Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing of Amendment No. 2 and Notice of No Objection to Advance Notice, as Modified by Amendment Nos. 1 and 2, To Introduce the Margin Liquidity Adjustment Charge and Include a Bid-Ask Risk Charge in the VaR Charge, 62342-62348 [2020-21785]
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Federal Register / Vol. 85, No. 192 / Friday, October 2, 2020 / Notices
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549, on official
business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of the
filing also will be available for
inspection and copying at the principal
office of the Exchange. All comments
received will be posted without change.
Persons submitting comments are
cautioned that we do not redact or edit
personal identifying information from
comment submissions. You should
submit only information that you wish
to make available publicly. All
submissions should refer to File
Number SR–MEMX–2020–09 and should
be submitted on or before October 23,
2020.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.20
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020–21768 Filed 10–1–20; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–90034; File No. SR–NSCC–
2020–804]
Self-Regulatory Organizations;
National Securities Clearing
Corporation; Notice of Filing of
Amendment No. 2 and Notice of No
Objection to Advance Notice, as
Modified by Amendment Nos. 1 and 2,
To Introduce the Margin Liquidity
Adjustment Charge and Include a BidAsk Risk Charge in the VaR Charge
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September 28, 2020.
On July 30, 2020, National Securities
Clearing Corporation (‘‘NSCC’’) filed
with the Securities and Exchange
Commission (‘‘Commission’’) advance
notice SR–NSCC–2020–804 pursuant to
Section 806(e)(1) of Title VIII of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled
Payment, Clearing and Settlement
20 17
CFR 200.30–3(a)(12).
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Supervision Act of 2010 (‘‘Clearing
Supervision Act’’),1 and Rule 19b–
4(n)(1)(i) 2 under the Securities
Exchange Act of 1934 (‘‘Exchange
Act’’) 3 to add two new charges to
NSCC’s margin methodology. On
August 13, 2020, NSCC filed
Amendment No. 1 to the advance
notice, to make clarifications and
corrections to the advance notice.4 The
advance notice, as modified by
Amendment No. 1, was published for
public comment in the Federal Register
on September 4, 2020,5 and the
Commission has received no comments
regarding the changes proposed in the
advance notice as modified by
Amendment No. 1. On September 10,
2020, the Commission received one
comment letter on NSCC’s related
Proposed Rule Change.6 To the extent
that the comment letter on the Proposed
Rule Change is relevant to the Advance
Notice, it is discussed below.7 On
August 27, 2020, NSCC filed
Amendment No. 2 to the advance notice
to provide additional data for the
Commission to consider in analyzing
the advance notice.8 The advance
1 12
U.S.C. 5465(e)(1).
CFR 240.19b–4(n)(1)(i).
3 15 U.S.C. 78a et seq.
4 Amendment No. 1 made clarifications and
corrections to the description of the advance notice
and Exhibits 3 and 5 of the filing.
5 Securities Exchange Act Release No. 89719
(September 1, 2020), 85 FR 55332 (September 4,
2020) (File No. SR–NSCC–2020–804) (‘‘Notice of
Filing’’). On July 30, 2020, NSCC also filed a related
proposed rule change (SR–NSCC–2020–016) with
the Commission pursuant to Section 19(b)(1) of the
Exchange Act and Rule 19b–4 thereunder. On
August 13, 2020, NSCC filed Amendment No. 1 to
the proposed rule change to make similar
clarifications and corrections to the proposed rule
change. See 15 U.S.C. 78s(b)(1) and 17 CFR
240.19b–4 respectively. The proposed rule change,
as amended by Amendment No. 1, was published
in the Federal Register on August 20, 2020.
Securities Exchange Act Release No. 89558 (August
14, 2020), 85 FR 51521 (August 20, 2020). On
August 27, 2020, NSCC filed Amendment No. 2 to
the proposed rule change to provide similar
additional data for the Commission’s consideration.
The proposed rule change, as amended by
Amendment Nos. 1 and 2, is hereinafter referred to
as the ‘‘Proposed Rule Change.’’ In the Proposed
Rule Change, NSCC seeks approval of proposed
changes to its rules necessary to implement the
Advance Notice. The comment period for the
related Proposed Rule Change filing closed on
September 10, 2020, and the Commission received
no comments.
6 See letter from Cass Sanford, Associated General
Counsel, OTC Markets Group (September 10, 2020)
(‘‘OTC Letter’’), available at https://www.sec.gov/
comments/sr-nscc-2020-016/srnscc20200167757533-223234.pdf.
7 As the proposals contained in the Advance
Notice were also filed as a proposed rule change,
all public comments received on the proposal are
considered regardless of whether the comments are
submitted on the Proposed Rule Change or the
Advance Notice.
8 In Amendment No. 2, NSCC updated Exhibit 3
to the advance notice to include impact analysis
2 17
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notice, as modified by Amendment Nos.
1 and 2, is hereinafter referred to as the
‘‘Advance Notice.’’ The Commission is
publishing this notice to solicit
comments on Amendment No. 2 from
interested persons and, for the reasons
discussed below, is hereby providing
notice of no objection to the Advance
Notice.
I. The Advance Notice
First, the proposals in the Advance
Notice would revise NSCC’s Rules and
Procedures (‘‘Rules’’) 9 to introduce the
Margin Liquidity Adjustment Charge
(‘‘MLA Charge’’) as an additional margin
component. Second, the proposals in
the Advance Notice would revise the
Rules to add a bid-ask spread risk
charge (‘‘Bid-Ask Spread Charge’’) to
NSCC’s margin calculations.
A. Background
NSCC provides central counterparty
(‘‘CCP’’) services, including clearing,
settlement, risk management, and a
guarantee of completion for virtually all
broker-to-broker trades involving equity
securities, corporate and municipal debt
securities, and certain other securities.
In its role as a CCP, a key tool that NSCC
uses to manage its credit exposure to its
members by determining and collecting
an appropriate Required Fund Deposit
(i.e., margin) for each member.10 The
aggregate of all members’ Required
Fund Deposits (together with certain
other deposits required under the Rules)
constitutes NSCC’s Clearing Fund,
which NSCC would access should a
defaulted member’s own Required Fund
Deposit be insufficient to satisfy losses
to NSCC caused by the liquidation of
that member’s portfolio.11
Each member’s Required Fund
Deposit consists of a number of
applicable components, which are
calculated to address specific risks that
the member’s portfolio presents to
NSCC.12 Generally, the largest
component of a member’s Required
Fund Deposit is the volatility charge,
which is intended to capture the risks
related to the movement of market
prices associated with the securities in
a member’s portfolio.13 NSCC’s
methodology for calculating the
data with respect to the proposals in the advance
notice. NSCC filed Exhibit 3 as a confidential
exhibit to the advance notice pursuant to 17 CFR
240.24b–2.
9 Capitalized terms not defined herein are defined
in the Rules, available at https://dtcc.com/∼/media/
Files/Downloads/legal/rules/nscc_rules.pdf.
10 See Rule 4 (Clearing Fund) and Procedure XV
(Clearing Fund Formula and Other Matters) of the
Rules (‘‘Procedure XV’’), supra note 8.
11 See id.
12 See id.
13 See id.
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volatility charge of the Required Fund
Deposit depends on the type of security.
For most securities, (e.g., equity
securities), NSCC calculates the
volatility charge as the greater of (1) the
larger of two separate calculations that
utilize a parametric Value at Risk
(‘‘VaR’’) model, (2) a gap risk measure
calculation based on the largest nonindex position in a portfolio that
exceeds a concentration threshold,
which addresses concentration risk that
the largest non-index position can
present within a member’s portfolio,
and (3) a portfolio margin floor
calculation based on the market values
of the long and short positions in the
portfolio, which addresses risks that
might not be adequately addressed with
the other volatility charge
calculations.14 For certain other
securities (e.g., corporate and municipal
bonds), NSCC’s Rules apply a haircutbased volatility charge that is calculated
by multiplying the absolute value of the
positions by a percentage.15 The
volatility charge is designed to calculate
the potential losses on a portfolio over
a three-day period of risk assumed
necessary to liquidate the portfolio,
within a 99 percent confidence level.16
NSCC states that it regularly assesses
market and liquidity risks as such risks
relate to its margin methodology to
evaluate whether margin levels are
commensurate with the particular risk
attributes of each relevant product,
portfolio, and market.17 NSCC states
that the proposed MLA Charge and BidAsk Spread Charge are necessary for
NSCC to effectively account for risks
associated with certain types and
attributes of member portfolios.18
B. Margin Liquidity Adjustment Charge
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NSCC’s current margin methodology
does not account for the risk of a
potential increase in market impact
costs that NSCC could incur when
liquidating a defaulted member’s
portfolio that contains a concentration
of large positions, as compared to the
overall market, in a particular security
or group of securities sharing a similar
risk profile.19 In a member default,
liquidating such large positions within
14 See id.; see also Securities Exchange Act
Release No. 82780 (February 26, 2018), 83 FR 9035
(March 2, 2018) (File No. SR–NSCC–2017–808);
Securities Exchange Act Release No. 82781
(February 26, 2018), 83 FR 9042 (March 2, 2018)
(File No. SR–NSCC–2017–020).
15 See id.
16 See Notice of Filing, supra note 5 at 55332, 34.
17 See Notice of Filing, supra note 5 at 55333.
18 See id.
19 See id.
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a potentially compressed timeframe 20
(i.e., in a fire sale) could have an impact
on the underlying market, resulting in
price moves that increases NSCC’s risk
of incurring additional liquidation costs.
Therefore, NSCC designed the MLA
Charge to address this specific risk.21
The MLA Charge would be based on
comparing the market value of member
portfolio positions in specified asset
groups 22 to the available trading
volume of those asset groups. If the
market value of a member’s positions in
a certain asset group is large in
comparison to the available trading
volume of that asset group,23 then it is
more likely that NSCC would have to
manage reduced marketability and
increased liquidation costs for those
positions during a member default
scenario. Specifically, NSCC’s margin
methodology assumes for each asset
group that a certain share of the market
can be liquidated without price
impact.24 Aggregate positions in an asset
group which exceed this share are
generally considered as large and would
therefore incur application of the MLA
Charge to anticipate and address those
increased costs.
For each position in a market
capitalization subgroup of the equities
asset group, NSCC would calculate the
market impact cost by multiplying four
components: (1) An impact cost
coefficient that is a multiple of the oneday market volatility of that subgroup
and is designed to measure impact
costs, (2) the gross market value of the
position in that subgroup, (3) the square
root of the gross market value of the
position in that subgroup in the
portfolio divided by an assumed
percentage of the average daily trading
volume of that subgroup, and (4) a
20 NSCC’s risk models assume the liquidation
occurs over a period of three business days. See
Notice of Filing, supra note 5 at 55333–34.
