Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Amendment No. 2 and Order Granting Accelerated Approval of a Proposed Rule Change, 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, 66646-66656 [2020-23138]
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66646
Federal Register / Vol. 85, No. 203 / Tuesday, October 20, 2020 / Notices
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–90181; File No. SR–NSCC–
2020–016]
Self-Regulatory Organizations;
National Securities Clearing
Corporation; Notice of Amendment No.
2 and Order Granting Accelerated
Approval of a Proposed Rule Change,
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
October 14, 2020.
On July 30, 2020, National Securities
Clearing Corporation (‘‘NSCC’’) filed
with the Securities and Exchange
Commission (‘‘Commission’’), pursuant
to Section 19(b)(1) of the Securities
Exchange Act of 1934 (‘‘Act’’) 1 and Rule
19b–4 thereunder,2 proposed rule
change SR–NSCC–2020–016 to add two
new charges to NSCC’s margin
methodology.3 On August 13, 2020,
NSCC filed Amendment No. 1 to the
proposed rule change, to make
clarifications and corrections to the
proposed rule change.4 The proposed
rule change, as modified by Amendment
No. 1, was published for public
comment in the Federal Register on
August 20, 2020.5 The Commission has
received comment letters on the
proposed rule change, as modified by
Amendment No. 1.6
On August 27, 2020, NSCC filed
Amendment No. 2 to the proposed rule
change to provide additional data for
the Commission to consider in
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 NSCC also filed the proposals contained in the
proposed rule change as advance notice SR–NSCC–
2020–804 with the Commission pursuant to Section
806(e)(1) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act entitled the Payment,
Clearing, and Settlement Supervision Act of 2010
(‘‘Clearing Supervision Act’’), 12 U.S.C. 5465(e)(1),
and Rule 19b–4(n)(1)(i) of the Act, 17 CFR 240.19b–
4(n)(1)(i).
4 Amendment No. 1 made clarifications and
corrections to the description of the proposed rule
change and Exhibits 3 and 5 of the filing. On August
13, 2020, NSCC filed Amendment No. 1 to the
advance notice to make similar clarifications and
corrections to the advance notice.
5 Securities Exchange Act Release No. 89558
(August 14, 2020), 85 FR 51521 (August 20, 2020)
(‘‘Notice’’). The advance notice, as modified by
Amendment No. 1, was published for public
comment in the Federal Register on September 4,
2020. Securities Exchange Act Release No. 89719
(September 1, 2020), 85 FR 55332 (September 4,
2020) (File No. SR–NSCC–2020–804). The comment
period for the advance notice, as modified by
Amendment No. 1 closed on September 21, 2020,
and the Commission received no comments.
6 Comments received are available at https://
www.sec.gov/comments/sr-nscc-2020-016/
srnscc2020016.htm.
2 17
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analyzing the proposed rule change.7
The proposed rule change, as modified
by Amendment Nos. 1 and 2, is
hereinafter referred to as the ‘‘Proposed
Rule Change.’’ On October 2, 2020,
pursuant to Section 19(b)(2) of the Act,8
the Commission designated a longer
period within which to approve,
disapprove, or institute proceedings to
determine whether to approve or
disapprove the Proposed Rule Change.9
The Commission is publishing this
notice to solicit comments on
Amendment No. 2 from interested
persons and, for the reasons discussed
below, to approve the Proposed Rule
Change on an accelerated basis.
I. Description of the Proposed Rule
Change
First, the Proposed Rule Change
would revise NSCC’s Rules and
Procedures (‘‘Rules’’) 10 to introduce the
Margin Liquidity Adjustment Charge
(‘‘MLA Charge’’) as an additional margin
component. Second, the Proposed Rule
Change 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 is determining and collecting
an appropriate Required Fund Deposit
(i.e., margin) for each member.11 The
aggregate of all members’ Required
Fund Deposits (together with certain
other deposits required under the Rules)
7 In Amendment No. 2, NSCC updated Exhibit 3
to the proposed rule change to include impact
analysis data with respect to the proposed rule
change. NSCC filed Exhibit 3 as a confidential
exhibit to the proposed rule change pursuant to 17
CFR 240.24b–2. On August 27, 2020, NSCC filed
Amendment No. 2 to the advance notice to provide
similar additional data for the Commission’s
consideration. The advance notice, as amended by
Amendment Nos. 1 and 2, is hereinafter referred to
as the ‘‘Advance Notice.’’ On October 2, 2020, the
Commission published notice of filing of
Amendment No. 2 and notice of no objection to the
Advance Notice. Securities Exchange Act Release
No. 90034 (September 28, 2020), 85 FR 62342
(October 2, 2020) (File No. SR–NSCC–2020–804).
8 15 U.S.C. 78s(b)(2).
9 Securities Exchange Act Release No. 90084
(October 2, 2020), 85 FR 63607 (October 8, 2020).
10 Capitalized terms not defined herein are
defined in the Rules, available at https://dtcc.com/
∼/media/Files/Downloads/legal/rules/nscc_
rules.pdf.
11 See Rule 4 (Clearing Fund) and Procedure XV
(Clearing Fund Formula and Other Matters) of the
Rules (‘‘Procedure XV’’), supra note 10.
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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.12
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.13 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.14 NSCC’s
methodology for calculating the
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.15 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.16 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.17
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.18 NSCC states
12 See
id.
id.
14 See id.
15 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).
16 See id.
17 See Notice, supra note 5 at 51522.
18 See id.
13 See
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Federal Register / Vol. 85, No. 203 / Tuesday, October 20, 2020 / Notices
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
B. Margin Liquidity Adjustment Charge
capitalization subgroup of the equities
NSCC’s current margin methodology
asset group, NSCC would calculate the
does not account for the risk of a
market impact cost by multiplying four
potential increase in costs that NSCC
components: (1) An impact cost
could incur when liquidating a
coefficient that is a multiple of the onedefaulted member’s portfolio that
day market volatility of that subgroup
contains a concentration of large
and is designed to measure impact
positions, as compared to the overall
costs, (2) the gross market value of the
market, in a particular security or group position in that subgroup, (3) the square
of securities sharing a similar risk
root of the gross market value of the
profile.20 In a member default,
position in that subgroup in the
liquidating such large positions within
portfolio divided by an assumed
a potentially compressed timeframe 21
percentage of the average daily trading
(e.g., in a fire sale) could have an impact volume of that subgroup, and (4) a
on the underlying market, resulting in
measurement of the relative weight of
price moves that increase NSCC’s risk of the position in that subgroup of the
incurring additional liquidation costs.
portfolio. With respect to the fourth
Therefore, NSCC designed the MLA
component, NSCC states that this
Charge to address this specific risk.22
measurement would include aggregating
The MLA Charge would be based on
the weight of each CUSIP in that
comparing the market value of member
position relative to the weight of that
portfolio positions in specified asset
CUSIP in the subgroup, such that a
23
groups to the available trading
portfolio with fewer positions in a
volume of those asset groups. If the
subgroup would have a higher measure
market value of a member’s positions in
of concentration for that subgroup.26
a certain asset group is large in
For each position in the municipal
comparison to the available trading
bond, corporate bond, Illiquid Securities
volume of that asset group,24 then it is
and UIT asset groups, and for positions
more likely that NSCC would have to
in the treasury ETP and other ETP
manage reduced marketability and
subgroups of the equities asset group,
increased liquidation costs for those
NSCC would calculate the market
positions during a member default
impact cost by multiplying three
scenario. Specifically, NSCC’s margin
components: (1) An impact cost
methodology would assume for each
coefficient that is a multiple of the oneasset group that a certain share of the
day market volatility of that asset group
market can be liquidated without price
or subgroup, (2) the gross market value
25
impact. Aggregate positions in an asset
of the position in that asset group or
subgroup, and (3) the square root of the
19 See id.
gross market value of the position in
20 See Notice, supra note 5 at 51522–23.
that asset group or subgroup in the
21 NSCC’s risk models assume the liquidation
portfolio divided by an assumed
occurs over a period of three business days. See
Notice, supra note 5 at 51523.
percentage of the average daily trading
22 See id.
volume of that subgroup.27
23 The specified asset groups would include (1)
For each asset group or subgroup,
equities (excluding equities defined as Illiquid
NSCC would compare the calculated
Securities pursuant to the Rules), (2) Illiquid
market impact cost to a portion of the
Securities, (3) unit investment trusts, or UITs, (4)
municipal bonds (including municipal bond
volatility charge that is allocated to
exchange-traded products, or ‘‘ETPs’’), and (5)
positions in that asset group or
corporate bonds (including corporate bond ETPs).
28
NSCC would then further segment the equities asset subgroup. If the ratio of the calculated
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.19
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.
24 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.
25 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,
supra note 5 at 51523–25.
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26 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,
supra note 5 at 51523–24.
27 See supra note 24.
28 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, supra note 5 at
51524. Any changes that NSCC deems appropriate
to this assumed period of risk would be subject to
NSCC’s model risk management governance
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66647
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.29 If the ratio of these two
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 Proposed Rule Change
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
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).
29 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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Federal Register / Vol. 85, No. 203 / Tuesday, October 20, 2020 / Notices
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.30
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.31 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.32
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
methodology.
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
30 See
31 See
Notice, supra note 5 at 51524.
Section I.(B)(2) of Procedure XV, supra
note 10.
32 See Notice, supra note 5 at 51524.
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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 group in a
member’s portfolio to calculate the
member’s final Bid-Ask Spread Charge.
NSCC determined the proposed initial
haircut rates based 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:
applicable to such organization. After
careful consideration, the Commission
finds that the Proposed Rule Change is
consistent with the requirements of the
Act and the rules and regulations
thereunder applicable to NSCC. In
particular, the Commission finds that
the Proposed Rule Change is consistent
with Sections 17A(b)(3)(F) and
(b)(3)(I) 37 of the Act and Rules 17Ad–
22(e)(4) and (e)(6) thereunder.38
A. Consistency With Section
17A(b)(3)(F)
Section 17A(b)(3)(F) of the Act
requires, in part, that the rules of a
Haircut
clearing agency, such as NSCC, be
Asset group
(bps)
designed to promote the prompt and
accurate clearance and settlement of
Large and medium capitalization
equities ......................................
5.0 securities transactions, assure the
Small capitalization equities .........
12.3 safeguarding of securities and funds
Micro-capitalization equities .........
23.1 which are in the custody or control of
ETPs .............................................
1.5 the clearing agency or for which it is
responsible, remove impediments to
NSCC proposes to review the haircut
and perfect the mechanism of a national
33
rates annually. Based on analyses of
system for the prompt and accurate
recent years’ simulation exercises,
clearance and settlement of securities
NSCC does not anticipate that these
transactions, and, in general, to protect
haircut rates would change significantly investors and the public interest.39 The
34
year over year. NSCC may also adjust
Commission believes that the Proposed
the haircut rates following its annual
Rule Change is consistent with Section
model validation review, to the extent
17A(b)(3)(F) of the Act.
the results of that review indicate the
First, as described above in Section
current haircut rates are not adequate to
I.A
and B, NSCC’s current margin
address the risk presented by
methodology
does not account for the
transaction costs from a bid-ask
potential
increase
in market impact
35
spread.
costs that NSCC could incur when
D. Description of Amendment No. 2
liquidating a defaulted member’s
portfolio where the portfolio contains a
In Amendment No. 2, NSCC updated
concentration of large positions in a
Exhibit 3 to the Proposed Rule Change
particular security or group of securities
to include impact analysis data with
sharing a similar risk profile. In
respect to the Proposed Rule Change.
