market environments in the forthcoming 1 day for futures positions and the forthcoming 3 days for cash positions. Projected portfolio profits and losses are calculated assuming these simulated environments will actually be realized. These simulations will be used to calculate VaR. Historical simulation is a continuation of the FICC margin methodology. With respect to the confidence level, FICC currently utilizes extreme value VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 theory 20 to determine the 99th percentile of loss distribution. Upon implementation of the NYPC Arrangement, FICC will utilize a frontweighting mechanism to determine the 99th percentile of loss distribution. This front-weighting mechanism will place more emphasis on more recent observations. Additionally, FICC’s VaR methodology will be enhanced to accommodate more securities; as a result, certain CUSIPs, which are now considered to be ‘‘non-priceable’’ (because, for example, of a lack of historical information regarding the security) and subject to a ‘‘haircut’’ requirement (i.e., fixed percentage charge) where offsets are not permitted, will be treated as ‘‘priceable’’ and therefore included in the core VaR calculation. Based on preliminary analyses, FICC expects that the FICC VaR component of the clearing fund requirement may be reduced by as much as approximately 20 percent for common FICC–NYPC members as a result of the NYPC Arrangement. In order to help ensure that this reduction in clearing fund is appropriately correlated to more precise assessment of exposures associated with considering offsetting positions and will not result in increased risks to the clearing agency, FICC has performed back testing analysis to verify that there will be sufficient coverage after the FICC–NYPC cross-margining reductions are applied. In the event of the insolvency or default of a member that participates in the NYPC Arrangement, the positions in such participant’s ‘‘one-pot’’ portfolio, including, where applicable, the positions of its Permitted Margin Affiliate at NYPC, will be liquidated by FICC and NYPC as a single portfolio and the liquidation proceeds will be applied to the defaulting participant’s obligations to FICC and NYPC in accordance with the provisions of the NYPC Agreement. The NYPC Agreement provides for the sharing of losses by FICC and NYPC in the event that the ‘‘one-pot’’ portfolio margin deposits of a defaulting participant are not sufficient to cover the losses resulting from the liquidation of that participant’s trades and positions. This loss-sharing arrangement can be summarized as follows: • If either clearing organization had a net loss (‘‘worse-off party’’), and the other had a net gain (‘‘better-off party’’) that is equal to or exceeds the worse-off 20 Extreme value theory is used to analyze outcomes beyond the 99 percent confidence interval used for VaR and provides an assessment of the size of these events. PO 00000 Frm 00134 Fmt 4703 Sfmt 4703 party’s net loss, then the better-off party pays the worse-off party the amount of the latter’s net loss. In this scenario, one clearing organization’s gain will extinguish the entire loss of the other clearing organization. • If either clearing organization had a net loss (‘‘worse-off party’’) and the other clearing organization had a net gain (‘‘better-off party’’) that is less than or equal to the worse-off party’s net loss, then the better-off party will pay the worse-off party an amount equal to the net gain. Thereafter, if such payment did not extinguish the net loss of the worse-off party, the better-off party will pay the worse-off party an amount equal to the lesser of: (i) The amount necessary to ensure that the net loss of each clearing organization is in proportion to the Constituent Margin Ratio or (ii) the better-off party’s ‘‘Maximum Transfer Payment’’ less the better-off party’s net gain. The ‘‘Maximum Transfer Payment’’ will be defined with respect to each clearing organization to mean an amount equal to the product of (i) the sum of the aggregate margin reductions of the clearing organizations and (ii) the other clearing organization’s Constituent Margin Ratio—in other words, the amount by which the other clearing organization reduced its margin requirements in reliance on the crossmargining arrangement. In this scenario, one clearing organization’s gain does not completely extinguish the entire loss of the other clearing organization, and the better-off party will be required to make an additional payment to the worse-off party. This potential additional payment will be capped as described in this paragraph. • If either clearing organization had a net loss, and the other had the same net loss, a smaller net loss, or no net loss, then: Æ In the event that the net losses of the clearing organizations were in proportion to the Constituent Margin Ratio, no payment will be made. Æ In the event that the net losses of the clearing organizations were not in proportion to the Constituent Margin Ratio, then the clearing organization that had a net loss which was less than its proportionate share of the total net losses incurred by the clearing organizations (‘‘better-off party’’) will pay the other clearing organization (‘‘worse-off party’’) an amount equal to the lesser of: (i) The better-off party’s Maximum Transfer Payment or (ii) the amount necessary to ensure that the clearing organizations’ respective net losses were allocated between them in proportion to the Constituent Margin Ratio. E:\FR\FM\04MRN1.SGM 04MRN1 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices • If FICC had a net gain after making a payment as described above, FICC will pay to NYPC the amount of any deficiency in the defaulting member’s customer segregated funds accounts or, if applicable, such defaulting member’s Permitted Margin Affiliate held at NYPC up to the amount of FICC’s net gain. • If FICC received a payment under the Netting Contract and Limited CrossGuaranty (‘‘Cross-Guaranty Agreement’’) 21 to which it is a party (i.e., because FICC had a net loss), and NYPC had a net loss, FICC will share the cross-guaranty payment with NYPC pro rata, where such pro rata share is determined by comparing the ratio of NYPC’s net loss to the sum of FICC’s and NYPC’s net losses. This allocation is appropriate because the ‘‘one-pot’’ combines FICC and NYPC proprietary positions into a unified portfolio that will be margined and liquidated as a single unit. FICC will no longer need to share the cross-guaranty payments with NYPC once NYPC becomes a party to the Cross-Guaranty Agreement. The GSD rules will further provide that FICC will offset its liquidation results in the event of a close out of the positions of a Cross-Margining Participant in the NYPC Agreement first with NYPC because the liquidation will essentially be of a single Margin Portfolio and then will present its results for purposes of the multilateral Cross-Guaranty Agreement. B. Access to NYPC Arrangement jlentini on DSKJ8SOYB1PROD with NOTICES FICC has represented that the NYPC Arrangement has been structured in a way that access to, and the benefits of, the ‘‘one-pot’’ are provided to other futures exchanges and DCOs on fair and reasonable terms as described below. The proposed ‘‘one-pot’’ cross-margining method is expected to allow members to post margin that should more accurately reflect the net risk of their aggregate positions across asset classes, thereby releasing excess capital into the economy for more efficient use. By linking positions in fixed income securities held at FICC with interest rate products traded on NYSE Liffe U.S. and other designated contract markets 21 FICC’s predecessors, the Government Securities Clearing Corporation (‘‘GSCC’’) and the MBS Clearing Corporation (‘‘MBSCC’’), filed rule filings in 2001 to enter into the Cross-Guaranty Agreement with The Depository Trust Company, National Securities Clearing Corporation, Emerging Markets Clearing Corporation, and The Options Clearing Corporation. Securities Exchange Act Release No. 45868 (May 2, 2002), 67 FR 31394. Under the agreement, if the assets of a defaulting member at one clearing agency exceed its liabilities to that clearing agency, those excess assets may be made available to satisfy the liabilities of that defaulting common member to another clearing agency. VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 (‘‘DCMs’’), the NYPC Arrangement has the potential to create a substantial pool of highly correlated assets that are capable of being cross-margined. This pool will deepen as more DCOs and DCMs join NYPC, creating the potential for even greater margin and risk offsets. The proposed ‘‘one-pot’’ is required to be accessed by other futures exchanges and DCOs via NYPC.22 FICC stated that this is done to ensure the uniformity and consistency of risk methodologies and risk management, to simplify and standardize operational requirements for new participants and to maximize the effectiveness of the one-pot arrangement. FICC stated that NYPC will initially clear certain contracts transacted on NYSE Liffe U.S. and that NYPC will clear for additional DCMs that seek to clear through NYPC as soon as it is feasible for NYPC do so. Such additional DCMs will be treated in the same way as NYSE Liffe US, i.e., they must: (i) Be eligible under the rules of NYPC, (ii) contribute to NYPC’s guaranty fund, (iii) demonstrate that they have the operational and technical ability to clear through NYPC, and (iv) enter into a clearing services agreement with NYPC. Moreover, NYPC has also committed to admit other DCOs as limited purpose participants as soon as it is feasible, thereby allowing such DCOs to participate in the one-pot margining arrangement with FICC through their limited purpose membership in NYPC.23 Such DCOs will be required to satisfy pre-defined, objective criteria set forth in NYPC’s rules.24 In particular, such DCOs must: (i) Submit trades subject to the limited purpose participant agreement between NYPC and each DCO that would otherwise be cleared by the DCO to NYPC, with NYPC acting as central counterparty and 22 Section 16 of the NYPC Agreement provides that FICC covenants and agrees that, during the term of the NYPC Agreement: (i) NYPC-cleared contracts shall have priority for margin offset purposes over any other cross-margining agreement; (ii) FICC will not enter into any other crossmargining agreement if such agreement would adversely affect the priority of NYPC and FICC under the NYPC Agreement with respect to available assets; and (iii) FICC will not, without the prior written consent of NYPC, amend the CME Agreement, if such further amendment would adversely affect NYPC’s right to cross-margin positions in eligible products prior to any crossmargining of CME positions with FICC-cleared contracts or adversely affect the priority of NYPC and FICC under the NYPC Agreement with respect to available assets. 23 See NYPC Agreement, Section 14. 24 NYPC’s rules can be viewed as part of NYPC’s DCO registration application on the CFTC’s Web site (http://.www.cftc.gov), as well as on NYPC’s Web site (http://www.nypclear.com). PO 00000 Frm 00135 Fmt 4703 Sfmt 4703 12147 DCO with respect to such trades,25 (ii) be eligible under the rules of NYPC and agree to be bound by the NYPC rules,26 (iii) contribute to NYPC’s guaranty fund,27 (iv) provide clearing services to unaffiliated markets on a ‘‘horizontal’’ basis (i.e., not limit their provision of clearing services on a vertical basis to a single market or limited number of markets),28 and (v) agree to participate using the uniform risk methodology and risk management policies, systems and procedures that have been adopted by FICC and NYPC for implementation and administration of the NYPC Arrangement.29 Reasonable clearing fees will be allocated between NYPC and the limited purpose participant DCO as may be agreed by NYPC and the DCO, taking into account factors such as the cost of services (including capital expenditures incurred by NYPC), technology that may be contributed by the limited purpose participant, the volume of transactions, and such other factors as may be relevant. FICC and NYPC anticipate that the limited purpose participant agreement will encompass the foregoing requirements for limited purpose membership contained in NYPC’s rules. Because each DCO could present different operational issues, terms beyond the basic rules provisions will be discussed on a case-by-case basis and reflected in the respective limited purpose participant agreement accordingly. FICC and NYPC envision that a possible structure for DCO limited purpose participation could be an omnibus account, with the DCO limited purpose participant essentially acting as 25 See NYPC Rule 801(b)(1). NYPC Rule 801(b)(2). 27 The NYPC Agreement provides that except as otherwise provided in a limited purpose participant agreement, a limited purpose participant shall make a contribution to the NYPC Guaranty Fund in form and substance similar to and in an amount that is no less than the amount of the NYSE Guaranty, which will initially consist of a $50,000,000 guaranty secured by $25,000,000 in cash during the first year of NYPC’s operations. FICC and NYPC have subsequently clarified and affirmatively represented that the limited purpose participant agreements will be individually negotiated and that ‘‘the Guaranty Fund contribution that will be required by NYPC from any Limited Purpose Participant will be determined by risk-based factors without regard to whether such contribution amount is more or less than the amount contributed to the NYPC Guaranty Fund by NYSE Euronext.’’ See Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011). See also Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). 28 See NYPC Rule 801(c)(1)(i). 29 See NYPC Rule 801(c)(1)(ii). 26 See E:\FR\FM\04MRN1.SGM 04MRN1 12148 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices jlentini on DSKJ8SOYB1PROD with NOTICES a processing agent for its clearing members vis-a-vis NYPC with respect to the submission of eligible positions of the DCO’s clearing members to NYPC for purposes of inclusion in the one-pot arrangement with FICC. In order for their eligible positions to be included in the ‘‘one-pot,’’ clearing members of the DCO limited purpose participant would be required to authorize the DCO to submit their positions to NYPC. Under such a structure, the DCO would be responsible for fulfilling all margin and guaranty fund requirements associated with the activity in the omnibus account. With respect to both the clearance of trades for unaffiliated DCMs and the admission of DCOs as limited purpose participants, FICC has indicated that NYPC has committed that it will complete the process to allow one or more DCMs or DCOs to be admitted and integrated into the ‘‘one-pot’’ crossmargining arrangement as soon as feasible, but no later than 24 months from the start of operations. FICC has represented that this provision is necessary to the effective implementation of the one-pot crossmargining methodology and that this window of time is required to allow for refinement and enhancement of certain systems after operations commence, to allow time for the possible simultaneous integration with multiple major clearing members so that fair market access is assured, and to allow time for the completion of the material operational challenge of connecting and integrating NYPC with the separate technologies of other DCMs and/or DCOs. However, during this interim period, NYPC may engage, and FICC has represented in its filing to the Commission that NYPC is engaging, in discussions with other DCMs and DCOs. FICC has also represented in its filing that NYPC anticipates that it will be able to complete the integration of additional DCMs and/or DCOs in advance of this two-year period. C. Other GSD Proposed Rule Changes The proposed rule filing allows FICC to permit margining of positions held in accounts of an affiliate of a member within GSD, akin to the inter-affiliate margining in the CME Arrangement and the proposed NYPC Arrangement. Thus, as in those arrangements, if a GSD member defaults, its GSD clearing fund deposits, cash settlement amounts and other available collateral will be available to FICC to cover the member’s default, as will the GSD clearing fund deposits and available collateral of any Permitted Margin Affiliate with which it cross-margins. VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 1. Loss Allocation Under the current loss allocation methodology in GSD Rule 4, Clearing Fund and Loss Allocation, GSD allocates losses first to the most recent counterparties of a defaulting member. The proposed changes to GSD Rule 4 will delete this step in the loss allocation methodology in order to achieve a more even distribution of losses among GSD members without a focus on recent counterparties. Under the proposed rule change any loss allocation will be made first against the retained earnings of FICC attributable to GSD in an amount up to 25 percent of FICC’s retained earnings or such higher amount as may be approved by the Board of Directors of FICC. If a loss still remains, GSD will divide the loss between the FICC Tier 1 Netting Members and the FICC Tier 2 Netting Members. The terms ‘‘Tier 1 Netting Member’’ and ‘‘Tier 2 Netting Member’’ have been introduced in the GSD Rules to reflect two different categories of membership, which have been designated as such by FICC for loss allocation purposes. Currently, only investment companies registered under the Investment Company Act of 1940, as amended, (which companies are subject to regulatory requirements restricting their ability to mutualize losses) will qualify as Tier 2 Netting Members. Tier 2 Netting Members will only be subject to loss to the extent they traded with the defaulting members and will not be responsible for mutualizing losses with participants with which they do not trade, in order to account for regulatory requirements applicable to such registered investment companies. Tier 1 Netting Members will be allocated the loss applicable to them first by assessing the Clearing Fund deposit of each such member in the amount of up to $50,000, equally. If a loss remains, Tier 1 Netting Members will be assessed ratably in accordance with the respective amounts of their Required Fund Deposits based on the average daily amount of the member’s Required Fund Deposit over the prior twelve months. Consistent with the current GSD rules, GSD members that are acting as inter-dealer brokers will be limited to a loss allocation of $5 million with respect to their inter-dealer broker activity. 