Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of No Objection To Advance Notice To Enhance National Securities Clearing Corporation's Haircut-Based Volatility Charge Applicable to Municipal Bonds, 8978-8982 [2020-03055]

Download as PDF 8978 Federal Register / Vol. 85, No. 32 / Tuesday, February 18, 2020 / Notices Commission, 100 F Street NE, Washington, DC 20549–1090. SECURITIES AND EXCHANGE COMMISSION All submissions should refer to File Number SR–CFE–2020–001. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s internet website (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–CFE–2020–001, and should be submitted on or before March 10, 2020. [Release No. 34–88162; File No. SR–NSCC– 2019–801] For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.9 J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2020–03088 Filed 2–14–20; 8:45 am] lotter on DSKBCFDHB2PROD with NOTICES BILLING CODE 8011–01–P 9 17 CFR 200.30–3(a)(73). VerDate Sep<11>2014 17:48 Feb 14, 2020 Jkt 250001 Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of No Objection To Advance Notice To Enhance National Securities Clearing Corporation’s Haircut-Based Volatility Charge Applicable to Municipal Bonds February 11, 2020. On December 13, 2019, National Securities Clearing Corporation (‘‘NSCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) advance notice SR–NSCC–2019–801 (‘‘Advance Notice’’) pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, entitled Payment, Clearing and Settlement Supervision Act of 2010 (‘‘Clearing Supervision Act’’) 1 and Rule 19b–4(n)(1)(i) 2 under the Securities Exchange Act of 1934 (‘‘Exchange Act’’ 3 to revise NSCC’s methodology for calculating margin amounts applicable to municipal bonds. The Advance Notice was published for public comment in the Federal Register on January 14, 2020,4 and the Commission has received no comments regarding the changes proposed in the Advance Notice.5 This publication serves as notice of no objection to the Advance Notice. I. The Advance Notice The proposals reflected in the Advance Notice would revise NSCC’s Rules and Procedures (‘‘Rules’’) 6 to 1 12 U.S.C. 5465(e)(1). CFR 240.19b–4(n)(1)(i). 3 15 U.S.C. 78a et seq. 4 Securities Exchange Act Release No. 87911 (January 8, 2020), 85 FR 2197 (January 14, 2020) (File No. SR–NSCC–2019–801) (‘‘Notice of Filing’’). On December 13, 2019, NSCC also filed a related proposed rule change (SR–NSCC–2019–004) with the Commission pursuant to Section 19(b)(1) of the Exchange Act and Rule 19b–4 thereunder (‘‘Proposed Rule Change’’). See 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b–4 respectively. In the Proposed Rule Change, which was published in the Federal Register on January 2, 2020, NSCC seeks approval of proposed changes to its rules necessary to implement the Advance Notice. Securities Exchange Act Release No. 87858 (December 26, 2019), 85 FR 149 (January 2, 2020). The comment period for the related Proposed Rule Change filing closed on January 23, 2020, and the Commission received no comments. 5 As the proposal contained in the Advance Notice was also filed as a proposed rule change, all public comments received on the proposal are considered regardless of whether the comments are submitted on the proposed rule change or the Advance Notice. 6 Capitalized terms not defined herein are defined in the Rules, available at https://dtcc.com/∼/media/ Files/Downloads/legal/rules/nscc_rules.pdf. 2 17 PO 00000 Frm 00174 Fmt 4703 Sfmt 4703 change the methodology NSCC uses for calculating the haircut-based margin charge applicable to municipal bonds. A. Background NSCC provides clearing, settlement, risk management, central counterparty services, and a guarantee of completion for virtually all broker-to-broker trades involving equity securities, corporate and municipal debt securities, and certain other securities. NSCC manages its credit exposure to its members by determining an appropriate Required Fund Deposit (i.e., margin) for each member.7 The aggregate of all NSCC members’ Required Fund Deposits (together with certain other deposits required under the Rules) constitute NSCC’s Clearing Fund, which NSCC would access should a defaulting member’s own Required Fund Deposit be insufficient to satisfy losses to NSCC caused by the liquidation of the defaulting member’s portfolio.8 NSCC collects each member’s Required Fund Deposit to mitigate potential losses to NSCC associated with the liquidation of the member’s portfolio in the event of the member’s default.9 Each member’s Required Fund Deposit consists of a number of applicable components, which are calculated to address specific risks that the member’s portfolio presents to NSCC.10 Generally, the largest component of a member’s Required Fund Deposit is the volatility component.11 The volatility component is designed to calculate the potential losses on a portfolio over a given period of time assumed necessary to liquidate the portfolio, within a 99% confidence level. The methodology for calculating the volatility component of the Required Fund Deposit depends on the type of security.12 Specifically, for certain 7 See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund Formula and Other Matters) of the Rules (‘‘Procedure XV’’), supra note 6. 8 See id. 9 The Rules identify when NSCC may cease to act for a member and the types of actions NSCC may take. For example, NSCC may suspend a firm’s membership with NSCC or prohibit or limit a member’s access to NSCC’s services in the event that member defaults on a financial or other obligation to NSCC. See Rule 46 (Restrictions on Access to Services) of the Rules, supra note 6. 10 Procedure XV, supra note 6. 11 See id. 12 For most securities (e.g., equity securities), NSCC calculates the volatility component as the greater of (1) the larger of two separate calculations that utilize a parametric Value at Risk (‘‘VaR’’) model, (2) a gap risk measure calculation based on the largest non-index position in a portfolio that exceeds a concentration threshold, which addresses concentration risk that can be present in a member’s portfolio, and (3) a portfolio margin floor calculation based on the market values of the long E:\FR\FM\18FEN1.SGM 18FEN1 Federal Register / Vol. 85, No. 32 / Tuesday, February 18, 2020 / Notices securities, including municipal bonds, NSCC calculates a haircut-based volatility component by multiplying the absolute value of a member’s positions in such securities by a certain percentage designated by NSCC.13 NSCC’s current methodology for designating the percentages used in calculating the haircut-based volatility component for municipal bonds involves distinguishing between municipal bonds based on tenor (i.e., remaining time to maturity), municipal sector (e.g., general obligation, transportation, healthcare, etc.), and credit rating.14 Pursuant to that methodology, NSCC assigns each tenorbased group a percentage.15 For municipal bonds rated higher than BBB+, the tenor-based percentage is the percentage NSCC uses to calculate the haircut-based volatility component.16 However, for municipal bonds rated BBB+ or lower, NSCC multiplies the tenor-based percentage by a sector-based risk factor, resulting in a larger percentage for the haircut.17 The additional sector-based risk factors account for the variable risks between municipal sectors associated with the various industries in which the bonds are issued and the sources of bond repayment.18 In all cases, the percentage used to calculate the municipal bond haircutbased volatility component is not less than 2%, regardless of a municipal bond’s credit rating.19 lotter on DSKBCFDHB2PROD with NOTICES B. New Changes to NSCC’s Methodology for Calculating Municipal Bond Haircut Percentages NSCC states that it regularly assesses its margining methodologies to evaluate and short positions in the portfolio, which addresses risks that might not be adequately addressed with the other volatility component calculations. See id.; see also Securities Exchange Act Release No. 82780 (February 26, 2018), 83 FR 9035 (March 2, 2018) (File No. SR–NSCC–2017– 808); Securities Exchange Act Release No. 82781 (February 26, 2018), 83 FR 9042 (March 2, 2018) (File No. SR–NSCC–2017–020). 13 Procedure XV, supra note 6. 14 Notice of Filing, supra note 4 at 2198. 15 See id. 16 For example, a $10MM short position in a municipal bond rated above BBB+ with 3 years to maturity is subject to the 2–5 years tenor-based group haircut of 5%, which applies to the absolute market value of the positions, resulting in a haircutbased volatility component of $500,000. Notice of Filing, supra note 4 at 2198. 