Specifically, Amendment No. 2 includes addition, as described above in Section
I.C, NSCC’s margin methodology does
impact studies for various time periods
not account for the risk of potential biddetailing the average and maximum
ask spread transaction costs when
MLA and Bid-Ask Charges for each
liquidating the securities in a defaulted
member, by both percentage and
member’s portfolio. NSCC proposes to
amount. NSCC filed Exhibit 3 as a
address these risks by adding the MLA
confidential exhibit to the Proposed
Charge and Bid-Ask Spread Charge,
Rule Change pursuant to 17 CFR
respectively, to its margin
240.24b–2.
methodology.40
II. Discussion and Commission
NSCC designed the MLA Charge and
Findings
Bid-Ask Spread Charge to ensure that
Section 19(b)(2)(C) of the Act 36
NSCC collects margin amounts
directs the Commission to approve a
sufficient to manage NSCC’s risk of
proposed rule change of a selfincurring costs associated with
regulatory organization if it finds that
liquidating defaulted member portfolios.
such proposed rule change is consistent Based on its review of the Proposed
with the requirements of the Act and the Rule Change, including confidential
rules and regulations thereunder
37 15
33 See
Notice, supra note 5 at 51525.
34 See id.
35 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 28.
36 15 U.S.C. 78s(b)(2)(C).
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Fmt 4703
Sfmt 4703
U.S.C. 78q-1(b)(3)(F) and (b)(3)(I).
CFR 240.17Ad–22(e)(4) and (e)(6).
39 15 U.S.C. 78q-1(b)(3)(F).
40 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.
38 17
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Federal Register / Vol. 85, No. 203 / Tuesday, October 20, 2020 / Notices
Exhibit 3 thereto,41 the Commission
understands that 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.
As discussed above, NSCC designed the
MLA Charge and Bid-Ask Spread
Charge, respectively, to reflect two
distinct and specific risks presented to
NSCC: (1) The risk associated with
liquidating a defaulted member’s
portfolio that holds concentrated
positions in securities sharing similar
risk profiles; as well as (2) the risks
associated with the bid-ask spread costs
relevant to the securities in the
defaulted member’s portfolio. As a
result, any margin increases that result
from the MLA and the Bid-Ask Spread
Charges are limited to address those
respective risks. This targeted increase
in available financial resources should
decrease the likelihood that losses
arising out of a member default
stemming from the liquidation of
concentrated positions or bid-ask
spreads would cause NSCC to exhaust
its financial resources and threaten the
operation of its critical clearance and
settlement services. Accordingly, the
Commission believes that the Proposed
Rule Change should help NSCC to
continue providing prompt and accurate
clearance and settlement of securities
transactions in the event of a member
default.
Second, 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 augment its ability to
manage the potential costs of liquidating
a defaulted member’s portfolio by
collecting 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 closeout process. Reducing the potential for
loss mutualization could, in turn,
reduce the potential knock-on effects to
non-defaulting members, their
customers, and NSCC arising out of a
member default. Accordingly, the
41 Specifically, the confidential Exhibit 3
submitted by NSCC includes, among other things,
impact studies for various time periods detailing
the average and maximum MLA and Bid-Ask
Spread Charges for each member, by both
percentage and amount, a detailed methodology
describing the calculation of the MLA and Bid-Ask
Spread Charges, and information regarding how
NSCC determined the appropriate methodology.
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18:08 Oct 19, 2020
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Commission believes the Proposed Rule
Change would promote the safeguarding
of securities and funds which are in the
custody or control of NSCC or for which
NSCC is responsible, consistent with
Section 17A(b)(3)(F) of the Act.
One commenter argues that the
Proposed Rule Change is not in the
public interest and would harm
investors and small businesses by
dampening small business capital
formation and liquidity and
discouraging trading activity, as
discussed more fully below.42 The
Commission disagrees that the proposal
is not in the public interest. The
Commission believes that the proposal
should help protect investors and the
public interest by mitigating some of the
risks presented by NSCC as a CCP.
Because a defaulting member could
place stresses on NSCC with respect to
NSCC’s ability to meet its clearance and
settlement obligations upon which the
broader financial system relies, it is
important that NSCC has a strong
margin methodology to limit NSCC’s
credit risk exposure in the event of a
member default. As described above, the
Proposed Rule Change would add two
charges specifically designed to address
risks that are not currently addressed in
NSCC’s margin methodology related to:
(1) The potential costs that NSCC may
incur when liquidating a portfolio that
is concentrated in a particular security
or group of securities with a similar risk
profile, and (2) the potential costs that
NSCC may incur to cover the bid-ask
spread when liquidating a portfolio.
These changes should help ensure that
NSCC collects sufficient margin that is
more commensurate with the risks
associated with the potential
concentration and bid-ask spread
liquidation costs identified above, and
thus more effectively cover its credit
exposures to its members. By collecting
margin that more accurately reflects the
risk characteristics of such portfolios
and the bid-ask spreads of securities
they contain (i.e., the potential
associated costs of liquidating such
portfolios), NSCC would be in a better
position to absorb and contain the
spread of any losses that might arise
from a member default. Therefore, the
proposal is designed to reduce the
possibility that NSCC would need to
call for additional resources from nondefaulting members due to a member
default, which could inhibit the ability
of these non-defaulting members to
facilitate securities transactions.
Accordingly, the Commission believes
42 Letter from James C. Snow, President/CCO,
Wilson-Davis & Co., Inc. (received September 30,
2020) at 1 (‘‘Wilson-Davis Letter’’).
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that the proposal is designed to protect
investors and the public interest by
mitigating some of the risks presented
by NSCC as a CCP.43
One commenter asserts that the
proposal dampens capital formation and
liquidity and that firms and investors
would stop participating in trades
because of the proposal.44 Specifically,
the commenter states that broker-dealers
would not be able to trade securities
issued by small companies because the
‘‘insurance requirement’’ would be too
high. In addition, the commenter states
that investors would be dissuaded from
trading in such securities. Overall, the
commenter argues that the Proposed
Rule Change is inconsistent with the
Commission’s mission of facilitating
capital formation.
First, with respect to the comment
regarding liquidity and capital
formation, the Commission believes that
limiting NSCC’s exposure to its
members by allowing NSCC to collect
margin to address the two risks that are
not currently addressed would benefit
members due to NSCC’s decreased
exposure to losses resulting from a
member default. Effectively mitigating
such risks would, in turn, reduce the
likelihood that NSCC would have to call
on its members to contribute additional
resources, which otherwise could be
used by its members to facilitate
securities transactions thereby
providing liquidity to the securities
markets. Thus, the Commission believes
that NSCC’s proposal, by helping nondefaulting members preserve their
financial resources, could promote
liquidity provision in such
circumstances because these resources
would be available to facilitate
securities transactions.
Nevertheless, the Commission
acknowledges that the proposal could
result in an increase in the margin
required to be collected from a member,
which, in turn, may result in such
member incurring additional costs to
access needed liquidity. Despite these
potential impacts, the Commission is
not persuaded that the Proposed Rule
Change would have a negative effect on
small business capital formation such
that it would be inconsistent with the
public interest or, more broadly, the
Commission’s mission. To the extent
that members incur funding costs
43 See Securities Exchange Act Release No. 78961
(September 28, 2016), 81 FR 70786, 70849 (October
13, 2016) (‘‘While central clearing generally benefits
the markets in which it is available, clearing
agencies can pose substantial risk to the financial
system as a whole, due in part to the fact that
central clearing concentrates risk in the clearing
agency.’’).
44 Wilson-Davis Letter at 4–5.
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associated with additional margin, they
may choose to distribute these costs
across transactions in all securities for
which they make markets rather than
allocate those costs only to transactions
in securities that require additional
margin. Thus, the fact that members
have flexibility in how they allocate
costs could mitigate negative impacts, if
any, on the liquidity and capital
formation of a particular subset of
issuers.
Both the MLA Charge and the Bid-Ask
Spread Charge would apply to all
securities cleared and settled at NSCC
and would not be directed to any
particular group of securities. The MLA
Charge would only apply to portfolios
where 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. Thus, the
application of the charge depends on
the particular mix of securities within
the specified asset groups in a member’s
portfolio and does not depend solely on
the presence of particular types of
securities. The Bid-Ask Spread Charge
would apply to all the securities in a
member’s portfolio and would not apply
only to a particular type of security. The
Commission acknowledges that the
haircuts that would determine the BidAsk Spread Charge would, in part,
consider the nature of the security, with
the highest haircut percentages
applicable to micro-cap and small-cap
securities. However, based on its
consideration of NSCC’s determination
of the haircut schedule, as informed by
NSCC’s 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, the
Commission believes that the haircut
schedule is appropriate given that such
securities likely would exhibit larger
bid-ask spreads, making the higher
haircut more conservative and
consistent with NSCC’s regulatory
requirements to collect margin
commensurate with the risks presented
by the securities.
Further, the Commission is not
persuaded by the commenter’s
generalized statements on the potential
impact on small business capital
formation that could result from
implementation of the Proposed Rule
Change, which are lacking any specific
data or analysis in support thereof. The
Commission acknowledges the
possibility that, as the commenter
asserted, issuers of securities in smaller
companies may experience a reduction
in liquidity because of the increased
margin requirements applicable to
transactions in such securities.
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Nevertheless, the Commission believes
that small business issuers that are more
liquid could benefit from greater access
to capital to the extent that the proposal
leads to a net increase in demand for
more liquid securities and a net
decrease in demand for less liquid
securities. Further, the Commission
does not agree with the commenter that
investors would be dissuaded from
trading in such securities. The
Commission is aware of research
suggesting that the stock prices of
smaller companies fall in response to a
reduction in liquidity until such
securities provide an adequate desired
return for investors.45 Thus, as long as
stock prices can adjust to reflect the
reduced liquidity, affected small issuers
may still be able to attract capital from
investors, albeit at a higher cost that
appropriately reflects the risks inherent
in the clearance and settlement of the
securities they issue. Moreover, to the
extent that investment decisions are
driven by other factors, such as the
future prospects of specific companies,
there might be no decrease in access to
capital or little change in cost.
In addition, the commenter’s
arguments ignore the potential benefits
to small businesses when their
securities are eligible for central clearing
by NSCC. As do other clearing agencies,
NSCC provides a number of services
that mitigate risk, reduce costs, and
enhance processing efficiencies for the
securities markets, market participants,
issuers (including small issuers), and
investors. By reducing NSCC’s risk
exposure to its members and thus the
likelihood of its failure, the proposal
helps ensure that NSCC would continue
to provide such services, which would
benefit securities markets, market
participants, issuers (including small
issuers), and investors. Thus, the
commenter does not take into account
any potential positive impacts on small
business capital formation that may
arise as a result of the Proposed Rule
Change.
Second, the Commission is not
persuaded that the Proposed Rule
Change will not protect investors solely
because of the potential for increased
costs. The Commission notes that
although the proposal may result in an
increase in margin requirements for
particular portfolios (as a result of the
MLA Charge) and to reflect the bid-ask
spread (as a result of the Bid-Ask Spread
Charge), such an increase is designed to
allow NSCC to reduce the risks when
liquidating a portfolio in the event of a
member default. As a result, NSCC
should be more resilient so that it can
satisfy its obligations as a CCP, which
facilitates the protection of investors by
helping to ensure that investors receive
the proceeds from their securities
transactions. In addition, as discussed
earlier, the Commission believes that
the proposal should help protect
investors and the public interest by
mitigating some of the risks presented
by NSCC as a CCP.
Therefore, notwithstanding the
potential unspecified impact on capital
formation in smaller and less liquid
markets, as described above, the
Commission believes that, in light of the
potential benefits to investors arising
from the Proposed Rule Change and the
overall improved risk management at
NSCC, the Proposed Rule Change is
designed to protect investors and the
public interest, consistent with Section
17A(b)(3)(F) of the Act.
Finally, one commenter asserted that
the Proposed Rule Change would add
impediments to the national system for
clearance and settlement because it
would create more complicated
algorithms that slow the clearance
process, burdens settlement and harms
investors, firms and small businesses.46
Based on the Commission’s review of
the materials that NSCC has filed in
connection with this Proposed Rule
Change and its general knowledge of the
information technology systems and
infrastructure in place at NSCC, the
Commission concludes that the
Proposed Rule Change would not slow
the clearance and settlement process at
NSCC. The Proposed Rule Change is
designed to enable NSCC to address two
risks that are not currently reflected in
its margin methodology. The proposal
introduces the MLA Charge as an
additional margin component, and adds
a Bid-Ask Spread Charge to NSCC’s
margin calculations. The Commission
believes that these new margin charges
will better enable NSCC to establish a
risk-based margin system that (1)
considers and produces 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.47 The
operation of the risk-based margin
46 Id.
45 See,
e.g., Viral Acharya and Lasse H. Pedersen,
2005, Asset pricing with liquidity risk, Journal of
Financial Economics 77(2) 375–410.