2. Margin Calculation—Intraday Margin Calls GSD proposes to calculate Clearing Fund requirements twice per day. GSD will retain its regular calculation and call as set out in the GSD rules. An PO 00000 Frm 00136 Fmt 4703 Sfmt 4703 additional daily intra-day calculation and call (‘‘Intraday Supplemental Clearing Fund Deposit’’) are being added to GSD’s rules.30 The intra-day call will be subject to a threshold that will be identified in FICC’s risk management procedures.31 In addition, GSD will process a mark-to-market pass-through twice per day, instead of the current practice of once daily. The second collection and pass-through of mark-tomarket amounts will include a limited set of components to be defined in FICC’s risk management procedures. All mark-to-market debits will be collected in full. FICC will pay out mark-tomarket credits only after any intra-day clearing fund deficit is met. Since GSD will be recalculating and margining a GSD member’s exposure intra-day, the margin calculation methodology set forth in GSD Rule 4, Clearing Fund and Loss Allocation, will be revised to eliminate the ‘‘Margin Requirement Differential’’ component of the FICC clearing fund calculation. In addition, GSD Rule 4 will be revised to provide that in the case of a Margin Portfolio that contains accounts of a Permitted Margin Affiliate, FICC will apply the highest VaR confidence level applicable to the GSD member or the Permitted Margin Affiliate, in the event that multiple confidence levels are used to determine margin. Application of a higher VaR confidence level will result in a higher margin rate. Consistent with current GSD rules, a minimum Required Fund Deposit of $5 million will apply to a member that maintains broker accounts. 3. Consolidated Funds-Only Settlement The funds-only settlement process at GSD currently requires a member to appoint a settling bank that will settle the member’s net debit or net credit amount due to or from GSD by way of the National Settlement Service of the Board of Governors of the Federal Reserve System (‘‘NSS’’). Any fundsonly settling bank that will settle for a member that is also an NYPC member or that will settle for a member and a Permitted Margin Affiliate that is an NYPC member will have its net-net credit or debit balances at each clearing corporation, other than balances with respect to futures positions of a ‘‘customer’’ as such term is defined in 30 See GSD Rule 4, Clearing Fund and Loss Allocation, Section 2a as proposed to be amended by the proposed rule change. 31 Id. FICC shall establish procedures for collection of an amount calculated in respect of a Member’s Intraday Supplemental Fund Deposit, including parameters regarding threshold amounts that require payment, and the form and time by which payment is required to be made to FICC. E:\FR\FM\04MRN1.SGM 04MRN1 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices CFTC Regulation 1.3(k), aggregated and netted for operational convenience and will pay or be paid such netted amount. The proposed rule change makes clear that, notwithstanding the consolidated settlement, the member will remain obligated to GSD for the full amount of its funds-only settlement amount. 4. Submission of Locked-In Trades from NYPC The current GSD rules allow for submission of ‘‘locked-in trades’’ (i.e., trades that are deemed compared when the data on the trade is received from a single source) 32 submitted by a lockedin trade source on behalf of a GSD member. Currently, designated lockedin trade sources are Federal Reserve Banks on behalf of the Treasury Department, Freddie Mac, and GCFAuthorized Inter-Dealer Brokers for GCF Repo transactions. Under the proposed rule change, GSD Rule 6C, Locked-In Comparison, will be amended to include NYPC as an additional lockedin trade source. This is necessary because there will be futures transactions cleared by NYPC that will proceed to physical delivery. NYPC will submit the trade data as a locked-in trade source for processing through FICC, identifying the GSD member that had authorized FICC to accept the locked-in trade from NYPC. Once these transactions are submitted to FICC, they will no longer be futures, but rather will be in the form of buys or sells eligible for processing by GSD. As will be the case with other locked-in trade submissions accepted by FICC, the GSD member designated in the trade information must have executed appropriate documentation evidencing to FICC its authorization of NYPC. jlentini on DSKJ8SOYB1PROD with NOTICES 5. Deletion of the Category 1/Category 2 Distinction The proposed rule change will delete the legacy characterization of certain types of members as either ‘‘Category 1’’ or ‘‘Category 2,’’ a distinction that currently applies to ‘‘Dealer Netting Members,’’ ‘‘Futures Commission Merchant Netting Members’’ and ‘‘InterDealer Broker Netting Members’’ at GSD. Historically, the two categories were 32 The term ‘‘Locked-In Trade’’ means a trade involving Eligible Securities that is deemed a compared trade once the data on such trade is received from a single, designated source and meets the requirements for submission of data on a locked-in trade pursuant to GSD’s rules, without the necessity of matching the data regarding the trade with data provided by each member that is or is acting on behalf of an original counterparty to the trade. The data regarding a locked-in trade are provided to FICC by a locked-in trade source that has been authorized by a member that is a party to the trade to provide such data to FICC. VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 used to margin lower capitalized members (i.e., Category 2) at a higher rate. Following FICC’s adoption of the VaR methodology for GSD in 2006,33 FICC has determined that the distinction between Category 1 and Category 2 members is no longer necessary. Rather than margin netting members at higher rates solely due to a single static capitalization threshold, FICC is able, by use of the VaR margin methodology, to margin netting members at a higher rate by applying a higher confidence level against any netting member, which, regardless of size, FICC has determined poses a higher risk. With the deletion of the Category 1/ Category 2 distinction, Section 1 of GSD Rule 13, Funds-Only Settlement, is proposed to be changed to provide that all netting members could receive forward mark adjustment payments, subject to FICC’s general discretion to withhold credits that would be otherwise due to a distressed netting member. 6. Amendment of CME Agreement The proposed NYPC Arrangement will necessitate an amendment to the CME Agreement to clarify that the NYPC Arrangement will take priority over the CME Arrangement when determining residual FICC positions that will be available for crossmargining with the CME. As a result, only those FICC positions that are not able to be cross-margined with NYPC positions under the NYPC Arrangement will generally be considered for crossmargining with the CME. In addition, when calculating and presenting liquidation results under the CME Agreement, the amendment will provide that FICC’s liquidation results will include FICC’s liquidation results in combination with NYPC’s liquidation results because the NYPC Agreement will provide for a right of first offset between FICC and NYPC. The CME Agreement showing the proposed changes was filed as an attachment to the proposed rule change as part of Exhibit 5. D. Summary of Other Proposed Changes to Rule Text In GSD Rule 1, Definitions, the following definitions are proposed to be added, revised or deleted: The terms ‘‘Broker Account’’ and ‘‘Dealer Account’’ will be added to the text of the GSD Rules. A ‘‘Broker Account’’ is an account that is maintained by an inter-dealer broker 33 Securities Exchange Act Release No. 55217 (January 31, 2007), 72 FR 5774. PO 00000 Frm 00137 Fmt 4703 Sfmt 4703 12149 netting member, or a segregated broker account of a netting member that is not an inter-dealer broker netting member. An account that is not a Broker Account is referred to as a Dealer Account. ‘‘Coverage Charge’’ will be revised to refer to the additional charge with respect to the member’s Required Fund Deposit (rather than its VaR Charge) which brings the member’s coverage to a targeted confidence level. ‘‘Current Net Settlement Positions’’ will be corrected to clarify its current intent, that it is calculated with respect to a certain business day and not necessarily on that day, since it may be calculated after market close on the day prior to its application (i.e., before or after midnight between the close of business one day and the open of business on the next day). ‘‘Excess Capital Differential’’ will be corrected to refer to the amount by which a member’s VaR Charge exceeds its excess capital, instead of by reference to the amount by which its required clearing fund deposit exceeds its excess capital. ‘‘Excess Capital Premium Calculation Amount’’ will be deleted because, with the introduction of VaR methodology, the calculation is no longer applicable. The terms ‘‘Excess Capital Differential’’ and ‘‘Excess Capital Ratio’’ will be amended to delete archaic references to ‘‘Excess Capital Premium Calculation Amount’’ and to refer instead to the comparison of a member’s capital calculation to its VaR Charge. In addition, the text of Section 14 of GSD Rule 3 will be amended to provide that the ‘‘Excess Capital Premium’’ charge applies to any type of entity that is a GSD netting member rather than limiting its applicability to only the specified types formerly identified in the text. ‘‘Excess Capital Ratio’’ will be amended to mean the quotient resulting from dividing the amount of a member’s VaR Charge by its excess net capital. ‘‘GSD Margin Group’’ will be added to refer to the GSD accounts within a Margin Portfolio. ‘‘Margin Portfolio’’ will be added to refer to the positions designated by the member as grouped for cross-margining, subject to the rules set forth in GSD Rule 4. ‘‘Dealer Accounts’’ and ‘‘Broker Accounts’’ cannot be combined in a common Margin Portfolio. A ‘‘Sponsoring Member Omnibus Account’’ cannot be combined with any other accounts. ‘‘Unadjusted GSD Margin Portfolio Amount’’ will be added to define the amount calculated by GSD with regard to a Margin Portfolio, before application of premiums, maximums or minimums. E:\FR\FM\04MRN1.SGM 04MRN1 12150 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices jlentini on DSKJ8SOYB1PROD with NOTICES It includes the VaR Charge and the coverage charge for GSD. In the case of a Cross-Margining Participant of GSD, the Unadjusted GSD Margin Portfolio Amount also will include the crossmargining reduction, if any. The terms ‘‘Category 2 Gross Margin Amount,’’ ‘‘Margin Adjustment Amount,’’ ‘‘Repo Volatility Factor,’’ and ‘‘Revised Gross Margin Amount’’ will be deleted from GSD Rule 1 since they are no longer used elsewhere in the GSD Rules. The Schedule of Repo Volatility Factors will be deleted because it is no longer applicable. In Section 2 of GSD Rule 3, Ongoing Membership Requirements, the requirement that GCF counterparties submit information relating to the composition of their NFE-related accounts,34 will be amended to require the submission of such information periodically, rather than on a quarterly basis. GSD currently requires this information every other month and by this change, FICC could institute periodic reporting on a schedule that is appropriate at such time, in response to current conditions. This has the potential to help tailor the frequency of reporting based on market conditions and thereby facilitate the risk management of the clearing agency. In Section 9 of GSD Rule 4, Clearing Fund and Loss Allocation, concerning the return of excess deposits and payments, FICC’s discretion to withhold the return of excess clearing fund to a member that has an outstanding payment obligation to FICC will be changed from being based on FICC’s determination that the member’s anticipated transactions or obligations over the next 90 calendar days may be reasonably expected to be materially different than those of the 90 prior calendar days, under the current rule, to being based on FICC’s determination that the member’s anticipated transactions or obligations in the near future may be reasonably expected to be materially different than those in the recent past. In addition, technical and clarifying changes are proposed to be made to the rules and cross-references to rule sections contained throughout. The rules have been reviewed by FICC and proposed to be corrected as needed 34 The term ‘‘NFE-Related Account’’ means each securities account and deposit account maintained by a GCF Clearing Agent Bank for an Interbank Pledging Member in which the GCF Clearing Agent Bank has, pursuant to agreement with the Interbank Pledging Member or by operation of law, a security interest or right of setoff securing or supporting the payment of obligations of such Interbank Pledging Member to the Bank, including each such account to which such Interbank Pledging Member’s Prorated Interbank Cash Amount is debited. See GSD Rule 1, Definitions. VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 to reflect the correct rule section references as originally intended. III. Comments The Commission received thirteen comments to the proposed rule change and four response letters responding to comments.35 Nine commenters supported the proposed rule.36 Of this group, seven commenters generally stated that the cross-margining proposal benefits competition by permitting ‘‘open access’’ to cross-margining.37 In addition, six commenters argued that the proposed rule change permits risk minimization 38 and promotes transparency.39 35 See supra notes 3 and 4. from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from Gary DeWaal, Senior Managing Director and Group General Counsel, Newedge USA, LLC (December 21, 2010); Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010); Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); Letter from John Willian, Managing Director, Goldman Sachs (December 17, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); Letter from Douglas Engmann, President, Engmann Options, Inc. (December 6, 2010); and Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010). 37 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); Letter from John Willian, Managing Director, Goldman Sachs (December 17, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from Gary DeWaal, Senior Managing Director and Group General Counsel, Newedge USA, LLC (December 21, 2010); and Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010). 38 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010); Letter from Douglas Engmann, President, Engmann Options, Inc. (December 6, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010). 39 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010). 36 Letter PO 00000 Frm 00138 Fmt 4703 Sfmt 4703 Three commenters opposed the proposed rule, absent changes to mitigate what they identified as anticompetitive features.40 One commenter recommended further study of the rule and its risk methodology, but agreed with the commenters opposing the proposed rule change on the grounds that the rule should permit only nonexclusive arrangements that promote competition.41 The commenters against the proposed rule change generally stated that the cross-margining scheme is anti-competitive and raises risk management issues. These commenters raised concerns or provided comments related to the following major aspects of the cross-margining proposal: (1) The effect on competition; (2) risk management; and (3) the effect on efficiency and costs. FICC responded to these comments in three comment letters that it submitted.42 A. Effect on Competition Many of the commenters’ concerns with respect to competition stemmed from FICC having an exclusive agreement to enter into a direct arrangement for ‘‘one-pot’’ crossmargining with NYPC.43 NYPC is jointly owned by NYSE Euronext and DTCC. DTCC is the parent company of FICC. NYSE Liffe is the global derivatives business of the NYSE Euronext. These affiliations combined with the exclusive nature of the direct arrangement raised concerns for these commenters. With regard to allowing other parties direct access to cross-margining, FICC argued that it is neither operationally feasible nor prudent to establish a framework of multiple, competing ‘‘one40 Letter from William H. Navin, Executive Vice President and General Counsel, The Options Clearing Corporation (December 21, 2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of ELX Futures, LP (December 15, 2010); and Letter from John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 2010). 41 Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010). 42 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011); Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). 