Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing of Proposed Rule Change, as Modified by Amendment No. 1, To Introduce the Margin Liquidity Adjustment Charge and Include a Bid-Ask Risk Charge in the VaR Charges, 51503-51510 [2020-18199]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 85, Number 162 (Thursday, August 20, 2020)]
[Notices]
[Pages 51503-51510]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-18199]


=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-89560; File No. SR-FICC-2020-009]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Proposed Rule Change, as Modified by Amendment No. 
1, To Introduce the Margin Liquidity Adjustment Charge and Include a 
Bid-Ask Risk Charge in the VaR Charges

August 14, 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 July 30, 2020, Fixed Income Clearing Corporation (``FICC'') filed 
with the Securities and Exchange Commission (``Commission'') proposed 
rule change SR-FICC-2020-009. On August 13, 2020, FICC filed Amendment 
No. 1 to the proposed rule change, to make clarifications and 
corrections to the proposed rule change.\3\ The proposed rule change, 
as modified by Amendment No. 1 (hereinafter, the ``Proposed Rule 
Change''), is described in Items I, II and III below, which Items have 
been prepared primarily by the clearing agency.\4\ 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.
    \3\ Amendment No. 1 made clarifications and corrections to the 
description of the proposed rule change and Exhibits 3 and 5 of the 
filing, and these clarifications and corrections have been 
incorporated, as appropriate, into the description of the proposed 
rule change in Item II below.
    \4\ On July 30, 2020, FICC filed the proposed rule change as an 
advance notice (SR-FICC-2020-802) with the Commission 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, 12 U.S.C. 5465(e)(1), and Rule 
19b-4(n)(1)(i) under the Act, 17 CFR 240.19b-4(n)(1)(i). On August 
13, 2020, FICC filed Amendment No. 1 to the advance notice to make 
similar clarifications and corrections to the advance notice. A copy 
of the advance notice, as modified by Amendment No. 1 (hereinafter, 
the ``Advance Notice'') is available at https://www.dtcc.com/legal/sec-rule-filings.aspx.
---------------------------------------------------------------------------

I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The Proposed Rule Change consists of modifications to the FICC 
Government Securities Division (``GSD'') Rulebook (``GSD Rules'') and 
the FICC Mortgage-Backed Securities Division (``MBSD'') Clearing Rules 
(``MBSD Rules,'' and together with the GSD Rules, ``Rules'') to 
introduce the Margin Liquidity Adjustment (``MLA'') charge as an 
additional component of GSD and MBSD's respective Clearing Funds, as 
described in greater detail below.\5\
---------------------------------------------------------------------------

    \5\ Capitalized terms not defined herein are defined in the GSD 
Rules, available at https://www.dtcc.com/~/media/Files/Downloads/
legal/rules/ficc_gov_rules.pdf, and the MBSD Rules, available at 
www.dtcc.com/~/media/Files/Downloads/legal/rules/
ficc_mbsd_rules.pdf.
---------------------------------------------------------------------------

    This Proposed Rule Change also consists of modifications to the GSD 
Rules, the MBSD Rules, the GSD Methodology Document--GSD Initial Market 
Risk Margin Model (``GSD QRM Methodology Document'') and the MBSD 
Methodology and Model Operations Document--MBSD Quantitative Risk Model 
(``MBSD QRM Methodology Document,'' and together with the GSD QRM 
Methodology Document, the ``QRM Methodology Documents'') in order to 
(i) enhance the calculation of the VaR Charges of GSD and MBSD to 
include a bid-ask spread risk charge, and (ii) make necessary technical 
changes to the QRM Methodology Documents in order to implement this 
proposed change.

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
    FICC is proposing to enhance the methodology for calculating 
Required Fund Deposits to the respective Clearing Funds of GSD and MBSD 
by (1) introducing a new component, the MLA charge, which would be 
calculated to address the risk presented to FICC when a Member's 
portfolio contains large net unsettled positions in a particular group 
of securities with a similar risk profile or in a particular 
transaction type (referred to as ``asset groups''),\6\ and (2) 
enhancing the calculation of the VaR Charges of GSD and MBSD by 
including a bid-ask spread risk charge, as described in more detail 
below.\7\
---------------------------------------------------------------------------

    \6\ References herein to ``Members'' refer to GSD Netting 
Members and MBSD Clearing Members, as such terms are defined in the 
Rules. References herein to ``net unsettled positions'' refer to, 
with respect to GSD, Net Unsettled Positions, as such term is 
defined in GSD Rule 1 (Definitions) and, with respect to MBSD, 
refers to the net positions that have not yet settled. Supra note 4.
    \7\ The results of a study of the potential impact of adopting 
the proposed changes have been provided to the Commission.
---------------------------------------------------------------------------

    FICC is also proposing to make certain technical changes to the QRM 
Methodology Documents, as described in below, in order to implement the 
proposed enhancement to the VaR Charges.
(i) Overview of the Required Fund Deposits and the Clearing Funds
    As part of its market risk management strategy, FICC manages its 
credit

[[Page 51504]]

exposure to Members by determining the appropriate Required Fund 
Deposits to the GSD and MBSD Clearing Fund and monitoring their 
sufficiency, as provided for in the Rules.\8\ The Required Fund 
Deposits serve as each Member's margin. The objective of a Member's 
Required Fund Deposit is to mitigate potential losses to FICC 
associated with liquidating a Member's portfolio in the event FICC 
ceases to act for that Member (hereinafter referred to as a 
``default'').\9\ The aggregate of all Members' Required Fund Deposits 
constitutes the respective GSD and MBSD Clearing Funds. FICC would 
access the GSD and MBSD Clearing Funds should a defaulting Member's own 
Required Fund Deposit be insufficient to satisfy losses to FICC caused 
by the liquidation of that Member's portfolio.
---------------------------------------------------------------------------

