Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of No Objection To Advance Notice To Modify the Calculation of the MBSD VaR Floor To Incorporate a Minimum Margin Amount, 32079-32085 [2021-12598]
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Federal Register / Vol. 86, No. 114 / Wednesday, June 16, 2021 / Notices
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.17
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021–12592 Filed 6–15–21; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–92142; File No. SR–LCH
SA 2021–001]
Self-Regulatory Organizations; LCH
SA; Notice of Designation of Longer
Period for Commission Action on
Proposed Rule Change Relating to the
Clearing of Single-Name Credit Default
Swaps by U.S. Customers
June 10, 2021.
On April 13, 2021, Banque Centrale
de Compensation, which conducts
business under the name LCH SA (‘‘LCH
SA’’), filed with the Securities and
Exchange Commission (‘‘Commission’’),
pursuant to Section 19(b)(1) of the
Securities Exchange Act (‘‘Act’’) 1 and
Rule 19b–4 thereunder,2 a proposed rule
change to amend its rules to allow LCH
SA to offer clearing services in respect
of single-name credit default swaps that
are security-based swaps submitted by
Clearing Members on behalf of their
U.S. Clients for clearing by LCH SA. The
proposed rule change was published for
comment in the Federal Register on
May 3, 2021.3 To date, the Commission
has not received comments on the
proposed rule change.
Section 19(b)(2) of the Act 4 provides
that within 45 days of the publication of
notice of the filing of a proposed rule
change, or within such longer period up
to 90 days as the Commission may
designate if it finds such longer period
to be appropriate and publishes its
reasons for so finding or as to which the
self-regulatory organization consents,
the Commission shall either approve the
proposed rule change, disapprove the
proposed rule change, or institute
proceedings to determine whether the
proposed rule change should be
disapproved. The 45th day from the
publication of notice of filing of this
proposed rule change is June 17, 2021.
17 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 Self-Regulatory Organizations; LCH SA; Notice
of Filing of Proposed Rule Change Relating to the
Clearing of Single-Name Credit Default Swaps by
U.S. Customers, Exchange Act Release No. 34–
91676 (April 26, 2021); 86 FR 23445 (May 3, 2021)
(SR–LCH SA–2021–001).
4 15 U.S.C. 78s(b)(2).
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The Commission is extending the 45day time period for Commission action
on the proposed rule change. The
Commission finds it is appropriate to
designate a longer period within which
to take action on the proposed rule
change so that it has sufficient time to
consider LCH SA’s proposed rule
change.
Accordingly, pursuant to Section
19(b)(2) 5 of the Act, and for the reasons
discussed above, the Commission
designates August 1, 2021, as the date
by which the Commission should either
approve or disapprove, or institute
proceedings to determine whether to
disapprove, the proposed rule change
(File No. SR–LCH SA–2021–001).
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.6
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021–12588 Filed 6–15–21; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–92145; File No. SR–FICC–
2020–804]
Self-Regulatory Organizations; Fixed
Income Clearing Corporation; Notice of
No Objection To Advance Notice To
Modify the Calculation of the MBSD
VaR Floor To Incorporate a Minimum
Margin Amount
June 10, 2021.
On November 27, 2020, Fixed Income
Clearing Corporation (‘‘FICC’’) filed
with the Securities and Exchange
Commission (‘‘Commission’’) advance
notice SR–FICC–2020–804 (‘‘Advance
Notice’’) pursuant to Section 806(e)(1) of
Title VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act,
entitled Payment, Clearing and
Settlement Supervision Act of 2010
(‘‘Clearing Supervision Act’’),1 and Rule
19b–4(n)(1)(i) 2 under the Securities
Exchange Act of 1934 (‘‘Exchange
Act’’).3 In the Advance Notice, FICC
proposes to add a minimum margin
amount calculation to its margin
methodology to enhance FICC’s margin
collections as needed in response to
periods of extreme market volatility, as
described more fully below. The
Advance Notice was published for
public comment in the Federal Register
5 15
U.S.C. 78s(b)(2).
CFR 200.30–3(a)(31).
1 12 U.S.C. 5465(e)(1).
2 17 CFR 240.19b–4(n)(1)(i).
3 15 U.S.C. 78a et seq.
6 17
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32079
on January 6, 2021.4 Upon publication
of the Notice of Filing, the Commission
extended the review period of the
Advance Notice for an additional 60
days because the Commission
determined that the Advance Notice
raised novel and complex issues.5 On
March 12, 2021, the Commission, by the
Division of Trading and Markets,
pursuant to delegated authority,6
requested additional information from
FICC pursuant to Section 806(e)(1)(D) of
the Act.7 The request for information
tolled the Commission’s period of
review of the Advance Notice until 60
days from the date of the Commission’s
receipt of the information requested
from FICC, absent an additional
information request.8
The Commission has received
comments on the changes proposed in
the Advance Notice.9 In addition, the
4 Securities Exchange Act Release No. 90834
(December 31, 2020), 86 FR 584 (January 6, 2021)
(File No. SR–FICC–2020–804) (‘‘Notice of Filing’’).
FICC also filed a related proposed rule change with
the Commission pursuant to Section 19(b)(1) of the
Exchange Act and Rule 19b–4 thereunder. 15 U.S.C.
78s(b)(1) and 17 CFR 240.19b-4, respectively. FICC
seeks approval of the proposed changes to its rules
necessary to implement the Advance Notice (the
‘‘Proposed Rule Change’’). The Proposed Rule
Change was published in the Federal Register on
December 10, 2020. Securities Exchange Act
Release No. 90568 (December 4, 2020), 85 FR 79541
(December 10, 2020) (SR–FICC–2020–017). On
December 30, 2020, the Commission published a
notice designating a longer period of time for
Commission action and a longer period for public
comment on the Proposed Rule Change. Securities
Exchange Act Release No. 90794 (December 23,
2020), 85 FR 86591 (December 30, 2020) (SR–FICC–
2020–017). On February 16, 2021, the Commission
published an order instituting proceedings to
determine whether to approve or disapprove the
Proposed Rule Change. Securities Exchange Act
Release No. 91092 (February 9, 2021), 86 FR 91092
(February 16, 2021) (SR–FICC–2020–017).
5 Pursuant to Section 806(e)(1)(H) of the Act, the
Commission may extend the review period of an
advance notice for an additional 60 days, if the
changes proposed in the advance notice raise novel
or complex issues, subject to the Commission
providing the FMU with prompt written notice of
the extension. 12 U.S.C. 5465(e)(1)(H); see also
Notice of Filing, supra note 4 at 590 (explaining the
Commission’s rationale for determining that the
proposed changes in the Advance Notice raised
novel and complex issues because (1) the proposed
changes to FICC’s margin model are a direct
response by FICC to address the unique
circumstances that occurred during the pandemicrelated market volatility in March and April 2020,
and (2) the proposed changes potentially could
impact the mortgage market).
6 17 CFR 200.30–3(a)(93).
7 12 U.S.C. 5465(e)(1)(D).
8 See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); see
Memorandum from the Office of Clearance and
Settlement, Division of Trading and Markets, titled
‘‘Commission’s Request for Additional
Information,’’ available at https://www.sec.gov/
comments/sr-ficc-2020-804/srficc2020804-8490035229981.pdf.
9 Comments on the Advance Notice are available
at https://www.sec.gov/comments/sr-ficc-2020-804/
srficc2020804.htm. Comments on the Proposed
Continued
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Federal Register / Vol. 86, No. 114 / Wednesday, June 16, 2021 / Notices
Commission received a letter from FICC
responding to the comments.10 This
publication serves as notice of no
objection to the Advance Notice.
I. The Advance Notice
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A. Background
FICC, through MBSD, serves as a
central counterparty (‘‘CCP’’) and
provider of clearance and settlement
services for the mortgage-backed
securities (‘‘MBS’’) markets. A key tool
that FICC uses to manage its respective
credit exposures to its members is the
daily collection of margin from each
member. The aggregated amount of all
members’ margin constitutes the
Clearing Fund, which FICC would
access should a defaulted member’s
own margin be insufficient to satisfy
losses to FICC caused by the liquidation
of that member’s portfolio.
Each member’s margin consists of a
number of applicable components,
including a value-at-risk (‘‘VaR’’) charge
(‘‘VaR Charge’’) designed to capture the
potential market price risk associated
with the securities in a member’s
portfolio. The VaR Charge is typically
the largest component of a member’s
margin requirement. The VaR Charge is
designed to provide an estimate of
FICC’s projected liquidation losses with
respect to a defaulted member’s
portfolio at a 99 percent confidence
level.
To determine each member’s daily
VaR Charge, FICC generally uses a
model-based calculation designed to
quantify the risks related to the
volatility of market prices associated
with the securities in a member’s
portfolio.11 As an alternative to this
Rule Change are available at https://www.sec.gov/
comments/sr-ficc-2020-017/srficc2020017.htm.
Because the proposals contained in the Advance
Notice and the Proposed Rule Change are the same,
all comments received on the proposal were
considered regardless of whether the comments
were submitted with respect to the Advance Notice
or the Proposed Rule Change.
10 See Letter from Timothy J. Cuddihy, Managing
Director of Depository Trust & Clearing Corporation
Financial Risk Management, (March 5, 2021) (‘‘FICC
Letter’’).
11 The model-based calculation, often referred to
as the sensitivity VaR model, relies on historical
risk factor time series data and security-level risk
sensitivity data. Specifically, for TBAs, the model
calculation incorporates the following risk factors:
(1) Key rate, which measures the sensitivity of a
price change to changes in interest rates; (2)
convexity, which measures the degree of curvature
in the price/yield relationship of key interest rates;
(3) spread, which is the yield spread added to a
benchmark yield curve to discount a TBA’s cash
flows to match its market price; (4) volatility, which
reflects the implied volatility observed from the
swaption market to estimate fluctuations in interest
rates; (5) mortgage basis, which captures the basis
risk between the prevailing mortgage rate and a
blended Treasury rate; and (6) time risk factor,
which accounts for the time value change (or carry
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calculation, FICC also uses a haircutbased calculation to determine the ‘‘VaR
Floor,’’ which replaces the model-based
calculation to become a member’s VaR
Charge in the event that the VaR Floor
is greater than the amount determined
by the model-based calculation.12 Thus,
the VaR Floor currently operates as a
minimum VaR Charge.
During the period of extreme market
volatility in March and April 2020,
FICC’s current model-based calculation
and the VaR Floor haircut-based
calculation generated VaR Charge
amounts that were not sufficient to
mitigate FICC’s credit exposure to its
members’ portfolios at a 99 percent
confidence level. Specifically, during
the period of extreme market volatility,
FICC observed that its margin
collections yielded backtesting
deficiencies beyond FICC’s risk
tolerance.13 FICC states that these
deficiencies arose from a particular
aspect of its margin methodology with
respect to MBS (particularly, higher
coupon TBAs 14), i.e., that current prices
may reflect higher mortgage prepayment
risk than FICC’s margin methodology
currently takes into account during
periods of extreme market volatility. In
the Advance Notice, FICC proposes to
revise the margin methodology in its
Rules 15 and its quantitative risk
model 16 to better address the risks
posed by member portfolios holding
adjustment) over an assumed liquidation period.