43 Letter from William H. Navin, Executive Vice President and General Counsel, The Options Clearing Corporation (December 21, 2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 2010); and Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010). E:\FR\FM\04MRN1.SGM 04MRN1 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices jlentini on DSKJ8SOYB1PROD with NOTICES pots’’ with multiple, competing DCOs under this arrangement.44 Among other things, such an arrangement would result in FICC clearing members that are members of multiple DCOs crossmargining their futures positions against different segments of their portfolios at FICC, rather than having the risk of their positions being measured comprehensively.45 FICC stated that it believes that the attendant risk of delays and errors in processing would substantially increase systemic risk as clearing members continuously moved positions at FICC from one cross-margin pot to another in order to maximize their margin savings.46 For example, there is the potential that operational issues of managing such movements across multiple systems would create risks in the settlement process by adding complexities associated with linking and monitoring the use of multiple one cross-margin pot arrangements. Furthermore, FICC stated that the existence of multiple ‘‘one-pots’’ would likely greatly complicate the liquidation of a cross-margining participant that was in default at FICC and NYPC, thereby increasing systemic risk.47 Commenters recognized that other DCOs (i.e., DCOs other than NYPC) will have the ability to obtain indirect access to the cross-margining arrangement by entering into a Limited Purpose Participant (‘‘LPP’’) agreement and becoming an LPP of NYPC. Commenters raised concerns about the potential for this type of indirect access, citing concerns about the requirements to agree to be bound by the rules of NYPC, agree to an allocation of clearing fees, and contribute to the NYPC guaranty fund in an amount equal to the contribution made by NYSE Euronext.48 FICC responded to these comments.49 Specifically, FICC stated that, while 44 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). 45 Id. 46 Id. 47 Id. 48 Letter from William H. Navin, Executive Vice President and General Counsel, The Options Clearing Corporation (December 21, 2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 2010); and Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010). 49 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011) and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation; Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 DCOs that are LPPs clearing through NYPC would need to abide by NYPC’s rules, NYPC’s intention is that there would be separate requirements (including with respect to margin deposits and guaranty fund contributions applied) to the LPP, on the one hand, and the LPP’s members, on the other, unless: (i) NYPC and the LPP separately agree to allocate those amounts to the LPP and its members, or (ii) a clearing member of NYPC is also a clearing member of an LPP.50 FICC and NYPC also represented that the NYPC rules would apply to a LPP but not to the members of the LPP, unless such members are otherwise clearing members of NYPC.51 In addition, FICC noted that NYPC Rule 801 is designed to permit maximum flexibility in structuring the admission of LPPs, as it is contemplated that any such admission would be subject to substantial negotiation between NYPC and the prospective LPP regarding the operational mechanics of margin deposits and related subjects.52 In addition, FICC has represented to the Commission that the fees NYPC charges LPPs will be determined on a case-by-case basis based on the services provided to recoup operational and other costs that NYPC incurs in integrating the new LPP.53 Moreover, FICC and NYPC clarified and affirmatively represented that the limited purpose participant agreements will be individually negotiated and that ‘‘the Guaranty Fund contribution that will be required by NYPC from any Limited Purpose Participant will be determined by risk-based factors without regard to whether such contribution amount is more or less than the amount contributed to the Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). 50 Id. 51 Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). 52 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011) and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011). 53 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011); Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). PO 00000 Frm 00139 Fmt 4703 Sfmt 4703 12151 NYPC Guaranty Fund by NYSE Euronext’’.54 Three commenters also noted that under the proposed structure, it may take up to two years before other DCMs are permitted to clear at NYPC or before other DCOs might be given indirect access in order to participate in the NYPC Arrangement, which may cause commercial impairment.55 Two other commenters, however, argued that the delay is not unduly burdensome on competition,56 with one in particular explaining that ‘‘[a]ny new arrangement needs the requisite time to ensure that it satisfies all of the underlying concerns and issues that may occur with any new concept’’.57 FICC responded, saying that the transition period is necessary to complete implementation, systems integration, and testing, among other things, and that it and NYPC have pledged to open the arrangement to other participants as soon as operationally feasible.58 FICC also stated that attempting to integrate a preexisting clearinghouse directly into the ‘‘one-pot’’ cross-margining arrangement would by necessity be even more difficult and likely more costly than the integration between FICC and NYPC, which was created in order to crossmargin positions with FICC.59 In 54 Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011) and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). 55 Letter from Richard D. Marshall, Ropes & Gray on behalf of ELX Futures, LP (December 15, 2010); Letter from William H. Navin, Executive Vice President and General Counsel, The Options Clearing Corporation (December 21, 2010); and Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010). 56 Letter from Gary DeWaal, Senior Managing Director and Group General Counsel, Newedge USA, LLC (December 21, 2010) and Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010). 57 Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010). 58 FICC represented that ‘‘[f]ollowing the announcement of NYPC, FICC, the NYPC management team and senior management of NYSE Euronext have repeatedly reached out to [The Options Clearing Corporation], as well as other DCOs and DCMs, to initiate the process of integrating such other organizations into the ‘single pot’. While those efforts have not yet been productive, FICC and NYPC remain committed to expanding the ‘single pot’ to include other DCOs and DCMs.’’ Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). See also supra Section II.B., at 16. 59 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation E:\FR\FM\04MRN1.SGM Continued 04MRN1 12152 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices addition, FICC has previously stated that NYPC has committed that it will complete the process to allow one or more DCMs or DCOs to be admitted and integrated into the ‘‘one-pot’’ crossmargining arrangement as soon as feasible, but no later than 24 months from the start of operations. The nine commenters in favor of the proposed rule change generally argued that the rule change will increase competition in trade execution and clearing which, in turn, will encourage innovation, efficiency, and improved choices.60 Furthermore, FICC also indicated that its proposal promotes competition. Specifically, FICC stated that ‘‘[u]nlike the traditional ‘vertical’ relationship between futures exchanges and their affiliated * * * DCOs * * *, NYPC has been uniquely structured * * * to allow unaffiliated DCOs and * * * DCMs * * * ‘open access’ to the benefits of the ‘single pot’ crossmargining arrangement as soon as operationally feasible, subject to only certain object, reasonable and nondiscriminatory criteria’’.61 FICC also stated that the current market for clearing U.S. dollar-denominated interest rates is dominated by one entity and that its approach has the potential to introduce competition in this market.62 jlentini on DSKJ8SOYB1PROD with NOTICES B. Risk Management Five commenters believed that the proposal would increase the transparency of risks across asset classes and allow regulators to better monitor and assess risk.63 These commenters supported the proposed rule’s use of the Value at Risk (VaR) methodology, because it is well understood, has been extensively tested, and relies on (January 4, 2011); and Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011). 60 See, e.g., Letter from John Willian, Managing Director, Goldman Sachs (December 17, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); and Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010). 61 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). 62 Id. 63 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010); Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010). VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 historical information to simulate the market.64 Moreover, two commenters noted that ‘‘one-pot’’ margining decreases the risk for market participants because it allows for the offset of risk between U.S. Treasury futures and U.S. Treasury cash bonds.65 Additionally, two commenters believed that the proposal allows for a greater portion of financial instruments to be centrally cleared, which, among other things, reduces overall risk.66 Two commenters, however, raised concerns about risk management, stating that because cross-margining allows for greater leverage than standard margining, in particular during periods of market stress and extreme volatility, the proposed rule may increase systemic risk.67 FICC responded by stating that ‘‘the NYPC–FICC margin model does not necessarily increase leverage and may, in fact, reduce leverage in highly risky portfolios with limited hedges.’’68 FICC further explained that, ‘‘[a]t the same time, the NYPC–FICC model can offer margin reductions for hedged portfolios because it more accurately estimates true economic risk by taking into account the benefits of highly correlated, offsetting positions in a single portfolio.’’69 One commenter suggested that the VaR method for calculating margin requirements should be tested further.70 This commenter also suggested that the scenario-based Standard Portfolio Analysis of Risk (‘‘SPAN’’) method be considered and tested in comparison to VaR. FICC’s response noted that the proposed VaR methodology is based on 64 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010); Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010); Letter from James B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010). 65 Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010) and Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010). 66 Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010) and Letter from John A. McCarthy, General Counsel, GETCO (December 21, 2010). 67 Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010) and Letter from John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 2010). 68 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). 69 Id 70 Letter from Joan C. Conley, Senior Vice President & Corporate Secretary, NASDAQ OMX (December 21, 2010). PO 00000 Frm 00140 Fmt 4703 Sfmt 4703 a common method of historical simulation and that it has conducted risk-related testing, including sensitivity tests, back testing of the model’s validity, and stress tests of the sufficiency of the guaranty fund.71 One commenter requested that documentation of previous consideration of the risk aspects of the proposal be made public.72 In response, FICC provided a discussion and analysis of its VaR methodology compared to SPAN.73 FICC explained that because it needs to measure the risk of combined portfolios for futures and cash positions, it believes that a historical VaR-based margin model provides a more accurate estimate of portfolio risk than SPAN.74 FICC noted, however, that because it is standard practice for the futures industry to use SPAN to calculate and monitor margin requirements, it will make available SPAN formatted calculations of its VaR-based customer risk parameters to clearing members and their customers. FICC also noted that in initially listing NYPC-clearing contracts, NYSE Liffe U.S. will use, among other factors, SPAN-formatted input parameters to establish minimum customer initial margin requirements for each NYPC-cleared interest rate contract and intra- and inter-commodity spreads.75 C. Effect on Efficiency and Costs Four commenters stated that the proposal promotes the reduction of risk that will lead to margin and capital efficiencies and lower costs.76 One 71 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). 72 Letter from Alex Kogan, Vice President and Deputy General Counsel, NASDAQ OMX (January 10, 2011). 73 Letter from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 7, 2011). The public record contains information regarding testing that went to the subject of risk management. The Commission also received from FICC proprietary, highly confidential information, including information about individual portfolios. This non-public information, in addition to the public information submitted in support of the rule proposal, supported the Commission’s conclusion that the proposal is consistent with the Act, but was not included in the public record because of its sensitivity. 74 Id. 75 Letter from Alex Kogan, Vice President and Deputy General Counsel, NASDAQ OMX (January 10, 2011). 76 Letter from Gary DeWaal, Senior Managing Director and Group General Counsel, Newedge USA, LLC (December 21, 2010); Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from Ronald Filler, Professor of Law and Director of the Center on Financial Services Law, New York Law School (December 8, 2010); and Letter from James B. Fuqua and David Kelly, E:\FR\FM\04MRN1.SGM 04MRN1 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices commenter believed that ‘‘one-pot’’ margining would increase cash flow and margin efficiencies for certain clearing members.77 Two commenters also stated that the ‘‘one-pot’’ approach will reduce delivery costs because it offers direct delivery of expiring futures contracts into cash bonds held at FICC, which will minimize fails and squeezes and improve price convergence and stress on the settlement system.78 Additionally, two commenters that were opposed to the cross-margining agreement as proposed also expressed their general support for ‘‘one-pot’’ cross-margining on the ground that it reduces risk while facilitating more efficient uses of capital markets.79 According to FICC’s response, the proposed rule streamlines the delivery process for U.S. Treasury futures, which will improve operational efficiency and decrease systemic settlement risk.80 FICC also stated that the proposal should increase liquidity by providing market participants with an alternate venue for trading U.S. dollardenominated interest rate futures contracts.81 jlentini on DSKJ8SOYB1PROD with NOTICES IV. Discussion The Commission has carefully considered the proposed rule change and the comments thereto and the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder, including Sections 17A(a)(2)(A)(ii) 82 and 17A(b)(3)(A), (F) and (I) of the Act.83 The proposed rule change provides for modifications to certain risk management related processes and definitions under GSD’s rules, including changes to the loss allocation Managing Directors, Legal, UBS Securities, LLC (December 20, 2010). 77 Letter from John Willian, Managing Director, Goldman Sachs (December 17, 2010). 78 Letter from Jack DiMaio, Managing Director, Morgan Stanley (December 2, 2010) and Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 2010). 79 Letter from John C. Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 2010) and Letter from William H. Navin, Executive Vice President and General Counsel, The Options Clearing Corporation (December 21, 2010). 80 Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). 81 Id. 82 15 U.S.C. 78q–1(b)(2)(A)(ii). This provision directs the Commission to use its authority to facilitate the establishment of coordinated facilities for clearance and settlement of transactions in securities and contracts of sale for future delivery. 