    \8\ See GSD Rule 4 (Clearing Fund and Loss Allocation) and MBSD 
Rule 4 (Clearing Fund Formula and Loss Allocation), supra note 4. 
FICC's market risk management strategy is designed to comply with 
Rule 17Ad-22(e)(4) under the Act, where these risks are referred to 
as ``credit risks.'' 17 CFR 240.17Ad-22(e)(4).
    \9\ The Rules identify when FICC may cease to act for a Member 
and the types of actions FICC may take. For example, FICC may 
suspend a firm's membership with FICC or prohibit or limit a 
Member's access to FICC's services in the event that Member defaults 
on a financial or other obligation to FICC. See GSD Rule 21 
(Restrictions on Access to Services), and MBSD Rule 14 (Restrictions 
on Access to Services), of the Rules, supra note 4.
---------------------------------------------------------------------------

    Pursuant to the Rules, each Member's Required Fund Deposit amount 
consists of a number of applicable components, each of which is 
calculated to address specific risks faced by FICC, as identified 
within the Rules.\10\ The VaR Charge comprises the largest portion of a 
Member's Required Fund Deposit amount. Currently, the GSD QRM 
Methodology Document states that the total VaR Charge for each 
portfolio is the sum of the sensitivity VaR of the portfolio plus the 
haircut charges plus the repo interest volatility charges plus the 
pool/TBA basis charge. In the MBSD QRM Methodology Document, the 
current description of the total VaR Charge states that it is the sum 
of the designated VaR Charge and the haircut charge.
---------------------------------------------------------------------------

    \10\ Supra note 4.
---------------------------------------------------------------------------

    The VaR Charge is calculated using a risk-based margin methodology 
that is intended to capture the risks related to market price that is 
associated with the securities in a Member's portfolio. This risk-based 
margin methodology is designed to project the potential losses that 
could occur in connection with the liquidation of a defaulting Member's 
portfolio, assuming a portfolio would take three days to liquidate in 
normal market conditions. The projected liquidation gains or losses are 
used to determine the amount of the VaR Charge, which is calculated to 
cover projected liquidation losses at 99 percent confidence level for 
Members.\11\
---------------------------------------------------------------------------

    \11\ Unregistered Investment Pool Clearing Members are subject 
to a VaR Charge with a minimum target confidence level assumption of 
99.5 percent. See MBSD Rule 4, Section 2(c), supra note 4.
---------------------------------------------------------------------------

    FICC regularly assesses market and liquidity risks as such risks 
relate to its margining methodologies to evaluate whether margin levels 
are commensurate with the particular risk attributes of each relevant 
product, portfolio, and market. The proposed changes to include the MLA 
charge to its Clearing Fund methodology and to enhance the VaR Charges 
by including a bid-ask spread risk charge, as described below, are the 
result of FICC's regular review of the effectiveness of its margining 
methodology.
(ii) Overview of Liquidation Transaction Costs and Proposed Changes
    Each of the proposed changes addresses a similar, but separate, 
risk that FICC faces increased transaction costs when it liquidates the 
net unsettled positions of a defaulted Member due to the unique 
characteristics of that Member's portfolio. The transaction costs to 
FICC to liquidate a defaulted Member's portfolio include both market 
impact costs and fixed costs. Market impact costs are the costs due to 
the marketability of a security, and generally increase when a 
portfolio contains large net unsettled positions in a particular group 
of securities with a similar risk profile or in a particular 
transaction type, as described more below. Fixed costs are the costs 
that generally do not fluctuate and may be caused by the bid-ask spread 
of a particular security. The bid-ask spread of a security accounts for 
the difference between the observed market price that a buyer is 
willing to pay for that security and the observed market price that a 
seller is willing to sell that security.
    The transaction cost to liquidate a defaulted Member's portfolio is 
currently captured by the measurement of market risk through the 
calculation of the VaR Charge.\12\ The proposed changes would 
supplement and enhance the current measurement of this market risk to 
address situations where the characteristics of the defaulted Member's 
portfolio could cause these costs to be higher than the amount 
collected for the VaR Charge.
---------------------------------------------------------------------------

    \12\ The calculation of the VaR Charge is described in GSD Rule 
1 (Definitions) and MBSD Rules 1 (Definitions). Supra note 4.
---------------------------------------------------------------------------

