Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing of Advance Notice To Amend the Mortgage-Backed Securities Division Stress Testing Methodology, 11413-11419 [2020-03996]
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Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Notices
to make available publicly. All
submissions should refer to File
Number SR–CboeEDGX–2020–009 and
should be submitted on or before March
19, 2020.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.28
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020–03919 Filed 2–26–20; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–88266; File No. SR–FICC–
2020–801]
Self-Regulatory Organizations; Fixed
Income Clearing Corporation; Notice of
Filing of Advance Notice To Amend the
Mortgage-Backed Securities Division
Stress Testing Methodology
February 24, 2020.
Pursuant to Section 806(e)(1) of Title
VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act
entitled the Payment, Clearing, and
Settlement Supervision Act of 2010
(‘‘Clearing Supervision Act’’) 1 and Rule
19b–4(n)(1)(i) under the Securities
Exchange Act of 1934 (‘‘Act’’),2 notice is
hereby given that on January 21, 2020,
Fixed Income Clearing Corporation
(‘‘FICC’’) filed with the Securities and
Exchange Commission (‘‘Commission’’)
the advance notice SR–FICC–2020–801
(‘‘Advance Notice’’) as described in
Items I, II and III below, which Items
have been prepared by the clearing
agency. The Commission is publishing
this notice to solicit comments on the
Advance Notice from interested
persons.
I. Clearing Agency’s Statement of the
Terms of Substance of the Advance
Notice
This Advance Notice consists of
modifications to the Mortgage-Backed
Securities Division’s (‘‘MBSD’’) stress
testing methodology.3 FICC is proposing
to (1) use vendor-supplied historical
risk factor 4 time series data (‘‘Historical
28 17
CFR 200.30–3(a)(12).
U.S.C. 5465(e)(1).
2 17 CFR 240.19b–4(n)(1)(i).
3 Capitalized terms used herein and not otherwise
defined shall have the meaning assigned to such
terms in the FICC MBSD Clearing Rules (the
‘‘MBSD Rules’’), available at www.dtcc.com/legal/
rules-and-procedures.aspx.
4 Generally, the term ‘‘risk factor’’ (or ‘‘risk
driver’’) means an attribute, characteristic, variable
or other concrete determinant that influences the
risk profile of a system, entity, or financial asset.
Risk factors may be causes of risk or merely
correlated with risk.
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Data’’) in MBSD’s stress testing
methodology’s historical stress scenario
selection (‘‘Scenario Selection’’)
process, (2) change the look-back period
for identifying historical stress scenarios
for the Scenario Selection process, (3)
use vendor-supplied security-level risk
sensitivity data 5 (‘‘Security-Level Data’’)
and Historical Data in the stress testing
methodology’s calculation of stress
profits and losses (‘‘P&L’’) for Clearing
Members’ portfolios,6 and (4) use a
back-up calculation in the event the
vendor fails to provide the SecurityLevel Data and Historical Data (such
failure, a ‘‘Vendor Data Disruption’’), as
described in greater detail below.7 The
5 The term ‘‘sensitivity’’ means the percentage
value change of a security given each risk factor
change.
6 The proposed change to use Security-Level Data
would be applicable to MBSD’s stress testing
methodology for historical and hypothetical
scenarios. The proposed change to use Historical
Data would be applicable only for historical
scenarios. FICC currently receives the SecurityLevel Data and Historical Data from a vendor. FICC
currently utilizes this Security-Level Data and
Historical Data in MBSD’s value-at-risk (‘‘VaR’’)
model, which calculates the VaR Charge component
in each Clearing Member’s margin (referred to in
the MBSD Rules as Required Fund Deposit). See
MBSD Rule 1, Definitions—VaR Charge, supra note
3. FICC is proposing to use this same data set in
MBSD’s Scenario Selection process, and stress P&L
calculation of each Clearing Member’s portfolio.
7 FICC would receive the following data from the
vendor:
• Interest rate (including 11 tenors) measures the
sensitivity of a price change to changes in interest
rates;
• convexity measures the degree of curvature in
the price/yield relationship of key interest rates
(convexity would not be utilized in the scenarios
selection process; it would only be utilized in the
stress P&L calculation);
• mortgage option adjusted spread is the yield
spread that is added to a benchmark yield curve to
discount a TBA’s cash flows to match its market
price, which takes into account a credit premium
and the option-like feature of mortgage-backedsecurities due to prepayment;
• interest rate volatility reflects the implied
volatility observed from the swaption market to
estimate fluctuations in interest rates; and
• mortgage basis captures the basis risk between
the prevailing mortgage rate and a blended U.S.
Treasury rate, which impacts borrowers’ refinance
incentives and the model prepayment assumptions.
The Historical Data would include (1) interest
rate, (2) mortgage option adjusted spread, (3)
interest rate volatility, and (4) mortgage basis.
The Security Level Data would include (1)
sensitivity to interest rates, (2) convexity, (3)
sensitivity to mortgage option adjusted spread, (4)
sensitivity to interest rate volatility, and (5)
sensitivity to mortgage basis.
FICC does not believe that its current engagement
of the vendor would present a conflict of interest
because the vendor is not an existing Clearing
Member nor are any of the vendor’s affiliates
existing Clearing Members. To the extent that the
vendor or any of its affiliates applies to become a
Clearing Member, FICC will negotiate an
appropriate information barrier with the applicant
in an effort to prevent a conflict of interest from
arising. An affiliate of the vendor currently provides
an existing service to FICC; however, this
arrangement does not present a conflict of interest
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11413
proposed changes would not require
modifications to the MBSD Rules.
II. Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Advance Notice
In its filing with the Commission, the
clearing agency included statements
concerning the purpose of and basis for
the Advance Notice and discussed any
comments it received on the Advance
Notice. The text of these statements may
be examined at the places specified in
Item IV below. The clearing agency has
prepared summaries, set forth in
sections A and B below, of the most
significant aspects of such statements.
(A) Clearing Agency’s Statement on
Comments on the Advance Notice
Received From Members, Participants,
or Others
FICC has not received or solicited any
written comments relating to this
proposal. FICC will notify the
Commission of any written comments
received by FICC.
(B) Advance Notice Filed Pursuant to
Section 806(e) of the Clearing
Supervision Act
I. Nature of the Proposed Change
A. Background
Stress testing is an essential
component of FICC’s risk management.
FICC uses stress testing to help ensure
that it is collecting adequate prefunded
financial resources 8 to cover MBSD’s
potential losses resulting from the
default of a Clearing Member and such
Clearing Member’s affiliated family (that
are also Clearing Members) (‘‘Affiliated
Family’’) under multiple extreme but
plausible market stress conditions
(sometimes referred to as ‘‘stress
scenarios’’).9 As set forth in the
Framework, the development of FICC’s
because the existing agreement between FICC and
the vendor, and the existing agreement between
FICC and the vendor’s affiliate, each contains
provisions that limit the sharing of confidential
information.
8 MBSD’s prefunded financial resources consist of
Required Fund Deposits collected from Clearing
Members in the form of cash and/or Eligible
Clearing Fund Securities, with any such Eligible
Clearing Fund Securities being subject to a haircut.
See MBSD Rules 1 and 4, supra note 3.
9 Consistent with the Clearing Agency Stress
Testing Framework (Market Risk) (‘‘Framework’’),
FICC aggregates each Clearing Member’s stress
deficiency within such Clearing Member’s
applicable Affiliated Family because FICC assumes
that all Affiliated Families will simultaneously
default, and the gains and losses of different legal
entities within an Affiliated Family would not
offset each other. The Framework is described in
rule filing SR–FICC–2017–009. See Securities
Exchange Act Release No. 82368 (December 19,
2017), 82 FR 61082 (December 26, 2017)
(‘‘Framework Approval Order’’).
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stress testing methodology is comprised
of three key components.10
The first component is the risk
identification process. FICC identifies
the principal credit/market risk drivers
that are representative and specific to
each Clearing Member’s portfolio to
determine potential risk exposure. FICC
accomplishes this by analyzing the
securities in each Clearing Member’s
portfolio to identify the principal
market price risk factor drivers and
capture the risk sensitivity of such
portfolios under stressed market
conditions.
The second component is the scenario
development process, which is designed
to construct comprehensive and
relevant sets of extreme but plausible
historical and hypothetical stress
scenarios. In order to select historical
stress scenarios, MBSD’s stress testing
model selects dates from the past that
represent stressed market conditions
based on the largest historical changes
of the selected risk factors. In order to
select hypothetical stress scenarios,
MBSD considers potential future events
and their perceived impact to portfolio
market risk factors.
The third component is the risk
measurement and aggregation process.
This process involves calculating risk
metrics for each Clearing Member’s
portfolio. The stress testing
methodology calculates stress P&L
under each stress scenario and
determines the loss amount exceeding a
Clearing Member’s Required Fund
Deposit for each scenario. This
calculation is referred to as the
‘‘Clearing Member Level Stress
Deficiencies.’’ In addition, the stress
testing methodology calculates the ratio
of an Affiliated Family’s deficiency 11
over the total value of the MBSD
Clearing Fund excluding the sum value
of the applicable Affiliated Family’s
Required Fund Deposits. This
calculation is referred to as the ‘‘Cover
1 Ratio.’’ 12
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B. Proposed Change to MBSD’s Stress
Testing Methodology
As further described below, FICC is
proposing to use Security-Level Data
and Historical Data in MBSD’s stress
testing methodology. Specifically, FICC
is proposing to (1) use Historical Data in
the Scenario Selection process, (2)
change the look-back period used for
identifying historical stress scenarios for
10 Id.
at 61083.
‘‘Affiliated Family deficiency’’ is the
aggregate of all Clearing Members’ stress
deficiencies within the applicable Affiliated
Family.
12 See Framework Approval Order, 82 FR at
61083.
11 An
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the Scenario Selection process, (3) use
Security-Level Data and Historical Data
in the methodology’s calculation of
stress P&L for Clearing Members’
portfolios,13 and (4) use a back-up
calculation in the event of a Vendor
Data Disruption.
(1) Proposed Change To Use Historical
Data in the Scenario Selection Process
FICC uses two risk factors as inputs to
the MBSD stress testing model for the
historical Scenario Selection process.
The risk factors are (1) interest rate and
(2) mortgage option adjusted spread.