21 See Notice of Filing, supra note 5 at 55333.
22 The specified asset groups would include (1)
equities (excluding equities defined as Illiquid
Securities pursuant to the Rules), (2) Illiquid
Securities, (3) unit investment trusts, or UITs, (4)
municipal bonds (including municipal bond
exchange-traded products, or ‘‘ETPs’’), and (5)
corporate bonds (including corporate bond ETPs).
NSCC would then further segment the equities asset
group into the following subgroups: (i) Microcapitalization equities, (ii) small capitalization
equities, (iii) medium capitalization equities, (iv)
large capitalization equities, (v) treasury ETPs, and
(vi) all other ETPs. See id.
23 NSCC states that it 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. See id.
24 NSCC would establish the particular share for
each asset group or subgroup based on empirical
research which includes the simulation of asset
liquidation over different time horizons. See Notice
of Filing, supra note 5 at 55333–34.
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62343
measurement of the relative weight of
the position in that subgroup of the
portfolio. With respect to the fourth
component, NSCC states that this
measurement would include aggregating
the weight of each CUSIP in that
position relative to the weight of that
CUSIP in the subgroup, such that a
portfolio with fewer positions in a
subgroup would have a higher measure
of concentration for that subgroup.25
For each position in the municipal
bond, corporate bond, Illiquid Securities
and UIT asset groups, and for positions
in the treasury ETP and other ETP
subgroups of the equities asset group,
NSCC would calculate the market
impact cost by multiplying three
components: (1) An impact cost
coefficient that is a multiple of the oneday market volatility of that asset group
or subgroup, (2) the gross market value
of the position in that asset group or
subgroup, and (3) the square root of the
gross market value of the position in
that asset group or subgroup in the
portfolio divided by an assumed
percentage of the average daily trading
volume of that subgroup.26
For each asset group or subgroup,
NSCC would compare the calculated
market impact cost to a portion of the
volatility charge that is allocated to
positions in that asset group or
subgroup.27 If the ratio of the calculated
market impact cost to the applicable
one-day volatility charge is greater than
a threshold, NSCC would apply an MLA
Charge to that asset group or
subgroup.28 If the ratio of these two
25 NSCC would calculate the relative weight by
dividing the absolute market value of a single
CUSIP in the member’s portfolio by the total
absolute market value of that portfolio. See Notice
of Filing, supra note 5 at 55334.
26 See supra note 22.
27 For purposes of this calculation, NSCC would
use a portion of the applicable volatility charge that
is based on a one-day assumed period of risk and
calculated by applying a simple square-root of time
scaling, referred to in this advance notice as ‘‘oneday volatility charge.’’ See Notice of Filing, supra
note 5 at 55334. Any changes that NSCC deems
appropriate to this assumed period of risk would be
subject to NSCC’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–NSCC–2017–008); 84458 (October 19,
2018), 83 FR 53925 (October 25, 2018) (File No. SR–
NSCC–2018–009); 88911 (May 20, 2020), 85 FR
31828 (May 27, 2020) (File No. SR–NSCC–2020–
008).
28 NSCC would set the initial threshold at 0.4,
because approximately 40 percent of the one-day
volatility charge currently addresses market impact
costs. NSCC would review this threshold from time
to time and any changes that NSCC deems
appropriate would be subject to NSCC’s model risk
management governance procedures set forth in the
Model Risk Management Framework. See id.
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amounts is equal to or less than this
threshold, NSCC would not apply an
MLA Charge to that asset group or
subgroup. The threshold would be
based on an estimate of the market
impact cost that is incorporated into the
calculation of the applicable one-day
volatility charge, such that NSCC would
only apply an MLA Charge when the
calculated market impact cost exceeds
this threshold.
When applicable, an MLA Charge for
each asset group or subgroup 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 one-day volatility
charge exceeds the threshold, and (2)
the one-day volatility charge allocated
to that asset group or subgroup.
For each portfolio, NSCC would total
the MLA Charges for positions in each
of the subgroups of the equities asset
group to determine an MLA Charge for
the positions in the equities asset group.
NSCC would then total the MLA Charge
for positions in the equities asset group
together with each of the MLA Charges
for positions in the other asset groups to
determine a total MLA Charge for a
member.
In certain circumstances, NSCC may
be able to partially mitigate the risks
that the MLA Charge is designed to
address by extending the time period for
liquidating a defaulted member’s
portfolio beyond the three day period.
Accordingly, the Advance Notice also
describes a method that NSCC would
use to reduce a member’s total MLA
Charge when the volatility charge
component of the member’s margin
increases beyond a specified point.
Specifically, NSCC would reduce the
member’s MLA Charge where the
market impact cost of a particular
portfolio, calculated as part of
determining the MLA Charge, would be
large relative to the one-day volatility
charge for that portfolio (i.e., a portion
of the three-day assumed margin period
of risk). When the ratio of calculated
market impact cost to the one-day
volatility charge is lower, NSCC would
not adjust the MLA Charge. However, as
the ratio gets higher, NSCC would
reduce the MLA Charge. NSCC designed
this reduction mechanism to avoid
assessing unnecessarily large MLA
Charges.29
On a daily basis, NSCC would
calculate the final MLA Charge for each
member (if applicable), to be included
as a component of each member’s
Required Fund Deposit.
Finally, NSCC would amend the
Rules to add the MLA Charge to the list
29 See
Notice of Filing, supra note 5 at 55334.
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of Clearing Fund components that are
excluded from the calculation of the
Excess Capital Premium charge.30 The
Excess Capital Premium is imposed on
a member when the member’s Required
Fund Deposit exceeds its excess net
capital. NSCC states that including the
MLA Charge in the calculation of the
Excess Capital Premium could lead to
more frequent and unnecessary Excess
Capital Premium charges, which is not
the intended purpose of the Excess
Capital Premium charge and could place
an unnecessary burden on members.31
C. Bid-Ask Spread Charge
The bid-ask spread refers to the
difference between the observed market
price that a buyer is willing to pay for
a security and the observed market price
at which a seller is willing to sell that
security. NSCC faces the risk of
potential bid-ask spread transaction
costs when liquidating the securities in
a defaulted member’s portfolio.
However, NSCC’s current margin
methodology does not account for this
risk of potential bid-ask spread
transaction costs to NSCC in connection
with liquidating a defaulted member’s
portfolio. Therefore, NSCC designed the
Bid-Ask Spread Charge to address this
deficiency in its current margin
methodologies.
The Bid-Ask Spread Charge would be
haircut-based and tailored to different
groups of assets that share similar bidask spread characteristics. NSCC would
assign each asset group a specified bidask spread haircut rate (measured in
basis points (‘‘bps’’)) that would be
applied to the gross market value of the
portfolio’s positions in that particular
asset group. NSCC would calculate the
product of the gross market value of the
portfolio’s positions in a particular asset
group and the applicable basis point
charge to obtain the bid-ask spread risk
charge for these positions. NSCC would
total the applicable bid-ask spread risk
charges for each asset class in a
member’s portfolio to calculate the
member’s final Bid-Ask Spread Charge.
NSCC determined the proposed initial
haircut rates on an analysis of bid-ask
spread transaction costs using (1) the
results of NSCC’s annual member
default simulation and (2) market data
sourced from a third-party data vendor.
NSCC’s proposed initial haircut rates
are listed in the table below:
30 See Section I.(B)(2) of Procedure XV, supra
note 8.
31 See Notice of Filing, supra note 5 at 55335.
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Asset group
Large and medium capitalization
equities ......................................
Small capitalization equities .........
Micro-capitalization equities .........
ETPs .............................................
Haircut
(bps)
5.0
12.3
23.1
1.5
NSCC proposes to review the haircut
rates annually.32 Based on analyses of
recent years’ simulation exercises,
NSCC does not anticipate that these
haircut rates would change significantly
year over year.33 NSCC 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.34
II. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the advance notice is
consistent with the Clearing
Supervision Act. Comments may be
submitted by any of the following
methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
NSCC–2020–804 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–2020–804. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the advance notice that
are filed with the Commission, and all
written communications relating to the
advance notice between the
Commission and any person, other than
32 See
id.
id.
34 All proposed changes to the haircuts would be
subject to NSCC’s model risk management
governance procedures set forth in the Model Risk
Management Framework. See supra note 26.
33 See
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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 such
filings will also be available for
inspection and copying at the principal
office of NSCC and NSCC’s website at
https://www.dtcc.com/legal.
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–2020–804
and should be submitted on or before
October 19, 2020.
Act and Section 17A of the Exchange
Act (the ‘‘Clearing Agency Rules’’).39
The Clearing Agency Rules require,
among other things, each covered
clearing agency to establish, implement,
maintain, and enforce written policies
and procedures that are reasonably
designed to meet certain minimum
requirements for its operations and risk
management practices on an ongoing
basis.40 As such, it is appropriate for the
Commission to review advance notices
against the Clearing Agency Rules and
the objectives and principles of these
risk management standards as described
in Section 805(b) of the Clearing
Supervision Act. As discussed below,
the Commission believes the proposal in
the Advance Notice is consistent with
the objectives and principles described
in Section 805(b) of the Clearing
Supervision Act,41 and in the Clearing
Agency Rules, in particular Rules
17Ad–22(e)(4) and (e)(6).42
III. Discussion and Commission
Findings
A. Consistency With Section 805(b) of
the Clearing Supervision Act
The Commission believes that the
Advance Notice is consistent with the
stated objectives and principles of
Section 805(b) of the Clearing
Supervision Act. 43
The Commission believes that
adopting NSCC’s proposed MLA Charge
and Bid-Ask Spread Charge would be
consistent with the promotion of robust
risk management at NSCC. As described
above in Section I.A and B, NSCC’s
current margin methodology does not
account for the potential increase in
Although the Clearing Supervision
Act does not specify a standard of
review for an advance notice, the stated
purpose of the Clearing Supervision Act
is instructive: To mitigate systemic risk
in the financial system and promote
financial stability by, among other
things, promoting uniform risk
management standards for SIFMUs and
strengthening the liquidity of SIFMUs.35
Section 805(a)(2) of the Clearing
Supervision Act authorizes the
Commission to prescribe regulations
containing risk management standards
for the payment, clearing, and
settlement activities of designated
clearing entities engaged in designated
activities for which the Commission is
the supervisory agency.36 Section 805(b)
of the Clearing Supervision Act
provides the following objectives and
principles for the Commission’s risk
management standards prescribed under
Section 805(a):37
• to promote robust risk management;
• to promote safety and soundness;
• to reduce systemic risks; and
• to support the stability of the
broader financial system.