    First, as described in more detail below, the MLA charge is 
designed to address the market impact costs of liquidating a defaulted 
Member's portfolio that may increase when that portfolio includes large 
net unsettled positions in a particular group of securities with a 
similar risk profile or in a particular transaction type. These 
positions may be more difficult to liquidate because a large number of 
securities with similar risk profiles could reduce the marketability of 
those large net unsettled positions, increasing the market impact costs 
to FICC. As described below, the MLA charge would supplement the VaR 
Charge.
    Second, as described in more detail below, the bid-ask spread risk 
charge would address the risk that the transaction costs of liquidating 
a defaulted Member's net unsettled positions may increase due to the 
fixed costs related to the bid-ask spread. As described below, this 
proposed change would be incorporated into, and, thereby, enhance the 
current measure of transaction costs through, the VaR Charge.
(iii) Proposed Margin Liquidity Adjustment Charge
    In order to address the risks of increased market impact costs 
presented by portfolios that contain large net unsettled positions in 
the same asset group, FICC is proposing to introduce a new component to 
the GSD and MBSD Clearing Fund formulas, the MLA charge.
    As noted above, a Member portfolio with large net unsettled 
positions in a particular group of securities with a similar risk 
profile or in a particular transaction type may be more difficult to 
liquidate in the market in the event the Member defaults because a 
concentration in that group of securities or in a transaction type 
could reduce the marketability of those large net unsettled positions. 
Therefore, such portfolios create a risk that FICC may face increased 
market impact cost to liquidate that portfolio in the assumed margin 
period of risk of three business days at market prices.
    The proposed MLA charge would be calculated to address this 
increased market impact cost by assessing sufficient margin to mitigate 
this risk. As described below, the proposed MLA charge would be 
calculated for different asset groups. Essentially, the calculation is 
designed to compare the total market value of a net unsettled position 
in a particular asset group, which FICC would be required to liquidate 
in the

[[Page 51505]]

event of a Member default, to the available trading volume of that 
asset group or equities subgroup in the market.\13\ If the market value 
of the net unsettled position is large, as compared to the available 
trading volume of that asset group, then there is an increased risk 
that FICC would face additional market impact costs in liquidating that 
position in the event of a Member default. Therefore, the proposed 
calculation would provide FICC with a measurement of the possible 
increased market impact cost that FICC could face when it liquidates a 
large net unsettled position in a particular asset group.
---------------------------------------------------------------------------

    \13\ FICC would determine average daily trading volume by 
reviewing data that is made publicly available by the Securities 
Industry and Financial Markets Association (``SIFMA''), at https://www.sifma.org/resources/archive/research/statistics.
---------------------------------------------------------------------------

    To calculate the MLA charge, FICC would categorize securities into 
separate asset groups. For GSD, asset groups would include the 
following, each of which have similar risk profiles: (a) U.S. Treasury 
securities, which would be further categorized by maturity--those 
maturing in (i) less than one year, (ii) equal to or more than one year 
and less than two years, (iii) equal to or more than two years and less 
than five years, (iv) equal to or more than five years and less than 
ten years, and (v) equal to or more than ten years; (b) Treasury-
Inflation Protected Securities (``TIPS''), which would be further 
categorized by maturity--those maturing in (i) less than two years, 
(ii) equal to or more than two years and less than six years, (iii) 
equal to or more than six years and less than eleven years, and (iv) 
equal to or more than eleven years; (c) U.S. agency bonds; and (d) 
mortgage pools transactions. For MBSD, to-be-announced (``TBA'') 
transactions, Specified Pool Trades and Stipulated Trades would be 
included in one mortgage-backed securities asset group.
    FICC would first calculate a measurement of market impact cost with 
respect to the net unsettled positions of a Member in each of these 
asset groups. As described above, the calculation of an MLA charge is 
designed to measure the potential additional market impact cost to FICC 
of closing out a large net unsettled position in that particular asset 
group.
    To determine the market impact cost for each net unsettled position 
in Treasuries maturing less than one year and TIPS for GSD and in the 
mortgage-backed securities asset group for MBSD, FICC would use the 
directional market impact cost, which is a function of the net 
unsettled position's net directional market value.\14\ To determine the 
market impact cost for all other net unsettled positions, FICC would 
add together two components: (1) The directional market impact cost, as 
described above, and (2) the basis cost, which is based on the net 
unsettled position's gross market value.\15\
---------------------------------------------------------------------------

    \14\ The net directional market value of an asset group within a 
portfolio is calculated as the absolute difference between the 
market value of the long net unsettled positions in that asset 
group, and the market value of the short net unsettled positions in 
that asset group. For example, if the market value of the long net 
unsettled positions is $100,000, and the market value of the short 
net unsettled positions is $150,000, the net directional market 
value of the asset group is $50,000.
    \15\ To determine the gross market value of the net unsettled 
positions in each asset group, FICC would sum the absolute value of 
each CUSIP in the asset group.
---------------------------------------------------------------------------

    The calculation of market impact cost for net unsettled positions 
in Treasuries maturing less than one year and TIPS for GSD and in the 
mortgage-backed securities asset group for MBSD would not include basis 
cost because basis risk is negligible for these types of positions.
    For all asset groups, when determining the market impact costs, the 
net directional market value and the gross market value of the net 
unsettled positions would be divided by the average daily volumes of 
the securities in that asset group over a lookback period.\16\
---------------------------------------------------------------------------

    \16\ Supra note 12.
---------------------------------------------------------------------------

    FICC would then compare the calculated market impact cost to a 
portion of the VaR Charge that is allocated to net unsettled positions 
in those asset groups.\17\ If the ratio of the calculated market impact 
cost to the 1-day VaR Charge is greater than a threshold, an MLA charge 
would be applied to that asset group.\18\ If the ratio of these two 
amounts is equal to or less than this threshold, an MLA charge would 
not be applied to that asset group. The threshold would be based on an 
estimate of the market impact cost that is incorporated into the 
calculation of the 1-day VaR charge, such that an MLA charge would 
apply only when the calculated market impact cost exceeds this 
threshold.
---------------------------------------------------------------------------