17 For example, a $10MM short position in a healthcare sector municipal bond rated BBB+ or lower with 3 years to maturity is subject to the 2–5 years tenor-based group haircut (5%) multiplied by the sector-based factor of 1.2, resulting in a 6% haircut-based volatility component of $600,000. Notice of Filing, supra note 4 at 2198. 18 See id. 19 Procedure XV, supra note 6. VerDate Sep<11>2014 17:48 Feb 14, 2020 Jkt 250001 whether margin levels are commensurate with the particular risk attributes of the various products, portfolios, and markets that NSCC serves.20 NSCC further states that based on recent impact studies, the margin levels generated from municipal bonds using the current methodology exceed the levels necessary to mitigate the risk associated with those securities.21 In the Advance Notice, NSCC proposes to change the methodology for calculating the municipal bond haircut-based volatility component so that the amount of margin NSCC collects is more commensurate with the risk attributes of those securities. As proposed in the Advance Notice, NSCC would retain the current provision that in all cases the percentage used to calculate the municipal bond haircut-based volatility component is not less than 2%, regardless of a municipal bond’s credit rating. NSCC would also continue to distinguish between municipal bonds based on tenor, credit rating, and municipal sector. However, NSCC would calculate the haircut percentages for various groups of municipal bonds based on the historical returns of one or more benchmark indices over a lookback period not shorter than 10 years, using a minimum 99% calibration percentile. The proposal would change the manner in which NSCC addresses the risk presented by lower-rated municipal bonds. Instead of the current methodology’s approach which applies a sector-based straight risk factor to the tenor-based haircut, resulting in a larger haircut percentage, the proposed approach would allow the calculation to be more precisely tailored to the risks presented by particular municipal bonds. Specifically, the new approach would base the haircut percentage on the historical returns of one or more benchmark indices, such as tenor-based indices, municipal bond sector-based indices, and high-yield indices, over a look-back period of at least ten years and would no longer use a sector-based straight risk factor for lower-rated municipal bonds. This approach should allow NSCC to more accurately calculate margin amounts appropriate for the risks presented by such municipal bonds by allowing NSCC to take into account a broader range of risk characteristics associated with municipal bonds. NSCC notes that, 20 Notice of Filing, supra note 4 at 2198. part of the Advance Notice, NSCC filed Exhibit 3—NSCC Impact Studies, comparing the current and proposed methodologies. Pursuant to 17 CFR 240.24b–2, NSCC requested confidential treatment of Exhibit 3. 21 As PO 00000 Frm 00175 Fmt 4703 Sfmt 4703 8979 based on recent impact studies comparing the current and proposed methodologies, the proposed methodology would manage NSCC’s applicable risks well above the 99% confidence level, although it would generate lower overall margin amounts.22 Under the proposal in the Advance Notice, NSCC states that for municipal bonds rated higher than BBB+, NSCC would use a tenor-based index as the applicable benchmark index.23 Specifically, NSCC would use the percentage derived from the tenor-based index as the haircut for the purpose of calculating the volatility component for municipal bonds rated higher than BBB+.24 For municipal bonds rated BBB+ or lower (or not rated), NSCC states that it would use a percentage that is the highest of: (1) The applicable tenor-based index, (2) municipal bond sector-based indices, and (3) a highyield index. 25 For all municipal bonds, when deriving the haircut percentage from the applicable indices, NSCC would use a look-back period of a 10 year rolling window plus a 1-year ‘‘worst case scenario’’ stress period.26 NSCC would identify the largest 3-day price return movement (reflected as a percentage) within the 99th percentile of all 3-day price return movements during the look-back period. Additionally, NSCC proposes to recalibrate the municipal bond haircut percentages no less frequently than annually. As proposed in the Advance Notice, NSCC would have the ability to modify certain aspects of the application of the proposed methodology consistent with NSCC’s applicable governance procedures and based on NSCC’s determination that such modifications are necessary to manage the applicable risks above the 99% confidence level. Specifically, based on NSCC’s regular review of its margin methodologies, NSCC would be able to modify: The frequency of re-calibrating the municipal bond haircut percentages; applicable benchmark indices and the applicable period for the price return 22 Notice of Filing, supra note 4 at 2199. 23 Id. 24 Id. 25 Id. 26 NSCC believes that a 10-year window plus 1-year stress period would capture relevant data and cover sufficient market data without diluting the ‘‘tail’’ with an abundance of data. NSCC believes this look-back period is typically long enough to capture at least two recent market cycles, whereas a longer look-back period might ‘‘flatten’’ out the results because recent volatile periods might be offset by non-volatile periods, making the more recent volatility appear less significant. Notice of Filing, supra note 4 at 2199. E:\FR\FM\18FEN1.SGM 18FEN1 8980 Federal Register / Vol. 85, No. 32 / Tuesday, February 18, 2020 / Notices used in the calculations; and the lookback period. NSCC states that any such modifications would be subject to the governance procedures applicable to all of NSCC’s margin methodologies, as set forth in NSCC’s Clearing Agency Model Risk Management Framework, which the Commission has approved.27 Finally, NSCC proposes a method to address extraordinary circumstances in which a certain municipality or issuer may present unique risks not otherwise captured by the proposed methodology’s use of a percentage derived from the maximum of the applicable tenor-based index, municipal bond sector-based indices, and highyield indices.28 In such scenarios, NSCC proposes to have the ability to use the highest percentage generated for any municipal bond group when calculating the haircut-based volatility component for municipal bonds issued by the municipality or issuer presenting such unique risks. II. Discussion and Commission Findings Although the Clearing Supervision Act does not specify a standard of review for an advance notice, the stated purpose of the Clearing Supervision Act is instructive: to mitigate systemic risk in the financial system and promote financial stability by, among other things, promoting uniform risk management standards for SIFMUs and strengthening the liquidity of SIFMUs.29 Section 805(a)(2) of the Clearing Supervision Act authorizes the Commission to prescribe regulations containing risk management standards for the payment, clearing, and settlement activities of designated clearing entities engaged in designated activities for which the Commission is the supervisory agency.30 Section 805(b) of the Clearing Supervision Act provides the following objectives and principles for the Commission’s risk management standards prescribed under Section 805(a):31 • To promote robust risk management; • to promote safety and soundness; • to reduce systemic risks; and • to support the stability of the broader financial system. Section 805(c) provides, in addition, that the Commission’s risk management standards may address such areas as risk management and default policies and procedures, among others areas.32 The Commission has adopted risk management standards under Section 805(a)(2) of the Clearing Supervision Act and Section 17A of the Exchange Act (the ‘‘Clearing Agency Rules’’).33 The Clearing Agency Rules require, among other things, each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures that are reasonably designed to meet certain minimum requirements for its operations and risk management practices on an ongoing basis.34 As such, it is appropriate for the Commission to review advance notices against the Clearing Agency Rules and the objectives and principles of these risk management standards as described in Section 805(b) of the Clearing Supervision Act. As discussed below, the Commission believes the proposal in the Advance Notice is consistent with the objectives and principles described in Section 805(b) of the Clearing Supervision Act,35 and in the Clearing Agency Rules, in particular Rules 17Ad–22(e)(4) and (e)(6).36 A. Consistency With Section 805(b) of the Clearing Supervision Act The Commission believes that the Advance Notice is consistent with the stated objectives and principles of Section 805(b) of the Clearing Supervision Act. As described above in Section I.A., NSCC’s current methodology calculates municipal bond haircut percentages using tenor-based percentages and sector-based risk factors. NSCC states that the current methodology generates margin amounts greater than necessary to mitigate NSCC’s risks associated with municipal bonds. NSCC proposes to replace the current methodology with one that would calculate the haircut percentages based on the historical returns of one or more benchmark 32 12 lotter on DSKBCFDHB2PROD with NOTICES 27 Id.; See also Securities Exchange Act Release No. 81485 (August 25, 2017), 82 FR 41433 (August 31, 2017) (File No. SR–NSCC–2017–008); Securities Exchange Act Release No. 84458 (October 19, 2018), 83 FR 53925 (October 25, 2018) (File No. SR– NSCC–2018–009). 