Section 805(c) provides, in addition,
that the Commission’s risk management
standards may address such areas as
risk management and default policies
and procedures, among others areas.38
The Commission has adopted risk
management standards under Section
805(a)(2) of the Clearing Supervision
35 See
12 U.S.C. 5461(b).
U.S.C. 5464(a)(2).
37 12 U.S.C. 5464(b).
38 12 U.S.C. 5464(c).
36 12
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39 17 CFR 240.17Ad–22. See Securities Exchange
Act Release No. 68080 (October 22, 2012), 77 FR
66220 (November 2, 2012) (S7–08–11). See also
Securities Exchange Act Release No. 78961
(September 28, 2016), 81 FR 70786 (October 13,
2016) (S7–03–14) (‘‘Covered Clearing Agency
Standards’’). NSCC is a ‘‘covered clearing agency’’
as defined in Rule 17Ad–22(a)(5).
40 17 CFR 240.17Ad–22.
41 12 U.S.C. 5464(b).
42 17 CFR 240.17Ad–22(e)(4) and (e)(6).
43 One of the issues raised by the OTC Letter is
directed at the Proposed Rule Change, will be
addressed in that context. Specifically, OTC
Markets Group argues that the proposal imposes an
undue burden on competition, stating that the
proposal would impose additional margin
requirements for firms processing transactions in
smaller and less liquid securities and
disproportionately impact member firms with lower
operating margins or higher costs of capital. That
issue is relevant to the Commission’s evaluation of
the related Proposed Rule Change, which is
conducted under the Exchange Act, but not to the
Commission’s evaluation of the Advance Notice,
which, as discussed below in Section III.B, is
conducted under the Clearing Supervision Act and
generally considers whether the proposal will
mitigate systemic risk and promote financial
stability. Accordingly, concerns regarding burden
on competition are not discussed herein but will be
addressed in the Commission’s review of the related
Proposed Rule Change, as applicable, under the
Exchange Act.
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market impact costs that NSCC could
incur when liquidating a defaulted
member’s portfolio where the portfolio
contains a concentration of large
positions in a particular security or
group of securities sharing a similar risk
profile. Additionally, as described above
in Section I.C, NSCC’s margin
methodology does not account for the
risk of potential bid-ask spread
transaction costs when liquidating the
securities in a defaulted member’s
portfolio. NSCC proposes to address
these respective risks by adding the
MLA Charge and Bid-Ask Spread
Charge to its margin methodology.44
Specifically, the MLA Charge should
better enable NSCC to manage the risk
of incurring costs associated with the
decreased marketability of a defaulted
member’s portfolio where the portfolio
contains a large position in securities
sharing similar risk profiles, resulting in
potentially higher liquidation costs. To
avoid excessive MLA Charges, NSCC
has identified circumstances that would
warrant reducing a member’s MLA
Charge when NSCC could otherwise
partially mitigate the relevant risks by
extending the time period for
liquidating a defaulted member’s
portfolio beyond the three day period.
The Commission views this targeted
reduction in the MLA Charge as a
feature of the proposal that
demonstrates a robust approach towards
managing the relevant risks through
appropriate (i.e., not simply ‘‘larger’’)
margin requirements. Additionally,
since NSCC’s current margin
methodology does not account for bidask spread transaction costs when
liquidating a defaulted member’s
portfolio, the Bid-Ask Spread Charge
should enable NSCC to manage such
risks. Accordingly, the Commission
believes that adopting the proposed
MLA Charge and Bid-Ask Spread
Charge would allow for measurement
and targeted mitigation of risks and
costs not captured elsewhere in NSCC’s
current margin methodology, and would
therefore provide for more
comprehensive management of risks in
a member default scenario, consistent
with the promotion of robust risk
management.
The commenter argues that NSCC’s
Advance Notice fails to provide
sufficient information to evaluate the
necessity and impact of the proposal.
Specifically, the commenter argues that
the proposal provides no explanation as
to why the current Clearing Fund
44 The Commission notes that the other clearing
agencies it regulates have charges to account for
these types of risks in their margin methodologies,
and that addressing these types of risks has received
a great deal of industry focus in recent years.
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formula is inadequate or how the
proposed methodology would limit
NSCC’s exposure in the event of a
member default. The Commission
disagrees. As described in the Notice
and noted above, NSCC’s current margin
methodology does not account for the
risk of a potential increase in market
impact costs that NSCC could incur
when liquidating a defaulted member’s
portfolio that contains a concentration
of large positions, as compared to the
overall market and account for this risk
of potential bid-ask spread transaction
costs in connection with liquidating a
defaulted member’s portfolio. As a
result, NSCC’s Advance Notice is
designed to address these specific risks,
that are currently unaddressed, and thus
limit NSCC’s exposure.
Furthermore, when considering the
issues raised in the Advance Notice, the
Commission thoroughly considered (1)
NSCC’s Advance Notice, including the
supporting exhibits that provided,
among other things, confidential impact
analyses regarding the proposals in
NSCC’s Advance Notice; 45 (2) the OTC
Letter; and (3) the Commission’s own
understanding of NSCC’s margin
methodology, with which the
Commission has experience from its
general supervision of NSCC. Based on
its review of these materials, the
Commission believes that, as set forth in
the Notice of Filing, NSCC has done
exactly what the commenter seeks, in
that the proposal explains why the
current methodology is inadequate (i.e.,
it does not address these particular
risks), and how the proposed
methodology would address this issue
(i.e., by including add-on charges
calibrated to address these particular
risks).46 Thus, notwithstanding the
comments raised in the OTC Letter, the
Commission believes that adopting the
proposed MLA Charge and Bid-Ask
Spread Charge would be consistent with
45 Specifically, the confidential Exhibit 3
submitted by NSCC includes, among other things,
(1) impact studies for various time periods detailing
the average and maximum MLA and Bid-Ask
Charges for each member, by both percentage and
amount, (2) a detailed methodology describing the
calculation of the MLA and Bid-Ask Charges, and
(3) information regarding how NSCC determined
the appropriate methodology.
46 Moreover, to the extent that the commenter
argues that additional detail or information is
necessary to enable the public to evaluate the
proposal, the Commission disagrees. With respect
to the MLA Charge, the Notice of Filing explains
that concentrated positions would lead to
application of the MLA Charge and provides
sufficient information as to the components that
would be used to make the determination of
concentration to allow a Member to consider
whether the MLA Charge would apply. With
respect to the Bid-Ask Spread Charge, the Notice of
Filing identifies the particular haircuts that would
apply to all securities.
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the promotion of robust risk
management at NSCC.
Further, the Commission believes that
adopting NSCC’s proposed MLA Charge
and Bid-Ask Spread Charge would be
consistent with promoting safety and
soundness at NSCC. NSCC designed the
MLA Charge and Bid-Ask Spread
Charge to ensure that NSCC collects
margin amounts sufficient to manage
NSCC’s risk of incurring costs
associated with liquidating defaulted
member portfolios. The proposed MLA
Charge and Bid-Ask Spread Charge
would generally provide NSCC with
additional resources to manage potential
losses arising out of a member default.
Such an increase in available financial
resources would decrease the likelihood
that losses arising out of a member
default would exceed NSCC’s resources
and threaten the safety and soundness
of NSCC’s ongoing operations.
Accordingly, the Commission believes
that adding the proposed MLA Charge
and Bid-Ask Spread Charge to NSCC’s
margin methodology would be
consistent with promoting safety and
soundness at NSCC.
Finally, the Commission believes that
adopting NSCC’s proposed MLA Charge
and Bid-Ask Spread Charge would be
consistent with reducing systemic risks
and supporting the stability of the
broader financial system. As discussed
above, in a member default scenario,
NSCC would access its Clearing Fund
should the defaulted member’s own
Required Fund Deposit be insufficient
to satisfy losses to NSCC caused by the
liquidation of that member’s portfolio.
NSCC proposes to add the MLA Charge
and Bid-Ask Spread Charge to its
margin methodology to better manage
the potential costs of liquidating a
defaulted member’s portfolio. NSCC
proposes to collect additional margin to
cover such costs. This, in turn, could
reduce the possibility that NSCC would
need to mutualize among the nondefaulting members a loss arising out of
the close-out process. Reducing the
potential for loss mutualization could,
in turn, reduce the potential knock-on
effects to non-defaulting members, their
customers, and the broader market
arising out of a member default. Further,
the Commission notes that, to the extent
that the MLA Charge results in any
reduction in members’ large positions in
securities with similar risk profiles, it
could reduce the potential risk of
adverse market impacts that can arise
from liquidating those large positions.
However, the Commission also notes
that the proposal to reduce the MLA
Charge when NSCC could otherwise
partially mitigate the relevant risks
would help ensure that NSCC would not
PO 00000
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Fmt 4703
Sfmt 4703
impose the MLA Charge without an
appropriate risk management basis.
Accordingly, the Commission believes
that NSCC’s adoption of the proposed
MLA Charge and Bid-Ask Spread
Charge would be consistent with the
reduction of systemic risk and
supporting the stability of the broader
financial system.
For the reasons stated above, the
Commission believes the changes
proposed in the Advance Notice are
consistent with Section 805(b) of the
Clearing Supervision Act.47
B. Consistency With Rule 17Ad–
22(e)(4)(i)
Rule 17Ad–22(e)(4)(i) requires that
NSCC establish, implement, maintain
and enforce written policies and
procedures reasonably designed to
effectively identify, measure, monitor,
and manage its credit exposures to
participants and those arising from its
payment, clearing, and settlement
processes, including by maintaining
sufficient financial resources to cover its
credit exposure to each participant fully
with a high degree of confidence.48
As described above in Section I.A and
B, NSCC’s current margin methodology
does not account for the risk of a
potential increase in market impact
costs that NSCC could incur when
liquidating a defaulted member’s
portfolio where the portfolio contains a
large position in securities sharing
similar risk profiles. Additionally, as
described above, NSCC’s current margin
methodology does not account for the
risk of potential bid-ask spread
transaction costs when liquidating the
securities in a defaulted member’s
portfolio. NSCC proposes to address
such risks by adding the MLA Charge
and Bid-Ask Spread Charge to its
margin methodology. Adding these
margin charges to NSCC’s margin
methodology should better enable NSCC
to collect margin amounts
commensurate with the risk attributes of
a broader range of its members’
portfolios than NSCC’s current margin
methodology. Specifically, the MLA
Charge should better enable NSCC to
manage the risk of increased costs to
NSCC associated with the decreased
marketability of a defaulted member’s
portfolio where the portfolio contains a
large position in securities sharing
similar risk profiles. Additionally, since
NSCC’s current margin methodology
does not account for bid-ask spread
transaction costs associated with
liquidating a defaulted member’s
portfolio, the Bid-Ask Spread Charge
47 12
48 17
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CFR 240.17Ad–22(e)(4)(i).