The interest rate risk factor consists of
swap rates 14 with tenors 15 of 2 years, 5
years, 10 years, and 30 years. The
mortgage option adjusted spread risk
factor is constructed as the difference
between the agency mortgage-backed
TBA securities’ current coupon rate and
the average swap rate, in each case, for
Fannie Mae (‘‘FNMA’’) 30-year
mortgages and Ginnie Mae (‘‘GNMA’’)
30-year mortgages. MBSD’s scenario
selection algorithm uses a technique
referred to as principal component
analysis 16 to convert correlated risk
factors into uncorrelated risk drivers
that account for the joint comovements 17 of the multiple risk
factors during the 10-year look-back
period.
FICC is proposing to continue to
utilize the interest rate risk factor and
the mortgage option adjusted spread risk
factor as inputs to MBSD’s stress testing
model, however, both risk factors would
be sourced from a vendor. FICC is also
proposing to include two new risk
factors in the methodology—interest
rate volatility and mortgage basis. The
proposed change would result in an
13 In connection with this proposal, FICC is not
proposing any changes to the hypothetical Scenario
Selection process other than to use the vendor’s
data. The hypothetical scenarios are currently
represented by five interest rate tenors (i.e., 1-year,
2-year, 5-year, 10-year, and 30-year tenors), one
mortgage option adjusted spread, and one interest
rate volatility point. The hypothetical scenarios are
reflected as shocks to the referenced risk factors.
This process would not change, however, in order
to calculate the stress P&L in the proposed model,
FICC would map the referenced risk factors to the
set of risk factors in the proposed model.
14 Generally, the term ‘‘swap rate’’ means the
fixed interest rate that the receiver demands in
exchange for the uncertainty of having to pay the
short-term floating rate over time.
15 Generally, the term ‘‘tenor’’ means the amount
of time left for the repayment of a loan or until a
financial contract expires.
16 Principal component analysis is a standard
statistical technique that is applied to a set of
observations of potentially correlated variables. It is
used to identify a set of linearly uncorrelated
variables, which are referred to as principal
components.
17 Generally, the term ‘‘joint co-movement’’
means the movement of two variables at the same
time.
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expansion of the number of tenors for
the existing interest rate risk factor and
an expansion of the number of
individual factors to the existing
mortgage option adjusted spread risk
factor. As a result of this change, the
proposed interest rate risk factor would
include 11 tenors and the proposed
mortgage option adjusted spread risk
factor would include up to
approximately 32 individual factors,18
which would differentiate between
various agency mortgage programs,
underlying collateral maturities, and the
level of moneyness.19
FICC is proposing to use the
Historical Data (as described above)
because this data is more
comprehensive, granular,20 and
transparent. The Historical Data is more
comprehensive and granular because (1)
it would reflect a total of four risk
factors (i.e., interest rate, interest rate
volatility, mortgage option adjusted
spread and mortgage basis), (2) the
proposed interest rate risk factor would
include 11 tenors and (3) the proposed
mortgage option adjusted spread risk
factor would include up to
approximately 32 individual factors. As
a result of this change, FICC believes
that the proposed Historical Data would
better explain the market price changes
of TBA transactions cleared by MBSD 21
and FICC would be able to identify
stress risk exposures under broader and
more varied market conditions. The
Historical Data would also provide
MBSD with an enhanced capability to
design more transparent scenarios.
Because Clearing Members typically use
risk factor analysis for their own risk
18 As described in the paragraph above, the
current stress testing methodology uses four tenors
for the interest rate risk factor and two individual
factors for the mortgage option adjusted spread risk
factor.
19 The changes of spread are parameterized
according to the difference between the underlying
weighted average coupon (‘‘WAC’’) and the current
prevailing mortgage rate. This difference is also
referred to as the ‘‘moneyness.’’ A TBA security
with a WAC that is 10 basis points higher than the
prevailing mortgage rate is said to be 10 basis points
in the money. Fifteen moneyness points are used
to parameterize the FNMA 30-year mortgage.
20 The term ‘‘granular’’ in the risk context means
detailed and diversified.
21 Specified Pool Trades and Stipulated Trades
are mapped to the corresponding TBAs. FICC’s
guarantee of Option Contracts on TBAs is limited
to the intrinsic value of the option positions
meaning that, when the underlying price of the
TBA position is above the call price, the Option
Contract is considered in-the-money and FICC’s
guarantee reflects this portion of the Option
Contract’s positive value at the time of a Clearing
Member’s insolvency. The value change of an
Option Contract’s position is simulated as the
change in its intrinsic value. No changes are being
proposed to MBSD’s treatment of Specified Pool
Trades, Stipulated Trades and Option Contracts
pursuant to this proposal.
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and financial reporting, such Members
would have comparable data and
analysis to stress test their portfolios.
Thus, Clearing Members would be able
to simulate their stressed portfolios to a
closer degree than under the existing
stress testing methodology.
(2) Proposed Change to the Look-Back
Period Used for the Identification of
Historical Stress Scenarios in the
Scenario Selection Process
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MBSD’s current set of historical stress
scenarios is comprised of scenarios that
reflect the most severe market price
movements which have been observed
during past periods of extreme market
conditions. To identify specific dates for
these market movements, MBSD’s stress
testing model analyzes the historical
risk factor time series data over a 10year look-back period. Specifically,
MBSD’s stress testing model currently
selects 50 historical scenarios based on
actual historical time periods observed
over a 10-year look-back period.22 On a
quarterly basis, MBSD eliminates all
historical data that fall outside the scope
of the 10-year look-back period.
FICC is proposing to change the
current 10-year look-back period to a
look-back period that starts on a fixed
date of May 29, 2002 and continues to
expand forward—meaning that no
portion of the timeframe within the
proposed look-back period would be
eliminated from the stress testing
model; instead the entire timeframe
within the look-back period would
continue to expand forward.23
FICC selected May 29, 2002 as the
fixed starting point based on its
assessment of the accuracy and
consistency of the Historical Data
provided by the vendor. FICC is
proposing this change because it
believes that the expanded look-back
period would better capture the
potential market price changes of TBA
securities, preserve historical dates that
would otherwise be eliminated under
the current 10-year look-back period,
and provide the stress testing model
22 In addition to these 50 historical scenarios,
FICC supplements the historical scenario set by
including additional events that have occurred
outside of the 10-year look-back period and have
been identified as important periods of historical
stress because such events have had a significant
impact on the financial market. These dates include
May 29, 1994 (when the Federal Reserve
significantly raised rates), October 5, 1998 (when
the Long-Term Capital Management crisis
occurred), and September 11, 2001 (when the
terrorist attacks occurred).
23 FICC would continue to include events that
have occurred prior to the proposed fixed date of
May 29, 2002. These events include the events
referred to in footnote 22 above.
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with a larger set of scenarios for the
historical Scenario Selection process.24
during larger market moves which are
typical of stress testing scenarios.
(3) Proposed Change To Use SecurityLevel Data and Historical Data in the
Stress Testing Model’s Stress P&L
Calculation
Currently, in order to determine the
potential loss to a Clearing Member’s
portfolio under a given stress scenario,
MBSD’s stress testing methodology
applies a profit-and-loss calculation that
multiplies a set of risk factors’ stress
movements by its corresponding risk
sensitivities. Currently this
methodology utilizes two interest rate
risk factors (i.e., 2-year swap rates and
10-year swap rates) and the FNMA 30year current coupon mortgage option
adjusted spread. The risk sensitivities
are estimated using an empirical
regression with a two-month look-back
period.25 FICC believes that the current
methodology’s use of a smaller set of
risk factors and the relatively short twomonth look-back period is a limitation
that contributes to an inability to
explain the results of the sensitivities
estimation.
FICC is proposing to leverage the
Security-Level Data and Historical Data
in the methodology’s calculation of
stress P&L. Specifically, FICC is
proposing to replace the current
empirical regression-based profit-andloss calculation with a financial profitand-loss calculation. The proposed
financial profit-and-loss calculation
would use the Security-Level Data and
Historical Data. The Security-Level Data
is generated using the vendor’s suite of
security valuation models that includes
an agency mortgage prepayment model
and interest rate term structure model.26
FICC believes that the vendor’s
approach generates more stable and
robust Security-Level Data and
addresses the limitations of the current
empirical regression algorithm.27
Because the proposed change would
include Security-Level Data, FICC
believes the proposed Security-Level
Data would improve the stress testing
model’s stress P&L calculation, and the
calculated results would be closer to
actual price changes for TBA securities
(4) Proposed Change To Use a Back-Up
Calculation in the Event of a Vendor
Data Disruption
As described above, FICC would
utilize the vendor’s data for MBSD’s
stress testing methodology. Prior to
MBSD’s use of this data in its VaR
model, FICC reviewed a description of
the vendor’s calculation methodology
and the manner in which the market
data is used to calibrate the vendor’s
models. At that time, The Depository
Trust & Clearing Corporation’s
(‘‘DTCC’’) Quantitative Risk
Management, Vendor Risk Management,
and Information Technology teams
conducted due diligence of the vendor
in order to evaluate its control
framework for managing key risks.28
FICC’s due diligence included an
assessment of the vendor’s technology
risk, business continuity, regulatory
compliance, and privacy controls.
Because of FICC’s due diligence and its
use of the vendor data in connection
with the calculation of MBSD’s margin
model, FICC understands and remains
comfortable with the vendor’s controls.
In addition, DTCC’s Data Integrity
department manages the data that FICC
receives including, but not limited to,
market data and analytical data
provided by vendors.29 As a result, FICC
feels comfortable with leveraging the
Security-Level Data and Historical Data
for purposes of MBSD’s stress testing
methodology.
In connection with FICC’s proposal to
use the Security-Level Data and
Historical Data in its stress testing
methodology for the historical and
hypothetical scenarios, FICC is also
24 Pursuant to the proposed change, the look-back
period would include at least 16 years of historical
data.
25 Empirical regression is a statistical measure
that determines the coefficient range used in the
stress P&L calculation.
26 A prepayment model captures cash flow
uncertainty as a result of unscheduled payments of
principal (prepayments). An interest rate term
structure model describes the relationship between
interest rates of different maturities.
27 As described above, these limitations include
the limited number of risk factors and the twomonth look-back period.
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28 DTCC is FICC’s parent company. DTCC
operates on a shared services model with respect to
FICC. Most corporate functions are established and
managed on an enterprise-wide basis pursuant to
intercompany agreements under which DTCC
generally provides a relevant service to FICC.