83 15 U.S.C. 78q–1(b)(3)(A), (F) and I. In approving the proposed rule change, the Commission considered the proposal’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 methodology, intraday margining, categories of membership, and related definitional changes. The Commission believes that these changes to GSD’s rules are consistent with Sections 17A(b)(3)(A) and (F) of the Act because they should help facilitate and promote the prompt and accurate clearance and settlement of securities transactions, and help assure the safeguarding of securities and funds under FICC’s control or for which it is responsible. In particular, the Commission believes that these changes to GSD’s rules, by virtue of strengthening FICC’s risk management and related operations, should result in a more timely, accurate, and efficient system of settlement. In addition, the proposed rule change would provide for a cross-margining arrangement between certain positions in GSD and NYPC. The Commission’s staff has closely evaluated the proposed cross-margining arrangement including the risk management, competition and efficiency issues raised by the proposed rule change (as discussed below) against the requirements of the Act, including Sections 17A(b)(3)(F) and (I) of the Act. Based on our staff’s analysis, and taking into consideration the matters discussed throughout, including the representations discussed below, the Commission finds the proposed rule change is consistent with the Act. A. Risk Management Section 17A(b)(3)(F) of the Act requires that the rules of a clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions and assure the safeguarding of securities and funds in the custody or control of the clearing agency or for which it is responsible.84 The Commission has historically supported and approved cross-margining at clearing agencies and has previously recognized the potential benefits of cross-margining systems, which include freeing capital through reduced margin requirements, reducing clearing costs by integrating clearing functions, reducing clearing organization risk by centralizing asset management and harmonizing liquidation procedures.85 The 84 15 U.S.C. 78q–1(b)(3)(F). e.g., Securities Exchange Act Release No. 27296 (September 26, 1989), 54 FR 41195 (approving proposed rule changes establishing cross-margining between The Options Clearing Corporation and the Chicago Mercantile Exchange) and Securities Exchange Act Release No. 26153 (October 3, 1988), 53 FR 39561 (approving proposed rule changes concerning cross-margining between The Options Clearing Corporation and the Intermarket Clearing Corporation). Previously, the Interim Report of the President’s Working Group on Financial Markets (May 1988) recommended that 85 See, PO 00000 Frm 00141 Fmt 4703 Sfmt 4703 12153 Commission has encouraged crossmargining arrangements as a way to promote more efficient risk management across product classes.86 Crossmargining arrangements may be consistent with Section 17A(b)(3)(F) in that they may strengthen the safeguarding of assets through effective risk controls that more broadly take into account offsetting positions of participants in both the cash and futures markets, and promote prompt and accurate clearance and settlement of securities through increased efficiencies. As set forth in the proposal, FICC will perform margin calculations using VaR methodology with a 99 percent confidence level and 3-day liquidation for cash positions and 1-day liquidation for futures, using historical information for the prior year (250 trading days for futures and 252 for cash positions) and the margin calculations will employ a front weighted mechanism that places a greater emphasis on more recent observations. FICC will also conduct daily back testing and assess an additional coverage component charged to participants if the back tests show insufficient coverage. In the event of unusual market conditions, FICC or NYPC could at any time require additional margin provided such requirements are consistent with the standards in Section 17A of the Exchange Act. The Commission believes these actions assist in the promotion under the proposed cross-margining arrangement of prompt and accurate clearance and settlement of securities transactions and help assure the safeguarding of securities and funds consistent with the requirements under Section 17A(b)(3)(F) of the Act because they would facilitate appropriate risk management by FICC by providing flexibility and promoting ongoing monitoring of risk.87 The proposal also contains provisions for managing risk in the event of a the SEC and CFTC facilitate cross-margining programs among clearing organizations. In addition, the Bachmann Task Force, which was formed by the Commission in response to the 1987 Market Break, presented its findings to the Commission in May 1992 that included, among other things, a recommendation that cross-margining programs among clearing agencies be implemented or expanded. See Securities Exchange Act Release No. 31904 (February 23, 1993), 58 FR 11806 (March 1, 1993). 86 See Securities and Exchange Act Release No. 44301, 66 FR 28297 (May 11, 2001) (order approving a ‘‘two-pot’’ cross-margining proposal between FICC’s predecessor and CME). In addition, the Interim Report of the President’s Working Group on Financial Markets (May 1988) also recommended that the SEC and CFTC facilitate cross-margining programs among clearing organizations. 87 15 U.S.C. 78q–1(b)(3)(F). E:\FR\FM\04MRN1.SGM 04MRN1 jlentini on DSKJ8SOYB1PROD with NOTICES 12154 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices member default. The NYPC Agreement provides for the sharing of losses by FICC and NYPC in the event that the ‘‘one-pot’’ portfolio margin deposits of a defaulting participant are not sufficient to cover the losses resulting from the liquidation of that participant’s trades and positions. In the event of a member default, the proposal requires that FICC and NYPC would liquidate posted margin as a single portfolio, which will allow them to preserve the value of the assets posted as collateral. In addition, FICC and NYPC are providing financial guarantees to each other in the event the available collateral is insufficient. These features of the proposed rule change would help to ensure that FICC is able to meet its settlement obligations in the event of default. As a result, the Commission believes that the proposal would promote the prompt and accurate clearance and settlement of securities transactions and assure the safeguarding of securities and funds in a manner consistent with Section 17A(b)(3)(F) of the Act.88 The Commission has previously noted that cross-margining systems entail certain risks.89 For instance, even in normal market conditions, products that have been highly correlated in the past may diverge and may diverge even more so in extreme market conditions. Such a breakdown in correlation might lead to inadequate clearing margins or losses upon a liquidation. To address these concerns, as noted in the description of the proposed rule change and in FICC’s response letters, FICC has performed testing of the VaR margining model. This included sensitivity tests of the model to changing market conditions, back tests of sample portfolios to check model validity, stress tests of sample portfolios to test the sufficiency of the NYPC guaranty fund, and back tests to verify the sufficiency of coverage after the FICC–NYPC cross-margining reductions are applied. The Commission takes commenters’ concerns about risk management seriously. As discussed below, to provide the Commission with enhanced ability to monitor FICC’s risk management, FICC has represented and undertaken to make continuing risk analysis reports, discussed below, to the Commission. This ongoing reporting should also help FICC conduct its own monitoring of the NYPC Arrangement. In addition, FICC is subject to the Commission’s ongoing examination program, which examines registered clearing agencies with respect to their risk management systems and other aspects of their operations. The Commission believes FICC’s prior analysis, as discussed above, as well as FICC’s commitment to provide additional reports on a periodic basis will promote the prompt and accurate clearance and settlement of securities transactions and help assure the safeguarding of securities and funds in a manner consistent with Section 17A(b)(3)(F) of the Act. B. Competition Section 17A(b)(3)(F) of the Act requires that the rules of a clearing agency are not designed to permit unfair discrimination in the admission of participants or among participants in the use of the clearing agency.90 Section 17A(b)(3)(I) of the Act requires that the rules of the clearing agency do not impose any burden on competition not necessary and appropriate in furtherance of the purposes of the Exchange Act.91 The Commission has carefully considered the comments and the responses submitted to the Commission. With respect to commenters’ concerns regarding the exclusive nature of the agreement to enter into a direct arrangement for ‘‘one-pot’’ crossmargining with NYPC, the Commission believes that FICC has raised valid concerns regarding the potential for greater risk arising from connections to multiple DCOs. The Commission believes that the NYPC Arrangement, and FICC’s representations in its responses, discussed above, regarding how indirect access would operate in practice, would provide increased potential for indirect access to the crossmargining arrangement by entering into a LPP agreement and becoming an LPP of NYPC. The Commission believes that the proposed FICC indirect access arrangement would provide a viable option for those seeking to access the ‘‘one-pot’’ cross-margining arrangement because it would be open to all DCOs and DCMs and would contain membership criteria that are commensurate with risks associated with accessing the ‘‘one-pot’’ crossmargining arrangement. Accordingly, the Commission believes the proposed cross-margining arrangement is not designed to permit unfair discrimination in the admission of participants or among participants in the use of the clearing agency consistent with Section 17A(b)(3)(F).92 88 15 90 15 89 Securities 91 15 U.S.C. 78q–1(b)(3)(F). Exchange Act Release No. 26153 (October 3, 1988), 53 FR 39561. VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 U.S.C. 78q–1(b)(3)(F). U.S.C. 78q–1(b)(3)(I). 92 15 U.S.C. 78q–1(b)(3)(F). PO 00000 Frm 00142 Fmt 4703 Sfmt 4703 The Commission acknowledges that the admission and integration of other DCMs or DCOs will not be immediate. However, the Commission believes that, in light of existing technological limitations, FICC has raised valid concerns regarding the operational feasibility of providing multiple links for direct access to the cross-margining arrangement at this time. These potential operational risks associated with managing such an arrangement, such as maintaining appropriate account of the positions of participants and calculating appropriate margin, must be weighed against the desire for greater direct access immediately. The Commission notes that FICC has previously indicated that NYPC has committed that it will complete the process to allow one or more DCMs or DCOs to be admitted and integrated into the ‘‘one-pot’’ cross-margining arrangement as soon as feasible, but no later than 24 months from the start of NYPC’s operations. FICC has stated that the transition period is necessary to complete implementation, systems integration, and testing, among other things, and that it would open the arrangement to other participants as soon as operationally feasible.93 The Commission believes that the operational issues, including those cited by FICC, would need to be resolved prior to admitting a DCM or DCO as an LPP. The Commission believes that this aspect of the proposal would not impose any burden on competition not necessary and appropriate in furtherance of the purposes of the Exchange Act consistent with Section 17A(b)(3)(I) of the Act. Moreover, the Commission notes that FICC has stated that the proposal would provide market participants with an alternate venue for trading U.S. dollardenominated interest rate futures contracts, thereby potentially helping to increase competition in this market. The Commission believes that these procompetitive features of the proposal are consistent with the Act. The Commission takes seriously commenters’ concerns regarding competition. As discussed below, FICC has represented and undertaken to provide the Commission with 93 FICC represented that following the announcement of NYPC, FICC, the NYPC management team and senior management of NYSE Euronext have been in discussions with other DCOs and DCMs to initiate the process of integrating such other organizations into the ‘‘one-pot.’’ While those efforts have not yet been productive, FICC and NYPC remain committed to expanding the ‘‘onepot’’ to include other DCOs and DCMs. Letter from Douglas Landy, Allen & Overy on behalf of the Fixed Income Clearing Corporation (January 4, 2011). E:\FR\FM\04MRN1.SGM 04MRN1 Federal Register / Vol. 76, No. 43 / Friday, March 4, 2011 / Notices jlentini on DSKJ8SOYB1PROD with NOTICES information about the LLP agreements concerning the proposed crossmargining arrangements. The Commission believes FICC’s commitment to provide ongoing information with respect LLP agreements would help to evaluate its efforts to facilitate indirect access and would thereby help to ensure that the proposal would not impose any burden on competition not necessary and appropriate in furtherance of the purposes of the Exchange Act, consistent with Section 17A(b)(3)(I) of the Act.94 The Commission anticipates that this information will be primarily used for the limited purpose of identifying any instances in which there is potential non-compliance with the terms of this order or the representations made by FICC. The Commission has considered the concerns presented by commenters and has determined that the benefits of the proposal outweigh any anti-competitive effects of the proposal. The Commission believes that the proposal would not impose any burden on competition not necessary and appropriate in furtherance of the purposes of the Exchange Act consistent with Section 17A(b)(3)(I) of the Act.95 C. Effect on Efficiency and Costs As previously discussed, both FICC and those commenting on the proposed rule change expect that the crossmargining proposal will reduce costs, including delivery costs, and increase cash flows through margin efficiencies. The Commission believes that the NYPC Arrangement has the potential to increase efficiencies by allowing clearing agencies to streamline the delivery process, employ common and coordinated risk management and margin methodologies, and lower costs for market participants. A ‘‘two-pot’’ arrangement allows for offsets and lowered margin based on correlations in a members’ cleared positions at different clearinghouses; however, there is not a unified arrangement for risk management or loss allocations.96 The ‘‘two-pot’’ crossmargining arrangements approved by the Commission in the past, including one between FICC and CME, have allowed clearinghouses to allow credit against the margin requirement for offsetting positions cleared at another clearinghouse, but each clearinghouse maintained and managed separate pools 94 15 U.S.C. 78q–1(b)(3)(I). U.S.C. 78q–1(b)(3)(I). 96 See Securities and Exchange Act Release No. 44301, 66 FR 28297 (May 11, 2001) (approving a ‘‘two-pot’’ cross-margining proposal between FICC’s predecessor and CME). 95 15 VerDate Mar<15>2010 19:16 Mar 03, 2011 Jkt 223001 of collateral. The ‘‘one-pot’’ arrangement would offer greater margin reductions than a ‘‘two-pot’’ arrangement. As result of these benefits in facilitating a more accurate and costeffective system for settlement, the Commission believes that the proposal would promote the prompt and accurate clearance and settlement of securities transactions and help assure the safeguarding of securities and funds in a manner consistent with Section 17A(b)(3)(F) of the Act.97 D. Additional Reporting As noted above, FICC has represented that it will provide certain information and reports to the Commission on an ongoing basis in order to facilitate ongoing monitoring of the crossmargining arrangement and thereby help ensure compliance with the standards in Section 17A of the Act.98 In particular, with respect to information pertaining to risk matters, the Commission believes that these reports would assist the Commission in its efforts to monitor risk management practices under the cross-margining arrangement by providing information to help confirm that the actual performance of the models and systems are consistent with those anticipated during tests prior to launch. Specifically, FICC has agreed to provide the following information upon the proposed rule change becoming effective: • For the first 250 trading days upon the proposed rule change becoming effective, FICC will provide the Commission staff with quarterly reports that itemize divergences between CME prices and NYSE Liffe prices for ‘‘lookalike contracts.’’ 99 • Semi-annually, FICC will provide the Commission staff with reports summarizing the sensitivity of the model used for the NYPC Agreement and the collected margin to the model’s assumptions and established parameters. • Quarterly, FICC will provide the Commission staff with detailed portfolio analyses of members participating in the NYPC Arrangement. • Monthly, FICC will provide the Commission staff with reports summarizing the details of: (1) Any instances in which the account of a 97 15 U.S.C. 78q–1(b)(3)(F). from Michael Bodson, Executive Managing Director, Fixed Income Clearing Corporation and Walt Lukken, Chief Executive Officer, New York Portfolio Clearing, LLC (February 27, 2011). 99 ‘‘Look-alike contracts’’ refers to contracts that have similar economic features but are traded separately on CME and NYSE Liffe. 98 Letter PO 00000 Frm 00143 Fmt 4703 Sfmt 4703 12155 member participating in the NYPC Agreement experienced a loss that exceeded its margin requirement and the magnitude of such loss; (2) FICC’s analysis of the sufficiency of NYPC’s guaranty fund in conjunction with NYPC; and (3) FICC’s analysis of daily correlations between the futures and cash products that are subject to the NYPC Arrangement. • FICC will provide the Commission staff with DTCC’s periodic default simulations that factor in members’ participation in the NYPC Agreement. • For 24 months upon the proposed rule change becoming effective, FICC will provide the Commission staff with information on a quarterly basis regarding potential LPPs, including progress on negotiations and discussions of agreements or potential agreements with potential LPPs. • FICC will provide the Commission all agreements entered into between NYPC and any LPPs, as well as all amendments to such agreements, including, but not limited to, those regarding changes in the fee arrangements. V. 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 Section 17A of the Act 100 and the rules and regulations thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (File No. SR– FICC–2010–09) be, and hereby is, approved. Elizabeth M. Murphy, Secretary. [FR Doc. 2011–4836 Filed 3–3–11; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–63969; File No. SR–BATS– 2011–007] Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change by BATS Exchange, Inc. to Adopt BATS Rule 11.21, entitled ‘‘Input of Accurate Information’’ February 25, 2011. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’),1 and Rule 19b–4 thereunder,2 100 15 U.S.C. 78q–1. U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 E:\FR\FM\04MRN1.SGM 04MRN1