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should enable NSCC to manage such
risks and costs.
The commenter suggests that the
proposals in NSCC’s Advance Notice are
duplicative of a separate NSCC proposal
regarding Illiquid Securities that is
currently pending before the
Commission.49 The commenter argues
that since both proposals include
provisions that would apply to Illiquid
Securities,50 thereby potentially
affecting their margin levels, both
proposals appear to address the same
concerns. Therefore, the commenter
suggests that instead of approving
NSCC’s Advance Notice, the
Commission should consolidate NSCC’s
Advance Notice together with the
Illiquid Securities Proposal and extend
the public comment period before the
Commission makes a substantive
determination.
The Commission disagrees with the
comments raised in the OTC Letter.
NSCC’s Advance Notice and the Illiquid
Securities Proposal deal with separate
and distinguishable aspects of NSCC’s
margin methodology, even if there is a
group of Illiquid Securities to which
both proposals would apply. The
Illiquid Securities Proposal is designed
to amend the method by which NSCC
determines the appropriate volatility
component of margin for a particular
thinly traded security, i.e., calculate
appropriate margin to cover potential
losses on a portfolio using historical,
mid-point securities prices. The
Advance Notice is designed to address
two specific risks that are not captured
directly by historical mid-point security
price movements and that are directed
at additional costs that may arise during
the liquidation of a Member’s portfolio
in the event of a default: (1) The
potential added costs of liquidating
large concentrated positions in a limited
period of time and (2) bid-ask spread
transactions costs.
Specifically, the Illiquid Securities
Proposal seeks to, among other things,
more accurately identify securities that
exhibit illiquid characteristics for
margin purposes and to establish a
separate haircut-based method for
determining the margin for Illiquid
Securities. NSCC’s methodology for
calculating the volatility component of
a member’s margin depends on the type
of securities in the member’s portfolio.
Generally, for most securities (e.g.,
49 Securities Exchange Act Release No. 88615
(April 9, 2020), 85 FR 21037 (April 15, 2020) (SR–
NSCC–2020–802) (‘‘Illiquid Securities Proposal’’).
50 Under NSCC’s Rules, Illiquid Securities may
include any security that meets the criteria set forth
in the term’s definition and would not necessarily
be limited to securities with small or micro market
capitalizations.
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19:38 Oct 01, 2020
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equity securities), NSCC calculates the
volatility component using, among other
things, a parametric Value at Risk
(‘‘VaR’’) model, and the volatility
component typically constitutes the
largest portion of a member’s required
margin. However, securities with
illiquid characteristics generally incur a
wider degree of price variability and are
less amenable to statistical analysis,
and, as such, may merit a more
conservative margining approach
through a haircut-based method. The
proposed haircut-based method is more
conservative because it does not allow
for inter-asset risk offsetting in the way
that the VaR model does.
Accordingly, for certain securities that
are less amenable to the statistical
analysis provided in the VaR model,
including Illiquid Securities, NSCC
currently calculates a haircut-based
volatility component by multiplying the
absolute value of a member’s positions
in such securities by a certain
percentage. NSCC’s pending Illiquid
Securities Proposal would, among other
things, establish a separate haircutbased method for determining the
volatility component of the margin for
Illiquid Securities. Thus, the Illiquid
Securities Proposal would alter the way
in which NSCC determines the
appropriate margin for Illiquid
Securities.
In contrast, NSCC’s Advance Notice is
not designed to identify which
securities exhibit illiquid
characteristics, and it would not alter
the methodology by which NSCC
determines the volatility component of
the margin for any particular securities,
including Illiquid Securities. Instead,
with respect to the MLA Charge, NSCC’s
Advance Notice relates to a new margin
charge add-on that, if triggered, applies
to all securities cleared at NSCC (i.e.,
not solely to Illiquid Securities), and the
proposed add-on is distinct from the
underlying margin otherwise collected
for all securities (including Illiquid
Securities). Rather than addressing the
volatility component of margin and the
potential losses on a portfolio, as does
the Illiquid Securities Proposal, the
proposal described in the Advance
Notice is designed to address the
discrete risks of a default liquidation
scenario. These discrete risks include
those associated with (1) concentrated
large positions in any type of security or
group of securities sharing a similar risk
profile, and (2) bid-ask spread
transaction costs that are currently
unaccounted for in NSCC’s margin
methodology. Moreover, the MLA
Charge would not automatically be
applied based on the security or type of
security that is held; instead, it would
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62347
only apply to concentrated positions
that could be difficult to liquidate in a
limited time in the event of a default.
Because NSCC’s Advance Notice and
the Illiquid Securities Proposal address
wholly separate and distinct aspects of
NSCC’s margin methodology, the
Commission disagrees with the OTC
Markets Group that the two proposals
should be consolidated or otherwise
disposed of together.
The Commission believes that adding
the MLA Charge and Bid-Ask Spread
Charge to NSCC’s margin methodology
should enable NSCC to more effectively
identify, measure, monitor, and manage
its credit exposures in connection with
liquidating a defaulted member’s
portfolio that may give rise to (1)
decreased marketability due to large
positions of securities sharing similar
risk profiles, and (2) bid-ask spread
transaction costs. Accordingly, the
Commission believes that adding the
MLA Charge and Bid-Ask Spread
Charge to NSCC’s margin methodology
would be consistent with Rule 17Ad–
22(e)(4)(i) because these new margin
charges should better enable NSCC to
maintain sufficient financial resources
to cover NSCC’s credit exposure to its
members fully with a high degree of
confidence.51
C. Consistency With Rules 17Ad–
22(e)(6)(i) and (v)
Rule 17Ad–22(e)(6)(i) requires that
NSCC establish, implement, maintain
and enforce written policies and
procedures reasonably designed to cover
its credit exposures to its participants by
establishing a risk-based margin system
that, at a minimum, considers, and
produces margin levels commensurate
with, the risks and particular attributes
of each relevant product, portfolio, and
market.52 Rule 17Ad–22(e)(6)(v)
requires that NSCC establish,
implement, maintain and enforce
written policies and procedures
reasonably designed to cover its credit
exposures to its participants by
establishing a risk-based margin system
that, at a minimum, uses an appropriate
method for measuring credit exposure
that accounts for relevant product risk
factors and portfolio effects across
products.53
As described above in Section I.A and
B, NSCC’s current margin methodology
does not account for the potential
increase in market impact costs when
liquidating a defaulted member’s
portfolio where the portfolio contains a
large position in securities sharing
51 Id.
52 17
53 17
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CFR 240.17Ad–22(e)(6)(v).
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similar risk profiles. NSCC proposes to
address this risk by adding the MLA
Charge to its margin methodologies. To
avoid excessive MLA Charges and
ensure margin requirements are
commensurate with the relevant risks,
NSCC also contemplates reducing a
member’s MLA Charge when NSCC
could otherwise partially mitigate the
relevant risks by extending the time
period for liquidating a defaulted
member’s portfolio beyond the three day
period.
Additionally, as described above in
Section I.A and B, NSCC’s current
margin methodology does not account
for the risk of incurring bid-ask spread
transaction costs when liquidating the
securities in a defaulted member’s
portfolio. NSCC proposes to address this
risk by adding the Bid-Ask Spread
Charge to its margin methodology.
Adding the MLA Charge and Bid-Ask
Spread Charge to NSCC’s margin
methodology should better enable NSCC
to collect margin amounts
commensurate with the risk attributes of
its members’ portfolios than NSCC’s
current margin methodology.
Specifically, the MLA Charge should
better enable NSCC to manage the risk
of increased costs to NSCC associated
with the decreased marketability of a
defaulted member’s portfolio where the
portfolio contains a large position in
securities sharing similar risk profiles.
Moreover, the proposal to reduce the
MLA Charge when NSCC could
otherwise partially mitigate the relevant
risks demonstrates how the proposal
provides an appropriate method for
measuring credit exposure, in that it
seeks to take into account the particular
circumstances related to a particular
portfolio when determining the MLA
Charge. Additionally, since NSCC’s
current margin methodology does not
account for bid-ask spread transaction
costs associated with liquidating a
defaulted member’s portfolio, the BidAsk Spread Charge should enable NSCC
to manage such risks.
Accordingly, the Commission believes
that adding the MLA Charge and BidAsk Spread Charge to NSCC’s margin
methodology would be consistent with
Rules 17Ad–22(e)(6)(i) and (v) because
these new margin charges should better
enable NSCC to establish a risk-based
margin system that (1) considers and
produces relevant margin levels
commensurate with the risks associated
with liquidating member portfolios in a
default scenario, including decreased
marketability of a portfolio’s securities
due to large positions in securities
sharing similar risk profiles and bid-ask
transaction costs, and (2) uses an
appropriate method for measuring credit
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19:38 Oct 01, 2020
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exposure that accounts for such risk
factors and portfolio effects.54
IV. Conclusion
It is therefore noticed, pursuant to
Section 806(e)(1)(I) of the Clearing
Supervision Act, that the Commission
does not object to Advance Notice (SR–
NSCC–2020–804) and that NSCC is
authorized to implement the proposed
change as of the date of this notice or
the date of an order by the Commission
approving Proposed Rule Change SR–
NSCC–2020–016, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020–21785 Filed 10–1–20; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–90033; File No. SR–FICC–
2020–802]
Self-Regulatory Organizations; Fixed
Income Clearing Corporation; Notice of
Filing of Amendment No. 2 and Notice
of No Objection to Advance Notice, as
Modified by Amendment Nos. 1 and 2,
to Introduce the Margin Liquidity
Adjustment Charge and Include a BidAsk Charge in the VaR Charges
September 28, 2020.
On July 30, 2020, Fixed Income
Clearing Corporation (‘‘FICC’’) filed
with the Securities and Exchange
Commission (‘‘Commission’’) advance
notice SR–FICC–2020–802 pursuant to
Section 806(e)(1) of Title VIII of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled
Payment, Clearing and Settlement
Supervision Act of 2010 (‘‘Clearing
Supervision Act’’),1 and Rule 19b–
4(n)(1)(i) 2 under the Securities
Exchange Act of 1934 (‘‘Exchange
Act’’) 3 to add two new charges to FICC’s
margin methodologies. On August 13,
2020, FICC filed Amendment No. 1 to
the advance notice, to make
clarifications and corrections to the
advance notice.4 The advance notice, as
modified by Amendment No. 1, was
published for public comment in the
Federal Register on September 4, 2020,5
54 17
CFR 240.17Ad–22(e)(6)(i) and (v).