28 For example, the market price risk for issues of a municipality facing technical default following a natural disaster may not be fully captured by the proposed methodology due to the liquidity profile of municipal securities. 29 See 12 U.S.C. 5461(b). 30 12 U.S.C. 5464(a)(2). 31 12 U.S.C. 5464(b). VerDate Sep<11>2014 17:48 Feb 14, 2020 Jkt 250001 U.S.C. 5464(c). CFR 240.17Ad–22. See Securities Exchange Act Release No. 68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7–08–11). See also Securities Exchange Act Release No. 78961 (September 28, 2016), 81 FR 70786 (October 13, 2016) (S7–03–14) (‘‘Covered Clearing Agency Standards’’). The Commission established an effective date of December 12, 2016 and a compliance date of April 11, 2017 for the Covered Clearing Agency Standards. NSCC is a ‘‘covered clearing agency’’ as defined in Rule 17Ad–22(a)(5). 34 17 CFR 240.17Ad–22. 35 12 U.S.C. 5464(b). 36 17 CFR 240.17Ad–22(e)(4) and (e)(6). 33 17 PO 00000 Frm 00176 Fmt 4703 Sfmt 4703 indices over a look-back period of not shorter than 10 years, using a minimum 99% calibration percentile. These changes would result in margin amounts that are more commensurate with the risk attributes of municipal bonds, while still managing NSCC’s applicable risks well above the 99% confidence level.37 Accordingly, the Commission believes that the proposed methodology for calculating municipal bond haircut percentages would be consistent with promoting robust risk management because the proposed methodology would enable NSCC to more precisely manage the relevant risks than the current methodology. Further, by helping to ensure that NSCC collects margin amounts sufficient to manage NSCC’s risks associated with municipal bonds, the proposed methodology would help limit NSCC’s exposure in the event of a default of a member with positions in municipal bonds. Accordingly, the Commission believes that the proposed methodology would be consistent with promoting safety and soundness at NSCC. Finally, as noted above, NSCC states that based on recent impact studies, while the proposed methodology would fully manage NSCC’s applicable risks well above the 99% confidence level, it would reduce margin requirements for every NSCC member holding positions in municipal bonds.38 The changes proposed in the Advance Notice would therefore result in lower capital demands on such members, who could benefit from having the ability to use their liquid resources for other purposes, including handling market stress events, which could, in turn, have beneficial implications for the stability of the broader financial system. Accordingly, the Division believes that the proposed methodology would be consistent with supporting the stability of the financial system and reducing systemic risks. As described above in Section I.B., NSCC proposes to re-calibrate the municipal bond haircut percentages no less frequently than annually. Regular re-calibration of the municipal bond haircut percentages is necessary to ensure that the relevant calculations and resulting margin levels take into account any changes over time to the risk attributes of municipal bonds. The Commission believes that the proposal to re-calibrate the municipal bond haircut percentages no less frequently than annually would be consistent with robust risk management because it 37 Notice 38 Id.; E:\FR\FM\18FEN1.SGM of Filing, supra note 4 at 2199. Proposed Rule Change, supra note 4 at 154. 18FEN1 lotter on DSKBCFDHB2PROD with NOTICES Federal Register / Vol. 85, No. 32 / Tuesday, February 18, 2020 / Notices would require NSCC to regularly review the municipal bond haircut percentages to ensure that margin levels remain commensurate with the particular risk attributes of municipal bonds. Additionally, by helping to ensure that NSCC continues to collect margin amounts sufficient to manage the risks associated with municipal bonds, NSCC’s proposal to re-calibrate the municipal bond haircut percentages no less frequently than annually would help limit NSCC’s exposure in the event of a default of a member with positions in municipal bonds. Accordingly, the Commission believes that NSCC’s proposal to re-calibrate the municipal bond haircut percentages no less frequently than annually would be consistent with promoting safety and soundness at NSCC, which in turn would support the stability of the broader financial system and reduce systemic risks. As described above in Section I.B., a certain municipality or issuer may present unique risks to NSCC not otherwise captured by the proposed methodology’s use of a percentage derived from the maximum of the applicable tenor-based index, municipal bond sector-based indices, and highyield indices. In such scenarios, NSCC proposes to have the ability to use the highest percentage generated for any municipal bond group when calculating the haircut-based volatility component for municipal bonds issued by the municipality or issuer presenting such unique risks. The Commission believes the proposed discretion allowing NSCC to apply the highest percentage to municipal bonds issued by a municipality or issuer presenting unique risks would be consistent with robust risk management by helping to ensure that NSCC collects sufficient margin amounts with respect to such securities. Additionally, by helping to ensure that NSCC collects sufficient margin amounts with respect to municipal bonds issued by a municipality or issuer presenting such unique risks, the proposed discretion could help limit NSCC’s exposure in the event of a default of a member with positions in such municipal bonds. Accordingly, the Commission believes that the proposed discretion allowing NSCC to apply the highest percentage to municipal bonds issued by a municipality or issuer presenting unique risks would be consistent with promoting safety and soundness at NSCC, which in turn would support the stability of the broader financial system and reduce systemic risks. VerDate Sep<11>2014 17:48 Feb 14, 2020 Jkt 250001 B. Consistency With Rule 17Ad– 22(e)(4)(i) Rule 17Ad–22(e)(4)(i) requires that NSCC establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by maintaining sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence.39 As described above in Section I.B., NSCC proposes to replace the current methodology for calculating municipal bond haircut percentages with a methodology that would utilize the historical returns of one or more benchmark indices over a look-back period of not shorter than 10 years, using a minimum 99% calibration percentile. These changes would result in more precisely determined margin amounts, while still managing NSCC’s applicable risks well above the 99% confidence level.40 Accordingly, the Commission believes that the proposed methodology is consistent with Rule 17Ad–22(e)(4)(i) because it should enable NSCC to effectively identify, measure, monitor, and manage its credit exposures to members with positions in municipal bonds, including by maintaining sufficient financial resources to cover NSCC’s credit exposure to such members fully with a high degree of confidence.41 As described above in Section I.B., NSCC proposes to re-calibrate the municipal bond haircut percentages no less frequently than annually. The proposal would require NSCC to regularly review the municipal bond haircut percentages, thereby helping to ensure that the haircut percentages and resulting margin levels take into account any changes over time to the risk attributes of municipal bonds. Accordingly, the Commission