Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing of Proposed Rule Change To Modify the Clearing Agency Model Risk Management Framework, 22222-22227 [2020-08378]
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Federal Register / Vol. 85, No. 77 / Tuesday, April 21, 2020 / Notices
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Self-Regulatory Organizations;
National Securities Clearing
Corporation; Notice of Filing of
Proposed Rule Change To Modify the
Clearing Agency Model Risk
Management Framework
April 15, 2020.
lotter on DSKBCFDHB2PROD with NOTICES
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’) 1 and Rule 19b–4 thereunder,2
notice is hereby given that on April 10,
2020, National Securities Clearing
Corporation (‘‘NSCC’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’) the proposed rule
change 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 proposed rule change
from interested persons.
I. Clearing Agency’s Statement of the
Terms of Substance of the Proposed
Rule Change
(a) The proposed rule change of NSCC
would amend the Clearing Agency
Model Risk Management Framework
(‘‘Framework’’) of NSCC and its
affiliates The Depository Trust Company
(‘‘DTC’’) and Fixed Income Clearing
Corporation (‘‘FICC,’’ and FICC together
with NSCC, the ‘‘CCPs,’’ and the CCPs
1 15
2 17
U.S.C. 78s(b)(1).
CFR 240.19b–4.
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together with DTC, the ‘‘Clearing
Agencies’’).3 Specifically, the proposed
rule change would amend the
Framework to (i) change the governance
structure for approval of a model 4
validation (‘‘Model Validation’’), (ii)
incorporate a model risk tolerance
statement (‘‘Model Risk Tolerance
Statement’’) and related provisions, (iii)
clarify the definition of Model Owner
(as defined below), (iv) reflect changes
in the role of the Model Risk
Governance Committee and a change of
its name, (v) redefine the first and
second line responsibilities and
incentives relating to model
performance monitoring and oversight
and (vi) make other technical and
clarifying changes to the text, as more
fully described below.
Although the Clearing Agencies
consider the Framework to be a rule, the
proposed rule change does not require
any changes to the Rules, By-Laws and
Organization Certificate of DTC (‘‘DTC
Rules’’), the Rulebook of the
Government Securities Division
(‘‘GSD’’) of Fixed Income Clearing
Corporation (such Rulebook hereinafter
referred to as ‘‘GSD Rules’’), the
Clearing Rules of the Mortgage-Backed
Securities Division (‘‘MBSD’’) of Fixed
Income Clearing Corporation (‘‘such
Clearing Rules hereinafter referred to as
‘‘MBSD Rules’’), or the Rules &
3 The Framework sets forth the model risk
management practices adopted by the Clearing
Agencies, which have been designed to assist the
Clearing Agencies in identifying, measuring,
monitoring, and managing the risks associated with
the design, development, implementation, use, and
validation of quantitative models. See Securities
Exchange Act Release No. 81485 (August 25, 2017),
82 FR 41433 (August 31, 2017) (File Nos. SR–DTC–
2017–008; SR–FICC–2017–014; SR–NSCC–2017–
008) (‘‘2017 Notice’’). The Framework is managed
by the Clearing Agencies’ risk management areas
generally responsible for model validation and
control matters, DTCC Model Validation and
Control (‘‘MVC’’), on behalf of each Clearing
Agency, with review and oversight by senior
management and the Risk Committee of the Board
of Directors of each of DTC, FICC, and NSCC
(collectively, ‘‘Boards’’). See Id.
4 The Clearing Agencies have adopted the
following definition for the term ‘‘model’’:
‘‘[M]odel’’ refers to a quantitative method, system,
or approach that applies statistical, economic,
financial, or mathematical theories, techniques, and
assumptions to process input data into quantitative
estimates. A ‘‘model’’ consists of three components:
An information input component, which delivers
assumptions and data to the model; a processing
component, which transforms inputs into estimates;
and a reporting component, which translates the
estimates into useful business information. The
definition of ‘‘model’’ also covers quantitative
approaches whose inputs are partially or wholly
qualitative or based on expert judgment, provided
that the output is quantitative in nature. See
Supervisory Guidance on Model Risk Management,
SR Letter 11–7, dated April 4, 2011, issued by the
Board of Governors of the Federal Reserve System
and the Office of the Comptroller of the Currency,
at 3.
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Procedures of NSCC (‘‘NSCC Rules’’), as
the Framework would be a standalone
document.5
II. Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Proposed Rule Change
In its filing with the Commission, the
clearing agency 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
clearing agency has prepared
summaries, set forth in sections A, B,
and C below, of the most significant
aspects of such statements.
(A) Clearing Agency’s Statement of the
Purpose of, and Statutory Basis for, the
Proposed Rule Change
1. Purpose
The proposed rule change would
amend the Framework to (i) change the
governance structure for approval of a
Model Validation, (ii) incorporate the
Model Risk Tolerance Statement with
respect to related forward-looking
provisions associated with maintaining
multiple model risk-related tolerance
statements, (iii) clarify the definition of
Model Owner, (iv) reflect changes in the
role of the Model Risk Governance
Committee and a change of its name, (v)
redefine the first and second line
responsibilities and incentives relating
to model performance monitoring and
oversight and (vi) make other technical
and clarifying changes to the text, as
more fully described below.
Although the Clearing Agencies
consider the Framework to be a rule, the
proposed rule change does not require
any changes to the DTC Rules, GSD
Rules, MBSD Rules, or NSCC Rules, as
the Framework would be a standalone
document.
Background
The Framework is maintained by the
Clearing Agencies for compliance with
Rule 17Ad–22 (e)(4)(i), (e)(4)(vii),
(e)(6)(iii), (e)(6)(vi), (e)(6)(vii), and
(e)(7)(vii) under the Act,6 and sets forth
the model risk management practices
5 Capitalized terms not defined herein are defined
in the DTC Rules, NSCC Rules, GSD Rules or MBSD
Rules, as applicable, available at https://dtcc.com/
legal/rules-and-procedures.
6 17 CFR 240.17Ad–22 (e)(4)(i), (e)(4)(vii),
(e)(6)(iii), (e)(6)(vi), (e)(6)(vii), and (e)(7)(vii). Each
of DTC, NSCC and FICC is a ‘‘covered clearing
agency’’ as defined in Rule 17Ad–22(a)(5) and must
comply with subsection (e) of Rule 17Ad–22.
References to Rule 17Ad–22(e)(6) and its
subparagraphs cited herein, and compliance
therewith, apply to the CCPs only and do not apply
to DTC.
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Federal Register / Vol. 85, No. 77 / Tuesday, April 21, 2020 / Notices
adopted by the Clearing Agencies,
which have been designed to assist the
Clearing Agencies in identifying,
measuring, monitoring, and managing
the risks associated with the design,
development, implementation, use, and
validation of quantitative models. The
Framework is managed by MVC, on
behalf of each Clearing Agency, with
review and oversight by senior
management of each Clearing Agency
and the Boards.7
Pursuant to the Framework, a model
developed for use by any of the Clearing
Agencies and meeting the above
definition for the term ‘‘model’’ is
included and tracked within a model
inventory (‘‘Model Inventory’’)
maintained by MVC.8
As Model Validation and the process
for approval of Model Validations is a
key concept that flows through the
Framework, NSCC is providing the
following background regarding Model
Validation to supplement the proposed
rule changes discussed further below.
Model Validation
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Pursuant to Section 3.3 (Full Model
Validation) of the Framework, each new
model undergoes a Model Validation
(unless provisionally approved, as
discussed below) pursuant to which
MVC verifies that the model is
performing as expected in accordance
with its design objectives and business
purpose. The Model Validation
standards, referred to in the Framework
as the full Model Validation standards
for any new model include, but are not
be limited to, the following core Model
Validation activities, as listed in the
Framework:
• Evaluation of the model
development documentation and
testing;
• evaluation of model theory and
assumptions, and identification of
potential limitations;
• evaluation of data inputs and
parameters;
• review of numerical
implementation including replication
for certain key model components,
which would vary from model to model;
• independent testing: Sensitivity
analysis, stress testing, and
benchmarking, as appropriate; and
• evaluation of model outputs, model
performance, and back testing.
7 The parent company of the Clearing Agencies is
The Depository Trust & Clearing Corporation
(‘‘DTCC’’). DTCC operates on a shared services
model with respect to the Clearing Agencies. Most
corporate functions are established and managed on
an enterprise-wide basis pursuant to intercompany
agreements under which it is generally DTCC that
provides a relevant service to a Clearing Agency.