See Securities Exchange Act Release No. 79491
(December 7, 2016), 81 FR 90001, 90003–04
(December 13, 2016) (File No. SR–FICC–2016–007).
12 FICC uses the VaR Floor to mitigate the risk
that the model-based calculation does not result in
margin amounts that accurately reflect FICC’s
applicable credit exposure, which may occur in
certain member portfolios containing long and short
positions in different asset classes that share a high
degree of historical price correlation.
13 Backtesting is an ex-post comparison of actual
outcomes (i.e., the actual margin collected) with
expected outcomes derived from the use of margin
models. See 17 CFR 240.17Ad–22(a)(1). FICC
conducts daily backtesting to determine the
adequacy of its margin assessments. MBSD’s
monthly backtesting coverage ratio with respect to
margin amounts was 86.6 percent in March 2020
and 94.2 percent in April 2020. See Notice of Filing,
supra note 4 at 585.
14 The vast majority of agency MBS trading occurs
in a forward market, on a ‘‘to-be-announced’’ or
‘‘TBA’’ basis. In a TBA trade, the seller agrees on
a sale price, but does not specify which particular
securities will be delivered to the buyer on
settlement day. Instead, only a few basic
characteristics of the securities are agreed upon,
such as the MBS program, maturity, coupon rate,
and the face value of the bonds to be delivered.
15 The MBSD Clearing Rules are available at
https://www.dtcc.com/legal/rules-andprocedures.aspx.
16 As part of the Advance Notice, FICC filed
Exhibit 5B—Proposed Changes to the Methodology
and Model Operations Document MBSD
Quantitative Risk Model (‘‘QRM Methodology’’).
Pursuant to 17 CFR 240.24b–2, FICC requested
confidential treatment of Exhibit 5B.
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TBAs during such volatile market
conditions.
B. Minimum Margin Amount
FICC proposes to introduce a new
minimum margin amount into its
margin methodology. Under the
proposal, FICC would revise the existing
definition of the VaR Floor to mean the
greater of (1) the current haircut-based
calculation, as described above, and (2)
the proposed minimum margin amount,
which would use a dynamic haircut
method based on observed TBA price
moves. Application of the minimum
margin amount would increase FICC’s
margin collection during periods of
extreme market volatility, particularly
when TBA price changes would
otherwise significantly exceed those
projected by either the model-based
calculation or the current VaR Floor
calculation.
Specifically, the minimum margin
amount would serve as a minimum VaR
Charge for net unsettled positions,
calculated using the historical market
price changes of certain benchmark TBA
securities.17 FICC proposes to calculate
the minimum margin amount per
member portfolio.18 The proposal
17 FICC would consider the MBSD portfolio as
consisting of four programs: Federal National
Mortgage Association (‘‘Fannie Mae’’) and Federal
Home Loan Mortgage Corporation (‘‘Freddie Mac’’)
conventional 30-year mortgage-backed securities
(‘‘CONV30’’), Government National Mortgage
Association (‘‘Ginnie Mae’’) 30-year mortgagebacked securities (‘‘GNMA30’’), Fannie Mae and
Freddie Mac conventional 15-year mortgage-backed
securities (‘‘CONV15’’), and Ginnie Mae 15-year
mortgage-backed securities (‘‘GNMA15’’). Each
program would, in turn, have a default benchmark
TBA security.
FICC would map 10-year and 20-year TBAs to the
corresponding 15-year TBA security benchmark. As
of August 31, 2020, 20-year TBAs account for less
than 0.5%, and 10-year TBAs account for less than
0.1%, of the positions in MBSD clearing portfolios.
FICC states that these TBAs were not selected as
separate TBA security benchmarks due to the
limited trading volumes in the market. See Notice
of Filing, supra note 4 at 586.
18 The specific calculation would involve the
following: FICC would first calculate risk factors
using historical market prices of the benchmark
TBA securities. FICC would then calculate each
member’s portfolio exposure on a net position
across all products and for each securitization
program (i.e., CONV30, GNMA30, CONV15 and
GNMA15). Finally, FICC would multiply a ‘‘base
risk factor’’ by the absolute value of the member’s
net position across all products, plus the sum of
each risk factor spread to the base risk factor
multiplied by the absolute value of its
corresponding position, to determine the minimum
margin amount.
To determine the base risk factor, FICC would
calculate an ‘‘outright risk factor’’ for GNMA30 and
CONV30, which constitute the majority of the TBA
market and of positions in MBSD portfolios. For
each member’s portfolio, FICC would assign the
base risk factor based on whether GNMA30 or
CONV30 constitutes the larger absolute net market
value in the portfolio. If GNMA30 constitutes the
larger absolute net market value in the portfolio, the
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would allow offsetting between short
and long positions within TBA
securities programs since the TBAs
aggregated in each program exhibit
similar risk profiles and can be netted
together to calculate the minimum
margin amount to cover the observed
market price changes for each portfolio.
The proposal would allow a lookback
period for those historical market price
moves and parameters of between one
and three years, and FICC would set the
initial lookback period for the minimum
margin amount calculation at two
years.19 FICC states that the minimum
margin amount would improve the
responsiveness of its margin
methodology during periods of market
volatility because it would have a
shorter lookback period than the modelbased calculation, which reflects a tenyear lookback period.20
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II. Discussion and Commission
Findings
Although the Clearing Supervision
Act does not specify a standard of
review for an advance notice, the stated
purpose of the Clearing Supervision Act
is instructive: To mitigate systemic risk
in the financial system and promote
financial stability by, among other
things, promoting uniform risk
management standards for SIFMUs and
strengthening the liquidity of SIFMUs.21
Section 805(a)(2) of the Clearing
Supervision Act authorizes the
Commission to prescribe regulations
containing risk management standards
for the payment, clearing, and
settlement activities of designated
clearing entities engaged in designated
activities for which the Commission is
the supervisory agency.22 Section 805(b)
of the Clearing Supervision Act
provides the following objectives and
base risk factor would be equal to the outright risk
factor for GNMA30. If CONV30 constitutes the
larger absolute net market value in the portfolio, the
base risk factor would be equal to the outright risk
factor for CONV30.
For a detailed example of the minimum margin
amount calculation, see Notice of Filing, supra note
4 at 586–87.
19 FICC would be permitted to adjust the lookback
period within the range in accordance with FICC’s
model risk management practices and governance
procedures set forth in the Clearing Agency Model
Risk Management Framework. See Securities
Exchange Act Release No. 81485 (August 25, 2017),
82 FR 41433 (August 31, 2017) (SR–DTC–2017–008;
SR–FICC–2017–014; SR–NSCC–2017–008);
Securities Exchange Act Release No. 84458 (October
19, 2018), 83 FR 53925 (October 25, 2018) (SR–
DTC–2018–009; SR–FICC–2018–010; SR–NSCC–
2018–009); Securities Exchange Act Release No.
88911 (May 20, 2020), 85 FR 31828 (May 27, 2020)
(SR–DTC–2020–008; SR–FICC–2020–004; SR–
NSCC–2020–008).
20 Notice of Filing, supra note 4 at 586; FICC
Letter at 5.
21 See 12 U.S.C. 5461(b).
22 12 U.S.C. 5464(a)(2).
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principles for the Commission’s risk
management standards prescribed under
Section 805(a): 23
• To promote robust risk
management;
• to promote safety and soundness;
• to reduce systemic risks; and
• to support the stability of the
broader financial system.
Section 805(c) provides, in addition,
that the Commission’s risk management
standards may address such areas as
risk management and default policies
and procedures, among others areas.24
The Commission has adopted risk
management standards under Section
805(a)(2) of the Clearing Supervision
Act and Section 17A of the Exchange
Act (the ‘‘Clearing Agency Rules’’).25
The Clearing Agency Rules require,
among other things, each covered
clearing agency to establish, implement,
maintain, and enforce written policies
and procedures that are reasonably
designed to meet certain minimum
requirements for its operations and risk
management practices on an ongoing
basis.26 As such, it is appropriate for the
Commission to review advance notices
against the Clearing Agency Rules and
the objectives and principles of these
risk management standards as described
in Section 805(b) of the Clearing
Supervision Act. As discussed below,
the Commission believes the proposals
in the Advance Notice are consistent
with the objectives and principles
described in Section 805(b) of the
Clearing Supervision Act 27 and in the
Clearing Agency Rules, in particular
Rule 17Ad–22(e)(4)(i) and (e)(6)(i) and
(v).28
A. Consistency With Section 805(b) of
the Clearing Supervision Act
The Commission believes that the
Advance Notice is consistent with the
stated objectives and principles of
Section 805(b) of the Clearing
Supervision Act.29 Specifically, the
Commission believes that the changes
proposed in the Advance Notice are
consistent with promoting robust risk
management, promoting safety and
soundness, reducing systemic risks, and
23 12
U.S.C. 5464(b).
U.S.C. 5464(c).
25 17 CFR 240.17Ad–22. See Securities Exchange
Act Release No. 68080 (October 22, 2012), 77 FR
66220 (November 2, 2012) (S7–08–11). See also
Securities Exchange Act Release No. 78961
(September 28, 2016), 81 FR 70786 (October 13,
2016) (S7–03–14) (‘‘Covered Clearing Agency
Standards’’). FICC is a ‘‘covered clearing agency’’ as
defined in Rule 17Ad–22(a)(5).
26 Id.
27 12 U.S.C. 5464(b).
28 17 CFR 240.17Ad–22(e)(4)(i) and (e)(6)(i).
29 12 U.S.C. 5464(b).
24 12
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supporting the broader financial
system.30
1. Promoting Robust Risk Management
and Safety and Soundness
The Commission believes that
adopting the proposed minimum margin
amount would be consistent with the
promotion of robust risk management
and safety and soundness at FICC. FICC
proposes to add the minimum margin
amount calculation to its margin
methodology to better ensure that FICC
collects sufficient margin amounts
during periods of extreme market
volatility to cover the costs that FICC
might incur upon liquidating a
defaulted member’s portfolio.
Specifically, FICC designed the
minimum margin amount calculation to
better manage the risk of incurring costs
associated with increased volatility in a
defaulted member’s portfolio that
contains a large position in TBAs. As
described above, during the period of
extreme market volatility in March and
April 2020, FICC’s margin methodology
generated margin amounts that were not
sufficient to mitigate FICC’s credit
exposure to its members’ portfolios at a
99 percent confidence level. The
minimum margin amount would collect
additional margin in such
circumstances, i.e., when the market
price volatility implied by both the
current VaR Charge calculation and the
current VaR Floor calculation is lower
than the market price volatility from
corresponding price changes of the
proposed TBA securities benchmarks
observed during the proposed lookback
period.