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at 1, 5.
Securities Exchange Act Release No. 90034
(September 28, 2020), 85 FR 62342 (October 2,
2020) (File No. SR–NSCC–2020–804).
47 See
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system, as amended by the proposal,
would not interfere with the clearance
and settlement of securities
transactions. As a result, the proposal
should not slow the clearance process,
burden settlement or harm investors,
firms and small businesses. Instead, the
Proposed Rule Change should help
ensure that NSCC will continue to
perform its vital role to settle
transactions on time and at their agreed
upon terms in the event of a member
default, which will better protect
investors, firms, small businesses, and
the broader financial system. Moreover,
the Commission does not believe that
the Proposed Rule Change would
impose any additional impediments on
the national system of clearance and
settlement; the fact that the application
of the revised margin methodology may,
in some instances, result in increased
margin requirements (as discussed in
more detail in Section II.B below) does
not constitute the imposition of such an
impediment.
The commenter also argues that the
Proposed Rule Change is an ineffective
attempt by NSCC to address its credit
risks.48 The commenter argues that
NSCC could address the risk directly by
modifying the settlement timeline.
According to the commenter, if the
NSCC proposed rules that would
eliminate the two-day settlement cycle
in favor of immediate, same-day
electronic settlement, the market risk
exposure would be eliminated. The
Commission disagrees with the
commenter. The securities industry
transitioned to the current two-day
settlement cycle on September 5, 2017,
only after a multi-year, industry-wide
initiative 49 and the Commission’s
amendment of Rule 15c6–1.50
Therefore, the commenter’s suggestion
that NSCC could unilaterally shorten
the current two-day settlement to a
same-day settlement cycle is not a
feasible alternative to the Proposed Rule
Change.
B. Consistency With Section 17A(b)(3)(I)
of the Act
Section 17A(b)(3)(I) of the Act
requires that the rules of a clearing
agency do not impose any burden on
competition not necessary or
appropriate in furtherance of the Act.51
This provision does not require the
Commission to find that a proposed rule
48 Wilson-Davis
Letter at 4.
Securities Exchange Act Release No. 78962
(September 28, 2016), 81 FR 69240, 69254 (October
5, 2016) (‘‘Discussion of Current Efforts To Shorten
the Settlement Cycle in the U.S.’’).
50 See Securities Exchange Act Release No. 80295
(March 22, 2017), 82 FR 15564 (March 29, 2017).
51 15 U.S.C. 78q–1(b)(3)(I).
49 See
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change represents the least anticompetitive means of achieving the
goal. Rather, it requires the Commission
to balance the competitive
considerations against other relevant
policy goals of the Act.52
Both commenters argue that the
Proposed Rule Change would
disproportionately impact member firms
with lower operating margins or higher
costs of capital.53 The Commission
acknowledges that the Proposed Rule
Change could entail increased margin
charges to some members, including
members that invest in concentrated
positions in securities sharing a
common risk profile and members that
invest in securities that have larger bidask spreads, which may include
microcap and small cap securities.
Nevertheless, as discussed above, the
Proposed Rule Change would calculate
the MLA Charge and Bid-Ask Spread
Charge based on the composition of a
member’s portfolio, regardless of
member size or type, and the charges
would not target or apply solely to
Illiquid Securities or securities with a
smaller market capitalization. Instead,
as discussed above in Sections I.B and
I.C, both the MLA and Bid-Ask Spread
Charges would serve to address
particular potential costs that NSCC
may incur when liquidating a portfolio
in a member default. To the extent a
particular member’s margin would
increase under the Proposed Rule
Change, that increase would be based on
the mix of securities that make up the
52 See Bradford National Clearing Corp., 590 F.2d
1085, 1105 (D.C. Cir. 1978).
53 See Wilson-Davis Letter at 4–5; Letter from
Cass Sanford, Associated General Counsel, OTC
Markets Group (September 11, 2020) at 2 (‘‘OTC
Letter’’). One commenter further states that the
Proposed Rule Change would double its required
margin, based on an impact study it received from
NSCC. (Wilson-Davis Letter at 2.) The commenter
states that the impact study covered only one
quarter of information and concludes that NSCC is
making this decision based solely on that analysis.
NSCC responds that the impact study cited in the
Wilson-Davis Letter did not include any potential
impacts of the Proposed Rule Change because that
impact study was provided by NSCC to WilsonDavis in connection with the separate Illiquid
Securities Proposal. NSCC states that it conducted
member outreach in August 2020, providing
members with, among other things, an impact study
on the Proposed Rule Change based on data from
the first quarter of 2020. NSCC further states that
the data show a total margin increase to NSCC
members by an average of 5.3% from the proposed
MLA Charge and by an average of 3.6% from the
proposed Bid-Ask Spread Charge. See Letter from
Timothy J. Cuddihy, Managing Director, DTCC
Financial Risk Management (October 7, 2020)
(‘‘NSCC Letter’’) at 2. Additionally, the confidential
materials filed by NSCC as part of the Proposed
Rule Change include an analysis of the impacts of
both charges, by member, over the year-long time
period June 2019 through May 2020. Based on the
Commission’s review of the impact analysis, the
Proposed Rule Change would not cause any NSCC
member’s volatility charge to double.
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66651
member’s portfolio and NSCC’s
requirement to collect margin to
appropriately address the associated
risks, which it currently does not do.
In addition, the Commission
acknowledges that the impact of
increased margin requirements may
present higher costs to some members
relative to others due to a number of
factors, such as access to liquidity
resources, cost of capital, business
model, and applicable regulatory
requirements. These higher relative
burdens may weaken certain members’
competitive positions relative to other
members. However, some members,
particularly those most affected by the
change, may respond to increased
margin requirements by adjusting their
liquidity management and business
models, such as by holding less
concentrated positions or shifting
liquidity provision towards securities
that are less likely to incur the proposed
charges.54 Such effects may mitigate
competitive effects on members.
Moreover, the Commission also notes
that NSCC is required to manage the risk
presented by each member by
establishing a risk-based margin
system.55 NSCC’s members include a
large and diverse population of entities.
By participating in NSCC, each member
is subject to the same margin
methodology which is designed to
satisfy NSCC’s regulatory obligation to
manage the risk presented by its
members.
Moreover, the Commission believes
that the Proposed Rule Change would
not impose a burden on competition
that is not necessary or appropriate in
furtherance of the Act. As discussed
above, NSCC faces the risk of
liquidation costs when a member’s
portfolio contains large positions in
securities sharing similar risk profiles.
Similarly, NSCC faces the risk of costs
that would materialize in connection
with the bid-ask spread of the securities
in a member’s portfolio. Such costs are
currently unaccounted for in NSCC’s
current margin methodology. NSCC has
provided impact analyses demonstrating
that the Proposed Rule Change would
result in margin levels that better reflect
the risks associated with (1)
concentrated large positions in
securities sharing a similar risk profile,
and (2) bid-ask spread transaction costs
than NSCC’s current margin
methodology. Since certain securities
and portfolio compositions present
NSCC with unique liquidation risks, the
Commission believes it is appropriate
54 See Section II.A infra (discussing capital
formation).
55 See 17 CFR 240.17Ad–22(e)(6)(i).
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for NSCC to require members holding
such securities or portfolio
compositions to provide margin
amounts commensurate with the
identified risks. Thus, the Commission
believes that the MLA Charge and BidAsk Spread Charge are margin
requirements that represent an
appropriate response to the risk
characteristics of members’ portfolio
holdings, and not an undue burden on
competition. Accordingly, the
Commission believes that the Proposed
Rule Change would help NSCC better
maintain sufficient financial resources
to cover its credit exposures to each
member in full with a high degree of
confidence. By helping NSCC to better
manage its credit exposure, the
Proposed Rule Change would help
NSCC better mitigate the potential
losses to NSCC associated with
liquidating a member’s portfolio in the
event of a member default, in
furtherance of NSCC’s obligations under
Section 17A(b)(3)(F) of the Act.
Additionally, the Commission notes
that in order 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
specific contemplation by NSCC of a
targeted reduction in the MLA Charge as
a feature of the Proposed Rule Change
that demonstrates an approach towards
managing the relevant risks through
appropriate (i.e., not simply ‘‘larger’’)
margin requirements.
Therefore, for the reasons stated
above, the Commission believes that the
Proposed Rule Change is consistent
with the requirements of Section
17A(b)(3)(I) of the Act 56 because any
competitive burden imposed by the
proposal is necessary or appropriate in
furtherance of the Act.
C. 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.57
56 15
57 17
U.S.C. 78q–1(b)(3)(I).
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
should enable NSCC to manage such
risks and costs.
One commenter suggests that the
Proposed Rule Change is duplicative of
a separate NSCC proposal regarding
Illiquid Securities that is currently
pending before the Commission.58 The
commenter argues that since both
proposals include provisions that would
affect margin levels with respect to
Illiquid Securities, both proposals
appear to address the same concerns.
Therefore, the commenter suggests that
instead of approving the Proposed Rule
Change, the Commission should
consolidate NSCC’s associated 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 commenter. The
Proposed Rule Change (and NSCC’s
associated Advance Notice) and the
Illiquid Securities Proposal deal with
separate and distinguishable aspects of
NSCC’s margin methodology, even if
58 OTC Markets Letter at 1–2 (citing Securities
Exchange Act Release No. 88615 (April 9, 2020), 85
FR 21037 (April 15, 2020) (SR–NSCC–2020–802)
(‘‘Illiquid Securities Proposal’’)).
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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
security, i.e., calculate appropriate
margin to cover potential losses on a
portfolio using historical, mid-point
securities prices. The Proposed Rule
Change is designed to address two
specific risks that are not captured
directly by historical mid-point security
price movements that may arise
specifically 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) bidask 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.
As stated above, for most securities (e.g.,
equity securities), NSCC calculates the
volatility component using, among other
things, a parametric 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, the Proposed Rule Change
is not designed to define what
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constitutes an Illiquid Security under
NSCC’s Rules, 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, the
Proposed Rule Change 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 Proposed Rule Change is
designed to address the discrete risks of
a default liquidation scenario 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 the
Proposed Rule Change and the Illiquid
Securities Proposal address wholly
separate and distinct aspects of NSCC’s
margin methodology, the Commission
disagrees with the commenter 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.59
D. Consistency With Rules 17Ad–
22(e)(6)
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.60 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.61
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
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.C, 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
60 17
59 Id.
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CFR 240.17Ad–22(e)(6)(v).
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66653
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
exposure that accounts for such risk
factors and portfolio effects.62
One commenter argues that the
Proposed Rule Change would burden
members with margin requirements that
are not commensurate with NSCC’s
actual risks, as evidenced by the lack of
recent settlement losses, and instead are
designed to mitigate imaginary risks.63
In addition, the commenter argues that
NSCC has not provided evidence of the
need for the Proposed Rule Change,
again citing the lack of recent settlement
losses. However, as discussed above, the
Commission believes that the proposed
changes to NSCC’s margin methodology
would enable it to collect margin
appropriately tailored to two particular
risks that are not currently addressed in
the existing margin methodology. The
Commission does not agree that the fact
that NSCC has not suffered recent
settlement losses obviates the need for
the Proposed Rule Change. Rule 17Ad–
22(e)(6)(iii) 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, calculates margin
62 17
CFR 240.17Ad–22(e)(6)(i) and (v).
Letter at 3, 5.