8 See 2017 Notice, supra note 3.
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Pursuant to the Framework, Full
Model Validation is applied under the
following circumstances: (i) For all new
models prior to their use in production;
(ii) during periodic Model Validations
(as described below); and (iii) when
model changes are made that require
independent Model Validation (as
further described below).
Pursuant to Section 3.4 (Periodic
Model Validation) of the Framework,
models approved for use in production
are subject to what is currently referred
to in the Framework as periodic Model
Validations for purposes of confirming
that the models continue to operate as
intended, identifying any deficiencies
that would call into question the
continuing validity of any such model’s
original approval and evaluating
whether the model and its prior
validation remain valid within the
dynamics of current market conditions.
In this regard, the Framework
describes that MVC performs a Model
Validation for each model approved for
use in production not less than annually
(or more frequently as may be
contemplated by such Clearing Agency’s
established risk management
framework), including each credit risk
model,9 liquidity risk model,10 and in
the case of FICC and NSCC, as central
counterparties, on their margin systems
and related models.11
Periodic Model Validations and a full
Model Validation follow identical
standards. The Framework states that in
certain cases, MVC may determine extra
Model Validation activities are
warranted based on previous Model
Validation work and findings, changes
in market conditions, or because
performance monitoring of a model
warrants extra validation.
Pursuant to the Framework all
findings that result from a new Model
Validation, a change Model Validation,
a periodic Model Validation, or in
connection with implementation of a
new model or model change, are
centrally tracked by MVC.
Proposed Rule Changes
Section 3.1 Model Inventory
Section 3.1 of the Framework
currently explains how any model
developed for use by any of the Clearing
Agencies and meeting the above
definition for the term ‘‘model’’ would
be subject to tracking within the Model
Inventory. MVC is charged with
responsibility for adding models to the
Model Inventory and for tracking
9 See
Rule 17Ad–22(e)(4)(vii). See supra note 6.
Rule 17Ad–22(e)(7)(vii). See supra note 6.
11 See Rule 17Ad–22(e)(6)(vi) and (vii). See supra
note 6.
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models listed in the Model Inventory.
Section 3.1 also describes how a Model
Inventory survey is conducted at least
annually across the Clearing Agencies to
confirm the Model Inventory is current.
During the Annual Model Inventory
Survey, any business area or support
function intending to have a model
developed for Clearing Agency use will
submit materials relevant to such
proposed model for MVC to review and
assess whether such proposed model
will be added to the Model Inventory.
Proposed Change To Enhance Flow and
Readability of Text
Pursuant to the proposed rule change,
NSCC would remove the use of the
modifier ‘‘Clearing Agency’’ with
respect to references to models in this
section and throughout the Framework.
The Framework relates solely to models
of the Clearing Agencies and the use of
this modifier is redundant. This change
would enhance the flow and readability
of the text by eliminating a redundancy.
Model Owner
Also, the proposed rule change would
move the first reference to the defined
term ‘‘Model Owner’’ from the last
paragraph of the section to the second
paragraph of the section and clarify the
meaning of the term. This reference
would appear in a new sentence that
would describe that a Model Owner is
the person designated by the applicable
business area or support function to be
responsible for a particular model, and
that the Model Owner is recorded as the
Model Owner for such model by MVC
in the Model Inventory. The Framework
currently describes the Model Owner as
responsible for the development or
operation of the model being validated
by MVC, without noting that the Model
Owner is an individual designated by
the applicable business unit or support
function. In this regard, the proposed
change would provide clarification that
an individual is designated as the Model
Owner by the applicable business area
or support function.
The proposed rule change would also
change the Clearing Agency title of the
individual that is the head of MVC that
is referred to in a footnote in this section
from being an Executive Director to
Managing Director of each Clearing
Agency to reflect that a more senior
officer of the Clearing Agencies would
be responsible for supervising the
MVC.12 The footnote also states that the
head of MVC reports to the Group Chief
10 See
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12 A Managing Director is senior to an Executive
Director.
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Federal Register / Vol. 85, No. 77 / Tuesday, April 21, 2020 / Notices
Risk Officer 13 rather than to any Model
Owner.14 This statement would be
amended to clarify the independence of
the MVC extends so that it is
independent from anyone who develops
and operates a model and not only a
Model Owner. Also relating to the status
of the head of MVC within the
governance structure of the Clearing
Agencies, this footnote would note that
the head of MVC is a member of the
Management Risk Committee (‘‘MRC’’).
Replacement of Term ‘‘Vendor’’ With
‘‘externally purchased’’
Section 3.1 currently contains a
paragraph which describes that all
models, whether internally developed
or purchased from a ‘‘vendor,’’ are
subject to Model Validation. Pursuant to
the proposed rule change, NSCC would
revise the text of this paragraph to
replace the term ‘‘vendor’’ with
‘‘externally purchased.’’ NSCC believes
use of the term ‘‘externally purchased’’,
rather than vendor, would provide
clarity with respect to sections of the
Framework that apply to models
developed internally versus externally.
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Section 3.2 Model Materiality and
Complexity
Section 3.2 of the Framework outlines
that MVC assigns a materiality rating
and a complexity rating to each model
after it is added to the Model Inventory
and describes that the applicable rating
impacts the model’s validation in terms
of prioritization and approval authority.
As more fully described below
regarding Section 3.6 of the Framework,
the proposed rule change would provide
for the delegation of approval authority
for all Model Validations from the
Clearing Agencies’ management level
committee responsible for model risk
management matters to MVC, and the
authority to approve model validations
would vest solely in MVC.15
In this regard, a materiality rating and
complexity rating would no longer be
determinative of approval authority and
the text that describes approval
13 The Clearing Agencies’ Model Risk
management standards and practices are subject to
the oversight and direction of the Group Chief Risk
Officer, who is the head of the Group Chief Risk
Office.
14 The purpose of the footnote is to make clear
that MVC management has an independent
reporting line to the Group Chief Risk Office,
without potential conflict of reporting to any person
that could be a Model Owner.
15 Currently, Model Validations that have a
materiality rating of ‘Medium’ or ‘High,’ must be
approved by the MRC, after the model has been
reviewed and recommended to the MRC for
approval by the MRGC. Additionally, all periodic
Model Validations must currently be approved by
the MRC to be deemed complete through review
and recommendation by the MRGC.
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authority as impacted by materiality and
complexity ratings would be deleted.
As a related change in the model
governance structure, the forum
currently referred to as the Model Risk
Governance Committee would no longer
maintain oversight authority in the
model validation process and the text in
this section would reflect that it is the
forum for review of Model Risk matters
rather than the formal forum for
addressing Model Risk matters. The
Model Risk Governance Committee’s
name would be revised in this section
and throughout to refer to it instead as
the Model Risk Governance Council
(‘‘MRGC’’) to reflect its proposed role as
an advisory body rather than being part
of the formal model governance process.
In this regard, the text of Section 3.2
would be revised to reflect that the
MRGC is a forum for review of, rather
than addressing, Model Risk matters
and a footnote would be added to state
that MRGC is an advisory body that has
no decision-making authority but would
discuss and/or review certain model
risk related matters which could result
in advice and/or recommendation,
which is generally directed to the
interested party of a given model that
brings the matter, as applicable.
The proposed change to shift
responsibility for Model Risk matters,
including approval of Model
Validations, to MVC would ensure that
MVC has sole responsibility for
approving Model Validations, as MVC is
best suited within the Clearing Agencies
to manage the quantitative and technical
expertise to carry out the related
functions.
Section 3.5—Model Change
Management
Section 3.5 (Model Change
Management) currently states that an
active model may require changes in
either structure or technique. Details for
any model change request are provided
to MVC for review and a determination
of whether full Model Validation is
required. This section also includes text
that states to the extent that a vendor’s
version change may impact any existing
model used in production, an impact
study of the version change along with
any other analysis/benchmarking shall
be conducted as appropriate in MVC’s
reasonable business discretion.
The process described in this section
will not be amended pursuant to the
proposed rule change, however, to
remain consistent with the use of
terminology as described with respect to
Section 3.1 above, references to
‘‘vendor’’ models in this section would
be revised to reflect that models not
developed by the Clearing Agencies
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would instead be referred to as
externally purchased.
Section 3.6—Model Approval and
Control
Section 3.6 (Model Approval and
Control) currently provides that all new
models, and all material changes to
existing models, undergo Model
Validation by MVC and must be
approved prior to business use.