The Commission believes that FICC’s
implementation of the minimum margin
amount would result in margin levels
that better reflect the risks and
particular attributes of member
portfolios holding positions in TBAs,
30 Several of the issues raised by the commenters
are directed at the Proposed Rule Change and will
be addressed in that context. These comments
generally relate to the proposal’s impact on
competition and its consistency with the Exchange
Act. See Letter from James Tabacchi, Chairman,
Independent Dealer and Trade Association, Mike
Fratantoni, Chief Economist/Senior Vice President,
Mortgage Bankers Association (January 26, 2021)
(‘‘IDTA/MBA Letter I’’) at 2–6; Letter from
Christopher A. Iacovella, Chief Executive Officer,
American Securities Association (January 28, 2021)
(‘‘ASA Letter’’) at 1–2; Letter from Christopher
Killian, Managing Director, Securities Industry and
Financial Markets Association (January 29, 2021)
(‘‘SIFMA Letter I’’) at 2–4 (commenting on impact
on competition and the application of Section
17A(b)(3)(F) of the Exchange Act). The
Commission’s evaluation of the Advance Notice is
conducted under the Clearing Supervision Act and,
as noted above, generally considers whether the
proposal would promote robust risk management,
promote safety and soundness, reduce systemic
risks, and support the broader financial system.
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including in times of increased market
price volatility such as what occurred in
March and April 2020. Accordingly, the
Commission believes that the proposal
is consistent with promoting robust risk
management because the minimum
margin amount would enable FICC to
better manage the relevant risks.
Further, the Commission has
reviewed and analyzed FICC’s analyses
regarding how the proposal would
improve FICC’s backtesting coverage,
which demonstrate that the proposal
would result in less credit exposure for
FICC to its members. By helping to
ensure that FICC collects margin
amounts sufficient to manage the risk
associated with its members’ portfolios
holding large TBA positions during
periods of extreme market volatility, the
proposed minimum margin amount
would help limit FICC’s exposure in a
member default scenario. The proposal
would generally provide FICC with
additional resources to manage potential
losses arising out of a member default.
Such an increase in FICC’s available
financial resources would decrease the
likelihood that losses arising out of a
member default would exceed FICC’s
prefunded resources and threaten the
safety and soundness of FICC’s ongoing
operations. Accordingly, the
Commission believes that the proposal
is also consistent with promoting safety
and soundness at FICC.
2. Reducing Systemic Risks and
Supporting the Stability of the Broader
Financial System
The Commission believes that the
proposed minimum margin amount is
consistent with reducing systemic risks
and supporting the stability of the
broader financial system. As discussed
above, FICC would access its Clearing
Fund should a defaulted member’s own
margin be insufficient to satisfy losses
caused by the liquidation of the
member’s portfolio. FICC proposes to
add the minimum margin amount
calculation to its margin methodology to
collect additional margin from members
to cover such costs, and thereby better
manage the potential costs of liquidating
a defaulted member’s portfolio. This
could reduce the possibility that FICC
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
resultant effects on non-defaulting
members, their customers, and the
broader market arising out of a member
default. Accordingly, the Commission
believes that adoption of the proposed
minimum margin amount by FICC is
consistent with the reduction of
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systemic risk and supporting the
stability of the broader financial system.
One commenter argues that the
proposed minimum margin amount is
not necessary because despite FICC’s
March-April 2020 backtesting
deficiencies, there were no failures that
caused broader systemic problems.31
Another commenter argues that the
proposed minimum margin amount is
not necessary because mid-sized broker/
dealers do not present significant risks
to the broader financial system.32 The
Commission disagrees with these
comments, as they do not take into
account FICC’s regulatory requirements
with respect to maintaining sufficient
financial resources. As discussed more
fully below, the standard under Rule
17Ad–22(e)(4) is not merely for FICC to
maintain sufficient financial resources
to avoid failures or systemic issues, but
to cover its credit exposure to each
participant fully with a high degree of
confidence.33 During periods of extreme
market volatility, FICC has
demonstrated that adding the minimum
margin amount to its margin
methodology would better enable FICC
to manage its credit exposures to
members by assessing appropriate
margin charges. The Commission has
reviewed and analyzed FICC’s
backtesting data, and agrees that the
data demonstrate that the minimum
margin amount would result in better
backtesting coverage and, therefore, less
credit exposure of FICC to its members.
Accordingly, the Commission believes
that the proposed minimum margin
amount would enable FICC to better
manage its credit risks resulting from
periods of extreme market volatility.
Morevoer, as discussed here, the
proposal should help FICC to contain
the effects of a member default from
spreading to other members and more
broadly to other market participants,
consistent with the objectives of
reducing systemic risks and supporting
the stability of the broader financial
system.
For the reasons stated above, the
Commission believes the changes
proposed in the Advance Notice are
consistent with Section 805(b) of the
Clearing Supervision Act.34
B. Consistency With Rule 17Ad–
22(e)(4)(i)
Rule 17Ad–22(e)(4)(i) requires that
FICC establish, implement, maintain
and enforce written policies and
procedures reasonably designed to
effectively identify, measure, monitor,
and manage its credit exposures to
participants and those arising from its
payment, clearing, and settlement
processes, including by maintaining
sufficient financial resources to cover its
credit exposure to each participant fully
with a high degree of confidence.35
Several commenters question whether
FICC has adequately demonstrated that
the proposal in the Advance Notice is
consistent with Rule 17Ad–22(e)(4)(i)
under the Act, arguing that there are
more effective methods that FICC could
use to mitigate the relevant risks. Three
commenters argue that the model-based
calculation is well-suited to address
FICC’s credit risk in volatile market
conditions, and instead of adding the
minimum margin amount to its margin
methodology, FICC should enhance this
calculation to address periods of
extreme market volatility such as
occurred in March and April 2020.36
In response to these comments, FICC
explains that enhancing the modelbased calculation would not be an
effective approach towards mitigating
the risk resulting from periods of
extreme market volatility. Although the
model-based calculation takes into
account risk factors typical to TBAs, the
extreme market volatility of March and
April 2020 was caused by other factors
(e.g., changes in the Federal Reserve
purchase program) affecting the TBA
markets, yet such factors are not
accounted for in the model-based
calculation.37 To further demonstrate
why the minimum margin amount is
necessary, FICC relies upon the results
of recent backtesting analyses
demonstrating that its existing VaR
Charge calculations did not respond
effectively to the March and April 2020
levels of market volatility and economic
uncertainty such that FICC’s margin
collections during that period did not
meet its 99 percent confidence level.38
The Commission believes that the
proposal in the Advance Notice is
consistent with Rule 17Ad–22(e)(4)(i)
under the Exchange Act.39 As described
above, FICC’s current VaR Charge
calculations resulted in margin amounts
that were not sufficient to mitigate
FICC’s credit exposure to its members’
portfolios at FICC’s targeted confidence
level during periods of extreme market
volatility, particularly when TBA price
changes significantly exceeded those
implied by the VaR model risk factors.
35 17
CFR 240.17Ad–22(e)(4)(i).
IDTA/MBA Letter I at 4–5; ASA Letter at
1; SIFMA Letter I at 2–3; SIFMA Letter II at 1–2.
37 See FICC Letter at 2–3.
38 See FICC Letter at 3.
39 17 CFR 240.17Ad–22(e)(4)(i).
36 See
31 See
SIFMA Letter I at 2.
IDTA/MBA Letter I at 3.
33 17 CFR 240.17Ad–22(e)(4)(i).
34 12 U.S.C. 5464(b).
32 See
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Adding the minimum margin amount
calculation to its margin methodology
should better enable FICC to collect
margin amounts that are sufficient to
mitigate FICC’s credit exposure to its
members’ portfolios.
In reaching this conclusion, the
Commission thoroughly reviewed and
analyzed the (1) Advance Notice,
including the supporting exhibits that
provided confidential information on
the calculation of the proposed
minimum margin amount, impact
analyses (including detailed information
regarding the impact of the proposed
change on the portfolio of each FICC
member over various time periods), and
backtesting coverage results, (2)
comments received, and (3) the
Comission’s own understanding of the
performance of the current margin
methodology, with which the
Commission has experience from its
general supervision of FICC, compared
to the proposed margin methodology.40
Specifically, as discussed above, the
Commission has considered the results
of FICC’s backtesting coverage analyses,
which indicate that the current margin
methodology results in backtesting
coverage that does not meet FICC’s
targeted confidence level. The analyses
also indicate that the minimum margin
amount would result in improved
backtesting coverage towards meeting
FICC’s targeted coverage level. FICC’s
backtesting data shows that if the
minimum margin amount had been in
place, overall margin backtesting
coverage (based on 12-month trailing
backtesting) would have increased from
approximately 99.3% to 99.6% through
January 31, 2020 and approximately
97.3% to 98.5% through June 30,
2020.41 Therefore, the proposal would
provide FICC with a more precise
margin calculation, thereby enabling
FICC to manage its credit exposures to
members by maintaining sufficient
financial resources to cover such
exposures fully with a high degree of
confidence.
In response to the comments
regarding enhancing the model-based
calculation instead of adding the
minimum margin amount, the
Commission believes that FICC’s modelbased calculation takes into account risk
factors that are typical TBA attributes,
whereas the extreme market volatility of
March and April 2020 was caused by
40 In addition, because the proposals contained in
the Advance Notice and the Proposed Rule Change
are the same, all information submitted by FICC
was considered regardless of whether the
information submitted with respect to the Advance
Notice or the Proposed Rule Change. See supra note
9.
41 See Notice of Filing, supra note 4 at 588.
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other external factors that are less
subject to modeling. Thus, the
commenters’ preferred approach is not a
viable alternative that would allow for
consideration of such factors.42
Accordingly, for the reasons
discussed above, the Commission
believes that the proposed minimum
margin amount is reasonably designed
to enable FICC to effectively identify,
measure, monitor, and manage its credit
exposure to members, consistent with
Rule 17Ad–22(e)(4)(i).43
C. Consistency With Rules 17Ad–
22(e)(6)(i) and (iii)
Rules 17Ad–22(e)(6)(i) and (iii)
require that FICC establish, implement,
maintain and enforce written policies
and procedures reasonably designed to
cover its credit exposures to its
participants by establishing a risk-based
margin system that, at a minimum,
considers, and produces margin levels
commensurate with, the risks and
particular attributes of each relevant
product, portfolio, and market, and
calculates margin sufficient to cover its
potential future exposure to
participants.44
One commenter suggests that the
minimum margin amount would be
inefficient and ineffective at collecting
margin amounts commensurate with the
risks presented by the securities in
member portfolios.45 Several
commenters argue that the proposed
minimum margin amount calculation
would produce sudden and persistent
spikes in margin requirements.46 One
commenter argues that the minimum
margin amount would effectively
replace FICC’s existing model-based
calculation with one likely to produce
procyclical results by increasing margin
requirements at times of increased
market volatility.47 One commenter
suggests the March–April 2020 market
volatility was so unique that FICC need
not adjust its margin methodology to
account for a future similar event.48
42 This Commission also notes that Section
19(b)(2)(C) of the Act directs the Commission to
approve a proposed rule change of a self-regulatory
organization if the change is consistent with the
requirements of the Act and the rules and
regulations thereunder applicable to such
organization. 15 U.S.C. 78s(b)(2)(C). Therefore, the
Commission is required to approve the proposal
unless the existence of alternatives identified by
commenters renders the proposal inconsistent with
the Act. The Commission does not believe this
threshold has been met.