believes that the proposal to re-calibrate the municipal bond haircut percentages no less frequently than annually is consistent with Rule 17Ad–22(e)(4)(i) because it should allow NSCC to effectively identify, measure, monitor, and manage its credit exposures to members with positions in municipal bonds, including by maintaining sufficient financial resources to cover NSCC’s credit exposure to such members fully with a high degree of confidence.42 39 17 CFR 240.17Ad–22(e)(4)(i). of Filing, supra note 4 at 2199. As described above in Section I.B., NSCC proposes to have the ability to use the highest percentage generated for any municipal bond group when calculating the haircut-based volatility component for municipal bonds issued by a municipality or issuer presenting unique risks not otherwise captured by the calculations in the proposed methodology. Such discretion should help ensure that NSCC collects sufficient margin amounts with respect to those securities. Accordingly, the Commission believes that the proposed ability to apply the highest percentage to such municipal bonds is consistent with Rule 17Ad–22(e)(4)(i) because it should better enable NSCC to effectively identify, measure, monitor, and manage its credit exposures to members with positions in such municipal bonds, including by maintaining sufficient financial resources to cover NSCC’s credit exposure to such members fully with a high degree of confidence.43 C. Consistency With Rules 17Ad– 22(e)(6)(i) and (v) Rule 17Ad–22(e)(6)(i) requires that NSCC establish, implement, maintain and enforce written policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that, at a minimum, considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market.44 Rule 17Ad–22(e)(6)(v) requires that NSCC establish, implement, maintain and enforce written policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that, at a minimum, uses an appropriate method for measuring credit exposure that accounts for relevant product risk factors and portfolio effects across products.45 As described above in Section I.B., NSCC proposes to replace the current methodology for calculating municipal bond haircut percentages with a methodology that would utilize the historical returns of one or more benchmark indices over a look-back period of not shorter than 10 years, using a minimum 99% calibration percentile. NSCC designed the proposed methodology to generate margin amounts that are more commensurate with the risk attributes of municipal bonds than the current methodology. Accordingly, the Commission believes 40 Notice 43 Id. 41 Id. 44 17 42 Id. 45 17 PO 00000 Frm 00177 Fmt 4703 Sfmt 4703 8981 E:\FR\FM\18FEN1.SGM CFR 240.17Ad–22(e)(6)(i). CFR 240.17Ad–22(e)(6)(v). 18FEN1 lotter on DSKBCFDHB2PROD with NOTICES 8982 Federal Register / Vol. 85, No. 32 / Tuesday, February 18, 2020 / Notices that the proposed methodology is consistent with Rules 17Ad–22(e)(6)(i) and (v) because it is designed to establish a risk-based margin system that (1) considers and produces relevant margin levels commensurate with the risks and particular attributes of municipal bonds, and (2) uses an appropriate method for measuring credit exposure that accounts for municipal bond risk factors and portfolio effects.46 As described above in Section I.B., NSCC proposes to re-calibrate the municipal bond haircut percentages no less frequently than annually. The proposal would require NSCC to regularly review the municipal bond haircut percentages, thereby helping to ensure that the haircut percentages and resulting margin levels take into account any changes over time to the risk attributes of municipal bonds. Accordingly, the Commission believes that the proposal to re-calibrate the municipal bond haircut percentages no less frequently than annually is consistent with Rules 17Ad–22(e)(6)(i) and (v) because it would contribute to a risk-based margin system designed to (1) consider and produce relevant margin levels commensurate with the risks and particular attributes of municipal bonds, and (2) use an appropriate method for measuring credit exposure that accounts for municipal bond risk factors and portfolio effects.47 As described above in Section I.B., NSCC proposes to have the ability to use the highest percentage generated for any municipal bond group when calculating the haircut-based volatility component for municipal bonds issued by a municipality or issuer presenting unique risks not otherwise captured by the calculations in the proposed methodology. This discretion should help ensure that NSCC collects sufficient margin amounts with respect to those securities. Accordingly, the Commission believes that the proposed discretion to apply the highest percentage to such municipal bonds is consistent with Rules 17Ad–22(e)(6)(i) and (v) because it would contribute to a risk-based margin system designed to (1) consider and produce relevant margin levels commensurate with the risks and particular attributes of municipal bonds, and (2) use an appropriate method for measuring credit exposure that accounts for municipal bond risk factors and portfolio effects.48 46 17 CFR 240.17Ad–22(e)(6)(i) and (v). It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Clearing Supervision Act, that the Commission does not object to Advance Notice (SR– NSCC–2019–801) and that NSCC is authorized to implement the proposed change as of the date of this notice or the date of an order by the Commission approving proposed rule change SR– NSCC–2019–004, whichever is later. By the Commission. J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2020–03055 Filed 2–14–20; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–88165; File No. SR–NYSE– 2020–08] Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Amend Its Price List February 11, 2020. Pursuant to Section 19(b)(1) 1 of the Securities Exchange Act of 1934 (the ‘‘Act’’) 2 and Rule 19b–4 thereunder,3 notice is hereby given that, on January 31, 2020, New York Stock Exchange LLC (‘‘NYSE’’ or the ‘‘Exchange’’) filed with the Securities and Exchange Commission (the ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the selfregulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to amend its Price List to eliminate the Step Up Tier 2 Adding Credit. The Exchange proposes to implement the fee changes effective February 3, 2020. The proposed rule change is available on the Exchange’s website at www.nyse.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. 1 15 U.S.C. 78s(b)(1). U.S.C. 78a. 3 17 CFR 240.19b–4. 2 15 47 Id. 48 17 III. Conclusion CFR 240.17Ad–22(e)(6)(i) and (v). VerDate Sep<11>2014 17:48 Feb 14, 2020 Jkt 250001 PO 00000 Frm 00178 Fmt 4703 Sfmt 4703 II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the self-regulatory organization included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of those statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant parts of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to amend its Price List to eliminate the Step Up Tier 2 Adding Credit. The proposed change responds to the current competitive environment where order flow providers have a choice of where to direct liquidity-providing orders by offering further incentives for member organizations to send additional displayed liquidity to the Exchange. The Exchange proposes to implement the fee changes effective February 3, 2020. Competitive Environment The Commission has repeatedly expressed its preference for competition over regulatory intervention in determining prices, products, and services in the securities markets. In Regulation NMS, the Commission highlighted the importance of market forces in determining prices and SRO revenues and, also, recognized that current regulation of the market system ‘‘has been remarkably successful in promoting market competition in its broader forms that are most important to investors and listed companies.’’ 4 As the Commission itself recognized, the market for trading services in NMS stocks has become ‘‘more fragmented and competitive.’’ 5 Indeed, equity trading is currently dispersed across 13 exchanges,6 31 alternative trading 4 See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37495, 37499 (June 29, 2005) (S7–10–04) (Final Rule) (‘‘Regulation NMS’’). 5 See Securities Exchange Act Release No. 51808, 84 FR 5202, 5253 (February 20, 2019) (File No. S7– 05–18) (Transaction Fee Pilot for NMS Stocks Final Rule) (‘‘Transaction Fee Pilot’’). 6 See Cboe Global Markets, U.S. Equities Market Volume Summary, available at https:// markets.cboe.com/us/equities/market_share/. See E:\FR\FM\18FEN1.SGM 18FEN1