Currently, in cases where such model’s
materiality is ‘‘Medium’’ or ‘‘High,’’
such Model Validation is reviewed by
the MRGC and recommended by the
MRGC to MRC, for approval.
As stated above, the proposed rule
change would redefine the first and
second line responsibilities and
incentives relating to model
performance monitoring and oversight.
With respect to the first line, the
proposed rule change would remove a
reference to the Financial Engineering
Unit (‘‘FEU’’) within Quantitative Risk
Management (‘‘QRM’’). QRM is a risk
management function within the Group
Chief Risk Office, and a representative
of QRM is the Model Owner for all
margin Models used by the CCPs under
the Standards for Covered Clearing
Agencies (‘‘Standards’’) under the
Securities Exchange Act of 1934.
Because the Model Owner resides in
QRM, QRM is responsible for
developing, testing, and signing-off on
new models and enhancements to
existing models before submitting any
such model to MVC for Model
Validation and approval. Due to an
organizational restructuring, FEU was
eliminated, and pursuant to the
proposed rule change, the
responsibilities of FEU described above
would vest in the Model Owners, who
as described with respect to the
proposed changes to Section 3.1 above,
would have responsibility for the
models.
With respect to the second line, the
proposed rule change would revise this
section to remove the requirement that
MRC approve any Model Validation. In
this regard, MVC would have the sole
and exclusive authority to approve a
model. As stated above, the Clearing
Agencies’ believe that the MVC is best
suited to address Model Validation
issues based on its quantitative and
technical expertise and knowledge, and
the section would be revised
accordingly to reflect MVC’s proposed
role in this regard. As such, the
proposed rule change would remove
any text that indicates that MRC
approval is required for any Model
Validation to be complete and/or for a
model to remain in production.
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Also, consistent with the change in
the role of MRGC from one of oversight
to instead acting in an advisory
capacity, as described above, the
proposed rule change would also
remove text indicating that MRGC
would review and recommend Model
Validations to MRC or have any role in
provisional approvals 16 of models.
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Section 3.8—Model Performance
Monitoring
Pursuant to the Framework, MVC is
currently responsible for model
performance monitoring and for each
Clearing Agency’s backtesting process,
which are integral parts of each Clearing
Agency’s model risk management
framework. In this regard, Section 3.8
(Model Performance Monitoring) of the
Framework states that model
performance monitoring is the process
of (i) evaluating an active model’s
ongoing performance based on
theoretical tests, (ii) monitoring the
model’s parameters through the use of
threshold indicators, and/or (iii)
backtesting using actual historical data/
realizations to test a Value-at-Risk
(‘‘VaR’’) model’s predictive power.
The proposed rule change would
eliminate references to ‘‘theoretical
tests’’ and ‘‘threshold indicators’’ and
‘‘historical data/realizations’’ to
represent a real-world depiction of the
model performance monitoring process.
These changes are being proposed
because the process of model
performance monitoring does not
always take into account theoretical
tests, threshold indicators, and/or
historical data/realizations, but ‘‘could’’
take some or all of these into account
and appropriate under the
circumstances. Therefore, the
elimination of the ties to these tests,
thresholds and use of historical data/
realizations are a more accurate
representation of the model
performance monitoring process.
In addition, Section 3.8 would be
revised to reflect changes to the roles of
Model Owners and the MVC consistent
with the roles of the first and second
lines described above, and add text
stating that Model Owners are
responsible for the design and execution
of model performance monitoring and
preparation of model performance
16 In this regard, Section 3.6 that states that
models may be provisionally approved by MVC for
a limited period, not to exceed six months unless
also approved by the MRGC, would be revised to
delete the reference to MRGC’s role. Consistent with
the changes relating to the second line as described
above, MVC would assume full responsibility for
provisional approvals and, and consistent with text
in Section 3.6, would continue to track all
provisional approvals to confirm provisional
periods and control measures are met.
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monitoring reports. The proposed text
would also state that MVC is
responsible for providing oversight of
model performance monitoring
activities by setting organizational
standards and providing critical
analysis for identifying Model issues
and/or limitations.17
One paragraph within Section 3.8
contains a statement that MVC is
responsible for model performance
monitoring, including review of riskbased models used to calculate margin
requirements and relevant parameters/
threshold indicators, sensitivity
analysis, and model backtesting results,
and preparation of related reports. It
also states that review of these model
performance measures is subject to
review by MRGC. To remain consistent
with the change in the role of MRGC
and the related consolidation of primary
responsibility for oversight in the model
governance process in MVC, as
described above, this paragraph would
be deleted.
Also, consistent with the shift of the
responsibility in this regard to Model
Owners, Section 3.8 would be clarified
to indicate that QRM, because the
Model Owner for all margin models
used by the CCPs under the Standards
would reside in QRM, would be
responsible for model performance
monitoring the CCP’s margin models
Section 3.9—Backtesting
Section 3.9 states that MVC is
responsible for each Clearing Agency’s
VaR backtesting processes for the
central counterparties, including for
model backtesting and Clearing Fund
Requirement (‘‘CFR’’) backtesting.
Consistent with the changes described
above, this section would be revised to
state that this backtesting function for
models and CFR would reside with
QRM, as it is the owner of margin
models and would be responsible for
performance monitoring functions with
respect to margin models.
Section 4.1—Board of Directors and
Senior Management Reporting
Section 4.1 describes MRGC as the
primary forum for MVC’s regular
reporting of Model Validation activities
and material Model Risks identified
through regular Model performance
monitoring. Reports and
recommendations with respect to Model
Risk management are made to the MRC
as described in Section 3.
Periodic reporting to the Risk
Committee of the Clearing Agencies’
17 The organizational standards apply to DTCC’s
subsidiaries, as applicable.
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Boards (‘‘BRC’’) regarding Model Risk
matters may include:
• Updates of Model Validation
findings and the status of annual
validations.
• Updates on significant Model Risk
matters, and on compliance matters
with respect to Model Risk policies and
procedures (including this Framework).
• Escalation of Model Risk matters as
set forth in the Market Risk Tolerance
Statement, and subsequent, regular
updates with respect thereto.
The proposed rule change would
revise Section 4.1 to reflect the changes
to the roles of MVC and MRGC as
described above. In this regard, the
proposed rule change would delete the
description of MRGC’s role as it would
no longer have oversight of Model
Validation and model performance
monitoring and would add MRC as a
recipient of periodic reporting. The
proposed rule change would also
generalize the statement relating to
escalation of matters as set forth in the
Market Risk Tolerance Statement to
instead refer to ‘‘the Risk Tolerance
Statements’’ to reflect the addition of a
reference to the Model Risk Tolerance
Statement as a supporting document for
the Framework, as more fully described
below.
Section 4.2—Escalation
Section 4.2 describes, among other
things, how on at least a monthly basis,
the key metrics identified in Section 3.9
(Backtesting) are reviewed by the
Market and Liquidity Risk Management
unit within the Group Chief Risk Office
and MVC and reported to MRC. Given
MVC’s reduced role with respect to
backtesting in this regard, the proposed
rule change would eliminate the
provision that MVC would review the
metrics.18
The proposed rule change would also
revise text for clarity and readability
with respect to statements on the review
of the Market Risk Tolerance Statement,
to reference ‘‘Risk Tolerance
Statements’’ more generally to reflect
the changes described herein. Also, the
proposed rule change would remove
MRGC’s role in review and approval of
changes to backtesting methodology and
instead vest that responsibility with
MVC, to reflect the change in oversight
of Model Validation from MRGC to
MVC.
Also, to enhance the readability and
flow of the text in this section, the
proposed rule change would move text
18 Text would be added to clarify that the risk
metrics are reported to MRC by the group within
Group Chief Risk Office responsible for risk
reporting. Currently, this function is known as Risk
Reporting.
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describing that (i) the review of the Risk
Tolerance Statements by the Managing
Director of the Market and Liquidity
Risk Management unit (‘‘MDMLRM’’)
within the Group Chief Risk Office will
occur on an at least annual basis, and
(ii) the BRC’s review and approval of the
Risk Tolerance Statements will occur on
an at least annual basis, to the end of
Section 4.2.19 The proposed change
would also replace the reference to
specific title of the MDMLRM to instead
refer to the owner of the Risk Tolerance
Statements, to provide for more generic
terminology that would not require
formal amendment in the Framework if
the title of the MDMLRM were to
change.