29 DTCC’s Data Integrity department oversees data
integrity on behalf of DTCC’s Counterparty Credit,
Market, and Liquidity Risk Management groups as
well as Securities Valuation, Model Validation and
Control, and Quantitative Risk Management
(collectively, Financial Risk Management (‘‘FRM’’)),
and the Systemic Risk Office. The Data Integrity
department’s mission is to align with FRM and
ensure that the highest data quality is managed for
the purpose of lowering risk and improving
efficiency within FRM. The Data Integrity
department’s prime directive consists of the
following: (1) Ensuring a data governance
framework is established and adhered to within
FRM; (2) ensuring sufficient integrity of key data
sources through active rules-based data monitoring;
(3) ensuring sufficient alerting is in place to inform
necessary parties when data anomalies occur; (4)
liaising with subject matter experts to resolve data
anomalies in an efficient and effective manner; and
(5) ensuring that critical FRM data is catalogued
and defined in the enterprise data dictionary.
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proposing a back-up calculation (as
described in the paragraph below) that
it would utilize in the event the vendor
fails to provide the data. If the vendor
fails to provide any data or a significant
portion of the data in accordance with
the timeframes agreed to by FICC and
the vendor, FICC would use the most
recently available data on the first day
that such disruption occurs. Subject to
discussions with the vendor, if a
Managing Director, who oversees
Market Risk Management, determines
that the vendor would resume providing
data within five (5) business days, such
Managing Director would determine
whether the daily stress testing
calculation should continue to be
calculated by using the most recently
available data or whether the back-up
calculation (as described below) should
be invoked, subject to the approval of
DTCC’s Group Chief Risk Officer or his/
her designee.30 Subject to discussions
with the vendor, if a Managing Director,
who oversees Market Risk Management,
determines that the data disruption
would extend beyond five (5) business
days, the back-up calculation would be
applied, subsequent to the approval of
DTCC’s Management Risk Committee,
followed by notification to the Board
Risk Committee.
The proposed back-up calculation
would be as follows: MBSD would (1)
calculate each Clearing Member’s
portfolio net exposures in four
securitization programs,31 (2) calculate
the stress return for each securitization
program as the three-day price return for
each securitization program index for
each scenario date, and (3) calculate
each Clearing Member’s stress P&L as
the sum of the products of the net
exposure of each securitization program
and the stress return value for each
securitization program. FICC would use
publicly available indices (e.g., the
Bloomberg FNMA 30-year index,
Bloomberg GNMA 30-year index,
Bloomberg FNMA 15-year index and
Bloomberg GNMA 15-year index) as the
data source for the stress return
calculations.32
30 For the avoidance of doubt, after taking into
consideration the vendor’s condition and, to the
extent applicable, market conditions, FICC may
treat the interruption as an extended data
interruption sooner.
31 The securitization programs are as follows: (1)
FNMA and Freddie Mac (‘‘FHLMC’’) conventional
30-year mortgage-backed securities, (2) GNMA 30year mortgage-backed securities, (3) FNMA and
FHLMC conventional 15-year mortgage-backed
securities, and (4) GNMA 15-year mortgage-backed
securities.
32 The proposed calculation is similar to MBSD’s
calculation of the Margin Proxy, which is the backup calculation that MBSD will use to calculate the
VaR Charge in the event of a vendor data
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C. Delayed Implementation of the
Proposal
This proposal would become
operative within 45 business days after
the date of the Commission’s notice of
no objection to this advance notice
filing. FICC would announce the
operative date in an important notice
issued to Clearing Members.33
II. Anticipated Effect on and
Management of Risks
FICC believes that the proposed
change to MBSD’s stress testing
methodology, which consists of
proposals to (1) use Historical Data in
the Scenario Selection process, (2)
change the 10-year look-back period
used for the identification of historical
stress scenarios in the Scenario
Selection process, (3) use Security-Level
Data and Historical Data in the stress
testing methodology’s calculation of
stress P&L for Clearing Members’
portfolios, and (4) use a back-up
calculation in the event of a Vendor
Data Disruption, would affect MBSD’s
management of risk because the changes
would help to ensure that MBSD’s stress
testing methodology more effectively
measures whether it is collecting
adequate prefunded financial resources
to cover its potential losses resulting
from the default of a Clearing Member
and its Affiliated Family under multiple
extreme but plausible market stress
conditions.
A. Proposed Change To Use Historical
Data in the Scenarios Selection Process
FICC’s proposal to utilize Historical
Data in MBSD’s historical stress
scenario selection process would affect
FICC’s management of risk because the
change would incorporate a broader
range of risk factors to better understand
a Clearing Member’s exposure to these
risk factors. As described above, the
proposed change would enable MBSD to
leverage vendor expertise in supplying
the risk data attributes that would then
be incorporated into MBSD’s stress
testing model. The data would expand
the number of tenors for the existing
interest rate risk factor and expand the
number of individual factors to the
existing mortgage option adjusted
spread risk factor. The proposed interest
rate risk factor would include 11 tenors
and the proposed mortgage option
adjusted spread risk factor would
include up to approximately 32
disruption. See MBSD Rule 1, Definitions—Margin
Proxy, supra note 3.
33 MBSD’s important notices are available at
https://www.dtcc.com/legal/importantnotices?subsidiary=FICC+-+MBS&pgs=1.
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individual factors.34 In addition, FICC
would include two new risk factors in
the methodology—interest rate volatility
and mortgage basis. FICC believes that
the proposed change would provide
more comprehensive, granular and
transparent risk representations that
enable sensitivity analysis on key model
parameters and assumptions.
B. Proposed Change to the 10-Year
Look-Back Period Used for the
Identification of Historical Stress
Scenarios in the Scenario Selection
Process
FICC’s proposal to change the current
10-year look-back period to a look-back
period that starts on a fixed date of May
29, 2002 and continues to expand
forward would affect FICC’s
management of risk because the change
(which includes at least 16 years of
historical data) would give MBSD the
ability to assess a broader spectrum of
historical stressed market events that
would be used in the stress testing
methodology to design a comprehensive
set of historical stress scenarios.
C. Proposed Change To Use SecurityLevel Data and Historical Data in the
Stress Testing Model’s Stress P&L
Calculation
FICC’s proposal to use Security-Level
Data and Historical Data in the stress
testing methodology’s calculation of
stress P&L would affect FICC’s
management of risk because leveraging
the vendor-supplied data would
improve the estimation of the stress P&L
calculation by giving FICC the ability to
attribute the stress loss under a given
stress scenario to specific risk factor
changes. As described above, FICC
would replace the current empirical
regression based profit-and-loss
calculation with a financial profit-andloss calculation that uses Security-Level
Data and Historical Data, which are not
included in the current algorithm.35
Thus, FICC believes the proposed
change would improve the stress testing
model’s stress P&L calculation because
the calculated results would be closer to
actual price changes for TBA securities
during larger market moves which are
typical of stress testing scenarios.
In an effort to assess the impact of the
proposed change, FICC compared the
results of the current stress testing
34 The proposed interest rate risk factor would
include 11 tenors between 3 months and 30 years,
and the proposed mortgage option adjusted spread
risk factor would include factors related to relative
value, spread between 15-year and 30-year
products, and spread between GNMA and FNMA.
35 As described above, the empirical regression
algorithm incorporates fewer risk factors and a
shorter look-back period.
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Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Notices
methodology with the proposed stress
testing methodology for the period of
February 1, 2018 through January 1,
2019 with respect to the historical stress
scenarios. The average of the maximum
daily historical Cover 1 Ratio for this
period is 20.3% for the proposed stress
testing methodology compared to 19.2%
for the current stress testing
methodology (meaning that the
proposed methodology would be
approximately 1.1% higher (on average)
than the current methodology).
lotter on DSKBCFDHB2PROD with NOTICES
D. Proposed Change To Use a Back-Up
Calculation in the Event of a Vendor
Data Disruption
FICC’s proposal to use a back-up
calculation would affect FICC’s
management of risk because it would
help to ensure that FICC continues to
test the adequacy of MBSD’s prefunded
financial resources in the event of a
Vendor Data Disruption. As described
above, FICC would manage the risks
associated with a potential data
disruption by using the most recently
available data (before the disruption) on
the first day that a data disruption
occurs. If the vendor fails to provide any
data or a significant portion of the data
in accordance with the timeframes
agreed to by FICC and the vendor, FICC
would use the most recently available
data on the first day that such
disruption occurs. Subject to
discussions with the vendor, if a
Managing Director, who oversees
Market Risk Management, determines
that the vendor would resume providing
data within five (5) business days, such
Managing Director would determine
whether the daily stress testing
calculation should continue to be
calculated by using the most recently
available data or whether the back-up
calculation should be invoked, subject
to the approval of DTCC’s Group Chief
Risk Officer or his/her designee. Subject
to discussions with the vendor, if a
Managing Director, who oversees
Market Risk Management, determines
that the data disruption would extend
beyond five (5) business days, the backup calculation would be applied,
subject to the approval of DTCC’s
Management Risk Committee, followed
by notification to the Board Risk
Committee.
III. Consistency With the Clearing
Supervision Act and the Covered
Clearing Agency Standards
Although the Clearing Supervision
Act does not specify a standard of
review for an advance notice, its stated
purpose is instructive: To mitigate
systemic risk in the financial system
and promote financial stability by,
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among other things, promoting uniform
risk management standards for
systemically important financial market
utilities and strengthening the liquidity
of systemically important financial
market utilities.36
Section 805(a)(2) of the Clearing
Supervision Act 37 authorizes the
Commission to prescribe risk
management standards for the payment,
clearing and settlement activities of
designated clearing entities, like FICC,
and financial institutions engaged in
designated activities for which the
Commission is the supervisory agency
or the appropriate financial regulator.
Section 805(b) of the Clearing
Supervision Act 38 states that the
objectives and principles for the risk
management standards prescribed under
Section 805(a) shall be to, among other
things, promote robust risk
management, promote safety and
soundness, reduce systemic risks, and
support the stability of the broader
financial system. The Commission has
adopted risk management standards
under Section 805(a)(2) of the Clearing
Supervision Act 39 and Section 17A of
the Act 40 (the risk management
standards are referred to as the
‘‘Covered Clearing Agency
Standards’’).41 The Covered Clearing
Agency Standards require registered
clearing agencies to establish,
implement, maintain, and enforce
written policies and procedures that are
reasonably designed to be consistent
with the minimum requirements for
their operations and risk management
practices on an ongoing basis.42
A. Consistency With Section 805(b) of
the Clearing Supervision Act
FICC believes that the proposed
changes in this advance notice are
consistent with the objectives and
principles of the risk management
standards as described in Section 805(b)
of the Clearing Supervision Act and in
the Covered Clearing Agency Standards.