    \17\ FICC's margining methodology uses a three-day assumed 
period of risk. For purposes of this calculation, FICC would use a 
portion of the VaR Charge that is based on one-day assumed period of 
risk and calculated by applying a simple square-root of time 
scaling, referred to in this Proposed Rule Change as ``1-day VaR 
Charge.'' Any changes that FICC deems appropriate to this assumed 
period of risk would be subject to FICC's model risk management 
governance procedures set forth in the Clearing Agency Model Risk 
Management Framework (``Model Risk Management Framework''). See 
Securities Exchange Act Release Nos. 81485 (August 25, 2017), 82 FR 
41433 (August 31, 2017) (File No. SR-FICC-2017-014); 84458 (October 
19, 2018), 83 FR 53925 (October 25, 2018) (File No. SR-FICC-2018-
010); 88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-
FICC-2020-004).
    \18\ FICC would review the method for calculating the thresholds 
from time to time and any changes that FICC deems appropriate would 
be subject to FICC's model risk management governance procedures set 
forth in the Model Risk Management Framework. See id.
---------------------------------------------------------------------------

    When applicable, an MLA charge for each asset group would be 
calculated as a proportion of the product of (1) the amount by which 
the ratio of the calculated market impact cost to the applicable 1-day 
VaR charge exceeds the threshold, and (2) the 1-day VaR charge 
allocated to that asset group.
    For each Member portfolio, FICC would add the MLA charges for net 
unsettled positions in each asset group to determine a total MLA charge 
for a Member.
    The ratio of the calculated market impact cost to the 1-day VaR 
Charge would also determine if FICC would apply a downward adjustment, 
based on a scaling factor, to the total MLA charge, and the size of any 
adjustment. For net unsettled positions that have a higher ratio of 
calculated market impact cost to the 1-day VaR Charge, FICC would apply 
a larger adjustment to the MLA charge by assuming that it would 
liquidate that position on a different timeframe than the assumed 
margin period of risk of three business days. For example, FICC may be 
able to mitigate potential losses associated with liquidating a 
Member's portfolio by liquidating a net unsettled position with a 
larger VaR Charge over a longer timeframe. Therefore, when applicable, 
FICC would apply a multiplier to the calculated MLA charge. When the 
ratio of calculated market impact cost to the 1-day VaR Charge is 
lower, the multiplier would be one, and no adjustment would be applied; 
as the ratio gets higher the multiplier decreases and the MLA charge is 
adjusted downward.
    The final MLA charge would be calculated daily and, when the charge 
is applicable, as described above, would be included as a component of 
Members' Required Fund Deposit.
MLA Excess Amount for GSD Sponsored Members
    For GSD, the calculation of the MLA charge for a Sponsored Member 
that clears through single account sponsored by a Sponsoring Member 
would be the same as described above. For a GSD Sponsored Member that 
clears through multiple accounts sponsored by multiple Sponsoring 
Members, in addition to calculating an MLA charge for each account (as 
described above), FICC would also calculate an MLA charge for the 
consolidated portfolio.

[[Page 51506]]