Other Changes
The Framework inconsistently uses
the term ‘‘model’’ without and with
initial capitalization, but currently
refers throughout to the risks relating to
models referred to in the Framework as
a defined term using initial
capitalization—‘‘Model Risk.’’ To
remain consistent with the usage of
‘‘model’’ throughout the Framework,
NSCC would conform all references to
the term ‘‘model’’, so they appear
without initial capitalization and
change references to Model Risk
throughout the Framework to eliminate
the initial capitalization of the term and
refer to it as ‘‘model risk.’’
The Executive Summary of the
Framework includes a description of
internal DTCC policies and procedures
that support the Framework, including
the (a) DTCC Model Risk Management
Policy, (b) DTCC Model Validation
Procedures, (c) DTCC Model Risk
Performance Monitoring Procedures, (d)
the DTCC Backtesting Procedures and
(e) Market Risk Tolerance Statement
(‘‘Related Procedures’’). In addition to
the policies and procedures described in
the Executive Summary, the proposed
rule change would list in the Executive
Summary as a supporting policy, the
Model Risk Tolerance Statement. The
Model Risk Tolerance Statement
articulates, among other things, risk
tolerance levels covering model design
and implementation, including
consideration of a model’s intended
purpose and/or its adequacy of
performance. The conclusion, based on
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19 The
Risk Tolerance Statements are also
reviewed on an at least annual basis by Operational
Risk Management, which, among other things, is
the business line responsible for enabling the
identification of the Clearing Agencies’ plausible
sources of operational risk in order to mitigate the
impact of a potential event related to those sources
using tailored risk profiles and monitoring risk
profiles in accordance with the relevant Risk
Tolerance Statements.
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risk tolerance levels, focuses on model
remediation.
Since the risk tolerance levels in both
the Market Risk Tolerance Statement 20
and the Model Risk Tolerance Statement
consider model remediation as the basis
of risk control, both are applicable to the
Framework. In this regard, the proposed
rule change would add a footnote after
the listing of the Model Risk Tolerance
Statement and the existing reference to
the Market Risk Tolerance Statement to
describe that with respect to the key
risks 21 of model risk and market risk,
each risk tolerance statement documents
the overall risk reduction or mitigation
objectives as it relates to model risk and
market risk activities and documents the
risk controls and other measures used to
manage such activities, including
escalation requirements in the event of
risk metric breaches. The footnote
would also state that the Risk Tolerance
Statements are reviewed, revised,
retired, and/or replaced, as the case may
be, and approved by the BRC (as defined
herein) annually, based upon the
circumstances, and the reasonable best
judgement of management, then existing
relating to model risk management
matters. Consistent with proposed
terminology described above with
respect to Sections 4.1 and 4.2, the
Model Risk Tolerance Statement and the
Market Risk Tolerance Statement would
be referred to collectively in the
Executive Summary as the ‘‘Risk
Tolerance Statements.’’
The Executive Summary also
indicates that the Related Procedures
may be updated or amended. The
Clearing Agencies regularly review their
internal policies and procedures, and in
addition to updating or amending them
as an administrative matter as they
deem appropriate, may also retire or
replace internal policies and procedures
as they deem appropriate. In this regard,
the proposed rule change would also
include text to the effect that each of the
Related Procedures and the Model Risk
Tolerance Statement may retired or
replaced (in addition to updated or
amended).
Effective Date
The proposed rule change would
become effective upon approval by the
Commission.
20 The Market Risk Tolerance Statement
articulates, among other things, risk tolerance levels
covering margin backtests covering backtest
coverage and stress tests covering exposure to
extreme market moves. The conclusion, based on
tolerance levels, focuses on model enhancement or
model remediation, as applicable.
21 DTCC has identified a set of key risks to better
guide the content, measurement, frequency, and
focus of our discussion and management of risk
generally across the Organization.
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Frm 00104
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2. Statutory Basis
The Clearing Agencies believe that the
Framework is consistent with Section
17A(b)(3)(F) of the Act,22 as well as Rule
17Ad–22 (e)(4)(vii), and (e)(7)(vii)
thereunder,23 for the reasons described
below.
Section 17A(b)(3)(F) of the Act 24
requires, inter alia, that the rules of a
clearing agency be designed to assure
the safeguarding of securities and funds
which are in the custody or control of
the clearing agency or for which it is
responsible. As described above, the
Framework describes the process by
which the Clearing Agencies identify,
measure, monitor, and manage the risks
associated with the design,
development, implementation, use, and
validation of quantitative models. The
quantitative models covered by the
Framework are applied by the Clearing
Agencies, as applicable, to evaluate and
address their respective risk exposures
associated with their settlement activity
and facilitate their ability to assure the
safeguarding of securities and funds
which are in the custody or control of
the clearing agency or for which it is
responsible. In this regard, the proposed
changes to the Framework support their
ability to develop models that are
applied to evaluate and address risk
exposure and facilitate the safeguarding
of securities and funds which are in the
custody or control of the Clearing
Agencies or for which they are
responsible by (i) changing the
governance structure for approval of a
Model Validation to transfer the
responsibility for approval of model
validations to the MVC, which is
composed of individuals with a higher
level of expertise relating to model
validations than members of the MRC,
which is currently responsible for such
approvals, thereby enhancing the ability
of the group conducting Model
Validations to evaluate risk exposures
relating to models, (ii) incorporating the
Model Risk Tolerance Statement into
the Framework which describes risk
tolerance levels covering model design
and implementation, including
consideration of a model’s intended
purpose and/or its adequacy of
performance, and therefore including a
cross-reference to a document which
describes an important gauge with
respect to the level of risk that may be
tolerated as part of managing the risk
presented to the Clearing Agencies
relating to models, (iii) clarifying the
definition of Model Owner, therefore
22 15
U.S.C. 78q–1(b)(3)(F).
note 6.
24 15 U.S.C. 78q–1(b)(3)(F).
23 Supra
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defining the first line responsible for
evaluating risk exposure, (iv) reflecting
changes in the role of the Model Risk
Governance Committee and a change its
name, which relates to the change in
governance structure that is designed to
enhance the independence in its new
role of responsibility for approval of
Model Validations which would
support the Clearing Agencies’ ability to
evaluate risk exposure, (v) redefining
the first and second line responsibilities
and incentives relating to model
performance monitoring and oversight,
therefore enhancing the process by
which risk relating to models is
evaluated, and (vi) making other
technical and clarifying changes to the
text, as described above, to improve the
text in defining roles and
responsibilities for the processes
established by the Clearing Agencies to
monitor risk. Therefore, NSCC believes
the proposed rule change is consistent
with the requirements of Section
17A(b)(3)(F) of the Act,25 because it
would facilitate the ability of the
Clearing Agencies to continue to
develop models that are applied to
evaluate and address risk exposure and
allow them to maintain a Framework
that facilitates the ability of the Clearing
Agencies to assure the safeguarding of
securities and funds which are in the
custody or control of the clearing agency
or for which it is responsible, as
described above.
Rule 17Ad–22(e)(4)(vii) 26 and
(e)(7)(vii) 27 under the Act requires, inter
alia, that a covered clearing agency
establish, implement, maintain and
enforce written policies and procedures
reasonably designed to perform Model
Validations on its credit risk models and
liquidity risk models not less than
annually or more frequently as may be
contemplated by the clearing agency’s
risk management framework established
pursuant to Rule 17Ad–22(e)(3).28 As
discussed above, the proposed rule
change would amend the Framework to
provide for enhanced clarity in the text
and enhanced efficiency with respect to
the approval process for Model
Validations at least annually. In this
regard, and as noted above, pursuant to
the Framework, Model Validations are
performed not less than annually on its
credit risk models and liquidity risk
models. Therefore, the Clearing
Agencies believe that the proposed
changes to the Framework are consistent
with Rule 17Ad–22(e)(4)(vii) 29 and
(e)(7)(vii) 30 under the Act.
Commission, 100 F Street NE,
Washington, DC 20549.
(B) Clearing Agency’s Statement on
Burden on Competition
All submissions should refer to File
Number SR–NSCC–2020–008. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549 on official
business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of the
filing also will be available for
inspection and copying at the principal
office of NSCC 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–NSCC–
2020–008 and should be submitted on
or before May 12, 2020.
None of the Clearing Agencies believe
that the Framework would have any
impact, or impose any burden, on
competition because the proposed rule
change reflects clarifying changes and
provides for a more efficient internal
governance process and would not
effectuate any changes to the Clearing
Agencies’ model risk management tools
as they currently apply to their
respective Members or Participants.