As discussed above, FICC is proposing
several changes to MBSD’s stress testing
methodology. FICC believes the
proposed changes are consistent with
promoting robust risk management
because the changes are designed to
enhance MBSD’s stress testing
methodology, which is used to help
ensure that MBSD collects adequate
prefunded financial resources to cover
36 See
12 U.S.C. 5461(b).
12 U.S.C. 5464(a)(2).
38 See 12 U.S.C. 5464(b).
39 See 12 U.S.C. 5464(a)(2)
40 See 15 U.S.C. 78q–1.
41 See 17 CFR 240.17Ad–22.
42 Id.
37 See
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11417
its potential losses resulting from the
default of a Clearing Member and its
Affiliated Family under multiple
extreme but plausible market stress
conditions.
First, FICC is proposing to leverage
Historical Data in the Scenario Selection
process. FICC believes the proposed
change would promote robust risk
management because the Historical Data
would incorporate a broader range of
risk factors that would be used in
MBSD’s stress testing model to better
understand a Clearing Member’s
exposure to these risk factors.
Second, FICC is proposing to change
the 10-year look-back period to a lookback period that starts on a fixed date
of May 29, 2002 and continues to
expand forward. FICC believes the
proposed change would promote robust
risk management because the change,
which includes at least 16 years of
historical data, would capture the
potential market price changes of TBA
securities over a longer time period,
preserve historical dates that would
otherwise be eliminated under the
current 10-year look-back period and
provide the stress testing model with a
larger set of scenarios for the historical
Scenario Selection process.
Third, FICC is proposing to leverage
Security-Level Data and Historical Data
in the methodology’s calculation of
stress P&L. FICC believes the proposed
change would promote robust risk
management because it would replace
the current empirical regression-based
profit-and-loss calculation with a
financial profit-and-loss calculation that
utilizes the Security-Level Data and
Historical Data. The change would
cause the stress testing model’s stress
P&L calculation to calculate amounts
that are closer to actual price changes
for TBA securities during larger market
moves in an effort to test the adequacy
of MBSD’s prefunded resources.
Fourth, FICC is proposing to use a
back-up calculation in the event of a
Vendor Data Disruption. FICC believes
the proposed change would promote
robust risk management because the
change would help to ensure that FICC
has a stress testing methodology in
place that allows it to continue to test
the adequacy of MBSD’s prefunded
financial resources in the event of a
Vendor Data Disruption.
For these reasons, FICC believes the
proposed changes would help to
promote MBSD’s robust risk
management, which, in turn, is
consistent with reducing systemic risks
and supporting the stability of the
broader financial system, consistent
with Section 805(b) of the Clearing
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lotter on DSKBCFDHB2PROD with NOTICES
Supervision Act.43 FICC also believes
the changes proposed in this advance
notice are consistent with promoting
safety and soundness, which, in turn, is
consistent with reducing systemic risks
and supporting the stability of the
broader financial system, consistent
with Section 805(b) of the Clearing
Supervision Act.44 As described above,
the proposed changes are designed to
help ensure that FICC’s stress testing
methodology measures whether MBSD
is collecting adequate prefunded
financial resources to cover its potential
losses resulting from the default of a
Clearing Member and its Affiliated
Family under multiple extreme but
plausible market stress conditions.
Because the proposed changes would
better position FICC to limit its
exposures to Clearing Members in the
event of a Clearing Member’s default,
FICC believes the proposed changes are
consistent with promoting safety and
soundness, which, in turn, is consistent
with reducing systemic risks and
supporting the stability of the broader
financial system.
B. Consistency With Rule 17Ad–22(e)(4)
Under the Act
This proposal is also designed to be
consistent with Rule 17Ad–22(e)(4)
under the Act, which requires, in part,
that each covered clearing agency
establish, implement, maintain and
enforce written policies and procedures
reasonably designed to effectively
identify, measure, monitor, and manage
its credit exposures to participants and
those arising from its payment, clearing,
and settlement processes.45
Rule 17Ad–22(e)(4)(i) under the Act
requires that a covered clearing agency
maintain sufficient financial resources
to cover its credit exposure to each
participant fully with a high degree of
confidence.46 The proposed changes are
consistent with Rule 17Ad–22(e)(4)(i)
because they describe how FICC has
developed and carries out a credit risk
management strategy to maintain
sufficient prefunded financial resources
to cover fully its credit exposures to
each Clearing Member with a high
degree of confidence.
FICC believes (1) the proposal to use
Historical Data in the historical Scenario
Selection process and incorporate a
broader range of risk factors that would
be used in MBSD’s stress testing model
would enable FICC to better understand
a Clearing Member’s exposure to these
risk factors, (2) the proposal to change
43 See
47 17
CFR 240.17Ad–22(e)(4)(i).
CFR 240.17Ad–22(e)(4)(vi)(A). The
Framework identifies the sources of MBSD’s
prefunded resources for purposes of meeting FICC’s
requirements under Rule 17Ad–22(e)(4)(iii).
12 U.S.C. 5464(b).
48 17
44 Id.
45 17
46 17
CFR 240.17Ad–22(e)(4).
CFR 240.17Ad–22(e)(4)(i).
VerDate Sep<11>2014
17:26 Feb 26, 2020
the 10-year look-back period to a lookback period that starts on a fixed date
of May 29, 2002 and continues to
expand forward would better capture
the potential market price changes of
TBA securities, preserve historical dates
that would otherwise be eliminated
under the current 10-year look-back
period and provide the stress testing
model with a larger set of scenarios for
the historical selection process, (3) the
proposal to leverage Security-Level Data
and Historical Data in the stress testing
methodology’s calculation of stress P&L
for Clearing Members’ portfolios would
provide for calculated amounts that are
closer to actual price changes for TBA
securities during larger market moves in
an effort to test the adequacy of MBSD’s
prefunded resources, and (4) the
proposal to use a back-up calculation
would help to ensure that FICC has a
methodology in place that allows it to
continue to measure the adequacy of
MBSD’s prefunded financial resources
in the event of a Vendor Data
Disruption. FICC believes that the
proposed changes would improve
MBSD’s stress testing methodology,
which is used to test the sufficiency of
MBSD’s prefunded resources daily to
support compliance with Rule 17Ad–
22(e)(4)(i). As such, FICC believes that,
taken together, the proposed changes are
designed to be consistent with the
requirements of Rule 17Ad–22(e)(4)(i)
under the Act.47
Rule 17Ad–22(e)(4)(vi)(A) under the
Act requires that a covered clearing
agency conduct stress testing of its total
financial resources once each day using
standard predetermined parameters and
assumptions.48 FICC believes the
proposal to (1) use Historical Data in the
historical Scenario Selection process, (2)
change the 10-year look-back period to
a look-back period that starts on a fixed
date of May 29, 2002 and continues to
expand forward, (3) leverage SecurityLevel Data and Historical Data in the
stress testing methodology’s calculation
of stress P&L for Clearing Members’
portfolios, and (4) use a back-up
calculation in the event of a Vendor
Data Disruption would reflect standard
predetermined parameters and
assumptions that FICC would use in
MBSD’s stress testing methodology to
conduct daily stress testing.
FICC believes that the proposed
changes would reflect its use of
standard predetermined parameters and
assumptions in FICC’s daily stress
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testing of its financial resources in order
to support compliance with Rule 17Ad–
22(e)(4)(vi)(A) under the Act.49 As such,
FICC believes that, taken together, the
proposed changes are designed to be
consistent with the requirements of Rule
17Ad–22(e)(4)(vi)(A) under the Act.50
III. Date of Effectiveness of the Advance
Notice, and Timing for Commission
Action
The proposed change may be
implemented if the Commission does
not object to the proposed change
within 60 days of the later of (i) the date
that the proposed change was filed with
the Commission or (ii) the date that any
additional information requested by the
Commission is received. The clearing
agency shall not implement the
proposed change if the Commission has
any objection to the proposed change.
The Commission may extend the
period for review by an additional 60
days if the proposed change raises novel
or complex issues, subject to the
Commission providing the clearing
agency with prompt written notice of
the extension. A proposed change may
be implemented in less than 60 days
from the date the advance notice is
filed, or the date further information
requested by the Commission is
received, if the Commission notifies the
clearing agency in writing that it does
not object to the proposed change and
authorizes the clearing agency to
implement the proposed change on an
earlier date, subject to any conditions
imposed by the Commission.
The clearing agency shall post notice
on its website of proposed changes that
are implemented.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the Advance Notice
is consistent with the Clearing
Supervision Act. Comments may be
submitted by any of the following
methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
FICC–2020–801 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549.
49 Id.
50 17
E:\FR\FM\27FEN1.SGM
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27FEN1
Federal Register / Vol. 85, No. 39 / Thursday, February 27, 2020 / Notices
All submissions should refer to File
Number SR–FICC–2020–801. 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 Advance Notice that
are filed with the Commission, and all
written communications relating to the
Advance Notice between the
Commission and any person, other than
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 FICC and on DTCC’s website
(https://dtcc.com/legal/sec-rulefilings.aspx). 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–FICC–
2020–801 and should be submitted on
or before March 13, 2020.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020–03996 Filed 2–26–20; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
lotter on DSKBCFDHB2PROD with NOTICES
[Release No. 34–88259; File No. SR–
CboeBZX–2020–007]
Self-Regulatory Organizations; Cboe
BZX Exchange, Inc.; Notice of Filing of
a Proposed Rule Change To Eliminate
the Requirement That the Intraday
Indicative Value Be Disseminated as
Set Forth Under Rule 14.11(c) for
Certain Series of Index Fund Shares
and Under Rule 14.11(i) for All Series
of Managed Fund Shares
February 21, 2020.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (the
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17:26 Feb 26, 2020
Jkt 250001
‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on February
14, 2020, Cboe BZX Exchange, Inc. (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 Exchange. 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
Cboe BZX Exchange, Inc. (the
‘‘Exchange’’ or ‘‘BZX’’) is filing with the
Securities and Exchange Commission
(‘‘Commission’’) a proposed rule change
to eliminate the requirement that the
Intraday Indicative Value be
disseminated as set forth under Rule
14.11(c) (‘‘Index Fund Shares’’) for
certain series of Index Fund Shares and
under Rule 14.11(i) (‘‘Managed Fund
Shares’’) for all series of Managed Fund
Shares. The text of the proposed rule
change is provided in Exhibit 5.
The text of the proposed rule change
is also available on the Exchange’s
website (https://markets.cboe.com/us/
equities/regulation/rule_filings/bzx/), at
the Exchange’s Office of the Secretary,
and at the Commission’s Public
Reference Room.
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
Exchange 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 these
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 aspects of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
Exchange Rules 14.11(c) and 14.11(i)
relate to the listing and trading of Index
Fund Shares and Managed Fund Shares
on the Exchange. Among a number of
other requirements, numerous subparagraphs of each of these rules require
that an intraday estimate of the value of
1 15
2 17
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CFR 240.19b–4.