63 Wilson-Davis
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sufficient to cover its potential future
exposure to participants in the interval
between the last margin collection and
the close out of positions following a
participant default.64 Potential future
exposure is, in turn, defined as the
maximum exposure estimated to occur
at a future point in time with an
established single-tailed confidence
level of at least 99 percent with respect
to the estimated distribution of future
exposure.65 Thus, to be consistent with
its regulatory requirements, NSCC must
consider potential future exposure,
which includes, among other things,
losses associated with the liquidation of
a defaulted member’s portfolio. Based
on its review and analysis of the
Proposed Rule Change, including the
confidential impact analyses
demonstrating the overall effects that
the proposed changes would have on
the overall margin collected by NSCC
and the confidential margin
methodology (i.e., the specific details of
how NSCC would calculate its margin
requirements under the proposed
changes), in conjunction with the
Commission’s supervisory observations,
the Commission believes that the
proposed changes would better enable
NSCC to collect margin commensurate
with the different levels of risk that
members pose to NSCC as a result of
their particular portfolio, which is
consistent with Rule 17Ad–22(e)(6)(i),
and to calculate margin sufficient to
cover its potential future exposure to its
participants, which is consistent with
Rule 17Ad–22(e)(6)(iii).
E. Consistency With Rules 17Ad–
22(e)(23)(ii)
Rule 17Ad–22(e)(23)(ii) 66 requires
each covered clearing agency to
establish, implement, maintain, and
enforce written policies and procedures
reasonably designed to provide
sufficient information to enable
participants to identify and evaluate the
risks, fees, and other material costs they
incur by participating in the covered
clearing agency.
Both commenters argue that the
Proposed Rule Change fails to provide
sufficient information to evaluate the
necessity and impact of the proposal.67
Specifically, one commenter argues that
the proposal provides no explanation as
to why NSCC’s current margin formula
is inadequate or how the proposed
methodology would limit NSCC’s
exposure in the event of a member
64 17
CFR 240.17Ad–22(e)(6)(iii).
CFR 240.17Ad–22(a)(13).
66 17 CFR 240.17Ad–22(e)(23)(ii).
67 See OTC Letter at 2; Wilson-Davis Letter at 1,
4–5.
65 17
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default.68 Another commenter stated
that the Proposed Rule Change does not
comply with Rule 17Ad–22(e)(23)(ii),
asserting that NSCC has not performed
the ‘‘requisite analysis’’ or gathered
sufficient data to fully understand the
impact of the proposal.69
The Commission disagrees with the
commenters that the Proposed Rule
Change does not provide sufficient
information to understand the potential
costs associated with participating in
NSCC, based on the materials reflected
in the Proposed Rule Change.70 When
considering the issues raised in the
68 See
OTC Letter at 2.
Wilson-Davis Letter at 2–3. Contrary to the
commenter’s implication, Rule 17Ad–22(e)(23) does
not prescribe any specific data or analysis that a
covered clearing agency, like NSCC, must perform
when making changes to its margin methodology.
Moreover, as discussed above in note 41, NSCC has
provided confidential impact analyses covering a
one-year time period to demonstrate the potential
impact of the Proposed Rule Change on its
members.
In addition, the commenter references Rule
17Ad–22(e)(23)(iii), which requires a covered
clearing agency, like NSCC, to establish, implement,
maintain, and enforce written policies and
procedures reasonably designed to provide basic
transaction volume and values. See Wilson-Davis
Letter at 2. However, the information described by
the commenter would not constitute basic data on
transaction volumes and values, as required by the
rule, and instead would appear to refer to more
detailed analysis of the impacts of particular margin
methodologies. Moreover, NSCC publicly provides
data on transaction volumes and values in its
quantitative disclosures, which are available at
https://www.dtcc.com/legal/policy-and-compliance.
70 One commenter argues that the proposal is
generally unclear, overly technical and
complicated, inappropriately relies on information
provided by NSCC to the Commission
confidentially, and thus prevents the public from
fully evaluating and providing meaningful
comment on the proposal. As stated above, the
Commission believes that the proposal adequately
explains why the current methodology is
inadequate (i.e., it does not address certain specific
risks), and how the proposed methodology would
address this issue (i.e., via the MLA Charge and BidAsk Spread Charge). Additionally, the Commission
does not believe that the Proposed Rule Change is
overly technical and complicated. The process of
measuring the risks involved with various member
portfolio compositions to determine appropriate
margin levels is technical, complex, and does not
distill into a simple formula. Instead, the process
often must utilize sophisticated risk models and
calculations. NSCC has described the methodology
that it would use to determine the margin to
address these specific risks with sufficient
specificity to allow a member to understand the
types of portfolios that would be subject to an
additional MLA Charge and to understand the
haircuts that would apply to determine the Bid-Ask
Spread Charge.
Moreover, the Commission believes that NSCC
appropriately submitted Exhibit 3 to the filing
confidentially because it includes detailed memberlevel margin data and other proprietary
information. Under its Rules, NSCC is not permitted
to disclose member-level information. See Rule 49
of the Rules, supra note 10. NSCC requested
confidential treatment of such materials and its
underlying detailed methodology documentation,
consistent with the applicable regulatory
requirements. See 17 CFR 240.24b–2.
69 See
PO 00000
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Proposed Rule Change, the Commission
thoroughly reviewed (1) the Proposed
Rule Change, including the supporting
exhibits that provided, among other
things, confidential impact analyses
regarding the proposals in the Proposed
Rule Change; (2) the comment letters;
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 described
in the Notice, NSCC has done exactly
what the commenters seek, 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 designed to address
these particular risks). As described in
the Notice and noted above, NSCC’s
current margin methodology neither
accounts 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, nor does NSCC’s current margin
methodology account for this risk of
potential bid-ask spread transaction
costs in connection with liquidating a
defaulted member’s portfolio. The
Proposed Rule Change is designed to
address these specific risks and limit
NSCC’s exposure in the event of a
member default.
The Proposed Rule Change describes
how NSCC would determine the MLA
and Bid-Ask Spread Charges. For both
charges, the Proposed Rule Change
identifies the relevant asset groupings
that NSCC would utilize. For the MLA
Charge, NSCC has described how the
charge would depend on whether a
member holds large aggregate positions
in an asset group. Thus, a member
should be able to consider whether its
positions would likely trigger the MLA
Charge in light of the relevant holdings
in its portfolio. For the Bid-Ask Spread
Charge, NSCC has identified that the
charge would be determined by
application of a haircut and provided a
schedule of the applicable haircuts.
Thus, a member should be able to
understand what the charge would be
for a particular security. In addition,
NSCC represented that in August 2020,
NSCC provided all its Members with the
results of an impact study regarding the
potential impacts of both the Illiquid
Securities Proposal and the MLA
Proposal and clearly delineated between
the impacts of these separate
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proposals.71 NSCC also included a
written summary of the MLA Proposal
and offered to schedule a call to discuss
these proposals and their potential
impacts.72 Moreover, NSCC has
provided impact analyses demonstrating
that the Proposed Rule Change would
result in margin levels that better reflect
the risks associated with (1)
concentrated large positions in
securities sharing a similar risk profile,
and (2) bid-ask spread transaction costs
than NSCC’s current margin
methodology. Accordingly, the
Commission believes that NSCC has
demonstrated the operation and impact
of the Proposed Rule Change, i.e., that
it would help NSCC better maintain
sufficient financial resources to cover its
credit exposures to each member in full
with a high degree of confidence.
Moreover, to provide transparency
and assist members in understanding
their margin requirements, NSCC
maintains the NSCC Risk Management
Reporting application on the Participant
Browser Service (‘‘PBS’’) and the NSCC
Risk Client Portal (‘‘Portal’’), which will
include this Proposed Rule Change once
it is implemented.73 The PBS is a
member-accessible website portal for
accessing reports and other disclosures.
The Risk Management Reporting
application enables a member to view
and download margin requirement
information and component details,
including issue-level margin
information related to start of day
volatility charges and mark-to-market,
intraday exposure, and other
components. Members are able to view
and download spreadsheets that contain
market amounts for current clearing
positions and the associated volatility
charges. In addition, NSCC represents
that the Portal provides members the
ability, for information purposes, to
view and analyze certain risks relating
to their portfolios, including calculators
to assess the risks and margin impacts
of certain activities and to compare their
portfolios to historical and average
values.
NSCC further maintains the NSCC
Client Calculator on the Portal that
provides functionality for members to
enter ‘‘what-if’’ position data and to
recalculate their volatility charges to
71 NSCC
Letter at 2.
More generally, NSCC stated that it
routinely reaches out to members that may be
impacted by its proposals. This outreach includes
impact study results and an offer to discuss those
results and the underlying proposal. Id.
73 See Letter from Timothy J. Cuddihy, Managing
Director DTCC Financial Risk Management,
submitted in response to comments on the Illiquid
Securities Proposal, available at, https://
www.sec.gov/comments/sr-nscc-2020-802/
srnscc2020802.htm.
72 Id.
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determine margin impact pre-trade. In
other words, this calculator allows
members to see the impact to the
volatility charge if specific transactions
are executed, or to anticipate the impact
of an increase or decrease to a current
clearing position. Using this calculator,
members have the ability to download
the Client Calculator portfolio detail to
modify a current margin portfolio,
upload the portfolio to run a margin
calculation, and view position level
outputs in order to make informed risk
management and execution decisions.
Taken together, these tools should
allow members to understand how these
charges would affect their portfolios.
Accordingly, notwithstanding the
comments, the Commission believes
that the Proposed Rule Change is not
inconsistent with Rule 17Ad–
22(e)(23)(ii).74
III. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning whether
Amendment No. 2 is consistent with the
Act. Comments may be submitted by
any of the following methods:
Electronic Comments
Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
Send an email to rule-comments@
sec.gov. Please include File Number SR–
NSCC–2020–016 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–2020–016. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the Proposed Rule
Change that are filed with the
Commission, and all written
communications relating to the
Proposed Rule Change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549, on official
business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of 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–2020–016
and should be submitted on or before
November 10, 2020.
IV. Accelerated Approval of the
Proposed Rule Change, as Modified by
Amendment No. 2
The Commission finds good cause,
pursuant to Section 19(b)(2)(C)(iii) of
the Act,75 to approve the Proposed Rule
Change, as modified by Amendment
Nos. 1 and 2, prior to the thirtieth day
after the date of publication of
Amendment No. 2 in the Federal
Register. As noted above, in
Amendment No. 2, NSCC updated the
confidential Exhibit 3 to the Proposed
Rule Change to include impact analysis
data with respect to the Proposed Rule
Change. Specifically, Amendment No. 2
includes impact studies for various time
periods detailing the average and
maximum MLA and Bid-Ask Charges
for each member, by both percentage
and amount. The Commission believes
that the member-level data in
Amendment No. 2 warrants confidential
treatment. Amendment No. 2 neither
modifies the Proposed Rule Change as
originally published in any substantive
manner, nor does Amendment No. 2
affect any rights or obligations of NSCC
or its members. Instead, Amendment
No. 2 provides the Commission with
information necessary to evaluate
whether the Proposed Rule Change is
consistent with the Act. Accordingly,
the Commission finds good cause,
pursuant to Section 19(b)(2)(C)(iii) of
the Act,76 to approve the Proposed Rule
Change, as modified by Amendment
Nos. 1 and 2, prior to the thirtieth day
after the date of publication of notice of
Amendment No. 2 in the Federal
Register.
V. Conclusion
On the basis of the foregoing, the
Commission finds that the Proposed
Rule Change, as modified by
75 15
74 17
PO 00000
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U.S.C. 78s(b)(2)(C)(iii).
76 Id.
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Amendment Nos. 1 and 2, is consistent
with the requirements of the Act and in
particular with the requirements of
Section 17A of the Act 77 and the rules
and regulations promulgated
thereunder.
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act 78 that
Proposed Rule Change SR–NSCC–2020–
016, as modified by Amendment Nos. 1
and 2, be, and hereby is, approved on
an accelerated basis.79
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.80
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020–23138 Filed 10–19–20; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–90186; File No. SR–
PEARL–2020–19]
Self-Regulatory Organizations; MIAX
PEARL, LLC; Notice of Filing and
Immediate Effectiveness of a Proposed
Rule Change To Amend the MIAX
PEARL Equities Fee Schedule To
Adopt Connectivity Fees, Port Fees, a
Technical Support Request Fee, and
Historical Market Data Fee
October 14, 2020.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on October
5, 2020, MIAX PEARL, LLC (‘‘MIAX
PEARL’’ or ‘‘Exchange’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’) a proposed rule change
as described in Items I, II, and III below,
which Items have been prepared by the
Exchange. The Commission is
publishing this notice to solicit
comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange is filing a proposal to
amend the MIAX PEARL Equities Fee
Schedule (the ‘‘Fee Schedule’’) by
adopting fees applicable to participants
trading equity securities on and/or using
77 15
U.S.C. 78q–1.