Agencies

[Federal Register Volume 85, Number 32 (Tuesday, February 18, 2020)]
[Notices]
[Pages 8978-8982]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-03055]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88162; File No. SR-NSCC-2019-801]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection To Advance Notice To Enhance 
National Securities Clearing Corporation's Haircut-Based Volatility 
Charge Applicable to Municipal Bonds

February 11, 2020.
    On December 13, 2019, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2019-801 (``Advance Notice'') 
pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, entitled Payment, Clearing 
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'') 
\1\ and Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 
1934 (``Exchange Act'' \3\ to revise NSCC's methodology for calculating 
margin amounts applicable to municipal bonds. The Advance Notice was 
published for public comment in the Federal Register on January 14, 
2020,\4\ and the Commission has received no comments regarding the 
changes proposed in the Advance Notice.\5\ This publication serves as 
notice of no objection to the Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ Securities Exchange Act Release No. 87911 (January 8, 2020), 
85 FR 2197 (January 14, 2020) (File No. SR-NSCC-2019-801) (``Notice 
of Filing''). On December 13, 2019, NSCC also filed a related 
proposed rule change (SR-NSCC-2019-004) with the Commission pursuant 
to Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder 
(``Proposed Rule Change''). See 15 U.S.C. 78s(b)(1) and 17 CFR 
240.19b-4 respectively. In the Proposed Rule Change, which was 
published in the Federal Register on January 2, 2020, NSCC seeks 
approval of proposed changes to its rules necessary to implement the 
Advance Notice. Securities Exchange Act Release No. 87858 (December 
26, 2019), 85 FR 149 (January 2, 2020). The comment period for the 
related Proposed Rule Change filing closed on January 23, 2020, and 
the Commission received no comments.
    \5\ As the proposal contained in the Advance Notice was also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the proposed rule change or the Advance Notice.
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I. The Advance Notice

    The proposals reflected in the Advance Notice would revise NSCC's 
Rules and Procedures (``Rules'') \6\ to change the methodology NSCC 
uses for calculating the haircut-based margin charge applicable to 
municipal bonds.
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    \6\ Capitalized terms not defined herein are defined in the 
Rules, available at https://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
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A. Background

    NSCC provides clearing, settlement, risk management, central 
counterparty services, and a guarantee of completion for virtually all 
broker-to-broker trades involving equity securities, corporate and 
municipal debt securities, and certain other securities. NSCC manages 
its credit exposure to its members by determining an appropriate 
Required Fund Deposit (i.e., margin) for each member.\7\ The aggregate 
of all NSCC members' Required Fund Deposits (together with certain 
other deposits required under the Rules) constitute NSCC's Clearing 
Fund, which NSCC would access should a defaulting member's own Required 
Fund Deposit be insufficient to satisfy losses to NSCC caused by the 
liquidation of the defaulting member's portfolio.\8\ NSCC collects each 
member's Required Fund Deposit to mitigate potential losses to NSCC 
associated with the liquidation of the member's portfolio in the event 
of the member's default.\9\
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    \7\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters) of the Rules (``Procedure XV''), supra 
note 6.
    \8\ See id.
    \9\ The Rules identify when NSCC may cease to act for a member 
and the types of actions NSCC may take. For example, NSCC may 
suspend a firm's membership with NSCC or prohibit or limit a 
member's access to NSCC's services in the event that member defaults 
on a financial or other obligation to NSCC. See Rule 46 
(Restrictions on Access to Services) of the Rules, supra note 6.
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    Each member's Required Fund Deposit consists of a number of 
applicable components, which are calculated to address specific risks 
that the member's portfolio presents to NSCC.\10\ Generally, the 
largest component of a member's Required Fund Deposit is the volatility 
component.\11\ The volatility component is designed to calculate the 
potential losses on a portfolio over a given period of time assumed 
necessary to liquidate the portfolio, within a 99% confidence level.
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    \10\ Procedure XV, supra note 6.
    \11\ See id.
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    The methodology for calculating the volatility component of the 
Required Fund Deposit depends on the type of security.\12\ 
Specifically, for certain