Agencies

[Federal Register Volume 76, Number 43 (Friday, March 4, 2011)]
[Notices]
[Pages 12144-12155]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-4836]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63986; File No. SR-FICC-2010-09]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change To Introduce Cross-
Margining of Certain Positions Cleared at the Fixed Income Clearing 
Corporation and Certain Positions Cleared at New York Portfolio 
Clearing, LLC

February 28, 2011.

I. Introduction

    On November 12, 2010, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2010-09 pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'').\1\ 
Notice of the proposed rule change was published in the Federal 
Register on November 30, 2010.\2\ The Commission initially received 
thirteen comments to the proposed rule change.\3\ FICC, as well as one 
of the commenters, submitted letters responding to the comments.\4\ For 
the reasons discussed below, the Commission is granting approval of the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 63361 (November 23, 
2010), 75 FR 74110 (November 30, 2010) (FICC-2010-09). In its filing 
with the Commission, FICC included statements concerning the purpose 
of and basis for the proposed rule change. The text of these 
statements are incorporated into the discussion of the proposed rule 
change in Section II below.
    \3\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Douglas Engmann, President, Engmann 
Options, Inc. (December 6, 2010); Letter from Ronald Filler, 
Professor of Law and Director of the Center on Financial Services 
Law, New York Law School (December 8, 2010); Letter from John C. 
Hiatt, Chief Administrative Officer, Ronin Capital (December 10, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from John Willian, 
Managing Director, Goldman Sachs (December 17, 2010); Letter from 
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS 
Securities, LLC (December 20, 2010); Letter from Donald J. Wilson, 
Jr., DRW Trading Group (December 21, 2010); Letter from John A. 
McCarthy, General Counsel, GETCO (December 21, 2010); Letter from 
Gary DeWaal, Senior Managing Director and Group General Counsel, 
Newedge USA, LLC (December 21, 2010); Letter from Adam C. Cooper, 
Senior Managing Director and Chief Legal Officer, Citadel, LLC 
(December 21, 2010); Letter from William H. Navin, Executive Vice 
President and General Counsel, The Options Clearing Corporation 
(December 21, 2010); and Letter from Joan C. Conley, Senior Vice 
President & Corporate Secretary, NASDAQ OMX (December 21, 2010).
    \4\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011); Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011); and Letter from Alex 
Kogan, Vice President and Deputy General Counsel, NASDAQ OMX 
(January 10, 2011).
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II. Description

    The proposed rule change allows FICC to offer cross-margining of 
certain positions cleared at its Government Securities Division 
(``GSD'') and certain positions cleared at New York Portfolio Clearing, 
LLC (``NYPC'').\5\ GSD members will be able to combine their positions 
at GSD with their positions at NYPC, or those positions of certain 
permitted affiliates cleared at NYPC, within a single margin portfolio 
(``Margin Portfolio''). The proposed rule change also makes certain 
other related changes to GSD's rules.
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    \5\ NYPC is jointly owned by NYSE Euronext and The Depository 
Trust & Clearing Corporation (``DTCC''). DTCC is the parent company 
of FICC. On January 31, 2011, the Commodity Futures Trading 
Commission (``CFTC'') approved NYPC's registration as a derivatives 
clearing organization (``DCO'') pursuant to Section 5b of the 
Commodity Exchange Act and Part 39 of the Regulations of the CFTC.
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A. Cross-Margining With NYPC

    Under the proposed rule, a member of FICC that is also an NYPC 
clearing member (``Joint Clearing Member'') could in accordance with 
the provisions of the GSD and NYPC Rules, elect to participate in the 
cross-margining arrangement. FICC's rules permit a GSD netting member 
that is a member (or that has an affiliate that is a member) of one or 
more Futures Clearing Organizations (``FCO''),\6\ such as NYPC, to 
become a cross-margining participant in a cross-margining arrangement 
between FICC and one or more FCOs with the consent of FICC and each 
such FCO. A netting member shall become a cross-margining participant 
upon acceptance of FICC and each applicable FCO of an agreement 
executed by such cross-margining participant in the form specified in 
the applicable cross-margining agreement.\7\
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    \6\ ``FCO'' is defined in GSD Rule 1 as a clearing organization 
for a board of trade designated as a contract market under Section 5 
of the Commodity Exchange Act that has entered into a Cross-
Margining Agreement with FICC.
    \7\ See GSD Rule 43, Cross-Margining Arrangements, Section 2. 
The cross-margining agreement between FICC and NYPC as well as the 
cross-margining participant agreements for joint and permitted 
affiliates are attached to FICC's filing of proposed rule change SR-
FICC-2010-09.
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    Participating in the cross-margining arrangement would permit a 
Joint Clearing Member to have its margin requirement calculated taking 
into account both its positions at FICC and NYPC, which should provide 
a clearer picture of its risk exposure and generally facilitate better 
risk assessment by FICC. Specifically, each Joint Clearing Member would 
have its margin requirement with respect to Eligible Positions (i.e., 
positions in certain securities netted by FICC or certain futures 
contracts cleared by an FCO) \8\ in its proprietary account at

[[Page 12145]]

NYPC and its margin requirement with respect to Eligible Positions at 
FICC calculated as a single portfolio, which would factor in the net 
risk of such Eligible Positions at both clearing organizations. In 
addition, an affiliate of a member of FICC that is also a clearing 
member of NYPC (``Permitted Margin Affiliate'') \9\ could similarly 
elect to participate in the cross-margining arrangement and have its 
margin requirement with respect to Eligible Positions in its 
proprietary account at NYPC calculated as a single portfolio with the 
Eligible Positions of the FICC member.
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    \8\ The term ``Eligible Position'' is currently defined in GSD's 
rules as a position in certain Eligible Netting Securities netted by 
FICC, or certain Government securities futures contracts or interest 
rate futures contracts cleared by a FCO as identified in a Cross-
Margining Agreement as eligible for cross-margining treatment.
    ``Eligible Netting Security'' is defined in GSD Rule 1 as an 
Eligible Security that FICC has designed as eligible for netting.
     ``Eligible Security'' is defined generally in GSD Rule 1 as a 
security issued or guaranteed by the United States, a U.S. 
government agency or instrumentality, a U.S. government-sponsored 
corporation, or any other security approved by FICC's board of 
directors from time to time, or one or more categories of such 
securities as represented by a generic CUSIP number, that FICC has 
listed on the Eligible Securities master file maintained by it 
pursuant to GSD Rule 30.
    \9\ The term ``Permitted Margin Affiliate'' is being added to 
GSD Rule 1 and is defined as an affiliate of a Member that is (i) 
also a member of GSD, and/or (ii) a member of an FCO with which FICC 
has entered into a Cross-Margining Agreement that provides for 
margining of positions between FICC and the FCO as if such positions 
were in a single portfolio and that directly or indirectly controls 
such particular member, or that is directly or indirectly controlled 
by or under common control with such particular member. Ownership of 
more than 50% of the common stock of the relevant entity (or 
equivalent equity interests in the case of a form of entity that 
does not issue common stock) will be conclusive evidence of prima 
facie control of such entity for purposes of this definition.
---------------------------------------------------------------------------

    The proposed rule allows (i) Joint Clearing Members and (ii) 
members of FICC and their Permitted Margin Affiliates to have their 
margin requirements for positions at FICC and NYPC determined as a 
single portfolio, with FICC and NYPC each having a security interest in 
such members' and Permitted Margin Affiliates' margin deposits and 
other collateral to secure their obligations to FICC and NYPC.
    The following types of FICC members will not be eligible to 
participate in the cross-margining arrangement (``NYPC Arrangement''), 
in order to allow FICC to maintain segregation of certain business or 
member types that are treated differently for purposes of loss 
allocation: (i) GSD Sponsored Members,\10\ (ii) Inter-Dealer Broker 
Netting Members,\11\ and (iii) Dealer Netting Members \12\ with respect 
to their segregated brokered accounts. In addition, in order for a Bank 
Netting Member \13\ to combine its accounts into a Margin Portfolio 
with any other accounts, it will have to demonstrate to the 
satisfaction of FICC and NYPC that doing so will comply with the 
regulatory requirements applicable to the Bank Netting Member (e.g., by 
providing an opinion of counsel or otherwise outlining compliance with 
relevant statutory provisions).\14\
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    \10\ A ``Sponsored Member'' of GSD is any person that has been 
approved by FICC to be sponsored into membership by a ``Sponsoring 
Member'' pursuant to GSD Rule 3A. A ``Sponsoring Member'' is a 
member of GSD's comparison and netting system whose application to 
become a sponsoring member has been approved by the FICC's board of 
directors pursuant to GSD Rule 3A. See GSD Rule 1, Definitions.
    \11\ The definition of ``Inter-Dealer Broker Netting Member,'' 
as revised by the proposed rule change, is an inter-dealer broker 
admitted to membership in GSD's netting system. See GSD Rule 2A, 
Initial Membership Requirements.
    \12\ The definition of a ``Dealer Netting Member,'' as revised 
by the proposed rule change, is a registered government securities 
dealer admitted to membership in GSD's netting system. See GSD Rule 
2A, Initial Membership Requirements.
    \13\ Under GSD Rule 2A, a person shall be eligible to apply to 
become a ``Bank Netting Member'' of GSD if it is a bank or trust 
company chartered as such under the laws of the United States, or a 
State thereof, or is a bank or trust company established or 
chartered under the laws of a non-U.S. jurisdiction, and 
participates in FICC through its U.S. branch or agency. A bank or 
trust company that is admitted to membership in GSD's netting 
system, the netting system, pursuant to these Rules, and whose 
membership in the netting system has not been terminated, shall be a 
Bank Netting Member. See GSD Rule 2A, Initial Membership 
Requirements, Section 2.
    \14\ See GSD Rule 4, Clearing Fund and Loss Allocation, Section 
1a as proposed to be amended by the proposed rule change.
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    In order to distinguish the NYPC Arrangement from an existing 
cross-margining arrangement between the Chicago Mercantile Exchange 
(``CME'') and FICC (``CME Arrangement''), the proposed rule amends the 
definition of ``Cross-Margining Agreement'' in the GSD rules to mean an 
agreement entered into between FICC and one or more FCOs pursuant to 
which a Cross-Margining Participant,\15\ in accordance with the 
provisions of the GSD Rules and otherwise at the discretion of FICC, 
could elect to have its Required Fund Deposit \16\ with respect to 
Eligible Positions at FICC, and its (or its Permitted Margin 
Affiliates' Required Fund Deposit, if applicable) margin requirements 
with respect to Eligible Positions at such FCO(s), calculated either 
(i) by taking into consideration the net risk of such Eligible 
Positions at each of the clearing organizations or (ii) as if such 
positions were in a single portfolio. The CME Arrangement falls into 
clause (i) of the definition, whereas the NYPC Arrangement will fall 
into clause (ii). Conforming changes will be made to GSD Rule 1, 
Definitions, relating to cross-margining. GSD Rule 43, Cross-Margining 
Arrangements, also will be amended to add provisions regarding single-
portfolio margining (i.e., the proposed NYPC Arrangement). To implement 
this proposal, FICC and NYPC will enter into a cross-margining 
agreement (``NYPC Agreement''). The NYPC Agreement was filed with the 
Commission as part of proposed rule change SR-FICC-2010-09 and will be 
appended to the GSD Rules and made a part thereof.
---------------------------------------------------------------------------