Frm 00090
Fmt 4703
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11419
a share of each series (the ‘‘Intraday
Indicative Value’’ or ‘‘IIV’’) of Index
Fund Shares and Managed Fund Shares
be disseminated and updated at least
every 15 seconds.3 The Exchange is
proposing to eliminate the requirement
to disseminate an IIV for all series of
Managed Fund Shares 4 listed on the
Exchange and for those series of Index
Fund Shares that also publish their
Portfolio Holdings (as defined below) on
a daily basis.
As part of this proposal, the Exchange
is also proposing to adopt proposed
Rule 14.11(c)(1)(F) to define the term
‘‘Portfolio Holdings’’ which would
mean the holdings of a particular series
of Index Fund Shares that will form the
basis for the calculation of its net asset
value (‘‘NAV’’) at the end of the
business day.5 Existing Exchange Rules
require issuers of Managed Fund Shares
to provide IIV and daily disclosure of
the Disclosed Portfolio.6 Similarly,
existing Exchange Rules require issuers
of Index Fund Shares to disseminate an
IIV for each fund, but do not universally
require daily disclosure of a fund’s
underlying holdings.7
The dissemination of an IIV, together
with disclosure of the fund’s underlying
3 See subparagraphs (c)(3)(C), (c)(6)(A), and
(c)(9)(B)(i)(e) of Exchange Rule 14.11. See also
subparagraphs (i)(3)(C), (i)(3)(D), (i)(4)(B)(i),
(i)(4)(B)(iii)(b), and (i)(4)(B)(iv) of Exchange Rule
14.11.
4 The Exchange notes that Rule
14.11(i)(4)(B)(ii)(a) requires that the Disclosed
Portfolio for a series of Managed Fund Shares be
disseminated at least once daily and be made
available to all market participants at the same time.
Further, Rule 14.11(i)(4)(B)(iii)(b) requires that the
Exchange consider suspension of trading in and
commence delisting proceedings for a series of
Managed Fund Shares where the Disclosed
Portfolio is not made available to all market
participants at the same time. As such, the
Exchange is proposing to eliminate the IIV
dissemination requirements entirely from Rule
14.11(i).
5 For purposes of Rule 14.11(c), Portfolio
Holdings would include various information, to the
extent applicable, as listed in proposed
subparagraphs (c)(1)(F)(i) through (c)(1)(F)(xi). The
proposed definition of Portfolio Holdings is
substantively identical to the definition of
‘‘Disclosed Portfolio’’ as set forth in Rule
14.11(i)(3)(B).
6 See subparagraphs (i)(3)(B), (i)(4)(A)(ii), and
(i)(4)(B)(ii) of Exchange Rule 14.11. The term
‘‘Disclosed Portfolio’’ means the identities and
quantities of the securities and other assets held by
the Investment Company that will form the basis for
the Investment Company’s calculation of net asset
value at the end of the business day. See also
Exchange Rule 14.11(i)(3)(B).
7 The Exchange notes that Rule 14.11(c)(1)(B)(iv)
would require the daily disclosure of certain
information related to a fund’s portfolio holdings
where a fund ‘‘seeks to provide investment results
that either exceed the performance of a specified
. . . index . . . by a specified multiple or that
correspond to the inverse (opposite) of the
performance of a specified . . . index . . . by a
specified multiple,’’ however, the Exchange does
not currently list any such funds.
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]]>Agencies
[Federal Register Volume 85, Number 39 (Thursday, February 27, 2020)]
[Notices]
[Pages 11413-11419]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-03996]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88266; File No. SR-FICC-2020-801]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Notice of Filing of Advance Notice To Amend the Mortgage-Backed
Securities Division Stress Testing Methodology
February 24, 2020.
Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act entitled the Payment,
Clearing, and Settlement Supervision Act of 2010 (``Clearing
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on
January 21, 2020, Fixed Income Clearing Corporation (``FICC'') filed
with the Securities and Exchange Commission (``Commission'') the
advance notice SR-FICC-2020-801 (``Advance Notice'') as described in
Items I, II and III below, which Items have been prepared by the
clearing agency. The Commission is publishing this notice to solicit
comments on the Advance Notice from interested persons.
---------------------------------------------------------------------------
\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
---------------------------------------------------------------------------
I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
This Advance Notice consists of modifications to the Mortgage-
Backed Securities Division's (``MBSD'') stress testing methodology.\3\
FICC is proposing to (1) use vendor-supplied historical risk factor \4\
time series data (``Historical Data'') in MBSD's stress testing
methodology's historical stress scenario selection (``Scenario
Selection'') process, (2) change the look-back period for identifying
historical stress scenarios for the Scenario Selection process, (3) use
vendor-supplied security-level risk sensitivity data \5\ (``Security-
Level Data'') and Historical Data in the stress testing methodology's
calculation of stress profits and losses (``P&L'') for Clearing
Members' portfolios,\6\ and (4) use a back-up calculation in the event
the vendor fails to provide the Security-Level Data and Historical Data
(such failure, a ``Vendor Data Disruption''), as described in greater
detail below.\7\ The proposed changes would not require modifications
to the MBSD Rules.
---------------------------------------------------------------------------
\3\ Capitalized terms used herein and not otherwise defined
shall have the meaning assigned to such terms in the FICC MBSD
Clearing Rules (the ``MBSD Rules''), available at www.dtcc.com/legal/rules-and-procedures.aspx.
\4\ Generally, the term ``risk factor'' (or ``risk driver'')
means an attribute, characteristic, variable or other concrete
determinant that influences the risk profile of a system, entity, or
financial asset. Risk factors may be causes of risk or merely
correlated with risk.
\5\ The term ``sensitivity'' means the percentage value change
of a security given each risk factor change.
\6\ The proposed change to use Security-Level Data would be
applicable to MBSD's stress testing methodology for historical and
hypothetical scenarios. The proposed change to use Historical Data
would be applicable only for historical scenarios. FICC currently
receives the Security-Level Data and Historical Data from a vendor.
FICC currently utilizes this Security-Level Data and Historical Data
in MBSD's value-at-risk (``VaR'') model, which calculates the VaR
Charge component in each Clearing Member's margin (referred to in
the MBSD Rules as Required Fund Deposit). See MBSD Rule 1,
Definitions--VaR Charge, supra note 3. FICC is proposing to use this
same data set in MBSD's Scenario Selection process, and stress P&L
calculation of each Clearing Member's portfolio.
\7\ FICC would receive the following data from the vendor:
Interest rate (including 11 tenors) measures the
sensitivity of a price change to changes in interest rates;
convexity measures the degree of curvature in the
price/yield relationship of key interest rates (convexity would not
be utilized in the scenarios selection process; it would only be
utilized in the stress P&L calculation);
mortgage option adjusted spread is the yield spread
that is added to a benchmark yield curve to discount a TBA's cash
flows to match its market price, which takes into account a credit
premium and the option-like feature of mortgage-backed-securities
due to prepayment;
interest rate volatility reflects the implied
volatility observed from the swaption market to estimate
fluctuations in interest rates; and
mortgage basis captures the basis risk between the
prevailing mortgage rate and a blended U.S. Treasury rate, which
impacts borrowers' refinance incentives and the model prepayment
assumptions.
The Historical Data would include (1) interest rate, (2)
mortgage option adjusted spread, (3) interest rate volatility, and
(4) mortgage basis.
The Security Level Data would include (1) sensitivity to
interest rates, (2) convexity, (3) sensitivity to mortgage option
adjusted spread, (4) sensitivity to interest rate volatility, and
(5) sensitivity to mortgage basis.
FICC does not believe that its current engagement of the vendor
would present a conflict of interest because the vendor is not an
existing Clearing Member nor are any of the vendor's affiliates
existing Clearing Members. To the extent that the vendor or any of
its affiliates applies to become a Clearing Member, FICC will
negotiate an appropriate information barrier with the applicant in
an effort to prevent a conflict of interest from arising. An
affiliate of the vendor currently provides an existing service to
FICC; however, this arrangement does not present a conflict of
interest because the existing agreement between FICC and the vendor,
and the existing agreement between FICC and the vendor's affiliate,
each contains provisions that limit the sharing of confidential
information.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
In its filing with the Commission, the clearing agency included
statements concerning the purpose of and basis for the Advance Notice
and discussed any comments it received on the Advance Notice. The text
of these statements may be examined at the places specified in Item IV
below. The clearing agency has prepared summaries, set forth in
sections A and B below, of the most significant aspects of such
statements.
(A) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants, or Others
FICC has not received or solicited any written comments relating to
this proposal. FICC will notify the Commission of any written comments
received by FICC.
(B) Advance Notice Filed Pursuant to Section 806(e) of the Clearing
Supervision Act
I. Nature of the Proposed Change
A. Background
Stress testing is an essential component of FICC's risk management.
FICC uses stress testing to help ensure that it is collecting adequate
prefunded financial resources \8\ to cover MBSD's potential losses
resulting from the default of a Clearing Member and such Clearing
Member's affiliated family (that are also Clearing Members)
(``Affiliated Family'') under multiple extreme but plausible market
stress conditions (sometimes referred to as ``stress scenarios'').\9\
As set forth in the Framework, the development of FICC's
[[Page 11414]]
stress testing methodology is comprised of three key components.\10\
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\8\ MBSD's prefunded financial resources consist of Required
Fund Deposits collected from Clearing Members in the form of cash
and/or Eligible Clearing Fund Securities, with any such Eligible
Clearing Fund Securities being subject to a haircut. See MBSD Rules
1 and 4, supra note 3.
\9\ Consistent with the Clearing Agency Stress Testing Framework
(Market Risk) (``Framework''), FICC aggregates each Clearing
Member's stress deficiency within such Clearing Member's applicable
Affiliated Family because FICC assumes that all Affiliated Families
will simultaneously default, and the gains and losses of different
legal entities within an Affiliated Family would not offset each
other. The Framework is described in rule filing SR-FICC-2017-009.
See Securities Exchange Act Release No. 82368 (December 19, 2017),
82 FR 61082 (December 26, 2017) (``Framework Approval Order'').
\10\ Id. at 61083.
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The first component is the risk identification process. FICC
identifies the principal credit/market risk drivers that are
representative and specific to each Clearing Member's portfolio to
determine potential risk exposure. FICC accomplishes this by analyzing
the securities in each Clearing Member's portfolio to identify the
principal market price risk factor drivers and capture the risk
sensitivity of such portfolios under stressed market conditions.