43 17 CFR 240.17Ad–22(e)(4)(i).
44 17 CFR 240.17Ad–22(e)(6)(i) and (iii).
45 See id.
46 See IDTA/MBA Letter I at 5; ASA Letter at 2;
SIFMA Letter I at 3–4.
47 See IDTA/MBA Letter I at 5.
48 See SIFMA Letter I at 3.
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In addition, one commenter argues
that the proposed minimum margin
amount is inconsistent with Rule 17Ad–
22(e)(6)(i) because the minimum margin
amount calculation is not reasonably
designed to mitigate future risk due to
its reliance on historical price
movements that will not generate
margin requirements that equate to
future protections against market
volatility.49 Two commenters argue that
the proposed minimum margin amount
calculation is not reasonably designed
to mitigate future risks because the
calculation relies on historical price
movements, which will not necessarily
generate margin amounts that will
protect against future periods of market
volatility.50 One commenter argues that
the MMA is not necessary despite the
March and April 2020 backtesting
deficiencies because there were no
failures or other events that caused
systemic issues.51
Several commenters speculate that
since the minimum margin amount is
typically larger than the model-based
calculation, the minimum margin
amount will likely become the
predominant calculation for
determining a member’s VaR Charge.52
One commenter argues that instead of
the minimum margin amount, FICC
should consider adding concentration
charges to its margin methodology to
address the relevant risks.53
In response, FICC states that any
increased margin requirements resulting
from the proposed minimum margin
amount during periods of extreme
market volatility would appropriately
reflect the relevant risks presented to
FICC by member portfolios holding
large TBA positions.54 FICC also states
that the minimum margin amount’s
reliance on observed price volatility
with a shorter lookback period will
provide margin that responds quicker
during market volatility to limit FICC’s
exposures.55 FICC also notes that the
margin increases that the minimum
margin amount would have imposed
following the March–April 2020 market
volatility would not have persisted at
such high levels indefinitely.56
In addition, regarding whether the
minimum margin amount will likely
become the predominant calculation for
determining a member’s VaR Charge,
49 See
50 See
IDTA/MBA Letter I at 4.
IDTA/MBA Letter I at 5; SIFMA Letter I at
2.
51 See
SIFMA Letter I at 2.
IDTA/MBA Letter I at 4–5; ASA Letter at
1; SIFMA Letter I at 2–3.
53 See IDTA/MBA Letter I at 5.
54 See FICC Letter at 5–6.
55 See id.
56 See id.
52 See
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FICC states that as the period of extreme
market volatility stabilized and the
model-based calculation recalibrated to
current market conditions, the average
daily VaR Charge increase decreased
from $2.2 billion (i.e., 42%) to $838
million (i.e., 7%) during the fourth
quarter of 2020.57 Regarding
concentration charges, FICC states that
concentration charges and the minimum
margin amount address separate and
distinct types of risk.58 Whereas the
minimum margin amount is designed to
cover the risk of market price volatility,
concentration charges (e.g., FICC’s
recently approved Margin Liquidity
Adjustment Charge 59) are designed to
mitigate the risk to FICC of incurring
additional market impact cost from
liquidating a directionally concentrated
portfolio.60
The Commission believes that the
proposal is consistent with Rule 17Ad–
22(e)(6)(i). Implementing the proposed
minimum margin amount would result
in margin requirements that reflect the
risks such holdings present to FICC
better than FICC’s current margin
methodology. In reaching this
conclusion and considering the
comments above, the Commission
thoroughly reviewed and analyzed the
(1) Advance Notice, including the
supporting exhibits that provided
confidential information on the
calculation of the proposed minimum
margin amount, impact analyses, and
backtesting coverage results, (2)
comments received, and (3) the
Commission’s own understanding of the
performance of the current margin
methodology, with which the
Commission has experience from its
general supervision of FICC, compared
to the proposed margin methodology.
Based on its review and analysis of
these materials, including the effect that
the minimum margin amount would
have on FICC’s backtesting coverage, the
Commission believes that the proposed
minimum margin amount is designed to
consider, and collect margin
commensurate with, the market risk
presented by member portfolios holding
TBA positions, specifically during
periods of market volatility such as
what occurred in March and April 2020.
For the same reasons, the Commission
disagrees with the comments suggesting
that the minimum margin amount
calculation is not designed to effectively
and efficiently collect margin sufficient
57 See
FICC Letter at 5.
FICC Letter at 7–8.
59 See Securities Exchange Act Release No. 90182
(October 14, 2020), 85 FR 66630 (October 20, 2020)
(SR–FICC–2020–009).
60 See FICC Letter at 7–8.
58 See
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to mitigate the risks presented by the
securities.
In response to comments regarding
the sudden and persistent increases in
margin that could arise from the
minimum margin amount, the
Commission acknowledges that, for
some member portfolios in certain
market conditions, application of the
minimum margin amount calculation
would result in an increase in the
member’s margin requirement based on
the potential exposures arising from the
TBA positions. The Commission notes
that, by design, the minimum margin
amount should respond more quickly to
heightened market volatility because of
its use of historical price data over a
relatively short lookback period, as
opposed to the model-based calculation
which relies on risk factors and uses a
longer lookback period.
The Commission also observes,
however, based on its review and
analysis of FICC’s confidential data and
analyses, that the increase in margin
requirements generated by the
minimum margin amount as compared
to the other calculations would
generally only apply during periods of
high market volatility and for a time
period thereafter.61 The frequency with
which the minimum margin amount
would constitute a majority of members’
margin requirements decreases as
markets become less volatile, and
therefore, is not expected to persist
indefinitely.62 The Commission believes
that including the minimum margin
amount as a potential method of
determining a member’s margin
requirement is appropriate, in light of
the potential exposures that could arise
in a time of heightened market volatility
and the need for FICC to cover those
exposures. Therefore, the Commission
believes that the proposal would
provide FICC with a margin calculation
better designed to enable FICC to cover
its credit exposures to its members by
enhancing FICC’s risk-based margin
system to produce margin levels
commensurate with, the risks and
particular attributes of TBAs during
periods of extreme market volatility.
In response to the comments
regarding the potential procyclical
nature of the minimum margin amount
calculation and whether it is
appropriate for the margin methodology
to take into account such extreme
market events, the Commission notes
61 FICC provided this data as part of its response
to the Commission’s Request for Additional
Information in connection with the Advance
Notice. Pursuant to 17 CFR 240.24b–2, FICC
requested confidential treatment of its RFI response.
See also FICC Letter at 5.
62 See FICC Letter at 5.
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that as a general matter, margin floors
generally operate to reduce
procyclicality by preventing margin
levels from falling too low. Moreover,
despite the commenters’ procyclicality
concerns, the Commission understands
that the purpose of the minimum
margin amount is to ensure that FICC
collects sufficient margin in times of
heightened market volatility, which
means that FICC would, by design,
collect additional margin at such times
if the minimum margin amount applies.
The Commission believes that, because
heightened market volatility may lead to
increased credit exposure for FICC, it is
reasonable for FICC’s margin
methodology to collect additional
margin at such times and to be
responsive to market activity of this
nature.
In response to the comment that the
proposed minimum margin amount is
not necessary because the March and
April 2020 market volatility did not
cause the failure of FICC members or
otherwise cause broader systemic
problems, the Commission disagrees.
Similar to the Commission’s analysis
above in Section II.B., the relevant
standard is not merely for FICC to
maintain sufficient financial resources
to avoid failures or systemic issues, but
for FICC to cover its credit exposures to
members with a risk-based margin
system that produces margin levels
commensurate with, the risks and
particular attributes of each relevant
product, portfolio, and market.63 During
periods of extreme market volatility,
FICC has demonstrated that adding the
minimum margin amount to its margin
methodology would better enable FICC
to manage its credit exposures to
members by producing margin charges
commensurate with the applicable risks.
The Commission has reviewed and
analyzed FICC’s backtesting data, and
agrees that the data demonstrate that the
minimum margin amount would result
in better backtesting coverage and,
therefore, less credit exposure of FICC to
its members. Accordingly, the
Commission believes that the proposed
minimum margin amount would enable
FICC to better manage its credit risks
resulting from periods of extreme
market volatility.
In response to the comments
regarding the minimum margin amount
calculation’s reliance on historical price
movements, the Commission does not
agree that Rules 17Ad–22(e)(6)(i) and
(iii) preclude FICC from implementing a
margin methodology that relies, at least
in part, on historical price movements
or that FICC’s margin methodology must
63 17
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generate margin requirements that
‘‘equate to future protections against
market volatility.’’ FICC’s credit
exposures are reasonably measured both
by events that have actually happened
as well as events that could potentially
occur in the future. For this reason, a
risk-based margin system is necessary
for FICC to cover its potential future
exposure to members.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, FICC must
consider potential future exposure,
which includes, among other things,
losses associated with the liquidation of
a defaulted member’s portfolio.
In response to the comments
regarding enhancing the model-based
calculation instead of adding the
minimum margin amount, the
Commission believes that, as FICC
stated in its response, the inputs to
FICC’s model-based calculation include
risk factors that are typical TBA
attributes, whereas the extreme market
volatility of March and April 2020,
which affected the TBA markets, was
caused by other external factors that are
less subject to modeling. Accordingly,
the Commission believes that FICC
would more effectively cover its
exposure during such periods by
including the minimum margin amount
as an alternative margin component
based the price volatility in each
member’s portfolio using observable
TBA benchmark prices, using a
relatively short lookback period.66
In response to the comments
regarding whether the minimum margin
amount will likely become the
predominant calculation for
determining a member’s VaR Charge,
the Commission disagrees. For example,
the average daily VaR Charge increase
from February 3, 2020 through June 30,
2020 would have been approximately
$2.2 billion or 42%, but as the modelbased calculation took into account the
current market conditions, the average
daily increase during Q4 of 2020 would
64 See 17 CFR 240.17Ad–22(e)(6)(iii) (requiring a
covered clearing agency to establish, implement,
maintain and enforce written policies and
procedures reasonably designed to cover its credit
exposures to its participants by establishing a riskbased margin system that, at a minimum, calculates
margin 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).