(C) Clearing Agency’s Statement on
Comments on the Proposed Rule
Change Received From Members,
Participants, or Others
The Clearing Agencies have not
solicited or received any written
comments relating to this proposal. The
Clearing Agencies will notify the
Commission of any written comments
received by the Clearing Agencies.
III. Date of Effectiveness of the
Proposed Rule Change, and Timing for
Commission Action
Within 45 days of the date of
publication of this notice in the Federal
Register or within such longer period
up to 90 days (i) as the Commission may
designate if it finds such longer period
to be appropriate and publishes its
reasons for so finding or (ii) as to which
the self-regulatory organization
consents, the Commission will:
(A) By order approve or disapprove
such proposed rule change, or
(B) institute proceedings to determine
whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.31
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020–08378 Filed 4–20–20; 8:45 am]
BILLING CODE 8011–01–P
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–
NSCC–2020–008 on the subject line.
Paper Comments
25 Id.
26 17 CFR 240.17Ad–22(e)(4) (in particular, 17
CFR 240.17Ad–22(e)(4)(vii)). See supra note 6.
27 17 CFR 240.17Ad–22(e)(7) (in particular, 17
CFR 240.17Ad–22(e)(7)(vii)). See supra note 6.
28 17 CFR 240.17Ad–22(e)(3). See supra note 6.
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• Send paper comments in triplicate
to Secretary, Securities and Exchange
29 Supra
30 Supra
PO 00000
note 6.
note 6.
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[Federal Register Volume 85, Number 77 (Tuesday, April 21, 2020)]
[Notices]
[Pages 22222-22227]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-08378]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88637; File No. SR-NSCC-2020-008]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Proposed Rule Change To Modify the
Clearing Agency Model Risk Management Framework
April 15, 2020.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on April 10, 2020, National Securities Clearing Corporation (``NSCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change 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 proposed rule change
from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
(a) The proposed rule change of NSCC would amend the Clearing
Agency Model Risk Management Framework (``Framework'') of NSCC and its
affiliates The Depository Trust Company (``DTC'') and Fixed Income
Clearing Corporation (``FICC,'' and FICC together with NSCC, the
``CCPs,'' and the CCPs together with DTC, the ``Clearing
Agencies'').\3\ Specifically, the proposed rule change would amend the
Framework to (i) change the governance structure for approval of a
model \4\ validation (``Model Validation''), (ii) incorporate a model
risk tolerance statement (``Model Risk Tolerance Statement'') and
related provisions, (iii) clarify the definition of Model Owner (as
defined below), (iv) reflect changes in the role of the Model Risk
Governance Committee and a change of its name, (v) redefine the first
and second line responsibilities and incentives relating to model
performance monitoring and oversight and (vi) make other technical and
clarifying changes to the text, as more fully described below.
---------------------------------------------------------------------------
\3\ The Framework sets forth the model risk management practices
adopted by the Clearing Agencies, which have been designed to assist
the Clearing Agencies in identifying, measuring, monitoring, and
managing the risks associated with the design, development,
implementation, use, and validation of quantitative models. See
Securities Exchange Act Release No. 81485 (August 25, 2017), 82 FR
41433 (August 31, 2017) (File Nos. SR-DTC-2017-008; SR-FICC-2017-
014; SR-NSCC-2017-008) (``2017 Notice''). The Framework is managed
by the Clearing Agencies' risk management areas generally
responsible for model validation and control matters, DTCC Model
Validation and Control (``MVC''), on behalf of each Clearing Agency,
with review and oversight by senior management and the Risk
Committee of the Board of Directors of each of DTC, FICC, and NSCC
(collectively, ``Boards''). See Id.
\4\ The Clearing Agencies have adopted the following definition
for the term ``model'': ``[M]odel'' refers to a quantitative method,
system, or approach that applies statistical, economic, financial,
or mathematical theories, techniques, and assumptions to process
input data into quantitative estimates. A ``model'' consists of
three components: An information input component, which delivers
assumptions and data to the model; a processing component, which
transforms inputs into estimates; and a reporting component, which
translates the estimates into useful business information. The
definition of ``model'' also covers quantitative approaches whose
inputs are partially or wholly qualitative or based on expert
judgment, provided that the output is quantitative in nature. See
Supervisory Guidance on Model Risk Management, SR Letter 11-7, dated
April 4, 2011, issued by the Board of Governors of the Federal
Reserve System and the Office of the Comptroller of the Currency, at
3.
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Although the Clearing Agencies consider the Framework to be a rule,
the proposed rule change does not require any changes to the Rules, By-
Laws and Organization Certificate of DTC (``DTC Rules''), the Rulebook
of the Government Securities Division (``GSD'') of Fixed Income
Clearing Corporation (such Rulebook hereinafter referred to as ``GSD
Rules''), the Clearing Rules of the Mortgage-Backed Securities Division
(``MBSD'') of Fixed Income Clearing Corporation (``such Clearing Rules
hereinafter referred to as ``MBSD Rules''), or the Rules & Procedures
of NSCC (``NSCC Rules''), as the Framework would be a standalone
document.\5\
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\5\ Capitalized terms not defined herein are defined in the DTC
Rules, NSCC Rules, GSD Rules or MBSD Rules, as applicable, available
at https://dtcc.com/legal/rules-and-procedures.
---------------------------------------------------------------------------
II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, the clearing agency 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 clearing agency has prepared summaries,
set forth in sections A, B, and C below, of the most significant
aspects of such statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
1. Purpose
The proposed rule change would amend the Framework to (i) change
the governance structure for approval of a Model Validation, (ii)
incorporate the Model Risk Tolerance Statement with respect to related
forward-looking provisions associated with maintaining multiple model
risk-related tolerance statements, (iii) clarify the definition of
Model Owner, (iv) reflect changes in the role of the Model Risk
Governance Committee and a change of its name, (v) redefine the first
and second line responsibilities and incentives relating to model
performance monitoring and oversight and (vi) make other technical and
clarifying changes to the text, as more fully described below.
Although the Clearing Agencies consider the Framework to be a rule,
the proposed rule change does not require any changes to the DTC Rules,
GSD Rules, MBSD Rules, or NSCC Rules, as the Framework would be a
standalone document.
Background
The Framework is maintained by the Clearing Agencies for compliance
with Rule 17Ad-22 (e)(4)(i), (e)(4)(vii), (e)(6)(iii), (e)(6)(vi),
(e)(6)(vii), and (e)(7)(vii) under the Act,\6\ and sets forth the model
risk management practices
[[Page 22223]]
adopted by the Clearing Agencies, which have been designed to assist
the Clearing Agencies in identifying, measuring, monitoring, and
managing the risks associated with the design, development,
implementation, use, and validation of quantitative models. The
Framework is managed by MVC, on behalf of each Clearing Agency, with
review and oversight by senior management of each Clearing Agency and
the Boards.\7\
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\6\ 17 CFR 240.17Ad-22 (e)(4)(i), (e)(4)(vii), (e)(6)(iii),
(e)(6)(vi), (e)(6)(vii), and (e)(7)(vii). Each of DTC, NSCC and FICC
is a ``covered clearing agency'' as defined in Rule 17Ad-22(a)(5)
and must comply with subsection (e) of Rule 17Ad-22. References to
Rule 17Ad-22(e)(6) and its subparagraphs cited herein, and
compliance therewith, apply to the CCPs only and do not apply to
DTC.
\7\ The parent company of the Clearing Agencies is The
Depository Trust & Clearing Corporation (``DTCC''). DTCC operates on
a shared services model with respect to the Clearing Agencies. Most
corporate functions are established and managed on an enterprise-
wide basis pursuant to intercompany agreements under which it is
generally DTCC that provides a relevant service to a Clearing
Agency.
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Pursuant to the Framework, a model developed for use by any of the
Clearing Agencies and meeting the above definition for the term
``model'' is included and tracked within a model inventory (``Model
Inventory'') maintained by MVC.\8\
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\8\ See 2017 Notice, supra note 3.
---------------------------------------------------------------------------
As Model Validation and the process for approval of Model
Validations is a key concept that flows through the Framework, NSCC is
providing the following background regarding Model Validation to
supplement the proposed rule changes discussed further below.