The second component is the scenario development process, which is
designed to construct comprehensive and relevant sets of extreme but
plausible historical and hypothetical stress scenarios. In order to
select historical stress scenarios, MBSD's stress testing model selects
dates from the past that represent stressed market conditions based on
the largest historical changes of the selected risk factors. In order
to select hypothetical stress scenarios, MBSD considers potential
future events and their perceived impact to portfolio market risk
factors.
The third component is the risk measurement and aggregation
process. This process involves calculating risk metrics for each
Clearing Member's portfolio. The stress testing methodology calculates
stress P&L under each stress scenario and determines the loss amount
exceeding a Clearing Member's Required Fund Deposit for each scenario.
This calculation is referred to as the ``Clearing Member Level Stress
Deficiencies.'' In addition, the stress testing methodology calculates
the ratio of an Affiliated Family's deficiency \11\ over the total
value of the MBSD Clearing Fund excluding the sum value of the
applicable Affiliated Family's Required Fund Deposits. This calculation
is referred to as the ``Cover 1 Ratio.'' \12\
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\11\ An ``Affiliated Family deficiency'' is the aggregate of all
Clearing Members' stress deficiencies within the applicable
Affiliated Family.
\12\ See Framework Approval Order, 82 FR at 61083.
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B. Proposed Change to MBSD's Stress Testing Methodology
As further described below, FICC is proposing to use Security-Level
Data and Historical Data in MBSD's stress testing methodology.
Specifically, FICC is proposing to (1) use Historical Data in the
Scenario Selection process, (2) change the look-back period used for
identifying historical stress scenarios for the Scenario Selection
process, (3) use Security-Level Data and Historical Data in the
methodology's calculation of stress P&L for Clearing Members'
portfolios,\13\ and (4) use a back-up calculation in the event of a
Vendor Data Disruption.
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\13\ In connection with this proposal, FICC is not proposing any
changes to the hypothetical Scenario Selection process other than to
use the vendor's data. The hypothetical scenarios are currently
represented by five interest rate tenors (i.e., 1-year, 2-year, 5-
year, 10-year, and 30-year tenors), one mortgage option adjusted
spread, and one interest rate volatility point. The hypothetical
scenarios are reflected as shocks to the referenced risk factors.
This process would not change, however, in order to calculate the
stress P&L in the proposed model, FICC would map the referenced risk
factors to the set of risk factors in the proposed model.
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(1) Proposed Change To Use Historical Data in the Scenario Selection
Process
FICC uses two risk factors as inputs to the MBSD stress testing
model for the historical Scenario Selection process. The risk factors
are (1) interest rate and (2) mortgage option adjusted spread. The
interest rate risk factor consists of swap rates \14\ with tenors \15\
of 2 years, 5 years, 10 years, and 30 years. The mortgage option
adjusted spread risk factor is constructed as the difference between
the agency mortgage-backed TBA securities' current coupon rate and the
average swap rate, in each case, for Fannie Mae (``FNMA'') 30-year
mortgages and Ginnie Mae (``GNMA'') 30-year mortgages. MBSD's scenario
selection algorithm uses a technique referred to as principal component
analysis \16\ to convert correlated risk factors into uncorrelated risk
drivers that account for the joint co-movements \17\ of the multiple
risk factors during the 10-year look-back period.
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\14\ Generally, the term ``swap rate'' means the fixed interest
rate that the receiver demands in exchange for the uncertainty of
having to pay the short-term floating rate over time.
\15\ Generally, the term ``tenor'' means the amount of time left
for the repayment of a loan or until a financial contract expires.
\16\ Principal component analysis is a standard statistical
technique that is applied to a set of observations of potentially
correlated variables. It is used to identify a set of linearly
uncorrelated variables, which are referred to as principal
components.
\17\ Generally, the term ``joint co-movement'' means the
movement of two variables at the same time.
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FICC is proposing to continue to utilize the interest rate risk
factor and the mortgage option adjusted spread risk factor as inputs to
MBSD's stress testing model, however, both risk factors would be
sourced from a vendor. FICC is also proposing to include two new risk
factors in the methodology--interest rate volatility and mortgage
basis. The proposed change would result in an expansion of the number
of tenors for the existing interest rate risk factor and an expansion
of the number of individual factors to the existing mortgage option
adjusted spread risk factor. As a result of this change, the proposed
interest rate risk factor would include 11 tenors and the proposed
mortgage option adjusted spread risk factor would include up to
approximately 32 individual factors,\18\ which would differentiate
between various agency mortgage programs, underlying collateral
maturities, and the level of moneyness.\19\
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\18\ As described in the paragraph above, the current stress
testing methodology uses four tenors for the interest rate risk
factor and two individual factors for the mortgage option adjusted
spread risk factor.
\19\ The changes of spread are parameterized according to the
difference between the underlying weighted average coupon (``WAC'')
and the current prevailing mortgage rate. This difference is also
referred to as the ``moneyness.'' A TBA security with a WAC that is
10 basis points higher than the prevailing mortgage rate is said to
be 10 basis points in the money. Fifteen moneyness points are used
to parameterize the FNMA 30-year mortgage.
---------------------------------------------------------------------------
FICC is proposing to use the Historical Data (as described above)
because this data is more comprehensive, granular,\20\ and transparent.
The Historical Data is more comprehensive and granular because (1) it
would reflect a total of four risk factors (i.e., interest rate,
interest rate volatility, mortgage option adjusted spread and mortgage
basis), (2) the proposed interest rate risk factor would include 11
tenors and (3) the proposed mortgage option adjusted spread risk factor
would include up to approximately 32 individual factors. As a result of
this change, FICC believes that the proposed Historical Data would
better explain the market price changes of TBA transactions cleared by
MBSD \21\ and FICC would be able to identify stress risk exposures
under broader and more varied market conditions. The Historical Data
would also provide MBSD with an enhanced capability to design more
transparent scenarios. Because Clearing Members typically use risk
factor analysis for their own risk
[[Page 11415]]
and financial reporting, such Members would have comparable data and
analysis to stress test their portfolios. Thus, Clearing Members would
be able to simulate their stressed portfolios to a closer degree than
under the existing stress testing methodology.
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\20\ The term ``granular'' in the risk context means detailed
and diversified.
\21\ Specified Pool Trades and Stipulated Trades are mapped to
the corresponding TBAs. FICC's guarantee of Option Contracts on TBAs
is limited to the intrinsic value of the option positions meaning
that, when the underlying price of the TBA position is above the
call price, the Option Contract is considered in-the-money and
FICC's guarantee reflects this portion of the Option Contract's
positive value at the time of a Clearing Member's insolvency. The
value change of an Option Contract's position is simulated as the
change in its intrinsic value. No changes are being proposed to
MBSD's treatment of Specified Pool Trades, Stipulated Trades and
Option Contracts pursuant to this proposal.
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(2) Proposed Change to the Look-Back Period Used for the Identification
of Historical Stress Scenarios in the Scenario Selection Process
MBSD's current set of historical stress scenarios is comprised of
scenarios that reflect the most severe market price movements which
have been observed during past periods of extreme market conditions. To
identify specific dates for these market movements, MBSD's stress
testing model analyzes the historical risk factor time series data over
a 10-year look-back period. Specifically, MBSD's stress testing model
currently selects 50 historical scenarios based on actual historical
time periods observed over a 10-year look-back period.\22\ On a
quarterly basis, MBSD eliminates all historical data that fall outside
the scope of the 10-year look-back period.
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\22\ In addition to these 50 historical scenarios, FICC
supplements the historical scenario set by including additional
events that have occurred outside of the 10-year look-back period
and have been identified as important periods of historical stress
because such events have had a significant impact on the financial
market. These dates include May 29, 1994 (when the Federal Reserve
significantly raised rates), October 5, 1998 (when the Long-Term
Capital Management crisis occurred), and September 11, 2001 (when
the terrorist attacks occurred).
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FICC is proposing to change the current 10-year look-back period to
a look-back period that starts on a fixed date of May 29, 2002 and
continues to expand forward--meaning that no portion of the timeframe
within the proposed look-back period would be eliminated from the
stress testing model; instead the entire timeframe within the look-back
period would continue to expand forward.\23\
---------------------------------------------------------------------------
\23\ FICC would continue to include events that have occurred
prior to the proposed fixed date of May 29, 2002. These events
include the events referred to in footnote 22 above.
---------------------------------------------------------------------------
FICC selected May 29, 2002 as the fixed starting point based on its
assessment of the accuracy and consistency of the Historical Data
provided by the vendor. FICC is proposing this change because it
believes that the expanded look-back period would better capture the
potential market price changes of TBA securities, preserve historical
dates that would otherwise be eliminated under the current 10-year
look-back period, and provide the stress testing model with a larger
set of scenarios for the historical Scenario Selection process.\24\
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\24\ Pursuant to the proposed change, the look-back period would
include at least 16 years of historical data.
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(3) Proposed Change To Use Security-Level Data and Historical Data in
the Stress Testing Model's Stress P&L Calculation
Currently, in order to determine the potential loss to a Clearing
Member's portfolio under a given stress scenario, MBSD's stress testing
methodology applies a profit-and-loss calculation that multiplies a set
of risk factors' stress movements by its corresponding risk
sensitivities. Currently this methodology utilizes two interest rate
risk factors (i.e., 2-year swap rates and 10-year swap rates) and the
FNMA 30-year current coupon mortgage option adjusted spread. The risk
sensitivities are estimated using an empirical regression with a two-
month look-back period.\25\ FICC believes that the current
methodology's use of a smaller set of risk factors and the relatively
short two-month look-back period is a limitation that contributes to an
inability to explain the results of the sensitivities estimation.
---------------------------------------------------------------------------
\25\ Empirical regression is a statistical measure that
determines the coefficient range used in the stress P&L calculation.
---------------------------------------------------------------------------
FICC is proposing to leverage the Security-Level Data and
Historical Data in the methodology's calculation of stress P&L.
Specifically, FICC is proposing to replace the current empirical
regression-based profit-and-loss calculation with a financial profit-
and-loss calculation. The proposed financial profit-and-loss
calculation would use the Security-Level Data and Historical Data. The
Security-Level Data is generated using the vendor's suite of security
valuation models that includes an agency mortgage prepayment model and
interest rate term structure model.\26\ FICC believes that the vendor's
approach generates more stable and robust Security-Level Data and
addresses the limitations of the current empirical regression
algorithm.\27\ Because the proposed change would include Security-Level
Data, FICC believes the proposed Security-Level Data would improve the
stress testing model's stress P&L calculation, and the calculated
results would be closer to actual price changes for TBA securities
during larger market moves which are typical of stress testing
scenarios.