65 17 CFR 240.17Ad–22(a)(13).
66 See FICC Letter at 3.
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32085
have been approximately $838 million
or 7%.67
Finally, in response to the comments
regarding concentration charges, the
Division states that there is a distinction
between concentration charges and the
VaR Charge in that they are generally
designed to mitigate different risks.
Whereas the VaR Charge is designed to
cover the risk of market price volatility,
concentration charges are typically
designed to mitigate the risk of
incurring additional market impact cost
from liquidating a directionally
concentrated portfolio.68
Accordingly, the Commission believes
that adding the minimum margin
amount to FICC’s margin methodology
would be consistent with Rules 17Ad–
22(e)(6)(i) and (iii) because this new
margin calculation should better enable
FICC to establish a risk-based margin
system that considers and produces
relevant margin levels commensurate
with the risks (including potential
future exposure) associated with
liquidating member portfolios in a
default scenario, including volatility in
the TBA market.69
SECURITIES AND EXCHANGE
COMMISSION
III. Conclusion
Cboe EDGX Exchange, Inc. (the
‘‘Exchange’’ or ‘‘EDGX’’) is filing with
the Securities and Exchange
Commission (‘‘Commission’’) a
proposed rule change to introduce a
new data product to be known as Short
Sale Volume data. The text of the
proposed rule change is provided in
Exhibit 5.
The text of the proposed rule change
is also available on the Exchange’s
website (https://markets.cboe.com/us/
options/regulation/rule_filings/edgx/),
at the Exchange’s Office of the
Secretary, and at the Commission’s
Public Reference Room.
It is therefore noticed, pursuant to
Section 806(e)(1)(I) of the Clearing
Supervision Act, that the Commission
does not object to Advance Notice (SR–
FICC–2020–804) and that FICC is
authorized to implement the proposed
change as of the date of this notice or
the date of an order by the Commission
approving proposed rule change SR–
FICC–2020–017, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021–12598 Filed 6–15–21; 8:45 am]
67 See FICC Letter at 5. The Commission’s
conclusion is also based upon information that
FICC submitted confidentially regarding memberlevel impact of the proposal from February through
December 2020.
68 See Securities Exchange Act Release No. 34–
90182 (October 14, 2020), 85 FR 66630 (October 20,
2020).
69 17 CFR 240.17Ad–22(e)(6)(i) and (iii).
Frm 00073
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Self-Regulatory Organizations; Cboe
EDGX Exchange, Inc.; Notice of Filing
of a Proposed Rule Change To
Introduce a New Data Product To Be
Known as Short Sale Volume Data
June 10, 2021.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (the
‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on May 28,
2021, Cboe EDGX Exchange, Inc. (the
‘‘Exchange’’ or ‘‘EDGX’’) filed with the
Securities and Exchange Commission
(the ‘‘Commission’’) the proposed rule
change as described in Items I and II
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
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
BILLING CODE 8011–01–P
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CboeEDGX–2021–027]
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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.
1 15
2 17
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]]>Agencies
[Federal Register Volume 86, Number 114 (Wednesday, June 16, 2021)]
[Notices]
[Pages 32079-32085]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-12598]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-92145; File No. SR-FICC-2020-804]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Notice of No Objection To Advance Notice To Modify the Calculation of
the MBSD VaR Floor To Incorporate a Minimum Margin Amount
June 10, 2021.
On November 27, 2020, Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission'')
advance notice SR-FICC-2020-804 (``Advance Notice'') pursuant to
Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, entitled Payment, Clearing and Settlement
Supervision Act of 2010 (``Clearing Supervision Act''),\1\ and Rule
19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934
(``Exchange Act'').\3\ In the Advance Notice, FICC proposes to add a
minimum margin amount calculation to its margin methodology to enhance
FICC's margin collections as needed in response to periods of extreme
market volatility, as described more fully below. The Advance Notice
was published for public comment in the Federal Register on January 6,
2021.\4\ Upon publication of the Notice of Filing, the Commission
extended the review period of the Advance Notice for an additional 60
days because the Commission determined that the Advance Notice raised
novel and complex issues.\5\ On March 12, 2021, the Commission, by the
Division of Trading and Markets, pursuant to delegated authority,\6\
requested additional information from FICC pursuant to Section
806(e)(1)(D) of the Act.\7\ The request for information tolled the
Commission's period of review of the Advance Notice until 60 days from
the date of the Commission's receipt of the information requested from
FICC, absent an additional information request.\8\
---------------------------------------------------------------------------
\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ 15 U.S.C. 78a et seq.
\4\ Securities Exchange Act Release No. 90834 (December 31,
2020), 86 FR 584 (January 6, 2021) (File No. SR-FICC-2020-804)
(``Notice of Filing''). FICC also filed a related proposed rule
change with the Commission pursuant to Section 19(b)(1) of the
Exchange Act and Rule 19b-4 thereunder. 15 U.S.C. 78s(b)(1) and 17
CFR 240.19b-4, respectively. FICC seeks approval of the proposed
changes to its rules necessary to implement the Advance Notice (the
``Proposed Rule Change''). The Proposed Rule Change was published in
the Federal Register on December 10, 2020. Securities Exchange Act
Release No. 90568 (December 4, 2020), 85 FR 79541 (December 10,
2020) (SR-FICC-2020-017). On December 30, 2020, the Commission
published a notice designating a longer period of time for
Commission action and a longer period for public comment on the
Proposed Rule Change. Securities Exchange Act Release No. 90794
(December 23, 2020), 85 FR 86591 (December 30, 2020) (SR-FICC-2020-
017). On February 16, 2021, the Commission published an order
instituting proceedings to determine whether to approve or
disapprove the Proposed Rule Change. Securities Exchange Act Release
No. 91092 (February 9, 2021), 86 FR 91092 (February 16, 2021) (SR-
FICC-2020-017).
\5\ Pursuant to Section 806(e)(1)(H) of the Act, the Commission
may extend the review period of an advance notice for an additional
60 days, if the changes proposed in the advance notice raise novel
or complex issues, subject to the Commission providing the FMU with
prompt written notice of the extension. 12 U.S.C. 5465(e)(1)(H); see
also Notice of Filing, supra note 4 at 590 (explaining the
Commission's rationale for determining that the proposed changes in
the Advance Notice raised novel and complex issues because (1) the
proposed changes to FICC's margin model are a direct response by
FICC to address the unique circumstances that occurred during the
pandemic-related market volatility in March and April 2020, and (2)
the proposed changes potentially could impact the mortgage market).
\6\ 17 CFR 200.30-3(a)(93).
\7\ 12 U.S.C. 5465(e)(1)(D).
\8\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); see Memorandum
from the Office of Clearance and Settlement, Division of Trading and
Markets, titled ``Commission's Request for Additional Information,''
available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804-8490035-229981.pdf.
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The Commission has received comments on the changes proposed in the
Advance Notice.\9\ In addition, the
[[Page 32080]]
Commission received a letter from FICC responding to the comments.\10\
This publication serves as notice of no objection to the Advance
Notice.
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\9\ Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804.htm. Comments on
the Proposed Rule Change are available at https://www.sec.gov/comments/sr-ficc-2020-017/srficc2020017.htm. Because the proposals
contained in the Advance Notice and the Proposed Rule Change are the
same, all comments received on the proposal were considered
regardless of whether the comments were submitted with respect to
the Advance Notice or the Proposed Rule Change.
\10\ See Letter from Timothy J. Cuddihy, Managing Director of
Depository Trust & Clearing Corporation Financial Risk Management,
(March 5, 2021) (``FICC Letter'').
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I. The Advance Notice
A. Background
FICC, through MBSD, serves as a central counterparty (``CCP'') and
provider of clearance and settlement services for the mortgage-backed
securities (``MBS'') markets. A key tool that FICC uses to manage its
respective credit exposures to its members is the daily collection of
margin from each member. The aggregated amount of all members' margin
constitutes the Clearing Fund, which FICC would access should a
defaulted member's own margin be insufficient to satisfy losses to FICC
caused by the liquidation of that member's portfolio.
Each member's margin consists of a number of applicable components,
including a value-at-risk (``VaR'') charge (``VaR Charge'') designed to
capture the potential market price risk associated with the securities
in a member's portfolio. The VaR Charge is typically the largest
component of a member's margin requirement. The VaR Charge is designed
to provide an estimate of FICC's projected liquidation losses with
respect to a defaulted member's portfolio at a 99 percent confidence
level.
To determine each member's daily VaR Charge, FICC generally uses a
model-based calculation designed to quantify the risks related to the
volatility of market prices associated with the securities in a
member's portfolio.\11\ As an alternative to this calculation, FICC
also uses a haircut-based calculation to determine the ``VaR Floor,''
which replaces the model-based calculation to become a member's VaR
Charge in the event that the VaR Floor is greater than the amount
determined by the model-based calculation.\12\ Thus, the VaR Floor
currently operates as a minimum VaR Charge.
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\11\ The model-based calculation, often referred to as the
sensitivity VaR model, relies on historical risk factor time series
data and security-level risk sensitivity data. Specifically, for
TBAs, the model calculation incorporates the following risk factors:
(1) Key rate, which measures the sensitivity of a price change to
changes in interest rates; (2) convexity, which measures the degree
of curvature in the price/yield relationship of key interest rates;
(3) spread, which is the yield spread added to a benchmark yield
curve to discount a TBA's cash flows to match its market price; (4)
volatility, which reflects the implied volatility observed from the
swaption market to estimate fluctuations in interest rates; (5)
mortgage basis, which captures the basis risk between the prevailing
mortgage rate and a blended Treasury rate; and (6) time risk factor,
which accounts for the time value change (or carry adjustment) over
an assumed liquidation period. See Securities Exchange Act Release
No. 79491 (December 7, 2016), 81 FR 90001, 90003-04 (December 13,
2016) (File No. SR-FICC-2016-007).
\12\ FICC uses the VaR Floor to mitigate the risk that the
model-based calculation does not result in margin amounts that
accurately reflect FICC's applicable credit exposure, which may
occur in certain member portfolios containing long and short
positions in different asset classes that share a high degree of
historical price correlation.
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During the period of extreme market volatility in March and April
2020, FICC's current model-based calculation and the VaR Floor haircut-
based calculation generated VaR Charge amounts that were not sufficient
to mitigate FICC's credit exposure to its members' portfolios at a 99
percent confidence level. Specifically, during the period of extreme
market volatility, FICC observed that its margin collections yielded
backtesting deficiencies beyond FICC's risk tolerance.\13\ FICC states
that these deficiencies arose from a particular aspect of its margin
methodology with respect to MBS (particularly, higher coupon TBAs
\14\), i.e., that current prices may reflect higher mortgage prepayment
risk than FICC's margin methodology currently takes into account during
periods of extreme market volatility. In the Advance Notice, FICC
proposes to revise the margin methodology in its Rules \15\ and its
quantitative risk model \16\ to better address the risks posed by
member portfolios holding TBAs during such volatile market conditions.