Model Validation
Pursuant to Section 3.3 (Full Model Validation) of the Framework,
each new model undergoes a Model Validation (unless provisionally
approved, as discussed below) pursuant to which MVC verifies that the
model is performing as expected in accordance with its design
objectives and business purpose. The Model Validation standards,
referred to in the Framework as the full Model Validation standards for
any new model include, but are not be limited to, the following core
Model Validation activities, as listed in the Framework:
Evaluation of the model development documentation and
testing;
evaluation of model theory and assumptions, and
identification of potential limitations;
evaluation of data inputs and parameters;
review of numerical implementation including replication
for certain key model components, which would vary from model to model;
independent testing: Sensitivity analysis, stress testing,
and benchmarking, as appropriate; and
evaluation of model outputs, model performance, and back
testing.
Pursuant to the Framework, Full Model Validation is applied under
the following circumstances: (i) For all new models prior to their use
in production; (ii) during periodic Model Validations (as described
below); and (iii) when model changes are made that require independent
Model Validation (as further described below).
Pursuant to Section 3.4 (Periodic Model Validation) of the
Framework, models approved for use in production are subject to what is
currently referred to in the Framework as periodic Model Validations
for purposes of confirming that the models continue to operate as
intended, identifying any deficiencies that would call into question
the continuing validity of any such model's original approval and
evaluating whether the model and its prior validation remain valid
within the dynamics of current market conditions.
In this regard, the Framework describes that MVC performs a Model
Validation for each model approved for use in production not less than
annually (or more frequently as may be contemplated by such Clearing
Agency's established risk management framework), including each credit
risk model,\9\ liquidity risk model,\10\ and in the case of FICC and
NSCC, as central counterparties, on their margin systems and related
models.\11\
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\9\ See Rule 17Ad-22(e)(4)(vii). See supra note 6.
\10\ See Rule 17Ad-22(e)(7)(vii). See supra note 6.
\11\ See Rule 17Ad-22(e)(6)(vi) and (vii). See supra note 6.
---------------------------------------------------------------------------
Periodic Model Validations and a full Model Validation follow
identical standards. The Framework states that in certain cases, MVC
may determine extra Model Validation activities are warranted based on
previous Model Validation work and findings, changes in market
conditions, or because performance monitoring of a model warrants extra
validation.
Pursuant to the Framework all findings that result from a new Model
Validation, a change Model Validation, a periodic Model Validation, or
in connection with implementation of a new model or model change, are
centrally tracked by MVC.
Proposed Rule Changes
Section 3.1 Model Inventory
Section 3.1 of the Framework currently explains how any model
developed for use by any of the Clearing Agencies and meeting the above
definition for the term ``model'' would be subject to tracking within
the Model Inventory. MVC is charged with responsibility for adding
models to the Model Inventory and for tracking models listed in the
Model Inventory. Section 3.1 also describes how a Model Inventory
survey is conducted at least annually across the Clearing Agencies to
confirm the Model Inventory is current. During the Annual Model
Inventory Survey, any business area or support function intending to
have a model developed for Clearing Agency use will submit materials
relevant to such proposed model for MVC to review and assess whether
such proposed model will be added to the Model Inventory.
Proposed Change To Enhance Flow and Readability of Text
Pursuant to the proposed rule change, NSCC would remove the use of
the modifier ``Clearing Agency'' with respect to references to models
in this section and throughout the Framework. The Framework relates
solely to models of the Clearing Agencies and the use of this modifier
is redundant. This change would enhance the flow and readability of the
text by eliminating a redundancy.
Model Owner
Also, the proposed rule change would move the first reference to
the defined term ``Model Owner'' from the last paragraph of the section
to the second paragraph of the section and clarify the meaning of the
term. This reference would appear in a new sentence that would describe
that a Model Owner is the person designated by the applicable business
area or support function to be responsible for a particular model, and
that the Model Owner is recorded as the Model Owner for such model by
MVC in the Model Inventory. The Framework currently describes the Model
Owner as responsible for the development or operation of the model
being validated by MVC, without noting that the Model Owner is an
individual designated by the applicable business unit or support
function. In this regard, the proposed change would provide
clarification that an individual is designated as the Model Owner by
the applicable business area or support function.
The proposed rule change would also change the Clearing Agency
title of the individual that is the head of MVC that is referred to in
a footnote in this section from being an Executive Director to Managing
Director of each Clearing Agency to reflect that a more senior officer
of the Clearing Agencies would be responsible for supervising the
MVC.\12\ The footnote also states that the head of MVC reports to the
Group Chief
[[Page 22224]]
Risk Officer \13\ rather than to any Model Owner.\14\ This statement
would be amended to clarify the independence of the MVC extends so that
it is independent from anyone who develops and operates a model and not
only a Model Owner. Also relating to the status of the head of MVC
within the governance structure of the Clearing Agencies, this footnote
would note that the head of MVC is a member of the Management Risk
Committee (``MRC'').
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\12\ A Managing Director is senior to an Executive Director.
\13\ The Clearing Agencies' Model Risk management standards and
practices are subject to the oversight and direction of the Group
Chief Risk Officer, who is the head of the Group Chief Risk Office.
\14\ The purpose of the footnote is to make clear that MVC
management has an independent reporting line to the Group Chief Risk
Office, without potential conflict of reporting to any person that
could be a Model Owner.
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Replacement of Term ``Vendor'' With ``externally purchased''
Section 3.1 currently contains a paragraph which describes that all
models, whether internally developed or purchased from a ``vendor,''
are subject to Model Validation. Pursuant to the proposed rule change,
NSCC would revise the text of this paragraph to replace the term
``vendor'' with ``externally purchased.'' NSCC believes use of the term
``externally purchased'', rather than vendor, would provide clarity
with respect to sections of the Framework that apply to models
developed internally versus externally.
Section 3.2 Model Materiality and Complexity
Section 3.2 of the Framework outlines that MVC assigns a
materiality rating and a complexity rating to each model after it is
added to the Model Inventory and describes that the applicable rating
impacts the model's validation in terms of prioritization and approval
authority.
As more fully described below regarding Section 3.6 of the
Framework, the proposed rule change would provide for the delegation of
approval authority for all Model Validations from the Clearing
Agencies' management level committee responsible for model risk
management matters to MVC, and the authority to approve model
validations would vest solely in MVC.\15\
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\15\ Currently, Model Validations that have a materiality rating
of `Medium' or `High,' must be approved by the MRC, after the model
has been reviewed and recommended to the MRC for approval by the
MRGC. Additionally, all periodic Model Validations must currently be
approved by the MRC to be deemed complete through review and
recommendation by the MRGC.
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In this regard, a materiality rating and complexity rating would no
longer be determinative of approval authority and the text that
describes approval authority as impacted by materiality and complexity
ratings would be deleted.
As a related change in the model governance structure, the forum
currently referred to as the Model Risk Governance Committee would no
longer maintain oversight authority in the model validation process and
the text in this section would reflect that it is the forum for review
of Model Risk matters rather than the formal forum for addressing Model
Risk matters. The Model Risk Governance Committee's name would be
revised in this section and throughout to refer to it instead as the
Model Risk Governance Council (``MRGC'') to reflect its proposed role
as an advisory body rather than being part of the formal model
governance process. In this regard, the text of Section 3.2 would be
revised to reflect that the MRGC is a forum for review of, rather than
addressing, Model Risk matters and a footnote would be added to state
that MRGC is an advisory body that has no decision-making authority but
would discuss and/or review certain model risk related matters which
could result in advice and/or recommendation, which is generally
directed to the interested party of a given model that brings the
matter, as applicable.
The proposed change to shift responsibility for Model Risk matters,
including approval of Model Validations, to MVC would ensure that MVC
has sole responsibility for approving Model Validations, as MVC is best
suited within the Clearing Agencies to manage the quantitative and
technical expertise to carry out the related functions.
Section 3.5--Model Change Management
Section 3.5 (Model Change Management) currently states that an
active model may require changes in either structure or technique.
Details for any model change request are provided to MVC for review and
a determination of whether full Model Validation is required. This
section also includes text that states to the extent that a vendor's
version change may impact any existing model used in production, an
impact study of the version change along with any other analysis/
benchmarking shall be conducted as appropriate in MVC's reasonable
business discretion.
The process described in this section will not be amended pursuant
to the proposed rule change, however, to remain consistent with the use
of terminology as described with respect to Section 3.1 above,
references to ``vendor'' models in this section would be revised to
reflect that models not developed by the Clearing Agencies would
instead be referred to as externally purchased.
Section 3.6--Model Approval and Control
Section 3.6 (Model Approval and Control) currently provides that
all new models, and all material changes to existing models, undergo
Model Validation by MVC and must be approved prior to business use.