[[Page 8979]]

securities, including municipal bonds, NSCC calculates a haircut-based 
volatility component by multiplying the absolute value of a member's 
positions in such securities by a certain percentage designated by 
NSCC.\13\
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    \12\ For most securities (e.g., equity securities), NSCC 
calculates the volatility component as the greater of (1) the larger 
of two separate calculations that utilize a parametric Value at Risk 
(``VaR'') model, (2) a gap risk measure calculation based on the 
largest non-index position in a portfolio that exceeds a 
concentration threshold, which addresses concentration risk that can 
be present in a member's portfolio, and (3) a portfolio margin floor 
calculation based on the market values of the long and short 
positions in the portfolio, which addresses risks that might not be 
adequately addressed with the other volatility component 
calculations. See id.; see also Securities Exchange Act Release No. 
82780 (February 26, 2018), 83 FR 9035 (March 2, 2018) (File No. SR-
NSCC-2017-808); Securities Exchange Act Release No. 82781 (February 
26, 2018), 83 FR 9042 (March 2, 2018) (File No. SR-NSCC-2017-020).
    \13\ Procedure XV, supra note 6.
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    NSCC's current methodology for designating the percentages used in 
calculating the haircut-based volatility component for municipal bonds 
involves distinguishing between municipal bonds based on tenor (i.e., 
remaining time to maturity), municipal sector (e.g., general 
obligation, transportation, healthcare, etc.), and credit rating.\14\ 
Pursuant to that methodology, NSCC assigns each tenor-based group a 
percentage.\15\ For municipal bonds rated higher than BBB+, the tenor-
based percentage is the percentage NSCC uses to calculate the haircut-
based volatility component.\16\ However, for municipal bonds rated BBB+ 
or lower, NSCC multiplies the tenor-based percentage by a sector-based 
risk factor, resulting in a larger percentage for the haircut.\17\ The 
additional sector-based risk factors account for the variable risks 
between municipal sectors associated with the various industries in 
which the bonds are issued and the sources of bond repayment.\18\
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    \14\ Notice of Filing, supra note 4 at 2198.
    \15\ See id.
    \16\ For example, a $10MM short position in a municipal bond 
rated above BBB+ with 3 years to maturity is subject to the 2-5 
years tenor-based group haircut of 5%, which applies to the absolute 
market value of the positions, resulting in a haircut-based 
volatility component of $500,000. Notice of Filing, supra note 4 at 
2198.
    \17\ For example, a $10MM short position in a healthcare sector 
municipal bond rated BBB+ or lower with 3 years to maturity is 
subject to the 2-5 years tenor-based group haircut (5%) multiplied 
by the sector-based factor of 1.2, resulting in a 6% haircut-based 
volatility component of $600,000. Notice of Filing, supra note 4 at 
2198.
    \18\ See id.
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    In all cases, the percentage used to calculate the municipal bond 
haircut-based volatility component is not less than 2%, regardless of a 
municipal bond's credit rating.\19\
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    \19\ Procedure XV, supra note 6.
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B. New Changes to NSCC's Methodology for Calculating Municipal Bond 
Haircut Percentages

    NSCC states that it regularly assesses its margining methodologies 
to evaluate whether margin levels are commensurate with the particular 
risk attributes of the various products, portfolios, and markets that 
NSCC serves.\20\ NSCC further states that based on recent impact 
studies, the margin levels generated from municipal bonds using the 
current methodology exceed the levels necessary to mitigate the risk 
associated with those securities.\21\ In the Advance Notice, NSCC 
proposes to change the methodology for calculating the municipal bond 
haircut-based volatility component so that the amount of margin NSCC 
collects is more commensurate with the risk attributes of those 
securities.
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    \20\ Notice of Filing, supra note 4 at 2198.
    \21\ As part of the Advance Notice, NSCC filed Exhibit 3--NSCC 
Impact Studies, comparing the current and proposed methodologies. 
Pursuant to 17 CFR 240.24b-2, NSCC requested confidential treatment 
of Exhibit 3.
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    As proposed in the Advance Notice, NSCC would retain the current 
provision that in all cases the percentage used to calculate the 
municipal bond haircut-based volatility component is not less than 2%, 
regardless of a municipal bond's credit rating. NSCC would also 
continue to distinguish between municipal bonds based on tenor, credit 
rating, and municipal sector. However, NSCC would calculate the haircut 
percentages for various groups of municipal bonds based on the 
historical returns of one or more benchmark indices over a look-back 
period not shorter than 10 years, using a minimum 99% calibration 
percentile.
    The proposal would change the manner in which NSCC addresses the 
risk presented by lower-rated municipal bonds. Instead of the current 
methodology's approach which applies a sector-based straight risk 
factor to the tenor-based haircut, resulting in a larger haircut 
percentage, the proposed approach would allow the calculation to be 
more precisely tailored to the risks presented by particular municipal 
bonds. Specifically, the new approach would base the haircut percentage 
on the historical returns of one or more benchmark indices, such as 
tenor-based indices, municipal bond sector-based indices, and high-
yield indices, over a look-back period of at least ten years and would 
no longer use a sector-based straight risk factor for lower-rated 
municipal bonds. This approach should allow NSCC to more accurately 
calculate margin amounts appropriate for the risks presented by such 
municipal bonds by allowing NSCC to take into account a broader range 
of risk characteristics associated with municipal bonds. NSCC notes 
that, based on recent impact studies comparing the current and proposed 
methodologies, the proposed methodology would manage NSCC's applicable 
risks well above the 99% confidence level, although it would generate 
lower overall margin amounts.\22\
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    \22\ Notice of Filing, supra note 4 at 2199.
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    Under the proposal in the Advance Notice, NSCC states that for 
municipal bonds rated higher than BBB+, NSCC would use a tenor-based 
index as the applicable benchmark index.\23\ Specifically, NSCC would 
use the percentage derived from the tenor-based index as the haircut 
for the purpose of calculating the volatility component for municipal 
bonds rated higher than BBB+.\24\ For municipal bonds rated BBB+ or 
lower (or not rated), NSCC states that it would use a percentage that 
is the highest of: (1) The applicable tenor-based index, (2) municipal 
bond sector-based indices, and (3) a high-yield index. \25\ For all 
municipal bonds, when deriving the haircut percentage from the 
applicable indices, NSCC would use a look-back period of a 10 year 
rolling window plus a 1-year ``worst case scenario'' stress period.\26\ 
NSCC would identify the largest 3-day price return movement (reflected 
as a percentage) within the 99th percentile of all 3-day price return 
movements during the look-back period. Additionally, NSCC proposes to 
re-calibrate the municipal bond haircut percentages no less frequently 
than annually.
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    \23\ Id.
    \24\ Id.
    \25\ Id.
    \26\ NSCC believes that a 10-year window plus 1-year stress 
period would capture relevant data and cover sufficient market data 
without diluting the ``tail'' with an abundance of data. NSCC 
believes this look-back period is typically long enough to capture 
at least two recent market cycles, whereas a longer look-back period 
might ``flatten'' out the results because recent volatile periods 
might be offset by non-volatile periods, making the more recent 
volatility appear less significant. Notice of Filing, supra note 4 
at 2199.
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    As proposed in the Advance Notice, NSCC would have the ability to 
modify certain aspects of the application of the proposed methodology 
consistent with NSCC's applicable governance procedures and based on 
NSCC's determination that such modifications are necessary to manage 
the applicable risks above the 99% confidence level. Specifically, 
based on NSCC's regular review of its margin methodologies, NSCC would 
be able to modify: The frequency of re-calibrating the municipal bond 
haircut percentages; applicable benchmark indices and the applicable 
period for the price return