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\13\ Backtesting is an ex-post comparison of actual outcomes
(i.e., the actual margin collected) with expected outcomes derived
from the use of margin models. See 17 CFR 240.17Ad-22(a)(1). FICC
conducts daily backtesting to determine the adequacy of its margin
assessments. MBSD's monthly backtesting coverage ratio with respect
to margin amounts was 86.6 percent in March 2020 and 94.2 percent in
April 2020. See Notice of Filing, supra note 4 at 585.
\14\ The vast majority of agency MBS trading occurs in a forward
market, on a ``to-be-announced'' or ``TBA'' basis. In a TBA trade,
the seller agrees on a sale price, but does not specify which
particular securities will be delivered to the buyer on settlement
day. Instead, only a few basic characteristics of the securities are
agreed upon, such as the MBS program, maturity, coupon rate, and the
face value of the bonds to be delivered.
\15\ The MBSD Clearing Rules are available at https://www.dtcc.com/legal/rules-and-procedures.aspx.
\16\ As part of the Advance Notice, FICC filed Exhibit 5B--
Proposed Changes to the Methodology and Model Operations Document
MBSD Quantitative Risk Model (``QRM Methodology''). Pursuant to 17
CFR 240.24b-2, FICC requested confidential treatment of Exhibit 5B.
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B. Minimum Margin Amount
FICC proposes to introduce a new minimum margin amount into its
margin methodology. Under the proposal, FICC would revise the existing
definition of the VaR Floor to mean the greater of (1) the current
haircut-based calculation, as described above, and (2) the proposed
minimum margin amount, which would use a dynamic haircut method based
on observed TBA price moves. Application of the minimum margin amount
would increase FICC's margin collection during periods of extreme
market volatility, particularly when TBA price changes would otherwise
significantly exceed those projected by either the model-based
calculation or the current VaR Floor calculation.
Specifically, the minimum margin amount would serve as a minimum
VaR Charge for net unsettled positions, calculated using the historical
market price changes of certain benchmark TBA securities.\17\ FICC
proposes to calculate the minimum margin amount per member
portfolio.\18\ The proposal
[[Page 32081]]
would allow offsetting between short and long positions within TBA
securities programs since the TBAs aggregated in each program exhibit
similar risk profiles and can be netted together to calculate the
minimum margin amount to cover the observed market price changes for
each portfolio.
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\17\ FICC would consider the MBSD portfolio as consisting of
four programs: Federal National Mortgage Association (``Fannie
Mae'') and Federal Home Loan Mortgage Corporation (``Freddie Mac'')
conventional 30-year mortgage-backed securities (``CONV30''),
Government National Mortgage Association (``Ginnie Mae'') 30-year
mortgage-backed securities (``GNMA30''), Fannie Mae and Freddie Mac
conventional 15-year mortgage-backed securities (``CONV15''), and
Ginnie Mae 15-year mortgage-backed securities (``GNMA15''). Each
program would, in turn, have a default benchmark TBA security.
FICC would map 10-year and 20-year TBAs to the corresponding
15-year TBA security benchmark. As of August 31, 2020, 20-year TBAs
account for less than 0.5%, and 10-year TBAs account for less than
0.1%, of the positions in MBSD clearing portfolios. FICC states that
these TBAs were not selected as separate TBA security benchmarks due
to the limited trading volumes in the market. See Notice of Filing,
supra note 4 at 586.
\18\ The specific calculation would involve the following: FICC
would first calculate risk factors using historical market prices of
the benchmark TBA securities. FICC would then calculate each
member's portfolio exposure on a net position across all products
and for each securitization program (i.e., CONV30, GNMA30, CONV15
and GNMA15). Finally, FICC would multiply a ``base risk factor'' by
the absolute value of the member's net position across all products,
plus the sum of each risk factor spread to the base risk factor
multiplied by the absolute value of its corresponding position, to
determine the minimum margin amount.
To determine the base risk factor, FICC would calculate an
``outright risk factor'' for GNMA30 and CONV30, which constitute the
majority of the TBA market and of positions in MBSD portfolios. For
each member's portfolio, FICC would assign the base risk factor
based on whether GNMA30 or CONV30 constitutes the larger absolute
net market value in the portfolio. If GNMA30 constitutes the larger
absolute net market value in the portfolio, the base risk factor
would be equal to the outright risk factor for GNMA30. If CONV30
constitutes the larger absolute net market value in the portfolio,
the base risk factor would be equal to the outright risk factor for
CONV30.
For a detailed example of the minimum margin amount calculation,
see Notice of Filing, supra note 4 at 586-87.
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The proposal would allow a lookback period for those historical
market price moves and parameters of between one and three years, and
FICC would set the initial lookback period for the minimum margin
amount calculation at two years.\19\ FICC states that the minimum
margin amount would improve the responsiveness of its margin
methodology during periods of market volatility because it would have a
shorter lookback period than the model-based calculation, which
reflects a ten-year lookback period.\20\
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\19\ FICC would be permitted to adjust the lookback period
within the range in accordance with FICC's model risk management
practices and governance procedures set forth in the Clearing Agency
Model Risk Management Framework. See Securities Exchange Act Release
No. 81485 (August 25, 2017), 82 FR 41433 (August 31, 2017) (SR-DTC-
2017-008; SR-FICC-2017-014; SR-NSCC-2017-008); Securities Exchange
Act Release No. 84458 (October 19, 2018), 83 FR 53925 (October 25,
2018) (SR-DTC-2018-009; SR-FICC-2018-010; SR-NSCC-2018-009);
Securities Exchange Act Release No. 88911 (May 20, 2020), 85 FR
31828 (May 27, 2020) (SR-DTC-2020-008; SR-FICC-2020-004; SR-NSCC-
2020-008).
\20\ Notice of Filing, supra note 4 at 586; FICC Letter at 5.
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II. Discussion and Commission Findings
Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, the stated purpose of the Clearing
Supervision Act is instructive: To mitigate systemic risk in the
financial system and promote financial stability by, among other
things, promoting uniform risk management standards for SIFMUs and
strengthening the liquidity of SIFMUs.\21\
---------------------------------------------------------------------------
\21\ See 12 U.S.C. 5461(b).
---------------------------------------------------------------------------
Section 805(a)(2) of the Clearing Supervision Act authorizes the
Commission to prescribe regulations containing risk management
standards for the payment, clearing, and settlement activities of
designated clearing entities engaged in designated activities for which
the Commission is the supervisory agency.\22\ Section 805(b) of the
Clearing Supervision Act provides the following objectives and
principles for the Commission's risk management standards prescribed
under Section 805(a): \23\
---------------------------------------------------------------------------
\22\ 12 U.S.C. 5464(a)(2).
\23\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
To promote robust risk management;
to promote safety and soundness;
to reduce systemic risks; and
to support the stability of the broader financial system.
Section 805(c) provides, in addition, that the Commission's risk
management standards may address such areas as risk management and
default policies and procedures, among others areas.\24\
---------------------------------------------------------------------------
\24\ 12 U.S.C. 5464(c).
---------------------------------------------------------------------------
The Commission has adopted risk management standards under Section
805(a)(2) of the Clearing Supervision Act and Section 17A of the
Exchange Act (the ``Clearing Agency Rules'').\25\ The Clearing Agency
Rules require, among other things, each covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to meet certain minimum
requirements for its operations and risk management practices on an
ongoing basis.\26\ As such, it is appropriate for the Commission to
review advance notices against the Clearing Agency Rules and the
objectives and principles of these risk management standards as
described in Section 805(b) of the Clearing Supervision Act. As
discussed below, the Commission believes the proposals in the Advance
Notice are consistent with the objectives and principles described in
Section 805(b) of the Clearing Supervision Act \27\ and in the Clearing
Agency Rules, in particular Rule 17Ad-22(e)(4)(i) and (e)(6)(i) and
(v).\28\
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\25\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No.
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11).
See also Securities Exchange Act Release No. 78961 (September 28,
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing
Agency Standards''). FICC is a ``covered clearing agency'' as
defined in Rule 17Ad-22(a)(5).
\26\ Id.
\27\ 12 U.S.C. 5464(b).
\28\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
The Commission believes that the Advance Notice is consistent with
the stated objectives and principles of Section 805(b) of the Clearing
Supervision Act.\29\ Specifically, the Commission believes that the
changes proposed in the Advance Notice are consistent with promoting
robust risk management, promoting safety and soundness, reducing
systemic risks, and supporting the broader financial system.\30\
---------------------------------------------------------------------------
\29\ 12 U.S.C. 5464(b).
\30\ Several of the issues raised by the commenters are directed
at the Proposed Rule Change and will be addressed in that context.
These comments generally relate to the proposal's impact on
competition and its consistency with the Exchange Act. See Letter
from James Tabacchi, Chairman, Independent Dealer and Trade
Association, Mike Fratantoni, Chief Economist/Senior Vice President,
Mortgage Bankers Association (January 26, 2021) (``IDTA/MBA Letter
I'') at 2-6; Letter from Christopher A. Iacovella, Chief Executive
Officer, American Securities Association (January 28, 2021) (``ASA
Letter'') at 1-2; Letter from Christopher Killian, Managing
Director, Securities Industry and Financial Markets Association
(January 29, 2021) (``SIFMA Letter I'') at 2-4 (commenting on impact
on competition and the application of Section 17A(b)(3)(F) of the
Exchange Act). The Commission's evaluation of the Advance Notice is
conducted under the Clearing Supervision Act and, as noted above,
generally considers whether the proposal would promote robust risk
management, promote safety and soundness, reduce systemic risks, and
support the broader financial system.
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1. Promoting Robust Risk Management and Safety and Soundness
The Commission believes that adopting the proposed minimum margin
amount would be consistent with the promotion of robust risk management
and safety and soundness at FICC. FICC proposes to add the minimum
margin amount calculation to its margin methodology to better ensure
that FICC collects sufficient margin amounts during periods of extreme
market volatility to cover the costs that FICC might incur upon
liquidating a defaulted member's portfolio.
Specifically, FICC designed the minimum margin amount calculation
to better manage the risk of incurring costs associated with increased
volatility in a defaulted member's portfolio that contains a large
position in TBAs. As described above, during the period of extreme
market volatility in March and April 2020, FICC's margin methodology
generated margin amounts that were not sufficient to mitigate FICC's
credit exposure to its members' portfolios at a 99 percent confidence
level. The minimum margin amount would collect additional margin in
such circumstances, i.e., when the market price volatility implied by
both the current VaR Charge calculation and the current VaR Floor
calculation is lower than the market price volatility from
corresponding price changes of the proposed TBA securities benchmarks
observed during the proposed lookback period.