U.S.C. 78s(b)(2).
79 In approving the proposed rule change, the
Commission considered the proposals’ impact on
efficiency, competition, and capital formation. 15
U.S.C. 78c(f). See also supra note 43 and
accompanying text.
80 17 CFR 200.30–3(a)(12).
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
78 15
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services provided by MIAX PEARL
Equities.3 The proposed fees are
scheduled to become operative
September 25, 2020.
The text of the proposed rule change
is available on the Exchange’s website at
https://www.miaxoptions.com/rulefilings/pearl at MIAX PEARL’s principal
office, and at the Commission’s Public
Reference Room.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
Exchange included statements
concerning the purpose of and basis for
the proposed rule change and discussed
any comments it received on the
proposed rule change. The text of these
statements may be examined at the
places specified in Item IV below. The
Exchange has prepared summaries, set
forth in sections A, B, and C below, of
the most significant aspects of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
On August 14, 2020, the Commission
approved the Exchange’s proposal to
adopt rules governing the trading of
equity securities, referred to as MIAX
PEARL Equities.4 The Exchange expects
to launch MIAX PEARL Equities on
September 25, 2020. The Exchange now
proposes to adopt a Definitions section
in the Fee Schedule as well as the
following fees in anticipation of the
launch of MIAX PEARL Equities: (1)
Connectivity fees for Equity Members 5
and non-Members; (2) Port fees (together
with the proposed connectivity fees, the
‘‘Proposed Access Fees’’); (3) a
Technical Support Request fee; and (4)
a fee for Historical Market Data
(collectively, the ‘‘Proposed Fees’’).6
3 See Exchange Rule 1901. The Exchange notes
that it submitted a separate filing with the
Commission pursuant to Section 19(b)(3)(A) of the
Act to establish the Fee Schedule and adopt
transaction fees. See SR–PEARL–2020–17 (filed
September 24, 2020).
4 See Securities Exchange Act Release No. 89563
(August 14, 2020), 85 FR 51510 (August 20, 2020)
(SR–PEARL–2020–03) (Order Approving a
Proposed Rule Change, as Modified by Amendment
No. 1, To Establish Rules Governing the Trading of
Equity Securities) (‘‘Approval Order’’).
5 The term ‘‘Equity Member’’ means a Member
authorized by the Exchange to transact business on
MIAX PEARL Equities. See Exchange Rule 1901.
6 The Exchange initially filed the proposed fee
changes on September 24, 2020 (SR–PEARL–2020–
18). On October 5, 2020, the Exchange withdrew
that filing and submitted this filing.
PO 00000
Frm 00124
Fmt 4703
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MIAX PEARL Equities, as a new
entrant into the equity securities
marketplace, has no revenues and no
market share. The Exchange believes
that exchanges, in setting fees of all
types, should meet very high standards
of transparency to demonstrate why
each new fee or fee increase meets the
requirements of the Act that fees be
reasonable, equitably allocated, not
unfairly discriminatory, and not create
an undue burden on competition among
members and markets. The Exchange
believes this high standard is especially
important when an exchange imposes
various access fees for market
participants to access an exchange’s
marketplace. The Exchange believes that
it is important to demonstrate that these
fees are based on its costs and
reasonable business needs. Accordingly,
the Exchange believes the Proposed
Fees in general, and the Proposed
Access Fees in particular, will allow the
Exchange to offset a portion of the
expenses the Exchange has and will
incur and that the Exchange has
provided sufficient transparency (as
described below) into how the Exchange
determined to charge such fees.
Definitions
The Exchange proposes to include a
Definitions section at the beginning of
the Fee Schedule, before the General
Notes section. The purpose of the
Definitions section is to provide market
participants greater clarity and
transparency regarding the applicability
of fees and rebates by defining terms
used within the Fee Schedule in a single
location. The Exchange notes that other
equities exchanges include Definitions
sections in their respective fee
schedules,7 and the Exchange believes
that including a Definitions section in
the front of the Fee Schedule makes the
Fee Schedule more user-friendly and
makes the Fee Schedule more
comprehensive.
Unless included in the Definition
section, capitalized terms used in the
Fee Schedule are defined in the MIAX
PEARL Equities Rules. Each of the
definitions proposed to be included in
the Fee Schedule are based on
definitions included in the existing
MIAX PEARL fee schedule applicable to
options or those of another exchange.
The Exchange proposes to define the
following terms in the Fee Schedule:
• ‘‘Cross-connect’’ occurs when the
affected third-party system is sited at
the same data center where MIAX
7 See Cboe BZX Exchange, Inc. Fee Schedule,
Definitions section; Cboe BYX Exchange, Inc.,
Definitions section; Cboe EDGA Exchange, Inc.,
Definitions section; Cboe EDGX Exchange, Inc.,
Definitions section.
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Agencies
[Federal Register Volume 85, Number 203 (Tuesday, October 20, 2020)]
[Notices]
[Pages 66646-66656]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-23138]
[[Page 66646]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-90181; File No. SR-NSCC-2020-016]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Amendment No. 2 and Order Granting Accelerated
Approval of a Proposed Rule Change, 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
October 14, 2020.
On July 30, 2020, National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\
proposed rule change SR-NSCC-2020-016 to add two new charges to NSCC's
margin methodology.\3\ On August 13, 2020, NSCC filed Amendment No. 1
to the proposed rule change, to make clarifications and corrections to
the proposed rule change.\4\ The proposed rule change, as modified by
Amendment No. 1, was published for public comment in the Federal
Register on August 20, 2020.\5\ The Commission has received comment
letters on the proposed rule change, as modified by Amendment No. 1.\6\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ NSCC also filed the proposals contained in the proposed rule
change as advance notice SR-NSCC-2020-804 with the Commission
pursuant to Section 806(e)(1) of the Dodd-Frank Wall Street Reform
and Consumer Protection Act entitled the Payment, Clearing, and
Settlement Supervision Act of 2010 (``Clearing Supervision Act''),
12 U.S.C. 5465(e)(1), and Rule 19b-4(n)(1)(i) of the Act, 17 CFR
240.19b-4(n)(1)(i).
\4\ Amendment No. 1 made clarifications and corrections to the
description of the proposed rule change and Exhibits 3 and 5 of the
filing. On August 13, 2020, NSCC filed Amendment No. 1 to the
advance notice to make similar clarifications and corrections to the
advance notice.
\5\ Securities Exchange Act Release No. 89558 (August 14, 2020),
85 FR 51521 (August 20, 2020) (``Notice''). The advance notice, as
modified by Amendment No. 1, was published for public comment in the
Federal Register on September 4, 2020. Securities Exchange Act
Release No. 89719 (September 1, 2020), 85 FR 55332 (September 4,
2020) (File No. SR-NSCC-2020-804). The comment period for the
advance notice, as modified by Amendment No. 1 closed on September
21, 2020, and the Commission received no comments.
\6\ Comments received are available at https://www.sec.gov/comments/sr-nscc-2020-016/srnscc2020016.htm.
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On August 27, 2020, NSCC filed Amendment No. 2 to the proposed rule
change to provide additional data for the Commission to consider in
analyzing the proposed rule change.\7\ The proposed rule change, as
modified by Amendment Nos. 1 and 2, is hereinafter referred to as the
``Proposed Rule Change.'' On October 2, 2020, pursuant to Section
19(b)(2) of the Act,\8\ the Commission designated a longer period
within which to approve, disapprove, or institute proceedings to
determine whether to approve or disapprove the Proposed Rule Change.\9\
The Commission is publishing this notice to solicit comments on
Amendment No. 2 from interested persons and, for the reasons discussed
below, to approve the Proposed Rule Change on an accelerated basis.
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\7\ In Amendment No. 2, NSCC updated Exhibit 3 to the proposed
rule change to include impact analysis data with respect to the
proposed rule change. NSCC filed Exhibit 3 as a confidential exhibit
to the proposed rule change pursuant to 17 CFR 240.24b-2. On August
27, 2020, NSCC filed Amendment No. 2 to the advance notice to
provide similar additional data for the Commission's consideration.
The advance notice, as amended by Amendment Nos. 1 and 2, is
hereinafter referred to as the ``Advance Notice.'' On October 2,
2020, the Commission published notice of filing of Amendment No. 2
and notice of no objection to the Advance Notice. Securities
Exchange Act Release No. 90034 (September 28, 2020), 85 FR 62342
(October 2, 2020) (File No. SR-NSCC-2020-804).
\8\ 15 U.S.C. 78s(b)(2).
\9\ Securities Exchange Act Release No. 90084 (October 2, 2020),
85 FR 63607 (October 8, 2020).
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I. Description of the Proposed Rule Change
First, the Proposed Rule Change would revise NSCC's Rules and
Procedures (``Rules'') \10\ to introduce the Margin Liquidity
Adjustment Charge (``MLA Charge'') as an additional margin component.
Second, the Proposed Rule Change 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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\10\ 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 is determining and collecting an appropriate
Required Fund Deposit (i.e., margin) for each member.\11\ 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.\12\
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\11\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund
Formula and Other Matters) of the Rules (``Procedure XV''), supra
note 10.
\12\ 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.\13\ 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.\14\ NSCC's methodology for calculating the 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.\15\ 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.\16\
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.\17\
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\13\ See id.
\14\ See id.
\15\ 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).
\16\ See id.
\17\ See Notice, supra note 5 at 51522.
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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.\18\ NSCC states
[[Page 66647]]
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.\19\
---------------------------------------------------------------------------
\18\ See id.
\19\ 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 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.\20\ In a member
default, liquidating such large positions within a potentially
compressed timeframe \21\ (e.g., in a fire sale) could have an impact
on the underlying market, resulting in price moves that increase NSCC's
risk of incurring additional liquidation costs. Therefore, NSCC
designed the MLA Charge to address this specific risk.\22\
---------------------------------------------------------------------------
\20\ See Notice, supra note 5 at 51522-23.
\21\ NSCC's risk models assume the liquidation occurs over a
period of three business days. See Notice, supra note 5 at 51523.
\22\ See id.
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The MLA Charge would be based on comparing the market value of
member portfolio positions in specified asset groups \23\ 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,\24\ 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 would assume for each
asset group that a certain share of the market can be liquidated
without price impact.\25\ 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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\23\ 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.
\24\ 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.
\25\ 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, supra note 5 at 51523-25.
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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.\26\
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\26\ 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, supra
note 5 at 51523-24.
---------------------------------------------------------------------------
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.\27\
---------------------------------------------------------------------------
\27\ See supra note 24.
---------------------------------------------------------------------------
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.\28\ 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.\29\ If the ratio of these two
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.
---------------------------------------------------------------------------
\28\ 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, supra note 5 at 51524. 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).
\29\ 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 Proposed Rule Change 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
[[Page 66648]]
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.\30\
---------------------------------------------------------------------------
\30\ See Notice, supra note 5 at 51524.
---------------------------------------------------------------------------
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.\31\ 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.\32\
---------------------------------------------------------------------------
\31\ See Section I.(B)(2) of Procedure XV, supra note 10.
\32\ See Notice, supra note 5 at 51524.
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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 methodology.
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 group in a member's portfolio to
calculate the member's final Bid-Ask Spread Charge.
NSCC determined the proposed initial haircut rates based 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.\33\ Based on
analyses of recent years' simulation exercises, NSCC does not
anticipate that these haircut rates would change significantly year
over year.\34\ 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.\35\
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\33\ See Notice, supra note 5 at 51525.
\34\ See id.
\35\ 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 28.