Currently, in cases where such model's materiality is ``Medium'' or
``High,'' such Model Validation is reviewed by the MRGC and recommended
by the MRGC to MRC, for approval.
As stated above, the proposed rule change would redefine the first
and second line responsibilities and incentives relating to model
performance monitoring and oversight.
With respect to the first line, the proposed rule change would
remove a reference to the Financial Engineering Unit (``FEU'') within
Quantitative Risk Management (``QRM''). QRM is a risk management
function within the Group Chief Risk Office, and a representative of
QRM is the Model Owner for all margin Models used by the CCPs under the
Standards for Covered Clearing Agencies (``Standards'') under the
Securities Exchange Act of 1934. Because the Model Owner resides in
QRM, QRM is responsible for developing, testing, and signing-off on new
models and enhancements to existing models before submitting any such
model to MVC for Model Validation and approval. Due to an
organizational restructuring, FEU was eliminated, and pursuant to the
proposed rule change, the responsibilities of FEU described above would
vest in the Model Owners, who as described with respect to the proposed
changes to Section 3.1 above, would have responsibility for the models.
With respect to the second line, the proposed rule change would
revise this section to remove the requirement that MRC approve any
Model Validation. In this regard, MVC would have the sole and exclusive
authority to approve a model. As stated above, the Clearing Agencies'
believe that the MVC is best suited to address Model Validation issues
based on its quantitative and technical expertise and knowledge, and
the section would be revised accordingly to reflect MVC's proposed role
in this regard. As such, the proposed rule change would remove any text
that indicates that MRC approval is required for any Model Validation
to be complete and/or for a model to remain in production.
[[Page 22225]]
Also, consistent with the change in the role of MRGC from one of
oversight to instead acting in an advisory capacity, as described
above, the proposed rule change would also remove text indicating that
MRGC would review and recommend Model Validations to MRC or have any
role in provisional approvals \16\ of models.
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\16\ In this regard, Section 3.6 that states that models may be
provisionally approved by MVC for a limited period, not to exceed
six months unless also approved by the MRGC, would be revised to
delete the reference to MRGC's role. Consistent with the changes
relating to the second line as described above, MVC would assume
full responsibility for provisional approvals and, and consistent
with text in Section 3.6, would continue to track all provisional
approvals to confirm provisional periods and control measures are
met.
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Section 3.8--Model Performance Monitoring
Pursuant to the Framework, MVC is currently responsible for model
performance monitoring and for each Clearing Agency's backtesting
process, which are integral parts of each Clearing Agency's model risk
management framework. In this regard, Section 3.8 (Model Performance
Monitoring) of the Framework states that model performance monitoring
is the process of (i) evaluating an active model's ongoing performance
based on theoretical tests, (ii) monitoring the model's parameters
through the use of threshold indicators, and/or (iii) backtesting using
actual historical data/realizations to test a Value-at-Risk (``VaR'')
model's predictive power.
The proposed rule change would eliminate references to
``theoretical tests'' and ``threshold indicators'' and ``historical
data/realizations'' to represent a real-world depiction of the model
performance monitoring process. These changes are being proposed
because the process of model performance monitoring does not always
take into account theoretical tests, threshold indicators, and/or
historical data/realizations, but ``could'' take some or all of these
into account and appropriate under the circumstances. Therefore, the
elimination of the ties to these tests, thresholds and use of
historical data/realizations are a more accurate representation of the
model performance monitoring process.
In addition, Section 3.8 would be revised to reflect changes to the
roles of Model Owners and the MVC consistent with the roles of the
first and second lines described above, and add text stating that Model
Owners are responsible for the design and execution of model
performance monitoring and preparation of model performance monitoring
reports. The proposed text would also state that MVC is responsible for
providing oversight of model performance monitoring activities by
setting organizational standards and providing critical analysis for
identifying Model issues and/or limitations.\17\
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\17\ The organizational standards apply to DTCC's subsidiaries,
as applicable.
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One paragraph within Section 3.8 contains a statement that MVC is
responsible for model performance monitoring, including review of risk-
based models used to calculate margin requirements and relevant
parameters/threshold indicators, sensitivity analysis, and model
backtesting results, and preparation of related reports. It also states
that review of these model performance measures is subject to review by
MRGC. To remain consistent with the change in the role of MRGC and the
related consolidation of primary responsibility for oversight in the
model governance process in MVC, as described above, this paragraph
would be deleted.
Also, consistent with the shift of the responsibility in this
regard to Model Owners, Section 3.8 would be clarified to indicate that
QRM, because the Model Owner for all margin models used by the CCPs
under the Standards would reside in QRM, would be responsible for model
performance monitoring the CCP's margin models
Section 3.9--Backtesting
Section 3.9 states that MVC is responsible for each Clearing
Agency's VaR backtesting processes for the central counterparties,
including for model backtesting and Clearing Fund Requirement (``CFR'')
backtesting. Consistent with the changes described above, this section
would be revised to state that this backtesting function for models and
CFR would reside with QRM, as it is the owner of margin models and
would be responsible for performance monitoring functions with respect
to margin models.
Section 4.1--Board of Directors and Senior Management Reporting
Section 4.1 describes MRGC as the primary forum for MVC's regular
reporting of Model Validation activities and material Model Risks
identified through regular Model performance monitoring. Reports and
recommendations with respect to Model Risk management are made to the
MRC as described in Section 3.
Periodic reporting to the Risk Committee of the Clearing Agencies'
Boards (``BRC'') regarding Model Risk matters may include:
Updates of Model Validation findings and the status of
annual validations.
Updates on significant Model Risk matters, and on
compliance matters with respect to Model Risk policies and procedures
(including this Framework).
Escalation of Model Risk matters as set forth in the
Market Risk Tolerance Statement, and subsequent, regular updates with
respect thereto.
The proposed rule change would revise Section 4.1 to reflect the
changes to the roles of MVC and MRGC as described above. In this
regard, the proposed rule change would delete the description of MRGC's
role as it would no longer have oversight of Model Validation and model
performance monitoring and would add MRC as a recipient of periodic
reporting. The proposed rule change would also generalize the statement
relating to escalation of matters as set forth in the Market Risk
Tolerance Statement to instead refer to ``the Risk Tolerance
Statements'' to reflect the addition of a reference to the Model Risk
Tolerance Statement as a supporting document for the Framework, as more
fully described below.
Section 4.2--Escalation
Section 4.2 describes, among other things, how on at least a
monthly basis, the key metrics identified in Section 3.9 (Backtesting)
are reviewed by the Market and Liquidity Risk Management unit within
the Group Chief Risk Office and MVC and reported to MRC. Given MVC's
reduced role with respect to backtesting in this regard, the proposed
rule change would eliminate the provision that MVC would review the
metrics.\18\
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\18\ Text would be added to clarify that the risk metrics are
reported to MRC by the group within Group Chief Risk Office
responsible for risk reporting. Currently, this function is known as
Risk Reporting.
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The proposed rule change would also revise text for clarity and
readability with respect to statements on the review of the Market Risk
Tolerance Statement, to reference ``Risk Tolerance Statements'' more
generally to reflect the changes described herein. Also, the proposed
rule change would remove MRGC's role in review and approval of changes
to backtesting methodology and instead vest that responsibility with
MVC, to reflect the change in oversight of Model Validation from MRGC
to MVC.
Also, to enhance the readability and flow of the text in this
section, the proposed rule change would move text
[[Page 22226]]
describing that (i) the review of the Risk Tolerance Statements by the
Managing Director of the Market and Liquidity Risk Management unit
(``MDMLRM'') within the Group Chief Risk Office will occur on an at
least annual basis, and (ii) the BRC's review and approval of the Risk
Tolerance Statements will occur on an at least annual basis, to the end
of Section 4.2.\19\ The proposed change would also replace the
reference to specific title of the MDMLRM to instead refer to the owner
of the Risk Tolerance Statements, to provide for more generic
terminology that would not require formal amendment in the Framework if
the title of the MDMLRM were to change.
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\19\ The Risk Tolerance Statements are also reviewed on an at
least annual basis by Operational Risk Management, which, among
other things, is the business line responsible for enabling the
identification of the Clearing Agencies' plausible sources of
operational risk in order to mitigate the impact of a potential
event related to those sources using tailored risk profiles and
monitoring risk profiles in accordance with the relevant Risk
Tolerance Statements.