U.S.C. 5465(e)(1).
2 17 CFR 240.19b–4(n)(1)(i).
3 15 U.S.C. 78a et seq.
4 Amendment No. 1 made clarifications and
corrections to the description of the advance notice
and Exhibits 3 and 5 of the filing.
5 Securities Exchange Act Release No. 89718
(September 1, 2020), 85 FR 55341 (September 4,
2020) (File No. SR–FICC–2020–802) (‘‘Notice of
Filing’’). On July 30, 2020, FICC also filed a related
1 12
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Fmt 4703
Sfmt 4703
and the Commission has received no
comments regarding the changes
proposed in the advance notice as
modified by Amendment No. 1.6 On
August 27, 2020, FICC filed Amendment
No. 2 to the advance notice to provide
additional data for the Commission to
consider in analyzing the advance
notice.7 The advance notice, as
modified by Amendment Nos. 1 and 2,
is hereinafter referred to as the
‘‘Advance Notice.’’ The Commission is
publishing this notice to solicit
comments on Amendment No. 2 from
interested persons and, for the reasons
discussed below, is hereby providing
notice of no objection to the Advance
Notice.
I. The Advance Notice
First, the proposals in the Advance
Notice would revise the FICC
Government Securities Division
(‘‘GSD’’) Rulebook (‘‘GSD Rules’’) and
FICC Mortgage-Backed Securities
Division (‘‘MBSD’’) Clearing Rules
(‘‘MBSD Rules,’’ and together with the
GSD Rules, the ‘‘Rules’’) 8 to introduce
the Margin Liquidity Adjustment Charge
(‘‘MLA Charge’’) as an additional margin
component. Second, the proposals in
the Advance Notice would revise the
Rules, GSD Methodology Document—
GSD Initial Market Risk Margin Model
(‘‘GSD QRM Methodology Document’’),
and MBSD Methodology and Model
proposed rule change (SR–FICC–2020–009) with
the Commission pursuant to Section 19(b)(1) of the
Exchange Act and Rule 19b–4 thereunder. On
August 13, 2020, FICC filed Amendment No. 1 to
the proposed rule change to make similar
clarifications and corrections to the proposed rule
change. See 15 U.S.C. 78s(b)(1) and 17 CFR
240.19b–4 respectively. The proposed rule change,
as amended by Amendment No. 1, was published
in the Federal Register on August 20, 2020.
Securities Exchange Act Release No. 89560 (August
14, 2020), 85 FR 51503 (August 20, 2020). On
August 27, 2020, FICC filed Amendment No. 2 to
the proposed rule change to provide similar
additional data for the Commission’s consideration.
The proposed rule change, as amended by
Amendment Nos. 1 and 2, is hereinafter referred to
as the ‘‘Proposed Rule Change.’’ In the Proposed
Rule Change, FICC seeks approval of proposed
changes to its rules necessary to implement the
Advance Notice. The comment period for the
related Proposed Rule Change filing closed on
September 10, 2020, and the Commission received
no comments.
6 As the proposals contained in the Advance
Notice were also filed as a proposed rule change,
all public comments received on the proposal are
considered regardless of whether the comments are
submitted on the Proposed Rule Change or the
Advance Notice.
7 In Amendment No. 2, FICC updated Exhibit 3
to the advance notice to include impact analysis
data with respect to the proposals in the advance
notice. FICC filed Exhibit 3 as a confidential exhibit
to the advance notice pursuant to 17 CFR 240.24b–
2.
8 Capitalized terms not defined herein are defined
in the Rules, available at https://www.dtcc.com/
legal/rules-and-procedures.aspx.
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]]>Agencies
[Federal Register Volume 85, Number 192 (Friday, October 2, 2020)]
[Notices]
[Pages 62342-62348]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-21785]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-90034; File No. SR-NSCC-2020-804]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Amendment No. 2 and Notice of No
Objection to Advance Notice, as Modified by Amendment Nos. 1 and 2, To
Introduce the Margin Liquidity Adjustment Charge and Include a Bid-Ask
Risk Charge in the VaR Charge
September 28, 2020.
On July 30, 2020, National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission'') advance notice SR-NSCC-2020-804 pursuant to Section
806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, entitled Payment, Clearing and Settlement
Supervision Act of 2010 (``Clearing Supervision Act''),\1\ and Rule
19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934
(``Exchange Act'') \3\ to add two new charges to NSCC's margin
methodology. On August 13, 2020, NSCC filed Amendment No. 1 to the
advance notice, to make clarifications and corrections to the advance
notice.\4\ The advance notice, as modified by Amendment No. 1, was
published for public comment in the Federal Register on September 4,
2020,\5\ and the Commission has received no comments regarding the
changes proposed in the advance notice as modified by Amendment No. 1.
On September 10, 2020, the Commission received one comment letter on
NSCC's related Proposed Rule Change.\6\ To the extent that the comment
letter on the Proposed Rule Change is relevant to the Advance Notice,
it is discussed below.\7\ On August 27, 2020, NSCC filed Amendment No.
2 to the advance notice to provide additional data for the Commission
to consider in analyzing the advance notice.\8\ The advance notice, as
modified by Amendment Nos. 1 and 2, is hereinafter referred to as the
``Advance Notice.'' The Commission is publishing this notice to solicit
comments on Amendment No. 2 from interested persons and, for the
reasons discussed below, is hereby providing notice of no objection to
the Advance Notice.
---------------------------------------------------------------------------
\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ 15 U.S.C. 78a et seq.
\4\ Amendment No. 1 made clarifications and corrections to the
description of the advance notice and Exhibits 3 and 5 of the
filing.
\5\ Securities Exchange Act Release No. 89719 (September 1,
2020), 85 FR 55332 (September 4, 2020) (File No. SR-NSCC-2020-804)
(``Notice of Filing''). On July 30, 2020, NSCC also filed a related
proposed rule change (SR-NSCC-2020-016) with the Commission pursuant
to Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder.
On August 13, 2020, NSCC filed Amendment No. 1 to the proposed rule
change to make similar clarifications and corrections to the
proposed rule change. See 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4
respectively. The proposed rule change, as amended by Amendment No.
1, was published in the Federal Register on August 20, 2020.
Securities Exchange Act Release No. 89558 (August 14, 2020), 85 FR
51521 (August 20, 2020). On August 27, 2020, NSCC filed Amendment
No. 2 to the proposed rule change to provide similar additional data
for the Commission's consideration. The proposed rule change, as
amended by Amendment Nos. 1 and 2, is hereinafter referred to as the
``Proposed Rule Change.'' In the Proposed Rule Change, NSCC seeks
approval of proposed changes to its rules necessary to implement the
Advance Notice. The comment period for the related Proposed Rule
Change filing closed on September 10, 2020, and the Commission
received no comments.
\6\ See letter from Cass Sanford, Associated General Counsel,
OTC Markets Group (September 10, 2020) (``OTC Letter''), available
at https://www.sec.gov/comments/sr-nscc-2020-016/srnscc2020016-7757533-223234.pdf.
\7\ As the proposals contained in the Advance Notice were also
filed as a proposed rule change, all public comments received on the
proposal are considered regardless of whether the comments are
submitted on the Proposed Rule Change or the Advance Notice.
\8\ In Amendment No. 2, NSCC updated Exhibit 3 to the advance
notice to include impact analysis data with respect to the proposals
in the advance notice. NSCC filed Exhibit 3 as a confidential
exhibit to the advance notice pursuant to 17 CFR 240.24b-2.
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I. The Advance Notice
First, the proposals in the Advance Notice would revise NSCC's
Rules and Procedures (``Rules'') \9\ to introduce the Margin Liquidity
Adjustment Charge (``MLA Charge'') as an additional margin component.
Second, the proposals in the Advance Notice would revise the Rules to
add a bid-ask spread risk charge (``Bid-Ask Spread Charge'') to NSCC's
margin calculations.
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\9\ Capitalized terms not defined herein are defined in the
Rules, available at https://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
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A. Background
NSCC provides central counterparty (``CCP'') services, including
clearing, settlement, risk management, and a guarantee of completion
for virtually all broker-to-broker trades involving equity securities,
corporate and municipal debt securities, and certain other securities.
In its role as a CCP, a key tool that NSCC uses to manage its credit
exposure to its members by determining and collecting an appropriate
Required Fund Deposit (i.e., margin) for each member.\10\ The aggregate
of all members' Required Fund Deposits (together with certain other
deposits required under the Rules) constitutes NSCC's Clearing Fund,
which NSCC would access should a defaulted member's own Required Fund
Deposit be insufficient to satisfy losses to NSCC caused by the
liquidation of that member's portfolio.\11\
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\10\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund
Formula and Other Matters) of the Rules (``Procedure XV''), supra
note 8.
\11\ See id.
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Each member's Required Fund Deposit consists of a number of
applicable components, which are calculated to address specific risks
that the member's portfolio presents to NSCC.\12\ Generally, the
largest component of a member's Required Fund Deposit is the volatility
charge, which is intended to capture the risks related to the movement
of market prices associated with the securities in a member's
portfolio.\13\ NSCC's methodology for calculating the
[[Page 62343]]
volatility charge of the Required Fund Deposit depends on the type of
security. For most securities, (e.g., equity securities), NSCC
calculates the volatility charge as the greater of (1) the larger of
two separate calculations that utilize a parametric Value at Risk
(``VaR'') model, (2) a gap risk measure calculation based on the
largest non-index position in a portfolio that exceeds a concentration
threshold, which addresses concentration risk that the largest non-
index position can present within a member's portfolio, and (3) a
portfolio margin floor calculation based on the market values of the
long and short positions in the portfolio, which addresses risks that
might not be adequately addressed with the other volatility charge
calculations.\14\ For certain other securities (e.g., corporate and
municipal bonds), NSCC's Rules apply a haircut-based volatility charge
that is calculated by multiplying the absolute value of the positions
by a percentage.\15\ The volatility charge is designed to calculate the
potential losses on a portfolio over a three-day period of risk assumed
necessary to liquidate the portfolio, within a 99 percent confidence
level.\16\
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\12\ See id.
\13\ See id.