The Commission believes that FICC's implementation of the minimum
margin amount would result in margin levels that better reflect the
risks and particular attributes of member portfolios holding positions
in TBAs,
[[Page 32082]]
including in times of increased market price volatility such as what
occurred in March and April 2020. Accordingly, the Commission believes
that the proposal is consistent with promoting robust risk management
because the minimum margin amount would enable FICC to better manage
the relevant risks.
Further, the Commission has reviewed and analyzed FICC's analyses
regarding how the proposal would improve FICC's backtesting coverage,
which demonstrate that the proposal would result in less credit
exposure for FICC to its members. By helping to ensure that FICC
collects margin amounts sufficient to manage the risk associated with
its members' portfolios holding large TBA positions during periods of
extreme market volatility, the proposed minimum margin amount would
help limit FICC's exposure in a member default scenario. The proposal
would generally provide FICC with additional resources to manage
potential losses arising out of a member default. Such an increase in
FICC's available financial resources would decrease the likelihood that
losses arising out of a member default would exceed FICC's prefunded
resources and threaten the safety and soundness of FICC's ongoing
operations. Accordingly, the Commission believes that the proposal is
also consistent with promoting safety and soundness at FICC.
2. Reducing Systemic Risks and Supporting the Stability of the Broader
Financial System
The Commission believes that the proposed minimum margin amount is
consistent with reducing systemic risks and supporting the stability of
the broader financial system. As discussed above, FICC would access its
Clearing Fund should a defaulted member's own margin be insufficient to
satisfy losses caused by the liquidation of the member's portfolio.
FICC proposes to add the minimum margin amount calculation to its
margin methodology to collect additional margin from members to cover
such costs, and thereby better manage the potential costs of
liquidating a defaulted member's portfolio. This could reduce the
possibility that FICC 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
resultant effects on non-defaulting members, their customers, and the
broader market arising out of a member default. Accordingly, the
Commission believes that adoption of the proposed minimum margin amount
by FICC is consistent with the reduction of systemic risk and
supporting the stability of the broader financial system.
One commenter argues that the proposed minimum margin amount is not
necessary because despite FICC's March-April 2020 backtesting
deficiencies, there were no failures that caused broader systemic
problems.\31\ Another commenter argues that the proposed minimum margin
amount is not necessary because mid-sized broker/dealers do not present
significant risks to the broader financial system.\32\ The Commission
disagrees with these comments, as they do not take into account FICC's
regulatory requirements with respect to maintaining sufficient
financial resources. As discussed more fully below, the standard under
Rule 17Ad-22(e)(4) is not merely for FICC to maintain sufficient
financial resources to avoid failures or systemic issues, but to cover
its credit exposure to each participant fully with a high degree of
confidence.\33\ During periods of extreme market volatility, FICC has
demonstrated that adding the minimum margin amount to its margin
methodology would better enable FICC to manage its credit exposures to
members by assessing appropriate margin charges. The Commission has
reviewed and analyzed FICC's backtesting data, and agrees that the data
demonstrate that the minimum margin amount would result in better
backtesting coverage and, therefore, less credit exposure of FICC to
its members. Accordingly, the Commission believes that the proposed
minimum margin amount would enable FICC to better manage its credit
risks resulting from periods of extreme market volatility. Morevoer, as
discussed here, the proposal should help FICC to contain the effects of
a member default from spreading to other members and more broadly to
other market participants, consistent with the objectives of reducing
systemic risks and supporting the stability of the broader financial
system.
---------------------------------------------------------------------------
\31\ See SIFMA Letter I at 2.
\32\ See IDTA/MBA Letter I at 3.
\33\ 17 CFR 240.17Ad-22(e)(4)(i).
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For the reasons stated above, the Commission believes the changes
proposed in the Advance Notice are consistent with Section 805(b) of
the Clearing Supervision Act.\34\
---------------------------------------------------------------------------
\34\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------
B. Consistency With Rule 17Ad-22(e)(4)(i)
Rule 17Ad-22(e)(4)(i) requires that FICC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to effectively identify, measure, monitor, and manage its
credit exposures to participants and those arising from its payment,
clearing, and settlement processes, including by maintaining sufficient
financial resources to cover its credit exposure to each participant
fully with a high degree of confidence.\35\
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\35\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------
Several commenters question whether FICC has adequately
demonstrated that the proposal in the Advance Notice is consistent with
Rule 17Ad-22(e)(4)(i) under the Act, arguing that there are more
effective methods that FICC could use to mitigate the relevant risks.
Three commenters argue that the model-based calculation is well-suited
to address FICC's credit risk in volatile market conditions, and
instead of adding the minimum margin amount to its margin methodology,
FICC should enhance this calculation to address periods of extreme
market volatility such as occurred in March and April 2020.\36\
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\36\ See IDTA/MBA Letter I at 4-5; ASA Letter at 1; SIFMA Letter
I at 2-3; SIFMA Letter II at 1-2.
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In response to these comments, FICC explains that enhancing the
model-based calculation would not be an effective approach towards
mitigating the risk resulting from periods of extreme market
volatility. Although the model-based calculation takes into account
risk factors typical to TBAs, the extreme market volatility of March
and April 2020 was caused by other factors (e.g., changes in the
Federal Reserve purchase program) affecting the TBA markets, yet such
factors are not accounted for in the model-based calculation.\37\ To
further demonstrate why the minimum margin amount is necessary, FICC
relies upon the results of recent backtesting analyses demonstrating
that its existing VaR Charge calculations did not respond effectively
to the March and April 2020 levels of market volatility and economic
uncertainty such that FICC's margin collections during that period did
not meet its 99 percent confidence level.\38\
---------------------------------------------------------------------------
\37\ See FICC Letter at 2-3.
\38\ See FICC Letter at 3.
---------------------------------------------------------------------------
The Commission believes that the proposal in the Advance Notice is
consistent with Rule 17Ad-22(e)(4)(i) under the Exchange Act.\39\ As
described above, FICC's current VaR Charge calculations resulted in
margin amounts that were not sufficient to mitigate FICC's credit
exposure to its members' portfolios at FICC's targeted confidence level
during periods of extreme market volatility, particularly when TBA
price changes significantly exceeded those implied by the VaR model
risk factors.
[[Page 32083]]
Adding the minimum margin amount calculation to its margin methodology
should better enable FICC to collect margin amounts that are sufficient
to mitigate FICC's credit exposure to its members' portfolios.
---------------------------------------------------------------------------
\39\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------
In reaching this conclusion, the Commission thoroughly reviewed and
analyzed the (1) Advance Notice, including the supporting exhibits that
provided confidential information on the calculation of the proposed
minimum margin amount, impact analyses (including detailed information
regarding the impact of the proposed change on the portfolio of each
FICC member over various time periods), and backtesting coverage
results, (2) comments received, and (3) the Comission's own
understanding of the performance of the current margin methodology,
with which the Commission has experience from its general supervision
of FICC, compared to the proposed margin methodology.\40\ Specifically,
as discussed above, the Commission has considered the results of FICC's
backtesting coverage analyses, which indicate that the current margin
methodology results in backtesting coverage that does not meet FICC's
targeted confidence level. The analyses also indicate that the minimum
margin amount would result in improved backtesting coverage towards
meeting FICC's targeted coverage level. FICC's backtesting data shows
that if the minimum margin amount had been in place, overall margin
backtesting coverage (based on 12-month trailing backtesting) would
have increased from approximately 99.3% to 99.6% through January 31,
2020 and approximately 97.3% to 98.5% through June 30, 2020.\41\
Therefore, the proposal would provide FICC with a more precise margin
calculation, thereby enabling FICC to manage its credit exposures to
members by maintaining sufficient financial resources to cover such
exposures fully with a high degree of confidence.
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\40\ In addition, because the proposals contained in the Advance
Notice and the Proposed Rule Change are the same, all information
submitted by FICC was considered regardless of whether the
information submitted with respect to the Advance Notice or the
Proposed Rule Change. See supra note 9.
\41\ See Notice of Filing, supra note 4 at 588.
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In response to the comments regarding enhancing the model-based
calculation instead of adding the minimum margin amount, the Commission
believes that FICC's model-based calculation takes into account risk
factors that are typical TBA attributes, whereas the extreme market
volatility of March and April 2020 was caused by other external factors
that are less subject to modeling. Thus, the commenters' preferred
approach is not a viable alternative that would allow for consideration
of such factors.\42\
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\42\ This Commission also notes that Section 19(b)(2)(C) of the
Act directs the Commission to approve a proposed rule change of a
self-regulatory organization if the change is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to such organization. 15 U.S.C. 78s(b)(2)(C). Therefore,
the Commission is required to approve the proposal unless the
existence of alternatives identified by commenters renders the
proposal inconsistent with the Act. The Commission does not believe
this threshold has been met.
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Accordingly, for the reasons discussed above, the Commission
believes that the proposed minimum margin amount is reasonably designed
to enable FICC to effectively identify, measure, monitor, and manage
its credit exposure to members, consistent with Rule 17Ad-
22(e)(4)(i).\43\
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\43\ 17 CFR 240.17Ad-22(e)(4)(i).
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C. Consistency With Rules 17Ad-22(e)(6)(i) and (iii)
Rules 17Ad-22(e)(6)(i) and (iii) require that FICC establish,
implement, maintain and enforce written policies and procedures
reasonably designed to cover its credit exposures to its participants
by establishing a risk-based margin system that, at a minimum,
considers, and produces margin levels commensurate with, the risks and
particular attributes of each relevant product, portfolio, and market,
and calculates margin sufficient to cover its potential future exposure
to participants.\44\
---------------------------------------------------------------------------
\44\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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One commenter suggests that the minimum margin amount would be
inefficient and ineffective at collecting margin amounts commensurate
with the risks presented by the securities in member portfolios.\45\
Several commenters argue that the proposed minimum margin amount
calculation would produce sudden and persistent spikes in margin
requirements.\46\ One commenter argues that the minimum margin amount
would effectively replace FICC's existing model-based calculation with
one likely to produce procyclical results by increasing margin
requirements at times of increased market volatility.\47\ One commenter
suggests the March-April 2020 market volatility was so unique that FICC
need not adjust its margin methodology to account for a future similar
event.\48\
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\45\ See id.
\46\ See IDTA/MBA Letter I at 5; ASA Letter at 2; SIFMA Letter I
at 3-4.
\47\ See IDTA/MBA Letter I at 5.
\48\ See SIFMA Letter I at 3.