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D. Description of Amendment No. 2
In Amendment No. 2, NSCC updated Exhibit 3 to the Proposed Rule
Change to include impact analysis data with respect to the Proposed
Rule Change. Specifically, Amendment No. 2 includes impact studies for
various time periods detailing the average and maximum MLA and Bid-Ask
Charges for each member, by both percentage and amount. NSCC filed
Exhibit 3 as a confidential exhibit to the Proposed Rule Change
pursuant to 17 CFR 240.24b-2.
II. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act \36\ directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to such organization. After careful consideration, the
Commission finds that the Proposed Rule Change is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to NSCC. In particular, the Commission finds that the
Proposed Rule Change is consistent with Sections 17A(b)(3)(F) and
(b)(3)(I) \37\ of the Act and Rules 17Ad-22(e)(4) and (e)(6)
thereunder.\38\
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\36\ 15 U.S.C. 78s(b)(2)(C).
\37\ 15 U.S.C. 78q-1(b)(3)(F) and (b)(3)(I).
\38\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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A. Consistency With Section 17A(b)(3)(F)
Section 17A(b)(3)(F) of the Act requires, in part, that the rules
of a clearing agency, such as NSCC, be designed to promote the prompt
and accurate clearance and settlement of securities transactions,
assure the safeguarding of securities and funds which are in the
custody or control of the clearing agency or for which it is
responsible, remove impediments to and perfect the mechanism of a
national system for the prompt and accurate clearance and settlement of
securities transactions, and, in general, to protect investors and the
public interest.\39\ The Commission believes that the Proposed Rule
Change is consistent with Section 17A(b)(3)(F) of the Act.
---------------------------------------------------------------------------
\39\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
First, 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. In addition, 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 risks by
adding the MLA Charge and Bid-Ask Spread Charge, respectively, to its
margin methodology.\40\
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\40\ 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.
---------------------------------------------------------------------------
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. Based on its review of the Proposed Rule Change, including
confidential
[[Page 66649]]
Exhibit 3 thereto,\41\ the Commission understands that 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. As discussed above, NSCC designed the MLA Charge and Bid-Ask
Spread Charge, respectively, to reflect two distinct and specific risks
presented to NSCC: (1) The risk associated with liquidating a defaulted
member's portfolio that holds concentrated positions in securities
sharing similar risk profiles; as well as (2) the risks associated with
the bid-ask spread costs relevant to the securities in the defaulted
member's portfolio. As a result, any margin increases that result from
the MLA and the Bid-Ask Spread Charges are limited to address those
respective risks. This targeted increase in available financial
resources should decrease the likelihood that losses arising out of a
member default stemming from the liquidation of concentrated positions
or bid-ask spreads would cause NSCC to exhaust its financial resources
and threaten the operation of its critical clearance and settlement
services. Accordingly, the Commission believes that the Proposed Rule
Change should help NSCC to continue providing prompt and accurate
clearance and settlement of securities transactions in the event of a
member default.
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\41\ Specifically, the confidential Exhibit 3 submitted by NSCC
includes, among other things, impact studies for various time
periods detailing the average and maximum MLA and Bid-Ask Spread
Charges for each member, by both percentage and amount, a detailed
methodology describing the calculation of the MLA and Bid-Ask Spread
Charges, and information regarding how NSCC determined the
appropriate methodology.
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Second, 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
augment its ability to manage the potential costs of liquidating a
defaulted member's portfolio by collecting 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 NSCC arising out of a member default.
Accordingly, the Commission believes the Proposed Rule Change would
promote the safeguarding of securities and funds which are in the
custody or control of NSCC or for which NSCC is responsible, consistent
with Section 17A(b)(3)(F) of the Act.
One commenter argues that the Proposed Rule Change is not in the
public interest and would harm investors and small businesses by
dampening small business capital formation and liquidity and
discouraging trading activity, as discussed more fully below.\42\ The
Commission disagrees that the proposal is not in the public interest.
The Commission believes that the proposal should help protect investors
and the public interest by mitigating some of the risks presented by
NSCC as a CCP. Because a defaulting member could place stresses on NSCC
with respect to NSCC's ability to meet its clearance and settlement
obligations upon which the broader financial system relies, it is
important that NSCC has a strong margin methodology to limit NSCC's
credit risk exposure in the event of a member default. As described
above, the Proposed Rule Change would add two charges specifically
designed to address risks that are not currently addressed in NSCC's
margin methodology related to: (1) The potential costs that NSCC may
incur when liquidating a portfolio that is concentrated in a particular
security or group of securities with a similar risk profile, and (2)
the potential costs that NSCC may incur to cover the bid-ask spread
when liquidating a portfolio. These changes should help ensure that
NSCC collects sufficient margin that is more commensurate with the
risks associated with the potential concentration and bid-ask spread
liquidation costs identified above, and thus more effectively cover its
credit exposures to its members. By collecting margin that more
accurately reflects the risk characteristics of such portfolios and the
bid-ask spreads of securities they contain (i.e., the potential
associated costs of liquidating such portfolios), NSCC would be in a
better position to absorb and contain the spread of any losses that
might arise from a member default. Therefore, the proposal is designed
to reduce the possibility that NSCC would need to call for additional
resources from non-defaulting members due to a member default, which
could inhibit the ability of these non-defaulting members to facilitate
securities transactions. Accordingly, the Commission believes that the
proposal is designed to protect investors and the public interest by
mitigating some of the risks presented by NSCC as a CCP.\43\
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\42\ Letter from James C. Snow, President/CCO, Wilson-Davis &
Co., Inc. (received September 30, 2020) at 1 (``Wilson-Davis
Letter'').
\43\ See Securities Exchange Act Release No. 78961 (September
28, 2016), 81 FR 70786, 70849 (October 13, 2016) (``While central
clearing generally benefits the markets in which it is available,
clearing agencies can pose substantial risk to the financial system
as a whole, due in part to the fact that central clearing
concentrates risk in the clearing agency.'').
---------------------------------------------------------------------------
One commenter asserts that the proposal dampens capital formation
and liquidity and that firms and investors would stop participating in
trades because of the proposal.\44\ Specifically, the commenter states
that broker-dealers would not be able to trade securities issued by
small companies because the ``insurance requirement'' would be too
high. In addition, the commenter states that investors would be
dissuaded from trading in such securities. Overall, the commenter
argues that the Proposed Rule Change is inconsistent with the
Commission's mission of facilitating capital formation.
---------------------------------------------------------------------------
\44\ Wilson-Davis Letter at 4-5.
---------------------------------------------------------------------------
First, with respect to the comment regarding liquidity and capital
formation, the Commission believes that limiting NSCC's exposure to its
members by allowing NSCC to collect margin to address the two risks
that are not currently addressed would benefit members due to NSCC's
decreased exposure to losses resulting from a member default.
Effectively mitigating such risks would, in turn, reduce the likelihood
that NSCC would have to call on its members to contribute additional
resources, which otherwise could be used by its members to facilitate
securities transactions thereby providing liquidity to the securities
markets. Thus, the Commission believes that NSCC's proposal, by helping
non-defaulting members preserve their financial resources, could
promote liquidity provision in such circumstances because these
resources would be available to facilitate securities transactions.
Nevertheless, the Commission acknowledges that the proposal could
result in an increase in the margin required to be collected from a
member, which, in turn, may result in such member incurring additional
costs to access needed liquidity. Despite these potential impacts, the
Commission is not persuaded that the Proposed Rule Change would have a
negative effect on small business capital formation such that it would
be inconsistent with the public interest or, more broadly, the
Commission's mission. To the extent that members incur funding costs
[[Page 66650]]
associated with additional margin, they may choose to distribute these
costs across transactions in all securities for which they make markets
rather than allocate those costs only to transactions in securities
that require additional margin. Thus, the fact that members have
flexibility in how they allocate costs could mitigate negative impacts,
if any, on the liquidity and capital formation of a particular subset
of issuers.
Both the MLA Charge and the Bid-Ask Spread Charge would apply to
all securities cleared and settled at NSCC and would not be directed to
any particular group of securities. The MLA Charge would only apply to
portfolios where 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. Thus, the application of the charge depends on the
particular mix of securities within the specified asset groups in a
member's portfolio and does not depend solely on the presence of
particular types of securities. The Bid-Ask Spread Charge would apply
to all the securities in a member's portfolio and would not apply only
to a particular type of security. The Commission acknowledges that the
haircuts that would determine the Bid-Ask Spread Charge would, in part,
consider the nature of the security, with the highest haircut
percentages applicable to micro-cap and small-cap securities. However,
based on its consideration of NSCC's determination of the haircut
schedule, as informed by NSCC's 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, the
Commission believes that the haircut schedule is appropriate given that
such securities likely would exhibit larger bid-ask spreads, making the
higher haircut more conservative and consistent with NSCC's regulatory
requirements to collect margin commensurate with the risks presented by
the securities.
Further, the Commission is not persuaded by the commenter's
generalized statements on the potential impact on small business
capital formation that could result from implementation of the Proposed
Rule Change, which are lacking any specific data or analysis in support
thereof. The Commission acknowledges the possibility that, as the
commenter asserted, issuers of securities in smaller companies may
experience a reduction in liquidity because of the increased margin
requirements applicable to transactions in such securities.
Nevertheless, the Commission believes that small business issuers that
are more liquid could benefit from greater access to capital to the
extent that the proposal leads to a net increase in demand for more
liquid securities and a net decrease in demand for less liquid
securities. Further, the Commission does not agree with the commenter
that investors would be dissuaded from trading in such securities. The
Commission is aware of research suggesting that the stock prices of
smaller companies fall in response to a reduction in liquidity until
such securities provide an adequate desired return for investors.\45\
Thus, as long as stock prices can adjust to reflect the reduced
liquidity, affected small issuers may still be able to attract capital
from investors, albeit at a higher cost that appropriately reflects the
risks inherent in the clearance and settlement of the securities they
issue. Moreover, to the extent that investment decisions are driven by
other factors, such as the future prospects of specific companies,
there might be no decrease in access to capital or little change in
cost.
---------------------------------------------------------------------------
\45\ See, e.g., Viral Acharya and Lasse H. Pedersen, 2005, Asset
pricing with liquidity risk, Journal of Financial Economics 77(2)
375-410.
---------------------------------------------------------------------------
In addition, the commenter's arguments ignore the potential
benefits to small businesses when their securities are eligible for
central clearing by NSCC. As do other clearing agencies, NSCC provides
a number of services that mitigate risk, reduce costs, and enhance
processing efficiencies for the securities markets, market
participants, issuers (including small issuers), and investors. By
reducing NSCC's risk exposure to its members and thus the likelihood of
its failure, the proposal helps ensure that NSCC would continue to
provide such services, which would benefit securities markets, market
participants, issuers (including small issuers), and investors. Thus,
the commenter does not take into account any potential positive impacts
on small business capital formation that may arise as a result of the
Proposed Rule Change.
Second, the Commission is not persuaded that the Proposed Rule
Change will not protect investors solely because of the potential for
increased costs. The Commission notes that although the proposal may
result in an increase in margin requirements for particular portfolios
(as a result of the MLA Charge) and to reflect the bid-ask spread (as a
result of the Bid-Ask Spread Charge), such an increase is designed to
allow NSCC to reduce the risks when liquidating a portfolio in the
event of a member default. As a result, NSCC should be more resilient
so that it can satisfy its obligations as a CCP, which facilitates the
protection of investors by helping to ensure that investors receive the
proceeds from their securities transactions. In addition, as discussed
earlier, the Commission believes that the proposal should help protect
investors and the public interest by mitigating some of the risks
presented by NSCC as a CCP.
Therefore, notwithstanding the potential unspecified impact on
capital formation in smaller and less liquid markets, as described
above, the Commission believes that, in light of the potential benefits
to investors arising from the Proposed Rule Change and the overall
improved risk management at NSCC, the Proposed Rule Change is designed
to protect investors and the public interest, consistent with Section
17A(b)(3)(F) of the Act.