\14\ See id.; see also Securities Exchange Act Release No. 82780
(February 26, 2018), 83 FR 9035 (March 2, 2018) (File No. SR-NSCC-
2017-808); Securities Exchange Act Release No. 82781 (February 26,
2018), 83 FR 9042 (March 2, 2018) (File No. SR-NSCC-2017-020).
\15\ See id.
\16\ See Notice of Filing, supra note 5 at 55332, 34.
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NSCC states that it regularly assesses market and liquidity risks
as such risks relate to its margin methodology to evaluate whether
margin levels are commensurate with the particular risk attributes of
each relevant product, portfolio, and market.\17\ NSCC states that the
proposed MLA Charge and Bid-Ask Spread Charge are necessary for NSCC to
effectively account for risks associated with certain types and
attributes of member portfolios.\18\
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\17\ See Notice of Filing, supra note 5 at 55333.
\18\ See id.
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B. Margin Liquidity Adjustment Charge
NSCC's current margin methodology does not account for the risk of
a potential increase in market impact costs that NSCC could incur when
liquidating a defaulted member's portfolio that contains a
concentration of large positions, as compared to the overall market, in
a particular security or group of securities sharing a similar risk
profile.\19\ In a member default, liquidating such large positions
within a potentially compressed timeframe \20\ (i.e., in a fire sale)
could have an impact on the underlying market, resulting in price moves
that increases NSCC's risk of incurring additional liquidation costs.
Therefore, NSCC designed the MLA Charge to address this specific
risk.\21\
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\19\ See id.
\20\ NSCC's risk models assume the liquidation occurs over a
period of three business days. See Notice of Filing, supra note 5 at
55333-34.
\21\ See Notice of Filing, supra note 5 at 55333.
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The MLA Charge would be based on comparing the market value of
member portfolio positions in specified asset groups \22\ to the
available trading volume of those asset groups. If the market value of
a member's positions in a certain asset group is large in comparison to
the available trading volume of that asset group,\23\ then it is more
likely that NSCC would have to manage reduced marketability and
increased liquidation costs for those positions during a member default
scenario. Specifically, NSCC's margin methodology assumes for each
asset group that a certain share of the market can be liquidated
without price impact.\24\ Aggregate positions in an asset group which
exceed this share are generally considered as large and would therefore
incur application of the MLA Charge to anticipate and address those
increased costs.
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\22\ The specified asset groups would include (1) equities
(excluding equities defined as Illiquid Securities pursuant to the
Rules), (2) Illiquid Securities, (3) unit investment trusts, or
UITs, (4) municipal bonds (including municipal bond exchange-traded
products, or ``ETPs''), and (5) corporate bonds (including corporate
bond ETPs). NSCC would then further segment the equities asset group
into the following subgroups: (i) Micro-capitalization equities,
(ii) small capitalization equities, (iii) medium capitalization
equities, (iv) large capitalization equities, (v) treasury ETPs, and
(vi) all other ETPs. See id.
\23\ NSCC states that it 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. See
id.
\24\ NSCC would establish the particular share for each asset
group or subgroup based on empirical research which includes the
simulation of asset liquidation over different time horizons. See
Notice of Filing, supra note 5 at 55333-34.
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For each position in a market capitalization subgroup of the
equities asset group, NSCC would calculate the market impact cost by
multiplying four components: (1) An impact cost coefficient that is a
multiple of the one-day market volatility of that subgroup and is
designed to measure impact costs, (2) the gross market value of the
position in that subgroup, (3) the square root of the gross market
value of the position in that subgroup in the portfolio divided by an
assumed percentage of the average daily trading volume of that
subgroup, and (4) a measurement of the relative weight of the position
in that subgroup of the portfolio. With respect to the fourth
component, NSCC states that this measurement would include aggregating
the weight of each CUSIP in that position relative to the weight of
that CUSIP in the subgroup, such that a portfolio with fewer positions
in a subgroup would have a higher measure of concentration for that
subgroup.\25\
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\25\ NSCC would calculate the relative weight by dividing the
absolute market value of a single CUSIP in the member's portfolio by
the total absolute market value of that portfolio. See Notice of
Filing, supra note 5 at 55334.
---------------------------------------------------------------------------
For each position in the municipal bond, corporate bond, Illiquid
Securities and UIT asset groups, and for positions in the treasury ETP
and other ETP subgroups of the equities asset group, NSCC would
calculate the market impact cost by multiplying three components: (1)
An impact cost coefficient that is a multiple of the one-day market
volatility of that asset group or subgroup, (2) the gross market value
of the position in that asset group or subgroup, and (3) the square
root of the gross market value of the position in that asset group or
subgroup in the portfolio divided by an assumed percentage of the
average daily trading volume of that subgroup.\26\
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\26\ See supra note 22.
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For each asset group or subgroup, NSCC would compare the calculated
market impact cost to a portion of the volatility charge that is
allocated to positions in that asset group or subgroup.\27\ If the
ratio of the calculated market impact cost to the applicable one-day
volatility charge is greater than a threshold, NSCC would apply an MLA
Charge to that asset group or subgroup.\28\ If the ratio of these two
[[Page 62344]]
amounts is equal to or less than this threshold, NSCC would not apply
an MLA Charge to that asset group or subgroup. The threshold would be
based on an estimate of the market impact cost that is incorporated
into the calculation of the applicable one-day volatility charge, such
that NSCC would only apply an MLA Charge when the calculated market
impact cost exceeds this threshold.
---------------------------------------------------------------------------
\27\ For purposes of this calculation, NSCC would use a portion
of the applicable volatility charge that is based on a one-day
assumed period of risk and calculated by applying a simple square-
root of time scaling, referred to in this advance notice as ``one-
day volatility charge.'' See Notice of Filing, supra note 5 at
55334. Any changes that NSCC deems appropriate to this assumed
period of risk would be subject to NSCC'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-NSCC-2017-008); 84458 (October
19, 2018), 83 FR 53925 (October 25, 2018) (File No. SR-NSCC-2018-
009); 88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-
NSCC-2020-008).
\28\ NSCC would set the initial threshold at 0.4, because
approximately 40 percent of the one-day volatility charge currently
addresses market impact costs. NSCC would review this threshold from
time to time and any changes that NSCC deems appropriate would be
subject to NSCC'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 or subgroup
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
one-day volatility charge exceeds the threshold, and (2) the one-day
volatility charge allocated to that asset group or subgroup.
For each portfolio, NSCC would total the MLA Charges for positions
in each of the subgroups of the equities asset group to determine an
MLA Charge for the positions in the equities asset group. NSCC would
then total the MLA Charge for positions in the equities asset group
together with each of the MLA Charges for positions in the other asset
groups to determine a total MLA Charge for a member.
In certain circumstances, NSCC may be able to partially mitigate
the risks that the MLA Charge is designed to address by extending the
time period for liquidating a defaulted member's portfolio beyond the
three day period. Accordingly, the Advance Notice also describes a
method that NSCC would use to reduce a member's total MLA Charge when
the volatility charge component of the member's margin increases beyond
a specified point. Specifically, NSCC would reduce the member's MLA
Charge where the market impact cost of a particular portfolio,
calculated as part of determining the MLA Charge, would be large
relative to the one-day volatility charge for that portfolio (i.e., a
portion of the three-day assumed margin period of risk). When the ratio
of calculated market impact cost to the one-day volatility charge is
lower, NSCC would not adjust the MLA Charge. However, as the ratio gets
higher, NSCC would reduce the MLA Charge. NSCC designed this reduction
mechanism to avoid assessing unnecessarily large MLA Charges.\29\
---------------------------------------------------------------------------
\29\ See Notice of Filing, supra note 5 at 55334.
---------------------------------------------------------------------------
On a daily basis, NSCC would calculate the final MLA Charge for
each member (if applicable), to be included as a component of each
member's Required Fund Deposit.
Finally, NSCC would amend the Rules to add the MLA Charge to the
list of Clearing Fund components that are excluded from the calculation
of the Excess Capital Premium charge.\30\ The Excess Capital Premium is
imposed on a member when the member's Required Fund Deposit exceeds its
excess net capital. NSCC states that including the MLA Charge in the
calculation of the Excess Capital Premium could lead to more frequent
and unnecessary Excess Capital Premium charges, which is not the
intended purpose of the Excess Capital Premium charge and could place
an unnecessary burden on members.\31\
---------------------------------------------------------------------------
\30\ See Section I.(B)(2) of Procedure XV, supra note 8.
\31\ See Notice of Filing, supra note 5 at 55335.
---------------------------------------------------------------------------
C. Bid-Ask Spread Charge
The bid-ask spread refers to the difference between the observed
market price that a buyer is willing to pay for a security and the
observed market price at which a seller is willing to sell that
security. NSCC faces the risk of potential bid-ask spread transaction
costs when liquidating the securities in a defaulted member's
portfolio. However, NSCC's current margin methodology does not account
for this risk of potential bid-ask spread transaction costs to NSCC in
connection with liquidating a defaulted member's portfolio. Therefore,
NSCC designed the Bid-Ask Spread Charge to address this deficiency in
its current margin methodologies.
The Bid-Ask Spread Charge would be haircut-based and tailored to
different groups of assets that share similar bid-ask spread
characteristics. NSCC would assign each asset group a specified bid-ask
spread haircut rate (measured in basis points (``bps'')) that would be
applied to the gross market value of the portfolio's positions in that
particular asset group. NSCC would calculate the product of the gross
market value of the portfolio's positions in a particular asset group
and the applicable basis point charge to obtain the bid-ask spread risk
charge for these positions. NSCC would total the applicable bid-ask
spread risk charges for each asset class in a member's portfolio to
calculate the member's final Bid-Ask Spread Charge.
NSCC determined the proposed initial haircut rates on an analysis
of bid-ask spread transaction costs using (1) the results of NSCC's
annual member default simulation and (2) market data sourced from a
third-party data vendor. NSCC's proposed initial haircut rates are
listed in the table below:
------------------------------------------------------------------------
Haircut
Asset group (bps)
------------------------------------------------------------------------
Large and medium capitalization equities..................... 5.0
Small capitalization equities................................ 12.3
Micro-capitalization equities................................ 23.1
ETPs......................................................... 1.5
------------------------------------------------------------------------
NSCC proposes to review the haircut rates annually.\32\ Based on
analyses of recent years' simulation exercises, NSCC does not
anticipate that these haircut rates would change significantly year
over year.\33\ NSCC 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.\34\
---------------------------------------------------------------------------
\32\ See id.
\33\ See id.
\34\ All proposed changes to the haircuts would be subject to
NSCC's model risk management governance procedures set forth in the
Model Risk Management Framework. See supra note 26.