[[Page 8980]]

used in the calculations; and the look-back period. NSCC states that 
any such modifications would be subject to the governance procedures 
applicable to all of NSCC's margin methodologies, as set forth in 
NSCC's Clearing Agency Model Risk Management Framework, which the 
Commission has approved.\27\
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    \27\ Id.; See also Securities Exchange Act Release No. 81485 
(August 25, 2017), 82 FR 41433 (August 31, 2017) (File No. SR-NSCC-
2017-008); Securities Exchange Act Release No. 84458 (October 19, 
2018), 83 FR 53925 (October 25, 2018) (File No. SR-NSCC-2018-009).
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    Finally, NSCC proposes a method to address extraordinary 
circumstances in which a certain municipality or issuer may present 
unique risks not otherwise captured by the proposed methodology's use 
of a percentage derived from the maximum of the applicable tenor-based 
index, municipal bond sector-based indices, and high-yield indices.\28\ 
In such scenarios, NSCC proposes to have the ability to use the highest 
percentage generated for any municipal bond group when calculating the 
haircut-based volatility component for municipal bonds issued by the 
municipality or issuer presenting such unique risks.
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    \28\ For example, the market price risk for issues of a 
municipality facing technical default following a natural disaster 
may not be fully captured by the proposed methodology due to the 
liquidity profile of municipal securities.
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II. Discussion and Commission Findings

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, the stated purpose of the Clearing 
Supervision Act is instructive: to mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for SIFMUs and 
strengthening the liquidity of SIFMUs.\29\
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    \29\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe regulations containing risk management 
standards for the payment, clearing, and settlement activities of 
designated clearing entities engaged in designated activities for which 
the Commission is the supervisory agency.\30\ Section 805(b) of the 
Clearing Supervision Act provides the following objectives and 
principles for the Commission's risk management standards prescribed 
under Section 805(a):\31\
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    \30\ 12 U.S.C. 5464(a)(2).
    \31\ 12 U.S.C. 5464(b).
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     To promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among others areas.\32\
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    \32\ 12 U.S.C. 5464(c).
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    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange Act (the ``Clearing Agency Rules'').\33\ The Clearing Agency 
Rules require, among other things, each covered clearing agency to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for its operations and risk management practices on an 
ongoing basis.\34\ As such, it is appropriate for the Commission to 
review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act. As 
discussed below, the Commission believes the proposal in the Advance 
Notice is consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act,\35\ and in the Clearing 
Agency Rules, in particular Rules 17Ad-22(e)(4) and (e)(6).\36\
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    \33\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11). 
See also Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards''). The Commission established an effective date of 
December 12, 2016 and a compliance date of April 11, 2017 for the 
Covered Clearing Agency Standards. NSCC is a ``covered clearing 
agency'' as defined in Rule 17Ad-22(a)(5).
    \34\ 17 CFR 240.17Ad-22.
    \35\ 12 U.S.C. 5464(b).
    \36\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the Advance Notice is consistent with 
the stated objectives and principles of Section 805(b) of the Clearing 
Supervision Act.
    As described above in Section I.A., NSCC's current methodology 
calculates municipal bond haircut percentages using tenor-based 
percentages and sector-based risk factors. NSCC states that the current 
methodology generates margin amounts greater than necessary to mitigate 
NSCC's risks associated with municipal bonds. NSCC proposes to replace 
the current methodology with one that would calculate the haircut 
percentages based on the historical returns of one or more benchmark 
indices over a look-back period of not shorter than 10 years, using a 
minimum 99% calibration percentile. These changes would result in 
margin amounts that are more commensurate with the risk attributes of 
municipal bonds, while still managing NSCC's applicable risks well 
above the 99% confidence level.\37\ Accordingly, the Commission 
believes that the proposed methodology for calculating municipal bond 
haircut percentages would be consistent with promoting robust risk 
management because the proposed methodology would enable NSCC to more 
precisely manage the relevant risks than the current methodology.
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    \37\ Notice of Filing, supra note 4 at 2199.
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    Further, by helping to ensure that NSCC collects margin amounts 
sufficient to manage NSCC's risks associated with municipal bonds, the 
proposed methodology would help limit NSCC's exposure in the event of a 
default of a member with positions in municipal bonds. Accordingly, the 
Commission believes that the proposed methodology would be consistent 
with promoting safety and soundness at NSCC.
    Finally, as noted above, NSCC states that based on recent impact 
studies, while the proposed methodology would fully manage NSCC's 
applicable risks well above the 99% confidence level, it would reduce 
margin requirements for every NSCC member holding positions in 
municipal bonds.\38\ The changes proposed in the Advance Notice would 
therefore result in lower capital demands on such members, who could 
benefit from having the ability to use their liquid resources for other 
purposes, including handling market stress events, which could, in 
turn, have beneficial implications for the stability of the broader 
financial system. Accordingly, the Division believes that the proposed 
methodology would be consistent with supporting the stability of the 
financial system and reducing systemic risks.
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    \38\ Id.; Proposed Rule Change, supra note 4 at 154.
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    As described above in Section I.B., NSCC proposes to re-calibrate 
the municipal bond haircut percentages no less frequently than 
annually. Regular re-calibration of the municipal bond haircut 
percentages is necessary to ensure that the relevant calculations and 
resulting margin levels take into account any changes over time to the 
risk attributes of municipal bonds. The Commission believes that the 
proposal to re-calibrate the municipal bond haircut percentages no less 
frequently than annually would be consistent with robust risk 
management because it

[[Page 8981]]

would require NSCC to regularly review the municipal bond haircut 
percentages to ensure that margin levels remain commensurate with the 
particular risk attributes of municipal bonds. Additionally, by helping 
to ensure that NSCC continues to collect margin amounts sufficient to 
manage the risks associated with municipal bonds, NSCC's proposal to 
re-calibrate the municipal bond haircut percentages no less frequently 
than annually would help limit NSCC's exposure in the event of a 
default of a member with positions in municipal bonds. Accordingly, the 
Commission believes that NSCC's proposal to re-calibrate the municipal 
bond haircut percentages no less frequently than annually would be 
consistent with promoting safety and soundness at NSCC, which in turn 
would support the stability of the broader financial system and reduce 
systemic risks.
    As described above in Section I.B., a certain municipality or 
issuer may present unique risks to NSCC not otherwise captured by the 
proposed methodology's use of a percentage derived from the maximum of 
the applicable tenor-based index, municipal bond sector-based indices, 
and high-yield indices. In such scenarios, NSCC proposes to have the 
ability to use the highest percentage generated for any municipal bond 
group when calculating the haircut-based volatility component for 
municipal bonds issued by the municipality or issuer presenting such 
unique risks. The Commission believes the proposed discretion allowing 
NSCC to apply the highest percentage to municipal bonds issued by a 
municipality or issuer presenting unique risks would be consistent with 
robust risk management by helping to ensure that NSCC collects 
sufficient margin amounts with respect to such securities. 
Additionally, by helping to ensure that NSCC collects sufficient margin 
amounts with respect to municipal bonds issued by a municipality or 
issuer presenting such unique risks, the proposed discretion could help 
limit NSCC's exposure in the event of a default of a member with 
positions in such municipal bonds. Accordingly, the Commission believes 
that the proposed discretion allowing NSCC to apply the highest 
percentage to municipal bonds issued by a municipality or issuer 
presenting unique risks would be consistent with promoting safety and 
soundness at NSCC, which in turn would support the stability of the 
broader financial system and reduce systemic risks.