Finally, one commenter asserted that the Proposed Rule Change would
add impediments to the national system for clearance and settlement
because it would create more complicated algorithms that slow the
clearance process, burdens settlement and harms investors, firms and
small businesses.\46\ Based on the Commission's review of the materials
that NSCC has filed in connection with this Proposed Rule Change and
its general knowledge of the information technology systems and
infrastructure in place at NSCC, the Commission concludes that the
Proposed Rule Change would not slow the clearance and settlement
process at NSCC. The Proposed Rule Change is designed to enable NSCC to
address two risks that are not currently reflected in its margin
methodology. The proposal introduces the MLA Charge as an additional
margin component, and adds a Bid-Ask Spread Charge to NSCC's margin
calculations. The Commission believes that these new margin charges
will better enable NSCC to establish a risk-based margin system that
(1) considers and produces 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.\47\ The operation of the risk-based margin
[[Page 66651]]
system, as amended by the proposal, would not interfere with the
clearance and settlement of securities transactions. As a result, the
proposal should not slow the clearance process, burden settlement or
harm investors, firms and small businesses. Instead, the Proposed Rule
Change should help ensure that NSCC will continue to perform its vital
role to settle transactions on time and at their agreed upon terms in
the event of a member default, which will better protect investors,
firms, small businesses, and the broader financial system. Moreover,
the Commission does not believe that the Proposed Rule Change would
impose any additional impediments on the national system of clearance
and settlement; the fact that the application of the revised margin
methodology may, in some instances, result in increased margin
requirements (as discussed in more detail in Section II.B below) does
not constitute the imposition of such an impediment.
---------------------------------------------------------------------------
\46\ Id. at 1, 5.
\47\ See Securities Exchange Act Release No. 90034 (September
28, 2020), 85 FR 62342 (October 2, 2020) (File No. SR-NSCC-2020-
804).
---------------------------------------------------------------------------
The commenter also argues that the Proposed Rule Change is an
ineffective attempt by NSCC to address its credit risks.\48\ The
commenter argues that NSCC could address the risk directly by modifying
the settlement timeline. According to the commenter, if the NSCC
proposed rules that would eliminate the two-day settlement cycle in
favor of immediate, same-day electronic settlement, the market risk
exposure would be eliminated. The Commission disagrees with the
commenter. The securities industry transitioned to the current two-day
settlement cycle on September 5, 2017, only after a multi-year,
industry-wide initiative \49\ and the Commission's amendment of Rule
15c6-1.\50\ Therefore, the commenter's suggestion that NSCC could
unilaterally shorten the current two-day settlement to a same-day
settlement cycle is not a feasible alternative to the Proposed Rule
Change.
---------------------------------------------------------------------------
\48\ Wilson-Davis Letter at 4.
\49\ See Securities Exchange Act Release No. 78962 (September
28, 2016), 81 FR 69240, 69254 (October 5, 2016) (``Discussion of
Current Efforts To Shorten the Settlement Cycle in the U.S.'').
\50\ See Securities Exchange Act Release No. 80295 (March 22,
2017), 82 FR 15564 (March 29, 2017).
---------------------------------------------------------------------------
B. Consistency With Section 17A(b)(3)(I) of the Act
Section 17A(b)(3)(I) of the Act requires that the rules of a
clearing agency do not impose any burden on competition not necessary
or appropriate in furtherance of the Act.\51\ This provision does not
require the Commission to find that a proposed rule change represents
the least anti-competitive means of achieving the goal. Rather, it
requires the Commission to balance the competitive considerations
against other relevant policy goals of the Act.\52\
---------------------------------------------------------------------------
\51\ 15 U.S.C. 78q-1(b)(3)(I).
\52\ See Bradford National Clearing Corp., 590 F.2d 1085, 1105
(D.C. Cir. 1978).
---------------------------------------------------------------------------
Both commenters argue that the Proposed Rule Change would
disproportionately impact member firms with lower operating margins or
higher costs of capital.\53\ The Commission acknowledges that the
Proposed Rule Change could entail increased margin charges to some
members, including members that invest in concentrated positions in
securities sharing a common risk profile and members that invest in
securities that have larger bid-ask spreads, which may include microcap
and small cap securities. Nevertheless, as discussed above, the
Proposed Rule Change would calculate the MLA Charge and Bid-Ask Spread
Charge based on the composition of a member's portfolio, regardless of
member size or type, and the charges would not target or apply solely
to Illiquid Securities or securities with a smaller market
capitalization. Instead, as discussed above in Sections I.B and I.C,
both the MLA and Bid-Ask Spread Charges would serve to address
particular potential costs that NSCC may incur when liquidating a
portfolio in a member default. To the extent a particular member's
margin would increase under the Proposed Rule Change, that increase
would be based on the mix of securities that make up the member's
portfolio and NSCC's requirement to collect margin to appropriately
address the associated risks, which it currently does not do.
---------------------------------------------------------------------------
\53\ See Wilson-Davis Letter at 4-5; Letter from Cass Sanford,
Associated General Counsel, OTC Markets Group (September 11, 2020)
at 2 (``OTC Letter''). One commenter further states that the
Proposed Rule Change would double its required margin, based on an
impact study it received from NSCC. (Wilson-Davis Letter at 2.) The
commenter states that the impact study covered only one quarter of
information and concludes that NSCC is making this decision based
solely on that analysis. NSCC responds that the impact study cited
in the Wilson-Davis Letter did not include any potential impacts of
the Proposed Rule Change because that impact study was provided by
NSCC to Wilson-Davis in connection with the separate Illiquid
Securities Proposal. NSCC states that it conducted member outreach
in August 2020, providing members with, among other things, an
impact study on the Proposed Rule Change based on data from the
first quarter of 2020. NSCC further states that the data show a
total margin increase to NSCC members by an average of 5.3% from the
proposed MLA Charge and by an average of 3.6% from the proposed Bid-
Ask Spread Charge. See Letter from Timothy J. Cuddihy, Managing
Director, DTCC Financial Risk Management (October 7, 2020) (``NSCC
Letter'') at 2. Additionally, the confidential materials filed by
NSCC as part of the Proposed Rule Change include an analysis of the
impacts of both charges, by member, over the year-long time period
June 2019 through May 2020. Based on the Commission's review of the
impact analysis, the Proposed Rule Change would not cause any NSCC
member's volatility charge to double.
---------------------------------------------------------------------------
In addition, the Commission acknowledges that the impact of
increased margin requirements may present higher costs to some members
relative to others due to a number of factors, such as access to
liquidity resources, cost of capital, business model, and applicable
regulatory requirements. These higher relative burdens may weaken
certain members' competitive positions relative to other members.
However, some members, particularly those most affected by the change,
may respond to increased margin requirements by adjusting their
liquidity management and business models, such as by holding less
concentrated positions or shifting liquidity provision towards
securities that are less likely to incur the proposed charges.\54\ Such
effects may mitigate competitive effects on members. Moreover, the
Commission also notes that NSCC is required to manage the risk
presented by each member by establishing a risk-based margin
system.\55\ NSCC's members include a large and diverse population of
entities. By participating in NSCC, each member is subject to the same
margin methodology which is designed to satisfy NSCC's regulatory
obligation to manage the risk presented by its members.
---------------------------------------------------------------------------
\54\ See Section II.A infra (discussing capital formation).
\55\ See 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------
Moreover, the Commission believes that the Proposed Rule Change
would not impose a burden on competition that is not necessary or
appropriate in furtherance of the Act. As discussed above, NSCC faces
the risk of liquidation costs when a member's portfolio contains large
positions in securities sharing similar risk profiles. Similarly, NSCC
faces the risk of costs that would materialize in connection with the
bid-ask spread of the securities in a member's portfolio. Such costs
are currently unaccounted for in NSCC's current margin methodology.
NSCC has provided impact analyses demonstrating that the Proposed Rule
Change would result in margin levels that better reflect the risks
associated with (1) concentrated large positions in securities sharing
a similar risk profile, and (2) bid-ask spread transaction costs than
NSCC's current margin methodology. Since certain securities and
portfolio compositions present NSCC with unique liquidation risks, the
Commission believes it is appropriate
[[Page 66652]]
for NSCC to require members holding such securities or portfolio
compositions to provide margin amounts commensurate with the identified
risks. Thus, the Commission believes that the MLA Charge and Bid-Ask
Spread Charge are margin requirements that represent an appropriate
response to the risk characteristics of members' portfolio holdings,
and not an undue burden on competition. Accordingly, the Commission
believes that the Proposed Rule Change would help NSCC better maintain
sufficient financial resources to cover its credit exposures to each
member in full with a high degree of confidence. By helping NSCC to
better manage its credit exposure, the Proposed Rule Change would help
NSCC better mitigate the potential losses to NSCC associated with
liquidating a member's portfolio in the event of a member default, in
furtherance of NSCC's obligations under Section 17A(b)(3)(F) of the
Act.
Additionally, the Commission notes that in order 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 specific contemplation by NSCC of a targeted
reduction in the MLA Charge as a feature of the Proposed Rule Change
that demonstrates an approach towards managing the relevant risks
through appropriate (i.e., not simply ``larger'') margin requirements.
Therefore, for the reasons stated above, the Commission believes
that the Proposed Rule Change is consistent with the requirements of
Section 17A(b)(3)(I) of the Act \56\ because any competitive burden
imposed by the proposal is necessary or appropriate in furtherance of
the Act.
---------------------------------------------------------------------------
\56\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
C. 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.\57\
---------------------------------------------------------------------------
\57\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------
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 should enable
NSCC to manage such risks and costs.
One commenter suggests that the Proposed Rule Change is duplicative
of a separate NSCC proposal regarding Illiquid Securities that is
currently pending before the Commission.\58\ The commenter argues that
since both proposals include provisions that would affect margin levels
with respect to Illiquid Securities, both proposals appear to address
the same concerns. Therefore, the commenter suggests that instead of
approving the Proposed Rule Change, the Commission should consolidate
NSCC's associated 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
commenter. The Proposed Rule Change (and NSCC's associated 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 security, i.e., calculate appropriate margin to cover
potential losses on a portfolio using historical, mid-point securities
prices. The Proposed Rule Change is designed to address two specific
risks that are not captured directly by historical mid-point security
price movements that may arise specifically 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.
---------------------------------------------------------------------------
\58\ OTC Markets Letter at 1-2 (citing Securities Exchange Act
Release No. 88615 (April 9, 2020), 85 FR 21037 (April 15, 2020) (SR-
NSCC-2020-802) (``Illiquid Securities Proposal'')).
---------------------------------------------------------------------------
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. As stated above, for most securities (e.g., equity
securities), NSCC calculates the volatility component using, among
other things, a parametric 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, the Proposed Rule Change is not designed to define
what
[[Page 66653]]
constitutes an Illiquid Security under NSCC's Rules, 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, the Proposed Rule
Change 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 Proposed Rule Change is designed to address
the discrete risks of a default liquidation scenario 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 the Proposed Rule Change and the Illiquid Securities Proposal
address wholly separate and distinct aspects of NSCC's margin
methodology, the Commission disagrees with the commenter 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.\59\
---------------------------------------------------------------------------
\59\ Id.
---------------------------------------------------------------------------
D. Consistency With Rules 17Ad-22(e)(6)
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.\60\ 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.\61\
---------------------------------------------------------------------------
\60\ 17 CFR 240.17Ad-22(e)(6)(i).
\61\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------
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 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.C, 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.\62\
---------------------------------------------------------------------------
\62\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
---------------------------------------------------------------------------
One commenter argues that the Proposed Rule Change would burden
members with margin requirements that are not commensurate with NSCC's
actual risks, as evidenced by the lack of recent settlement losses, and
instead are designed to mitigate imaginary risks.\63\ In addition, the
commenter argues that NSCC has not provided evidence of the need for
the Proposed Rule Change, again citing the lack of recent settlement
losses. However, as discussed above, the Commission believes that the
proposed changes to NSCC's margin methodology would enable it to
collect margin appropriately tailored to two particular risks that are
not currently addressed in the existing margin methodology. The
Commission does not agree that the fact that NSCC has not suffered
recent settlement losses obviates the need for the Proposed Rule
Change. Rule 17Ad-22(e)(6)(iii) 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,
calculates margin
[[Page 66654]]
sufficient to cover its potential future exposure to participants in
the interval between the last margin collection and the close out of
positions following a participant default.\64\ Potential future
exposure is, in turn, defined as the maximum exposure estimated to
occur at a future point in time with an established single-tailed
confidence level of at least 99 percent with respect to the estimated
distribution of future exposure.\65\ Thus, to be consistent with its
regulatory requirements, NSCC must consider potential future exposure,
which includes, among other things, losses associated with the
liquidation of a defaulted member's portfolio. Based on its review and
analysis of the Proposed Rule Change, including the confidential impact
analyses demonstrating the overall effects that the proposed changes
would have on the overall margin collected by NSCC and the confidential
margin methodology (i.e., the specific details of how NSCC would
calculate its margin requirements under the proposed changes), in
conjunction with the Commission's supervisory observations, the
Commission believes that the proposed changes would better enable NSCC
to collect margin commensurate with the different levels of risk that
members pose to NSCC as a result of their particular portfolio, which
is consistent with Rule 17Ad-22(e)(6)(i), and to calculate margin
sufficient to cover its potential future exposure to its participants,
which is consistent with Rule 17Ad-22(e)(6)(iii).