    \15\ The term ``Cross-Margining Participant'' is defined in GSD 
Rule 1 as a Netting Member that is authorized by FICC to participate 
in the Cross-Margining Arrangement between FICC and one or more FCOs 
pursuant to a Cross-Margining Agreement. GSD Rule 1 defines the term 
``Cross-Margining Arrangement'' as the arrangement established 
between FICC and one or more FCOs pursuant to Cross-Margining 
Agreements and GSD Rule 43.
    \16\ The definition of ``Required Fund Deposit,'' as revised by 
the proposed rule change, is the amount that a Netting Member is 
required by a GSD rule to contribute to GSD's clearing fund. See GSD 
Rule 1, Definitions.
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    Pursuant to the NYPC Agreement, and consistent with previous 
approvals of cross-margining arrangements involving DCOs,\17\ cross-
margining with certain NYPC positions will be limited to positions 
carried in proprietary accounts of clearing members of NYPC. Customers 
of NYPC clearing members will not be permitted to participate in the 
NYPC Arrangement, as their participation would require the resolution 
of additional issues associated with fund segregation and operations. 
Neither FICC nor NYPC rules require their members to participate in the 
NYPC Arrangement, and any such participation by FICC and NYPC members 
will be voluntary. Joint Clearing Members and members of FICC and their 
Permitted Margin Affiliates will be required to execute the requisite 
cross-margining participant agreements.\18\
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    \17\ See, e.g., Securities Exchange Act Release No. 44301 (May 
11, 2001), 66 FR 28207 (approving a proposed rule change 
establishing cross-margining between FICC and CME) and Securities 
Exchange Act Release No. 27296 (September 26, 1989), 54 FR 41195 
(approving a proposed rule change establishing cross-margining 
between The Options Clearing Corporation and the CME).
    \18\ The NYPC Agreement and the cross-margining participant 
agreements for Joint Members and Permitted Affiliates were filed 
with the Commission as part of the proposed rule change.
---------------------------------------------------------------------------

    FICC will be responsible for performing the margin calculations in 
its capacity as the Administrator under the terms of the NYPC 
Agreement. Specifically, FICC will determine the combined FICC clearing 
fund and NYPC original margin requirement for each participant.\19\ 
FICC will calculate those requirements using a Value-at-Risk (``VaR'') 
methodology, with a 99-percent confidence level and a 3-day liquidation 
period for cash positions and a 1-day liquidation period for futures 
positions. In addition, each cross-margining participant's ``one-pot'' 
margin requirement will be subject to a daily

[[Page 12146]]

back test, and a supplemental risk-related charge referred to as a 
coverage component that will be applied to the participant in the event 
that the back test reflects insufficient coverage. The ``one-pot'' 
margin requirement for each participant would then be allocated between 
FICC and NYPC in proportion to the clearing organizations' respective 
``stand-alone'' margin requirements--in other words, an amount 
reflecting the ratio of what each clearing organization would have 
required from that participant if it was not participating in the 
cross-margining program (``Constituent Margin Ratio''). The NYPC 
Agreement provides that either FICC or NYPC can, at any time, require 
additional margin to be deposited by a Cross-Margining Participant 
above what is calculated under the NYPC Agreement based upon the 
financial condition of the participant, unusual market conditions, or 
other special circumstances (e.g., in the event of regulatory or 
criminal proceedings). The standards that FICC proposes to use for 
these purposes are the standards currently contained in the GSD rules, 
so that notwithstanding the calculation of a Cross-Margin Participant's 
clearing fund requirement pursuant to the NYPC Agreement, FICC will 
retain its rights under the GSD rules to charge additional clearing 
fund contributions under the circumstances specified in the GSD rules. 
For example, the GSD rules provide that if a Dealer Netting Member 
falls below its minimum financial requirement, it shall be required to 
make additional clearing fund contributions equal to the greater of (i) 
$1 million or (ii) 25 percent of its Required Fund Deposit.
---------------------------------------------------------------------------

    \19\ Original margin is the NYPC equivalent of the FICC clearing 
fund.
---------------------------------------------------------------------------

    FICC will utilize the same VaR methodology for calculating margin 
for futures and cash positions. Under this method, the prior 250 days 
of historical information for futures positions and the prior 252 days 
of historical information for cash positions, including prices, spreads 
and market variables such as Treasury zero-coupon yields and London 
Interbank Offered Rate curves, are used to simulate the market 
environments in the forthcoming 1 day for futures positions and the 
forthcoming 3 days for cash positions. Projected portfolio profits and 
losses are calculated assuming these simulated environments will 
actually be realized. These simulations will be used to calculate VaR. 
Historical simulation is a continuation of the FICC margin methodology.
    With respect to the confidence level, FICC currently utilizes 
extreme value theory \20\ to determine the 99th percentile of loss 
distribution. Upon implementation of the NYPC Arrangement, FICC will 
utilize a front-weighting mechanism to determine the 99th percentile of 
loss distribution. This front-weighting mechanism will place more 
emphasis on more recent observations. Additionally, FICC's VaR 
methodology will be enhanced to accommodate more securities; as a 
result, certain CUSIPs, which are now considered to be ``non-
priceable'' (because, for example, of a lack of historical information 
regarding the security) and subject to a ``haircut'' requirement (i.e., 
fixed percentage charge) where offsets are not permitted, will be 
treated as ``priceable'' and therefore included in the core VaR 
calculation.
---------------------------------------------------------------------------

    \20\ Extreme value theory is used to analyze outcomes beyond the 
99 percent confidence interval used for VaR and provides an 
assessment of the size of these events.
---------------------------------------------------------------------------

    Based on preliminary analyses, FICC expects that the FICC VaR 
component of the clearing fund requirement may be reduced by as much as 
approximately 20 percent for common FICC-NYPC members as a result of 
the NYPC Arrangement. In order to help ensure that this reduction in 
clearing fund is appropriately correlated to more precise assessment of 
exposures associated with considering offsetting positions and will not 
result in increased risks to the clearing agency, FICC has performed 
back testing analysis to verify that there will be sufficient coverage 
after the FICC-NYPC cross-margining reductions are applied.
    In the event of the insolvency or default of a member that 
participates in the NYPC Arrangement, the positions in such 
participant's ``one-pot'' portfolio, including, where applicable, the 
positions of its Permitted Margin Affiliate at NYPC, will be liquidated 
by FICC and NYPC as a single portfolio and the liquidation proceeds 
will be applied to the defaulting participant's obligations to FICC and 
NYPC in accordance with the provisions of the NYPC Agreement.
    The NYPC Agreement provides for the sharing of losses by FICC and 
NYPC in the event that the ``one-pot'' portfolio margin deposits of a 
defaulting participant are not sufficient to cover the losses resulting 
from the liquidation of that participant's trades and positions. This 
loss-sharing arrangement can be summarized as follows:
     If either clearing organization had a net loss (``worse-
off party''), and the other had a net gain (``better-off party'') that 
is equal to or exceeds the worse-off party's net loss, then the better-
off party pays the worse-off party the amount of the latter's net loss. 
In this scenario, one clearing organization's gain will extinguish the 
entire loss of the other clearing organization.
     If either clearing organization had a net loss (``worse-
off party'') and the other clearing organization had a net gain 
(``better-off party'') that is less than or equal to the worse-off 
party's net loss, then the better-off party will pay the worse-off 
party an amount equal to the net gain. Thereafter, if such payment did 
not extinguish the net loss of the worse-off party, the better-off 
party will pay the worse-off party an amount equal to the lesser of: 
(i) The amount necessary to ensure that the net loss of each clearing 
organization is in proportion to the Constituent Margin Ratio or (ii) 
the better-off party's ``Maximum Transfer Payment'' less the better-off 
party's net gain. The ``Maximum Transfer Payment'' will be defined with 
respect to each clearing organization to mean an amount equal to the 
product of (i) the sum of the aggregate margin reductions of the 
clearing organizations and (ii) the other clearing organization's 
Constituent Margin Ratio--in other words, the amount by which the other 
clearing organization reduced its margin requirements in reliance on 
the cross-margining arrangement. In this scenario, one clearing 
organization's gain does not completely extinguish the entire loss of 
the other clearing organization, and the better-off party will be 
required to make an additional payment to the worse-off party. This 
potential additional payment will be capped as described in this 
paragraph.
     If either clearing organization had a net loss, and the 
other had the same net loss, a smaller net loss, or no net loss, then:
    [cir] In the event that the net losses of the clearing 
organizations were in proportion to the Constituent Margin Ratio, no 
payment will be made.
    [cir] In the event that the net losses of the clearing 
organizations were not in proportion to the Constituent Margin Ratio, 
then the clearing organization that had a net loss which was less than 
its proportionate share of the total net losses incurred by the 
clearing organizations (``better-off party'') will pay the other 
clearing organization (``worse-off party'') an amount equal to the 
lesser of: (i) The better-off party's Maximum Transfer Payment or (ii) 
the amount necessary to ensure that the clearing organizations' 
respective net losses were allocated between them in proportion to the 
Constituent Margin Ratio.

[[Page 12147]]

     If FICC had a net gain after making a payment as described 
above, FICC will pay to NYPC the amount of any deficiency in the 
defaulting member's customer segregated funds accounts or, if 
applicable, such defaulting member's Permitted Margin Affiliate held at 
NYPC up to the amount of FICC's net gain.
     If FICC received a payment under the Netting Contract and 
Limited Cross-Guaranty (``Cross-Guaranty Agreement'') \21\ to which it 
is a party (i.e., because FICC had a net loss), and NYPC had a net 
loss, FICC will share the cross-guaranty payment with NYPC pro rata, 
where such pro rata share is determined by comparing the ratio of 
NYPC's net loss to the sum of FICC's and NYPC's net losses. This 
allocation is appropriate because the ``one-pot'' combines FICC and 
NYPC proprietary positions into a unified portfolio that will be 
margined and liquidated as a single unit. FICC will no longer need to 
share the cross-guaranty payments with NYPC once NYPC becomes a party 
to the Cross-Guaranty Agreement.
---------------------------------------------------------------------------

    \21\ FICC's predecessors, the Government Securities Clearing 
Corporation (``GSCC'') and the MBS Clearing Corporation (``MBSCC''), 
filed rule filings in 2001 to enter into the Cross-Guaranty 
Agreement with The Depository Trust Company, National Securities 
Clearing Corporation, Emerging Markets Clearing Corporation, and The 
Options Clearing Corporation. Securities Exchange Act Release No. 
45868 (May 2, 2002), 67 FR 31394. Under the agreement, if the assets 
of a defaulting member at one clearing agency exceed its liabilities 
to that clearing agency, those excess assets may be made available 
to satisfy the liabilities of that defaulting common member to 
another clearing agency.
---------------------------------------------------------------------------

    The GSD rules will further provide that FICC will offset its 
liquidation results in the event of a close out of the positions of a 
Cross-Margining Participant in the NYPC Agreement first with NYPC 
because the liquidation will essentially be of a single Margin 
Portfolio and then will present its results for purposes of the 
multilateral Cross-Guaranty Agreement.

B. Access to NYPC Arrangement

    FICC has represented that the NYPC Arrangement has been structured 
in a way that access to, and the benefits of, the ``one-pot'' are 
provided to other futures exchanges and DCOs on fair and reasonable 
terms as described below. The proposed ``one-pot'' cross-margining 
method is expected to allow members to post margin that should more 
accurately reflect the net risk of their aggregate positions across 
asset classes, thereby releasing excess capital into the economy for 
more efficient use. By linking positions in fixed income securities 
held at FICC with interest rate products traded on NYSE Liffe U.S. and 
other designated contract markets (``DCMs''), the NYPC Arrangement has 
the potential to create a substantial pool of highly correlated assets 
that are capable of being cross-margined. This pool will deepen as more 
DCOs and DCMs join NYPC, creating the potential for even greater margin 
and risk offsets.
    The proposed ``one-pot'' is required to be accessed by other 
futures exchanges and DCOs via NYPC.\22\ FICC stated that this is done 
to ensure the uniformity and consistency of risk methodologies and risk 
management, to simplify and standardize operational requirements for 
new participants and to maximize the effectiveness of the one-pot 
arrangement.
---------------------------------------------------------------------------

    \22\ Section 16 of the NYPC Agreement provides that FICC 
covenants and agrees that, during the term of the NYPC Agreement: 
(i) NYPC-cleared contracts shall have priority for margin offset 
purposes over any other cross-margining agreement; (ii) FICC will 
not enter into any other cross-margining agreement if such agreement 
would adversely affect the priority of NYPC and FICC under the NYPC 
Agreement with respect to available assets; and (iii) FICC will not, 
without the prior written consent of NYPC, amend the CME Agreement, 
if such further amendment would adversely affect NYPC's right to 
cross-margin positions in eligible products prior to any cross-
margining of CME positions with FICC-cleared contracts or adversely 
affect the priority of NYPC and FICC under the NYPC Agreement with 
respect to available assets.
---------------------------------------------------------------------------