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

    Rule 17Ad-22(e)(4)(i) requires that NSCC establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to effectively identify, measure, monitor, and manage its 
credit exposures to participants and those arising from its payment, 
clearing, and settlement processes, including by maintaining sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence.\39\
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    \39\ 17 CFR 240.17Ad-22(e)(4)(i).
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    As described above in Section I.B., NSCC proposes to replace the 
current methodology for calculating municipal bond haircut percentages 
with a methodology that would utilize the historical returns of one or 
more benchmark indices over a look-back period of not shorter than 10 
years, using a minimum 99% calibration percentile. These changes would 
result in more precisely determined margin amounts, while still 
managing NSCC's applicable risks well above the 99% confidence 
level.\40\ Accordingly, the Commission believes that the proposed 
methodology is consistent with Rule 17Ad-22(e)(4)(i) because it should 
enable NSCC to effectively identify, measure, monitor, and manage its 
credit exposures to members with positions in municipal bonds, 
including by maintaining sufficient financial resources to cover NSCC's 
credit exposure to such members fully with a high degree of 
confidence.\41\
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    \40\ Notice of Filing, supra note 4 at 2199.
    \41\ Id.
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    As described above in Section I.B., NSCC proposes to re-calibrate 
the municipal bond haircut percentages no less frequently than 
annually. The proposal would require NSCC to regularly review the 
municipal bond haircut percentages, thereby helping to ensure that the 
haircut percentages and resulting margin levels take into account any 
changes over time to the risk attributes of municipal bonds. 
Accordingly, the Commission believes that the proposal to re-calibrate 
the municipal bond haircut percentages no less frequently than annually 
is consistent with Rule 17Ad-22(e)(4)(i) because it should allow NSCC 
to effectively identify, measure, monitor, and manage its credit 
exposures to members with positions in municipal bonds, including by 
maintaining sufficient financial resources to cover NSCC's credit 
exposure to such members fully with a high degree of confidence.\42\
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    \42\ Id.
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    As described above in Section I.B., NSCC proposes to have the 
ability to use the highest percentage generated for any municipal bond 
group when calculating the haircut-based volatility component for 
municipal bonds issued by a municipality or issuer presenting unique 
risks not otherwise captured by the calculations in the proposed 
methodology. Such discretion should help ensure that NSCC collects 
sufficient margin amounts with respect to those securities. 
Accordingly, the Commission believes that the proposed ability to apply 
the highest percentage to such municipal bonds is consistent with Rule 
17Ad-22(e)(4)(i) because it should better enable NSCC to effectively 
identify, measure, monitor, and manage its credit exposures to members 
with positions in such municipal bonds, including by maintaining 
sufficient financial resources to cover NSCC's credit exposure to such 
members fully with a high degree of confidence.\43\
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    \43\ Id.
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C. Consistency With Rules 17Ad-22(e)(6)(i) and (v)

    Rule 17Ad-22(e)(6)(i) requires that NSCC establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to cover its credit exposures to its participants by 
establishing a risk-based margin system that, at a minimum, considers, 
and produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market.\44\ Rule 
17Ad-22(e)(6)(v) requires that NSCC establish, implement, maintain and 
enforce written policies and procedures reasonably designed to cover 
its credit exposures to its participants by establishing a risk-based 
margin system that, at a minimum, uses an appropriate method for 
measuring credit exposure that accounts for relevant product risk 
factors and portfolio effects across products.\45\
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    \44\ 17 CFR 240.17Ad-22(e)(6)(i).
    \45\ 17 CFR 240.17Ad-22(e)(6)(v).
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    As described above in Section I.B., NSCC proposes to replace the 
current methodology for calculating municipal bond haircut percentages 
with a methodology that would utilize the historical returns of one or 
more benchmark indices over a look-back period of not shorter than 10 
years, using a minimum 99% calibration percentile. NSCC designed the 
proposed methodology to generate margin amounts that are more 
commensurate with the risk attributes of municipal bonds than the 
current methodology. Accordingly, the Commission believes

[[Page 8982]]

that the proposed methodology is consistent with Rules 17Ad-22(e)(6)(i) 
and (v) because it is designed to establish a risk-based margin system 
that (1) considers and produces relevant margin levels commensurate 
with the risks and particular attributes of municipal bonds, and (2) 
uses an appropriate method for measuring credit exposure that accounts 
for municipal bond risk factors and portfolio effects.\46\
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    \46\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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    As described above in Section I.B., NSCC proposes to re-calibrate 
the municipal bond haircut percentages no less frequently than 
annually. The proposal would require NSCC to regularly review the 
municipal bond haircut percentages, thereby helping to ensure that the 
haircut percentages and resulting margin levels take into account any 
changes over time to the risk attributes of municipal bonds. 
Accordingly, the Commission believes that the proposal to re-calibrate 
the municipal bond haircut percentages no less frequently than annually 
is consistent with Rules 17Ad-22(e)(6)(i) and (v) because it would 
contribute to a risk-based margin system designed to (1) consider and 
produce relevant margin levels commensurate with the risks and 
particular attributes of municipal bonds, and (2) use an appropriate 
method for measuring credit exposure that accounts for municipal bond 
risk factors and portfolio effects.\47\
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    \47\ Id.
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    As described above in Section I.B., NSCC proposes to have the 
ability to use the highest percentage generated for any municipal bond 
group when calculating the haircut-based volatility component for 
municipal bonds issued by a municipality or issuer presenting unique 
risks not otherwise captured by the calculations in the proposed 
methodology. This discretion should help ensure that NSCC collects 
sufficient margin amounts with respect to those securities. 
Accordingly, the Commission believes that the proposed discretion to 
apply the highest percentage to such municipal bonds is consistent with 
Rules 17Ad-22(e)(6)(i) and (v) because it would contribute to a risk-
based margin system designed to (1) consider and produce relevant 
margin levels commensurate with the risks and particular attributes of 
municipal bonds, and (2) use an appropriate method for measuring credit 
exposure that accounts for municipal bond risk factors and portfolio 
effects.\48\
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    \48\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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III. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission does not object to 
Advance Notice (SR-NSCC-2019-801) and that NSCC is authorized to 
implement the proposed change as of the date of this notice or the date 
of an order by the Commission approving proposed rule change SR-NSCC-
2019-004, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-03055 Filed 2-14-20; 8:45 am]
 BILLING CODE 8011-01-P
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