---------------------------------------------------------------------------
II. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the advance
notice is consistent with the Clearing Supervision Act. Comments may be
submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-NSCC-2020-804 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-2020-804. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (https://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the advance notice that are filed with the
Commission, and all written communications relating to the advance
notice between the Commission and any person, other than
[[Page 62345]]
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 such filings will also be available
for inspection and copying at the principal office of NSCC and NSCC's
website at https://www.dtcc.com/legal.
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-2020-804 and should be
submitted on or before October 19, 2020.
III. Discussion and Commission Findings
Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, the stated purpose of the Clearing
Supervision Act is instructive: To mitigate systemic risk in the
financial system and promote financial stability by, among other
things, promoting uniform risk management standards for SIFMUs and
strengthening the liquidity of SIFMUs.\35\
---------------------------------------------------------------------------
\35\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------
Section 805(a)(2) of the Clearing Supervision Act authorizes the
Commission to prescribe regulations containing risk management
standards for the payment, clearing, and settlement activities of
designated clearing entities engaged in designated activities for which
the Commission is the supervisory agency.\36\ Section 805(b) of the
Clearing Supervision Act provides the following objectives and
principles for the Commission's risk management standards prescribed
under Section 805(a):\37\
---------------------------------------------------------------------------
\36\ 12 U.S.C. 5464(a)(2).
\37\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
to promote robust risk management;
to promote safety and soundness;
to reduce systemic risks; and
to support the stability of the broader financial system.
Section 805(c) provides, in addition, that the Commission's risk
management standards may address such areas as risk management and
default policies and procedures, among others areas.\38\
---------------------------------------------------------------------------
\38\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------
The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and Section 17A of the
Exchange Act (the ``Clearing Agency Rules'').\39\ The Clearing Agency
Rules require, among other things, each covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to meet certain minimum
requirements for its operations and risk management practices on an
ongoing basis.\40\ As such, it is appropriate for the Commission to
review advance notices against the Clearing Agency Rules and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Clearing Supervision Act. As
discussed below, the Commission believes the proposal in the Advance
Notice is consistent with the objectives and principles described in
Section 805(b) of the Clearing Supervision Act,\41\ and in the Clearing
Agency Rules, in particular Rules 17Ad-22(e)(4) and (e)(6).\42\
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\39\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No.
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
See also Securities Exchange Act Release No. 78961 (September 28,
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing
Agency Standards''). NSCC is a ``covered clearing agency'' as
defined in Rule 17Ad-22(a)(5).
\40\ 17 CFR 240.17Ad-22.
\41\ 12 U.S.C. 5464(b).
\42\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
The Commission believes that the Advance Notice is consistent with
the stated objectives and principles of Section 805(b) of the Clearing
Supervision Act. \43\
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\43\ One of the issues raised by the OTC Letter is directed at
the Proposed Rule Change, will be addressed in that context.
Specifically, OTC Markets Group argues that the proposal imposes an
undue burden on competition, stating that the proposal would impose
additional margin requirements for firms processing transactions in
smaller and less liquid securities and disproportionately impact
member firms with lower operating margins or higher costs of
capital. That issue is relevant to the Commission's evaluation of
the related Proposed Rule Change, which is conducted under the
Exchange Act, but not to the Commission's evaluation of the Advance
Notice, which, as discussed below in Section III.B, is conducted
under the Clearing Supervision Act and generally considers whether
the proposal will mitigate systemic risk and promote financial
stability. Accordingly, concerns regarding burden on competition are
not discussed herein but will be addressed in the Commission's
review of the related Proposed Rule Change, as applicable, under the
Exchange Act.
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The Commission believes that adopting NSCC's proposed MLA Charge
and Bid-Ask Spread Charge would be consistent with the promotion of
robust risk management at NSCC. As described above in Section I.A and
B, NSCC's current margin methodology does not account for the potential
increase in market impact costs that NSCC could incur when liquidating
a defaulted member's portfolio where the portfolio contains a
concentration of large positions in a particular security or group of
securities sharing a similar risk profile. Additionally, as described
above in Section I.C, NSCC's margin methodology does not account for
the risk of potential bid-ask spread transaction costs when liquidating
the securities in a defaulted member's portfolio. NSCC proposes to
address these respective risks by adding the MLA Charge and Bid-Ask
Spread Charge to its margin methodology.\44\
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\44\ The Commission notes that the other clearing agencies it
regulates have charges to account for these types of risks in their
margin methodologies, and that addressing these types of risks has
received a great deal of industry focus in recent years.
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Specifically, the MLA Charge should better enable NSCC to manage
the risk of incurring costs associated with the decreased marketability
of a defaulted member's portfolio where the portfolio contains a large
position in securities sharing similar risk profiles, resulting in
potentially higher liquidation costs. To avoid excessive MLA Charges,
NSCC has identified circumstances that would warrant reducing a
member's MLA Charge when NSCC could otherwise partially mitigate the
relevant risks by extending the time period for liquidating a defaulted
member's portfolio beyond the three day period. The Commission views
this targeted reduction in the MLA Charge as a feature of the proposal
that demonstrates a robust approach towards managing the relevant risks
through appropriate (i.e., not simply ``larger'') margin requirements.
Additionally, since NSCC's current margin methodology does not account
for bid-ask spread transaction costs when liquidating a defaulted
member's portfolio, the Bid-Ask Spread Charge should enable NSCC to
manage such risks. Accordingly, the Commission believes that adopting
the proposed MLA Charge and Bid-Ask Spread Charge would allow for
measurement and targeted mitigation of risks and costs not captured
elsewhere in NSCC's current margin methodology, and would therefore
provide for more comprehensive management of risks in a member default
scenario, consistent with the promotion of robust risk management.
The commenter argues that NSCC's Advance Notice fails to provide
sufficient information to evaluate the necessity and impact of the
proposal. Specifically, the commenter argues that the proposal provides
no explanation as to why the current Clearing Fund
[[Page 62346]]
formula is inadequate or how the proposed methodology would limit
NSCC's exposure in the event of a member default. The Commission
disagrees. As described in the Notice and noted above, NSCC's current
margin methodology does not account for the risk of a potential
increase in market impact costs that NSCC could incur when liquidating
a defaulted member's portfolio that contains a concentration of large
positions, as compared to the overall market and account for this risk
of potential bid-ask spread transaction costs in connection with
liquidating a defaulted member's portfolio. As a result, NSCC's Advance
Notice is designed to address these specific risks, that are currently
unaddressed, and thus limit NSCC's exposure.
Furthermore, when considering the issues raised in the Advance
Notice, the Commission thoroughly considered (1) NSCC's Advance Notice,
including the supporting exhibits that provided, among other things,
confidential impact analyses regarding the proposals in NSCC's Advance
Notice; \45\ (2) the OTC Letter; and (3) the Commission's own
understanding of NSCC's margin methodology, with which the Commission
has experience from its general supervision of NSCC. Based on its
review of these materials, the Commission believes that, as set forth
in the Notice of Filing, NSCC has done exactly what the commenter
seeks, in that the proposal explains why the current methodology is
inadequate (i.e., it does not address these particular risks), and how
the proposed methodology would address this issue (i.e., by including
add-on charges calibrated to address these particular risks).\46\ Thus,
notwithstanding the comments raised in the OTC Letter, the Commission
believes that adopting the proposed MLA Charge and Bid-Ask Spread
Charge would be consistent with the promotion of robust risk management
at NSCC.
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\45\ Specifically, the confidential Exhibit 3 submitted by NSCC
includes, among other things, (1) impact studies for various time
periods detailing the average and maximum MLA and Bid-Ask Charges
for each member, by both percentage and amount, (2) a detailed
methodology describing the calculation of the MLA and Bid-Ask
Charges, and (3) information regarding how NSCC determined the
appropriate methodology.
\46\ Moreover, to the extent that the commenter argues that
additional detail or information is necessary to enable the public
to evaluate the proposal, the Commission disagrees. With respect to
the MLA Charge, the Notice of Filing explains that concentrated
positions would lead to application of the MLA Charge and provides
sufficient information as to the components that would be used to
make the determination of concentration to allow a Member to
consider whether the MLA Charge would apply. With respect to the
Bid-Ask Spread Charge, the Notice of Filing identifies the
particular haircuts that would apply to all securities.
---------------------------------------------------------------------------
Further, the Commission believes that adopting NSCC's proposed MLA
Charge and Bid-Ask Spread Charge would be consistent with promoting
safety and soundness at NSCC. NSCC designed the MLA Charge and Bid-Ask
Spread Charge to ensure that NSCC collects margin amounts sufficient to
manage NSCC's risk of incurring costs associated with liquidating
defaulted member portfolios. The proposed MLA Charge and Bid-Ask Spread
Charge would generally provide NSCC with additional resources to manage
potential losses arising out of a member default. Such an increase in
available financial resources would decrease the likelihood that losses
arising out of a member default would exceed NSCC's resources and
threaten the safety and soundness of NSCC's ongoing operations.
Accordingly, the Commission believes that adding the proposed MLA
Charge and Bid-Ask Spread Charge to NSCC's margin methodology would be
consistent with promoting safety and soundness at NSCC.
Finally, the Commission believes that adopting NSCC's proposed MLA
Charge and Bid-Ask Spread Charge would be consistent with reducing
systemic risks and supporting the stability of the broader financial
system. As discussed above, in a member default scenario, NSCC would
access its Clearing Fund should the defaulted member's own Required
Fund Deposit be insufficient to satisfy losses to NSCC caused by the
liquidation of that member's portfolio. NSCC proposes to add the MLA
Charge and Bid-Ask Spread Charge to its margin methodology to better
manage the potential costs of liquidating a defaulted member's
portfolio. NSCC proposes to collect additional margin to cover such
costs. This, in turn, could reduce the possibility that NSCC would need
to mutualize among the non-defaulting members a loss arising out of the
close-out process. Reducing the potential for loss mutualization could,
in turn, reduce the potential knock-on effects to non-defaulting
members, their customers, and the broader market arising out of a
member default. Further, the Commission notes that, to the extent that
the MLA Charge results in any reduction in members' large positions in
securities with similar risk profiles, it could reduce the potential
risk of adverse market impacts that can arise from liquidating those
large positions. However, the Commission also notes that the proposal
to reduce the MLA Charge when NSCC could otherwise partially mitigate
the relevant risks would help ensure that NSCC would not impose the MLA
Charge without an appropriate risk management basis. Accordingly, the
Commission believes that NSCC's adoption of the proposed MLA Charge and
Bid-Ask Spread Charge would be consistent with the reduction of
systemic risk and supporting the stability of the broader financial
system.