    If the MLA charge of the consolidated portfolio is higher than the 
sum of all MLA charges for each account of the Sponsored Member, the 
Sponsored Member would be charged the amount of such difference, to be 
referred to as the ``MLA Excess Amount,'' in addition to the applicable 
MLA charge. If the MLA charge of the consolidated portfolio is not 
higher than the sum of all MLA charges for each account of the 
Sponsored Member, then the Sponsored Member will only be charged an MLA 
charge for each sponsored account, as applicable.
    The MLA Excess Amount is designed to capture the additional market 
impact cost that could be incurred when a Sponsored Member defaults, 
and each of the Sponsoring Members liquidates net unsettled positions 
associated with that defaulted Sponsored Member. If large net unsettled 
positions in the same asset group are being liquidated by multiple 
Sponsoring Members, the market impact cost to liquidate those positions 
could increase. The MLA Excess Amount would address this additional 
market impact cost by capturing any difference between the calculations 
of the MLA charge for each sponsored account and for the consolidated 
portfolio.
Proposed Changes to GSD and MBSD Rules
    The proposal described above would be implemented into the GSD 
Rules and MBSD Rules. Specifically, FICC would amend GSD Rule 1 
(Definitions) and MBSD Rule 1 (Definitions) to include a description of 
the MLA charge.
    The proposed change to GSD Rule 1 (Definitions) would first 
identify each of the asset groups and would then separately describe 
the two calculations of market impact cost by these asset groups by 
identifying the components of these calculations. The proposed 
definition would state that GSD would compare the calculated market 
impact cost to a portion of that Member's VaR Charge, to determine if 
an MLA charge would be applied to an asset group. The proposed 
definition would then state that GSD would add each of the applicable 
MLA charges calculated for each asset group together. Finally, the 
proposed definition would state that GSD may apply a downward adjusting 
scaling factor to result in a final MLA charge. The proposed change to 
GSD Rule 1 (Definitions) would also include a definition of the ``MLA 
Excess Amount.'' The proposed definition would state that it would be 
an additional charge applicable to Sponsored Members that clear through 
multiple accounts sponsored by multiple Sponsoring Members and would 
describe how the additional charge would be determined.
    The proposed change to MBSD Rule 1 (Definitions) would define the 
MBS asset group, for purposes of calculating this charge, and would 
then describe the calculation of market impact cost for that asst group 
by identifying the components of this calculation. The proposed 
definition would state that MBSD would compare the calculated market 
impact cost to a portion of the Member's VaR Charge, to determine if an 
MLA charge would be applied to a net unsettled position. Finally, the 
proposed definition would state that MBSD may apply a downward 
adjusting scaling factor to result in a final MLA charge.
    FICC would also amend GSD Rule 4 (Clearing Fund and Loss 
Allocation) and MBSD Rule 4 (Clearing Fund and Loss Allocation) to 
include the MLA charge as a component of the Clearing Fund formula.
(iv) Proposed Bid-Ask Spread Risk Charge
    FICC has identified potential risk that its margining methodologies 
do not account for the transaction costs related to bid-ask spread in 
the market that could be incurred when liquidating a portfolio. Bid-ask 
spreads account for the difference between the observed market price 
that a buyer is willing to pay for a security and the observed market 
price that a seller is willing to sell that security. Therefore, FICC 
is proposing to amend the VaR models of GSD and MBSD to include a bid-
ask spread risk charge in the VaR Charges of GSD and MBSD to address 
this risk.
    In order to calculate this charge, GSD would segment Members' 
portfolios into separate bid-ask spread risk classes by product type 
and maturity. The bid-ask spread risk classes would be separated into 
the following types: (a) Mortgage pools (``MBS''); (b) TIPS; (c) U.S. 
agency bonds; and (d) U.S. Treasury securities, which would be further 
segmented into separate classes based on maturities as follows: (i) 
Less than five years, (ii) equal to or more than five years and less 
than ten years, and (iii) equal to or more than ten years. FICC would 
further segment the U.S. Treasury securities into separate classes 
based on maturities.
    Only the MBS asset group is applicable to MBSD Member portfolios. 
FICC would exclude Option Contracts in to-be-announced (``TBA'') 
transactions from the bid-ask spread risk charge because, in the event 
of a Member default, FICC would liquidate any Option Contracts in TBAs 
in a Member's portfolio at the intrinsic value of the Option Contract 
and, therefore, does not face a transaction cost related to the bid-ask 
spread.
    Each product type and maturity risk class would be assigned a 
specific bid-ask spread haircut rate in the form of a basis point 
charge that would be applied to the gross market value in that 
particular risk class. The applicable bid-ask spread risk charge would 
be the product of the gross market value in a particular risk class in 
the Member's portfolio and the applicable basis point charge. The bid-
ask spread risk charge would be calculated at the portfolio level, such 
that FICC would aggregate the bid-ask spread risk charges of the 
applicable risk classes for the Member's portfolio.
    FICC proposes to review the haircut rates annually based on either 
the analysis of liquidation transaction costs related to the bid-ask 
spread that is conducted in connection with its annual simulation of a 
Member default or market data that is sourced from a third-party data 
vendor. Based on the analyses from recent years' simulation exercises, 
FICC does not anticipate that these haircut rates would change 
significantly year over year. FICC may also adjust the haircut rates 
following its annual model validation review, to the extent the results 
of that review indicate the current haircut rates are not adequate to 
address the risk presented by transaction costs from a bid-ask 
spread.\19\
---------------------------------------------------------------------------

    \19\ All proposed changes to the haircuts would be subject to 
FICC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See id.
---------------------------------------------------------------------------

    The proposed initial haircuts are based on the analysis from the 
most recent annual default simulation and market data sourced from a 
third-party data vendor, and are listed in the table below:

----------------------------------------------------------------------------------------------------------------
                                                                                                        Haircut
                  Class                             Asset class                    Maturity              (bps)
----------------------------------------------------------------------------------------------------------------
MBS......................................  MBS.........................  All........................         0.8

[[Page 51507]]

 
TIPS.....................................  TIPS........................  All........................         2.1
Agency...................................  Agency bonds................  All........................         3.8
Treasury 5-..............................  Treasury....................  < 5 years..................         0.6
Treasury 5-10............................  Treasury....................  5-10 years.................         0.7
Treasury 10+.............................  Treasury....................  >10 years..................         0.7
----------------------------------------------------------------------------------------------------------------

Proposed Changes to GSD and MBSD Rules
    The proposal described above would be implemented into the GSD 
Rules and MBSD Rules. Specifically, FICC would include a description of 
the bid-ask spread risk charge in the current definitions of the VaR 
Charge in GSD Rule 1 (Definitions) and MBSD Rule 1 (Definitions). The 
proposed change would state that the calculations the VaR Charge shall 
include an additional bid-ask spread risk charge measured by 
multiplying the gross market value of each net unsettled position by a 
basis point charge. The proposed change would also state that the basis 
point charge would be based on six risk classes and would identify 
those risk classes.
Proposed Changes to QRM Methodology Documents
    To implement this proposal, FICC is proposing to amend the QRM 
Methodology Documents to describe the bid-ask spread risk charge. 
Specifically, FICC would describe (i) that the bid-ask spread risk 
charge is designed to mitigate the risk related to transaction costs in 
liquidating a portfolio in the event of a Member default; (ii) how the 
bid-ask spread risk charge would be calculated; and (ii) the impact 
analysis that was conducted in each of the QRM Methodology Documents. 
The GSD QRM Methodology Document would describe the proposed six 
classes (listed in the table above). The MBSD QRM Methodology Document 
would state that the only class for MBSD portfolios is the MBS asset 
class, and that the Option Contracts in TBAs would be excluded from the 
proposed charge. Finally, FICC would update the descriptions of the 
total VaR Charge in the QRM Methodology Documents to include the bid-
ask spread risk charge as a component of this charge.
(v) Proposed Technical Changes
    Finally, FICC would amend the QRM Methodology Documents to re-
number the sections and tables, and update certain section titles, as 
necessary, to add a new section that describes the proposed bid-ask 
spread risk charge.
(vi) Implementation Timeframe
    FICC would implement the proposed changes no later than 10 Business 
Days after the later of the approval of the Proposed Rule Change and no 
objection to the related advance notice \20\ by the Commission. FICC 
would announce the effective date of the proposed changes by Important 
Notice posted to its website.
---------------------------------------------------------------------------