---------------------------------------------------------------------------
\63\ Wilson-Davis Letter at 3, 5.
\64\ 17 CFR 240.17Ad-22(e)(6)(iii).
\65\ 17 CFR 240.17Ad-22(a)(13).
---------------------------------------------------------------------------
E. Consistency With Rules 17Ad-22(e)(23)(ii)
Rule 17Ad-22(e)(23)(ii) \66\ requires each covered clearing agency
to establish, implement, maintain, and enforce written policies and
procedures reasonably designed to provide sufficient information to
enable participants to identify and evaluate the risks, fees, and other
material costs they incur by participating in the covered clearing
agency.
---------------------------------------------------------------------------
\66\ 17 CFR 240.17Ad-22(e)(23)(ii).
---------------------------------------------------------------------------
Both commenters argue that the Proposed Rule Change fails to
provide sufficient information to evaluate the necessity and impact of
the proposal.\67\ Specifically, one commenter argues that the proposal
provides no explanation as to why NSCC's current margin formula is
inadequate or how the proposed methodology would limit NSCC's exposure
in the event of a member default.\68\ Another commenter stated that the
Proposed Rule Change does not comply with Rule 17Ad-22(e)(23)(ii),
asserting that NSCC has not performed the ``requisite analysis'' or
gathered sufficient data to fully understand the impact of the
proposal.\69\
---------------------------------------------------------------------------
\67\ See OTC Letter at 2; Wilson-Davis Letter at 1, 4-5.
\68\ See OTC Letter at 2.
\69\ See Wilson-Davis Letter at 2-3. Contrary to the commenter's
implication, Rule 17Ad-22(e)(23) does not prescribe any specific
data or analysis that a covered clearing agency, like NSCC, must
perform when making changes to its margin methodology. Moreover, as
discussed above in note 41, NSCC has provided confidential impact
analyses covering a one-year time period to demonstrate the
potential impact of the Proposed Rule Change on its members.
In addition, the commenter references Rule 17Ad-22(e)(23)(iii),
which requires a covered clearing agency, like NSCC, to establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to provide basic transaction volume and values.
See Wilson-Davis Letter at 2. However, the information described by
the commenter would not constitute basic data on transaction volumes
and values, as required by the rule, and instead would appear to
refer to more detailed analysis of the impacts of particular margin
methodologies. Moreover, NSCC publicly provides data on transaction
volumes and values in its quantitative disclosures, which are
available at https://www.dtcc.com/legal/policy-and-compliance.
---------------------------------------------------------------------------
The Commission disagrees with the commenters that the Proposed Rule
Change does not provide sufficient information to understand the
potential costs associated with participating in NSCC, based on the
materials reflected in the Proposed Rule Change.\70\ When considering
the issues raised in the Proposed Rule Change, the Commission
thoroughly reviewed (1) the Proposed Rule Change, including the
supporting exhibits that provided, among other things, confidential
impact analyses regarding the proposals in the Proposed Rule Change;
(2) the comment letters; 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 described in the Notice,
NSCC has done exactly what the commenters seek, 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 designed to
address these particular risks). As described in the Notice and noted
above, NSCC's current margin methodology neither accounts 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,
nor does NSCC's current margin methodology account for this risk of
potential bid-ask spread transaction costs in connection with
liquidating a defaulted member's portfolio. The Proposed Rule Change is
designed to address these specific risks and limit NSCC's exposure in
the event of a member default.
---------------------------------------------------------------------------
\70\ One commenter argues that the proposal is generally
unclear, overly technical and complicated, inappropriately relies on
information provided by NSCC to the Commission confidentially, and
thus prevents the public from fully evaluating and providing
meaningful comment on the proposal. As stated above, the Commission
believes that the proposal adequately explains why the current
methodology is inadequate (i.e., it does not address certain
specific risks), and how the proposed methodology would address this
issue (i.e., via the MLA Charge and Bid-Ask Spread Charge).
Additionally, the Commission does not believe that the Proposed Rule
Change is overly technical and complicated. The process of measuring
the risks involved with various member portfolio compositions to
determine appropriate margin levels is technical, complex, and does
not distill into a simple formula. Instead, the process often must
utilize sophisticated risk models and calculations. NSCC has
described the methodology that it would use to determine the margin
to address these specific risks with sufficient specificity to allow
a member to understand the types of portfolios that would be subject
to an additional MLA Charge and to understand the haircuts that
would apply to determine the Bid-Ask Spread Charge.
Moreover, the Commission believes that NSCC appropriately
submitted Exhibit 3 to the filing confidentially because it includes
detailed member-level margin data and other proprietary information.
Under its Rules, NSCC is not permitted to disclose member-level
information. See Rule 49 of the Rules, supra note 10. NSCC requested
confidential treatment of such materials and its underlying detailed
methodology documentation, consistent with the applicable regulatory
requirements. See 17 CFR 240.24b-2.
---------------------------------------------------------------------------
The Proposed Rule Change describes how NSCC would determine the MLA
and Bid-Ask Spread Charges. For both charges, the Proposed Rule Change
identifies the relevant asset groupings that NSCC would utilize. For
the MLA Charge, NSCC has described how the charge would depend on
whether a member holds large aggregate positions in an asset group.
Thus, a member should be able to consider whether its positions would
likely trigger the MLA Charge in light of the relevant holdings in its
portfolio. For the Bid-Ask Spread Charge, NSCC has identified that the
charge would be determined by application of a haircut and provided a
schedule of the applicable haircuts. Thus, a member should be able to
understand what the charge would be for a particular security. In
addition, NSCC represented that in August 2020, NSCC provided all its
Members with the results of an impact study regarding the potential
impacts of both the Illiquid Securities Proposal and the MLA Proposal
and clearly delineated between the impacts of these separate
[[Page 66655]]
proposals.\71\ NSCC also included a written summary of the MLA Proposal
and offered to schedule a call to discuss these proposals and their
potential impacts.\72\ Moreover, NSCC has provided impact analyses
demonstrating that the Proposed Rule Change would result in margin
levels that better reflect the risks associated with (1) concentrated
large positions in securities sharing a similar risk profile, and (2)
bid-ask spread transaction costs than NSCC's current margin
methodology. Accordingly, the Commission believes that NSCC has
demonstrated the operation and impact of the Proposed Rule Change,
i.e., that it would help NSCC better maintain sufficient financial
resources to cover its credit exposures to each member in full with a
high degree of confidence.
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\71\ NSCC Letter at 2.
\72\ Id. More generally, NSCC stated that it routinely reaches
out to members that may be impacted by its proposals. This outreach
includes impact study results and an offer to discuss those results
and the underlying proposal. Id.
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Moreover, to provide transparency and assist members in
understanding their margin requirements, NSCC maintains the NSCC Risk
Management Reporting application on the Participant Browser Service
(``PBS'') and the NSCC Risk Client Portal (``Portal''), which will
include this Proposed Rule Change once it is implemented.\73\ The PBS
is a member-accessible website portal for accessing reports and other
disclosures. The Risk Management Reporting application enables a member
to view and download margin requirement information and component
details, including issue-level margin information related to start of
day volatility charges and mark-to-market, intraday exposure, and other
components. Members are able to view and download spreadsheets that
contain market amounts for current clearing positions and the
associated volatility charges. In addition, NSCC represents that the
Portal provides members the ability, for information purposes, to view
and analyze certain risks relating to their portfolios, including
calculators to assess the risks and margin impacts of certain
activities and to compare their portfolios to historical and average
values.
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\73\ See Letter from Timothy J. Cuddihy, Managing Director DTCC
Financial Risk Management, submitted in response to comments on the
Illiquid Securities Proposal, available at, https://www.sec.gov/comments/sr-nscc-2020-802/srnscc2020802.htm.
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NSCC further maintains the NSCC Client Calculator on the Portal
that provides functionality for members to enter ``what-if'' position
data and to recalculate their volatility charges to determine margin
impact pre-trade. In other words, this calculator allows members to see
the impact to the volatility charge if specific transactions are
executed, or to anticipate the impact of an increase or decrease to a
current clearing position. Using this calculator, members have the
ability to download the Client Calculator portfolio detail to modify a
current margin portfolio, upload the portfolio to run a margin
calculation, and view position level outputs in order to make informed
risk management and execution decisions.
Taken together, these tools should allow members to understand how
these charges would affect their portfolios. Accordingly,
notwithstanding the comments, the Commission believes that the Proposed
Rule Change is not inconsistent with Rule 17Ad-22(e)(23)(ii).\74\
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\74\ 17 CFR 240.17Ad-22(e)(23)(ii).
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III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning whether Amendment No. 2 is consistent with the
Act. Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include File Number
SR-NSCC-2020-016 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-2020-016. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (https://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the Proposed Rule Change that are filed with
the Commission, and all written communications relating to the Proposed
Rule Change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of 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-2020-016 and should be
submitted on or before November 10, 2020.
IV. Accelerated Approval of the Proposed Rule Change, as Modified by
Amendment No. 2
The Commission finds good cause, pursuant to Section
19(b)(2)(C)(iii) of the Act,\75\ to approve the Proposed Rule Change,
as modified by Amendment Nos. 1 and 2, prior to the thirtieth day after
the date of publication of Amendment No. 2 in the Federal Register. As
noted above, in Amendment No. 2, NSCC updated the confidential Exhibit
3 to the Proposed Rule Change to include impact analysis data with
respect to the Proposed Rule Change. Specifically, Amendment No. 2
includes impact studies for various time periods detailing the average
and maximum MLA and Bid-Ask Charges for each member, by both percentage
and amount. The Commission believes that the member-level data in
Amendment No. 2 warrants confidential treatment. Amendment No. 2
neither modifies the Proposed Rule Change as originally published in
any substantive manner, nor does Amendment No. 2 affect any rights or
obligations of NSCC or its members. Instead, Amendment No. 2 provides
the Commission with information necessary to evaluate whether the
Proposed Rule Change is consistent with the Act. Accordingly, the
Commission finds good cause, pursuant to Section 19(b)(2)(C)(iii) of
the Act,\76\ to approve the Proposed Rule Change, as modified by
Amendment Nos. 1 and 2, prior to the thirtieth day after the date of
publication of notice of Amendment No. 2 in the Federal Register.
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\75\ 15 U.S.C. 78s(b)(2)(C)(iii).
\76\ Id.
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V. Conclusion
On the basis of the foregoing, the Commission finds that the
Proposed Rule Change, as modified by
[[Page 66656]]
Amendment Nos. 1 and 2, is consistent with the requirements of the Act
and in particular with the requirements of Section 17A of the Act \77\
and the rules and regulations promulgated thereunder.
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\77\ 15 U.S.C. 78q-1.
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act
\78\ that Proposed Rule Change SR-NSCC-2020-016, as modified by
Amendment Nos. 1 and 2, be, and hereby is, approved on an accelerated
basis.\79\
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\78\ 15 U.S.C. 78s(b)(2).
\79\ In approving the proposed rule change, the Commission
considered the proposals' impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f). See also supra note 43 and
accompanying text.
\80\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\80\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-23138 Filed 10-19-20; 8:45 am]
BILLING CODE 8011-01-P