    FICC stated that NYPC will initially clear certain contracts 
transacted on NYSE Liffe U.S. and that NYPC will clear for additional 
DCMs that seek to clear through NYPC as soon as it is feasible for NYPC 
do so. Such additional DCMs will be treated in the same way as NYSE 
Liffe US, i.e., they must: (i) Be eligible under the rules of NYPC, 
(ii) contribute to NYPC's guaranty fund, (iii) demonstrate that they 
have the operational and technical ability to clear through NYPC, and 
(iv) enter into a clearing services agreement with NYPC.
    Moreover, NYPC has also committed to admit other DCOs as limited 
purpose participants as soon as it is feasible, thereby allowing such 
DCOs to participate in the one-pot margining arrangement with FICC 
through their limited purpose membership in NYPC.\23\ Such DCOs will be 
required to satisfy pre-defined, objective criteria set forth in NYPC's 
rules.\24\ In particular, such DCOs must: (i) Submit trades subject to 
the limited purpose participant agreement between NYPC and each DCO 
that would otherwise be cleared by the DCO to NYPC, with NYPC acting as 
central counterparty and DCO with respect to such trades,\25\ (ii) be 
eligible under the rules of NYPC and agree to be bound by the NYPC 
rules,\26\ (iii) contribute to NYPC's guaranty fund,\27\ (iv) provide 
clearing services to unaffiliated markets on a ``horizontal'' basis 
(i.e., not limit their provision of clearing services on a vertical 
basis to a single market or limited number of markets),\28\ and (v) 
agree to participate using the uniform risk methodology and risk 
management policies, systems and procedures that have been adopted by 
FICC and NYPC for implementation and administration of the NYPC 
Arrangement.\29\ Reasonable clearing fees will be allocated between 
NYPC and the limited purpose participant DCO as may be agreed by NYPC 
and the DCO, taking into account factors such as the cost of services 
(including capital expenditures incurred by NYPC), technology that may 
be contributed by the limited purpose participant, the volume of 
transactions, and such other factors as may be relevant.
---------------------------------------------------------------------------

    \23\ See NYPC Agreement, Section 14.
    \24\ NYPC's rules can be viewed as part of NYPC's DCO 
registration application on the CFTC's Web site (http:/
/.www.cftc.gov), as well as on NYPC's Web site (http://www.nypclear.com).
    \25\ See NYPC Rule 801(b)(1).
    \26\ See NYPC Rule 801(b)(2).
    \27\ The NYPC Agreement provides that except as otherwise 
provided in a limited purpose participant agreement, a limited 
purpose participant shall make a contribution to the NYPC Guaranty 
Fund in form and substance similar to and in an amount that is no 
less than the amount of the NYSE Guaranty, which will initially 
consist of a $50,000,000 guaranty secured by $25,000,000 in cash 
during the first year of NYPC's operations. FICC and NYPC have 
subsequently clarified and affirmatively represented that the 
limited purpose participant agreements will be individually 
negotiated and that ``the Guaranty Fund contribution that will be 
required by NYPC from any Limited Purpose Participant will be 
determined by risk-based factors without regard to whether such 
contribution amount is more or less than the amount contributed to 
the NYPC Guaranty Fund by NYSE Euronext.'' See Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011). See also Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
    \28\ See NYPC Rule 801(c)(1)(i).
    \29\ See NYPC Rule 801(c)(1)(ii).
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    FICC and NYPC anticipate that the limited purpose participant 
agreement will encompass the foregoing requirements for limited purpose 
membership contained in NYPC's rules. Because each DCO could present 
different operational issues, terms beyond the basic rules provisions 
will be discussed on a case-by-case basis and reflected in the 
respective limited purpose participant agreement accordingly. FICC and 
NYPC envision that a possible structure for DCO limited purpose 
participation could be an omnibus account, with the DCO limited purpose 
participant essentially acting as

[[Page 12148]]

a processing agent for its clearing members vis-a-vis NYPC with respect 
to the submission of eligible positions of the DCO's clearing members 
to NYPC for purposes of inclusion in the one-pot arrangement with FICC. 
In order for their eligible positions to be included in the ``one-
pot,'' clearing members of the DCO limited purpose participant would be 
required to authorize the DCO to submit their positions to NYPC. Under 
such a structure, the DCO would be responsible for fulfilling all 
margin and guaranty fund requirements associated with the activity in 
the omnibus account.
    With respect to both the clearance of trades for unaffiliated DCMs 
and the admission of DCOs as limited purpose participants, FICC has 
indicated that NYPC has committed that it will complete the process to 
allow one or more DCMs or DCOs to be admitted and integrated into the 
``one-pot'' cross-margining arrangement as soon as feasible, but no 
later than 24 months from the start of operations. FICC has represented 
that this provision is necessary to the effective implementation of the 
one-pot cross-margining methodology and that this window of time is 
required to allow for refinement and enhancement of certain systems 
after operations commence, to allow time for the possible simultaneous 
integration with multiple major clearing members so that fair market 
access is assured, and to allow time for the completion of the material 
operational challenge of connecting and integrating NYPC with the 
separate technologies of other DCMs and/or DCOs. However, during this 
interim period, NYPC may engage, and FICC has represented in its filing 
to the Commission that NYPC is engaging, in discussions with other DCMs 
and DCOs. FICC has also represented in its filing that NYPC anticipates 
that it will be able to complete the integration of additional DCMs 
and/or DCOs in advance of this two-year period.

C. Other GSD Proposed Rule Changes

    The proposed rule filing allows FICC to permit margining of 
positions held in accounts of an affiliate of a member within GSD, akin 
to the inter-affiliate margining in the CME Arrangement and the 
proposed NYPC Arrangement. Thus, as in those arrangements, if a GSD 
member defaults, its GSD clearing fund deposits, cash settlement 
amounts and other available collateral will be available to FICC to 
cover the member's default, as will the GSD clearing fund deposits and 
available collateral of any Permitted Margin Affiliate with which it 
cross-margins.
1. Loss Allocation
    Under the current loss allocation methodology in GSD Rule 4, 
Clearing Fund and Loss Allocation, GSD allocates losses first to the 
most recent counterparties of a defaulting member. The proposed changes 
to GSD Rule 4 will delete this step in the loss allocation methodology 
in order to achieve a more even distribution of losses among GSD 
members without a focus on recent counterparties.
    Under the proposed rule change any loss allocation will be made 
first against the retained earnings of FICC attributable to GSD in an 
amount up to 25 percent of FICC's retained earnings or such higher 
amount as may be approved by the Board of Directors of FICC.
    If a loss still remains, GSD will divide the loss between the FICC 
Tier 1 Netting Members and the FICC Tier 2 Netting Members. The terms 
``Tier 1 Netting Member'' and ``Tier 2 Netting Member'' have been 
introduced in the GSD Rules to reflect two different categories of 
membership, which have been designated as such by FICC for loss 
allocation purposes. Currently, only investment companies registered 
under the Investment Company Act of 1940, as amended, (which companies 
are subject to regulatory requirements restricting their ability to 
mutualize losses) will qualify as Tier 2 Netting Members. Tier 2 
Netting Members will only be subject to loss to the extent they traded 
with the defaulting members and will not be responsible for mutualizing 
losses with participants with which they do not trade, in order to 
account for regulatory requirements applicable to such registered 
investment companies.
    Tier 1 Netting Members will be allocated the loss applicable to 
them first by assessing the Clearing Fund deposit of each such member 
in the amount of up to $50,000, equally. If a loss remains, Tier 1 
Netting Members will be assessed ratably in accordance with the 
respective amounts of their Required Fund Deposits based on the average 
daily amount of the member's Required Fund Deposit over the prior 
twelve months. Consistent with the current GSD rules, GSD members that 
are acting as inter-dealer brokers will be limited to a loss allocation 
of $5 million with respect to their inter-dealer broker activity.
2. Margin Calculation--Intraday Margin Calls
    GSD proposes to calculate Clearing Fund requirements twice per day. 
GSD will retain its regular calculation and call as set out in the GSD 
rules. An additional daily intra-day calculation and call (``Intraday 
Supplemental Clearing Fund Deposit'') are being added to GSD's 
rules.\30\ The intra-day call will be subject to a threshold that will 
be identified in FICC's risk management procedures.\31\ In addition, 
GSD will process a mark-to-market pass-through twice per day, instead 
of the current practice of once daily. The second collection and pass-
through of mark-to-market amounts will include a limited set of 
components to be defined in FICC's risk management procedures. All 
mark-to-market debits will be collected in full. FICC will pay out 
mark-to-market credits only after any intra-day clearing fund deficit 
is met.
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    \30\ See GSD Rule 4, Clearing Fund and Loss Allocation, Section 
2a as proposed to be amended by the proposed rule change.
    \31\ Id. FICC shall establish procedures for collection of an 
amount calculated in respect of a Member's Intraday Supplemental 
Fund Deposit, including parameters regarding threshold amounts that 
require payment, and the form and time by which payment is required 
to be made to FICC.
---------------------------------------------------------------------------

    Since GSD will be recalculating and margining a GSD member's 
exposure intra-day, the margin calculation methodology set forth in GSD 
Rule 4, Clearing Fund and Loss Allocation, will be revised to eliminate 
the ``Margin Requirement Differential'' component of the FICC clearing 
fund calculation. In addition, GSD Rule 4 will be revised to provide 
that in the case of a Margin Portfolio that contains accounts of a 
Permitted Margin Affiliate, FICC will apply the highest VaR confidence 
level applicable to the GSD member or the Permitted Margin Affiliate, 
in the event that multiple confidence levels are used to determine 
margin. Application of a higher VaR confidence level will result in a 
higher margin rate. Consistent with current GSD rules, a minimum 
Required Fund Deposit of $5 million will apply to a member that 
maintains broker accounts.
3. Consolidated Funds-Only Settlement
    The funds-only settlement process at GSD currently requires a 
member to appoint a settling bank that will settle the member's net 
debit or net credit amount due to or from GSD by way of the National 
Settlement Service of the Board of Governors of the Federal Reserve 
System (``NSS''). Any funds-only settling bank that will settle for a 
member that is also an NYPC member or that will settle for a member and 
a Permitted Margin Affiliate that is an NYPC member will have its net-
net credit or debit balances at each clearing corporation, other than 
balances with respect to futures positions of a ``customer'' as such 
term is defined in

[[Page 12149]]

CFTC Regulation 1.3(k), aggregated and netted for operational 
convenience and will pay or be paid such netted amount. The proposed 
rule change makes clear that, notwithstanding the consolidated 
settlement, the member will remain obligated to GSD for the full amount 
of its funds-only settlement amount.
4. Submission of Locked-In Trades from NYPC
    The current GSD rules allow for submission of ``locked-in trades'' 
(i.e., trades that are deemed compared when the data on the trade is 
received from a single source) \32\ submitted by a locked-in trade 
source on behalf of a GSD member. Currently, designated locked-in trade 
sources are Federal Reserve Banks on behalf of the Treasury Department, 
Freddie Mac, and GCF-Authorized Inter-Dealer Brokers for GCF Repo 
transactions. Under the proposed rule change, GSD Rule 6C, Locked-In 
Comparison, will be amended to include NYPC as an additional locked-in 
trade source. This is necessary because there will be futures 
transactions cleared by NYPC that will proceed to physical delivery. 
NYPC will submit the trade data as a locked-in trade source for 
processing through FICC, identifying the GSD member that had authorized 
FICC to accept the locked-in trade from NYPC. Once these transactions 
are submitted to FICC, they will no longer be futures, but rather will 
be in the form of buys or sells eligible for processing by GSD. As will 
be the case with other locked-in trade submissions accepted by FICC, 
the GSD member designated in the trade information must have executed 
appropriate documentation evidencing to FICC its authorization of NYPC.
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    \32\ The term ``Locked-In Trade'' means a trade involving 
Eligible Securities that is deemed a compared trade once the data on 
such trade is received from a single, designated source and meets 
the requirements for submission of data on a locked-in trade 
pursuant to GSD's rules, without the necessity of matching the data 
regarding the trade with data provided by each member that is or is 
acting on behalf of an original counterparty to the trade. The data 
regarding a locked-in trade are provided to FICC by a locked-in 
trade source that has been authorized by a member that is a party to 
the trade to provide such data to FICC.
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5. Deletion of the Category 1/Category 2 Distinction
    The proposed rule change will delete the legacy characterization of 
certain types of members as either ``Category 1'' or ``Category 2,'' a 
distinction that currently applies to ``Dealer Netting Members,'' 
``Futures Commission Merchant Netting Members'' and ``Inter-Dealer 
Broker Netting Members'' at GSD. Historically, the two categories were 
used to margin lower capitalized members (i.e., Category 2) at a higher 
rate. Following FICC's adoption of the VaR methodology for GSD in 
2006,\33\ FICC has determined that the distinction between Category 1 
and Category 2 members is no longer necessary. Rather than margin 
netting members at higher rates solely due to a single static 
capitalization threshold, FICC is able, by use of the VaR margin 
methodology, to margin netting members at a higher rate by applying a 
higher confidence level against any netting member, which, regardless 
of size, FICC has determined poses a higher risk.
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    \33\ Securities Exchange Act Release No. 55217 (January 31, 
2007), 72 FR 5774.
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    With the deletion of the Category 1/Category 2 distinction, Section 
1 of GSD Rule 13, Funds-Only Settlement, is proposed to be changed to 
provide that all netting members could receive forward mark adjustment 
payments, subject to FICC's general discretion to withhold credits that 
would be otherwise due to a distressed netting member.
6. Amendment of CME Agreement
    The proposed NYPC Arrangement will necessitate an amendment to the 
CME Agreement to clarify that the NYPC Arrangement will take priority 
over the CME Arrangement when determining residual FICC positions that 
will be available for cross-margining with the CME. As a result, only 
those FICC positions that are not able to be cross-margined with NYPC 
positions under the NYPC Arrangement will generally be considered for 
cross-margining with the CME. In addition, when calculating and 
presenting liquidation results under the CME Agreement, the amendment 
will provide that FICC's liquidation results will include FICC's 
liquidation results in combination with NYPC's liquidation results 
because the NYPC Agreement will provide for a right of first offset 
between FICC and NYPC. The CME Agreement showing the proposed changes 
was filed as an attachment to the proposed rule change as part of 
Exhibit 5.