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Other Changes
The Framework inconsistently uses the term ``model'' without and
with initial capitalization, but currently refers throughout to the
risks relating to models referred to in the Framework as a defined term
using initial capitalization--``Model Risk.'' To remain consistent with
the usage of ``model'' throughout the Framework, NSCC would conform all
references to the term ``model'', so they appear without initial
capitalization and change references to Model Risk throughout the
Framework to eliminate the initial capitalization of the term and refer
to it as ``model risk.''
The Executive Summary of the Framework includes a description of
internal DTCC policies and procedures that support the Framework,
including the (a) DTCC Model Risk Management Policy, (b) DTCC Model
Validation Procedures, (c) DTCC Model Risk Performance Monitoring
Procedures, (d) the DTCC Backtesting Procedures and (e) Market Risk
Tolerance Statement (``Related Procedures''). In addition to the
policies and procedures described in the Executive Summary, the
proposed rule change would list in the Executive Summary as a
supporting policy, the Model Risk Tolerance Statement. The Model Risk
Tolerance Statement articulates, among other things, risk tolerance
levels covering model design and implementation, including
consideration of a model's intended purpose and/or its adequacy of
performance. The conclusion, based on risk tolerance levels, focuses on
model remediation.
Since the risk tolerance levels in both the Market Risk Tolerance
Statement \20\ and the Model Risk Tolerance Statement consider model
remediation as the basis of risk control, both are applicable to the
Framework. In this regard, the proposed rule change would add a
footnote after the listing of the Model Risk Tolerance Statement and
the existing reference to the Market Risk Tolerance Statement to
describe that with respect to the key risks \21\ of model risk and
market risk, each risk tolerance statement documents the overall risk
reduction or mitigation objectives as it relates to model risk and
market risk activities and documents the risk controls and other
measures used to manage such activities, including escalation
requirements in the event of risk metric breaches. The footnote would
also state that the Risk Tolerance Statements are reviewed, revised,
retired, and/or replaced, as the case may be, and approved by the BRC
(as defined herein) annually, based upon the circumstances, and the
reasonable best judgement of management, then existing relating to
model risk management matters. Consistent with proposed terminology
described above with respect to Sections 4.1 and 4.2, the Model Risk
Tolerance Statement and the Market Risk Tolerance Statement would be
referred to collectively in the Executive Summary as the ``Risk
Tolerance Statements.''
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\20\ The Market Risk Tolerance Statement articulates, among
other things, risk tolerance levels covering margin backtests
covering backtest coverage and stress tests covering exposure to
extreme market moves. The conclusion, based on tolerance levels,
focuses on model enhancement or model remediation, as applicable.
\21\ DTCC has identified a set of key risks to better guide the
content, measurement, frequency, and focus of our discussion and
management of risk generally across the Organization.
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The Executive Summary also indicates that the Related Procedures
may be updated or amended. The Clearing Agencies regularly review their
internal policies and procedures, and in addition to updating or
amending them as an administrative matter as they deem appropriate, may
also retire or replace internal policies and procedures as they deem
appropriate. In this regard, the proposed rule change would also
include text to the effect that each of the Related Procedures and the
Model Risk Tolerance Statement may retired or replaced (in addition to
updated or amended).
Effective Date
The proposed rule change would become effective upon approval by
the Commission.
2. Statutory Basis
The Clearing Agencies believe that the Framework is consistent with
Section 17A(b)(3)(F) of the Act,\22\ as well as Rule 17Ad-22
(e)(4)(vii), and (e)(7)(vii) thereunder,\23\ for the reasons described
below.
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\22\ 15 U.S.C. 78q-1(b)(3)(F).
\23\ Supra note 6.
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Section 17A(b)(3)(F) of the Act \24\ requires, inter alia, that the
rules of a clearing agency be designed to assure the safeguarding of
securities and funds which are in the custody or control of the
clearing agency or for which it is responsible. As described above, the
Framework describes the process by which the Clearing Agencies
identify, measure, monitor, and manage the risks associated with the
design, development, implementation, use, and validation of
quantitative models. The quantitative models covered by the Framework
are applied by the Clearing Agencies, as applicable, to evaluate and
address their respective risk exposures associated with their
settlement activity and facilitate their ability to assure the
safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible. In this
regard, the proposed changes to the Framework support their ability to
develop models that are applied to evaluate and address risk exposure
and facilitate the safeguarding of securities and funds which are in
the custody or control of the Clearing Agencies or for which they are
responsible by (i) changing the governance structure for approval of a
Model Validation to transfer the responsibility for approval of model
validations to the MVC, which is composed of individuals with a higher
level of expertise relating to model validations than members of the
MRC, which is currently responsible for such approvals, thereby
enhancing the ability of the group conducting Model Validations to
evaluate risk exposures relating to models, (ii) incorporating the
Model Risk Tolerance Statement into the Framework which describes risk
tolerance levels covering model design and implementation, including
consideration of a model's intended purpose and/or its adequacy of
performance, and therefore including a cross-reference to a document
which describes an important gauge with respect to the level of risk
that may be tolerated as part of managing the risk presented to the
Clearing Agencies relating to models, (iii) clarifying the definition
of Model Owner, therefore
[[Page 22227]]
defining the first line responsible for evaluating risk exposure, (iv)
reflecting changes in the role of the Model Risk Governance Committee
and a change its name, which relates to the change in governance
structure that is designed to enhance the independence in its new role
of responsibility for approval of Model Validations which would support
the Clearing Agencies' ability to evaluate risk exposure, (v)
redefining the first and second line responsibilities and incentives
relating to model performance monitoring and oversight, therefore
enhancing the process by which risk relating to models is evaluated,
and (vi) making other technical and clarifying changes to the text, as
described above, to improve the text in defining roles and
responsibilities for the processes established by the Clearing Agencies
to monitor risk. Therefore, NSCC believes the proposed rule change is
consistent with the requirements of Section 17A(b)(3)(F) of the
Act,\25\ because it would facilitate the ability of the Clearing
Agencies to continue to develop models that are applied to evaluate and
address risk exposure and allow them to maintain a Framework that
facilitates the ability of the Clearing Agencies to assure the
safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible, as
described above.
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\24\ 15 U.S.C. 78q-1(b)(3)(F).
\25\ Id.
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Rule 17Ad-22(e)(4)(vii) \26\ and (e)(7)(vii) \27\ under the Act
requires, inter alia, that a covered clearing agency establish,
implement, maintain and enforce written policies and procedures
reasonably designed to perform Model Validations on its credit risk
models and liquidity risk models not less than annually or more
frequently as may be contemplated by the clearing agency's risk
management framework established pursuant to Rule 17Ad-22(e)(3).\28\ As
discussed above, the proposed rule change would amend the Framework to
provide for enhanced clarity in the text and enhanced efficiency with
respect to the approval process for Model Validations at least
annually. In this regard, and as noted above, pursuant to the
Framework, Model Validations are performed not less than annually on
its credit risk models and liquidity risk models. Therefore, the
Clearing Agencies believe that the proposed changes to the Framework
are consistent with Rule 17Ad-22(e)(4)(vii) \29\ and (e)(7)(vii) \30\
under the Act.
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\26\ 17 CFR 240.17Ad-22(e)(4) (in particular, 17 CFR 240.17Ad-
22(e)(4)(vii)). See supra note 6.
\27\ 17 CFR 240.17Ad-22(e)(7) (in particular, 17 CFR 240.17Ad-
22(e)(7)(vii)). See supra note 6.
\28\ 17 CFR 240.17Ad-22(e)(3). See supra note 6.
\29\ Supra note 6.
\30\ Supra note 6.
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(B) Clearing Agency's Statement on Burden on Competition
None of the Clearing Agencies believe that the Framework would have
any impact, or impose any burden, on competition because the proposed
rule change reflects clarifying changes and provides for a more
efficient internal governance process and would not effectuate any
changes to the Clearing Agencies' model risk management tools as they
currently apply to their respective Members or Participants.
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants, or Others
The Clearing Agencies have not solicited or received any written
comments relating to this proposal. The Clearing Agencies will notify
the Commission of any written comments received by the Clearing
Agencies.
III. Date of Effectiveness of the Proposed Rule Change, and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the 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-NSCC-2020-008 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-NSCC-2020-008. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (https://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of NSCC 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-NSCC-2020-008 and should be submitted on
or before May 12, 2020.
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\31\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\31\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-08378 Filed 4-20-20; 8:45 am]
BILLING CODE 8011-01-P