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In addition, one commenter argues that the proposed minimum margin
amount is inconsistent with Rule 17Ad-22(e)(6)(i) because the minimum
margin amount calculation is not reasonably designed to mitigate future
risk due to its reliance on historical price movements that will not
generate margin requirements that equate to future protections against
market volatility.\49\ Two commenters argue that the proposed minimum
margin amount calculation is not reasonably designed to mitigate future
risks because the calculation relies on historical price movements,
which will not necessarily generate margin amounts that will protect
against future periods of market volatility.\50\ One commenter argues
that the MMA is not necessary despite the March and April 2020
backtesting deficiencies because there were no failures or other events
that caused systemic issues.\51\
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\49\ See IDTA/MBA Letter I at 4.
\50\ See IDTA/MBA Letter I at 5; SIFMA Letter I at 2.
\51\ See SIFMA Letter I at 2.
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Several commenters speculate that since the minimum margin amount
is typically larger than the model-based calculation, the minimum
margin amount will likely become the predominant calculation for
determining a member's VaR Charge.\52\ One commenter argues that
instead of the minimum margin amount, FICC should consider adding
concentration charges to its margin methodology to address the relevant
risks.\53\
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\52\ See IDTA/MBA Letter I at 4-5; ASA Letter at 1; SIFMA Letter
I at 2-3.
\53\ See IDTA/MBA Letter I at 5.
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In response, FICC states that any increased margin requirements
resulting from the proposed minimum margin amount during periods of
extreme market volatility would appropriately reflect the relevant
risks presented to FICC by member portfolios holding large TBA
positions.\54\ FICC also states that the minimum margin amount's
reliance on observed price volatility with a shorter lookback period
will provide margin that responds quicker during market volatility to
limit FICC's exposures.\55\ FICC also notes that the margin increases
that the minimum margin amount would have imposed following the March-
April 2020 market volatility would not have persisted at such high
levels indefinitely.\56\
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\54\ See FICC Letter at 5-6.
\55\ See id.
\56\ See id.
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In addition, regarding whether the minimum margin amount will
likely become the predominant calculation for determining a member's
VaR Charge,
[[Page 32084]]
FICC states that as the period of extreme market volatility stabilized
and the model-based calculation recalibrated to current market
conditions, the average daily VaR Charge increase decreased from $2.2
billion (i.e., 42%) to $838 million (i.e., 7%) during the fourth
quarter of 2020.\57\ Regarding concentration charges, FICC states that
concentration charges and the minimum margin amount address separate
and distinct types of risk.\58\ Whereas the minimum margin amount is
designed to cover the risk of market price volatility, concentration
charges (e.g., FICC's recently approved Margin Liquidity Adjustment
Charge \59\) are designed to mitigate the risk to FICC of incurring
additional market impact cost from liquidating a directionally
concentrated portfolio.\60\
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\57\ See FICC Letter at 5.
\58\ See FICC Letter at 7-8.
\59\ See Securities Exchange Act Release No. 90182 (October 14,
2020), 85 FR 66630 (October 20, 2020) (SR-FICC-2020-009).
\60\ See FICC Letter at 7-8.
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The Commission believes that the proposal is consistent with Rule
17Ad-22(e)(6)(i). Implementing the proposed minimum margin amount would
result in margin requirements that reflect the risks such holdings
present to FICC better than FICC's current margin methodology. In
reaching this conclusion and considering the comments above, the
Commission thoroughly reviewed and analyzed the (1) Advance Notice,
including the supporting exhibits that provided confidential
information on the calculation of the proposed minimum margin amount,
impact analyses, and backtesting coverage results, (2) comments
received, and (3) the Commission's own understanding of the performance
of the current margin methodology, with which the Commission has
experience from its general supervision of FICC, compared to the
proposed margin methodology. Based on its review and analysis of these
materials, including the effect that the minimum margin amount would
have on FICC's backtesting coverage, the Commission believes that the
proposed minimum margin amount is designed to consider, and collect
margin commensurate with, the market risk presented by member
portfolios holding TBA positions, specifically during periods of market
volatility such as what occurred in March and April 2020. For the same
reasons, the Commission disagrees with the comments suggesting that the
minimum margin amount calculation is not designed to effectively and
efficiently collect margin sufficient to mitigate the risks presented
by the securities.
In response to comments regarding the sudden and persistent
increases in margin that could arise from the minimum margin amount,
the Commission acknowledges that, for some member portfolios in certain
market conditions, application of the minimum margin amount calculation
would result in an increase in the member's margin requirement based on
the potential exposures arising from the TBA positions. The Commission
notes that, by design, the minimum margin amount should respond more
quickly to heightened market volatility because of its use of
historical price data over a relatively short lookback period, as
opposed to the model-based calculation which relies on risk factors and
uses a longer lookback period.
The Commission also observes, however, based on its review and
analysis of FICC's confidential data and analyses, that the increase in
margin requirements generated by the minimum margin amount as compared
to the other calculations would generally only apply during periods of
high market volatility and for a time period thereafter.\61\ The
frequency with which the minimum margin amount would constitute a
majority of members' margin requirements decreases as markets become
less volatile, and therefore, is not expected to persist
indefinitely.\62\ The Commission believes that including the minimum
margin amount as a potential method of determining a member's margin
requirement is appropriate, in light of the potential exposures that
could arise in a time of heightened market volatility and the need for
FICC to cover those exposures. Therefore, the Commission believes that
the proposal would provide FICC with a margin calculation better
designed to enable FICC to cover its credit exposures to its members by
enhancing FICC's risk-based margin system to produce margin levels
commensurate with, the risks and particular attributes of TBAs during
periods of extreme market volatility.
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\61\ FICC provided this data as part of its response to the
Commission's Request for Additional Information in connection with
the Advance Notice. Pursuant to 17 CFR 240.24b-2, FICC requested
confidential treatment of its RFI response. See also FICC Letter at
5.
\62\ See FICC Letter at 5.
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In response to the comments regarding the potential procyclical
nature of the minimum margin amount calculation and whether it is
appropriate for the margin methodology to take into account such
extreme market events, the Commission notes that as a general matter,
margin floors generally operate to reduce procyclicality by preventing
margin levels from falling too low. Moreover, despite the commenters'
procyclicality concerns, the Commission understands that the purpose of
the minimum margin amount is to ensure that FICC collects sufficient
margin in times of heightened market volatility, which means that FICC
would, by design, collect additional margin at such times if the
minimum margin amount applies. The Commission believes that, because
heightened market volatility may lead to increased credit exposure for
FICC, it is reasonable for FICC's margin methodology to collect
additional margin at such times and to be responsive to market activity
of this nature.
In response to the comment that the proposed minimum margin amount
is not necessary because the March and April 2020 market volatility did
not cause the failure of FICC members or otherwise cause broader
systemic problems, the Commission disagrees. Similar to the
Commission's analysis above in Section II.B., the relevant standard is
not merely for FICC to maintain sufficient financial resources to avoid
failures or systemic issues, but for FICC to cover its credit exposures
to members with a risk-based margin system that produces margin levels
commensurate with, the risks and particular attributes of each relevant
product, portfolio, and market.\63\ During periods of extreme market
volatility, FICC has demonstrated that adding the minimum margin amount
to its margin methodology would better enable FICC to manage its credit
exposures to members by producing margin charges commensurate with the
applicable risks. The Commission has reviewed and analyzed FICC's
backtesting data, and agrees that the data demonstrate that the minimum
margin amount would result in better backtesting coverage and,
therefore, less credit exposure of FICC to its members. Accordingly,
the Commission believes that the proposed minimum margin amount would
enable FICC to better manage its credit risks resulting from periods of
extreme market volatility.
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\63\ 17 CFR 240.17Ad-22(e)(6)(i).
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In response to the comments regarding the minimum margin amount
calculation's reliance on historical price movements, the Commission
does not agree that Rules 17Ad-22(e)(6)(i) and (iii) preclude FICC from
implementing a margin methodology that relies, at least in part, on
historical price movements or that FICC's margin methodology must
[[Page 32085]]
generate margin requirements that ``equate to future protections
against market volatility.'' FICC's credit exposures are reasonably
measured both by events that have actually happened as well as events
that could potentially occur in the future. For this reason, a risk-
based margin system is necessary for FICC to cover its potential future
exposure to members.\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,
FICC must consider potential future exposure, which includes, among
other things, losses associated with the liquidation of a defaulted
member's portfolio.
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\64\ See 17 CFR 240.17Ad-22(e)(6)(iii) (requiring a covered
clearing agency to 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 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).
\65\ 17 CFR 240.17Ad-22(a)(13).
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In response to the comments regarding enhancing the model-based
calculation instead of adding the minimum margin amount, the Commission
believes that, as FICC stated in its response, the inputs to FICC's
model-based calculation include risk factors that are typical TBA
attributes, whereas the extreme market volatility of March and April
2020, which affected the TBA markets, was caused by other external
factors that are less subject to modeling. Accordingly, the Commission
believes that FICC would more effectively cover its exposure during
such periods by including the minimum margin amount as an alternative
margin component based the price volatility in each member's portfolio
using observable TBA benchmark prices, using a relatively short
lookback period.\66\
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\66\ See FICC Letter at 3.
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In response to the comments regarding whether the minimum margin
amount will likely become the predominant calculation for determining a
member's VaR Charge, the Commission disagrees. For example, the average
daily VaR Charge increase from February 3, 2020 through June 30, 2020
would have been approximately $2.2 billion or 42%, but as the model-
based calculation took into account the current market conditions, the
average daily increase during Q4 of 2020 would have been approximately
$838 million or 7%.\67\
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\67\ See FICC Letter at 5. The Commission's conclusion is also
based upon information that FICC submitted confidentially regarding
member-level impact of the proposal from February through December
2020.
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Finally, in response to the comments regarding concentration
charges, the Division states that there is a distinction between
concentration charges and the VaR Charge in that they are generally
designed to mitigate different risks. Whereas the VaR Charge is
designed to cover the risk of market price volatility, concentration
charges are typically designed to mitigate the risk of incurring
additional market impact cost from liquidating a directionally
concentrated portfolio.\68\
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\68\ See Securities Exchange Act Release No. 34-90182 (October
14, 2020), 85 FR 66630 (October 20, 2020).
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Accordingly, the Commission believes that adding the minimum margin
amount to FICC's margin methodology would be consistent with Rules
17Ad-22(e)(6)(i) and (iii) because this new margin calculation should
better enable FICC to establish a risk-based margin system that
considers and produces relevant margin levels commensurate with the
risks (including potential future exposure) associated with liquidating
member portfolios in a default scenario, including volatility in the
TBA market.\69\
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\69\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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III. Conclusion
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the
Clearing Supervision Act, that the Commission does not object to
Advance Notice (SR-FICC-2020-804) and that FICC is authorized to
implement the proposed change as of the date of this notice or the date
of an order by the Commission approving proposed rule change SR-FICC-
2020-017, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-12598 Filed 6-15-21; 8:45 am]
BILLING CODE 8011-01-P