For the reasons stated above, the Commission believes the changes
proposed in the Advance Notice are consistent with Section 805(b) of
the Clearing Supervision Act.\47\
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\47\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(4)(i)
Rule 17Ad-22(e)(4)(i) requires that NSCC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to effectively identify, measure, monitor, and manage its
credit exposures to participants and those arising from its payment,
clearing, and settlement processes, including by maintaining sufficient
financial resources to cover its credit exposure to each participant
fully with a high degree of confidence.\48\
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\48\ 17 CFR 240.17Ad-22(e)(4)(i).
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As described above in Section I.A and B, NSCC's current margin
methodology does not account for the risk of a potential increase in
market impact costs that NSCC could incur when liquidating a defaulted
member's portfolio where the portfolio contains a large position in
securities sharing similar risk profiles. Additionally, as described
above, NSCC's current margin methodology does not account for the risk
of potential bid-ask spread transaction costs when liquidating the
securities in a defaulted member's portfolio. NSCC proposes to address
such risks by adding the MLA Charge and Bid-Ask Spread Charge to its
margin methodology. Adding these margin charges to NSCC's margin
methodology should better enable NSCC to collect margin amounts
commensurate with the risk attributes of a broader range of its
members' portfolios than NSCC's current margin methodology.
Specifically, the MLA Charge should better enable NSCC to manage the
risk of increased costs to NSCC associated with the decreased
marketability of a defaulted member's portfolio where the portfolio
contains a large position in securities sharing similar risk profiles.
Additionally, since NSCC's current margin methodology does not account
for bid-ask spread transaction costs associated with liquidating a
defaulted member's portfolio, the Bid-Ask Spread Charge
[[Page 62347]]
should enable NSCC to manage such risks and costs.
The commenter suggests that the proposals in NSCC's Advance Notice
are duplicative of a separate NSCC proposal regarding Illiquid
Securities that is currently pending before the Commission.\49\ The
commenter argues that since both proposals include provisions that
would apply to Illiquid Securities,\50\ thereby potentially affecting
their margin levels, both proposals appear to address the same
concerns. Therefore, the commenter suggests that instead of approving
NSCC's Advance Notice, the Commission should consolidate NSCC's Advance
Notice together with the Illiquid Securities Proposal and extend the
public comment period before the Commission makes a substantive
determination.
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\49\ Securities Exchange Act Release No. 88615 (April 9, 2020),
85 FR 21037 (April 15, 2020) (SR-NSCC-2020-802) (``Illiquid
Securities Proposal'').
\50\ Under NSCC's Rules, Illiquid Securities may include any
security that meets the criteria set forth in the term's definition
and would not necessarily be limited to securities with small or
micro market capitalizations.
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The Commission disagrees with the comments raised in the OTC
Letter. NSCC's Advance Notice and the Illiquid Securities Proposal deal
with separate and distinguishable aspects of NSCC's margin methodology,
even if there is a group of Illiquid Securities to which both proposals
would apply. The Illiquid Securities Proposal is designed to amend the
method by which NSCC determines the appropriate volatility component of
margin for a particular thinly traded security, i.e., calculate
appropriate margin to cover potential losses on a portfolio using
historical, mid-point securities prices. The Advance Notice is designed
to address two specific risks that are not captured directly by
historical mid-point security price movements and that are directed at
additional costs that may arise during the liquidation of a Member's
portfolio in the event of a default: (1) The potential added costs of
liquidating large concentrated positions in a limited period of time
and (2) bid-ask spread transactions costs.
Specifically, the Illiquid Securities Proposal seeks to, among
other things, more accurately identify securities that exhibit illiquid
characteristics for margin purposes and to establish a separate
haircut-based method for determining the margin for Illiquid
Securities. NSCC's methodology for calculating the volatility component
of a member's margin depends on the type of securities in the member's
portfolio. Generally, for most securities (e.g., equity securities),
NSCC calculates the volatility component using, among other things, a
parametric Value at Risk (``VaR'') model, and the volatility component
typically constitutes the largest portion of a member's required
margin. However, securities with illiquid characteristics generally
incur a wider degree of price variability and are less amenable to
statistical analysis, and, as such, may merit a more conservative
margining approach through a haircut-based method. The proposed
haircut-based method is more conservative because it does not allow for
inter-asset risk offsetting in the way that the VaR model does.
Accordingly, for certain securities that are less amenable to the
statistical analysis provided in the VaR model, including Illiquid
Securities, NSCC currently calculates a haircut-based volatility
component by multiplying the absolute value of a member's positions in
such securities by a certain percentage. NSCC's pending Illiquid
Securities Proposal would, among other things, establish a separate
haircut-based method for determining the volatility component of the
margin for Illiquid Securities. Thus, the Illiquid Securities Proposal
would alter the way in which NSCC determines the appropriate margin for
Illiquid Securities.
In contrast, NSCC's Advance Notice is not designed to identify
which securities exhibit illiquid characteristics, and it would not
alter the methodology by which NSCC determines the volatility component
of the margin for any particular securities, including Illiquid
Securities. Instead, with respect to the MLA Charge, NSCC's Advance
Notice relates to a new margin charge add-on that, if triggered,
applies to all securities cleared at NSCC (i.e., not solely to Illiquid
Securities), and the proposed add-on is distinct from the underlying
margin otherwise collected for all securities (including Illiquid
Securities). Rather than addressing the volatility component of margin
and the potential losses on a portfolio, as does the Illiquid
Securities Proposal, the proposal described in the Advance Notice is
designed to address the discrete risks of a default liquidation
scenario. These discrete risks include those associated with (1)
concentrated large positions in any type of security or group of
securities sharing a similar risk profile, and (2) bid-ask spread
transaction costs that are currently unaccounted for in NSCC's margin
methodology. Moreover, the MLA Charge would not automatically be
applied based on the security or type of security that is held;
instead, it would only apply to concentrated positions that could be
difficult to liquidate in a limited time in the event of a default.
Because NSCC's Advance Notice and the Illiquid Securities Proposal
address wholly separate and distinct aspects of NSCC's margin
methodology, the Commission disagrees with the OTC Markets Group that
the two proposals should be consolidated or otherwise disposed of
together.
The Commission believes that adding the MLA Charge and Bid-Ask
Spread Charge to NSCC's margin methodology should enable NSCC to more
effectively identify, measure, monitor, and manage its credit exposures
in connection with liquidating a defaulted member's portfolio that may
give rise to (1) decreased marketability due to large positions of
securities sharing similar risk profiles, and (2) bid-ask spread
transaction costs. Accordingly, the Commission believes that adding the
MLA Charge and Bid-Ask Spread Charge to NSCC's margin methodology would
be consistent with Rule 17Ad-22(e)(4)(i) because these new margin
charges should better enable NSCC to maintain sufficient financial
resources to cover NSCC's credit exposure to its members fully with a
high degree of confidence.\51\
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\51\ Id.
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C. Consistency With Rules 17Ad-22(e)(6)(i) and (v)
Rule 17Ad-22(e)(6)(i) requires that NSCC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to cover its credit exposures to its participants by
establishing a risk-based margin system that, at a minimum, considers,
and produces margin levels commensurate with, the risks and particular
attributes of each relevant product, portfolio, and market.\52\ Rule
17Ad-22(e)(6)(v) requires that NSCC establish, implement, maintain and
enforce written policies and procedures reasonably designed to cover
its credit exposures to its participants by establishing a risk-based
margin system that, at a minimum, uses an appropriate method for
measuring credit exposure that accounts for relevant product risk
factors and portfolio effects across products.\53\
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\52\ 17 CFR 240.17Ad-22(e)(6)(i).
\53\ 17 CFR 240.17Ad-22(e)(6)(v).
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As described above in Section I.A and B, NSCC's current margin
methodology does not account for the potential increase in market
impact costs when liquidating a defaulted member's portfolio where the
portfolio contains a large position in securities sharing
[[Page 62348]]
similar risk profiles. NSCC proposes to address this risk by adding the
MLA Charge to its margin methodologies. To avoid excessive MLA Charges
and ensure margin requirements are commensurate with the relevant
risks, NSCC also contemplates reducing a member's MLA Charge when NSCC
could otherwise partially mitigate the relevant risks by extending the
time period for liquidating a defaulted member's portfolio beyond the
three day period.
Additionally, as described above in Section I.A and B, NSCC's
current margin methodology does not account for the risk of incurring
bid-ask spread transaction costs when liquidating the securities in a
defaulted member's portfolio. NSCC proposes to address this risk by
adding the Bid-Ask Spread Charge to its margin methodology. Adding the
MLA Charge and Bid-Ask Spread Charge to NSCC's margin methodology
should better enable NSCC to collect margin amounts commensurate with
the risk attributes of its members' portfolios than NSCC's current
margin methodology. Specifically, the MLA Charge should better enable
NSCC to manage the risk of increased costs to NSCC associated with the
decreased marketability of a defaulted member's portfolio where the
portfolio contains a large position in securities sharing similar risk
profiles. Moreover, the proposal to reduce the MLA Charge when NSCC
could otherwise partially mitigate the relevant risks demonstrates how
the proposal provides an appropriate method for measuring credit
exposure, in that it seeks to take into account the particular
circumstances related to a particular portfolio when determining the
MLA Charge. Additionally, since NSCC's current margin methodology does
not account for bid-ask spread transaction costs associated with
liquidating a defaulted member's portfolio, the Bid-Ask Spread Charge
should enable NSCC to manage such risks.
Accordingly, the Commission believes that adding the MLA Charge and
Bid-Ask Spread Charge to NSCC's margin methodology would be consistent
with Rules 17Ad-22(e)(6)(i) and (v) because these new margin charges
should better enable NSCC to establish a risk-based margin system that
(1) considers and produces relevant margin levels commensurate with the
risks associated with liquidating member portfolios in a default
scenario, including decreased marketability of a portfolio's securities
due to large positions in securities sharing similar risk profiles and
bid-ask transaction costs, and (2) uses an appropriate method for
measuring credit exposure that accounts for such risk factors and
portfolio effects.\54\
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\54\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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IV. Conclusion
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Clearing Supervision Act, that the Commission does not object to
Advance Notice (SR-NSCC-2020-804) and that NSCC is authorized to
implement the proposed change as of the date of this notice or the date
of an order by the Commission approving Proposed Rule Change SR-NSCC-
2020-016, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-21785 Filed 10-1-20; 8:45 am]
BILLING CODE 8011-01-P