    \20\ Supra note 3.
---------------------------------------------------------------------------

2. Statutory Basis
    FICC believes that the proposed changes are consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a registered clearing agency. In particular, FICC 
believes the proposed changes are consistent with Section 17A(b)(3)(F) 
of the Act,\21\ and Rules 17Ad-22(e)(4)(i) and (e)(6)(i), each 
promulgated under the Act,\22\ for the reasons described below.
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78q-1(b)(3)(F).
    \22\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i).
---------------------------------------------------------------------------

    Section 17A(b)(3)(F) of the Act requires that the rules of FICC be 
designed to, among other things, assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency or 
for which it is responsible.\23\ FICC believes the proposed change to 
implement the MLA charge is designed to assure the safeguarding of 
securities and funds which are in its custody or control or for which 
it is responsible because it is designed to address the market impact 
costs to FICC of liquidating a Member's portfolio in the event of that 
Member's default. Specifically, the proposed MLA charge would allow 
FICC to collect sufficient financial resources to cover its exposure 
that it may face increased market impact costs in liquidating net 
unsettled positions in a particular group of securities with a similar 
risk profile or in a particular transaction type that are not captured 
by the VaR Charge. Additionally, as described above, the proposed MLA 
Excess Amount is designed to capture any additional market impact cost 
that could be incurred when each of the Sponsoring Members liquidates 
large net unsettled positions in securities of the same asset group 
that are all associated with one defaulted Sponsored Member.
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    The Clearing Fund is a key tool that FICC uses to mitigate 
potential losses to FICC associated with liquidating a Member's 
portfolio in the event of Member default. Therefore, the proposed 
change to include the MLA charge among the Clearing Fund components, 
when applicable, would enable FICC to better address the increased 
market impact costs of liquidating net unsettled positions in a 
particular group of securities with a similar risk profile or in a 
particular transaction type, such that, in the event of Member default, 
FICC's operations would not be disrupted and non-defaulting Members 
would not be exposed to losses they cannot anticipate or control. In 
this way, the Proposed Rule Change to implement the MLA charge is 
designed to assure the safeguarding of securities and funds which are 
in the custody or control of FICC or for which it is responsible, 
consistent with Section 17A(b)(3)(F) of the Act.\24\
---------------------------------------------------------------------------

    \24\ Id.
---------------------------------------------------------------------------

    Additionally, FICC believes that the proposed change to amend the 
VaR model of each of GSD and MBSD to include bid-ask spread risk charge 
within Members' final VaR Charge would be designed to assure the 
safeguarding of securities and funds that are in the custody or control 
of FICC or for which it is responsible because the proposed change 
would enable FICC to better limit its exposure to increased transaction 
costs due to the bid-ask spread in the market when liquidating the a 
defaulted Member's portfolio. FICC believes that including the above-
described bid-ask spread risk charge within the VaR Charges would 
better ensure that FICC calculates and collects sufficient margin and, 
thereby, better enable FICC to limit its exposure to these transaction 
costs. By enabling FICC to limit its exposure to Members in this way, 
the proposed change is designed to better ensure that, in the event of 
a Member Default, FICC would have adequate margin from the defaulting 
Member and non-defaulting Members would not be exposed to losses they 
cannot anticipate or control.

[[Page 51508]]

In this way, the proposed change to include the bid-ask spread risk 
charge within the calculation of the final VaR Charges of GSD and MBSD 
would be designed to assure the safeguarding of securities and funds 
which are in the custody or control of FICC or for which it is 
responsible and therefore consistent with Section 17A(b)(3)(F) of the 
Act.\25\
---------------------------------------------------------------------------

    \25\ Id.
---------------------------------------------------------------------------

    FICC believes that the proposed technical changes described above 
are designed to assure the safeguarding of securities and funds which 
are in the custody and control of the clearing agency or for which it 
is responsible, consistent with Section 17A(b)(3)(F) the Act.\26\ FICC 
believes the proposed technical changes would also enhance the clarity 
of the QRM Methodology Documents for FICC. Having clear and accurate 
methodology documents, which describe how the bid-ask spread risk 
charge would be calculated and that such bid-ask spread risk charge is 
included within the calculation of the final VaR Charges of GSD and 
MBSD, would help to ensure that FICC continues to accurately calculate 
and assess margin and in turn, collect sufficient margin from its 
Members and better enable FICC to limit its exposures to the risks 
related to increased transaction costs due to the bid-ask spread in the 
market that could be incurred when liquidating a portfolio. By better 
enabling FICC to limit its exposure to Member's in this way, the 
proposed change is designed to better ensure that, in the event of a 
Member default, FICC would have adequate margin from the defaulting 
Member and non-defaulting Members would not be exposed to losses they 
cannot anticipate or control. In this way, the proposed technical 
changes to the QRM Methodology Documents would be designed to assure 
the safeguarding of securities and funds which are in the custody or 
control of FICC or for which it is responsible and therefore consistent 
with Section 17A(b)(3)(F) of the Act.\27\
---------------------------------------------------------------------------

    \26\ Id.
    \27\ Id.
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(4)(i) under the Act requires, in part, that FICC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes, including 
by maintaining sufficient financial resources to cover its credit 
exposure to each participant fully with a high degree of 
confidence.\28\
---------------------------------------------------------------------------