D. Summary of Other Proposed Changes to Rule Text

    In GSD Rule 1, Definitions, the following definitions are proposed 
to be added, revised or deleted:
    The terms ``Broker Account'' and ``Dealer Account'' will be added 
to the text of the GSD Rules. A ``Broker Account'' is an account that 
is maintained by an inter-dealer broker netting member, or a segregated 
broker account of a netting member that is not an inter-dealer broker 
netting member. An account that is not a Broker Account is referred to 
as a Dealer Account.
    ``Coverage Charge'' will be revised to refer to the additional 
charge with respect to the member's Required Fund Deposit (rather than 
its VaR Charge) which brings the member's coverage to a targeted 
confidence level.
    ``Current Net Settlement Positions'' will be corrected to clarify 
its current intent, that it is calculated with respect to a certain 
business day and not necessarily on that day, since it may be 
calculated after market close on the day prior to its application 
(i.e., before or after midnight between the close of business one day 
and the open of business on the next day).
    ``Excess Capital Differential'' will be corrected to refer to the 
amount by which a member's VaR Charge exceeds its excess capital, 
instead of by reference to the amount by which its required clearing 
fund deposit exceeds its excess capital.
    ``Excess Capital Premium Calculation Amount'' will be deleted 
because, with the introduction of VaR methodology, the calculation is 
no longer applicable. The terms ``Excess Capital Differential'' and 
``Excess Capital Ratio'' will be amended to delete archaic references 
to ``Excess Capital Premium Calculation Amount'' and to refer instead 
to the comparison of a member's capital calculation to its VaR Charge. 
In addition, the text of Section 14 of GSD Rule 3 will be amended to 
provide that the ``Excess Capital Premium'' charge applies to any type 
of entity that is a GSD netting member rather than limiting its 
applicability to only the specified types formerly identified in the 
text.
    ``Excess Capital Ratio'' will be amended to mean the quotient 
resulting from dividing the amount of a member's VaR Charge by its 
excess net capital.
    ``GSD Margin Group'' will be added to refer to the GSD accounts 
within a Margin Portfolio.
    ``Margin Portfolio'' will be added to refer to the positions 
designated by the member as grouped for cross-margining, subject to the 
rules set forth in GSD Rule 4. ``Dealer Accounts'' and ``Broker 
Accounts'' cannot be combined in a common Margin Portfolio. A 
``Sponsoring Member Omnibus Account'' cannot be combined with any other 
accounts.
    ``Unadjusted GSD Margin Portfolio Amount'' will be added to define 
the amount calculated by GSD with regard to a Margin Portfolio, before 
application of premiums, maximums or minimums.

[[Page 12150]]

It includes the VaR Charge and the coverage charge for GSD. In the case 
of a Cross-Margining Participant of GSD, the Unadjusted GSD Margin 
Portfolio Amount also will include the cross-margining reduction, if 
any.
    The terms ``Category 2 Gross Margin Amount,'' ``Margin Adjustment 
Amount,'' ``Repo Volatility Factor,'' and ``Revised Gross Margin 
Amount'' will be deleted from GSD Rule 1 since they are no longer used 
elsewhere in the GSD Rules. The Schedule of Repo Volatility Factors 
will be deleted because it is no longer applicable.
    In Section 2 of GSD Rule 3, Ongoing Membership Requirements, the 
requirement that GCF counterparties submit information relating to the 
composition of their NFE-related accounts,\34\ will be amended to 
require the submission of such information periodically, rather than on 
a quarterly basis. GSD currently requires this information every other 
month and by this change, FICC could institute periodic reporting on a 
schedule that is appropriate at such time, in response to current 
conditions. This has the potential to help tailor the frequency of 
reporting based on market conditions and thereby facilitate the risk 
management of the clearing agency.
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    \34\ The term ``NFE-Related Account'' means each securities 
account and deposit account maintained by a GCF Clearing Agent Bank 
for an Interbank Pledging Member in which the GCF Clearing Agent 
Bank has, pursuant to agreement with the Interbank Pledging Member 
or by operation of law, a security interest or right of setoff 
securing or supporting the payment of obligations of such Interbank 
Pledging Member to the Bank, including each such account to which 
such Interbank Pledging Member's Prorated Interbank Cash Amount is 
debited. See GSD Rule 1, Definitions.
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    In Section 9 of GSD Rule 4, Clearing Fund and Loss Allocation, 
concerning the return of excess deposits and payments, FICC's 
discretion to withhold the return of excess clearing fund to a member 
that has an outstanding payment obligation to FICC will be changed from 
being based on FICC's determination that the member's anticipated 
transactions or obligations over the next 90 calendar days may be 
reasonably expected to be materially different than those of the 90 
prior calendar days, under the current rule, to being based on FICC's 
determination that the member's anticipated transactions or obligations 
in the near future may be reasonably expected to be materially 
different than those in the recent past. In addition, technical and 
clarifying changes are proposed to be made to the rules and cross-
references to rule sections contained throughout. The rules have been 
reviewed by FICC and proposed to be corrected as needed to reflect the 
correct rule section references as originally intended.

III. Comments

    The Commission received thirteen comments to the proposed rule 
change and four response letters responding to comments.\35\ Nine 
commenters supported the proposed rule.\36\ Of this group, seven 
commenters generally stated that the cross-margining proposal benefits 
competition by permitting ``open access'' to cross-margining.\37\ In 
addition, six commenters argued that the proposed rule change permits 
risk minimization \38\ and promotes transparency.\39\
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    \35\ See supra notes 3 and 4.
    \36\ Letter from Adam C. Cooper, Senior Managing Director and 
Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from 
Gary DeWaal, Senior Managing Director and Group General Counsel, 
Newedge USA, LLC (December 21, 2010); Letter from John A. McCarthy, 
General Counsel, GETCO (December 21, 2010); Letter from Donald J. 
Wilson, Jr., DRW Trading Group (December 21, 2010); Letter from 
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS 
Securities, LLC (December 20, 2010); Letter from John Willian, 
Managing Director, Goldman Sachs (December 17, 2010); Letter from 
Ronald Filler, Professor of Law and Director of the Center on 
Financial Services Law, New York Law School (December 8, 2010); 
Letter from Douglas Engmann, President, Engmann Options, Inc. 
(December 6, 2010); and Letter from Jack DiMaio, Managing Director, 
Morgan Stanley (December 2, 2010).
    \37\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Ronald Filler, Professor of Law and 
Director of the Center on Financial Services Law, New York Law 
School (December 8, 2010); Letter from John Willian, Managing 
Director, Goldman Sachs (December 17, 2010); Letter from James B. 
Fuqua and David Kelly, Managing Directors, Legal, UBS Securities, 
LLC (December 20, 2010); Letter from Adam C. Cooper, Senior Managing 
Director and Chief Legal Officer, Citadel, LLC (December 21, 2010); 
Letter from Gary DeWaal, Senior Managing Director and Group General 
Counsel, Newedge USA, LLC (December 21, 2010); and Letter from John 
A. McCarthy, General Counsel, GETCO (December 21, 2010).
    \38\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Douglas Engmann, President, Engmann 
Options, Inc. (December 6, 2010); Letter from Ronald Filler, 
Professor of Law and Director of the Center on Financial Services 
Law, New York Law School (December 8, 2010); Letter from John A. 
McCarthy, General Counsel, GETCO (December 21, 2010); Letter from 
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS 
Securities, LLC (December 20, 2010); and Letter from Donald J. 
Wilson, Jr., DRW Trading Group (December 21, 2010).
    \39\ Letter from Jack DiMaio, Managing Director, Morgan Stanley 
(December 2, 2010); Letter from Ronald Filler, Professor of Law and 
Director of the Center on Financial Services Law, New York Law 
School (December 8, 2010); Letter from James B. Fuqua and David 
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20, 
2010); Letter from Adam C. Cooper, Senior Managing Director and 
Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from 
John A. McCarthy, General Counsel, GETCO (December 21, 2010); and 
Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21, 
2010).
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    Three commenters opposed the proposed rule, absent changes to 
mitigate what they identified as anti-competitive features.\40\ One 
commenter recommended further study of the rule and its risk 
methodology, but agreed with the commenters opposing the proposed rule 
change on the grounds that the rule should permit only non-exclusive 
arrangements that promote competition.\41\ The commenters against the 
proposed rule change generally stated that the cross-margining scheme 
is anti-competitive and raises risk management issues. These commenters 
raised concerns or provided comments related to the following major 
aspects of the cross-margining proposal: (1) The effect on competition; 
(2) risk management; and (3) the effect on efficiency and costs. FICC 
responded to these comments in three comment letters that it 
submitted.\42\
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    \40\ Letter from William H. Navin, Executive Vice President and 
General Counsel, The Options Clearing Corporation (December 21, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); and Letter from John C. Hiatt, 
Chief Administrative Officer, Ronin Capital (December 10, 2010).
    \41\ Letter from Joan C. Conley, Senior Vice President & 
Corporate Secretary, NASDAQ OMX (December 21, 2010).
    \42\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011); Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
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A. Effect on Competition

    Many of the commenters' concerns with respect to competition 
stemmed from FICC having an exclusive agreement to enter into a direct 
arrangement for ``one-pot'' cross-margining with NYPC.\43\ NYPC is 
jointly owned by NYSE Euronext and DTCC. DTCC is the parent company of 
FICC. NYSE Liffe is the global derivatives business of the NYSE 
Euronext. These affiliations combined with the exclusive nature of the 
direct arrangement raised concerns for these commenters.
---------------------------------------------------------------------------

    \43\ Letter from William H. Navin, Executive Vice President and 
General Counsel, The Options Clearing Corporation (December 21, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt, 
Chief Administrative Officer, Ronin Capital (December 10, 2010); and 
Letter from Joan C. Conley, Senior Vice President & Corporate 
Secretary, NASDAQ OMX (December 21, 2010).
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    With regard to allowing other parties direct access to cross-
margining, FICC argued that it is neither operationally feasible nor 
prudent to establish a framework of multiple, competing ``one-

[[Page 12151]]

pots'' with multiple, competing DCOs under this arrangement.\44\ Among 
other things, such an arrangement would result in FICC clearing members 
that are members of multiple DCOs cross-margining their futures 
positions against different segments of their portfolios at FICC, 
rather than having the risk of their positions being measured 
comprehensively.\45\ FICC stated that it believes that the attendant 
risk of delays and errors in processing would substantially increase 
systemic risk as clearing members continuously moved positions at FICC 
from one cross-margin pot to another in order to maximize their margin 
savings.\46\ For example, there is the potential that operational 
issues of managing such movements across multiple systems would create 
risks in the settlement process by adding complexities associated with 
linking and monitoring the use of multiple one cross-margin pot 
arrangements. Furthermore, FICC stated that the existence of multiple 
``one-pots'' would likely greatly complicate the liquidation of a 
cross-margining participant that was in default at FICC and NYPC, 
thereby increasing systemic risk.\47\
---------------------------------------------------------------------------

    \44\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011).
    \45\ Id.
    \46\ Id.
    \47\ Id.
---------------------------------------------------------------------------

    Commenters recognized that other DCOs (i.e., DCOs other than NYPC) 
will have the ability to obtain indirect access to the cross-margining 
arrangement by entering into a Limited Purpose Participant (``LPP'') 
agreement and becoming an LPP of NYPC. Commenters raised concerns about 
the potential for this type of indirect access, citing concerns about 
the requirements to agree to be bound by the rules of NYPC, agree to an 
allocation of clearing fees, and contribute to the NYPC guaranty fund 
in an amount equal to the contribution made by NYSE Euronext.\48\
---------------------------------------------------------------------------

    \48\ Letter from William H. Navin, Executive Vice President and 
General Counsel, The Options Clearing Corporation (December 21, 
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of 
ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt, 
Chief Administrative Officer, Ronin Capital (December 10, 2010); and 
Letter from Joan C. Conley, Senior Vice President & Corporate 
Secretary, NASDAQ OMX (December 21, 2010).
---------------------------------------------------------------------------

    FICC responded to these comments.\49\ Specifically, FICC stated 
that, while DCOs that are LPPs clearing through NYPC would need to 
abide by NYPC's rules, NYPC's intention is that there would be separate 
requirements (including with respect to margin deposits and guaranty 
fund contributions applied) to the LPP, on the one hand, and the LPP's 
members, on the other, unless: (i) NYPC and the LPP separately agree to 
allocate those amounts to the LPP and its members, or (ii) a clearing 
member of NYPC is also a clearing member of an LPP.\50\ FICC and NYPC 
also represented that the NYPC rules would apply to a LPP but not to 
the members of the LPP, unless such members are otherwise clearing 
members of NYPC.\51\ In addition, FICC noted that NYPC Rule 801 is 
designed to permit maximum flexibility in structuring the admission of 
LPPs, as it is contemplated that any such admission would be subject to 
substantial negotiation between NYPC and the prospective LPP regarding 
the operational mechanics of margin deposits and related subjects.\52\
---------------------------------------------------------------------------

    \49\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011) and Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation; Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael 
Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 27, 2011).
    \50\ Id.
    \51\ Letter from Michael Bodson, Executive Managing Director, 
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive 
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
    \52\ Letter from Douglas Landy, Allen & Overy on behalf of the 
Fixed Income Clearing Corporation (January 4, 2011) and Letter from 
Michael Bodson, Executive Managing Director, Fixed Income Clearing 
Corporation and Walt Lukken, Chief Executive Officer, New York 
Portfolio Clearing, LLC (February 7, 2011).
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    In addition, FICC has represented to the Commission that the fees 
NYPC charges LPPs will be determined on a case-by-case basis based on 
the services provided to recoup operational and other costs that NYPC 
incurs in integrating the new LPP.\53\ Moreover, FICC and NYPC 
clarified and affirmatively represented that the limited purpose 
participant agreements will be individually negotiated and that ``the 
Guaranty Fund contribution that will be required by NYPC from any 
Limited Purpose Participant will be determined by risk-based factors 
without regard to whether such contribution amount is more or less than 
the amount contributed to the NYPC Guaranty Fund by NYSE 
Euronext''.\54\
---------------------------------------------------------------------------

    \53\ Letter from Douglas Landy, Allen