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\26\ A prepayment model captures cash flow uncertainty as a
result of unscheduled payments of principal (prepayments). An
interest rate term structure model describes the relationship
between interest rates of different maturities.
\27\ As described above, these limitations include the limited
number of risk factors and the two-month look-back period.
---------------------------------------------------------------------------
(4) Proposed Change To Use a Back-Up Calculation in the Event of a
Vendor Data Disruption
As described above, FICC would utilize the vendor's data for MBSD's
stress testing methodology. Prior to MBSD's use of this data in its VaR
model, FICC reviewed a description of the vendor's calculation
methodology and the manner in which the market data is used to
calibrate the vendor's models. At that time, The Depository Trust &
Clearing Corporation's (``DTCC'') Quantitative Risk Management, Vendor
Risk Management, and Information Technology teams conducted due
diligence of the vendor in order to evaluate its control framework for
managing key risks.\28\ FICC's due diligence included an assessment of
the vendor's technology risk, business continuity, regulatory
compliance, and privacy controls. Because of FICC's due diligence and
its use of the vendor data in connection with the calculation of MBSD's
margin model, FICC understands and remains comfortable with the
vendor's controls. In addition, DTCC's Data Integrity department
manages the data that FICC receives including, but not limited to,
market data and analytical data provided by vendors.\29\ As a result,
FICC feels comfortable with leveraging the Security-Level Data and
Historical Data for purposes of MBSD's stress testing methodology.
---------------------------------------------------------------------------
\28\ DTCC is FICC's parent company. DTCC operates on a shared
services model with respect to FICC. Most corporate functions are
established and managed on an enterprise-wide basis pursuant to
intercompany agreements under which DTCC generally provides a
relevant service to FICC.
\29\ DTCC's Data Integrity department oversees data integrity on
behalf of DTCC's Counterparty Credit, Market, and Liquidity Risk
Management groups as well as Securities Valuation, Model Validation
and Control, and Quantitative Risk Management (collectively,
Financial Risk Management (``FRM'')), and the Systemic Risk Office.
The Data Integrity department's mission is to align with FRM and
ensure that the highest data quality is managed for the purpose of
lowering risk and improving efficiency within FRM. The Data
Integrity department's prime directive consists of the following:
(1) Ensuring a data governance framework is established and adhered
to within FRM; (2) ensuring sufficient integrity of key data sources
through active rules-based data monitoring; (3) ensuring sufficient
alerting is in place to inform necessary parties when data anomalies
occur; (4) liaising with subject matter experts to resolve data
anomalies in an efficient and effective manner; and (5) ensuring
that critical FRM data is catalogued and defined in the enterprise
data dictionary.
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In connection with FICC's proposal to use the Security-Level Data
and Historical Data in its stress testing methodology for the
historical and hypothetical scenarios, FICC is also
[[Page 11416]]
proposing a back-up calculation (as described in the paragraph below)
that it would utilize in the event the vendor fails to provide the
data. If the vendor fails to provide any data or a significant portion
of the data in accordance with the timeframes agreed to by FICC and the
vendor, FICC would use the most recently available data on the first
day that such disruption occurs. Subject to discussions with the
vendor, if a Managing Director, who oversees Market Risk Management,
determines that the vendor would resume providing data within five (5)
business days, such Managing Director would determine whether the daily
stress testing calculation should continue to be calculated by using
the most recently available data or whether the back-up calculation (as
described below) should be invoked, subject to the approval of DTCC's
Group Chief Risk Officer or his/her designee.\30\ Subject to
discussions with the vendor, if a Managing Director, who oversees
Market Risk Management, determines that the data disruption would
extend beyond five (5) business days, the back-up calculation would be
applied, subsequent to the approval of DTCC's Management Risk
Committee, followed by notification to the Board Risk Committee.
---------------------------------------------------------------------------
\30\ For the avoidance of doubt, after taking into consideration
the vendor's condition and, to the extent applicable, market
conditions, FICC may treat the interruption as an extended data
interruption sooner.
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The proposed back-up calculation would be as follows: MBSD would
(1) calculate each Clearing Member's portfolio net exposures in four
securitization programs,\31\ (2) calculate the stress return for each
securitization program as the three-day price return for each
securitization program index for each scenario date, and (3) calculate
each Clearing Member's stress P&L as the sum of the products of the net
exposure of each securitization program and the stress return value for
each securitization program. FICC would use publicly available indices
(e.g., the Bloomberg FNMA 30-year index, Bloomberg GNMA 30-year index,
Bloomberg FNMA 15-year index and Bloomberg GNMA 15-year index) as the
data source for the stress return calculations.\32\
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\31\ The securitization programs are as follows: (1) FNMA and
Freddie Mac (``FHLMC'') conventional 30-year mortgage-backed
securities, (2) GNMA 30-year mortgage-backed securities, (3) FNMA
and FHLMC conventional 15-year mortgage-backed securities, and (4)
GNMA 15-year mortgage-backed securities.
\32\ The proposed calculation is similar to MBSD's calculation
of the Margin Proxy, which is the back-up calculation that MBSD will
use to calculate the VaR Charge in the event of a vendor data
disruption. See MBSD Rule 1, Definitions--Margin Proxy, supra note
3.
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C. Delayed Implementation of the Proposal
This proposal would become operative within 45 business days after
the date of the Commission's notice of no objection to this advance
notice filing. FICC would announce the operative date in an important
notice issued to Clearing Members.\33\
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\33\ MBSD's important notices are available at https://www.dtcc.com/legal/important-notices?subsidiary=FICC+-+MBS&pgs=1.
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II. Anticipated Effect on and Management of Risks
FICC believes that the proposed change to MBSD's stress testing
methodology, which consists of proposals to (1) use Historical Data in
the Scenario Selection process, (2) change the 10-year look-back period
used for the identification of historical stress scenarios in the
Scenario Selection process, (3) use Security-Level Data and Historical
Data in the stress testing methodology's calculation of stress P&L for
Clearing Members' portfolios, and (4) use a back-up calculation in the
event of a Vendor Data Disruption, would affect MBSD's management of
risk because the changes would help to ensure that MBSD's stress
testing methodology more effectively measures whether it is collecting
adequate prefunded financial resources to cover its potential losses
resulting from the default of a Clearing Member and its Affiliated
Family under multiple extreme but plausible market stress conditions.
A. Proposed Change To Use Historical Data in the Scenarios Selection
Process
FICC's proposal to utilize Historical Data in MBSD's historical
stress scenario selection process would affect FICC's management of
risk because the change would incorporate a broader range of risk
factors to better understand a Clearing Member's exposure to these risk
factors. As described above, the proposed change would enable MBSD to
leverage vendor expertise in supplying the risk data attributes that
would then be incorporated into MBSD's stress testing model. The data
would expand the number of tenors for the existing interest rate risk
factor and expand the number of individual factors to the existing
mortgage option adjusted spread risk factor. The proposed interest rate
risk factor would include 11 tenors and the proposed mortgage option
adjusted spread risk factor would include up to approximately 32
individual factors.\34\ In addition, FICC would include two new risk
factors in the methodology--interest rate volatility and mortgage
basis. FICC believes that the proposed change would provide more
comprehensive, granular and transparent risk representations that
enable sensitivity analysis on key model parameters and assumptions.
---------------------------------------------------------------------------
\34\ The proposed interest rate risk factor would include 11
tenors between 3 months and 30 years, and the proposed mortgage
option adjusted spread risk factor would include factors related to
relative value, spread between 15-year and 30-year products, and
spread between GNMA and FNMA.
---------------------------------------------------------------------------
B. Proposed Change to the 10-Year Look-Back Period Used for the
Identification of Historical Stress Scenarios in the Scenario Selection
Process
FICC's proposal to change the current 10-year look-back period to a
look-back period that starts on a fixed date of May 29, 2002 and
continues to expand forward would affect FICC's management of risk
because the change (which includes at least 16 years of historical
data) would give MBSD the ability to assess a broader spectrum of
historical stressed market events that would be used in the stress
testing methodology to design a comprehensive set of historical stress
scenarios.
C. Proposed Change To Use Security-Level Data and Historical Data in
the Stress Testing Model's Stress P&L Calculation
FICC's proposal to use Security-Level Data and Historical Data in
the stress testing methodology's calculation of stress P&L would affect
FICC's management of risk because leveraging the vendor-supplied data
would improve the estimation of the stress P&L calculation by giving
FICC the ability to attribute the stress loss under a given stress
scenario to specific risk factor changes. As described above, FICC
would replace the current empirical regression based profit-and-loss
calculation with a financial profit-and-loss calculation that uses
Security-Level Data and Historical Data, which are not included in the
current algorithm.\35\ Thus, FICC believes the proposed change would
improve the stress testing model's stress P&L calculation because the
calculated results would be closer to actual price changes for TBA
securities during larger market moves which are typical of stress
testing scenarios.
---------------------------------------------------------------------------
\35\ As described above, the empirical regression algorithm
incorporates fewer risk factors and a shorter look-back period.
---------------------------------------------------------------------------
In an effort to assess the impact of the proposed change, FICC
compared the results of the current stress testing
[[Page 11417]]
methodology with the proposed stress testing methodology for the period
of February 1, 2018 through January 1, 2019 with respect to the
historical stress scenarios. The average of the maximum daily
historical Cover 1 Ratio for this period is 20.3% for the proposed
stress testing methodology compared to 19.2% for the current stress
testing methodology (meaning that the proposed methodology would be
approximately 1.1% higher (on average) than the current methodology).
D. Proposed Change To Use a Back-Up Calculation in the Event of a
Vendor Data Disruption
FICC's proposal to use a back-up calculation would affect FICC's
management of risk because it would help to ensure that FICC continues
to test the adequacy of MBSD's prefunded financial resources in the
event of a Vendor Data Disruption. As described above, FICC would
manage the risks associated with a potential data disruption by using
the most recently available data (before the disruption) on the first
day that a data disruption occurs. If the vendor fails to provide any
data or a significant portion of the data in accordance with the
timeframes agreed to by FICC and the vendor, FICC would use the most
recently available data on the first day that such disruption occurs.
Subject to discussions with the vendor, if a Managing Director, who
oversees Market Risk Management, determines that the vendor would
resume providing data within five (5) business days, such Managing
Director would determine whether the daily stress testing calculation
should continue to be calculated by using the most recently available
data or whether the back-up calculation should be invoked, subject to
the approval of DTCC's Group Chief Risk Officer or his/her designee.