    \28\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    As described above, FICC believes that both of the proposed changes 
would enable it to better identify, measure, monitor, and, through the 
collection of Members' Required Fund Deposits, manage its credit 
exposures to Members by maintaining sufficient resources to cover those 
credit exposures fully with a high degree of confidence.
    Specifically, FICC believes that the proposed MLA charge would 
effectively mitigate the risks related to large net unsettled positions 
of securities in the same asset group within a portfolio and would 
address the potential increased risks FICC may face related to its 
ability to liquidate such positions in the event of a Member default. 
The proposed MLA Excess Amount would supplement this proposed charge to 
capture any additional market impact cost related to Sponsored Members 
that clear through multiple accounts with multiple Sponsoring Members.
    Therefore, FICC believes that the proposal would enhance FICC's 
ability to effectively identify, measure and monitor its credit 
exposures and would enhance its ability to maintain sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence. As such, FICC believes the 
proposed changes are consistent with Rule 17Ad-22(e)(4)(i) under the 
Act.\29\
---------------------------------------------------------------------------

    \29\ Id.
---------------------------------------------------------------------------

    Additionally, FICC believes that the proposed bid-ask spread risk 
charge would enhance FICC's ability to identify, measure, monitor and 
manage its credit exposures to Members and those exposures arising from 
its payment, clearing, and settlement processes because the proposed 
changes would better ensure that FICC maintains sufficient financial 
resources to cover its credit exposure to each Member with a high 
degree of confidence. FICC believes that the proposed change would 
enable FICC to more effectively identify, measure, monitor and manage 
its exposures to risks related to market price, and enable it to better 
limit its exposure to potential losses from Member defaults by 
providing a more effective measure of the risks related to market 
price. As described above, due to the bid-ask spread in the market, 
there is an observable transaction cost to liquidate a portfolio. The 
proposed bid-ask spread risk charge is designed to manage the risk 
related to this transaction cost in the event a Member's portfolio is 
liquidated. As such, FICC believes that the proposed change would 
better address the potential risks that FICC may face that are related 
to its ability liquidate a Member's net unsettled positions in the 
event of that firm's default, and thereby enhance FICC's ability to 
effectively identify, measure and monitor its credit exposures and 
would enhance its ability to maintain sufficient financial resources to 
cover its credit exposure to each participant fully with a high degree 
of confidence. In this way, FICC believes this proposed change is also 
consistent with Rule 17Ad-22(e)(4)(i) under the Act.\30\
---------------------------------------------------------------------------

    \30\ Id.
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(6)(i) under the Act requires, in part, that FICC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market.\31\
---------------------------------------------------------------------------

    \31\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    The Required Fund Deposits are made up of risk-based components (as 
margin) that are calculated and assessed daily to limit FICC's credit 
exposures to Members, including the VaR Charges. FICC's proposed change 
to introduce an MLA charge is designed to more effectively address the 
risks presented by large net unsettled positions in the same asset 
group. FICC believes the addition of the MLA charge would enable FICC 
to assess a more appropriate level of margin that accounts for these 
risks. This proposed change is designed to assist FICC in maintaining a 
risk-based margin system that considers, and produces margin levels 
commensurate with, the risks and particular attributes of portfolios 
that contain large net unsettled positions in the same asset group and 
may be more difficult to liquidate in the event of a Member default. 
The proposed MLA Excess Amount would further this goal by measuring any 
additional risks that could be presented by a Sponsored Member that 
clears through multiple accounts at multiple Sponsoring Members. 
Therefore, FICC believes the proposed change is consistent with Rule 
17Ad-22(e)(6)(i) under the Act.\32\
---------------------------------------------------------------------------

    \32\ Id.
---------------------------------------------------------------------------

    Furthermore, FICC believes that including the bid-ask spread risk 
charge within the calculation of the final VaR Charges of GSD and MBSD 
would provide FICC with a better assessment of its risks related to 
market price. This proposed change would enable FICC to assess a more 
appropriate level of margin that accounts for this risk at the

[[Page 51509]]

portfolio level. As such, each Member portfolio would be subject to a 
risk-based margining system that, at minimum, considers, and produces 
margin levels commensurate with, the risks and particular attributes of 
each relevant product, portfolio, and market, consistent with Rule 
17Ad-22(e)(6)(i) under the Act.\33\
---------------------------------------------------------------------------

    \33\ Id.
---------------------------------------------------------------------------