Subject to discussions with the vendor, if a Managing Director, who
oversees Market Risk Management, determines that the data disruption
would extend beyond five (5) business days, the back-up calculation
would be applied, subject to the approval of DTCC's Management Risk
Committee, followed by notification to the Board Risk Committee.
III. Consistency With the Clearing Supervision Act and the Covered
Clearing Agency Standards
Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, its stated purpose is instructive: To
mitigate systemic risk in the financial system and promote financial
stability by, among other things, promoting uniform risk management
standards for systemically important financial market utilities and
strengthening the liquidity of systemically important financial market
utilities.\36\
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\36\ See 12 U.S.C. 5461(b).
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Section 805(a)(2) of the Clearing Supervision Act \37\ authorizes
the Commission to prescribe risk management standards for the payment,
clearing and settlement activities of designated clearing entities,
like FICC, and financial institutions engaged in designated activities
for which the Commission is the supervisory agency or the appropriate
financial regulator. Section 805(b) of the Clearing Supervision Act
\38\ states that the objectives and principles for the risk management
standards prescribed under Section 805(a) shall be to, among other
things, promote robust risk management, promote safety and soundness,
reduce systemic risks, and support the stability of the broader
financial system. The Commission has adopted risk management standards
under Section 805(a)(2) of the Clearing Supervision Act \39\ and
Section 17A of the Act \40\ (the risk management standards are referred
to as the ``Covered Clearing Agency Standards'').\41\ The Covered
Clearing Agency Standards require registered clearing agencies to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to be consistent with the
minimum requirements for their operations and risk management practices
on an ongoing basis.\42\
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\37\ See 12 U.S.C. 5464(a)(2).
\38\ See 12 U.S.C. 5464(b).
\39\ See 12 U.S.C. 5464(a)(2)
\40\ See 15 U.S.C. 78q-1.
\41\ See 17 CFR 240.17Ad-22.
\42\ Id.
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A. Consistency With Section 805(b) of the Clearing Supervision Act
FICC believes that the proposed changes in this advance notice are
consistent with the objectives and principles of the risk management
standards as described in Section 805(b) of the Clearing Supervision
Act and in the Covered Clearing Agency Standards. As discussed above,
FICC is proposing several changes to MBSD's stress testing methodology.
FICC believes the proposed changes are consistent with promoting robust
risk management because the changes are designed to enhance MBSD's
stress testing methodology, which is used to help ensure that MBSD
collects adequate prefunded financial resources to cover its potential
losses resulting from the default of a Clearing Member and its
Affiliated Family under multiple extreme but plausible market stress
conditions.
First, FICC is proposing to leverage Historical Data in the
Scenario Selection process. FICC believes the proposed change would
promote robust risk management because the Historical Data would
incorporate a broader range of risk factors that would be used in
MBSD's stress testing model to better understand a Clearing Member's
exposure to these risk factors.
Second, FICC is proposing to change the 10-year look-back period to
a look-back period that starts on a fixed date of May 29, 2002 and
continues to expand forward. FICC believes the proposed change would
promote robust risk management because the change, which includes at
least 16 years of historical data, would capture the potential market
price changes of TBA securities over a longer time period, preserve
historical dates that would otherwise be eliminated under the current
10-year look-back period and provide the stress testing model with a
larger set of scenarios for the historical Scenario Selection process.
Third, FICC is proposing to leverage Security-Level Data and
Historical Data in the methodology's calculation of stress P&L. FICC
believes the proposed change would promote robust risk management
because it would replace the current empirical regression-based profit-
and-loss calculation with a financial profit-and-loss calculation that
utilizes the Security-Level Data and Historical Data. The change would
cause the stress testing model's stress P&L calculation to calculate
amounts that are closer to actual price changes for TBA securities
during larger market moves in an effort to test the adequacy of MBSD's
prefunded resources.
Fourth, FICC is proposing to use a back-up calculation in the event
of a Vendor Data Disruption. FICC believes the proposed change would
promote robust risk management because the change would help to ensure
that FICC has a stress testing methodology in place that allows it to
continue to test the adequacy of MBSD's prefunded financial resources
in the event of a Vendor Data Disruption.
For these reasons, FICC believes the proposed changes would help to
promote MBSD's robust risk management, which, in turn, is consistent
with reducing systemic risks and supporting the stability of the
broader financial system, consistent with Section 805(b) of the
Clearing
[[Page 11418]]
Supervision Act.\43\ FICC also believes the changes proposed in this
advance notice are consistent with promoting safety and soundness,
which, in turn, is consistent with reducing systemic risks and
supporting the stability of the broader financial system, consistent
with Section 805(b) of the Clearing Supervision Act.\44\ As described
above, the proposed changes are designed to help ensure that FICC's
stress testing methodology measures whether MBSD is collecting adequate
prefunded financial resources to cover its potential losses resulting
from the default of a Clearing Member and its Affiliated Family under
multiple extreme but plausible market stress conditions. Because the
proposed changes would better position FICC to limit its exposures to
Clearing Members in the event of a Clearing Member's default, FICC
believes the proposed changes are consistent with promoting safety and
soundness, which, in turn, is consistent with reducing systemic risks
and supporting the stability of the broader financial system.
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\43\ See 12 U.S.C. 5464(b).
\44\ Id.
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B. Consistency With Rule 17Ad-22(e)(4) Under the Act
This proposal is also designed to be consistent with Rule 17Ad-
22(e)(4) under the Act, which requires, in part, that each covered
clearing agency establish, implement, maintain and enforce written
policies and procedures reasonably designed to effectively identify,
measure, monitor, and manage its credit exposures to participants and
those arising from its payment, clearing, and settlement processes.\45\
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\45\ 17 CFR 240.17Ad-22(e)(4).
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Rule 17Ad-22(e)(4)(i) under the Act requires that a covered
clearing agency maintain sufficient financial resources to cover its
credit exposure to each participant fully with a high degree of
confidence.\46\ The proposed changes are consistent with Rule 17Ad-
22(e)(4)(i) because they describe how FICC has developed and carries
out a credit risk management strategy to maintain sufficient prefunded
financial resources to cover fully its credit exposures to each
Clearing Member with a high degree of confidence.
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\46\ 17 CFR 240.17Ad-22(e)(4)(i).
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FICC believes (1) the proposal to use Historical Data in the
historical Scenario Selection process and incorporate a broader range
of risk factors that would be used in MBSD's stress testing model would
enable FICC to better understand a Clearing Member's exposure to these
risk factors, (2) the proposal to change the 10-year look-back period
to a look-back period that starts on a fixed date of May 29, 2002 and
continues to expand forward would better capture the potential market
price changes of TBA securities, preserve historical dates that would
otherwise be eliminated under the current 10-year look-back period and
provide the stress testing model with a larger set of scenarios for the
historical selection process, (3) the proposal to leverage Security-
Level Data and Historical Data in the stress testing methodology's
calculation of stress P&L for Clearing Members' portfolios would
provide for calculated amounts that are closer to actual price changes
for TBA securities during larger market moves in an effort to test the
adequacy of MBSD's prefunded resources, and (4) the proposal to use a
back-up calculation would help to ensure that FICC has a methodology in
place that allows it to continue to measure the adequacy of MBSD's
prefunded financial resources in the event of a Vendor Data Disruption.
FICC believes that the proposed changes would improve MBSD's stress
testing methodology, which is used to test the sufficiency of MBSD's
prefunded resources daily to support compliance with Rule 17Ad-
22(e)(4)(i). As such, FICC believes that, taken together, the proposed
changes are designed to be consistent with the requirements of Rule
17Ad-22(e)(4)(i) under the Act.\47\
---------------------------------------------------------------------------
\47\ 17 CFR 240.17Ad-22(e)(4)(i).
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Rule 17Ad-22(e)(4)(vi)(A) under the Act requires that a covered
clearing agency conduct stress testing of its total financial resources
once each day using standard predetermined parameters and
assumptions.\48\ FICC believes the proposal to (1) use Historical Data
in the historical Scenario Selection process, (2) change the 10-year
look-back period to a look-back period that starts on a fixed date of
May 29, 2002 and continues to expand forward, (3) leverage Security-
Level Data and Historical Data in the stress testing methodology's
calculation of stress P&L for Clearing Members' portfolios, and (4) use
a back-up calculation in the event of a Vendor Data Disruption would
reflect standard predetermined parameters and assumptions that FICC
would use in MBSD's stress testing methodology to conduct daily stress
testing.
---------------------------------------------------------------------------
\48\ 17 CFR 240.17Ad-22(e)(4)(vi)(A). The Framework identifies
the sources of MBSD's prefunded resources for purposes of meeting
FICC's requirements under Rule 17Ad-22(e)(4)(iii).
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FICC believes that the proposed changes would reflect its use of
standard predetermined parameters and assumptions in FICC's daily
stress testing of its financial resources in order to support
compliance with Rule 17Ad-22(e)(4)(vi)(A) under the Act.\49\ As such,
FICC believes that, taken together, the proposed changes are designed
to be consistent with the requirements of Rule 17Ad-22(e)(4)(vi)(A)
under the Act.\50\
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\49\ Id.
\50\ 17 CFR 240.17Ad-22(e)(4)(vi)(A).
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III. Date of Effectiveness of the Advance Notice, and Timing for
Commission Action
The proposed change may be implemented if the Commission does not
object to the proposed change within 60 days of the later of (i) the
date that the proposed change was filed with the Commission or (ii) the
date that any additional information requested by the Commission is
received. The clearing agency shall not implement the proposed change
if the Commission has any objection to the proposed change.
The Commission may extend the period for review by an additional 60
days if the proposed change raises novel or complex issues, subject to
the Commission providing the clearing agency with prompt written notice
of the extension. A proposed change may be implemented in less than 60
days from the date the advance notice is filed, or the date further
information requested by the Commission is received, if the Commission
notifies the clearing agency in writing that it does not object to the
proposed change and authorizes the clearing agency to implement the
proposed change on an earlier date, subject to any conditions imposed
by the Commission.
The clearing agency shall post notice on its website of proposed
changes that are implemented.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the Advance
Notice is consistent with the Clearing Supervision Act. Comments may be
submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-FICC-2020-801 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
[[Page 11419]]
All submissions should refer to File Number SR-FICC-2020-801. 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 Advance Notice that are filed with the
Commission, and all written communications relating to the Advance
Notice between the Commission and any person, other than 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 FICC and on DTCC's website
(https://dtcc.com/legal/sec-rule-filings.aspx). 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-FICC-2020-801 and should be submitted on
or before March 13, 2020.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-03996 Filed 2-26-20; 8:45 am]
BILLING CODE 8011-01-P