(B) Clearing Agency's Statement on Burden on Competition

    FICC believes that the proposed changes could have an impact on 
competition. Specifically, FICC believes the proposed changes could 
burden competition because they would result in larger Required Fund 
Deposit amounts for Members when the additional charges are applicable 
and result in a Required Fund Deposit that is greater than the amount 
calculated pursuant to the current formula.
    When the proposal results in a larger Required Fund Deposit, the 
proposed change could burden competition for Members that have lower 
operating margins or higher costs of capital compared to other Members. 
However, the increase in Required Fund Deposit would be in direct 
relation to the specific risks presented by each Member's net unsettled 
positions, and each Member's Required Fund Deposit would continue to be 
calculated with the same parameters and at the same confidence level 
for each Member. Therefore, Members that present similar net unsettled 
positions, regardless of the type of Member, would have similar impacts 
on their Required Fund Deposit amounts. As such FICC believes that any 
burden on competition imposed by the proposed changes would not be 
significant and, further, would be both necessary and appropriate in 
furtherance of FICC's efforts to mitigate risks and meet the 
requirements of the Act, as described in this filing and further below.
    FICC believes the above described burden on competition that may be 
created by the proposed MLA charge and the bid-ask spread risk charge 
would be necessary in furtherance of the Act, specifically Section 
17A(b)(3)(F) of the Act.\34\ As stated above, the proposed MLA charge 
is designed to address the market impact costs to FICC of liquidating a 
Member's portfolio in the event of that Member's default. Specifically, 
the proposed MLA charge would allow FICC to collect sufficient 
financial resources to cover its exposure that it may face increased 
market impact costs in liquidating net unsettled positions that are not 
captured by the VaR Charge. Additionally, as described above, the 
proposed MLA Excess Amount is designed to capture any additional market 
impact cost that could be incurred when each of the Sponsoring Members 
liquidates large net unsettled positions in securities of the same 
asset group that are all associated with one defaulted Sponsored 
Member. Likewise, the proposed bid-ask spread risk charge is designed 
to help limit FICC's exposures to the increased transaction costs due 
to the bid-ask spread in the market that could be incurred when 
liquidating a Member's portfolio in the event of a Member default. 
Therefore, FICC believes this proposed change is consistent with the 
requirements of Section 17A(b)(3)(F) of the Act, which requires that 
the Rules be designed to assure the safeguarding of securities and 
funds that are in FICC's custody or control or which it is 
responsible.\35\
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78q-1(b)(3)(F).
    \35\ Id.
---------------------------------------------------------------------------

    FICC believes these proposed changes would also support FICC's 
compliance with Rules 17Ad-22(e)(4)(i) and Rule 17Ad-22(e)(6)(i) under 
the Act, which require FICC to establish, implement, maintain and 
enforce written policies and procedures reasonably designed to (x) 
effectively identify, measure, monitor, and manage its credit exposures 
to participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence; and (y) cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market.\36\
---------------------------------------------------------------------------

    \36\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i).
---------------------------------------------------------------------------

    As described above, FICC believes the introduction of the MLA 
charge would allow FICC to employ a risk-based methodology that would 
address the increased market impact costs that FICC could face when 
liquidating net unsettled positions in a particular group of securities 
with a similar risk profile or in a particular transaction type. The 
proposed MLA Excess Amount would supplement this proposed charge to 
capture any additional market impact cost related to Sponsored Members 
that clear through multiple accounts with multiple Sponsoring Members. 
Similarly, the proposed change to include the bid-ask spread risk 
charge within the calculation of the VaR Charge would allow FICC to 
employ a risk-based methodology that would better measure the 
transaction costs that could be incurred in liquidating a defaulted 
Member's portfolio. Therefore, the proposed changes would better limit 
FICC's credit exposures to Members, consistent with the requirements of 
Rules 17Ad-22(e)(4)(i) and Rule 17Ad-22(e)(6)(i) under the Act.\37\
---------------------------------------------------------------------------

    \37\ Id.
---------------------------------------------------------------------------

    FICC believes that the above described burden on competition that 
could be created by the proposed changes would be appropriate in 
furtherance of the Act because such changes have been appropriately 
designed to assure the safeguarding of securities and funds which are 
in the custody or control of FICC or for which it is responsible, as 
described in detail above. The proposed MLA charge and the proposed 
bid-ask spread risk charge would also enable FICC to produce margin 
levels more commensurate with the risks and particular attributes of 
each Member's portfolio.
    The proposed MLA charge and the MLA Excess Amount would do this by 
measuring the increased market impact costs that FICC may face when 
liquidating a defaulted Member's portfolio that includes net unsettled 
positions in a particular group of securities with a similar risk 
profile or in a particular transaction type. With respect to the 
proposed bid-ask spread risk charge, a haircut (in the form of a basis 
point charge that would be applied to the gross market value) would be 
applied to separate risk classes in the portfolio. As described above, 
for purposes of calculating this charge, the portfolio would be 
segmented into separate risk classes, by asset group and maturity, and 
a haircut would be applied to the gross market value of each group. 
Therefore, because the proposed changes are designed to provide FICC 
with an appropriate measure of the risks (i.e., risks related to both 
market impact costs and transaction costs) presented by Members' 
portfolios, FICC believes the proposal is appropriately designed to 
meet its risk management goals and its regulatory obligations.
    FICC believes that it has designed the proposed changes in an 
appropriate way in order to meet compliance with its obligations under 
the Act. Specifically, the proposals would improve the risk-based 
margining methodology that FICC employs to set margin requirements and 
better limit FICC's credit exposures to its Members. Therefore, as 
described above, FICC believes the proposed changes are necessary and 
appropriate

[[Page 51510]]

in furtherance of FICC's obligations under the Act, specifically 
Section 17A(b)(3)(F) of the Act \38\ and Rules 17Ad-22(e)(4)(i) and 
Rule 17Ad-22(e)(6)(i) under the Act.\39\
---------------------------------------------------------------------------

    \38\ 15 U.S.C. 78q-1(b)(3)(F).
    \39\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i).
---------------------------------------------------------------------------

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
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.

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.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

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-FICC-2020-009 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-FICC-2020-009. 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 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-2020-009 and should be submitted on 
or before September 10, 2020.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\40\
J. Matthew DeLesDernier,
Assistant Secretary.


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

    \40\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

[FR Doc. 2020-18199 Filed 8-19-20; 8:45 am]
BILLING CODE 8011-01-P